Ramifications Of The Increased Threshold Limit Under The Insolvency And Bankruptcy Code,2016 (IBC)

Background

“...Now because of Insolvency and Bankruptcy Code, the return of nearly Rs. 3 lakh crore into the system has been assured.”

-Hon’ble Prime Minister, Shri Narendra Modi at the Republic Summit, 2019 on November 26, 2019

IBC’s juggernaut is on a roll. IBC is a renaissance in terms of legislation that has ushered in a paradigm shift in quicker recovery of bad loans unlike the past regime where it used to take banks and creditors years of painful wait to recover the dues.

The intendment of IBC was primarily to enable banks recover sticky loans in a time bound manner ideally through resolution and revival of the corporate debtor and in the event of resolution process being unsuccessful, through liquidation of the corporate debtor. The latest data from IBBI indicates that as on 31.12.2019, a total 3,312 cases of Corporate Insolvency Resolution Process (CIRP) have commenced so far. Out of which a staggering 49.21% (1,630) CIRPs have been triggered by the operational creditors alone, followed by about 43.44% by FCs and remaining by the CDs. Of these 3,312 CIRPs, 246 have been closed on appeal or review or settled; 135 have been withdrawn; 780 have ended in liquidation and 190 have ended in approval of resolution plans; with in praesenti 1961 cases undergoing CIRP1.

And yes, IBC did prove to be a game changer which helped to sinew the Indian economy mired with staggering level of NPAs. As on December 2019, approximately 21,136 applications have been filed under IBC and about 9,653 cases involving a total amount of Rs 3.74 lakh crore have been disposed of at pre-admission stage of IBC. Of the cases, where CIRP proceedings got actually commenced, IBC enabled creditors in recovering Rs 1.6 lakh crores in a period of mere 3 years of its launch something quite unheard of as compared to the erstwhile era of recovery of debts through Civil Procedure Code, DRT, SARFAESI, Arbitration and Lok Adalats2.

While this threshold seemed to be creditor-friendly during the formative stages of IBC but as the time progressed, it started signalling otherwise. It came to be seen that more and more creditors, mostly operational, started using IBC as an mechanism to extort companies many of them being Micro, Small, Medium Enterprises (MSMEs) by hanging the sword of admission to CIRP down their throat in order to settle the claims outside the Court. With the corporate debtors fearing the risk of appointment of an Interim Resolution Professional (IRP) and losing control of their company, many often succumbed to these pressure tactics of the operational creditors and often coughed up amounts many times over the original debt to wriggle out of the threat of bankruptcy.

Significantly, the main culprit was the low threshold level of Rs 1 lakh due to which recovery claims greater than Rs. 1 lakh instead of being previously filed in Civil Courts under CPC, DRT, SARFAESI came to be instituted in National Company Law Tribunals (NCLT) resulting in sheer abuse of the benign provisions of the Code. Moreover, NCLTs with their limited bandwidth got clogged with trivial matters and frivolous insolvency petitions wherein precious months got wasted in purely adjudicating the merits of their admissibility. While many such claims eventually ended up in getting dismissed or are getting withdrawn but that happened only after consuming precious time and energy of NCLT which instead could have been more fruitfully expended in devouring upon the genuine cases.

The Supreme Court through a series of judgments interpreted the various provisions of the IBC and tried as much as possible to prohibit IBC, 2016 from getting used as a recovery mechanism and NCLT as a recovery forum. Towards this end, the government too promptly brought out a significant number of amendments to IBC to keep it alive with the changing times.

An urgent need was felt to redress this problem. Although murmurs have long been in the media3 about the government mulling plans to ramp up this threshold for initiating insolvency process but the breather finally came on 24.03.2020 amid the corona virus outbreak.

The Finance Minister vide a press conference4 on 24.03.2020 announced that the threshold limit will be increased in order to mitigate the threat of insolvency that would have probably loomed large for many MSMEs when the lockdown is lifted for realisation of nominal claims. On 24.03.2020, the Government, in exercise of its powers under section 4 of the Insolvency and Bankruptcy Code, 2016 (“Code”)5 increased the minimum amount of default to initiate IBC proceedings from Rs. 1,00,000/- to Rs. 1,00,00,000/-. The notification S.O. 1205(E) reads thus:

“In exercise of the powers conferred by the proviso to section 4 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), the Central Government hereby specifies one crore rupees as the minimum amount of default for the purposes of the said section.”

Further, the Finance Minister indicated in the said press conference that if the current situation of economic distress prevails till 30.04.2020, then the government shall consider suspension of filing of section 7(financial debt), section 9(operational debt) and section 10 (voluntary insolvency) petitions for a period of 6 months so as to stop the companies at large from being forced into insolvency proceedings arising from default under the prevalent Force Majeure circumstances.

Implications of the increased threshold level on various stakeholders

A positive side of the increase in threshold is that it will reduce the number of cases being filed at NCLT and in turn increase the efficiency of the Tribunal in speedy disposal of the defaults cases and also providing an opportunity to the Tribunal to spend greater amount of time in revival of larger companies whose resolution has far greater implications for the economy at large.

Another positive side of the increase in the threshold is that it will be a boon for companies regularly facing pressure tactics foisted by operational creditors for recovery of nominal claims. It will also aid in survival of many MSMEs likely to face financial distress in the wake of Covid-19 outbreak.

Nonetheless, a flipside of the notification is that those operational creditors which are not able to meet the increased threshold will now have to resort to previously setup mechanisms of debt recovery as are available under Civil Procedure Code, the MSME Act or go for Alternate Dispute Resolution mechanisms all which are fraught with time consuming delays with the disputes being adjudicated solely on the basis of merits. However, such recovery measures by an operational creditor could even end up getting stalled by way of moratorium being imposed on it under IBC in the event that the CIRP is initiated against the operational creditor (who could be a corporate debtor also) by another creditor who meets the modified limit.

Another repercussion is that many employees and workmen may not be able to file insolvency petition against their employers as seldom the salary outstanding crosses Rs. 1 crore and hence, they will now have no other option but to seek recourse to the recovery options as are available under the past legal regime.

This notification is likely to have yet another determinantal effect – as per section 7 of the Code, a financial creditor either by itself or jointly with other financial creditors can file an insolvency petition in order to meet the new threshold criteria but no such remedy is available under section 9 of the Code to operational creditors with each operational creditor being required to individually meet the new threshold. Be that as it may, it is important to note that owing to the very nature of their dues, individual operational debts often do not go as high as Rs. 1 crore anyway.

Another possible flip side is that many lawyers who had set up their practice dominantly around filing insolvency petitions for recovery of claims will have to re-work their strategy as much of the business of smaller clients is likely to get dried up.

Scenario Analysis in the wake of increased threshold limits

The possible fallouts of the revised threshold can be better understood by analyzing the different scenarios mentioned hereinunder:

Scenario No. 1:

ABC Private Ltd. has committed a default in repayment of loan of Rs. 75 lakhs taken from a bank X. Can another financial creditor Y, to whom ABC Private Ltd. has defaulted Rs. 35 lakhs team up with X to file a joint application against ABC?

Yes. Section 7 (1) of the Code provides that a financial creditor can file application either by itself or jointly with other financial creditors.

Scenario No. 2:

ABC Private Ltd. has also defaulted in loan payments to Bank U of Rs. 60 Lakhs and also of other financial creditor V for a sum of Rs 30 Lakhs. Also, the company has defaulted in payments to operational creditor W of Rs. 70 Lakhs. Can Bank U, V and W together approach NCLT?

No, since in the instant case, the total financial debt is Rs. 90 Lakhs. While section 7 (1) allows financial creditors to jointly file application basis, but IBC does not permit operational debts to be aggregated with financial debts.

Scenario No. 3:

ABC Private Ltd. also has three operational creditors viz. P, Q and R to whom it owes Rs. 155 Lakhs, Rs.40 lakhs and Rs. 35 lakhs respectively. Can P, Q, R operational creditors team up with each other to file a joint insolvency Petition?

No. Unlike the case of financial creditors, Section 8 and 9 of IBC contains no provision of aggregating debt owed by different operational creditors. Ergo, each operational creditors has to individually meet the threshold under section 4. Consequently, in the instant case, the revised threshold is only met by P and he alone can file insolvency petition. To this end, Q and R have not been rendered remediless as they can file the respective claims with the Insolvency Professional.

Scenario No. 4:

ABC Private Ltd.’ total salaries payable to all its employees and workmen are Rs. 3 crores. However, the dues of no individual employee or workman exceeds Rs. 1 crore. Can an individual employee file an invoke IBC proceedings against ABC?

No. Employees and Workmen fall in the category of Operational Creditor. Considering that fact that ABC owes to no individual, salary in excess of Rs. crore, hence an employee cannot individually file an application against ABC.

Conclusion

Of course, it is noteworthy, that the Finance Minister was proactive by increasing the threshold limit with a view to protect the MSMEs likely to be dragged into insolvency in the aftermath of Covid19 outbreak. Yet, by going from one end of the pendulum to another opposite end militates against the benign scheme and object of the Code as now many genuine operational creditors are left high and dry. They will again have to resort to previous recovery mechanisms which are fraught with perennial delays and are afflicted with frustrating court processes. Such a high threshold level may also have to be reduced to weather the impact of another scourge arising therefrom. A possible means to mitigate the ill-effects of the increased limit is to adopt a sweet spot that would balance both the objectives. Perhaps, adopting an “intelligible differentia” in the classification of financial and operational creditors could also be contemplated through an appropriate amendment.