The unprecedented times of COVID-19 pandemic have not only generated consequences from a social perspective but have also put a halt to economic growth. Companies across the world are facing disruptions in the supply of inputs, deficit demand, and restriction of credit provisions. For this reason, the nations are strengthening their insolvency regimes to mitigate the current harm to an extent.
The United Kingdom did not remain alien to this volatile environment of COVID-19. A Survey shows that due to COVID-19, 79 percent of the businesses have a decreased turnover, and 20 percent have suspended trading in the UK. Hence, for reinstating the economy, the government laid down the Corporate Insolvency and Governance Act (Act). It provides for two-prong measures: permanent and temporary measures.
While the UK brings the Act to prevent insolvencies, India has promulgated the Insolvency and Bankruptcy (Amendment) Ordinance, 2020, (Ordinance). The Ordinance seeks to put to rest the speculations that were raised by suspending the initiation of corporate insolvency under the Insolvency and Bankruptcy Code, 2016 (IBC). However, the Ordinance has certain shortcomings. Hence, this post aims to categorically unfold the UK insolvency regime and establish a framework that India should adopt.
Permanent Changes
Free-standing moratorium
The Act promulgates a free-standing moratorium. As per this, the financially distressed companies can seek a moratorium. Hence, a creditor without prior leave of the court cannot take legal action against the company.[i] The free-standing moratorium is built on the facets of the existing administration moratorium in the Insolvency Act 1986.[ii] But unlike the administration moratorium, now, there would be a monitor, a licensed insolvency practitioner, to keep an eye over the framework adopted by the company. From a procedural perspective, an eligible company as per Schedule ZA1 of the Act may obtain a moratorium by filing relevant documents the director’s statement and a statement from the appointed monitor that the company is or will be soon insolvent with the court.[iii] After filing of the documents, the initial period has been capped at 20 days, subject to extensions to a year.
In the author’s view, the measure leaves a grey area regarding the initiation after the period elapses if the default continues. Illustration: X defaults for €10,000 in January 2020. Subsequently, due to COVID-19, X seeks a moratorium. Now, once the period ends, there is no clarity on whether a creditor can initiate an insolvency procedure for that debt. Nevertheless, the moratorium is significant because it does not provide absolute autonomy to debtors:
- Monitor Appointment: In case, there is non-compliance with the procedure by the company or commission of an offence, the monitor can bring an end to the moratorium.
- Harming creditor’s interest: If the creditor’s interests are unfairly harmed by the company, the court may exercise its discretion.
On the other hand, Section 10A of the Ordinance provides that no corporate insolvency proceedings can be initiated for any default arising after 25 March 2020. It puts a blanket ban on debts accruing for up to one year. However, there are several shortcomings with the Indian measure. One, while the Ordinance has been promulgated to aid businesses, there is no parallel to have a permanent and complete prohibition on the debts accruing during the pandemic. Instead, the UK measure should be considered, which provides that the debts accrued during the moratorium have to be paid. Two, the Ordinance carves an absolute autonomy to the debtors. On the contrary, the UK measure provides certain exceptions of the monitor and harm to the creditor’s interest. Lack of such measures circumscribes India’s capability to mitigate the dramatic consequences of COVID-19.
Restructuring plan
Similar to the existing scheme of arrangement procedure in Part 26 of the UK Companies Act, 2006, the Act provides for a restructuring plan. The issue resurrected now is that although the arrangement helps in restructuring, it lacks the mechanism to implement the plan on all the creditors. Broadly, the restructuring plan involves one, a compromise or an arrangement proposed between the company and the creditors; and two, the compromise should ‘eliminate, reduce or prevent, or mitigate the effect of financial difficulties’ which affects the ability of a company to carry on a business.
From a procedural perspective, the plan requires the approval of a majority of a minimum of 75 percent creditors from each class. It confers the courts with the ability to ‘cram-down-across-classes’. With such a power, courts can approve the plan even if a few classes did not vote in favour of the plan. Irrespective of the need for scrutiny, the measure is significant because of its association with the moratorium, unlike the prior scheme of arrangement.[iv]
India relies on the debt restructuring mechanisms that were modeled way before the IBC enactment. Broadly, there are following schemes of an arrangement available: One, the arrangement under Section 230, Companies Act, 2013, read with Companies (Compromises, Arrangement, and Amalgamations) Rules, 2016. This scheme outlines the increment in the company’s profitability by rearranging its debt obligations. Two, the scheme for Micro, Small and Medium Enterprises (MSME), which provides for the one-time restructuring of MSME’s debts ‘without a downgrade in the asset classification’. Although this is an appreciated move, such limited measures would not suffice the companies to bear the crisis. Moreover, the non-binding nature of the debt restructuring would bring uncertainty in acceptance of the plan. Hence, India should adopt the UK mechanism, which makes the rearrangement binding. This can also be done by adopting the pre-packaged plan half-devised in 2019.
Prohibition of supplier termination clauses in contracts
To reinstate the growth of companies in the dilapidated economy, the Act further proposes a provision that aims to protect a company’s chain of supply. This measure provides for the extension of prohibition of supplier termination clauses in contracts to all goods and services. Interestingly, the measure is not purely one-sided. Instead, it aims to strike a balance between the supplier’s interest and the companies. This is for the reason that the Act provides certain exceptions to the supplier under Schedule 12 and 13 of the Act. For instance, on the ground of ‘hardship’ to the supplier, or by reaching an agreement with the distressed company, a supplier can terminate the contract. Furthermore, the Act seeks to keep small suppliers outside of the purview of the prohibition. Considering the legislative intent, this is arguably a significant facet as it would not leave the small suppliers in distress.
India has not yet suspended the supplier termination clauses in contracts. During these unprecedented times, the revival of a company becomes more difficult. This is grounded on the fact that the IBC under Section 14(2) provides that even during an insolvency process, the debtor has the exception to the moratorium for ‘essential goods and services’. During these testing times, such an exception dilapidates the corporate revival. On the contrary, the UK Act extends the suspension to all goods and services. Hence, to ensure an effective revival, it is imperative to adopt the UK measure.
Temporary Changes
Winding up petitions and statutory demands
Research demonstrates that nearly a fifth of small and medium-sized companies in the UK will have no liquidity in the crisis. Symptomatically, they are on the verge of insolvency. Therefore, the Act prohibits the initiation of corporate insolvency resolution. Not only this, but it also prohibits the filing of a winding-up petition on or after 27 April 2020 based on failure to comply with statutory demand until 30 June 2020. The prohibition is subject to the exception of a creditor having reasonable grounds such as if COVID-19 has not had a ‘financial effect’[v] on the debtor and that the debtor would have been unable to pay the debt in any case.
On the other hand, India imposes a blanket ban on the initiation of insolvency procedures. Due to this, a winding-up petition cannot be brought against the debtor company for up to one year and perpetuity for COVID-19 debts. Such a decision goes against the interest of creditors. Not only this, but the debtors may also get an opportunity to reinstate their revival by prejudicing the interests of creditors. On the contrary, the UK Act provides an exception of reasonable grounds to the creditor. Hence, taking a cue from the UK, the period to bring a winding-up petition should also be restricted for a certain period.
Wrongful trading
Both India and the UK have tentatively removed the director’s liability arising from wrongful trading. This is an appreciated move in the short term to ensure cash flow. However, there may be an influx of actions for wrongful trading after the period elapses. At that juncture, the sole liability would lie on the directors to prove that every action of theirs was towards minimizing the losses of creditors. Moreover, the amendment contravenes the principles envisioned behind this measure as this reform was made to prevent wrongful conduct of the companies.[vi] Hence, the legislative intent behind it is uncertain.
Conclusion
The author submits that the bleak economic growth during COVID-19 in the UK can be resolved through the adopted insolvency measures. Taking into consideration the speculation in the Indian Ordinance, the author submits that India should adopt the measures provided by the UK Act. The measures will undoubtedly aid in mitigating the upheaval caused due to the COVID-19 crisis. The Czech Republic and Australia have also brought the measures adopted by the UK. Hence, there is no ambiguity in its universal acceptance to stabilize the deterioration of the economy during the crisis.
References
[i] A prior leave can be taken in case the director or the Secretary of State presents a winding-up petition. See Corporate Insolvency and Governance Act 2020, schedule 1-8.
[ii] See Insolvency Act 1986, schedule B1.
[iii] For the list of the relevant documents, see Corporate Insolvency and Governance Act 2020, s A6.
[iv] Unlike previous scheme arrangement, the new plan provides for a moratorium to keep company assets consolidated during the restructuring negotiations. See Corporate Insolvency and Governance Act 2020, 901H.
[v] Corporate Insolvency and Governance Act 2020, schedule 10. The term ‘financial effect’ is left open-ended here. Hence, it has to be decided on a case-to-case basis.
[vi] Andrew Keay and Michael Murray, ‘Making Company Directors Liable: A Comparative Analysis of Wrongful Trading in the United Kingdom and Insolvent Trading in Australia’ (2005) 14 Intl. Insolvency Rev. 27.
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