These announcements are complementary to the measures announced by India’s central bank, the Reserve Bank of India (RBI), which has permitted banks to grant moratoria on repayment of debts for a fixed period. However, at this stage, it is not clear if the exclusion of COVID-19-related debt from the definition of default will continue after the suspension, or if suspension will be carried out only for such defaults. The government’s strategy appears to be motivated to ensure that distress on account of the COVID-19 pandemic is resolved with forbearance on the part of lenders, and that premature recourse to insolvency proceedings is avoided.

Both these concerns are exacerbated by the prescriptive design of the IBC, which requires a change in control on initiation of insolvency proceedings, and a “sale of the debtor” to an unrelated party (in most cases).

These were features that were included in the backdrop of rising non-performing loans to counteract the lack of effective tools to deal with recalcitrant promoters, and to promote a market for corporate control in an economy dominated by closely-held businesses. However, this “change in control” and “sale to unrelated party” model may not be feasible or value-maximising in a period of macro-economic distress.

The government also appears to be concerned with “flattening the bankruptcy curve” so as to not overburden already overstretched institutional infrastructure, and to prevent consequent value destruction.

The Indian government’s predicament, while unenviable, is not entirely unique. Other countries, too, are facing such problems, and many have responded by making it harder to initiate insolvency proceedings (Australia and Singapore), providing statutory fora to negotiate moratoria with lenders (New Zealand), announcing new tools for insolvency resolution (the UK) and making insolvency resolution tools less costly (the US and Colombia). Yet, India appears to be going far further than many other jurisdictions by completely stopping recourse to insolvency proceedings.

In the absence of recourse to any insolvency proceedings there would be no effective statutorily binding mechanism available for insolvency resolution, even to debtors who may wish to renegotiate their debts. Experience thus far has suggested that purely out-of-court restructuring has not been very effective in resolving distress, with high possibilities of hold-outs. Even schemes of arrangement have not been used extensively for debt restructuring, unlike in other jurisdictions.

Instead, lenders have chosen to attempt piecemeal enforcement in the interim. If this trend continues, we might find lenders (particularly non-institutional lenders) resorting to value-destructive asset sales, or waiting for suspension to be lifted to flood institutional infrastructure with insolvency proceedings.

This will undermine the government’s goals entirely. If lenders choose to not act at all, or choose less value-maximising methods to resolve distress, there is a further risk of financial sector distress, which India may not have adequate tools to resolve at present.

Given this, it may be helpful for the government to supplement its decision to suspend recourse to the IBC by proposing alternate insolvency resolution tools. The government has already announced that it will notify a new insolvency resolution framework for micro, small and medium enterprises (MSMEs) in the coming days.

This is expected to be a pre-packaged version of the resolution framework under the IBC, and may offer further insights on how the government is expecting non-MSME insolvency resolutions to work as well.

However, it remains to be seen if a modified version of the insolvency resolution process under the IBC will suffice in these vastly changed macro-economic conditions, or if the government will need to offer a new model for insolvency resolution.

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