Insolvency Code amendments and BITs: A possible recourse for foreign creditors

Back to Arbitration Committee publications

Poornima Advani
[e-mail]

Introduction

The COVID-19 pandemic has drastically altered the dynamics of the Indian economy. Indian businesses are struggling to keep up with the demand deficit in the market. In this backdrop, the government announced a series of amendments to the Insolvency and Bankruptcy Code 2016 (the 'Code'). The primary objective of these amendments is to safeguard Indian businesses from being pushed into insolvency proceedings in this volatile environment.

On 24 March 2020, the minimum threshold for default under section 4 of the Code was increased to one crore rupees from one lakh to deter the triggering of insolvency proceedings against Indian companies. More importantly, the government promulgated an ordinance which introduced a blanket ban on the initiation of Corporate Insolvency Resolution Proceedings (CIRP). The Ordinance inserted section 10A in the Code, which prohibits the debtors, financial creditors, and operational creditors for six months (extending up to one year) from initiating CIRP under sections 7, 9, and 10 of the Code for a default arising on or after 25 March 2020. Further, a proviso to section 10A dictates that no application shall ever be filed to initiate CIRP for a default occurring during the specified period. While Indian companies, especially the micro, small and medium enterprises (MSME) sector, have welcomed such a move as it allows them some breathing space, a blanket suspension for initiating CIRP may be fraught with difficulties.

The room for ambiguities

While the perpetual insolvency holiday (the 'IBC Moratorium') protects Indian business from the imminent threat of bankruptcy, the Ordinance paves the path with future loopholes, which again would require judicial intervention to fill the gaps. This endless cycle, thus, goes on.

The Ordinance assumes 'any default' as arising due to the COVID-19 pandemic and the subsequent lockdown. Thus, it protects any default arising during the said period, regardless of whether the pandemic had any effect. This safe harbour allows corporate debtors to take advantage of the provision and evade their liabilities and obligations. Besides, it is silent on the question of continuing debts and their treatment. A debt which arises in the lockdown period continues until after the suspension period, whether it comes under the purview of this protection or not is a question which is yet to be resolved. Further, the proviso to section 10A provides for a perpetual prohibition of initiating CIRP, which allows wilful defaulters to circumvent the law.

Alternative resolution mechanisms

With the IBC suspension in place, creditors and debtors are looking for possible alternate routes available for restructuring debts and dealing with stressed assets. Section 230 of the Companies Act 2013 provides for a scheme of arrangement between the members and the creditors. However, section 230 focuses on the debtors and reverses the trend of 'creditor-in-control' under the IBC. Further, a scheme under section 230 requires approval of three-quarters in value of creditors before it is approved by the NCLT,and this process usually takes a minimum of six to eight months before it can be completed. Thus, while section 230 provides an alternative route, certain modifications must be made before it can match the resolution mechanism under the Code.

The concept of a pre-pack insolvency resolution offers a more viable alternative to the IBC Moratorium. Pre-pack insolvency is a hybrid of in-court and out-of-court insolvency where an arrangement for restructuring is reached between the company, creditors, and the potential buyer before the appointment of an insolvency professional. The concept of pre-packs is yet to formally percolate into the Indian market. However, with the IBC Moratorium, they could assume a central role in the resolution process. The key advantages of pre-pack insolvency are that it is less time consuming, cheaper, and eases the burden on the NCLT. However, the biggest challenge posed by pre-packs revolves around transparency and accountability. The negotiations between the creditors and investors take place in private as opposed to the open-bidding regime under CIRP.

With regard to foreign creditors, there is no exclusive alternate mechanism which can be adopted by them. Though the provisions of the Companies Act apply to companies in India with foreign investment, there is no special recourse for foreign creditors. In such a scenario, it is quite possible that foreign investors might rely on Bilateral Investment Treaty (BIT) claims, as below.

IBC Moratorium vis-à-vis BIT claims

The IBC Moratorium is poised to compel the foreign creditors, wanting to initiate insolvency proceedings against corporate debtors, to seek refuge under BIT claims. While India has unilaterally terminated 58 BITs in 2017, most BITs have a sunset clause making it possible for investors to bring claims under the BITs for a period of 15 to 20 years. Apart from this, India currently has 14 BITs in force, most of them with developing countries.

The IBC Moratorium makes India susceptible to investors' claims under protections offered by BITs. These include Fair and Equitable Treatment (FET), Full Protection and Security National Treatment, Market Access, Protection against Expropriation, and the Most Favoured Nation clause. With regard to COVID-19 related measures such as the lockdown or the IBC Moratorium, protections of FET and National Treatment may be favourable grounds for investors to bring claims against Indian companies.

Fair and Equitable Treatment claims

The FET is one of the most invoked substantive standards in Investment Treaty Arbitrations. Procedurally, fair and equitable treatment requires a state to afford due process to investments. An FET clause essentially seeks to protect the legitimate expectations of investors which are kept in consideration before making an investment. The scope of legitimate expectation was discussed by the Antaris tribunal that, in a claim, an investor must establish that: clear and explicit (or implicit) representations were made by or attributable to the state in order to induce the investment; such representations were reasonably relied upon by the claimants; and these representations were subsequently repudiated by the state. The IBC has been fundamental in inducing finance because it provides the investor with a stable insolvency regime. Moreover, the IBC Moratorium may satisfy the Antaris standard to repudiate the insolvency regime. In Tecmed v Mexico,it was held that a state must act in a consistent manner, free from ambiguity and totally transparently. Such ambiguity may refer to India downplaying the consequences of the pandemic (such as declaring that the current pandemic was not a public health emergency) but taking drastic measures afterwards as a policy measure. These measures refer to the lockdown originated in March 2020 and the IBC Moratorium that ensued afterward.

Since the IBC was a legal framework based on which foreign creditors entered the Indian market, a tribunal may find India to have breached the FET protection based on the precedent set by LG&E Energy Corporation v Argentine Republic. It was held that the State went too far by completely dismantling the very legal framework constructed to attract investors. However, the tribunal took into account the ensuing economic crisis and accepted Argentina's defence of necessity and excluded its liability to foreign investors. Such an argument may be accepted by a tribunal considering that the 'Great lockdown' was termed as 'Worst Economic Downturn Since the Great Depression' by the International Monetary Fund.

National Treatment claims

National Treatment (NT) is the standard that requires treatment for foreign parties to be no less favourable than that of nationals and companies of the host state. While determining NT claims, tribunals measure whether competitive players were accorded the same treatment in the domestic market. In this particular scenario, India will not be in breach of NT obligations since it is not the case that access to IBC-based resolution is only available to domestic creditors and not to foreign creditors. Meanwhile, all firms have recourse to section 230 of the Companies Act 2013 in the given scenario. Therefore, it is unlikely that the NT threshold will be met in a tribunal.

Defences which can be used against COVID-19 related Investment claims

Apart from specific exceptions in BITs (which vary across BITs), India will have recourse to customary International law defences which are also codified in ILC articles on State Responsibility. There are six circumstances precluding wrongfulness that are recognised under customary international law - of these, three are potentially relevant to COVID-19 measures: force majeure; distress; and necessity.

Since force majeuredeals with performance of obligations, distress deals with threat to life, the relevant exception in the case of the IBC Moratorium is that of necessity. The defence of necessity is only available when an act of a state: (1) is the only way for the state to safeguard an essential interest against a grave and imminent peril; and (2) does not seriously impair an essential interest of the state. India could argue that the IBC Moratorium was the only way it could have averted the imminent peril from the pandemic to the economy. This defence is much in line with the decision in LG&E Energy Corporation as discussed earlier. Moreover, in National Grid v Argentina,the defence of necessity was accepted by the tribunal since the state action was to maintain essential services vital to the health and welfare of the population. The moratorium was imposed taking into account the health of the MSME sector, which supports jobs and carries out essential services vital to the economy.

Conclusion

The pandemic is unprecedented in its scope and scale, as it is evident from the damage toeconomic indicators at record levels. In this backdrop, the government used timely levers to enforce the IBC Moratorium through an Ordinance, but this too could have an adverse impact, considering that not all defaults must be COVID-19 related.

However, there exist alternate resolution mechanisms in order to protect creditors' interests, as discussed earlier. With regard to foreign investors, they are expected to bring in BIT claims as a result of the IBC Moratorium, but India's measures only seek to achieve legitimate public policy goals in the dwindling economic scenario. In contrast, Argentina has taken drastic measures such as nationalisation of industries on the pretext of pursuing policy goals. It is unclear how tribunals may deal with the possible BIT claims which may arise due to the measures undertaken by states during the pandemic.

The possible defences available with India against FET and/or NT claims as elucidated above do not necessarily mean that it is all a bed of roses for the government. Since the triggering of a BIT claim in itself is a costly measure, the government may consider actively participating in global diplomacy in order to limit the possible claims.

Back to Arbitration Committee publications