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Time to Protect Indian Businesses from Insolvency

The medium to long term financial effects of Coronavirus are yet to unfold, but the magnitude is already anticipated to be huge. Many countries across the world are announcing financial packages for businesses. India is also on the track to take a decision on relief packages.

With widespread lockdowns, the coming months are expected to witness a series of defaults by many viable businesses, and in this situation, we need to protect viable Indian businesses from landing up in our bankruptcy tribunals, for no fault of their promoters.

Broadly speaking – today an Indian company can be pushed into insolvency proceedings if it defaults in the discharge of its liability worth over INR 1,00,000/- (USD 1,322) towards a financial creditor or an operational creditor. With a few statutory exceptions and very limited way-outs, the promoters today face a real threat of losing their businesses forever if a creditor decides to opt for a legal action upon default in a single payment above the said threshold.

The bankruptcy and insolvency landscape in India has significantly changed from the regime prevailing prior to the introduction of the Insolvency and Bankruptcy Code (“the IBC”) in 2016. The most prominent feature of the IBC is “corporate insolvency resolution process” or CIRP, during which period the creditors assume control of the company and bids to acquire its business are publicly invited by an insolvency resolution professional. The board of directors of the company is suspended during the CIRP period, and in most cases, the promoters are legally prohibited from repurchasing their companies. This mechanism of CIRP was absent under the previous regime, governed by the (Indian) Companies Act, 2013. During that time, in certain cases the High Courts granted a few weeks’ of time to the promoters to settle with the creditor(s), failing which notification of winding up was published and the official liquidator took charge to liquidate the assets of the company.

The IBC stipulates a more mechanical approach, leaving little discretion with the learned judges of the National Company Law Tribunal (“NCLT”), which is the adjudicating authority under the IBC. The practitioners of the earlier company courts would agree that during the earlier regime it was expected from a creditor to show, in addition to a default of a similar threshold, that the corporate debtor is also unviable as a business. The courts went through the past balance sheets, read auditor’s reports while quoting them in judgments, and frequently observed in courtrooms that businesses give employment, and viable businesses cannot be liquidated just because of a default.

Since the advent of the IBC, the focus changed, and for a reason – the “CIRP”. Who will buy an unviable business during a CIRP? No one. What will then a CIRP achieve? Nothing.

The “business viability/un-viability” test was perhaps therefore never propagated in the IBC. Resultantly, a default above the threshold is enough, by itself, to trigger a CIRP, with all its consequences under the IBC. What the IBC also doesn’t consider is – the reason for such default.

Time has come for us to realise that unviable businesses anyway fail the CIRP. The reports published by the Insolvency and Bankruptcy Board of India evidence that four out of every five CIRPs are not able to find a resolution anyway. Eventually, such unviable companies are thrown into liquidation. No one wins.

We should, therefore, think of a course correction, and to save numerous Indian businesses that would otherwise land up in CIRPs because defaults are now imminent – and more painful – without any fault of the promoters. We need to acknowledge, with evidence now, that each default does not indicate a fault of the promoters, and survival of the businesses of all sizes is vital for the survival of the economy. The IBC and NCLTs also have a much larger economic and functional role, beyond facilitating the buying and selling of the businesses and assets or enforcing settlements by promoters under fear of CIRPs.

We, therefore, feel that the “reason for the default” should, in some way at-least, form part of the judicial consideration while admitting cases under the IBC. Viability of the business should form another vital consideration, even if the focus is on CIRP. The thresholds also should be raised much above INR 1,00,000/-, which we note is a work in progress anyway.

Let’s save our businesses. It takes years to create each viable business. The above-suggested actions may not be exhaustive. Our hon’ble judges also have always found innovative solutions, such as reverse CIRP, when the situation demands. It is now time for the law also to consider that exceptions (habitual defaulters) are not the rule.

Force Majeure and Coronavirus: Frequently Asked Questions

Part 1: Force Majeure and Suspension/Termination of Contracts

Coronavirus (COVID-19) is turning out to be a twin fold pandemic – that started with affecting public health and soon spread throughout the economy. Sudden global shutdown and travel restrictions have brought the economy to a screeching halt before most of us could even comprehend the real impact. Many businesses are still at a loss and are only doing guesswork regarding the magnitude of potential losses and recalibration needed for the businesses to survive this time, and remain viable.

Resultantly, certain harsh realities stare at us, and certain brutal questions are to be answered. With specific reference to Indian laws, we have attempted to answer some of these questions which businesses are asking concerning the possibility to suspend, extend or cancel their contractual obligations and their ability to reduce workforce and other recurring costs and liabilities.

You are reading Part 1 of our series on “Force Majeure and Covid-19: Frequently Asked Questions”. In the next part, to be published on March 20, 2020, we would discuss the possibility of reduction in workforce and wage bills.

Question:    What is a force majeure clause and how does it help the contracting parties?
Answer:       Force majeure is commonly defined as an unforeseen irresistible force, such as an act of God or war. Performance of a contract by a party facing a force majeure situation may be impossible. Recognising this, most contracts include a force majeure clause, which permits a party, when facing a force majeure situation, to temporarily suspend its performance under the contract.

A suspension under a contract, in accordance with its force majeure clause, entitles the party suspending it to be exempted from performing its obligations under the contract. Accordingly, during the period of suspension, such party is not held liable for breach of its contractual obligations. The contract springs back to life and operation once the force majeure situation subsides. The contracts usually also provide for the termination, if the force majeure situation continues beyond a specific number of days.

 

Question: Is the outbreak of COVID-19 a force majeure situation?
Answer:       Force majeure clauses are a contractual feature. Indian laws do not define “force majeure”, from the perspective of contract laws.

The answer, therefore, lies in answer to the question – what are the identified force majeure situations in your particular contract? Most contracts illustrate various situations as “force majeure events”. Some contracts use words like “epidemic”, “Government order” (of shutdown) and “any other situation making the conduct of business impossible” as examples of force majeure situations. COVID-19 would easily qualify as a force majeure event in such cases.

On the other hand, some contracts give a more restrictive definition of force majeure, limiting it to physical damage to the business premises or change in law or policy.

As force majeure clauses permit contractual non-performance, they are likely to be given a narrow interpretation by the courts, when scrutinized.

Accordingly, to answer, the outbreak of COVID-19 does not automatically become a force majeure situation, and its classification as such largely depends on the language of your specific contract(s).

Question:    If COVID-19 qualifies as a force majeure situation in my contract, am I exempt from its performance?
Answer: Your chances of performance exemption are good, but not automatic. Even if COVID-19 can comfortably be classified as a force majeure situation in your contract, you must remember that:

Your performance is not suspended automatically: You would most likely need to issue a written notice to the other party, as specified in your force majeure clause, invoking the clause and notifying suspension of your obligations. Some contracts also require a party giving a force majeure notice to give a plan to mitigate the loss caused to the other party. Therefore, read your contract and follow what it prescribes.

Force majeure should affect your performance: The performance is also not suspended just because a force majeure situation has arisen unless it significantly affects your performance capabilities. A party invoking a force majeure clause should, therefore, be prepared to demonstrate as to how the occurrence of a force majeure situation has made performance by such party “impossible”. The common legal understanding is that a mere occurrence of a force majeure situation, without a real impact on contractual performance capabilities of such party, would not entitle it to suspend its performance under the contract. As lawyers, we see that some of the parties would face this challenge if their counterparties decide to legally oppose the suspension.

Question: If COVID-19 cannot be a force majeure situation in my contract or if my contract does not have a force majeure clause, what recourse do I have?
Answer:   It is still not ending of the road for you. Indian Contract Act, 1872 enshrines the doctrine of frustration of contracts, which means that a contract would become void if its performance is rendered impossible or unlawful after the contract has been made. Void contracts are unenforceable, the result of which, in layman terms, is that such contracts cannot render a party liable for their non-performance.

Similar to force majeure, the frustration of a contract would also need a party claiming so to demonstrate as to how the occurrence of a situation (COVID-19, being the case in point) has made performance by such party “impossible” or “unlawful”.

Please however note that, unlike force majeure, the frustration of a contract renders it void with immediate effect, and the law does not provide for a suspension of such a contract. Of course, if one party claims “frustration of the contract”, and then both the parties are willing to suspend the contract, they can contractually agree to a suspension. In economic difficult times, new contracts are also hard to come by, so the suspension is a real business possibility following frustration. The suspension, however, cannot be enforced in absence of a contractual stipulation (e.g. force majeure) or with the consent of the contracting parties.

Question:    While invoking force majeure clause, can we propose reduced/alternative performance?
Answer: Indian contract law requires that a party shall do everything within its control to mitigate the loss to the other party. Therefore, a party can propose reduced/alternative performance during a force majeure period. Such reduced/alternative performance may however not be enforced upon the other party unless your force majeure clause so provides. If the other party does not agree to such reduced/alternative performance (consider cases where insufficient raw material supply would make the running of the plant itself commercially untenable), one can revert to full suspension of performance.

Each case should, however, be assessed carefully, before reduced/alternative performance is proposed. Force majeure, when available, is a contractually enforceable suspension right. A unilateral amendment is ordinarily never enforceable. In cases where the contractual relationships are complex, a party needs to assess whether a proposal for reduced/alternative performance would give an opportunity to the other party to deny the applicability of force majeure clause itself.

Conclusion:

Force majeure and frustration of contracts are contractually and legally viable tools that provide a real possibility to the businesses to deal with the current situation. Case to case assessment is however needed before implementation of these options.