Government’s Covid-19 insolvency relief may be a double-edged sword

By Manish Jha and Vishrutyi Sahni

The global COVID-19 pandemic and its consequential lockdown are having an economic ripple effect on the business of Indian citizens. To mitigate its impact, in the last tranche of economic reforms, the Central Government made numerous changes upon the Insolvency and Bankruptcy Code, 2016 (“IBC“), and its adjudicatory processes, which will have wide-ranging ramifications.

While stakeholders of the IBC are tuned to adapt to the ever-changing nature of this legislation, we must understand the rationale and impact of the changes being introduced to bandage the imminent economic effect.

Increasing of threshold to Rs 1 crore
In exercise of its powers under Section 4 of the IBC, the Central Government has raised the threshold for invoking insolvency to Rs 1 crore from the existing Rs 1 lakh.

This amendment is to mainly prevent triggering of insolvency against micro, small, and medium enterprises (MSMEs), which are struck by the lockdown hard. The government is also going to notify the special insolvency resolution framework for MSMEs under Section 240A of the Code.

However, the measure is not in line with the intent. This revision may provide relief to certain MSMEs who have financial or large operational debts. But it fails to consider the numerous MSMEs occupying the position of “operational creditors” under the IBC with claims of trade debts, salary, or wage claims, which are often lower than Rs 1 crore. This provision will relegate MSMEs to civil remedies for debt recovery and may have an effect of excluding it under the IBC. At this cost, the amendment may have successfully addressed the issue of frivolous recovery claims initiated under the grab of insolvency processes due to the seemingly low original threshold of rupees one lakh.

Moreover, this revision has also raised numerous practical uncertainties. There is no clarity on what happens to defaults in the range of Rs 1 lakh to Rs 1 crore that occurred before the outbreak. While NCLT has clarified the amendment not to be retrospective, there is a lack of clarity on the fate of operational debt claims where a demand notice has been issued, but insolvency not initiated.

Suspension of Corporate Insolvency Resolution Process (“CIRP“)
The purpose of a suspension of CIRP for a year is to avoid the potential disruptions caused to a company in case of initiation of CIRP by financial creditors, operational creditors, or the resolution applicant. However, it has collateral ramifications on all stakeholders involved. The suspension of CIRP by financial creditors under Section 7 of the IBC will leave lenders circumspect to the limited remedies available in case of default and lead to reduced avenues for raising debts.

If recourse to Section 9 is suspended, operational creditors, too, would be left in a lurch. The imposition of the suspension, coupled with the increase in the insolvency threshold, will force operational creditors to approach the already burdened civil courts.

Section 10 provides the defaulting company to submit itself to CIRP. The suspension of this provision would be counterproductive, and those who would like to seek recourse under Section 10, on account of the economic losses incurred during the pandemic, would be left remediless.

Exclusion of COVID-19 related debt from the definition of “default”
As a measure for businesses, the Central Government also intends to exclude COVID-19 related debt from the definition of “default” under the IBC, to prevent triggering insolvency proceedings. This measure, too, only benefits the defaulting corporation, with no redressal for the entity suffering the default. Moreover, this proposal does not preclude companies from initiating insolvency proceedings to create pressure and make the purported defaulting company bleed money on defending the IBC proceeding, with an additional burden on NCLTs to decide in all such cases whether the default caused was due to COVID-19.

Other COVID- related amendments
Additionally, for computation of the time-limits for activities related to CIRP and liquidation, the period of lockdown has been excluded by inserting Regulation 40C to CIRP Regulations, 2016, and Regulation 47A to the Liquidation Regulations, 2016.

The NCLT and NCLAT have introduced procedural reforms to mitigate the impact of the lockdown. They hear urgent matters even during the lockdown with prior email notifications. They have extended the interim orders till the next date of hearing. And limitation has been extended for all proceedings till the courts reopen.

Insolvency & Bankruptcy (Amendment) Act, 2020 promulgated (“IBC 2020”)
The government has come up with IBC 2020 to streamline the CIRP, protect last-mile funding, and boost investment in financially distressed sectors.

The changes put a threshold condition for initiating CIRP by the financial creditors, who are allottees under a real estate project. The amendments have also introduced a requirement to ensure the maintenance of a supply of essential goods and services and protection from the suspension or termination of critical business licenses, registrations, and government permits during the moratorium.

It also imports safeguards for successful bidders, the corporate debtors, and its assets from the offenses of the former promoters or management. Now, the central government may notify any debt to include it in the definition of interim finance.

Though these amendments under IBC 2020 have been in force since December 28, 2019, and the constitutional challenge to its provisions is still pending. Only when the courts reopen that this amendment will be tested in practice.

The directives of the Central Government to tide over these trying times are laudable. However, many of these changes are myopic and will create problems for its stakeholders in the long run.

In these circumstances, the Adjudicating Authorities—who are not only adjudicating disputes arising out of the IBC but also under the company law and the competition law disputes—must institutionalise technology. This one reform can singularly disburden the courts, optimize resources, curtail delays, and reduce operational costs.

India took decades to implement such an effective insolvency regime and improve its global ranking of doing business. This pandemic must not rewind the clock and start all over again.

Manish Jha is Partner and Vishrutyi Sahni is Associate at J Sagar Associates.

Lawyers living in lap of luxury as promotions, hikes increase after Amarchand Mangaldas split

Mumbai: Lawyers, even young ones, have never had it so good. Consider this: recently, a Delhi-based firm that specializes in regulatory affairs, asked its partners to choose a car from a range of premium brands. The firm was going to buy the car for the lawyers.

Or consider this: in top Mumbai law firms, giving very low interest or no interest loans for buying homes is a common incentive, offered to even relatively junior lawyers.

The Amarchand Mangaldas split started a trend of pay hikes and poaching that’s continuing and big and even mid-sized law firms have been forced to get into the game. And the game’s about to get sharper.

According to a Mumbai-based managing partner of a mid-sized law firm, many lawyers are waiting for their annual bonuses and are sitting on the fence. They will review other offers once the bonus comes in, he said.

ET spoke to many law firm seniors and headhunters for this story. Some spoke on the condition that they not be identified.

Many firms have hiked pay across all levels by 12-25%, said those who know the market. Quicker promotions have become the norm.

Lawyers in their late 30s and early 40s are being offered the prized job of practice heads (leading a specialist team). Partnerships are being fast-tracked. This was unheard of earlier.

Just money won’t keep talent anymore, a headhunter said.

“Not just lateral hires at higher pay- …firms are upping compensation levels and giving quicker career advances to retain senior middle level talent,” Balanand Menon, head, legal consulting, at legal search and consulting firm Vahura, said.

In many firms, founders are leveraging their close relationships with their star lawyers to retain them with a promise of getting them the choicest assignments and a greater say in firm management.

There’s no shortage of lawyers, but there’s a shortage of quality lawyers. “Most firms will report that they receive a large number of applications from lawyers every month but will also report that the general quality is very uncertain,” Vishwang Desai, managing partner of Mumbai-based Desai & Diwanji, said.

Desai & Diwanji offers a variety of performance bonuses and foreign offsites. There are plans to offer all employees insurance and fun incentives like company-paid monthly bar nights.

Nishith Dhruv, managing partner of MDP Partners, said the firm’s biggest challenge is recruiting talented lawyers. “We organize offsites twice a year…every month there is a party on the house…but the biggest incentive we offer to right people is to show them their future with the firm.”

Many other firms also emphasize the importance of an exciting working environment in retaining and recruiting talent. “We feel that offering challenging work and giving the freedom to execute it are effective ways to retain talent,” Somasekhar Sundaresan, partner at J Sagar Associates, said.

Abhijit Joshi, founder of Veritas Legal, said a combination of money, culture and treatment of talent is the key incentive. “Anyone of them alone may not be sufficient in the long run.”

How much of this salary boom is because of the Amarchand Mangaldas split and will it last?

Headhunters and senior lawyers said the split did cause a spike but there’s evidence of a general uptick as well. Bigger jumps will come once economic activity picks up across the board.

“Salaries will increase by and large in most firms…larger jumps will come once general industrial activity and multi-sector transactional work increases. Currently, technology and ecommerce, alternative energy and pharmaceuticals are seeing significant interest for corporate transactions…most of the other sectors are seeing no acceleration,” says Desai.

As of now, lawyers’ fees for top jobs haven’t gone up significantly but over- all law firm revenues are on the rise.

Yasmin Lambert, a consultant and equity partner at London-based research firm RSG Consulting, said fee rates haven’t really changed during the past 12 months, but the overall law firm revenues for 2015-15 are expected to have risen by 10-25% for the top 40 Indian law firms. The consulting company puts combined revenues of Indian law firms doing corporate and commercial work at over a billion dollars.

Partnership models in consultancies, law firms face test

Partnerships at professional services and law firms are under strain for the first time since the last two decades following a crushing cash crunch, mounting recurring costs and a fall in demand of services due to the downturn stoked by Covid-19.

The firms have restricted the drawdown of partners, slashed or postponed the big bonuses, and in some cases, even capitalised part of the salary.

Many clients did not clear year-end payments, extended payment cycles or re-negotiated prices on existing work punching a big hole on the revenues of consultancies and law firms.

Many partners of larger professional services firms like Deloitte, PwC, EY and KPMG and magic circle law firms are experiencing for the first time the downside and risk that comes along with the ‘partner’ tag.

Like in one of the big four firms, partners were told that their bonuses —often 20% to 40% of annual salaries—will be added to the working capital of the firm and they will be given 7% interest on that amount.

Older partners say all partners are entrepreneurs and they should be expected to be equal participants in both the good and bad times and capital contribution is an important responsibility of all partners.

The equity-based partnership model has over the years created hundreds of crorepatis in consultancies and law firms.

“A wider set of ownership persification, equity participation and risk sharing is expected to happen in the coming years, where high leverage on fixed costs may not be feasible for the firms any more. At an inpidual level, many partners, and particularly the younger lot, will have to learn to adapt to this culture of risk sharing,” said Kartik Radia, managing partner of Mazars India LLP

Despite growing fears, most have put on brave face and doled out promotions and hikes to other employees to keep the morale high in stressful times.

“The traditional partnership model for law firms will definitely be stress-tested to some degree. Firms not able to manage their cash flows in the short term will be particularly hit hard and will need to take active measures to keep afloat at the risk of losing talent for more stable outfits,” adds Haigreve Khaitan, partner of full-service law firm Khaitan & Co.

Rajat Sethi, partner, S&R Associates, said irrespective of size, firms will face difficulties in riding out this period. “Law firms and consulting firms work on the model that surplus cash is distributed at the end of the financial year,” said Sethi, adding that based on examples from the past, law firms perish when they run out of cash even though they may have very talented lawyers.

According to experts, the traditional partnership model could change as firms will be very careful before they add new partners and team members.

“Traditionally, most Indian firms have not closed any financial year with operating losses in the last 20 years. Therefore, partners were never asked to bring money from home to cover for such losses,” said Mohit Saraf, senior partner of law firm L&L Partners.

But some experts say insist partnership model works well in tough times.

“No one knows how badly any organisation will be affected but the brunt of the effect will be absorbed by the partners and we will attempt to shield the attorneys to the extent possible,” said Vivek Chandy, joint managing partner at J Sagar Associates (JSA). “In a situation like this, we believe that the partnership model will work well with the strong shielding the weaker. The fact is, many of the strong ones were protected in the past, and that is the circle of life.”

Many fear that for the first time some of the high paying partners may even book losses. In a typical partnership model, partners are expected to make three times their salary. At the end of the year, partners also get to share part of the total profits, depending on their equity holding.

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