In response to the COVID-19 pandemic, the government significantly amended India’s Insolvency and Bankruptcy Code, 2016, with the objective of protecting businesses during these volatile times.
In brief, the amendments to the bankruptcy code include an increase in the threshold for initiation of corporate insolvency resolution process to Rs 1 crore and what seems to be a permanent ban on the initiation of proceedings under Sections 7, 9, 10 of the Code for a default arising on or after March 25, 2020 for a period of six months (up to one year as may be notified).
While the time period for calculation of default seems to be pegged at six months (extendable up to a year), there is significant ambiguity with respect to the suspension on initiation of insolvency proceedings with respect to these defaults. While the main provision states that the suspension may be in operation for six months, the proviso to the Section 10A of the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 suggests that insolvency proceedings can never be initiated for the said default.
While these steps have been taken with the objective of primarily protecting MSMEs, the government seems to have turned a blind eye towards foreign creditors and investors who have huge stakes in the businesses. In the event Indian companies are unable to pay off their debts or keep up their promises with respect to return on investments, foreign investors and creditors are now going to be unable to exercise their rights and remedies under the Code, given the amendments.
In this background, it is crucial for India to be wary of the fact that foreign investors, relying on the bilateral investment treaties (BIT) entered into with India, can bring forth action against the government for the above amendments.
Benign or baleful BITs?
As on date, India has only 14 active BITs and has terminated 58 of the BITs in 2017, after the White Industries Australia Ltd v. The Republic of India dispute. However, the sunset clauses in several of the unilaterally terminated BITs will protect the existing investments made prior to 2017.
Under these BITs (existing and terminated one’s with sunset clauses), a foreign investor, is offered the following protections – protection against expropriation, fair and equitable treatment (FET), national treatment, most-favoured nation treatment, full protection and security and provision of means to ensure effective assertion of rights. Adequate protection and compensation clauses exist in these BITs in the event that the Indian government falters on its promises to the foreign investor.
Given the amendments to the Code, which substantially limit the rights of the foreign investors to effectively assert their rights, which were promised prior to making the investment in India, there is a strong possibility that foreign investors will initiate action against India under the BITs, for violation of FET clause, legitimate expectations and effective means rights.
Fair and equitable treatment and legitimate expectation
The introduction of the Code and its implementation has resulted in a paradigm shift as to how India is perceived globally for doing business. During the introduction of the Code, the then finance minister, Arun Jaitley, had promised great investment opportunities for foreign investors with the commencement of the Code.
Accordingly, India has made substantial gains in the ‘World Bank’s Doing Business’ rankings wherein it has moved from the 142nd position in 2014 to the 63rd position globally in 2019. From being ranked as 138th in 2009, India has now been ranked as 52nd for ‘Resolving Insolvency’. The Code has contributed to the positive change in the investment mood.
Foreign Direct Investment (FDI) inflows into India on a year on year basis has been stable and highest since the introduction of the Code. The FDI inflow in the year of 2016-2017 was $60,220 million, $60,974 million in the year 2017-2018, $62,001 million in the year 2018-2019 and the highest in the year of 2019-2020 standing at $73,455 million.
On the basis of these promises offered at the time of introduction of the Code, foreign investors can allege a breach of the FET clause. A clear precedent in this regard is the decision in Tecmed v Mexico, wherein the Tribunal observed that the contracting state is required to adhere to the expectations that were taken into account by the foreign investor at the time of making the investment. According to the FET clause, every State is required to provide, in the least, the international minimum standard of protection to the property/investment of the foreign investor. It is essentially supposed to provide adequate protection to the investor’s legitimate expectation and provide a stable and predictable business environment.
The amendments to the Code can also be challenged on the basis that it takes away the investor’s rights to effectively assert their rights. In this regard, the White’s case becomes relevant. Pursuant to significant delays in the Indian judicial system, the Tribunal had awarded compensation amounting to $4.08 million to be paid to White Industries on the basis that India had not provided the investor “effective means of asserting its claims and enforcing rights”. The Tribunal noted that at a time when the foreign investor requires their dispute to be adjudicated, the contracting state must offer effective rights and remedies.
At this juncture, it is crucial to examine the time period of the amendments. As stated earlier, ambiguity exists with respect to the duration of the suspension. In the event that the suspension is permanent for COVID-19 related defaults, foreign investors have a stronger cause of action in alleging that the effective means of asserting their rights has been permanently impaired.
However, in the event that the suspension is for a period of six months, India may adopt the defence that there is no permanent breach or violation and it is merely a postponement of effective means of asserting rights. However, on a conspectus of decisions of various international tribunals, foreign investors may still be able to bring a claim on the basis that although the measure may be temporary, the deprivation to their investment is not merely ephemeral. (Refer to Phelps Dodge International Corp. v. The Islamic Republic of Iran)
Exceptions to a claim under a BIT are likely to be covered in the respective BIT. There is a possibility that measures taken to curb COVID-19 could be brought within the ambit of these exceptions, thereby protecting a State against a claim raised under the BIT.
Apart from exceptions contained in the treaty, customary international law sets out certain defences which could be invoked against claims under a BIT. These are codified under the International Law Commission’s Articles on Responsibility of State for Internationally Wrongful Acts (ILC Articles). The ones relevant to COVID-19 measures would be, a) force majeure; b) necessity; c) distress.
While force majeure would be a defence against performance of obligations, distress would be available in situations of protection of an individual’s life. The relevant exception to a BIT claim that could be invoked against the legislative measures, such as suspension of the Code, would be the defence of “necessity”.
As per Article 25 of the ILC Articles, the prerequisite for invocation of the defence of necessity is that: a) this was the only available measure available against an imminent danger; b) and the measures do not impair the obligations towards foreign States. However, the invocation would not hold good if the State invoking the defence was a contributing factor to the ‘situation of necessity’ or the international obligations outweighs the necessity.
Two decisions rendered during the Argentina economic crisis presumes significance. First, in National Grid v. Argentina, the Tribunal held that the measures taken by Argentina amounted to a breach of the FET clause. The Tribunal observed that Argentina had failed to honour the assurances relied upon by National Grid prior to making its investment and had fundamentally changed the legal framework relied upon by National Grid at the time of making its investment.
However, in Salini Impreglio v. Argentina, the Tribunal relying on the decision in Parkerings-Compagniet AS v. Lithuania observed that an investor’s legitimate expectation can never be that the legal framework of the country will undergo no change. That said, the Tribunal acknowledged that the investor ought to be protected against unreasonable modifications to the law.
In conclusion, with respect to the Central government’s move to suspend the initiation of proceedings under Sections 7, 9, 10 of the Code, the stated objective is to prevent companies from being declared insolvent on account of the pandemic. That being so, it could be argued that the suspension was the “only” available measure against an imminent peril, i.e. the threat of bankruptcy due to economic slump created by the pandemic.
However, in light of wordings of Section 10A proviso, foreign creditors can certainly maintain that their interests have been hampered and rights impaired, as they have lost out on their bargaining position and effective means of gaining control over the defaulting company, which was promised prior to their investment.
It is more so crucial to note that irrespective of whether the arbitration results in an award favourable to foreign creditors, the expenditure involved in defending every BIT claim will certainly be an unnecessary burden on the exchequer. Furthermore, given India’s stance on “attracting foreign investment” and improving ease of doing business, it may not be prudent for the Indian government to ignore the ever lurking threat of BIT claims. There is an urgent need for India to collaborate with the international community to limit its exposure to the lurking threats of BIT claims, which is further accentuated now in light of India’s ban of 59 Chinese applications.
Pawan Jhabak is an advocate practicing at the Madras high court. Ramya Subramaniam is an alumni of National Law School of India University and an advocate practicing at the Madras high court. Sriram Venkatavaradan is an advocate practicing at the Madras high court.