With the advent of climate change, the long-standing debate on its challenges and impacts has gained mainstream traction in the business realm due to the heightened risks to corporate liquidity and solvency. With businesses becoming increasingly vulnerable to climate-related disruptions, insolvency laws must adapt to ensure comprehensive risk management and sustainable recovery. This article explores the comparative analysis of insolvency laws across the globe, with a particular focus on the Indian perspective, highlighting how climate change impacts the insolvency process.
Global Trends in Insolvency Laws and Climate Change
Globally, insolvency laws have evolved to address not only traditional financial distress but also the emerging challenges posed by climate change by incorporating climate risk into insolvency frameworks by jurisdictions like United States, United Kingdom and Australia. One notable trend is the shift towards Debtor-in-Possession (DIP) Financing, adopted by USA and UK, which enables companies to restructure its debts while remaining in control of its business operations, subject to the oversight and jurisdiction of the court. In United States, the Pacific Gas and Electric Company (PG&E) voluntarily filed for reorganization in 2019 due to billion dollars liability from wildfires that were aggravated by climate change. PG&E emerged from bankruptcy in June 2020 after a comprehensive restructuring plan was approved, which included compensation for wildfire victims and substantial investments in wildfire mitigation measures.
Another global trend is the increased use of Pre-Packaged Insolvency, which can be used as a strategic tool to manage environmental risks/liabilities, facilitate asset transactions and streamline the restructuring process. By transferring environmental liabilities to specialized third-party firms under a guaranteed fixed-price remediation contract, companies can separate these burdensome obligations from their core assets. This not only enhances the attractiveness of these assets to potential buyers but also ensures that environmental remediation is fully funded and compliant with regulatory standards. As a result, this approach helps achieve the rehabilitative goals of bankruptcy by preserving asset value while addressing environmental responsibilities, making it a vital strategy in new-age corporate restructuring. However, critics argue that pre-packaged insolvencies may not always prioritize creditor interests or ensure fair outcomes.
Similarly, another growing global trend is Creation of Environmental Trust, which is different from an environmental risk/liability transfer, as it is set up specifically to handle environmental cleanup obligations. These trusts are established as a financial mechanism to ensure the cleanup and remediation of contaminated sites, particularly in cases where the responsible party may be insolvent or unable to fulfil their obligations. These trusts are often created during bankruptcy proceedings to allocate funds specifically for addressing environmental liabilities, ensuring that the necessary remediation work continues even after the company’s assets are liquidated or restructured. A notable example is the case of In re Tronox Inc., where the court approved the creation of custodial trusts funded with $115 million. These trusts were designed to manage and remediate contaminated sites, allowing Tronox to resolve its environmental liabilities while focusing on its core business operations post-bankruptcy.
Additionally, countries are increasingly revising their insolvency frameworks to tackle the emerging climate-related challenges affecting corporate solvency. The integration of climate-related financial disclosures, as per the Task Force on Climate-related Financial Disclosures, is enhancing transparency and helping stakeholders assess climate risks. Sustainable finance initiatives and carbon pricing mechanisms are being adopted to incentivize green investments and penalize high-emission practices, thus reshaping industry dynamics. Further, climate risk disclosure regulations and ESG standards are driving companies to align with environmental goals influencing their financial health.
Indian Perspective on Insolvency Laws and Climate Change
In India, the Insolvency and Bankruptcy Code (IBC), 2016, has been an instrumental legislation in resolving insolvencies, emphasizing restructuring and rehabilitation over liquidation. However, climate change poses new challenges for Indian businesses, particularly micro, small, and medium enterprises (MSMEs), which are vulnerable to climate-related disruptions.
The Supreme Court has recently in the judgment of Hari Babu Thota, allowed promoters to submit resolution plans even if their entities were registered as MSMEs post-CIRP commencement, which paves the way for a more dynamic interpretation of the IBC, aligning it with contemporary economic and environmental realities.
The Essar Steel India Ltd. case which affirms the primacy of Committee of Creditors (CoC) in decision-making process for any concern under insolvency, emphasizes the necessity of considering broader economic and social factors in insolvency resolutions. This principle can be extended to include climate risk assessments as part of the CoC’s evaluation criteria.
In the case of Gujarat Urja Vikas Nigam Ltd., where the Corporate Debtor was constrained to file a petition under Section 10 of the IBC due to the adverse effects of rainfall and floods on its solar power plant, the Supreme Court upheld the preservation of the Power Purchase Agreement. The Court ruled against the attempt of Gujarat Urja Vikas Nigam to terminate the agreement solely on the grounds of insolvency. This decision stresses the impact of climate change on business operations and highlights the necessity for insolvency laws to adapt to emerging challenges, including, but not limited to the rise in non-performing assets due to climate-related stress in the banking sector, the complexities involved in asset valuation and debtor viability assessment.
Climate Change and Insolvency: A Need for Proactive Measures
The impact of climate change on businesses is multifaceted, affecting supply chains, asset valuations, and overall financial stability. As such, there is a growing consensus on the need for insolvency frameworks to be more resilient to climate-related risks. This necessitates a proactive approach, including legislative reforms, regulatory guidance, and judicial activism.
In India, the incorporation of Environmental, Social, and Governance (ESG) criteria into corporate governance and insolvency proceedings could be a significant step forward. The Securities and Exchange Board of India (SEBI) has already introduced mandatory ESG disclosures for listed companies, in alignment with global best practices. Extending these requirements to the insolvency process would ensure that climate risks are adequately assessed and managed.
Furthermore, the integration of climate risk assessments into the resolution plans approved by the CoC could enhance the resilience of the restructured entities. This would involve conducting comprehensive environmental impact assessments and incorporating mitigation strategies into the business plans of distressed companies. By doing so, the insolvency framework can contribute to sustainable economic development and minimize the long-term financial risks associated with climate change.
Conclusion
The comparative analysis of insolvency laws in the context of climate change reveals a growing recognition of the need to integrate environmental considerations into the insolvency process. While jurisdictions like the United States, the United Kingdom, and Australia have made significant strides in this direction, India is still in the nascent stages of addressing these challenges.
As climate change continues to reshape the global economic landscape, the integration of environmental considerations into insolvency laws will be crucial in fostering a more resilient and sustainable future. Through proactive measures and legislative reforms, countries can mitigate the financial risks posed by climate change and promote long-term economic stability.