The Insolvency and Bankruptcy Code, 2016- An overview

         The Insolvency and Bankruptcy Code, 2016- An overview

                                                                                   Swathy Nair[1] & Swetha Nair[2]

The most significant legislation of 2016 is the Insolvency and Bankruptcy code, which has been described by finance minister Arun Jaitley[3] as the most important economic reform next to GST since independence. After the adoption of Globalization and liberalization in 1990s, some of the commercial laws have become inadequate to deal with the cases arising in present scenario.  In this shrinking world, it has become necessary the convergence of commercial and economic laws. Bankruptcy of the firms and individuals and the legal procedures to deal with the same have huge implications for an economy[4].

The Insolvency and Bankruptcy Code 2016 (hereinafter the Code), is a comprehensive law which covers the entire subject matter of corporate as well as individual insolvency under a single umbrella eliminating   multiple judicial fora.

The new Code has created a situation in which entrepreneurs can raise money from market and need not depend upon banks for finance. Therefore it is said that the Code is the channel through which India will come out with substantial share in the Global economy, especially in digital revolution.     

Back Ground of the Legislation

Today, India is one among the fastest growing economies. Nevertheless, in order to maintain this growth, Banks and Insolvency and Bankruptcy regime should rediscover themselves as sustaining their key functions. The earlier system was such that it put the Banks at the receiving end leading to accumulation of non-performing assets. The Indian Banks have a troubled debt pile of 121 billion Dollars, out of which almost 100 billion are in the books of the public sector banks.  As per the data collected and provided by RBI[5], by the end of December 2015, stressed assets rose to more that 14% of the banking sector loans. More than Rs. 11400 Cr bad loans had been written off. The Supreme Court has recently asked the Central Government to draw over the bankruptcy system to get rid of bad loans.

In order to cut down the burden of increasing non-performing assets, different kinds of reforms were necessary. However, an immediate change in the Insolvency and Bankruptcy Laws was important. Therefore, Bankruptcy Law Reforms Committee (BLRC) in 2014 under the chairmanship of Mr. T.K. Viswanathan[6], former Union Law Secretary, was set up, in view of recommending an Indian Bankruptcy Code to replace the existing laws and applicable  both to non-financial corporations and individuals. The draft Insolvency and Bankruptcy Code was submitted in 2015.

The Code is a major change and departs from prior frame work of insolvency laws, which were often interpreted by the courts in favour of the debtors. The code establishes a comprehensive Law dealing with both Corporate and Individual insolvency to bring professionalism and efficiency in insolvency proceedings. It aims at expeditious resolution of insolvency, promotion of fruitful investments, releasing resources of the banks frozen in unproductive segments and improving the viability of credit materials. The Code amends Companies Act and a number of other Acts to effectively deal with corporate insolvency. As this legislation enables early and timely insolvency resolution, it is a leap in the correct direction.

The Prior Legal Frame Work

Earlier the legal and procedural frame work for regulating insolvency was laid down in several legislations such as

  • Companies Act, 1956
  • Sick Industrial Companies (Special Provision) Act, 1985 [SICA]
  • Securitisation and Reconstruction of Financial Assets and Enforcement Security Interest Act (SARFAESI) Act,2002
  • Recovery of Debts due to Banks and financial institutions Act,1993 [RDB Act]
  • The Presidency Towns Insolvency Act, 1909
  • The Provincial Insolvency Act, 1920
  • The Limited Liability Partnership Act, 2008

Insolvency and Bankruptcy of Companies are dealt with SICA 1985, RDB Act 1993, SARFAESI Act 2002 and the Companies Act 1956. In 2002, though a lot of amendments were made in Companies Act, before these could be implemented, the decision to replace the entire Act by a new enactment came. Deliberation went on for almost 11 years. However, even after this long deliberation, the 2013 Act lacked proper insolvency regime. Under this liquidation of companies was handled by the High Courts. In 2002 the banks and financial institutions were empowered to enforce their security interest without taking recourse to the court through the provisions of the SARFAESI Act. Though  the said powers have been given to the banks and FIs a number of other lenders/ creditors including NBFCs, individuals and firms who supply goods and services to the corporate, lend money to them and subscribe to the bonds issued by the corporate, did not have recourse to the same[7]. The consequence of this was the retarded growth of the credit market in India, especially the bond market. Individual insolvency was dealt with by the Courts under The Presidency Town’s Insolvency Act 1909 and The Provincial Insolvency Act 1920.

In short a number of tribunals were operating in the Insolvency and Bankruptcy regime, namely BIFR, DRT, High Courts and NCLT and their appellate Tribunals.                    

The Highlights of the Act

The Code makes a time limit of 180 days in which corporate insolvency should be resolved. Nevertheless, if in this period 75% of the creditors do not agree on the revival plan, the firm will automatically go into liquidation. An extension of 90 days may be granted if the creditors decide by 3/4th majority that the matter is too complex to deal within the prescribed period. The Code also makes provisions for monetary penalty and Jail term for concealment of property, defrauding creditors and furnishing false information.  

The act provides for the establishment of the following institutional framework:

  • Insolvency professionals (IP) to conduct the resolution process and manage the company during the resolution proceeding.
  • Insolvency professional Agencies (IPA) to regulate professionals by conducting examinations to enrol them and to enforce a code of conduct.
  • Information Utilities (IUs) to collect and disseminate financial information to facilitate insolvency resolution.
  • Insolvency and Bankruptcy Board of India (IBBI) to regulate Professionals, Agencies and Utilities.
  • National Company Law Tribunal (NCLT) to adjudicate corporate Insolvency.
  • Debt Recover Tribunal (DRT) to adjudicate Individual Insolvency and Insolvency of Unlimited Liability Partnerships.
  • National Company Law Appellate Tribunal (NCLAT) and Debt Recovery Appellate Tribunal (DRAT) to hear appeals from orders or decisions of the Board, NCLT, and DRT.
  • The Insolvency and Bankruptcy Fund of India.

Insolvency Professionals and Insolvency Professional Agencies:- The important function of the IPA’s is to regulate, insolvency professionals and to enforce a code of conduct, the Code allows for multiple IPAs to operate simultaneously which would enable competition in the sector[8]. The insolvency professionals will conduct and run the entire insolvency process. Insolvency Professionals are practicing Chartered Accountants, Company Secretaries, Advocates or Cost Accountants who have registered with the IBBI. Section 29 lays down the most important function of the IP- preparation of the information memorandum. In individual insolvency, he acts as the bankruptcy trustee who is in charge of the liquidation estate.

Insolvency and Bankruptcy Board of India:- The Insolvency and Bankruptcy Board of India is entrusted with the primary function of regulating the IPs, IPAs and IUs. The Board has the power to appoint, license and de-license insolvency professionals and to conduct disciplinary proceedings. The Board comprises of senior Government functionaries and other members who would be appointed by the Government.

Information Utilities:- The IUs will collect, collate and disseminate the information from listed companies and their financial as well as operational(workers, employees, statutory creditors etc whose past payments are due) creditors. All solvent debtors and creditors are required to furnish data to IUs regarding debts, liabilities, assets against which secured loans have been obtained and the instances of default. An individual Insolvency data base is also proposed to be set up.

Corporate Insolvency Resolution Process:-

  • Under the threshold for initiating corporate insolvency resolution process is default in repayment of financial debt or operational debt (wages or salaries due to workers or employees). In other words, a single default may also trigger insolvency resolution process. There is no requirement of notice to the debtor before filing the application for insolvency resolution by the financial creditor. The debtor himself can also file for insolvency resolution.
  • On verification of default, the adjudicating authority will announce the initiation of insolvency resolution process and will appoint an Interim Insolvency Professional (IIP) within 14 days of the admission of the application. The verification has to be done on the data available with the IUs.
  • The IIP will immediately take over the possession of all assets and management of the affairs of the corporate debtor. He shall constitute a creditors committee which consist of an IP and the financial creditors. From the IIP the Committee will take over the entire responsibility for running the resolution process.
  • The IP will form a resolution plan and will place it before the committee. Even the creditors can submit such a plan. If more than 70% of the financial creditors in value terms consent to the plan, the IP will send it to the adjudicating authority for its approval.
  • Once the authority sanctions the plan, it becomes binding on all financial and operational creditors and on the shareholders. From the date of the insolvency resolution order by the authority there will be a moratorium against any action or recovery proceedings against the corporate debtor for 180. The authority may extend this to 270 days.
  • If the committee does not approve the plan within 180 days or 270 days as may be extended by the adjudicating authority, the corporate debtor would be ordered to be wound up will have to go through liquidation.

The Insolvency and Bankruptcy Code, 2016 – Procedure and Key Highlights

Fast Track Insolvency Resolution Process:-  The aim with which the Code is established is to conclude the procedure within half of the default period specified in the Code. The person or entity seeking the fastest relief will have onus on the process at set-off and the person or entity that sets-off the fast track process must support that the case is fit for the ‘fast-track’.[9]  Thus the person who fills the application for fast track process will have to file the application along with the proof of existence of default on the part of the corporate debtor under Section 55 of the Act. This proof has to be obtained from the records available with the information utility or from such other source as may be specified by the board.

This process has to be completed within 90 or extended time of 135 days from the date of commencement of the insolvency resolution. It can be extended by the adjudicatory authority only if 75% of the creditors in the committee vote for it.

Insolvency Resolution Process for Individuals or Unlimited Partnerships: The Code applies to Individuals or Unlimited Partnerships, when the default amount is Rs.1000 or more. The Government has the power to revise it to a higher threshold.

The Code envisages two district processes in case of insolvencies: automatic fresh start and insolvency resolution. Under the automatic fresh start processes eligible debtors (basis gross income) can apply to the DRT for discharge from certain debts, not exceeding a specified threshold allowing them to start afresh[10].

The Insolvency Resolution process includes a repayment plan by the debtor, for approval of creditors. If it is approved by the creditors, the DRT passes an order, which binds the debtor and creditors to the repayment plan. If it is rejected, the debtor/ creditor can apply for a bankruptcy order.

How does the Act Impact the Companies Act?

In respect of corporate insolvency the Code adopted an approach under Sections 7, 8 and 9, which is centred on the applicant, providing for different mechanisms for financial and operational creditors and for corporate applicants.

Further, while laying down this classification for creditor triggered insolvency mechanisms, the Code leaves the other winding up mechanisms to be governed by the Companies Act 2013 itself[11].

There is a larger policy shift evident in this legislation with respect to the winding up mechanism[12]. Replacing the single tier system for creditor triggered winding up, the Code provides for a two tier mechanism. First, the Resolution Professional shall set forth an insolvency resolution plan to repay the debts of the Company, only on the failure of this step that the law allows to have recourse to the second step, the winding up of the company. This which was earlier applicable for sick companies is now available for all companies. In order to give effect to this, the Code repeals the entire Chapter related to sick Companies in the Companies Act, 2013 under Clause (8) of Schedule 7 appended to the Code.

Though the provisions in the Code in relation to liquidation of a corporate debtor is almost similar those in the Companies Act, 2013. However, one difference that worth mentioning is that when an order of appointing a liquidator is made under Section 33 of the Act, an appeal from it will lie only on the limited grounds of material irregularity and fraud. Similarly, the Code introduces the concept of liquidation estate wherein all the assets provided in Section 36(3) of the Code shall form part of the liquidation estate[13]. The liquidator, while dealing with the liquidation estate shall act as a fiduciary to the creditors. For the purpose of obtaining proof of claims and identification of the liquidation estate assets the liquidator shall have, in addition to the powers granted to the liquidator by the existing law, the code empowers him to have access to any information system. Also, the liquidator has now been granted powers by the Code to make applications to avoid extortionate credit transactions, whether financial or operational, made within two years prior to the commencement of the insolvency commencement date. When the NCLT is satisfied by such an application, it may pass orders restoring status quo ante of the transactions, set aside the transaction as a whole or require returning any sum of money received by any person in such transaction.

With respect to the position of creditors, there is no considerable change, expect that priority for the payment of the workmen’s dues relating to wages and salary which are payable for a period of two years preceding the winding up order or other such other period as may be prescribed has been expressly conferred[14]. Also, the non- obstante clause under the Companies Act 2013stands omitted.

Powers of NCLT – National Company Law Tribunal

Benefits to the Economy

The Indian economy expects the following benefits as from the bankruptcy reform,

Availability of Finance to Business with Fewer Tangible Assets: In Indian Credit Market, creditors have always preferred secured credits and as such small business organisations with less tangible assets were often denied credit. Now, with improvement in the rights of creditors, the said shall also be able to avail credit facility.

Rescuing distressed entities: Under the SARFAESI Act,2002 the lenders often used to take control of the assets and sell the security in order to recover the defaulted amount, of business concerns which could have rescued as a going concern. Under the Code it will be possible to save more number of units on going concern basis by following the time bound insolvency resolution process.

Wider Distribution of Credit: On account of the week rights granted to the lenders prior to the Code, they always preferred to lend in favour of a very small set of ‘safe borrowers’. Thus other business organisations became dependent on equity financing which is very expensive and made the business of small entities unviable. With the enactment of the Code, Which provides stronger rights to the creditors, the creditors will not hesitate to offer loans to small enterprises and thus finance will be available to a large number of deserving entrepreneurs.

Growth of Credit Market: The Code enables higher recovery rates for corporate bondholders which would catalyze the development of bond market in India. This will help business entities avail cheaper finance, especially in the infrastructure sector.

Increased Investor Confidence:  A foreign lender or investor can also cause a quick liquidation of the investee/ borrower company in case of default of the terms of the Shareholders Agreement/ Loan Agreement and pull back his investment/ loan, which will be a huge confidence booster while making the investment/ lending. The same will result in higher foreign investment/loans in the country[15]

Challenges in Implementation

The challenge in the implementation of the new Code is that, the law requires a total change in the mindset and established norms and practices of

  • Corporate and other business organisations which are debtors
  • Creditors such as banks, financial institutions, investors in debt instruments
  • Those who supply goods and services on credit and others who can be operational debtors such as workers and employees.
  • The judiciary

Another hurdle in the way of the Code is that, in cases of loans to micro and small enterprises, it would be physically impossible to take possession of defaulting enterprises and ask Insolvency Practitioners to manage them. In such cases the banks will have to examine feasibility of restructuring the debts by resorting to Debt Recovery Laws[16].

We should understand that generalist judges cannot be posted to do specialist duties. Since Insolvency is one of the complex and most complicated laws, NCLT is going to deal with newer types of high volume litigation. Thus it requires a unique approach and only those who are capable to understand not only the economic laws but also the nuances of accountancy and cost accountancy can deliver the desired results. As Bentham said “judge made law can never be better than the judges who make them”. So we have to focus on the capacity Building of for enhancing expertise of members of NCLT and DRTs who are going to interpret this Code because the subject matter is emerging, complex and intermingled with market forces[17]. Similarly, the jurisdiction to deal with personal insolvency is vested with the DRT. This will make the law further inaccessible since DRT at present is having a huge backlog of cases and a considerable number of them are yet to start functioning.    

Lacunae in the Act

  • First of all, the debate centres on the question whether this kind of powers should have been invested in a Board consisting of government officials and government-nominated members or such functions should have been assigned to an autonomous body, independent of governmental control such as Medical Council, Bar Council, and Institute of Chartered Accountants etc. The critics point out that the government should have stayed outside and supervised instead of having a direct role in the Board.
  • The aspect of cross border insolvency issues are not addressed in this Code. In view of the emerging global finance and credit market, an attempt must have been made to include cross border issues modelling UNCITRAL guidelines.
  • When a default is found out, the Tribunal is required to immediately appoint an interim insolvency professional under Section 7(5) (a). It has to be noted that using the word “shall” makes a mandatory obligation upon the NCLT to admit such application and appoint the insolvency professional, irrespective of the solvency of the company and bona-fide defences, on a mere occurrence of default. Under this provision an insolvency application will be admitted even on the failure to pay a part of an instalment of a debt.        
  • It is also criticised that the authority of the court to nullify or order restoration of transactions, which are of extortionate nature, on the request of the liquidator is drastic in nature and would destroy party autonomy and freedom of trade and commerce.
  • The Code constitutes an Insolvency and Bankruptcy Fund which may accept contributions. A person contributing to this Fund can withdraw them for reasons such as making payments to workmen in case of insolvency proceedings being initiated against him. Moreover, the person contributing will not get interest. The Code fails to mention any other purpose for which the Fund is created. It is not clear why one will voluntarily contribute to the Fund when there is no interest.
  • The Code provides for a Fresh Start Process under which an individual having assets and debt under a threshold will be eligible for debt waiver of up to Rs.35000. these limits include i) Gross annual income of less than 60000 ii) assets under 20000 iii) no ownership of a house. It may be argued that these limits are unreasonably law as there may few individuals who meat these criterion and who will be credit worthy to receive loan[18].

Conclusion

In the Ranking Index of World Bank, of countries on the ease of doing business, India ranks only 130 out of 189 countries in 2016. In South Asia, India lags behind Bhutan, Nepal, Sri lanka and Maldives. In terms of easiness in insolvency resolution, India ranks 136. The week insolvency regime in India, the significant lacunae the earlier frame works and systematic abuse of such lacunae are the reasons which our credit markets and business environment in such a distressed state.

Moreover, India’s banking is in throes of a crisis. Almost 10 trillion of loans are struck. Freeing up this money is crucial for the banking sector to go about its business[19]. When this law is in place, once a default occurs, it will be resolved within a period of 180 days after the bankruptcy application is filed. Thus ideally speaking, it could have expeditiously dealt with messy situations such as Vijay Mallia and JayPee issues.  

The code is a revolutionary step as it lays down a frame work which will transform credit market in India with improved rights of the lenders, especially that of the unsecured creditors, the availability of credit in the market would improve and as a consequence cost of credit will reduce. This will intern improve the competitiveness of the firms promoting economic growth. The aim of the new law is to encourage entrepreneurship and innovation.

The Code also marks a shift from the debtor centric liquidation process to creditor determined liquidation process. Under the present law, business organisations that are not performing will perish faster than merely prolonging the inevitable death, which will make the resources held by such organisations available for other entrepreneurs.

The fate of the Code rests on how it will be implemented and how the adjudicatory authorities are going to deal with the functions assigned to it under the law. It is a welcome step that, in view of the broad philosophy that insolvency resolution should be commercial and professionally driven, rather than being court driven, the functions of the judicial authorities is limited to ensuring due process rather than deciding on the merits of the resolution.               

  

          

[1] IV BSL LLB, ILS Law College, Pune, swathynairminu@gmail.com, 7030611709

[2] IV BSL LLB, ILS Law College, Pune, swethanairminnu@gmail.com , 8408985938

[3]  Arun Jaitley to Table Bankruptcy Bill in Parliament on Monday, firstpost.com  (20/12/2015 ), available at http://www.firstpost.com/politics/arun-jaitley-to-table–bankruptcy-bill-in-parliament-in-on-monday-2553118.html , last seen on 1/3/2017

[4] N. Sharma, Corporate Insolvency Process under the Insolvency and Bankruptcy Code , 2016- An Analysis,  3Chartered Secretary 56 (2016).

[5]  K. Parwez, India’s Banking Woes & Laws on Insolvency & Bankruptcy, 8(6) Lex witness, 20 (2016).    

[6] Supra 5.

[7] Supra  4 at 58.

[8] Ministry of Finance, Government of India, Report of the Bankruptcy Law Reforms Committee 2015,  available at http://finmin.nic.in/reports/BLRCReportVol1_04112015.pdf , last seen on 2/3/2017.

[9] H.K. Sharma, Insolvency and Bankruptcy Code, 2016 – Fast Track Corporate Insolvency Resolution Process,  46(9) Chartered Secretary 67,68  (2016).

[10] Trilegal, India: Insolvency and Bankruptcy Code, 2016-Key Highlights , Mondaq ,available at http://www.mondaq.com/india/x/492318/Insolvency+Bankruptcy/The+Insolvency+And+Bankruptcy+Code+2016+Key+Highlights, last seen on 4/3/2017.   

[11]  P.H.A. Pandian, Corporate Insolvency Resolution Process and the Bankruptcy Code and its Impact on the Companies Act, 46(9) Chartered Secretary  62 (2016).

[12] See Chapters II & III, Insolvency and Bankruptcy Code, 2016.

[13] Supra 11 at 66.

[14]  G. M. Ramamurthy, Position of Secured Creditor in Winding up and liquidation of Corporate Debtor, 46(9) Chartered Secretary 74, 76 (2016).

[15] Supra 4 at 61.

[16] M.R. Umarji, Challenges in Implementation of Insolvency and Bankruptcy Code, 46(9) Chartered Secretary  46, 48 (2016).

[17] Dr. TK Viswanathan,The Insolvency and Bankruptcy Code, 8(6) Lex Witness  24,25 (2017).

[18]A. Gayam and V. Khullar, Insolvency and Bankruptcy Code: Issues for Consideration, PRS legislative Research, available at http://www.prsindia.org/insolvency-and-bankruptcy-code-issues-for-consideration/ ,last seen on 1/3/2017.

[19] K. Narayan, Simply put: Why the proposed Bankruptcy Code is needed, how it’ll tackle bad debts,  The Indian Express(10/5/2016), available at http://indianexpress.com/article/explained/bankruptcy-code-passed-why-the-proposed-bankruptcy-code-is-needed-how-itll-tackle-bad-debts-2792444/, last seen on 3/3/2017.

 

Details of Authors 

Above write-up has been prepared  by Ms. Swathy Nair and Ms. Swetha Nair, who are 5th year law students in ILS Law College, Pune.

Authors has published their write-ups on various legal and procedural issues.

You can reach them at minnaminnisnairsnair@gmail.com

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