Insolvency and Bankruptcy Code, 2016


Ajit Kumar AJIT KUMARWISDOM IAS, New Delhi.


On May 11, 2016, the Rajya Sabha passed the major economic reform bill moved by the government i.e. ‘Insolvency and Bankruptcy Code, 2016’. This is considered as the biggest economic reform next only to GST. The Lok Sabha had earlier passed the bill on 5th May, 2016. 

In India, the legal and institutional machinery for dealing with debt default has not been in line with global standards. The recovery action by creditors, either through the Contract Act or through special laws such as the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 and the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, has not had desired outcomes. Similarly, action through the Sick Industrial Companies (Special Provisions) Act, 1985 and the winding up provisions of the Companies Act, 1956 have neither been able to aid recovery for lenders nor aid restructuring of firms. Laws dealing with individual insolvency, the Presidential Towns insolvency Act, 1909 and the Provincial Insolvency Act. 1920, are almost a century old. This has hampered the confidence of the lender.

When lenders are unconfident, debt access for borrowers is diminished. This reflects in the state of the credit markets in India. Secured credit by banks is the largest component of the credit market in India. The corporate bond market is yet to develop. 

Reasons

There are multiple overlapping laws and adjudicating forums dealing with financial failure and insolvency of companies and individuals in India. The current legal and institutional framework does not aid lenders in effective and timely recovery or restructuring of defaulted assets and causes undue strain on the Indian credit system. 

The Code offers a uniform, comprehensive insolvency legislation encompassing all companies, partnerships and individuals (other than financial firms). 

Objective

The objective of the new law is to promote entrepreneurship, availability of credit, and balance the interests of all stakeholders by consolidating and amending the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner and for maximization of value of assets of such persons and matters connected with it. 

The law aims to consolidate the laws relating to insolvency of companies and limited liability entities (including limited liability partnerships and other entities with limited liability), unlimited liability partnerships and individuals, presently contained in a number of legislations, into a single legislation.
Such consolidation will provide for a greater clarity in law and facilitate the application of consistent and coherent provisions to different stakeholders affected by business failure or inability to pay debt. 

Salient Features

The salient features of the law are as follows: 
(i) Clear, coherent and speedy process for early identification of financial distress and resolution of companies and limited liability entities if the underlying business is found to be viable.

(ii) Two distinct processes for resolution of individuals, namely- “Fresh Start” and “Insolvency Resolution”. 

(iii) Debt Recovery Tribunal and National Company Law Tribunal to act as Adjudicating Authority and deal with the cases related to insolvency, liquidation and bankruptcy process in respect of individuals and unlimited partnership firms and in respect of companies and limited liabilities entities respectively. 

(iv) Establishment of an Insolvency and Bankruptcy Board of India to exercise regulatory oversight over insolvency professionals, insolvency professional agencies and information utilities. 
 
(v) Insolvency professionals would handle the commercial aspects of insolvency resolution process. Insolvency professional agencies will develop professional standards, code of ethics and be first level regulator for insolvency professionals members leading to development of a competitive industry for such professionals. 

(vi) Information utilities would collect, collate, authenticate and disseminate financial information to be used in insolvency, liquidation and bankruptcy proceedings. 

(vii) Enabling provisions to deal with cross border insolvency

The essential idea of the new law is that when a firm defaults on its debt, control shifts from the shareholders / promoters to a Committee of Creditors, who have 180 days in which to evaluate proposals from various players about resuscitating the company or taking it into liquidation. When decisions are taken in a time-bound manner, there is a greater chance that the firm can be saved as a going concern, and the productive resources of the economy (the labour and the capital) can be put to the best use. This is in complete departure with the experience under the SICA regime where there were delays leading to destruction of the value of the firm.

The vision of the new law is to encourage entrepreneurship and innovation. Some business ventures will always fail, but they will be handled rapidly and swiftly. Entrepreneurs and lenders will be able to move on, instead of being bogged down with decisions taken in the past. 

Insolvency Resolution Process

1. Insolvency Resolution Process for Corporate Debtors: Two-Stage Process

To initiate an insolvency process for corporate debtors, the default should be at least INR 100,000 (USD 1495) (which limit may be increased up to INR 10,000,000 (USD 149,500) by the Government). The Code proposes two independent stages:

Insolvency Resolution Process, during which financial creditors assess whether the debtor's business is viable to continue and the options for its rescue and revival; and
Liquidation, if the insolvency resolution process fails or financial creditors decide to wind down and distribute the assets of the debtor.

(a) The Insolvency Resolution Process (IRP)

The IRP provides a collective mechanism to lenders to deal with the overall distressed position of a corporate debtor. This is a significant departure from the existing legal framework under which the primary onus to initiate a reorganisation process lies with the debtor, and lenders may pursue distinct actions for recovery, security enforcement and debt restructuring.

The Code envisages the following steps in the IRP:

(i) Commencement of the IRP
A financial creditor (for a defaulted financial debt) or an operational creditor (for an unpaid operational debt) can initiate an IRP against a corporate debtor at the National Company Law Tribunal (NCLT).
The defaulting corporate debtor, its shareholders or employees, may also initiate voluntary insolvency proceedings.

(ii) Moratorium

The NCLT orders a moratorium on the debtor's operations for the period of the IRP. This operates as a 'calm period' during which no judicial proceedings for recovery, enforcement of security interest, sale or transfer of assets, or termination of essential contracts can take place against the debtor.

(iii) Appointment of Resolution Professional

The NCLT appoints an insolvency professional or 'Resolution Professional' to administer the IRP. The Resolution Professional's primary function is to take over the management of the corporate borrower and operate its business as a going concern under the broad directions of a committee of creditors. This is similar to the approach under the UK insolvency laws, but distinct from the "debtor in possession" approach under Chapter 11 of the US bankruptcy code. Under the US bankruptcy code, the debtor's management retains control while the bankruptcy professional only oversees the business in order to prevent asset stripping on the part of the promoters.
Therefore, the thrust of the Code is to allow a shift of control from the defaulting debtor's management to its creditors, where the creditors drive the business of the debtor with the Resolution Professional acting as their agent.

(iv) Creditors Committee and Revival Plan

The Resolution Professional identifies the financial creditors and constitutes a creditors committee. Operational creditors above a certain threshold are allowed to attend meetings of the committee but do not have voting power. Each decision of the creditors committee requires a 75% majority vote. Decisions of the creditors committee are binding on the corporate debtor and all its creditors.
The creditors committee considers proposals for the revival of the debtor and must decide whether to proceed with a revival plan or liquidation within a period of 180 days (subject to a one-time extension by 90 days). Anyone can submit a revival proposal, but it must necessarily provide for payment of operational debts to the extent of the liquidation waterfall.

The Code does not elaborate on the types of revival plans that may be adopted, which may include fresh finance, sale of assets, haircuts, change of management etc.

(b) Liquidation

Under the Code, a corporate debtor may be put into liquidation in the following scenarios:
(i) A 75% majority of the creditor's committee resolves to liquidate the corporate debtor at any time during the insolvency resolution process;

(ii) The creditor's committee does not approve a resolution plan within 180 days (or within the extended 90 days);

(iii) The NCLT rejects the resolution plan submitted to it on technical grounds; or

(iv) The debtor contravenes the agreed resolution plan and an affected person makes an application to the NCLT to liquidate the corporate debtor.

Once the NCLT passes an order of liquidation, a moratorium is imposed on the pending legal proceedings against the corporate debtor, and the assets of the debtor (including the proceeds of liquidation) vest in the liquidation estate.

2. Insolvency Resolution Process for Individuals/Unlimited Partnerships



For individuals and unlimited partnerships, the Code applies in all cases where the minimum default amount is INR 1000 (USD 15) and above (the Government may later revise the minimum amount of default to a higher threshold). The Code envisages two distinct processes in case of insolvencies: automatic fresh start and insolvency resolution.



Under the automatic fresh start process, eligible debtors (basis gross income) can apply to the Debt Recovery Tribunal (DRT) for discharge from certain debts not exceeding a specified threshold, allowing them to start afresh.



The insolvency resolution process consists of preparation of a repayment plan by the debtor, for approval of creditors. If approved, the DRT passes an order binding the debtor and creditors to the repayment plan. If the plan is rejected or fails, the debtor or creditors may apply for a bankruptcy order.



Institutional Infrastructure
 
A key innovation of the Insolvency and Bankruptcy Code is four pillars of institutional infrastructure. 

The first pillar of institutional infrastructure is a class of regulated persons, the ‘Insolvency Professionals’. They would play a key role in the efficient working of the bankruptcy process. They would be regulated by ‘Insolvency Professional Agencies’. 

The second pillar of institutional infrastructure is a new industry of `Information Utilities'. These would store facts about lenders and terms of lending in electronic databases. This would eliminate delays and disputes about facts when default does take place. 

The third pillar of institutional infrastructure is in adjudication. The NCLT will be the forum where firm insolvency will be heard and DRTs will be the forum where individual insolvencies will be heard. These institutions, along with their Appellate bodies, viz., NCLAT and DRATs will be adequately strengthened so as to achieve world class functioning of the bankruptcy process. 

The fourth pillar of institutional infrastructure is a regulator viz., ‘The Insolvency and Bankruptcy Board of India’. This body will have regulatory over-sight over the Insolvency Professional, Insolvency Professional agencies and information utilities. 

Importance of the Code

The Insolvency and Bankruptcy Code is thus a comprehensive and systemic reform, which will give a quantum leap to the functioning of the credit market. It would take India from among relatively weak insolvency regimes to becoming one of the world's best insolvency regimes. It lays the foundations for the development of the corporate bond market, which would finance the infrastructure projects of the future. The passing of this Code and implementation of the same will give a big boost to ease of doing business in India. 
 
Advantages of the Code

- Address cross-border insolvency through bilateral agreements with other countries

- Shorter time frames for every step in the insolvency process—right from filing a bankruptcy application to the time available for filing claims and appeals in the debt recovery tribunals (DRTs), National Company Law Tribunals (NCLTs) and courts.

- Having a robust insolvency resolution mechanism can help creditors recover a larger part of their investment faster, allowing them to re-invest in other businesses, thereby facilitating the efficient flow of capital across the economy

- Creation of a new class of insolvency professionals that will specialize in helping sick companies.
- Creation of information utilities that will collate all information about debtors to prevent serial defaulters from misusing the system.

- Ensure time-bound settlement of insolvency, enable faster turnaround of businesses and create a data base of serial defaulters—all critical in resolving India’s bad debt problem which has crippled bank lending.

- Improve India’s position in the World Bank’s Doing Business ranking.

- There will be one single law in place of multiple laws and remove the overlapping jurisdiction
 
Critique of the Code

- Time-bound insolvency resolution will require establishment of several new institutional mechanisms.  The current capacity of debt recovery tribunals may be inadequate to take up the additional role.

- IPAs, regulated by the Board, will be created for regulating the functioning of IPs.  This approach of having regulated entities further regulate professionals may be contrary to the current practice of regulating licensed professionals.  Further, requiring a high value of performance bond may deter the formation of IPAs.

- The order of priority to distribute assets during liquidation is unclear. For instance – why secured creditors will receive their entire outstanding amount, rather than up to their collateral value; why unsecured creditors have priority over trade creditors? and why government dues will be repaid after unsecured creditors.

- The Code provides for the creation of multiple IUs. However, it’s possible that complete information about a company may not be available through a single IU. This may lead to financial information being scattered across these IUs.

- The Code creates an Insolvency and Bankruptcy Fund.  However, it does not specify the manner of usage of the fund.




Sunday, 22nd May 2016, 09:34:59 PM

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