In the backdrop of Vijay Mallya episode and season of corporate defaults when public sector banks and financial institutions are helplessly chasing their dues in largely protracted legal battles, the Parliament of India in the first week of May swiftly passed Insolvency and Bankruptcy Code 2016 (New Code). The New Code will now be sent for President's assent before it is formally enacted.
"Insolvency" or "Bankruptcy" in common parlance refers to incapacity of a person in repaying legitimate dues of a third party. An insolvency state of affairs may be resolved by changing repayment terms of dues or writing-off part of debt. If insolvency state of affairs cannot be resolved this way, a business can be closed down and assets of debtor may be sold to secure money for repayment of dues. Corporate insolvency in India till now has always been regulated and administered by multiple and sometime overlapping laws including Companies Act, DRT Act, SARFAESI Act and SICA Act to name a few. Since early 90s, the lenders have largely relied upon BIFR (abbreviation to Board for Industrial and Financial Reconstruction) under provisions of SICA Act to address the reconstruction and rehabilitation of 'sick' and 'potentially sick' companies. However the efforts to revive these companies through BIFR have mostly remained unsuccessful and instead have resulted in benefiting unscrupulous promoters and wilful defaulters in delaying the debt recovery and prolonging the existence of inefficient businesses at the cost of helpless lenders and tax payers. On the other hand, individual insolvency has always been regulated and administered through the Presidency Towns Insolvency Act (for residents of Mumbai, Kolkata and Chennai) and Provincial Insolvency Act (for other residents) which are century old legislations and have now outlived their utility.
New Code proposes to consolidate the existing legal framework by repealing above said two legislations regulating individual insolvencies and amending eleven other laws regulating corporate insolvencies in India. The New Code proposes to create a single comprehensive law to address the insolvency and bankruptcy issues across the board. With a dual objective of implementing ease of doing business and improving India's global ranking in terms of time taken to close a business which is presently significantly poor when compared to other countries, the New Code creates a time-bound process for insolvency resolution of individuals, unregistered partnership firms and companies (including special statute companies and limited liability partnerships). Insolvency and liquidation of financial service providers including those regulated by SEBI, RBI and IRDA has been purposely kept out from scope of New Code given the linkage between financial service providers and systemic risk implications for the economy which warrants a separate regulatory regime for them.
New Code prescribes a fixed timeline of 180 days for insolvency resolution failing which the assets of borrowers may be sold to repay the creditors. It provides for an institutionalised professional framework to run insolvency resolution process. The process involves (a) licensed Insolvency Professionals (IPs) to administer the insolvency resolution process and manage the assets of the debtor; (b) Insolvency Professional Agencies (IPAs) to register and regulate the IPs and enforce their code of conduct on IPs; and (c) Information Utilities (IUs) as custodian of financial, debt and default information of the debtors. These professional agencies will in turn be regulated and monitored by the Insolvency and Bankruptcy Board of India (Bankruptcy Board). Presently, it is unclear if function of Bankruptcy Board and IPA regulating the IPs will overlap to some extent given the role designated for each of them under the New Code. Also whether the existing credit information companies could assume the role of proposed IUs and if such IUs can have a common information sharing platform on a real time basis. To ease the mounting burden of Courts from high number of corporate default litigations on which Chief Justice of India recently got emotional, the adjudication role under the New Code will be played by the National Company Law Tribunal (NCLT) for body corporate insolvents and Debt Recovery Tribunal (DRT) for individual and firm insolvents. Although this is encouraging, poor track record of DRTs in disposing the debt recovery matters may prove to be a bottleneck in successfully implementing the New Code, unless there is a comprehensive overhaul of DRTs by fresh infrastructure and capacity build-up.
Whilst procedural aspects of new law may be discussed in detail endlessly, there are few finer points which one may want to have a closer look. For instance, new law suggests change in the order of priority to distribute assets during liquidation. Like, government dues which were given preferential payment treatment under the Companies Act have moved down in the priority chart prescribed under New Code. Further unsecured creditors for financial debt have been offered priority over operational or trade unsecured creditors as well as government, which seems illogical. Secured creditors have been offered upper hand as they will be able to realise their entire outstanding amount (and not only the value of their security interest) either by enforcing the security interest or relinquishing the security interest to the liquidation estate. Similarly in the provisions dealing with the adjudication process, NCLT has been offered mere fourteen days' time to ascertain the existence of a default based on the records of IUs or other evidence provided by an applicant creditor in the corporate insolvency resolution process (CIRP). This is too without offering an opportunity of being heard to the corporate debtor. This may defeat the principle of natural justice vis-à-vis the corporate debtor and NCLT may end up admitting several frivolous petitions. Some of these provisions need a close review.
Recent increase in non-performing asset level at public sector banks and rising number of corporate defaulters may have prompted GOI to introduce the New Code expeditiously. Some of the acts such as concealment of property, defrauding creditors, misconduct in course of insolvency resolution process, falsification of books of corporate debtor, wilful and material omissions from statements relating to affairs of corporate debtor and false representations to creditors are made criminal offence under the New Code which will act as deterrent for the defaulting borrowers. The New Code is expected to have far reaching implications in enabling fast recovery of dues much before the capital is eroded. This would also help in flushing out the inefficient businesses from the system and would facilitate deploying fresh capital to the more deserving enterprises strengthening Start-up India initiative of GOI in true sense. Undoubtedly, it brings a ray of hope for lenders beyond a dark tunnel.
Author is a principal associate with law firm - IC Legal based in Mumbai.
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