India: Insolvency And Bankruptcy Act, 2016: A Boon For Secured Creditors

Insolvency is a term which has always been related to an individual or a company/business. Often the term is used for describing the insolvency of a company. A company is said to have become insolvent when the net liabilities of its business becomes greater than the assets possessed by the business organization. One of the major concerns which arise at the time of winding up of a company is recovery of the debts. Companies are given various loans and investments by numerous banks, shareholders, secured creditors etc. Secured creditors are the entities which must be the first to be satisfied by paying back the debts at the time of winding up. Banks are the major creditors in this group, often holding a fixed charge on property or other business assets. At present there are numerous laws and adjudicating institutions dealing with financial failures in India. However, the legal and institutional framework did not aid lenders in effective and timely recovery or restructuring of defaulted assets and caused undue strain on the Indian credit system. For this reason, the Government of India after the recommendation of the joint committee of Parliament introduced the Insolvency and Bankruptcy Bill on 21st December 2015, which subsequently became an Act after the assent of the President on 28th May 2016.

The new Insolvency Act incorporates certain changes and brings forth new provisions which promise to discard the faults which were present in the previous acts. Prior to the Act, the Indian banking system was highly fragmented, implemented by multiple judicial forums resulting in lack of certainty in jurisdiction with almost every statute having an overlapping jurisdiction upon the other. Even though there was no single law that dealt with insolvency and bankruptcy in corporate sector; there were two prominent statutes that dealt with debt recovery, i.e. the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 ("RDDB") and the Securitizations and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 ("SARFAESI"). In addition to this, the revival and rehabilitation of "sick" industrial companies was looked into by the Sick Industrial Companies (Special Industries) Act, 1985. In addition, Banks could seek recourse to the corporate debt restructuring (CDR) and joint lenders forum (JLF) mechanism for resolving stressed consortium loans.

LIMITATIONS OF PREVIOUS ACTS

The previous acts suffered from various limitations which included applicability, fulfilling objectives, and being effective.

  • The RDDB Act and SARFAESI Act applied only to Indian banks ad not to foreign banks and nonbanking lenders (increasingly important sources of funding for business of in India). In addition to this, a major issue is that these acts are also aimed at debt recovery rather than assessment of an enterprise as a going concern. Even when the proceedings are triggered, the directors of the company retain their control over the Company and its assets, thereby creating a risk of asset depreciation.
  • The SICA applies only to industrial companies which creates a major problem since India is increasingly becoming a services-led economy. Further, under SICA, even if the Board for Industrial & Financial Reconstruction ("BIFR") recommends liquidation, a reference is made to the High Court, which re-examines the recommendation and potentially even reverses it.
  • Like RDDB Act, CDR and JLF also apply only to regulated banks and non-banking finance companies and are meant as banking regulation to give capital relief rather than address insolvency in a systemic manner.

With an aim to address these problems, provide with expeditious recovery, to empower all classes of creditors and redeploy capital into more profitable ventures, , the Ministry of Finance formed the Bankruptcy Law Reform Committee which submitted its report and a draft Insolvency and Bankruptcy Code ("IBC") in November 2015.

The objectives of this Act are –

  1. To empower all creditors-secured, unsecured, domestic, international financial and operational to trigger resolution;
  2. To enable the resolution process to start at earliest sign of financial distress;
  3. It provides a single forum overseeing all insolvency and liquidation proceedings;
  4. It enables a calm period where other proceedings do not derail existing ones;
  5. It replaces existing management during insolvency proceedings while keeping the enterprise as a going concern;
  6. It offers finite time limit within which debtor's viability can be assessed and
  7. Under bankruptcy, lays out a linear liquidation mechanism.

The Insolvency and Bankruptcy Act, 2016 has various salient features which makes the Act an important milestone in the field of expeditious recovery of debts and ensuring the secured creditors with successful credit recovery. The salient features are –

  1. Insolvency Resolution Process: The Act specifies similar insolvency resolution processes for companies and individuals, which will have to be completed within 180 days. This limit may be extended to an additional 90 days in certain circumstances. The resolution process will involve negotiations between the debtor and creditors to draft a resolution plan. The process would end under two circumstances,
    1. When the creditors decide to evolve a resolution plan or sell the assets of the debtor and;
    2. When 180 days time period for negotiations has come to an end.

In case a plan cannot be negotiated upon during the time limit, the assets of the debtor will be sold to repay his outstanding dues.

  1. Priority under liquidation: The assets will be distributed in the following order, in case of liquidation:
    1. fees of insolvency professional and costs related to the resolution process,
    2. workmen's dues and secured creditors,
    3. employee wages,
    4. unsecured creditors,
    5. government dues and remaining secured creditors,
    6. any remaining debt, and
    7. Shareholders.
  1. Insolvency professionals and agencies: The resolution process will be conducted by a licensed insolvency professional (IP). The IP will control the assets of the debtor during the process. Insolvency professional agencies will be created to regulate these IPs. The agencies will conduct examinations to enroll IPs and enforce a code of conduct for their functioning.
  2. Insolvency Regulatory Board: A separate Board shall be established other than the National Company Law Tribunal ("NCLT") and the Debts Recovery Tribunal ("DRT") for dealing with matters of Insolvency and Bankruptcy of Companies. This board would oversee and regulate the functioning of the IPs, insolvency professional agencies and information utilities. The composition of the Board would be of 10 members, which would include representative members from Central Government and the Reserve Bank of India.
  3. Insolvency and Bankruptcy Fund: The Act shall create an Insolvency and Bankruptcy Fund. The Fund would receive contributions from any person. This contribution has to be voluntary. In cases where the insolvency proceedings start against any of such contributors, the member shall be allowed to withdraw his contribution from the IB Fund so as to protect his assets from being liquidated and for making payments to the workmen etc.
  4. Adjudicatory Authorities: The Act proposes two tribunals to adjudicate insolvency resolution cases: (i) National Company Law Tribunal will adjudicate cases for companies and limited liability partnerships, and (ii) Debt Recovery Tribunal will adjudicate cases for individuals and partnership firms.
  5. Moratorium: One of the most significant features of the Act is the grant of moratorium during which creditor action will be stayed. This is not automatic and has to be granted by the Adjudicating Authority on the recommendation of the Resolution Professional.
  6. Offences: The Act also provides with penalties for the companies or the individuals who commit offences under the act (such as concealing property). The punishment for companies defaulting under the corporate insolvency is imprisonment up to five years, fine to the tune of One Crore Rupees, or both. Whereas, punishment under individual insolvency (such as providing false information) shall be an imprisonment for a period of six months, or a fine up to the tune of Five Lac Rupees, or both.

CONCLUSION

The previous acts dealing in insolvency and recovery of debts had cluttered the whole procedure and effectiveness of the acts by giving overlapping powers to each other. The overlapping powers had led to haphazard procedures and confusing scenarios where the secured creditors i.e. the banks did not had the proper remedies when it came to recovery of debts. The mere fact that the decisions given by the DRT could be reversed by High Court on appeal made it very lengthy and tiring process for the creditors. The time taken by such proceedings proved to be beneficial for the Board of the Companies as they used to get time for asset stripping.

The new Insolvency and Bankruptcy Act provides for speedy disposals of these processes as it divides the authority and the jurisdiction of the NCLT and DRT between individuals and companies. It also provides with a list of priorities which shall be given preference for settlement of such debts at the time of liquidation of the assets of the company (first on the list is settlement of liquidation cost). The New Act which provides for various funds and offences seems to be a touchstone for providing fair chance to the creditors for recovery of their debts in a very simple process, free from any encumbrances.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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