Insolvency resolution procedures in India were often perceived to be both operationally inadequate and lacking in efficacy, resulting in an adverse impact on both investor sentiment and the performance of domestic lenders. Additionally, with the existence of several overlapping legislations such as the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 ("RDDB Act"), the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 ("SARFAESI Act") and the Companies Act, 2013 ("2013 Act"), along with multiple institutional frameworks established under these legislations, the process of insolvency resolution was complicated and time consuming, often taking about 5-6 years to complete. Further, insolvent individuals were covered under a separate set of legislations such as the Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920, which too were deemed unsuitable in a rapidly evolving commercial environment.
With the increasing exposure of foreign entities to businesses across multiple sectors in India, having an effective mechanism to address insolvency and cover creditor rights is seen as crucial in galvanizing investor sentiment and in ensuring the long term sustainability of the economy.
The Insolvency and Bankruptcy Code, 2016 ("Code") was introduced in the Lower House of the Parliament of India on December 21, 2015 with the view to consolidate and amend the laws relating to reorganisation and resolving the insolvency of corporates, partnerships and individuals. The Code is expected to help promote entrepreneurship, availability of credit and balance the interests of all concerned stakeholders. The Code was approved by the Lower House of the Indian Parliament on May 5, 2016 and by the Upper House on May 11, 2016, and subsequently received presidential assent on May 28, 2016. However, the provisions of the Code have at present not been brought into force, and the commencement of the same shall be undertaken from such date as may be notified by the Government of India. By introducing a number of new agencies in the Indian insolvency landscape, such as insolvency resolution professionals ("IRPs"), insolvency professional agencies ("IPAs") and information utilities, the Code marks a significant shift in the manner of conducting insolvency proceedings in India.
In the course of this article, we shall discuss the adjudicatory mechanisms adopted under the Code and the challenges relating to the same. Further, we shall discuss the outstanding concerns surrounding the moratorium on parallel legal proceedings and the feasibility of stringent timelines in an untested adjudicatory environment, in addition to other teething problems that may be encountered in the early stages of implementation of the Code.
In line with its overall structure, the Code provides for separate adjudicatory processes for different classes of debtor entities, namely companies and limited liability partnerships ("LLPs") on the one hand, and individuals and partnership firms on the other.
As per Chapter I of Part II of the Code, insolvency resolution proceedings in relation to companies and LLPs are to be conducted by the National Company Law Tribunal ("NCLT"), established under the 2013 Act. Significantly, the Central Government has duly notified the setting up of the NCLT w.e.f. 1 June, 2016 by a notification dated 1 June, 2016. Once the sections of the Code are notified, the NCLT will be tasked with the role of appointing an interim IRP at the outset, and subsequently approving the resolution or repayment plan, if duly approved by the creditors of the debtor entity in accordance with the Code. In the event that a resolution or repayment plan is not submitted within the prescribed timeline or if the same is rejected for non-compliance with the provisions of the Code, the NCLT shall order the liquidation of the corporate debtor. Additionally, the NCLT may also order for liquidation in the event that the IRP intimates a decision of the creditor's committee to liquidate the debtor or upon a contravention of the approved resolution plan by the debtor.
The Code provides for the following waterfall for distribution of amounts pursuant to liquidation of a corporate debtor in the following order of priority:
- Insolvency resolution/liquidation process costs;
- Workmen's dues for the period of 24 months preceding liquidation commencement date and debts owed to secured creditors if they have relinquished securities (For the purposes of companies and LLPs, 'workmen's dues' shall has the meaning assigned to the term under Section 326 of the 2013 Act).
- Wages and unpaid dues owed to employees other than workmen for the period of 12 months preceding the liquidation commencement date. 'Workmen' are defined in accordance with Section 2(s) of the Industrial Disputes Act, 1947.
- Financial debts owed to unsecured creditors
- Any amount due to the government of the period of two years preceding the liquidation commencement date and debts owed to secured creditors for any amount unpaid following the enforcement of security interest
- Any remaining dues and debts
- Preference shareholders
- Equity shareholders or partners
One will note that the above is different from the existing distribution waterfall under the Companies Act, 1956, where priority was accorded to secured creditors and dues owed to governmental bodies.
An order of the NCLT may be appealed against before its appellate forum, the National Company Law Appellate Tribunal ("NCLAT") within a timeframe of 30 days (extendable by another 15 days at the discretion of the NCLAT). An order of the NCLT may be appealed against on either of the following grounds:
- The approved resolution plan is not in compliance with any applicable law;
- Material irregularity in exercise of powers by the IRP during the insolvency resolution period;
- Debts owed to operational creditors have not been provided for in the resolution plan in the manner specified by the Insolvency and Bankruptcy Board of India ("Board");
- Insolvency resolution costs have not been provided for repayment in preference to other debts; or
- The approved resolution plan does not comply with any other criteria specified by the Board.
An appeal against an order of the NCLAT shall lie with the Supreme Court of India ("Supreme Court"), if such appeal is on a matter of law. The appeal has to be filed within 45 days from the date of receipt of the order (extendable by another 15 days at the discretion of the Supreme Court).
Individuals and Partnership Firms
Chapter I of Part III of the Code provides that insolvency resolution proceedings in relation to individuals and partnership firms shall be adjudicated upon by the Debt Recovery Tribunal ("DRT") constituted under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993. The role of the DRT involves the appointment of the IRP, the admission or rejection of the resolution application (on the basis of a report prepared by the insolvency resolution professional), issuance of a public notice to the creditors and approval or rejection of the repayment plan approved by the creditors. Further, the DRT shall also commence bankruptcy proceedings under the prescribed circumstances.
In line with the approach applicable to corporate debtors, the Code has provided for payment in the following order of priority pursuant to the liquidation an individual or partnership firm:
- Costs incurred by the bankruptcy trustee;
- Workmen's dues for the period of 24 months preceding the bankruptcy commencement date AND debts owed to secured creditors (Please note that the Companies Act, 2013 definition of 'workmen's dues' is not applicable in relation to the bankruptcy of individuals/partnerships).
- Wages and unpaid dues owed to employees other than workmen for the period of 12 months preceding the bankruptcy commencement date.
- Any amount due to the Government of the period of two years preceding the bankruptcy commencement date.
- Any remaining dues and debts, including unsecured debts.
An appeal against an order of the DRT shall lie with the Debt Recovery Appellate Tribunal ("DRAT"), with such appeal having to be filed within a timeframe of 30 days (extendable by another 15 days at the discretion of the DRAT). An appeal against an order of the DRAT on a question of law may be filed with the Supreme Court within a period of 45 days (extendable by another 15 days at the discretion of the Supreme Court).
Opportunities and Challenges
Expanded Right of Access
In a significant shift from the existing legal regime governing corporate insolvency resolution, the Code provides for a right of access to the NCLT for all classes of creditors, including financial and operational creditors. The definition of 'operational creditor' under Chapter I of Part II of the Code is expansive and includes trade creditors, employees and government bodies or agencies to whom any statutory dues are owned. This is in sharp contrast to the provisions of existing legislations such as the RDDB Act, which restricts the remedy to a select class of lenders, i.e. banks and financial institutions, or the SARFAESAI Act, which is limits its purview to secured creditors. This development under the Code may therefore be seen as an effort to place the interests of various classes of lenders on an equal footing and recognize the role of newer forms of credit transactions in a rapidly evolving economy.
Specific carve-out – Personal guarantors of corporate entities
While proceedings in relation to individuals are adjudicated upon by the DRT, the Code provides an exception for applications relating to insolvency resolution or bankruptcy of a personal guarantor of a corporate debtor whose insolvency resolution or liquidation proceedings are pending before the NCLT. The effect of the carve out would be to address the proceedings concerning both the corporate debtor and the personal guarantor in a uniform consolidated manner, given the overlapping fact situation and issues in contention. The same is expected to provide sufficient ease to parties by avoiding duplication of proceedings before different forums.
The early stages of the implementation of the Code are expected to see significant challenges, particularly in light of the aggressive timelines set under the Code for the conclusion of insolvency resolution proceedings. The Code requires the process for corporate debtors to be concluded before the NCLT within a period of 180 days from the date of admission of the application (extendable by a further period of up to 90 days). The resolution process governing individuals and partnerships before the DRT too is subject to stringent timelines, including in relation to the appointment of the resolution professional, (17 days) submission of the report by the resolution professional to the DRT (10 days) and submission of the repayment plan (21 days from submission of the last claim).
It is also not out of place to mention that even prior to implementation of the Code, significant steps will be required to be taken to set up IRPs and IRA and ensure that there are adequate number of IRPs certified.
While the NCLT, having been established very recently, is still an untested entity, the existing benches of the DRT are already overburdened with ongoing matters. Further, the NCLT presently has only 11 benches across India. The ability of these adjudicatory bodies to cope with the disputes arising under the Code, within the prescribed timelines, remains to be seen. However, in order to provide these bodies with sufficient leeway to tackle these early challenges, the Code permits the Government to give effect to its provisions in a staggered manner, permitting a gradual transfer of powers and responsibilities over a reasonable period of time.
Moratorium on Parallel Proceedings
Among the more important aspects of the resolution process under the Code is the provision for a moratorium on parallel legal proceedings against the debtor during the pendency of the insolvency resolution proceedings before the NCLT or the DRT (as applicable). While such a moratorium provision serves as a significant comfort to debtors handling an insolvency scenario, it also curtails the ability of lenders to exercise alternate means of seeking relief. Given the potential impact of the same, the substance and scope of the moratorium provisions assumes significance.
The Code provides that upon the commencement of an insolvency proceeding in relation to companies or LLPs, the NCLT shall by order declare a moratorium on (i) the institution of suits; and (ii) the continuation of pending suits or proceedings, against the corporate debtor, including the execution of any judgment, decree or order in any court, tribunal or arbitral panel. Therefore, while the scope of the moratorium covers all manner of proceedings against the debtor (including those not related to recovery of debts), the language of the provision appears to provide a window to creditors to institute or initiate any legal proceeding other than a suit, so long as the same is not continued.
On the other hand, the moratorium provisions applicable to individuals and partnerships firms limit the moratorium to any legal action or proceeding pending in respect of any debt, with the creditors not being permitted to institute any legal action or proceedings in respect of any debt. Therefore, while the moratorium covers both the institution and continuation of proceedings, the scope of both is restricted to proceedings in respect of any debt. Therefore, it would appear that criminal proceedings or proceedings for specific performance against the debtor, so long as not relating to any debt, would be permitted to be instituted and continued.
The absence of such restrictive language in relation to corporate debtors conveys an inconsistency in approach with corporate debtors being potentially shielded from criminal or other proceedings (even if not related to any debt), while individuals and partnership firms would continue to be exposed to the same.
The Way Forward
The enactment of the Code marks the beginning of a concerted effort to institute a streamlined, consolidated and time-bound insolvency resolution regime in India. The move may be viewed in the context of the larger effort undertaken by the Indian Government to create a more business friendly environment by introducing greater regulatory clarity and simplified dispute resolution procedures. Other instances of this effort have been seen in the recent relaxations provided under the foreign investment regulations, the amendments undertaken to the arbitration law regime and in the constitution of specialised courts to deal with commercial matters.
However, the manner of implementation and effectiveness of the Code remains in question. Its impact in expediting insolvency and liquidation proceedings is dependent upon the constitution of the relevant adjudicatory and regulatory authorities, and the growth of a market in the new agencies envisaged under the Code, namely, the IRPs, IPAs and information utilities. The Code, in its current form, requires the IPAs to both regulate their member IRPs and simultaneously compete in a market with multiple IPAs. Therefore, there may be a conflict of interest between the regulatory and competitive goals of IPAs, with IPAs being unwilling to take action against erring member IRPs in order to project a positive image. Further, the effectiveness of the information utilities will depend heavily on infrastructure creation and maintenance, something that has been an issue with Governmental institutions in the past.
A comprehensive and sustained effort at implementing the objectives of the Code in their letter and spirit will give a significant impetus to investor sentiment and be a crucial element in furthering the ease of doing business in India.
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