India: Not Every Bankrupt Will Be A Total Failure!

Last Updated: 3 January 2017
Article by Vikrant Rana and Chanakya Sharma

The Insolvency and Bankruptcy Code, 2016

The Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as "the Code") received the President's assent on May 28, 2016 and has subsequently been brought into force. The Code has an overriding effect on contradicting provisions of Companies Act, 2013, Sick Industrial Companies (Special Provisions) Act, 1985, and Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920 Recovery of Debts Due to Banks and Financial Institutions Act, 1993 and Limited Liability Partnership Act, 2008 and provides a simple and cogent Insolvency code.

Introduction:

Nature is ruled by the fundamental phenomenon of 'survival of the fittest'. A corollary of this is that failures and inability to survive will be an inevitable part of an ecosystem- whether biological or economical. In today's optimistic and energized economic environment, when it comes to startup & capital economies, such a statement carries the risk of sounding cynical. However, the unprecedented codification of the laws related to Insolvency and Bankruptcy in India, have induced a notion that not all unsuccessful business or financial projects need to be "failures". The codification brings to India a smooth Insolvency Resolution Process, which will prove to be a win-win situation for creditors and debtors as far as possible.

Background:

When a business fails or defaults, the due course of action is to reorganize its human resource, capital and other resources and reintegrate it thereby mitigating the loss caused to the economic ecosystem at large. The BLRC Report1 very rightly captures the need of an efficient insolvency resolution mechanism, "The failure of some business plans is integral to the process of the market economy. When business failure takes place, the best outcome for society is to have a rapid renegotiation between the financiers, to finance the going concern using a new arrangement of liabilities and with a new management team. If this cannot be done, the best outcome for society is a rapid liquidation. When such arrangements can be put into place, the market process of creative destruction will work smoothly, with greater competitive vigor and greater competition."

Erstwhile legislations:

Efforts have been made previously, for smoothening insolvency proceedings and ironing out the creditor's losses by suitable legislations. However, these efforts were directed towards remedying or rectifying the existing laws and filling up their loopholes thereby making only incremental changes. It is noteworthy that in the making of this Code the efforts of the BLR Committee were directed towards creating a new legislation that would provide redressal for all aspects related to insolvency at one station itself. The present Committee2 had taken up the task of drafting a single unified framework which deals with bankruptcy and insolvency by persons other than financial firms. The Committee chose the strategy of repealing many existing laws on bankruptcy and insolvency, and writing a clean modern law which provides a simple, coherent, and effective answer to the problems under Indian conditions.3 This Code not only expedites the process of insolvency resolution, but also facilitates effective and detailed procedure, authorities and powers vested in those authorities.

What does it seek to achieve?

The Code seeks to achieve, "A time bound manner for maximisation of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues and to establish an Insolvency and Bankruptcy Board of India, and for matters connected therewith or incidental thereto."4

The value of the creditor's investment will depreciate (value destruction) with the change in such a dynamic economy hence an expedited resolution is necessary. Achieving a high recovery rate is primarily about identifying and combating the sources of delay5, hence, a time-bound resolution is sought.

Creditor's Control on default:

A limited liability company is a contract between equity and debt. As long as debt obligations are met, equity owners have complete control, and creditors have no say in how the business is run. When default takes place, control is supposed to transfer to the creditors; with the equity owners having no say6. In the Code's provisions a paradigm shift is seen from debtor's control to creditor's control upon default. This shift is vital as there was misuse of the resolution process which was previously used only as an excuse to prolong meeting the creditor's obligations. The recovery rates obtained in India are among the lowest in the world. The BLRC report estimated that when default takes place, broadly speaking, lenders seem to recover 20% of the value of debt, on an NPV basis.

Institutional Infrastructure:

The Code facilitates two Adjudicating Authorities, the National Company Law Tribunal which will preside over matters of companies, limited liability entities and the Debt Recovery Tribunal which will preside over mattes of individuals, unlimited liability partnership firms. An Insolvency and Bankruptcy Board (IBB) will be established by the Code. This Board is similar to SEBI and will be the regulatory authority for insolvency proceedings, the Insolvency Professional Agency (IPA), Insolvency Professional (IP) and the Information Utilities (IU). Appeals can be made to National Company Law Appellate Tribunal and Debt Recovery Appellate Tribunal respectively.

What are IPAs, IPs and IUs?

The Code prescribes establishment of Insolvency Professional Agencies (IPA) which will regulate the Insolvency Professionals (IP). The IPA will prescribe qualifications for the IPs, who will be required to be enrolled with the Agencies for functioning. Once an application for insolvency is admitted, the IPs will take over the administration of the Company and the Board of Directors will cease to have control. The Information Utilities will serve as one single window for information about the company to be available for creditors and debtors as well according to prescribed rules. This ensures transparency and access to untainted information which will be helpful during the Resolution Process/ Liquidation Process.

Section 244 in the Code provides that until the Insolvency and Bankruptcy Board is constituted or a financial sector regulator is designated, its powers shall be exercised by the central government. This provides for early and easy execution of the Code, establishment of the entire infrastructure and eco-systems need not be awaited. The execution is thereby expedited.

What is the IRP?

When there is a default in the business, the financial creditors, the operational creditors or the debtor himself can apply for Resolution to the Adjudicating Authority. Even though the operational creditors have a right to initiate the process by application they cannot form a part of the committee of creditors (CoC), who participate in the Resolution Process. When the application is admitted by the Adjudicating Authority, the IPs will take over control of the Company.

The Insolvency Resolution Process is a platform for communication between the creditors and the debtors to agree on the viability of the business and the future resolution plans. The creditors and debtors will collectively come up with such a Resolution Plan. This plan is to be approved by 75% of the Creditor's Committee. As, the process is time bound, there is a prescribed time limit of 90 days extendable up to 180 days, to come up with agreeable plan.

If however, no agreeable solution is reached by the CoC, then the company will move for liquidation.

Moratorium- The Calm Period:

When the application is admitted, and a public notice is issued, the moratorium begins. The creditor cannot claim his security interests during this period. It provides a calm period for conducting discussions and deliberations at the CoC. During the calm period the status quo of the debtor's assets is to be maintained.

Liquidation: On Priority basis

Before the expiry of the insolvency resolution process period or the maximum period permitted for completion of the corporate insolvency resolution process, if the Adjudicating Authority does not receive a resolution plan or the same is rejected by an order, the Adjudicating Authority shall pass an order requiring the corporate debtor to issue a public announcement stating that the corporate debtor is in liquidation. The Adjudicating Authority will also issue a notice regarding such liquidation to the corporate debtor.

On the appointment of a liquidator, all powers of the board of directors, key managerial personnel and the partners of the corporate debtor, shall cease to have effect and shall be vested in the liquidator.

Chapter IV provides for fast track liquidation process, which has a resolution time period of 90 days, in accordance with the rules prescribed by the Central Government. Also, the following chapter, Chapter V provides for a voluntary liquidation process.

The waterfall:

The assets will be liquidated according to the priority prescribed under the Code which is as follows:

Priority is given (a) to costs or the IRP followed by (b) secured creditors and workmen and employee dues; further (c) followed by financial debts of unsecured creditors; and lastly (d) dues to be paid to the Central and State Government. After these are cleared, the remaining dues and equity will be satisfied.

The BLR Committee had recommended to keep the right of the Central and State Government in the distribution waterfall in liquidation at a priority below the unsecured financial creditors in addition to all kinds of secured creditors for promoting the availability of credit and developing a market for unsecured financing (including the development of bond markets). In the long run, this would increase the availability of finance, reduce the cost of capital, promote entrepreneurship and lead to faster economic growth. The government also will be the beneficiary of this process as economic growth will increase revenues. Further, efficiency enhancement and consequent greater value capture through the proposed insolvency regime will bring in additional gains to both the economy and the exchequer.7

Fresh Start Proceedings:

A unique feature of the Code is seen in Chapter II. It provides for conditions in which a debtor (only applicable to individual) may be discharged of his qualified debt if the conditions under Section 88 are fulfilled. The Section provides that if any person whose:

  • gross annual income does not exceed sixty thousand rupees;
  • aggregate value of the assets does not exceed twenty thousand rupees;
  • aggregate value of the qualifying debts does not exceed thirty-five thousand rupees;

And who is not an undischarged bankrupt; and does not own a dwelling unit, irrespective of whether it is encumbered or not; and does not have any previous or pending fresh start process against him will be entitled to discharge of debt under the fresh start proceedings. These proceedings will held startups considerably.

The Code prescribes a detailed process for discharging such persons' qualified debt.

Concluding marks:

For attracting investment into the country, the foremost concern of a creditor is that there should be some security for his/her investment. This compels creditors to invest only in reputed businesses. If a creditor has enough trust that if the business fails, his credit can be recovered, he will be encouraged to invest. The modern credit market will prosper significantly when such credit is easily accessible.

With so many budding and emerging startups and small industries in the Country, the harness of such an unprecedented legislation is a welcome move for both young business ideas and experienced investors. The access to capital market and a low risk investment mechanism which the Code seeks to establish, will surely contribute to more resource and capital inflow in the market thereby contributing significantly to the Indian economy.

Footnotes

 1 Bankruptcy Law Reforms Committee Report, Vol I ("BLRC Report")

2 Bankruptcy Law Reforms Committee chaired by T.K. Vishwanathan

3 Bankruptcy Law Reforms Committee Report, Vol I ("BLRC Report")

4 ibid

5 ibid

6 ibid

7 ibid

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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