India: Guide To Insolvency Code - Protection ‘From ' Banks/FIs? Or ‘For' Them?


According to Merriam Webster dictionary, an Insolvent is a person who is a) unable to pay his debts as they fall due in the usual course of business and b) having liabilities in excess of a reasonable market value of assets held.

Insolvency is defined as the fact or state of being insolvent.

Insolvency can further be, either cash flow insolvency wherein the debtor suffers from lack of financial liquidity to pay off his debts though the value of his assets may be in excess of his total liabilities or the Balance Sheet insolvency wherein the liquidated value of all the assets would not be sufficient to cover off all the liabilities of the Debtor.

Evolution of insolvency law

As is the case of majority of the laws, insolvency laws in India find their origin in the English Law. While initially reliance was placed on the statutes enacted in the UK, the Indian Insolvency Act was passed in 1848. Over the years several enactments and amendments were brought in, especially resulting from the 26th Law Commission, and erstwhile laws (Presidency Towns Insolvency Act 1909 and Provincial Insolvency Act 1920) continued to be in effect till they were replaced by the Insolvency and Bankruptcy Code, 2016 (IBC). Objective of the Insolvency Laws The primary objective of any Insolvency or Bankruptcy law is to protect the troubled debtor from going into a tailspin and help it revive while at the same time balance the interests of all classes of creditors (including workmen) against it. Not only this is beneficial for the troubled debtor and associated creditors but also for the overall health of the financial system and economy as a whole.

Simple and effective insolvency laws go a long way in improving the overall business and investment climate of a nation. Friendly and time bound resolution of insolvency proceedings play a vital role in determining investor confidence by helping investors sail through a troubled investment in an efficient manner. Notably, India was ranked 130 out of 189 Countries evaluated on the Ease of Doing Business index and ranks 136 out of 189 Countries on the resolving insolvencies in the World Bank's Index Report 2016.

Besides the obvious intent to revive the ailing debtor and improve investor confidence, it is interesting to note, that a common theme which has prevailed and observed by various committees and commissions over the years on insolvency is to address the needs and grievance of classes of creditors other than secured creditors. Be it the Law Commission report of 1964 or the Bankruptcy Law Reforms committee of 2015, there is consensus on plight of non-secured creditors who are often left in the lurch.

Bankers/ Secured Creditors – The Privileged Class

While secured creditors traditionally have had remedies available under the Code of Civil Procedure, even the Companies Act carved out special protection for their claims on the assets of a troubled enterprise. Banks and other Financial Institutions (FIs) have traditionally been the largest lenders to corporate debtors and most often hold a mortgage or charge over the assets of the borrowers to whom the loan is extended.

With the expansion of the economy, the reliance on bank finance has increased tremendously over the last few decades. Increasingly, more and more regulations have been brought in to assess and manage the financial health of the banks considering the immense impact that a failure will have on the overall economy.

While the banking regulator brought various regulations for the banks on conducting their business, the Legislature has tried to augment the financial health of the banks, and thereby the entire economy, by bringing in specific legislations to help them address the challenges of ever mounting Non Performing Assets (NPAs) and difficulty in recovery thereof. The Recovery of Debts and Bankruptcy Act (RDB) came about in 1993 and the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) act in 2002. It is pertinent to note that these two Acts have been specially created to cater to the interest of the Banks/ FIs, who most often than not are the only group of secured creditor. Also, the banks/FIs have the liberty to proceed under either or both of these acts and this right to proceed simultaneously has passed the test of constitutionality.

Is IBC meant to benefit the Banks/FIsr to protect from it?

The context above leads to an interesting proposition - given the fact that the object of the IBC is to revive the enterprise and to cater to all classes of creditors and the fact that the bankers already have very specific remedies available to them under SARFAESI and RDB, is the IBC meant to offer further protection to the bankers in recovering their debt or is it to protect the debtors and other classes of creditors from the coercive action of banks/FIs?

In our view, though there is no express bar or restriction placed on the secured creditors from initiating proceedings under the IBC, it is not a simple argument and should be academically debated to arrive at a logical view:

a) Against common logic: If the application under section 7 of IBC is admitted, then the moratorium placed by section 14 of IBC will stop any action taken under 13(4) of SARFAESI. Therefore, if the banks/FIs having already taken action under section 13(4) of SARFAESI are allowed to initiate proceedings under section 7 of IBC, then it will amount to them putting on hold their own action taken under SARFAESI. Such a situation would not only be quite bizarre but also lead to wastage of precious time and resources of all the parties involved.

b) No additional relief: Even if the Bank/ FI has not taken any action under SARFAESI, there is no incremental remedy available to the Banks/FIs than what is already available in the existing provisions available to them under SARFAESI and RDB. On the contrary, by initiating action under IBC, the bankers are only increasing the overall time to realize their due by subjecting themselves to the outcome of the resolution plan and the jurisdiction of the adjudicating authority.

Why No Express Bar?

The legislature in its wisdom has not expressly barred the bankers or secured creditors from initiating action under IBC despite there being a specific section for the purpose i.e. Section 11. This makes us ponder over the view taken so far and consider what might be the intent of legislature in not placing an express bar on the banks/FIs despite specific and similar relief already available to them. Following scenarios will help understand as to why the legislature has not expressly barred the banks/FIs or secured creditors from moving under the IBC despite it being almost contradictory not only to the objective of the insolvency laws but also creating multiplicity of proceedings and forum shopping by the banks:

a) No default towards one bank: In case of multi lender scenario or a consortium, as the case may be, if the default is only towards one of the lenders, say A, then that particular lender will have the right to proceed under SARFAESI to sell the secured asset. The sale of the secured asset may lead to downfall of the entire enterprise and as a result may lead to the default of the other bank, say B, whose account was not in default. The legislature has in its foresight worded the section 7 accordingly to accommodate such a situation. Section 7 of IBC states that a creditor can approach under section 7 not only for its own default but for a default of another creditor. Such an application from Bank B under section 7 will put on hold the action under SARFAESI taken by the Bank A thereby not only protecting the debtor but also Bank B and help it revive the firm. These rights were not available to the Bank B otherwise.

b) Creditors holding less 40% of Debt: Again in a multi lender situation, if 40% of the creditors do not wish to go for action under SARFAESI they cannot stop the other 60%. However, with the provisioning of the IBC, those creditors having minority share in the secured asset can also protect the debtors from the coercive action of the majority of the creditors.

In view of the above discussion, it is clear that though there is no express bar on the Banks/FIs to move under IBC, the primary intent is not to cater to their interests but to all the other classes of creditors who do not have any remedy under SARFAESI and RDB and are at the mercy of the secured creditors. The secured creditor's only intent has been to recover their debts and they have, historically, not shown any consideration for either the revival or the debtor or the interest of any other stakeholder group. IBC provides a right to such class of creditors who either did not have a right under the earlier acts or were not able to effectively exercise that right in view of the dominant position held by the banks. Considering the fact that the IBC is to facilitate the revival of the company, letting the bankers initiate the proceedings would lead to continuous harassment of the ailing debtor at multiple forums and only contribute in its eventual downfall.

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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