India: The Insolvency And Bankruptcy Code (Amendment) Ordinance, 2018: Key Highlights

Last Updated: 3 July 2018
Article by Trilegal .

The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018 brings about significant changes to improve the insolvency resolution framework in India.

Background

While the enactment of the Insolvency and Bankruptcy Code, 2016 (Code) brought significant improvements to the insolvency resolution process in India, recent cases highlighted several practical issues and interpretational anomalies under the Code.

These issues were considered by an insolvency law committee constituted by the Ministry of Corporate Affairs (Committee) in consultation with key stakeholders. Based on the recommendations of the Committee, the Insolvency and Bankruptcy Code (Amendment) Ordinance 2018 (Ordinance) was notified on 6 June 2018.

Key Highlights and Takeways

(a)Homebuyers as Financial Creditors

In 2016, when the Code and regulations framed thereunder were brought into force, the insolvency resolution framework provided that any 'financial creditor' (i.e. any person to whom a financial debt being a debt for borrowed money is owed), 'operational creditor' (i.e. any person to whom an operational debt such as a trade debt is owed) or a corporate debtor itself could initiate an insolvency resolution process.

The question whether advances paid by homebuyers to the real estate developers should be categorised as a financial or operational debt (or instead, a separate category of debt), assumed significance in a spate of insolvency petitions against failing real estate projects. It was apparent that the Code did not provide a suitable framework for the protection of homebuyers who had advanced significantly larger amounts to the company as compared to the banks who had constituted the committee of creditors and were steering resolution processes.

In August 2017, the regulations under the Code were amended to classify homebuyers as 'other creditors' who would have the right to file claims before the liquidator, but the amendment did not elaborate on other rights available to them (i.e., whether 'other creditors' could initiate insolvency proceedings or participate in the committee of creditors, whether their claims would be protected under the resolution plan approved by the committee of creditors etc.). The Ordinance has now definitively resolved this ambiguity by classifying any 'amounts raised from an allottee under a real estate project' as financial debt.

Key Takeaway

With the Ordinance coming into effect, retail consumers in the real estate industry such as homebuyers will now have the right to initiate insolvency against real estate developers and the right to be represented in the committee of creditors (CoC) bringing them at par with banks and other financial creditors in real estate projects.

It remains to be seen whether similar protection will be sought by other consumer facing industries, where retail consumers typically pay large "advances" to purchase goods and services.

(b)Eligibility of Resolution Applicants

Under the recently introduced section 29A of the Code, related parties of the corporate debtor and other entities or their promoters whose loans have been non-performing assets (NPAs) for a period of 1 year, were disqualified from being resolution applicants. The underlying intent of the amendment was to prevent persons who had contributed to the failure of the debtor from getting back their assets at significant discounts.

There was however broad consensus among stakeholders in the industry that the extension of the disqualification to persons acting jointly or in concert had led to unintended consequences of multiple layers of persons being disqualified (even if remotely connected to the disqualified person).

The Ordinance now clarifies that the following persons will not be disqualified from participating in the resolution process:

  1. financial entities (defined to include asset reconstruction companies, alternate investment funds, scheduled banks, overseas financial institutions, investment vehicles, registered foreign portfolio investors and foreign venture capital investors), who are not affiliated to the corporate debtor; and
  2. entities who hold an NPA account pursuant to the acquisition of a corporate debtor under an earlier insolvency resolution process – this exemption is available for a period of three years from the date of approval of the prior resolution plan.
  3. regulated financial creditors who are affiliated to the debtor solely because of their equity holdings pursuant to a debt restructuring scheme implemented prior to the initiation of insolvency proceedings.
  4. guarantors of a corporate debtor, unless the guarantee has been enforced and remains unpaid in full or part by the guarantor.

In the context of disqualification of persons who control companies in which a preferential, undervalued, fraudulent or extortionate credit transaction has taken place, the Ordinance has brought some clarity by providing that this disqualification will not apply to bona-fide acquirers of such companies under an insolvency resolution or other similar restructuring process.

Key Takeaway

The amendments have refined the disqualification criteria under Section 29A to focus on wilful defaulters, persons responsible for the financial failure of the corporate debtor under resolution, or those persons who themselves are in financial distress in other entities and are hence unsuitable to drive a turnaround in the corporate debtor under resolution.

The Ordinance removes uncertainty with respect to the ability of genuine strategic and financial investors, creditors and specialised players in the distressed debt space to participate in insolvency resolution.

(c)Operational Creditors

One of the practical concerns under the Code, in the context of operational creditors, was that a corporate debtor was required to establish both the existence of a dispute and the pendency of a suit or arbitration proceeding, to dispute an insolvency application brought by an operational creditor.

In this context, the Supreme Court recently held that a dispute prior to the receipt of a demand notice from an operational creditor, may exist in forms other than a pending suit or arbitration proceedings. In line with the Supreme Court ruling, the Ordinance now clarifies that there is no dual requirement to establish the existence of a dispute and outstanding proceedings, to dispute insolvency proceedings initiated by an operational creditor.

The requirement for submission of a certificate from a financial institution confirming that the operational debt is due has been made optional. Alternate means of proving non-payment of operational debt, such as records from information utilities or other record as may be notified by the Central Government, has also been permitted.

Key Takeaway

The Ordinance can be expected to stem the flow of premature insolvency actions brought by trade creditors against debtors who have bona-fide disputes regarding the existence of such debts.

From the perspective of trade creditors, this Ordinance has eased the process of initiation of insolvency for foreign suppliers and vendors, as the process of obtaining a certification from an Indian financial institution was cumbersome.

(d)Shareholder approval for Initiation of Corporate Insolvency by the Corporate Debtor

The Ordinance requires shareholders or individuals/persons in management or control of the corporate debtor to pass a special resolution of at least three-fourth of the total number of shareholders or partners (in case of a LLP), before initiation of corporate insolvency resolution process by the corporate debtor.

(e)Moratorium

Upon the admission of an insolvency application under the Code by the NCLT, a moratorium of 180 days applies which prohibits the creditors from taking any action to recover or enforce any security interest created by the debtor. There have been divergent judgements on whether the scope of the moratorium includes enforcement action against assets of third parties such as the promoter or guarantor provided as security to the creditor. NCLAT held in a recent case that a security or guarantee provided by a third party and a guarantor's personal property can be proceeded against by a financial creditor to recover its outstanding dues even during the moratorium period, as properties not owned by the debtor would not fall within the ambit of the moratorium declared under the regulations.

The Ordinance has clarified that moratorium will not be applicable to a surety in a contract of guarantee - the scope of the moratorium is restricted to the assets of the corporate debtor only. Therefore, there is no bar against enforcement actions taken against the assets of a guarantor to a corporate debtor during the moratorium period.

(f)Voting threshold for decisions of the CoC

To encourage a speedy resolution, the Ordinance has relaxed voting threshold for certain decisions taken by the CoC:

  1. Threshold for approval of a resolution plan, extension of CIRP beyond 180 days, appointment of the resolution professional, and certain other critical decisions has been reduced from 75% to 66% of the financial creditors by value.
  2. Threshold for approval of other routine decisions has been reduced from 75% to 51% of the financial creditors by value.

(g)Authorised representative for creditors

The Ordinance provides a new mechanism for debenture holders, deposit holders, retail creditors (such as large numbers of homebuyers in real estate projects) and other specified classes of financial creditors in the CoC to be represented in CoC meetings through a separate trustee, agent, authorised representative or insolvency professional, who would act on their behalf in CoC meetings.

(h)Treatment of MSMEs

The Committee noted that micro, small and medium enterprises (MSMEs) who are mostly operational creditors to businesses are especially susceptible to working capital mismatch (i.e., any temporary credit disruption created by the insolvency of the debtors of such MSMEs could have implications on the ability of MSMEs to service their debts). MSMEs being pushed into liquidation affects the livelihood of employees and workers. Further, the sale of an MSME in a timebound bid process under insolvency resolution is unlikely to attract interest from large number of bidders.

To avoid these issues, the Committee had recommended that a specific exemption be given to corporate debtors which are MSMEs, by permitting a promoter who is not a wilful defaulter, to bid for the MSME in insolvency. This recommendation has been accepted and the Ordinance has introduced such exemption.

(i)Initiating IBC proceedings where winding-up proceedings are pending

The leave of the High Court or National Company Law tribunal (NCLT) must be obtained for initiating insolvency proceedings under the Code, if any petition for winding up is pending in any High Court or NCLT against the corporate debtor under the Companies Act.

(j)Application of Limitation Act, 1963

Prior to the Ordinance, there was ambiguity regarding the applicability of the Limitation Act, 1963 to the Code. Specifically, the issue regarding the revival of the right of creditors holding time-barred debts to file for insolvency resolution and right of claimants to file time-barred claims with the insolvency resolution professional were considered by the NCLAT in various matters. The NCLAT ruled that the limitation period (3 years) for initiating insolvency proceedings for all claims existing prior to the Code would begin from the date of its coming into effect, i.e., 1 December 2016. This gave an opportunity to the creditors to initiate fresh insolvency proceedings for debts which otherwise were not recoverable due to the expiry of the limitation period.

The Committee was however of the opinion that insolvency laws should not have the effect of affording a fresh opportunity for creditors and claimants who did not exercise their remedy in a timely manner. The Ordinance now expressly clarifies this position, by providing that the Limitation Act would apply to proceedings under the Code.

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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