The strength of economy of a country depends on the strength and efficiency of the financial system, which depends on sound and solvent system of the banking system. While credit growth is one of the drivers of economic growth, Non Performing Assets (NPAs) are a curse to the economic growth of the country. On the parameter of resolving insolvency, India is ranked 136 among 189 countries. At present, it takes more than four years to resolve a case of bankruptcy in India, according to the World Bank. Reserve Bank of India (RBI) has identified the NPAs as any interest or loan repayments which are delayed beyond ninety (90) days.
In order to curtail the rising of NPAs, and poor recovery of loans, reforms with respect to financial, corporate, banking, etc and reduce the time to resolve the cases of bankruptcy became significant. It has become a need for a well functioning insolvency laws to develop the credit markets. Thus Ministry of Finance set up the Bankruptcy Law Reform Committee (“BLRC”) in the year 2014 under the Chairmanship of Mr. T.K Vishwanathan, who was a former Secretary General, Lok Sabha and Former Union Law Secretary. The main objective of this BLRC was to recommend to all non-financial corporations and individuals that would replace the existing framework.
Insolvency is a situation when an individual or a firm is unable to meet the financial obligations due to its creditors and when the status is legally declared by the court of law that an individual or a firm becomes insolvent when it cannot meet its financial obligation; it is referred to as bankruptcy. The existing laws and framework with regards to bankruptcy and insolvency in India are as follows:
- The Presidency Towns Insolvency Act, 1909
- The Provincial Insolvency Act, 1920
- Securitization and Reconstruction of Financial Assets and Enforcement of Security Act (SARFAESI) Act, 2002
- Recovery of Debts due to Banks and Financial Institutions Act, 1993
- Companies Act, 2013
- Sick Industrial Companies (Special Provisions) Act, 1985
So, there is no single law that deals with insolvency and bankruptcy in India. The multiple overlapping laws and adjudicating forums for financial failure and insolvency of companies and individuals in India has led to time consuming legal redressal process.
In order to curtail the overlapping jurisdiction of different forums, India has taken a step to introduce the Insolvency and Bankruptcy Code, 2016 (“Code”). This Code streamlines and consolidates all the existing laws to simplify the process. This Code will provide an easy exit options for insolvent and sick firms. The passage of the bill will allow quick and prompt action to be taken in the early stage of debt default by a firm, maximizing the recovery amount. The creditors will not suffer by red-tap and promoters will directly become accountable for any financial lapses. The Code ensures quicker resolution of the bad-loan problems.
Features of insolvency and bankruptcy Code, 2016
The successful implementation of the Code shall depend on the establishment and smooth functioning of new entities proposed to be setup under the Code:
- Insolvency and bankruptcy Board of India to regulate insolvency professionals, insolvency professional agencies and information utilities and make model bye-laws for insolvency professional agencies and its members.
- Insolvency professionals to take necessary actions with regards to insolvency resolution, fresh start, liquidation or bankruptcy process from the initiation stage.
- Insolvency professional agencies to make bye-laws in consistence of the model bye-laws made by the Board and regulate and monitor insolvency professionals.
- Information Utilities to collect, collate, authenticate financial information to facilitate insolvency resolution.
The Code also requires two agencies for adjudication:
- National Company Law Tribunal (NCLT) under Companies Act,2013 for companies and LLPs.
- Debt Recovery Tribunal (DRT) under Recovery of Debts due to Banks and Financial Institutions Act, 1993 for individual and unlimited liability partnership firms, which are overloaded with pending cases.
Another important feature of the Code is Time-bound process for insolvency resolutions. On the admission of the case to either of the adjudicating authorities, the whole process of recovery, according to the Code shall be concluded within one hundred and eighty (180) days. The time limit may be extended by 90 days; hence the maximum time limit provided for the process of resolution is two hundred and seventy (270) days. This will expedite the process of recovery and curtail down unnecessary delays.
The Code further provides an order of priority to distribute assets during liquidation. The first privilege for distribution goes to secured creditors. The secured creditors get the entire amount. Then, the next privilege is given to workmen’s dues for twelve (12) months. Then after the payments due to employees and then, financial dues owed to unsecured creditors, the government dues, for example taxes shall be paid, other debts, preference shareholders and equity shareholders shall receive the last priority.
Bankruptcy and insolvency process for companies and limited liability entities.
The Code provides a clean coherent and speedy process for early identification of financial distress and revival of companies and limited liability entities. Where any corporate debtor commits a default, a financial creditor, an operational creditor or the corporate debtor itself may initiate corporate insolvency resolution process in respect of such corporate debtor. The creditor shall, along with the application furnish—
- record of the default recorded with the information utility or such other record or evidence of default as may be specified;
- the name of the resolution professional proposed to act as an interim resolution professional; and
- any other information as may be specified by the Board.
The adjudicating authority shall, within fourteen days of the receipt of the application ascertain the existence of a default from the records of an information utility or on the basis of other evidence furnished by the financial creditor. If the Adjudicating Authority is satisfied with the same, it shall communicate to the creditor and the corporate debtor. In case the authority finds any defect, it shall communicate the same to the applicant and give seven days time to rectify the same. After the authority is satisfied with the application, the process of liquidation proceeds. However, the following persons are not entitled to apply for insolvency process:
- a corporate debtor undergoing a corporate insolvency resolution process; or
- a corporate debtor having completed corporate insolvency resolution process twelve months preceding the date of making of the application; or
- a corporate debtor or a financial creditor who has violated any of the terms of resolution plan which was approved twelve months before the date of making of an application under this Chapter; or
- a corporate debtor in respect of whom a liquidation order has been made.
In the case when applicant is a corporate debtor and intends to liquidate itself voluntarily and has not committed any default may initiate voluntary liquidation proceedings shall meet the following conditions:
- a declaration from majority of the directors of the company verified by an affidavit stating that they have made a full inquiry of the into the affairs of the company and they have formed an opinion that either the company has no debt or that it will be able to pay its debts in full from the proceeds of assets to be sold in the voluntary liquidation and the company is not being liquidated to defraud any person.
- Must furnish documents as follows:
- audited financial statements and record of business operations of the company for the previous two years or for the period since its incorporation, whichever is later.
- a report of the valuation of the assets of the company, if any prepared by a registered valuer.
- within four weeks of a declaration and shall be:
- a special resolution of the members of the company in a general meeting requiring the company to be liquidated voluntarily and appointing an insolvency professional to act as the liquidator
- a resolution of the members of the company in a general meeting requiring the company to be liquidated voluntarily as a result of expiry of the period of its duration, if any, fixed by its articles or on the occurrence of any event in respect of which the articles provide that the company shall be dissolved, as the case may be and appointing an insolvency professional to act as the liquidator.
In case the company owes any debt to any person, creditors representing two-thirds in value of the debt of the company shall approve the resolution passed. The same shall be informed to registrar of companies as well.
The Code gives us a swift process and timeline of 180 days for dealing with application of insolvency resolution which can be extended to 90 (ninety) days by adjudicating authority, that is in case of companies and limited liability entities, the adjudicating authority shall be NCLT. After the insolvency resolution process is approved by 75% of voting share of financial creditors, the adjudicating authority sanctions the plan for liquidation.
Bankruptcy and insolvency process for individuals and unlimited liability partnerships.
The Code provides two swift processes to adjudicate the insolvency matters for individual and unlimited liability partnerships. The first process is “Fresh Start” where the Code provides a thresh limit for an individual to eligible to apply and referred to as “qualifying debts” and provides a time limit of 180 days for investigation and issue an order. The second process is “Insolvency Resolution” where the parties go for negotiation to an agreeable repayment plan which is supervised by resolution professionals. In case both these methods fail, and then bankruptcy of an individual can be initiated. In such a case, the bankruptcy trustee shall be responsible for the administration of the process. A debtor, who is unable to pay his debt and fulfils the conditions, shall be entitled to make an application for a fresh start for discharge of his qualifying debt. The conditions that the debtor shall fulfil are as follows:
- the gross annual income of the debtor does not exceed sixty thousand rupees;
- the aggregate value of the assets of the debtor does not exceed twenty thousand rupees;
- the aggregate value of the qualifying debts does not exceed thirty-five thousand rupees;
- he is not an undischarged bankrupt;
- he does not own a dwelling unit, irrespective of whether it is encumbered or not;
- a fresh start process, insolvency resolution process or bankruptcy process is not subsisting against him; and
- no previous fresh start order under this Chapter has been made in relation to him in the preceding twelve months of the date of the application for fresh start.
A debtor who commits a default may apply, either personally or through a resolution professional, to the adjudicating authority for initiating the insolvency resolution process, by submitting an application. If the debtor is a partner of a firm, such debtor shall not apply under this Chapter to the Adjudicating Authority in respect of the firm unless all or a majority of the partners of the firm file the application jointly. The following are the debtors who cannot apply for insolvency resolution process:
- an undischarged bankrupt
- undergoing a fresh start process
- undergoing an insolvency resolution process
- undergoing a bankruptcy process
Even, creditor may apply either by himself, or jointly with other creditors, or through a resolution professional to the Adjudicating Authority for initiating an insolvency resolution process under this section by submitting an application. An application shall be accompanied with details and documents relating to—
- the debts owed by the debtor to the creditor or creditors submitting the application for insolvency resolution process as on the date of application;
- the failure by the debtor to pay the debt within a period of fourteen days of the service of the notice of demand; and
- relevant evidence of such default or non-repayment of debt.
The resolution professional shall examine the application and within ten days of his appointment, and submit a report to the adjudicating authority recommending for approval or rejection of the application. In case the application is made by the creditor to initiate insolvency resolution process, the resolution professional may require the debtor to prove repayment of the debt claimed as unpaid by the creditor by furnishing the following:
- evidence of electronic transfer of the unpaid amount from the bank account of the debtor;
- evidence of encashment of a cheque issued by the debtor; or
- a signed acknowledgment by the creditor accepting receipt of dues.
After the application is accepted, the adjudicating authority shall issue a public notice within seven days of passing the order inviting claims from all creditors within twenty-one days of such issue. The creditors shall register claims with the resolution professional by sending details of the claims by way of electronic communications or through courier, speed post or registered letter. Then, the debtor shall prepare, in consultation with the resolution professional, a repayment plan containing a proposal to the creditors for restructuring of his debts or affairs. After the plan is made, a meeting shall be help with the creditors and passed by majority. Once it is accepted, the adjudicating authority shall give orders to execute the plans.
Issues and Analysis of the Code
The Code allows multiple IPAs to operate simultaneously, which could enable competition in the market.This may result to conflict of interest between the regulatory and competitive goals of IPAs. The Code allows the IPAs to conduct its own examinations to qualify and enroll as IP, but it is unclear that in this case, that if an IP qualifying from a particular IPA can work with another IPA or if an IP is eligible to enroll himself with multiple IPAs. In case, there is a restriction for an IP to move from one particular IPA to another, there will be an adverse effect on the competition in the market. Also, due to the creation of multiple IPAs, the financial information of a company will be scattered in the market and that may adversely affect the goodwill of the company in the market.
Another issue, from what I could gather, is that none of the existing laws are being repealed. There must be a clear demarcation as to when these laws apply and clear overriding provisions in cases of conflict with the code. This is a naive expectation. If these laws are not repealed, we will certainly create a far bigger mess than we have now.
Moreover, the Code provides for the creation of multiple IUs. However, it does not specify that full information about a company will be accessible through a single query from any IU. This may lead to financial information being scattered across these IUs.
Another issue is about the priority list; it is unclear why the secured creditor shall get full outstanding amount instead of the amount equal to collateral value held by him. This will adversely affect the return of dues held by the persons, who are below the secured creditors in the priority list. Moreover, the Code provides that government dues will be paid off after payments made due to secured and unsecured creditors, employees and workmen. There will be a ‘conflict of law’ between the Companies Act, 2013 and the Code as under Companies Act,2013 the secured creditors are entitled to the amount of claims of the assets held by them and the government dues are paid alongside or before the employees, which is just the opposite incase of the Code. Due to this, the government will have no gain of the liquidation process.
The next issue about the Code is that the Code provides a provision for the establishment of Insolvency and Bankruptcy Fund but is silent about the process of utilization of the Fund.
Further if we talk about jurisdiction part, there are huge pendency of cases and a lot of money is stuck with DRTs. Now the question arises that in such situation do the DRTs have the capacity to take up additional roles? On the other hand, NCLT and NCLAT are going to be a common forum for two major laws, i.e., Companies Act and the Code. This means that NCLT will have the case load of CLB, High Courts and Board for Industrial and Financial Reconstruction. Thousands of such cases are pending which the NCLT needs to hear. This load may lead to collapse of conventional government techniques of setting up the tribunals.
Finally, there is a good chance that players in the system will gang up, technically terminating “insolvency” after 180 or 270 days, and then feeding off the corpse, under the benign supervision of the “regulator”.
The current status as on 20th August, 2016 of the Code is that it has got assent of President on 28th May 2016 but it is yet to come into force as Central Government under Sec 1(3) reserve its right of its given enforcement date. The Code interacts with numerous laws. The code visualises rapid closure of firms in liquidation. However, earlier attempts of the same have run into conflicts with labor laws, and Industrial Disputes Act, 1947. These conflicts must be examined, analysed and steps must be taken to ensure that the same conflicts do not re-appear as case law to be-devil the implementation of liquidation under the Code. Sector regulators such as RBI, SEBI and for Insurance Regulatory Development Authority (IRDA) will need to review and revise their regulations to ensure rapid resolutions of defaults under the Code. Similarly, SEBI ‘s norms for merger and acquisition closure of listed companies, and debt to equity conversions will need to review, as will similar provisions under Companies Act, 2013. Though NCLTs and DRTs starts functioning but full enforcement of the Code will be possible by the end of the financial year. Also, the Code suggests major amendments under the Companies Act 2013 and various Acts under Sec 245 to 255 which will not be enforced until Central Government notify the Code under Sec 1(3). Under sec. 188 of the Code, government is required to establish Insolvency and Bankruptcy Board of India which is yet to be constituted. Hence, once the Code is notified, the relevant amendments can be made in the laws with which the Code interacts and then, we can expect the smooth functioning of the Code.
 Bankruptcy Law Reforms Committee, Ministry of Finance, 4 November 2015, http://finmin.nic.in/reports/BLRCReportVol1_04112015.pdf
Published on September 09, 2016
Author: Abhishek Gupta, Associate
Samisti Legal LLP