7 PM I Three years on, Insolvency and Bankruptcy Code is learning from outcomes, growing stronger| 29th November 2019

Context: Insolvency and Bankruptcy Code (IBC) 2016

Insolvency and Bankruptcy:

  • Insolvency is a state of financial distress in which someone is unable to pay their bills. It can lead to insolvency proceedings, in which legal action will be taken against the insolvent entity, and assets may be liquidated to pay off outstanding debts.
  • Bankruptcy is the legal proceeding involving a person or business that is unable to repay outstanding debts. It is carried out to allow individuals or businesses freedom from their debts, while simultaneously providing creditors an opportunity for repayment.
  • In Indian constitution, insolvency and bankruptcy are covered in the Seventh Schedule under the Concurrent List, allowing both states and the Centre to develop the legislative framework. However, in India, there is no state legislative history regarding either insolvency or bankruptcy in the post-Independence period.

Background for Insolvency and Bankruptcy Code (IBC):

  • Till the year 1985, the legal framework for dealing with corporate insolvency and bankruptcy in India consisted of only one law, ‘the Companies Act, 1956’.
  • Post 1985, there were various scattered laws relating to insolvency and bankruptcy which caused inadequate and ineffective results with undue delays. For example:
    • The Sick Industrial Companies Act, 1985 (SICA) for liquidation and winding up of the company.
    • The Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (RDDBFI) for debt recovery by banks and financial institutions.
    • Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) for security enforcement.
  • The new Code is based on the report of the ‘Bankruptcy Law Reform Committee’. The legislation of the Code is a historical development for economic reforms in India.

Insolvency and Bankruptcy Code (IBC):

  • The Insolvency and Bankruptcy Code passed by the Parliament is a welcome overhaul of the existing framework dealing with insolvency of corporates, individuals, partnerships and other entities. It paves the way for much-needed reforms while focussing on creditor driven insolvency resolution.
  • The Code offers a uniform, comprehensive insolvency legislation encompassing all companies, partnerships, and individuals (other than financial firms).
  • One of the fundamental features of the Code is that it allows creditors to assess the viability of a debtor as a business decision, and agree upon a plan for its revival or a speedy liquidation.
  • The Code creates a new institutional framework, consisting of a regulator, insolvency professionals, information utilities and adjudicatory mechanisms, that will facilitate a formal and time bound insolvency resolution process and liquidation.

Objectives of IBC:

  • Consolidate and amend all existing insolvency laws in India.
  • To simplify and expedite the Insolvency and Bankruptcy Proceedings in India.
  • To protect the interest of creditors including stakeholders in a company.
  • To revive the company in a time-bound manner.
  • To promote entrepreneurship.
  • To get the necessary relief to the creditors and consequently increase the credit supply in the economy.
  • To work out a new and timely recovery procedure to be adopted by the banks, financial institutions or individuals.
  • To set up an Insolvency and Bankruptcy Board of India.
  • Maximization of the value of assets of corporate persons.

Who facilitates the insolvency resolution under the Code? The Code creates various institutions to facilitate resolution of insolvency.  These are as follows:

  • Insolvency Professionals: A specialised cadre of licensed professionals is proposed to be created. These professionals will administer the resolution process, manage the assets of the debtor, and provide information for creditors to assist them in decision making.
  • Insolvency Professional Agencies: The insolvency professionals will be registered with insolvency professional agencies. The agencies conduct examinations to certify the insolvency professionals and enforce a code of conduct for their performance.
  • Information Utilities: Creditors will report financial information of the debt owed to them by the debtor. Such information will include records of debt, liabilities and defaults.
  • Adjudicating authorities: The proceedings of the resolution process will be adjudicated by the National Companies Law Tribunal (NCLT), for companies; and the Debt Recovery Tribunal (DRT), for individuals. The duties of the authorities will include approval to initiate the resolution process, appoint the insolvency professional, and approve the final decision of creditors.
  • Insolvency and Bankruptcy Board: The Board will regulate insolvency professionals, insolvency professional agencies and information utilities set up under the Code.  The Board will consist of representatives of Reserve Bank of India, and the Ministries of Finance, Corporate Affairs and Law.

Steps to resolve insolvency:

  • Initiation: When a default occurs, the resolution process may be initiated by the debtor or creditor. The insolvency professional administers the process.  The professional provides financial information of the debtor from the information utilities to the creditor and manage the debtor’s assets.  This process lasts for 180 days and any legal action against the debtor is prohibited during this period.
  • Decision to resolve insolvency: A committee consisting of the financial creditors who lent money to the debtor will be formed by the insolvency professional. The creditors committee will take a decision regarding the future of the outstanding debt owed to them.  If a decision is not taken in 180 days, the debtor’s assets go into liquidation.
  • Liquidation: If the debtor goes into liquidation, an insolvency professional administers the liquidation process. Proceeds from the sale of the debtor’s assets are distributed in the following order of precedence: i) insolvency resolution costs, including the remuneration to the insolvency professional, ii) secured creditors, whose loans are backed by collateral, dues to workers, other employees, iii) unsecured creditors, iv) dues to government, v) priority shareholders and vi) equity shareholders.

Outcomes of the IBC:

  • The success rate of companies under several regulations pre-2016 was abysmally low and varied from 16 per cent to a maximum of 25 per cent. In contrast, the success rate of companies under the IBC in terms of a closure is already at 41 per cent and increasing.
  • The recovery rate is 43 per cent, up from 12 per cent in financial year 2015 through other mechanisms with defaulting promoters losing control of the company. 
  • The Essar judgement, assuming a provision of 80 per cent, could potentially result in a provision writeback of more than Rs 30,000 crore for the banking system.
  • According to details released by the Insolvency and Bankruptcy Board of India (IBBI), out of the 1,484 cases admitted for the corporate insolvency resolution process (CIRP), 586 have been closed till December 2018. That marks a hit rate of about 40%.
  • According to the World Bank, before IBC, the time taken to resolve stressed loans was 4.3 years and recovery rate was 26% for financial creditors. Two years into IBC, this has improved to 48% recovery, which takes about 1-1.5 years through the IBC.

Trends that need attention:

  • Small threshold limit: The number of cases admitted through Lok Adalats and DRTs has declined significantly post introduction of the IBC. Given the very small threshold limit of Rs 1 lakh, operational creditors seem to be more aggressive in dragging the corporate debtor into the NCLT, eating up the bandwidth of the court and thereby delaying resolution of the bigger cases and defying the main objective of the IBC.
  • Mostly opting for liquidation: It is observed that more than 23 per cent of the admitted companies ended with liquidation. As companies are admitted into liquidation, the employees on the rolls of the company are only cumulatively compensated till the resolution process is completed, while the contractual employees are downsized.
  • It is also observed that sectors such as construction and electricity, where there are no hard assets, are also being dragged to the NCLT and such companies are mostly liquidated. 
  • Role of culture: IBC has been largely successful, in countries like China and Japan, where culture has played a crucial role. Japan makes bankruptcy a personal, not business, failure. This characterisation of bankruptcy in Japan often leads to tragedy for the individual, be it isolation from family or otherwise. In Chinese society, the notion of bankruptcy has long been condemned as “bad luck”.  Interestingly, in India, ordinary households take it upon themselves to repay their debt (household debt to GDP is lowest across all countries at 11 per cent of GDP).

Way forward:

  • Government needs to rethink about increasing the threshold value substantially from Rs 1 lakh and increasing the number of NCLT benches with a preponderance of more erudite professionals who understand the financial system better. This will ensure that the IBC platform is not used as a recovery but more as a resolution tool.
  • Regulations must be made allowing foreign portfolio investors (FPIs) to acquire stressed rupee loans directly instead of going through an asset reconstruction company (ARC) and allowing eligible external commercial borrowing investors to fund the acquisition of stressed companies both under the IBC and outside it.
  • Efforts should be made to find a resolution for companies such as construction and electricity (that do not have hard assets) outside the NCLT. As these could save resources and time for hard-pressed NCLT benches.
  • The recent empirical work on links between corporate bond markets and the bankruptcy system predicts that safe firms will issue bonds but higher risk firms, issue bonds as long as bankruptcy is efficient. This needs more analysis in Indian context.

Source: https://indianexpress.com/article/opinion/columns/insolvency-and-bankruptcy-code-nclt-companies-6141701/

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