Exigency for an Ideal Economy- The Insolvency and Bankruptcy Code, 2016

Requisite of A Consolidated Code:

The Insolvency and Bankruptcy Code, 2016 (herein referred to as the “Code”) is a major legal breakthrough towards assessing the viability of an enterprise and the overall resolution of the stressed assets laws in the country. The economy is straddled with humongous NPAs in the financial sector and the twin balance-sheet deficit problem is plaguing the banking sector no end. It’s one of the largest legal advancement in the country’s war to clean up around $117 billion of stressed assets in the economy.

In such a situation Code provides for resolution in a time bound manner, promotes entrepreneurship which will lead to an improvement in credit availability and would balance interest of all stakeholders. The Code envisages to minimize the role of Adjudicating Authority and tackles laws of 100-year vintage like the Presidency Towns Insolvency Act, 1909, the Provincial Towns Insolvency Act, 1920 and Sick Industrial Companies (Special Provisions) Repeal Act, 2003 along with the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, the Recovery of Debt Due to Banks and Financial Institutions Act, 1993, and the Companies Act, 2013.

These statutes provided for a disparate process of debt restructuring, and asset seizure and realization in order to facilitate the satisfaction of outstanding debts. As is evident, a plethora of legislation dealing with insolvency and liquidation led to immense confusion in the legal system, and there was a grave necessity to overhaul the insolvency regime. All of these multiple legal avenues, and a hamstrung court system led to India witnessing a huge piling up of non-performing assets, and creditors waiting for years at end to recover their money. The Bankruptcy Code is an effort at a comprehensive reform of the fragmented regime of corporate insolvency framework, in order to allow credit to flow more freely in India and instilling faith in investors for speedy disposal of their claims.
It proposes a paradigm shift from the existing ‘Debtor in possession’ to a ‘Creditor in control’ regime. 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.

The Bankruptcy Law Reform Committee also known as Vishwanathan Committee (“BLRC” or the “Committee”) was set up by the Department of Economic Affairs (DEA), Ministry of Finance (MoF), under the Chairmanship of Mr. T.K. Vishwanathan (former Secretary General, Lok Sabha and former Union Law Secretary) by an office order dated August 22, 2014 to study the “corporate bankruptcy legal framework in India” and submit a report to the Government for reforming the system.
During the course of its deliberations, the Committee decided to divide the project into two parts: (i) to examine the present legal framework for corporate insolvency and suggest immediate reforms, and (ii) to develop an ‘Insolvency Code’ for India covering all aspects of personal and business insolvency.

The Vishwanathan Committee designed a set of processes to resolve insolvency and bankruptcy and with the suggestions of various committees, professionals and general public, the Insolvency and Bankruptcy Code, 2016 (IBC) was enacted and came into force with effect from 28th May, 2016. The Parliament in accordance with Article 254(1), Constitution of India 1950 has the power to make laws with respect to any of the matters listed in List I (Union List) and List III (Concurrent List) of the Seventh Schedule to the Constitution of India, 1950 (“Constitution”). States also have the power to enact laws on matters listed in List III, besides List II (State List). In case of repugnancy, or conflict between laws made by the Parliament and State Legislature on a matter relatable to List III, the parliamentary law prevails. This is unless the State has sought presidential assent for its law, in which case it prevails in that state only. ‘Bankruptcy and Insolvency’ is an item specified in Entry 9 of List III.
Entry 43 of List I deals with ‘incorporation, regulation and winding up of trading corporations, including banking, insurance and financial corporations, but not including co-operative societies’ whereas Entry 44 of List I deals with ‘incorporation, regulation and winding up of corporations, whether trading or not, with objects not confined to one State, but not including universities.’ Further, Entry 32 of List II deals with ‘incorporation, regulation and winding up of corporations, other than those specified in List I…’ While the entries in List I do not raise any issues regarding the Parliament’s competence to pass a law on such entries, the power of the State Legislatures to enact a law on a matter under Entry 32 of List II does not, in any matter whatsoever, affect the Parliament’s power to enact a law under Entry 9 of list III.

1. Companies Act (CA), 1956/ 2013:
Chapter V of the CA 1956 provides for a mechanism by which corporate revival and rehabilitation may be undertaken. Section 391 of CA 1956 provides for a court-supervised process by which a company can enter into a scheme of arrangement or a compromise with its creditors and/or members. The nature of the scheme or compromise that can be proposed under this provision is very wide: it includes schemes or compromises that may be proposed to restore the company to profitability. The winding up proceedings under the CA 1956 are carried out voluntarily (members’ voluntary liquidation, which is a liquidation procedure for solvent companies, and creditors’ voluntary liquidation), or compulsorily by the High Court.
The CA 2013 uses ‘sickness’ as the preliminary criterion for determining whether a company should be rescued or not. However, it does not prescribe any statutory test for determining ‘sickness’ and leaves much to the discretion of the NCLT. The BLRC notes that if some of the procedural steps envisaged in Chapter XIX are collapsed, the viability of a business can be considered at the time of determination of sickness at a very early stage of the proceedings, which will also make the process of making that determination objective. The viability of the business can be considered by a committee of creditors (in a meeting convened by an interim administrator) only after a company has been declared sick. Liquidation should not be seen as a measure of last resort for unviable businesses that have become insolvent – they should be liquidated as soon as possible to minimize the losses for all the stakeholders.
The CA 2013 provides for a moratorium on enforcement proceedings to be granted on an application to the NCLT, and for a fixed duration of 120 days. The purpose of a moratorium is to (a) keep a debtor company’s assets together during the rescue proceedings by providing relief from debt enforcement in certain circumstances and (b) avoid multiple legal actions without undermining the interest of the creditors. However, the provision on the grant of moratorium in CA 2013 suffers from the following problems: (i) wide discretion to the NCLT to determine whether a moratorium should be granted or not; (ii) no provision for lifting the moratorium or modifying its terms once it has been granted; (iii) no consideration of creditor interests in granting the moratorium; (iv) no express requirement for consideration by the NCLT of creditor interests in making the decision to granting the moratorium.
Chapter XIX of the CA 2013 (Section 253 to 258) relating to winding up of companies have not been notified yet. Provisions under Section 253 (1) permits a secured creditor or a debtor company to make a reference to the NCLT for declaring the company to be a ‘sick company’ if it is unable to pay/secure/compound the debt when a demand for payment has been made by secured creditors representing 50% or more of the outstanding amount of debt within thirty days of the service of notice of demand. The BLRC opines that the present criteria for initiating rescue proceedings by creditors and the debtor company may not facilitate early intervention and timely rescue. If a company has already defaulted on 50% of its outstanding debt, it is very likely that it has reached a stage where it would be very difficult to recue it effectively. Moreover, the Act concentrates more on the secured creditors rather than on unsecured creditors for determining the sickness of the Company.
The CA 2013 provides that an interim administrator or the company administrator can take-over the management of the debtor company (which might facilitate siphoning of assets) (Section 260), but only on being directed to do so by the NCLT. Once again, it leaves too much to the discretion of the NCLT without providing any criteria to guide the exercise of such discretion. Given that an NCLT order for takeover of management can be appealed before the NCLAT (and subsequently before the Supreme Court), the law should specify a non-exhaustive list of grounds on which the NCLT may direct that the management may or may not be taken over to avoid the possibility of protracted disputes on the question of takeover of management. Also, the NCLT have been given wide powers to determine the powers and functions of the company administrator which again leaves room for abuse of law and discretion in the hand of NCLT.

CA 2013 provides for appointment of liquidators and administrator from a Government approved pool of private professionals. Although CA 2013 provides for a fairly comprehensive regime for the liquidators, some issues relating to the appointment, qualification and regulation remain to be addressed. Moreover, CA 2013 provisions in relation to regulation of administrators seem fairly underdeveloped and leave much to the discretion of the NCLT.
The current scheme of the CA 2013 does not provide for the participation of creditors in the appointment of the company administrator (who is appointed at a later stage for the purpose of preparing/implementing a scheme of revival and/or taking over the management or assets). He is to be appointed by the NCLT. There is a strong case to be made for creditor involvement in the process of appointment of the company administrator. Creditors are likely to be most incentivised to select the person who is best suited for the task – as the fees payable to the company administrator may be taken out of the company’s assets, the creditors will often choose a person who is familiar with the company’s business, its activities or assets or has skills, knowledge or experience in handling the particular circumstances of the case.

Failure of the Regime: lack of timely rescue mechanism: SICA as failing in its mandate to provide a timely rescue mechanism for sick industrial companies. It has been seen that delays were a routine matter with BIFR proceedings. It has been estimated that it takes about 5-7 years for a sick industrial company to be revived after BIFR proceedings. These delays are augmented by the routine challenges to BIFR decisions before the AAIFR and High Courts. Consequently, although the SICA was originally meant to limit judicial oversight to the minimum required, there has been a significant degree of court involvement in the rescue process. The major setbacks for rehabilitation packages in SICA were the inability of the BIFR to distinguish between cases suitable for rehabilitation and for winding up, the pro-debtor and anti-creditor nature of BIFR proceedings, the provision of an automatic moratorium on enforcement proceedings and the debtor-in-possession regime. Another major drawback of SICA was reflected by the Goswami Committee and subsequently in the Eradi Committee in 2000, elaborated on the fact that since the Act concentrated on “debtor-in-possession” regime, this would give rise to risky implementation of rescue measures as the cost of the proceedings would be borne by the creditors. The RBI report (2001) has criticised SICA as being “seriously flawed” and “notoriously dilatory”.

The SARFAESI Act envisages specialised resolution agencies in the form of Asset Reconstruction Companies (“ARCs”) to resolve Non-performing Assets (“NPAs”) and other specified bank loans under distress. ARCs are seen as vehicles to increase the liquidity of banks which can divest themselves of bad loans by transferring them to the ARCs. But given their powers to resort to several measures (which includes taking over the management and conversion of debt into equity among others) for recovering the value underlying those loans, ARCs can (at least in theory) also help in insolvency resolution of a company. The banks are required to hold exposure in the sold loans through subscription to security receipts issued by the special purpose vehicle holding the assets under consideration. Such offloaded assets are generally held in trusts that issue security receipts and are managed by the ARCs in their capacity as trustees. It may be noted that an ARC can takeover the management of the borrower only for the purpose of ‘realization of dues’. The management of the company has to be restored back to the borrower after realisation of the dues. Therefore, this mechanism is largely seen as a debt recovery tool and not an insolvency resolution tool (i.e., it does not facilitate rescue/ revival in practice).

The report enlightens on the various factors which led to the failure of the Indian Corporate Insolvency Regime which were delays in execution of proceedings, unnecessary court intervention requirement at certain levels, lack of an institutional framework for a swift implementation, complicated priority regime for distribution (in liquidation), holdouts by certain creditors in rescue through schemes of arrangement and compromises with creditors and multiple forums spread across different legislations leading to multiplicity of legal actions on the same cause of action and related conflicts.
Keeping this at reach, the report provides for an immediate response to the reforms for improving the corporate insolvency regime. The report also hints at the ingredients of an effective insolvency law stating that an ideal insolvency regime needs to strike the right balance between the interests of all the stakeholders by a reasonable allocation of risks among them. It also touches upon the need of hierarchy of payments and the ultimate aim of reorganisations i.e. promoting resurgence of the enterprise as a going concern, rather than death or liquidation of the enterprise.

The reasoning revolves around major issues with respect to debtor protection regime being substituted by creditor protection regime, promoting economic growth with a proper allocative efficiency mechanism as a sound corporate insolvency law can help this process by enabling reallocation of ‘inefficiently utilized resources’ and ‘ousting of inefficient participants’ from the market. Moreover, protection of credit markets in India have been given a boost up by this impressive legal move and its successful implementation will definitely aim at securing the interests of all the stakeholders at large.

This Article was first published here on TAXGURU.

By Puneet Agrawal, Partner, & Tejaswini Tripathy, Associate of ALA Legal, Advocates & Solicitors

GST Law India is a blog on GST and allied commercial laws managed by members of the law firm ALA Legal.