Insolvency and Bankruptcy Code 2015

To facilitate easy and time bound closure of business in India, Government has introduced the Insolvency and Bankruptcy Code 2015 in Parliament. Currently, the bill is referred to a 30-member joint committee of the Members of Parliament for further scrutiny. The joint committee is formed with 20 members from Lok Sabha, and the rest from the Rajya Sabha. The joint committee is expected to submit its report by the last day of first week of the Budget session. As it is a Money Bill, the Rajya Sabha has limited powers towards this bill.

What is Insolvency?

The term insolvency is used for both individuals and organizations. For individuals, it is known as bankruptcy and for corporate it is called corporate insolvency. Both refer to a situation when an individual or company are not able to pay the debt in present or near future and the value of assets held by them are less than liability.

Difference between insolvency & bankruptcy

Insolvency is a situation when the debtor cannot meet its financial obligations i.e when he cannot pay back the money to lender on time. Warning signs could be decrease in sales, high dependence on credit, delay in payments etc. Bankruptcy is a legal declaration of insolvency. In this, the debtor files an application with the court to declare himself insolvent or the creditor files an application against the insolvent. Therefore it is a last stage of insolvency. We note here that while insolvency is a financial situation and bankruptcy is a legal condition. Insolvency may or may not lead to bankruptcy.

The World Bank’s doing business report 2016 pointed out that it takes more than 4 years to resolve insolvency cases in India, as against 1.5 years in OECD countries. In summary, it is very difficult to solve insolvency and similarly difficult to exit from a business. This is one of the reasons that India is placed at 130 out of 189 countries in the ease of doing business.

Current Insolvency Procedure

In case of insolvency, there are different arrangements for example:

• Company voluntary arrangement, which means an arrangement between the board of company and its creditor to reschedule the debt and in return accordingly restructure the company’s business under the new business development strategy.
• Taking over the administration of the company and protecting company’s assets from any form of creditor’s action.
• Liquidation, which is a process in which company is closed down by converting all the assets into cash value and then it is distributed, sold off to the creditors and the shareholders of the company.

The process is carried out by the professional insolvency practitioners who are licensed to do so.

Legal Framework

‘Bankruptcy and Insolvency’ falls in List III i.e. concurrent list. Therefore both the state as well as the centre have the power to make law on the subject. In case of conflict between laws made by the Parliament and State Legislature the parliamentary law will prevail. Then, there are three laws (Companies Acts of 1956 and 2013; and Sick industrial Companies Act 1985) which handle the corporate insolvency procedures in India. Further, the solvency process is highly fragmented with powers given to debtors and the creditors under various laws. The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 was passed to provide an easy exit of the business and protect the interest of the creditors. As per the provisions of the act, secured creditors can enforce their security interest without the intervention of the court. But under the act, debtors can challenge the enforcement by creditors within 45 days in court. This will delay the process. And the present SARFAESI Act was more favourable to secured creditors only.

In summary, India’s insolvency regime is not very effective. It’s a multi-layered legal framework involving various tribunals, a time consuming process. Because of the long-time proceedings, the assets involved in the case will lose their value and the returns will be low. The inability to recover the funds has resulted in accumulation of Non-Performing Assets (NPA) for the creditors like banks. It is not entrepreneur friendly, and no easy exit option is available to them. The lethargic insolvency procedure in India is mainly because of the officials attending to it and the delays in courts and tribunal.

T K Vishwanathan Committee Report

To fix the issues with the current insolvency regime, the government had set up a high level Bankruptcy Law Reform Committee (BLRC) in August 2014 under Dr. T. K. Viswanathan (former Law Secretary). This committee had submitted its report in November 2015 while suggesting new institutions and structures to modernize the present outdated system. After consultation with stakeholders about the committee recommendations, government prepared a draft bill and introduced it in the Parliament.

Key recommendations

The committee recommended a structure similar to efficient insolvency regime across the world. The key recommendations are enumerated below:

• A company should not be allowed to remain alive only for the purpose of preventing the unemployment.
• Amend the Companies Act to fasten the liquidation process and to ensure the creditor have dominance over the viability of the company.
• Creditor may initiate the rescue proceeding if the debtor company fails to pay single undisputed debt exceeding a prescribed limit and within 3 months of the notice of demand.
• Committees for distressed micro small and medium enterprises should be established for resolving the financial distress through administrative mechanism.
• Amendment of Securities Contract Regulation Act (SCRA) 1956 which provides certain provisions for settlement in the financial contracts which provide exemptions from the normal operation of insolvency law
• Liquidation should not be the last resort for insolvent companies; rather approach should be to minimize the losses of all parties and give way to concrete framework to the India’s insolvency regime through a mixture of substantive institutional changes.
• The easy exit option will give the entrepreneurs a viable choice to start. However the investment climate would also get a boost and would further strengthen the stability of the economy.

Improvements proposed in Insolvency and Bankruptcy Code

The Insolvency and Bankruptcy Code aims to create an overarching framework for revamping or easy winding up of a business. It will be applicable to individuals, companies, limited liability partnerships, partnership firms and other legal entities registered in India as may be notified, except for those with a dominantly financial function. This implies that all types of entities will come under one single law. It will also repeal the archaic laws like Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920.

Salient Features

The bill contains a clear speedy mechanism for early identification of financial distress and initiate revival/re-organisation of the company if it is viable. The bill proposes a timeline of 180 days to deal with the applications for insolvency resolution with an option of extending it by 90 days for exceptional cases. The insolvency resolution plan has to be approved by 75% of the creditors. If the plan is approved, then the adjudicating authority will give its sanction. In case of rejection of insolvency resolution plan, the adjudicating authority will pass an order for liquidation. The bill also contains provisions for a fast-track insolvency resolution process for certain categories of entities where the resolution process has to be completed within 90 days with a window for a one-time extension of 45 days. The fast-track resolution of insolvency cases will improve the recovery of debt and money. It will reduce the conflicts between creditors and the debtors. Higher recovery will reduce the Non-Performing Assets (NPA). The other benefits are: promotion of entrepreneurship, availability of credit etc.

The other positive aspect of the bill is creation of two separate regulators – the insolvency regulator and the insolvency adjudicating authority. The insolvency regulator exercise regulatory oversight over a proposed new class of insolvency professionals, agencies and information utilities. There are two separate adjudicating authorities:

• The Debt Recovery Tribunal (DRT), which has jurisdiction over individuals and unlimited liability partnership firms. Appeals from the order of DRT shall lie to the Debt Recovery Appellate Tribunal (DRAT).
• The National Company Law Tribunal (“NCLT”), which has jurisdiction over companies, limited liability entities. Appeals from the order of NCLT shall lie to the National Company Law Appellate Tribunal (“NCLAT”). NCLAT shall be the appellate authority to hear appeals arising out of the orders passed by the regulator in respect of insolvency professionals or information utilities.

Information utilities will collect, authenticate and disseminate financial information from listed companies and financial and operational creditors of companies. A database will be created to provide information on the insolvency status of individuals. The bill also proposes to set up Insolvency and Bankruptcy Fund.

The clarity on repayment under the new framework will encourage the corporate and infrastructure bond market. The bill also empowers employees, whose past payments were due, to initiate insolvency proceedings. In case of the insolvency resolution process for individuals, the bill proposed the option of “Fresh Start” process for individuals with annual gross income less than Rs.60,000 and aggregate asset value less than Rs. 20,000.

What about financial sector insolvencies?

The Financial Sector Legislative Reforms Commission (FSLRC) had recommended creating a resolution corporation to monitor financial firms. The aim is to either revive it if possible by change of management or close it. The proposal is to promote the Deposit Insurance and Credit Guarantee Corporation (DICGC) as Resolution Corporation.

Expected Outcomes

Once the code will come into place it will minimize the problem of delay as there are strict timelines within which the case has to be disposed off. The code will also consolidate the existing laws thus making the process simpler. Easy exit option is anticipated for sick firms and insolvents. It will help improve the ease of doing business in India. Quick disposal of cases will maximize the recovery amount. The code brings about legal certainty and predictability in the process as there is an organized process for insolvency resolution. The procedure can be initiated by either the creditor or the debtor. Till the period of 180 days gets over, no claims can be initiated against the debtor. Thus the process has inbuilt incentives for creditors to join process rather than initiating individual actions. The code will create a comprehensive institutional architecture to deal with insolvency. Establishment of information utilities will help in creating a database to provide information on the insolvency status of individuals. In addition to this specialized insolvency professionals will help in guiding through the process. All above benefits will relieve the stressed assets easily and speedily thereby enabling the higher flow of capital in the economy. Easy process of claim by the creditors also encourages financial institutions to extend credit facilities thus strengthening the financial markets with increased availability of credit for business. The bankruptcy code will make it easier for companies to wind up failed businesses and bring India on a par with developed nations in terms of resolving bankruptcy issues.

Conclusion

Though there are no prefect laws and bankruptcy code anywhere in the world, the presence of a strong framework is essential to deal with corporate insolvency and creditor and debtor protection in a hassle-free manner. The Insolvency and Bankruptcy Code would provide such environment to ensure easy exit for sick companies and help the country to improve its position in easy of doing business.