One of the essential business supporting element is a mechanism to settle failed or bankrupt entities without causing damage to any players in the economy. Continuation of financially non-viable businesses leads to locking of funds and physical assets. Similarly, it may lead to stress for the lender who have provided loan to the distressed business entity. For this, a bankruptcy code in the form of set of laws for the resolution of failed entities/individuals is needed.
Bankruptcy is a financial condition where a firm/individual is unable to repay debts to creditors. Under India’s Insolvency and Bankruptcy Code 2016, a bankrupt entity is a debtor who has been adjudged as bankrupt by an adjudicating authority through passing a bankruptcy order.
In every economy, there should be a legal procedure accompanied by institutions that collectively can resolve or settle the problems of failed institutions. An early resolution with sound principles will help the related parties like banks not to suffer from the failure of the business entity to whom they have provided a loan. Similarly, the Insolvency and Bankruptcy Procedures will help to ensure confidence of banks, foreign investors, associated companies in crisis mitigation mechanism related to business entities in the country.
A situation where investable money locked for a long time in litigations is the least preferred situation for business partners and lenders. Use of the bankruptcy procedure also may help the failing entity to resolve its problems early without going to a worst case scenario.
For establishing an insolvency regulation related to entities and individuals, the Parliament has enacted Insolvency and Bankruptcy Code 2016. The Code offers a uniform, comprehensive insolvency legislation encompassing all companies, partnerships and individuals (other than financial firms). For financial firms like banks, insolvency is a much delicate issue and for this a separate resolution regime will be enacted later.
The Code provides clear, coherent and speedy process for early identification of financial distress and resolution of entities if the underlying business is found to be viable. It suggests two options – a restructuring if the firm is viable and liquidation if it is not financially viable. Resolution should be done quickly and judiciously to ensure that business is not stuck.
The new code will replace existing bankruptcy laws and cover companies, limited liability partnerships, partnership firms, other corporate persons, and individuals, and any other body specified by the Government. There are Sick Industrial Companies Act, the Recovery of Debt Due to Banks and Financial Institutions Act, and Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI). Besides, DRTs, Lok Adalats are also dealing with bankruptcy procedures. All these will be substituted/guided by the Insolvency and Bankruptcy Code on bankruptcy matters as it consolidates/improves the existing laws.
The Code specifies a timeframe — 180 days after the process is initiated, plus a 90-day extension — for resolving insolvency.
A major feature of the Code is that it creates a four pillars of institutional infrastructure for administering the bankruptcy procedure. These entities/agencies are:
Insolvency and Bankruptcy Board of India: is the regulator that will oversee the new entities.
Insolvency Professionals: will conduct the insolvency resolution process, take over the management of a company, assist creditors in the collection of relevant information, and manage the liquidation process,
Insolvency Professional Agencies: will examine and certify the insolvency professionals, and
Information Utilities: collect, collate and disseminate financial information related to debtors,
An important prerequisite for the success of the Code is the presence of sophisticated institutions and professionals who should facilitate the resolution procedure. Highly skilled insolvency professionals and matured institutions critical for making the entire process workable.
As per the new law, when a loan default occurs, either the borrower or the lender approaches the NCLT or DRT (Debt Recovery Tribunal) for initiating the resolution process. The Code provides two options if a firm files insolvency: first is an Insolvency Resolution Process, during which creditors assess whether the debtor’s financial position is viable for him to continue and if so, they have to search options for the rescue of the firm. The second option is liquidation.
The adjudicating authority for insolvency issues of a Company/LLP is prescribed to be the NCLT and National Company Law Appellate Tribunal (NCLAT), and for individuals and partnership firms, it is the extant DRT and Debt Recovery Appellate Tribunal (DRAT).
Next step is that creditors appoint an interim Insolvency Professional (IP) to take control of the debtor’s assets and company’s operations, collect financial information of the debtor from information utilities, and constitute the creditors’ committee.
Third step is that the committee has to then take decisions regarding insolvency resolution by a 75% majority. During the insolvency resolution period, the management of the debtor is placed in the hands of an resolution professional.
Fourth step is that once the resolution is passed; the committee has to decide on the restructuring process through either a revised repayment plan or liquidation of the assets of the company. If no decision is made, the debtor’s assets will be liquidated to repay the debt.
The final step is that the resolution plan will be sent to the tribunal for final approval, and implemented once approved.
The bankruptcy code has provisions to address cross-border insolvency through bilateral agreements with other countries.
The Code proposes shorter time duration for the completion of insolvency process. Filing for bankruptcy has to be done in three months and other procedures like filing claims and appeals are also to be done quickly. The entire process will be completed within 180 days
Workers’ interests are highly protected under the law. Here, the money due to workers and employees from the provident fund, the pension fund and gratuity fund shouldn’t be included in the estate of the bankrupt company or individual. Similarly, in case of liquidation, workers’ salaries for up to 24 months will get first priority, ahead of secured creditors.
Anyone who was declared is not allowed to hold public office, and politicians and government officials cannot hold any public office if they are declared bankrupt.
The Insolvency and Bankruptcy Code is thus a comprehensive and systemic reform, that ensures speedy solution to insolvency and bankruptcy. Such a swift procedure will help creditors considerable as well as avoid distressed firms negatively affecting the economic and financial activities. The Code is big stride for ease of doing business in India
Key Features
Insolvency Resolution : The Code outlines separate insolvency resolution processes for individuals, companies and partnership firms.The process may be initiated by either the debtor or the creditors. A maximum time limit, for completion of the insolvency resolution process,has been set for corporates and individuals. For companies, the process will have to be completed in 180 days, which may be extended by 90 days, if a majority of the creditors agree. For start ups (other than partnership firms), small companies and other companies (with asset less than Rs. 1 crore), resolution process would be completed within 90 days of initiation of request which may be extended by 45 days.
Insolvency regulator: The Code establishes the Insolvency and Bankruptcy Board of India, to oversee the insolvency proceedings in the country and regulate the entities registered under it. The Board will have 10 members, including representatives from the Ministries of Finance and Law, and the Reserve Bank of India.
Insolvency professionals: The insolvency process will be managed by licensed professionals. These professionals will also control the assets of the debtor during the insolvency process.
Bankruptcy and Insolvency Adjudicator: The Code proposes two separate tribunals to oversee the process of insolvency resolution, for individuals and companies: (i) the National Company Law Tribunal for Companies and Limited Liability Partnership firms; and (ii) the Debt Recovery Tribunal for individuals and partnerships.
The four pillars of the IBC framework
Adjudication: In the case of insolvency of companies, the adjudication authority is the National Company Law Tribunal (NCLT), while the cases involving individuals and limited liability partnerships are dealt by the Debts Recovery Tribunals (DRTs).
Insolvency Professional (IP): They play a key role in resolution, liquidation and bankruptcy processes.
Information Utilities (IU): Electronically store data about lenders.
Regulator: Insolvency Bankruptcy Board of India.
Procedure
A plea for insolvency is submitted to the adjudicating authority (NCLT in case of corporate debtors) by financial or operation creditors or the corporate debtor itself. The maximum time allowed to either accept or reject the plea is 14 days. If the plea is accepted, the tribunal has to appoint an Insolvency Resolution Professional (IRP) to draft a resolution plan within 180 days (extendable by 90 days). following which the Corporate Insolvency Resolution process is initiated by the court. For the said period, the board of directors of the company stands suspended, and the promoters do not have a say in the management of the company. The IRP, if required, can seek the support of the company’s management for day-to-day operations. if the CIRP fails in reviving the company the liquidation process is initiated.
Amendments
The Bill prohibits certain persons from submitting a resolution plan in case of defaults. These include: (i) wilful defaulters, (ii) promoters or management of the company if it has an outstanding non-performing debt for over a year, and (iii) disqualified directors, among others. Further, it bars the sale of property of a defaulter to such persons during liquidation.
Major positive recent events happened due to IBC
Vedanta recently acquired bankrupt Electrosteel Steels, which made a loan default of Rs. 10,273cr, for Rs. 5,320cr under the IBC.
Further, last month, Tata Steel bought bankrupt Bhushan Steel for Rs. 35,500cr. Bhushan Steel had a loan default of Rs. 44,478cr to banks.
The two companies were among the RBI's list of 12 corporate borrowers which account for 1/4th of Indian banking industry NPAs
Part A:
How it works in case of a company?
When a company makes a payment default of at least Rs. 1 lakh, an insolvency application can be made either by the company's creditors or debtors to the NCLT.
Then, the NCLT appoints an interim insolvency resolution professional (IRP), placing the company under a moratorium.
Upon the appointment of IRP, the board of the company gets suspended till the completion of the resolution process.
Part B:
How it works in case of a company?
IRP then creates a committee of creditors of the company, which appoints the final insolvency resolution professional (IP).
IP drafts a resolution plan which requires the approval of the committee of creditors within 180 days, with a grace period of another 90 days, and the final approval of the NCLT.
If the plan doesn't get approved in 270 days, the company goes into liquidation.
Effect
How IBC is helping ailing Indian banking industry to recover?
To avoid losing the control of their business under the IBC, promoters of as many as 2,100 companies have cleared their bank dues of Rs. 83,000cr.
By now, at least 2,434 fresh cases have been filed before NCLT and at least 2,304 other cases seeking the winding-up of companies have been transferred from various high courts.
Of these, 2,750 cases have been disposed of.
Who's paid first when a company is liquidated under IBC?
Priority Order
Who's paid first when a company is liquidated under IBC?
Under IBC, the proceeds of a liquidation are distributed in the following order of priority:
Insolvency resolution process, liquidation costs
Workmen' dues pending 24 months, secured creditors
Unpaid dues owed to employees other than workmen for 12 months
Unsecured creditors
Any amount due to the Central Government and the State Government
Any remaining debts/dues
Preference shareholders
Equity shareholders, partners
.
Some More details:::
THE CODE
The Code offers a uniform, comprehensive insolvency legislation encompassing all companies, partnerships and individuals (other than financial firms). The Government is proposing a separate framework for bankruptcy resolution in failing banks and financial sector entities.
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.
KEY HIGHLIGHTS
1. Corporate Debtors: Two-Stage Process
To initiate an insolvency process for corporate debtors, the default should be at least INR 100,000 (USD 1495) (which limit may be increased up to INR 10,000,000 (USD 149,500) by the Government). The Code proposes two independent stages:
Insolvency Resolution Process, during which financial creditors assess whether the debtor's business is viable to continue and the options for its rescue and revival; and
Liquidation, if the insolvency resolution process fails or financial creditors decide to wind down and distribute the assets of the debtor.
(a) The Insolvency Resolution Process (IRP)
The IRP provides a collective mechanism to lenders to deal with the overall distressed position of a corporate debtor. This is a significant departure from the existing legal framework under which the primary onus to initiate a reorganisation process lies with the debtor, and lenders may pursue distinct actions for recovery, security enforcement and debt restructuring.
The Code envisages the following steps in the IRP:
(i) Commencement of the IRP
A financial creditor (for a defaulted financial debt) or an operational creditor (for an unpaid operational debt) can initiate an IRP against a corporate debtor at the National Company Law Tribunal (NCLT).
The defaulting corporate debtor, its shareholders or employees, may also initiate voluntary insolvency proceedings.
(ii) Moratorium
The NCLT orders a moratorium on the debtor's operations for the period of the IRP. This operates as a 'calm period' during which no judicial proceedings for recovery, enforcement of security interest, sale or transfer of assets, or termination of essential contracts can take place against the debtor.
(iii) Appointment of Resolution Professional
The NCLT appoints an insolvency professional or 'Resolution Professional' to administer the IRP. The Resolution Professional's primary function is to take over the management of the corporate borrower and operate its business as a going concern under the broad directions of a committee of creditors. This is similar to the approach under the UK insolvency laws, but distinct from the "debtor in possession" approach under Chapter 11 of the US bankruptcy code. Under the US bankruptcy code, the debtor's management retains control while the bankruptcy professional only oversees the business in order to prevent asset stripping on the part of the promoters.
Therefore, the thrust of the Code is to allow a shift of control from the defaulting debtor's management to its creditors, where the creditors drive the business of the debtor with the Resolution Professional acting as their agent.
(iv) Creditors Committee and Revival Plan
The Resolution Professional identifies the financial creditors and constitutes a creditors committee. Operational creditors above a certain threshold are allowed to attend meetings of the committee but do not have voting power. Each decision of the creditors committee requires a 75% majority vote. Decisions of the creditors committee are binding on the corporate debtor and all its creditors.
The creditors committee considers proposals for the revival of the debtor and must decide whether to proceed with a revival plan or liquidation within a period of 180 days (subject to a one-time extension by 90 days). Anyone can submit a revival proposal, but it must necessarily provide for payment of operational debts to the extent of the liquidation waterfall.
The Code does not elaborate on the types of revival plans that may be adopted, which may include fresh finance, sale of assets, haircuts, change of management etc.
(b) Liquidation
Under the Code, a corporate debtor may be put into liquidation in the following scenarios:
(i) A 75% majority of the creditor's committee resolves to liquidate the corporate debtor at any time during the insolvency resolution process;
(ii) The creditor's committee does not approve a resolution plan within 180 days (or within the extended 90 days);
(iii) The NCLT rejects the resolution plan submitted to it on technical grounds; or
(iv) The debtor contravenes the agreed resolution plan and an affected person makes an application to the NCLT to liquidate the corporate debtor.
Once the NCLT passes an order of liquidation, a moratorium is imposed on the pending legal proceedings against the corporate debtor, and the assets of the debtor (including the proceeds of liquidation) vest in the liquidation estate.
Priority of Claims
The Code significantly changes the priority waterfall for distribution of liquidation proceeds.
After the costs of insolvency resolution (including any interim finance), secured debt together with workmen dues for the preceding 24 months rank highest in priority. Central and state Government dues stand below the claims of secured creditors, workmen dues, employee dues and other unsecured financial creditors. Under the earlier regime, Government dues were immediately below the claims of secured creditors and workmen in order of priority.
Upon liquidation, a secured creditor may choose to realise his security and receive proceeds from the sale of the secured assets in first priority. If the secured creditor enforces his claims outside the liquidation, he must contribute any excess proceeds to the liquidation trust. Further, in case of any shortfall in recovery, the secured creditors will be junior to the unsecured creditors to the extent of the shortfall.
2. Insolvency Resolution Process for Individuals/Unlimited Partnerships
For individuals and unlimited partnerships, the Code applies in all cases where the minimum default amount is INR 1000 (USD 15) and above (the Government may later revise the minimum amount of default to a higher threshold). The Code envisages two distinct processes in case of insolvencies: automatic fresh start and insolvency resolution.
Under the automatic fresh start process, eligible debtors (basis gross income) can apply to the Debt Recovery Tribunal (DRT) for discharge from certain debts not exceeding a specified threshold, allowing them to start afresh.
The insolvency resolution process consists of preparation of a repayment plan by the debtor, for approval of creditors. If approved, the DRT passes an order binding the debtor and creditors to the repayment plan. If the plan is rejected or fails, the debtor or creditors may apply for a bankruptcy order.
3. Institutional Infrastructure
(a) The Insolvency Regulator
The Code provides for the constitution of a new insolvency regulator i.e., the Insolvency and Bankruptcy Board of India (Board). Its role includes: (i) overseeing the functioning of insolvency intermediaries i.e., insolvency professionals, insolvency professional agencies and information utilities; and (ii) regulating the insolvency process.
(b) Insolvency Resolution Professionals
The Code provides for insolvency professionals as intermediaries who would play a key role in the efficient working of the bankruptcy process. The Code contemplates insolvency professionals as a class of regulated but private professionals having minimum standards of professional and ethical conduct.
In the resolution process, the insolvency professional verifies the claims of the creditors, constitutes a creditors committee, runs the debtor's business during the moratorium period and helps the creditors in reaching a consensus for a revival plan. In liquidation, the insolvency professional acts as a liquidator and bankruptcy trustee.
(c) Information Utilities
A notable feature of the Code is the creation of information utilities to collect, collate, authenticate and disseminate financial information of debtors in centralised electronic databases. The Code requires creditors to provide financial information of debtors to multiple utilities on an ongoing basis. Such information would be available to creditors, resolution professionals, liquidators and other stakeholders in insolvency and bankruptcy proceedings. The purpose of this is to remove information asymmetry and dependency on the debtor's management for critical information that is needed to swiftly resolve insolvency.
(d) Adjudicatory authorities
The adjudicating authority for corporate insolvency and liquidation is the NCLT. Appeals from NCLT orders lie to the National Company Law Appellate Tribunal and thereafter to the Supreme Court of India. For individuals and other persons, the adjudicating authority is the DRT, appeals lie to the Debt Recovery Appellate Tribunal and thereafter to the Supreme Court.
In keeping with the broad philosophy that insolvency resolution must be commercially and professionally driven (rather than court driven), the role of adjudicating authorities is limited to ensuring due process rather than adjudicating on the merits of the insolvency resolution.
CONCLUSION
India currently ranks 136( As on 2018 now it is 100) out of 189 countries in the World Bank's index on the ease of resolving insolvencies. India's weak insolvency regime, its significant inefficiencies and systematic abuse are some of the reasons for the distressed state of credit markets in India today. The Code promises to bring about far-reaching reforms with a thrust on creditor driven insolvency resolution. It aims at early identification of financial failure and maximising the asset value of insolvent firms. The Code also has provisions to address cross border insolvency through bilateral agreements and reciprocal arrangements with other countries.
The unified regime envisages a structured and time-bound process for insolvency resolution and liquidation, which should significantly improve debt recovery rates and revitalise the ailing Indian corporate bond markets.
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.