Insolvency and Bankruptcy Code

Insolvency and Bankruptcy Code

This article deals with ‘Insolvency and Bankruptcy Code.’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .

What is Bankruptcy ?

Bankruptcy is a legal status usually imposed by a Court, on a firm or individual unable to meet  their debt obligations.

 Drawbacks of Earlier System of Bankruptcy

  1. It takes on average 4.3 years to resolve insolvencies in India (compared to 0.7 years in Japan)  ‘
  2. Creditors recover just 25% in India compared to 93% in Japan.
  3. It was difficult to wind up unviable company  —> this acted as huge barrier for entrepreneurs (as Start-ups are prone to failure)
  4. It has inhibited the development of a vibrant corporate bond market in India
  5. It has led to ‘Evergreening of loans‘ which has resulted in large NPA of Banks.  
  6. Multiplicity of Acts to deal with Insolvency like Sick  Companies Act, 1985; SARFAESI Act etc. leads to delays and corruption because of  overlapping provisions .

Provisions of the Act

  • Who can Initiate Insolvency Resolution Process ? – It can be initiated by
    • Business or debtor who has defaulted on dues (but he shouldn’t be Wilful Defaulter) , OR
    • Lenders and creditors to a firm
  • Speed will be  the main essence of insolvency proceedings
    • 180-day limit for the Committee of Creditors’ , which will have representation of all lenders in proportion to their advances, to decide one of three alternatives — liquidation of the company, sale of the company as a going-concern, or restructuring of debt. 
    • They can demand 90 extra days from Adjudicating Authority in exceptional cases.

If three-fourths in value of creditors are unable to agree on one of the three options within the 180/270 -day period, then the liquidation process will automatically commence.

  • Such speedy winding up is to be achieved by  creating a host of new institutions. These would include:
    • During the time insolvency proceedings are going on , Insolvency Professionals will  take over the management of a company, assist creditors in the collection of relevant information, and later  manage the liquidation process,
    • Insolvency Professional Agencies who will examine and certify these professionals,
    • Information Utilities, which will collect, collate and disseminate financial information related to debtors to facilitate insolvency, liquidation & bankruptcy , (NeSL (National E-Governance Services Limited) is the first Info Utility)
    • Insolvency Regulator: Establish  Insolvency and Bankruptcy Board of India (IBBI)  to exercise regulatory oversight 
  • Insolvency Adjudicating Authority :The final decision to accept or reject the insolvency resolution plan rests with the adjudicating authority. Adjucating Authority in these cases are
    • Debt Recovery Tribunal (“DRT”) in individuals and unlimited liability partnership firms. 
    • National Company Law Tribunal (“NCLT”) in companies & limited liability entities
  • The bill has provisions to tackle issues of cross-border insolvency. (although rules regarding this have not been notified)
  • The bill has provision of personal insolvency in case the promoter of company has given personal guarantee against the loans taken by the company. (Eg : Personal Insolvency procedure was initiated by SBI against Anil Ambani who had given personal guarantee for loan of ₹1200 crore taken by his companies RCom & Reliance Infratel Limited (RITL)
  • 2018 Amendment : Earlier, Promoters and defaulters bided for their companies and bought them back . Amendment  stop promoters and defaulters from bidding for companies undergoing resolution 
  • 2019 Amendment :  Home buyers would be treated as financial creditors (in case of Real Estate Projects) and shall have the right to be represented in the Committee of Creditors  .
Insolvency and Bankruptcy Code

Positive effects of Insolvency and Bankruptcy Code

  1. Easy exit policies will be  major boost for Start up India .
  2. It will improve the rank of India on ease of doing business index .
  3. It can help in reducing the menace  of NPA  .
  4. Cases in High Courts will reduce because adjucating authority is DRT & NCLT . 

Shortcomings of Insolvency and Bankruptcy Code

  • It lacks provisions equivalent to those of Chapter 11 of the US bankruptcy law, which allow a voluntary appeal by a debtor to be given a chance for a turnaround that the bankruptcy court can grant, if the court finds it feasible, regardless of the creditors’ verdict.
  • IBC interacts with numerous laws. Eg labour laws and the Industrial Disputes Act, 1947. 
  • Proposed resolution plan requires 75% in value of creditors to sign for it. This creates the risk of the minority creditors being disenfranchised.
  • Code provides a hard deadline of 180/270 days for completion of corporate insolvency process, failing which, liquidation will start . Negotiating under the shadow of liquidation may lead parties to not conduct a wide enough market search for the ailing corporate debtor and will likely result in fire sales (translating into creditor under-recoveries). 
  • There is  need to increase the number of NCLT benches, number of IP Professionals, use ICT technology for faster case proceedings.
  • Issue of Group insolvency needs to be fixed. Group insolvency means, insolvency of one company of a group of companies . Eg : Tata Sons has many companies like Tata Motors, Tata Capital , TCS etc. There needs to be more clarity on issue when one or more than one company of group undergoes insolvency process.

Working Appraisal of Insolvency and Bankruptcy Code

  • IBC Regime is working better than previous any other regime .Upto September 2019,  743 corporates have completed the process yielding either resolution or liquidation and 498 corporates have commenced voluntary liquidation process.
  • Time to settle insolvencies has decreased to 340 days (from 4.3 years earlier) .
  • Corporate behaviour wrt outstanding  unpaid loans has also changed. Earlier, Insolvency process used to take 4.3 years, hence Corporate houses used to be non-serious about paying these unpaid loans. Now, time to solve insolvency has decreased to less than year  and as a result, they have started repaying loans in fear of losing control over company.
  • Amount recovered – Shows mix Trend
    • In case of big loans like that of Bhushan Steel, Banks were able to recover 85% .
    • But in case of MSME loans, recovery rate is below 50% (but still higher than previous recovery)
  • Uniform and universal application :  RBI has withdrawn other resolution schemes such as Strategic Debt Restructuring (SDR) Scheme , Scheme for Sustainable Structuring of Stressed Assets (S4A) etc. 
  • In Ease of Doing Business, Rank of India wrt resolving Insolvency has decreased due to these changes .

Jan 2019 – Supreme Court Judgement on Constitutionality of IBC

  • Supreme Court declared IBC to be constitutionally valid .
  • Challenge : Operational Creditors challenged it on grounds of violative of Article 14 .
  • Supreme Court argument : Intelligible differentiation can be made between Operational Creditors and Financial Creditors since repayment of debt infuses capital into the economy and banks .  Thus, relative importance of financial creditors is more vis-a-vis operational creditors.

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