IBC: The Insolvency And Bankruptcy Code, 2016: A Game Changer By CS Mukesh Karna


INTRODUCTION

The Insolvency and Bankruptcy Code, 2016 received President’s assent on May 28th, 2016. The objectives of Code to consolidate and amend the laws relating to reorganisation and insolvency resolution of Corporate, Partnership firms and Individuals in a time bound manner for maximisation of value of assets, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues and to establish an Insolvency and Bankruptcy Board of India. The Code contains 255 Sections and 11 Schedules.

The provisions of this Insolvency and Bankruptcy Code shall apply to-

  1. any company incorporated under the Companies Act, 2013 or under any previous company law;
  2. any other company governed by any special Act for the time being in force, except in so far as the said provisions are inconsistent with the provisions of such special Act;
  3. any Limited Liability Partnership incorporated under the Limited Liability Partnership Act, 2008;
  4. such other body incorporated under any law for the time being in force, as the Central Government may, by notification, specify in this behalf; and
  5. partnership firms and individuals, in relation to their insolvency, liquidation, voluntary liquidation or bankruptcy, as the case may be.

 
WHAT IS INSOLVENCY AND BANKRUPTCY?

Insolvency

Insolvency is the state of being unable to pay the money owed by a person or company on time. The person in a state of insolvency is said to be insolvent. There are two forms of insolvency:

  1. Cash-flow insolvency and
  2. Balance-sheet insolvency.
Cash-flow insolvency is when a person or company has enough assets to pay debts but insufficient liquid assets for the payment. For example, a person may own a farmhouse and a valuable car, but not have enough liquid assets to pay debts. Cash-flow insolvency can usually be resolved by negotiation. For example, the bill collector may wait until the car is sold and the debtor agrees to pay a penalty. Balance-sheet insolvency is when a person or company does not have sufficient assets to pay all of their debts.

Bankruptcy

Bankruptcy is a legal status of an inability of a person or other entity to repay the debts. In most of the jurisdictions, bankruptcy is imposed by a court and it is rarely initiated by the debtor.

INSOLVENCY LAWS IN INDIA AND SOME OTHER COUNTRIES:

Insolvency laws around the world have evolved in different ways with a focus on various strategies for dealing with the insolvent.

Country

Laws

Australia

Corporations Act, 2001 governs the corporate insolvency in Australia. Companies can be put into Voluntary Administration, Creditors Voluntary Liquidation & Court Liquidation. If the creditors are secured and a charge is registered then they are able to appoint receiver and manager.

Canada

In Canada, bankruptcy and insolvency are generally regulated by the Bankruptcy and Insolvency Act. The alternate ways are available for larger companies, whose total debts exceed $5 million. This law is called the Companies Creditors Arrangements Act.

South Africa

If the owners of business become a balance sheet insolvent then they become personally liable for business debts in South Africa. This type of insolvency is often regarded as a normal business practice in South Africa. The debts become due when the owner of a business is able to fulfil its debt obligation.

Switzerland

Insolvency or foreclosure may lead to the seizure and auctioning off of assets under Swiss Law for individuals and bankruptcy proceedings for registered commercial entities.

Turkey

Turkish insolvency law is regulated by Enforcement and Bankruptcy Law. The main concept of the insolvency law is very similar to Swiss insolvency laws. Enforcement methods here refer to the realization of pledged property, seizure of assets.

The United Kingdom

In the United Kingdom, the insolvency is governed by UK Insolvency Act, 1986. In this law, the Insolvency is defined in both terms

·      Cash flow insolvency, and

·      Balance sheet insolvency

 
India

Bankruptcy & Insolvency is in Concurrent List (Entry 9 of List III - Seventh Schedule) under the Constitution of India. The List III is also called Concurrent List. Both the Central and State Government can make laws relating to this List.

The winding up of companies is regulated by the Companies Act under the supervision of the court. Article 19 (1) (g) of the Constitution of India gives enough freedom to enter the battleground of business and profession but it exerts restrictions on the closure of any industrial undertaking. Such restrictions are justified on the ground of public interest to prevent unemployment.

The stream of insolvency laws in India previous to Insolvency and Bankruptcy Code, 2016 can be segregated under following heads:
 
Insolvency of Companies

  • Companies Act, 2013.
  • The Sick Industrial Companies (Special Provisions) Act, 1985.
  • Corporate Debt Restructuring Scheme.
  • Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI).
  • RBI Guideline.
 
Insolvency of individuals and unincorporated entities

  • Provincial Insolvency Act, 1920.
  • Presidency Towns Insolvency Act, 1909.
Insolvency of incorporated associations and other incorporated bodies

  • This deals with the insolvency of bodies like co-operative societies and body corporates incorporated under the certain legislation.

 
WHY IS CODE GAME CHANGER?
 
The Insolvency and Bankruptcy Code, 2016 is a game changer because it aims to resolve various problems. These difficulties can be overviewed as follows:
 
Thirteen different laws:
 
The Insolvency and Bankruptcy code is essential because currently the issues related to insolvency and bankruptcy is resolved under thirteen different laws. This code seeks to replace the Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920. In addition, it seeks to amend 11 laws, including the Companies Act, 2013, Recovery of Debts Due to Banks and Financial Institutions Act, 1993 and Sick Industrial Companies (Special Provisions) Repeal Act, 2003, among others.
 
Four different Agencies:
 
Prior to the insertion of new code, there were four different legal routes available to the debtors and creditors:

  1. the high courts,
  2. the Company Law Board (Now NCLT)
  3. the Board for Industrial and Financial Reconstruction (BIFR), and
  4. the Debt Recovery Tribunals (DRTs)
This could lead to multiple negotiations, multiple penalties etc. for the debtor, which manifolds the worries of debtors. Such parallel proceedings had also given rise to numerous instances of conflict between the laws. These different agencies have overlapping jurisdiction, giving rise to the potential of systemic delays and complexities in the process. This new code overcomes these issues, by bringing in new provisions.

Time Frame in insolvency proceeding:
 
As per World Bank data, the average time takes in insolvency proceedings in India is more than four years. The new code has proposed 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.

(Source: World Bank)

The average time taken in insolvency proceedings in India is more than four years. The above chart shows that India is at the bottom for the average resolution time period whereas, Japan leads among other countries followed by the UK, US, and China.

Un-justified & poor liquidation process:  
 
The new code targets to minimize the involvement of the adjudicator. Earlier, the process was settled through the appointment of liquidator which is prone to red-tapeism, chronic corruption. Currently, approximately one-fourth of the value of assets is recovered by the creditors even after the liquidation process. The easing of liquidation process can help the banks recover a lot of bad debts.
(Source: World Bank)
 
The recovery rate in India is very poor in comparing with China, Russia, Japan, US, and the UK. The above chart shows that India is at the 6th position while comparing it with seven countries.
 
Not an Ease of doing business:
 
India has been ranked at a lower position by World Bank for ease of Doing Business. According to World Bank data, it takes more than four years to wind up an ailing company in India. The exit from the business creates havoc and the previous code doesn’t help in an easy exit of trouble-prone entities.
 
Debt to GDP Percentage:
 
India recorded a Government Debt to GDP of 66.40% of the country's Gross Domestic Product in 2014. Government Debt to GDP in India averaged 73.46% from 1991 until 2014, reaching an all-time high of 84.20% in 2003 and a record low of 66% in 1996. Government Debt to GDP in India is reported by the Ministry of Finance, Government of India.
 
(Source: Ministry of Finance, Government of India)

NEW INSTITUTIONS:

The Insolvency and Bankruptcy Code, 2016 proposed to create a host of new institutions. These would include:


Insolvency Professional Agency
 
Insolvency Professional will conduct the insolvency resolution process and will take over the management of a company. They will assist creditors in the collection of relevant information, and facilitation of the liquidation process. The insolvency professionals will be registered with Insolvency Professional Agencies, who will examine and certify these professionals.
 
Information Utility

Information Utilities will collect, collate and disseminate financial information related to debtors.
 
Insolvency and Bankruptcy Board of India
 
The Code establishes the Insolvency and Bankruptcy Board of India, to overview the insolvency proceedings in the country and regulate the entities registered under it. The Board will have 10 members:

  • A Chairperson
  • Three members not below the rank of joint secretary or equivalent, one of each represent the Ministry of Finance, the Ministry of Corporate Affair and Ministry of Law as ex-officio.
  • Reserve Bank of India will nominate one member as ex-officio.
  • Central Government will nominate five other members out of which at least three shall be the whole time members.
STAGES OF RESOLUTION PROCESS:

There are five stages of the resolution process:

Stage First: When a default of loan occurs, and either the borrower or the lender approaches the National Company Law Tribunal in case of Company/ Limited Liability Partnership or Debt Recovery Tribunal in case of Partnership Firm / Individual for initiating the resolution process.

Stage Second: The creditors appoint an interim Insolvency Professional to take control of the debtor’s assets and the company’s operations. He collects financial information of the debtor from information utilities and constitutes the creditors’ committee.

Stage Third: Then the committee has to take decisions regarding insolvency resolution by a two-thirds majority.

Stage Forth: Once a resolution is passed, the committee has to decide on the restructuring process that could either be a revised repayment plan for the company, or liquidation of the assets of the company. If no decision is made during the resolution process, the debtor’s assets will be liquidated to repay the debt.

Stage Fifth: The resolution plan will be sent to the tribunal for final approval, and implemented after the approval.
 
BANKRUPTCY AND INSOLVENCY ADJUDICATOR
 
The Code proposed two separate tribunals to look after the process of insolvency resolution for individuals and companies:
  1. The National Company Law Tribunal will look after the resolution process for Companies and Limited Liability Partnership; and
  2. The Debt Recovery Tribunal looks after the resolution process for individuals and partnerships.
 
DISTRIBUTION OF LIQUIDATED ASSETS UNDER NEW REGIME
 
The new law gives a committee of creditors 180 days to evaluate proposals from various players about resuscitating the company or taking it into liquidation. Liquidated assets will be distributed in the following order of priority:

 
TIMELINES AS PROPOSED IN CODE
 
The Insolvency and Bankruptcy code, 2016 proposed the timelines for completion of insolvency resolution process as given in below chart:
WHY IS A BANKRUPTCY LAW SUCH A BIG DEAL?
 
The bad debts of Indian banking sector have roared up and consistently piling up day by day. According to central bank data, the gross bad loans, advances whose terms have been restructured and written-off accounts have risen to 14.5% of banking sector loans at the end of December 2015. This implies that nearly Rs 10 trillion of loans of banks are stuck. It is crucial to release this heavy amount and facilitate the growth of the banking sector.

Top 10 Banks writing off bad debt in 2015

Name of Bank

Amount             (In Rs. Crore)

SBI

21,313

PNB

6,587

India Overseas Bank

3,131

Allahabad Bank

2,109

IDBI Bank Ltd

1,609

Bank of Baroda

1,564

Syndicate Bank

1,527

Canara Bank

1,472

UCO Bank

1,401

Central Bank of India

1,386


(Source: Reserve Bank of India)

Top 10 Banks writing off bad debt in last three financial years.

Name of Bank

Amount (in Rs. Crore)

SBI

40,084

PNB

9,531

India Overseas Bank

6,247

Allahabad Bank

4,243

Oriental Bank of Commerce

3,593

Bank of Baroda

4,884

Syndicate Bank

3,849

Canara Bank

4,598

Bank of India

4,983

Central Bank of India

4,442


(Source: Reserve Bank of India)

The multiplicity of laws did not facilitate the banks to recover their loans. Debt Recovery Tribunals are dealing with a backlog of Rs 4 trillion worth of cases. However, less than 20% of cases have been taken up by various channels such as DRTs, Lok Adalats and SARFAESI during the previous three financial years.

Some of the world’s largest Corporate Bankruptcy:

Name of Corporate

Bankruptcy Date

Assets

Lehman Brother

15 Sep. 2008

$691 Billion

Washington Mutual

26 Sep. 2008

$327.9 Billion

Wordcom

21 July 2002

$103.9 Billion

General Motors

1 June 2009

$91 Billion

CIT

1 Nov. 2009

&71 Billion

Enron

2 Dec. 2001

$65.5 Billion

Conseco

17 Dec. 2002

$61 Billion

Chrysler LLC

30 April 2009

$39 Billion

Thornburg Mortgage

1 May 2009

$36.5 Billion

Pacific Gas and Electric Co.

6 April 2001

$36.1 Billion

Texaco

12 April 1987

$34.9 Billion

Financial Corp. of America

9 Sep. 1988

$33.8 Billion

 
CONCLUSION
 
The Code contains focuses on early identification of financial distress and to facilitate the revival or re-organisation of the company. The code proposed 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. Under the new code of Insolvency and Bankruptcy, it is proposed that the insolvency resolution plan has to be approved by two-thirds of the creditors. After the approval of a plan by creditors, it will be sanctioned by the adjudicating authority. In case of rejection of insolvency resolution plan, the adjudicating authority will pass an order for liquidation. The new code has been viewed as a positive reform strategy for the financial especially for banks at a state level. The new laws will give creditors a legal roadmap for recovering their dues in a time-bound manner. Henceforth, it is one of the biggest economic reforms and can be viewed as a game changer.
 
References:
  1. Insolvency and Bankruptcy Code, 2016

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