The
Narendra Modi-government has finally succeeded to get cleared the
Bankruptcy Code from the Lok Sabha to
enhance ease of doing business in the
country and facilitate timely debt recovery in cases of default. The Lok Sabha
has cleared the Bill on May 5 and it would effectively unlock the assets stuck
up with bankrupt borrowers. On becoming a law it would enable banks to push for
resolution/recovery of the money from a troubled company within a period of 180
days, with a grace period of another 90 days if majority (75 per cent) of
creditors would agree to it. If the recovery doesn’t happen even then, the
company will be liquidated automatically. The Insolvency and Bankruptcy code,
2016 passed by the Lok Sabha (LS) on 5 May, 2016 would indeed ensure time-bound
settlement of insolvency, enable faster turnaround of sick businesses and
create a database of serial defaulters. The bill is yet to be approved by Rajya
Sabha.
The
new code will replace the existing bankruptcy code of the country by doing away
with at least 12 different legislations in existence hitherto. Some of these
legislations are centuries old. It will cover individuals, companies, limited
liability partnerships and partnership firms. The bill also includes provisions
to address cross-border insolvency through bilateral agreements with other
countries.
The
new code proposes to repeal the Presidency Towns Insolvency Act, 1909, and
Provincial Insolvency Act, 1920 of British time, along with amending the other
11 legislations, including the Companies Act, 2013; Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interest Act,
2002; Limited Liability Partnership Act, 2008, etc. Policy-related aspects are
being addressed in the code itself and vaious procedural aspects will be dealt
under delegated legislations for the sake of flexibility. The code is unique in
its approach as it has drawn the positive attributes of the bankruptcy systems
of the US and the UK, like providing for a moratorium period during the
resolution process, time-bound insolvency process, etc. But it is yet to
address certain important aspects such as lifting of moratorium in the cases of
fraud, option for management of affairs by the corporate debtor under
supervision, etc. Another deviation is with respect to the chapter 11 of the US
Bankruptcy Code which provides for debtor in possession concept, i.e. the
debtor continues to manage the affairs of the company during the insolvency
resolution process. The new code of India proposes the management of affairs by
an insolvency resolution professional similar to the UK bankruptcy laws.
One
of the important feature is that this new Code empowers both the corporate
debtor and the creditors to initiate corporate resolution process on the
trigger of a loan default. On the initiation of bankruptcy, an Insolvency
Resolution Professional (IRP) will assume control of the corporate debtor’s
management, displacing the incumbents. But, merely enabling stakeholders to
move for insolvency resolution does not mean they will be motivated to move.
Counter-intuitively,
the only stakeholders that have adequate information about the solvency risk of
a firm are the management of the borrowing unit. But, because the probability
of the management surviving in case of bankruptcy under the current Code is
zero after moving for the same, it is most unlikely that they will move for the
insolvency resolution process at all.
The
insolvency resolution process could be initiated by a corporate debtor who has
defaulted in payment of his dues or by creditors, on either case, whether it is
financial or operational. When the process is triggered on, the creditors’
claims will be frozen for 180 days, during which time they will hear proposals
for revival and decide on the future course of action. As per the new code
within those 180 days, 75% of financial creditors must agree to such a revival
plan. If this minimum threshold is not met, the defaulting firm would
automatically go into liquidation. But, if three-fourths of the financial
creditors consider the case complex and feel it cannot be addressed within 180
days, the adjudicator could grant a one-time extension of up to 90 days on the
process. Thus, it has to be resolved with in 180+90=270 days.
The
model that Chapter 11 of the US Bankruptcy Code offers is instructive and
appears to have better flexibility in this regard. Under Chapter 11 of the US
code, the management retains its job during the bankruptcy process except that
the creditors and the Court are empowered to appoint a trustee. The Court can
also appoint an examiner to investigate the affairs of the debtor. Thus in US,
the management retains in management control in bankruptcy, except that they
manage “in the shadow of a trustee” appointed as aforesaid and as such, the
risk that they will indulge in asset stripping during the process appears
substantially mitigated.
As
the new code now attempts to create a formal insolvency resolution process
(IRP) for businesses, either by coming up with a viable survival mechanism or
by ensuring speedy liquidation, it will effectively curb the number of
long-pending cases of default substantially. The code now envisages a new
regulator also for bankruptcies—the Insolvency and Bankruptcy Board of
India—while introducing professionals who will handle insolvency cases and
insolvency professional agencies to oversee the overall supervision of the
Insolvency Board. The code also proposes for information utilities to collect,
collate, authenticate and disseminate financial information from listed
companies and financial and operational creditors of companies. This will help
make the IRP smoother, transparent and dependable by maintaining a range of
financial information about companies.
Currently,
four different forums—High Courts, Company Law Board (CLB), Board for
Industrial and Financial Reconstruction (BIFR) and Debt Recovery Tribunal
(DRT)—have overlapping jurisdictions, which used to give rise to systemic
delays and complexities in the process. The code helps to overcome these
challenges and would help to reduce the burden on the courts as all litigations
will be filed under the code before the National Company Law Tribunal (NCLT)
for corporate insolvency and insolvency of LLPs, and before DRT for individual
insolvency and insolvency of unlimited partnership firms. So, the burden on
judiciary would reduce considerably. Though, this model offers incentive for
the management to move the insolvency resolution process at the earliest.
Besides, the commentary to the Code also highlights the need to distinguish
corporate failure from corporate malfeasance. Yet, a blanket rule for replacing
the management with IRP also appears repulsive as well as internally
incoherent.
But,
inspite of all minor limitations, the code is the most desired and awaited.
Because the Present mode for recovering money from a defaulted corporate
borrower is nightmarish for bankers, and it takes years for the Debt Recovery
Tribunals (DRTs) to overcome the litigations. Promoters on defaulters,
typically drag banks to various other courts on one or the other pretext to
delay their payments. By the time, the whole process gets over, there remains
nothing for banks to recover. The underlying value of the assets gets eroded
sharply by then. Yhough, It is not yet clear whether the new bankruptcy law
would also allow a defaulted debtor to move to a higher court against the
lenders or not. If it is yes then, things aren’t going to be different, even
now. Therefore, even when the new law is in place, its success would depend on
how conducive our legal system would there be to support the execution of the
new Law and how fast banks would be able to exercise their rights. Otherwise in
Vijay Mallya's-Kingfisher case the banks have been fighting this case with this
liquor baron in different courts (DRTs, High Courts and Supreme Courts), and
even after 4 years of default, there has been no meaningful progress on
recovery. Even he has left thecountry.
With
this new code, the time-frame to resolve bankruptcy in India would atleast get
shortened to one year. It will help creditors to recover the debt faster and
will also help to improve India’s position in World Bank’s ease of doing
business ranking.
So,
it is true that the proposed bankruptcy law, on replacing the Presidency Towns
Insolvency Act, 1909, would come handy for banks to deal with future cases of
default. However, a big question that emerges is whether the existing stock of
bad loans, where recovery from corporations pending for several years the new
code would be applicable or not which are currently in DRTs.
Another
praiseworthy attribute in corporated in the new code is for protecting worker’s interest. The code will allow the
money due to workers and employees from the provident fund, the pension fund
and gratuity fund would not be included in the estate of the bankrupt company
or individual. Further, workers’s salaries of up to 24 months will get the
first priority in case of liquidation of assets of a company, ahead of secured
creditors.
Howerver,
Corporate democracy requires that each class of creditors under the proposed
resolution plan vote separately on it. So nerely enabling each of them to
attend the creditor committee meetings as “observer” as the bill (as passed by
the Lok Sabha) has sought to do appears inconsistent with corporate democracy.
Indeed the Chapter 11 of the US Bankruptry code provides for class voting to
ensure that the sanction of the resolution plan is truly representative.
Finally,
since the Code provides a hard deadline of 180/270 days for completing corporate
insolvency resolution process and failing which, the Code mandates the
“Adjudicating Authority” to order liquidation (Section 33 (2) of the Code, the Code offers a much smooth process for
recovery of debt from defaulters.
