The National Company Law Tribunal (“NCLT”), Mumbai Bench, on 18 January 2017 passed an order allowing the first application filed under the Insolvency and Bankruptcy Code, 2016. The said application (“Creditor Petition”) was filed by ICICI Bank under section 7 of the Insolvency and Bankruptcy Code, 2016 (“the Code”). Section 7 provides for initiation of corporate insolvency resolution process by a creditor against a corporate debtor. During the pendency of the said Creditor Petition, the corporate debtor therein filed an interim application, stating that on the date of filing of the Creditor Petition, the liabilities and debts of the debtor were suspended pursuant to an order of the Industry, Labour and Energy Department of Maharashtra. Such order was given by the department under the Maharashtra Relief Undertaking Act, (“MRU Act”) to provide financial assistance to the debtor and as a measure to prevent unemployment. It was argued by the debtor that by virtue of such order a proceeding under the Code cannot be initiated against the debtor. The NCLT while deciding the issue observed that the Code has come into existence subsequent to the MRU Act, and shall prevail over any other law in force. The Bench further observed that a proceeding under the Code shall not cause unemployment and even in the event of liquidation, the rights of the employees will be sufficiently protected. Therefore it was held by the Bench that the order under the MRU Act will not be a bar to pass an order under section 7 of the Code.[i] Thus an order of Moratorium in the said Creditor Petition was passed and directions to initiate the corporate insolvency resolution process under the Code, were given. The direction under the moratorium included prohibition and/or stay of proceedings against the debtor under any other law in force, including the SARFAESI Act.
Context of the Bankruptcy Code
The various laws that dealt with insolvencies and bankruptcies before the commencement of the Code are:
- Presidency Towns Insolvency Act, 1909 – to deal with bankruptcy of individuals in the presidential towns of Bombay, Calcutta and Madras.
- Provincial Insolvency Act, 1920 – to deal with bankruptcy of individuals in the rest of India.
Insolvency for companies is dealt with under the following legislations:
- Companies Act, 2013 (the “Companies Act”)/ Companies Act , 1956
- Sick Industrial Companies Act, 1985 (the “SICA”)
- Recovery of Debt Due to Banks and Financial Institutions Act, 1993 (the “RDDBFI Act”)
- Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI”).
With the existence of these overlapping legislations and adjudicating forums, the insolvency proceedings were usually met with systemic delays and inefficiencies. The creditors were unable to get a timely recovery and reorganisation of their assets.
It was in this background that the Bankruptcy Law Reforms Committee (BLRC) was established on 22 August 2014 for providing an entrepreneur friendly legal bankruptcy framework as was announced in the Budget Speech (2014-15). “The Government also identified Bankruptcy Law Reform as a key priority for improving the ease of doing business and had announced in the Budget Speech 2015-16 that a comprehensive Bankruptcy Code, ‘meeting global standards and providing necessary judicial capacity’, will be brought in the year 2015-16.”[ii]
Accordingly, the BLRC submitted its Report and draft Bill on 4 November 2015. Based on the report, as well as public/stakeholder consultations, the Insolvency and Bankruptcy Code, 2015 was finalized. The Bill was introduced in the Lok Sabha on 21 December 2015 and referred to a Joint Committee of Parliament on 23 December 2015. The Joint Committee of Parliament submitted its report on 28 April 2016.The Insolvency and Bankruptcy Code, 2016 was passed by the Lok Sabha on 5 May 2015 and by the Rajya Sabha on 11 May 2016 and published in the Official Gazette on 28 May 2016.
Objective of the Code
The Code aims “to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner and for maximization of value of assets of such persons and matters connected therewith or incidental thereto.” [iii]
“The present code is the result of the various reforms undertaken by the government to effectuate insolvency in India. This measure is expected to provide a greater clarity in law and facilitate the application of a consistent and comprehensive mechanism to different stakeholders affected by financial failure or inability to pay debt”.[iv]
Structure of the Code
The Code is divided into 5 parts and has 11 schedules which include amendments to different legislations.
Part I – Preliminary;
Part II – Insolvency Resolution of Corporate Persons;
Part III – Insolvency Resolution of Individuals and Partnership Firms;
Part IV – Regulation of Insolvency Professionals, Agencies and Information Utilities;
Part V – Miscellaneous.
Key Features of the Code
1. Two-stage Process for Dealing with Defaulting Debtors
The Code lays down two independent stages for insolvency resolution: a) The 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 b) Liquidation, if the insolvency resolution process fails or financial creditors decide to wind down and distribute the assets of the debtor.
1.1 The Insolvency Resolution Process (“IRP”)
“The IRP provides a collective mechanism to creditors to deal with the overall distressed position of a corporate debtor. This Code 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.”[v] Further, there is a timeline of 180 days to complete the IRP, which may under exceptional circumstances, be extended for a further period of 90 days.[vi]
The Code lays down the following steps in the IRP[vii]:
i) Initiation of Proceedings at NCLT: An IRP against a corporate debtor can be initiated by filing an application at the National Company Law Tribunal (NCLT). The defaulting corporate debtor, its shareholders or employees, may also initiate voluntary insolvency proceedings. The court has to, within 14 days of the receipt of the application ascertain the existence of default and accordingly admit or reject the application.
ii) The following persons may make an application under the Code:
- Financial Creditor (u/s 7 of the Code)
- Operational Creditor (u/s 9 of the Code)
- Defaulting Debtor (u/s 10 of the Code)
Where an operational creditor makes an application he has to submit the proof of default and also obtain a certificate from the financial institution with whom the debtor maintains his accounts. Such certificate must declare that no payment has been made towards the unpaid debt. The NCLT may in the absence of such certificate or any other requisite document, reject the application for commencing IRP.[viii]
iii) Moratorium: Once existence of default is ascertained and application is admitted, the NCLT shall order a moratorium on the debtor’s operations for the period of the IRP. During this period 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.
iv) Appointment of Resolution Professional: The NCLT shall appoint an insolvency professional to conduct the IRP. The Insolvency Professional’s primary function is to take over the management of the corporate debtor and operate its business as a going concern under the broad directions of a committee of creditors. Therefore, the impetus 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. This is similar to the approach under the UK insolvency laws.
v) Creditors Committee: The Insolvency Professional shall identify the financial creditors and constitute a creditors committee. Operational creditors having more than 10% of the debt as outstanding are also invited to attend the meetings of the committee but do not have a right to vote. 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 an extension of 90 days under exceptional circumstances).
If the IRP fails, or during the IRP the creditors decide to liquidate the debtor company, an application can be made for the same and the NCLT may pass an order accordingly. Such application can also be made by the corporate debtor or any other person affected by the revival plan arrived at in the IRP.
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.
2. Institutional Framework
2.1 The Insolvency Regulator: The Code provides for the constitution of an insolvency regulator i.e., the Insolvency and Bankruptcy Board of India (Board).Its role includes: (i) regulating the conduct of the insolvency professionals, insolvency professional agencies and information utilities; (ii) regulating the insolvency process.
2.2 Insolvency Professionals: The Code provides for insolvency professionals to undertake the IRP. These professionals are instrumental in the efficient resolution of insolvency. The Code contemplates insolvency professionals as a class of regulated but private professionals having minimum standards of professional and ethical conduct. Developing of such standards is the role of the Insolvency Regulator. In the resolution process, the role of the insolvency professional is to verify the claims of the creditors, constitute a creditors committee, run the debtor’s business during the moratorium’ period and help the creditors in finalising a revival plan. The Insolvency Professional is to act as an agent of the creditors during the resolution period.
2.3 Information Utilities: The Code provides for 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 shall be available to creditors, resolution professionals, liquidators and other stakeholders in insolvency and bankruptcy proceedings. The purpose of this is to remove the delay in proceedings caused due to unavailability or restricted access to information about the debtor.
2.4 Adjudicating Authorities: The adjudicating authorities for corporate insolvency and liquidation are the NCLT and its respective appellate authority. For individuals and other persons, the adjudicating authority is the DRT and its respective appellate authority. This distinguished the jurisdictions of the various forums and deals with the problem of overlapping jurisdictions.
3. Individuals and partnerships
The Code provides for a different mechanism for insolvency of individuals and unlimited liability partnerships. The Code provides for two distinct processes to deal with insolvency of individuals/partnership firms:
3.1 Fresh Start Process: Where the aggregate value of qualifying debts does not exceed INR 35,000 and the debtor satisfies such other conditions as laid down in section 80(2) of the Code, the debtor may make an application for a fresh start. Such application is made for discharge of debts not exceeding INR 35,000 and to give the individual an opportunity for starting afresh. Chapter II of Part III contains provisions for fresh start applications.
3.2 Insolvency Resolution Process: The insolvency resolution process consists of preparation of a repayment plan by the debtor, for approval of creditors. If approved, the DRT shall pass 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.
4. Priority of Claims
The Code brings about a major shift in the priority of claims in liquidation proceedings. While the costs of insolvency resolution have to be paid out first, the next priority is given to the dues of the secured creditors and workmen for the preceding 24 months. Central and State Government dues rank below the claims of secured creditors, workmen dues, employee dues and other unsecured financial creditors.[ix] Under the earlier law, Government dues were immediately below the claims of secured creditors and workmen in order of priority.
5. The Code repeals the two legislations dealing with bankruptcy of Individuals thereby undertaking to regulate the proceedings of bankruptcy of Individuals.[x] (These sections have not yet been notified)
6. The Code provides for enforcement of its provisions in cases of cross border insolvency provided that the Government of India enters into agreements with other countries for the same. This is the first step towards recognising cross border insolvency proceedings.[xi] (These sections have not yet been notified)
Concerns about the Code
1. While the main aim of the Code is to provide uniform, adequate and speedy insolvency resolution process it is argued that the Code is titled in favour of the creditors and does not sufficiently protect the interests of the debtors.
2. Even though the Code has touched upon the subject of cross border insolvency, it does not provide for any mechanism to deal with cross border insolvencies and merely states that its provisions thereof may apply if the Government enters into an agreement with the foreign countries for the same.
3. The lack of structural capacity to handle the cases is critical to the successful implementation of the Code. The NCLT will be overburdened with cases from the Company Law Board and the DRT. This would result in delayed adjudication which ultimately strikes the purpose of the Code.
4. The Insolvency professionals (“IP”) play a huge role under the code, but the code lacks explanation regarding the eligibility criteria of the IPs. It is a new profession that has been introduced under the code and it urges an appropriate authority and standards to control and manage the function of the IPs`[xii]
5. The code prescribes that the information utilities shall play a major role in a case under the Code. The Code however, also provides for creation of multiple information utilities. As such it becomes important that the database is centralised and information is spread across the utilities. In the absence of proper organisational structure, this would lead to scattered information and delay in obtaining the required information.
6. The manner in which the Code is currently being implemented seems to focus more on expeditiously operationalising the law rather than effectively implementing it. These concerns, if not addressed suitably, will defeat the purpose of enacting a new insolvency law to improve the recovery rate in order to promote the development of credit markets and entrepreneurship.
While the enforcement of the code has been a swift process and brings the insolvency framework of India at par with the international standards, its effective implementation depends on the efficacy of the institutional framework and the availability of qualified IPs within as short a span of time. Further, other existing debt recovery/enforcement laws are being amended in the light of the code to bring into effect an enabling infrastructure to deal with debt recovery and insolvency for it is important how these acts deal with the overlapping rights and interests created by them.
(Authored by Shreya Asopa, Associate)
[i] ICICI Bank Ltd. v. Innoventive Industries Limited, (NCLT, Mumbai Bench) C.P. No. 01/I&BP/NCLT/MAH/2016
[ii] Press Information Bureau, Government of India, Ministry of Finance on 4 November 2015 http://pib.nic.in/newsite/PrintRelease.aspx?relid=130200
[iii] Preamble of the Code
[iv] Press Information Bureau, Government of India, Background material for Economic Editor’s Conference (EEC)-2016 – Department of Economic Affairs (http://pib.nic.in/newsite/backgrounders.aspx?relid=153462)
[vi] Section 12 of the Code
[viii] Smart Timings Steel Limited v. National Steel and Agro Industries Ltd. (NCLT, Mumbai Bench) C.P. No. 06/I&BP/MAH/2017
[ix] Section 53 of the Code
[x] Section 243 of the Code
[xi] Section 234 of the Code