INSOLVENCY AND BANKRUPTCY CODE 2016
This article is written by Anamta Khan, a student of National Law University, Delhi. The article explains the Insolvency And Bankruptcy Code 2016
The Indian banking sector in the last couple of years has been plaguing with the issue of non-performing assets. As per the report of the World Bank, non-performing assets are comprised of 2.6% of the total loans issued by the banking sector in the year 2011[1]. And by the year 2016, the non-performing assets of the Indian banking sector had increased to more than 9.1%.
To condone the problem of non-performing assets, the government of India and RBI has implemented a host of reforms. And one of the biggest reforms that were implemented by the government of India in December 2016 is the insolvency and Bankruptcy Code. This article explains the concept of insolvency and bankruptcy, the need for it in the Indian market, and the process under the code. Additionally, this Article also analyses the progress done under the code in the last five years and lacuna present in the law.
Meaning of Insolvency and Bankruptcy
For example, let’s assume A is a manufacturer who has taken a loan from a bank B and has also purchase certain raw materials from a vendor C. Bank B has given a credit to A, and vendor C has also provided raw materials to A. Technically speaking, A will be referred to as a borrower or debtor and B and C will be referred to as creditors. As per Bankruptcy Code, in the market, there are two types of creditors [2],
– Financial creditor
– Operational creditor
A financial creditor is the one who has provides or gives loans for certain consideration. The financial creditor accepts certain collateral from the borrower and in turn, will give a loan to the borrower. Since he collects collateral, he is also referred to as a secured creditor.
In the case of an operational creditor, he provides goods or services upon credit to the buyer in the market. As he has already received the credit, he’s expecting certain payments from the buyer in the market. Since he doesn’t take any kind of collateral before giving the credit to the buyer, he is referred to as an unsecured creditor.
In the above example, bank B becomes the financial creditor and the C becomes an operational creditor. They both expect some sort of payment from the buyer or the borrower in the market. Assuming a situation where A is unable to pay the amount back to B and C. This inability of the borrower of making repayments to the creditors is referred to as a concept of insolvency. To resolve this insolvency there is a legal process or a legal framework which is referred to as bankruptcy.
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Need of consolidated framework of IBC-
- The multiplicity of legislative pieces- Before the IBC code came into the picture; there were numerous laws for corporate borrowers and retail borrowers. For corporate borrowers, there were laws such as the Company’s act of 1936, the Companies Act of 2013, etc. For retail borrowers, laws were such as the SARFAESI (securitization and reconstruction of financial assets and enforcement of security interest) act 2002, and The Recovery of debt due to banks and financial institutions act of 1993. Rather than having this kind of fragmented legislation, IBC provides a single framework for debt resolving insolvency for both retail and corporate borrowers.
- The time record for completion of insolvency resolution was very high and recovery rates are very low in case of failure. The recovery rate refers basically represents how much of the loan is recovered by the creditor once the insolvency resolution proceedings are done. In India it was very low, just 25.7% [3]. Among BRICS countries, India was the worst-performing nation in terms of recovery rate and time required for completion of insolvency proceedings.
- High non-performing assets (NPA’s)- As time consumption for insolvency proceedings is very high, the non-performing assets in the case of the Indian market have kept on climbing up in the last couple of years. India is one of those economies which are setting up a huge pile of non-performing assets. RBI has taken few reforms in lieu of this such as, strategic debt restructuring, S4A, 5:25, asset quality review, etc. Despite having taken so many reforms, the issue of non-performing assets in the Indian economy have been on rising. Consequences of high NPA are increasing lending rate, disrupting the investment cycle of the economy, credit cycle, and limiting the growth potential of the economy.
- Ease of doing business- With the passage of the IBC code, India’s ranking will scale up on charts of ease of doing business index.
Provisions of Insolvency and Bankruptcy code 2016-
It introduces the creditor in control (CIC ) regime. Before the implementation of the code, the debtor used to file for insolvency and still continue to own the assets of the borrowing company. But under the new regime, once the creditors lose the faith and the repayment capacity of the borrower, they can simply approach the NCLT and file for the insolvency resolution process. Once the case has been accepted and admitted by the NCLT the insolvency professional will be made in charge of the company.
With the passage of IBC, it has led to establishing three types of authorities in India-
– Insolvency and Bankruptcy Board of India [4] will ensure that all the stakeholders in the process of insolvency resolution will abide by the provisions of the IBC.
– Insolvency professionals who are the experts in conducting insolvency resolution process
– Information utilities [5], are the central repositories of financial as well as credit-related information of the borrower
Apart from these authorities, there are two quasi-judicial bodies. First is the debt recovery tribunal(DRT) which will take up insolvency resolution cases for individual borrowers and the second one is a national company law tribunal which will take over the insolvency resolution cases of corporate borrowers
Apart from this, the insolvency resolution has to be provided within a time limit of 180 days. This time period is also referred to as the moratorium period. During this particular moratorium period, no further cases will be accepted against this particular company. This period can be extended to 90 days which is the prerogative of insolvency professionals.
Insolvency resolution at this stage simply means that either the creditor will decide to sell this particular company to a new buyer in a market referred to as a resolution applicant or else they will decide not to liquidate the company. The provisions of the insolvency and Bankruptcy Code are not applicable to financial institutions or financial firms.
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Process of insolvency resolution
- First, the creditor or debtor will approach the adjudicating authority. (DRT/NCLT). Within a stipulated time period, NCLT has to accept a case or reject it.
- Once the case is accepted NCLT will appoint an insolvency professional who is in charge of the operations of the company. Secondly, it will appoint a committee of creditors that is basically the committee of financial creditors. And thirdly, it would even seek financial as well as credit-related information from information utilities and provided the committee of creditors.
- Committee of creditors are given the time period of 180 + (90) days to discuss, deliberate, and decide that either they want to sell that company to a buyer in the market or liquidate the company.
- Next the insolvency professional will convey the decision to adjudicating authority who in turn gives effect to the decision of the committee of creditors.
- And if the committee of creditors does not come to a decision either at the end of 180 days or at the end of the 270 days, the insolvency professional by default will give a recommendation of liquidating the company to the adjudicating authority which will issue an order given the effect to this particular recommendation.
In the last five years, there have been thousands of cases that have been filed under the code. The highest numbers of cases filed are by operational creditors. Since they do not have any kind of collateral it is very difficult for these kinds of creditors to get the payment from the companies which are under financial stress. But under the IBC irrespective of whether you’re an operational creditor or financial creditor, if you lose faith in the repayment ability of the borrower, you can simply approach the tribunal and file for the insolvency resolution process.
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Recent 2020 Amendment to IBC code –
In present COVID times, World Bank recognized two main challenges in this field –
- Preventing otherwise viable firms from prematurely being pushed into insolvency
- Increase in the number of firms that will not survive the crisis without resolution of insolvency.
In light of this Insolvency Bankruptcy Code (Amendment) Bill 2020, was passed which amended IBC 2016. This ordinance seeks to prohibit the initiation of insolvency proceedings for default arising during 6 months from March 2, 2020. This amendment also marked that IBC cannot be initiated for enterprises below 1 crore.
In a recent case, Manish Kumar v Union of India[6] constitutional validity of sections 3, 4, and 10 of the insolvency and bankruptcy code was challenged along with the recent amendments. Supreme Court upheld the validity of these sections and the amendments. Justice KM Joseph observed that at least 100 home buyers need to come together to file an insolvency application in the National Company Law Tribunal (NCLT) to trigger the IBC against a defaulting company.
The IBC process is beset with a few issues such as issue of taxation, withdrawal, moratorium period problematic approach as well as the fraudulent practices of the company.
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Taxation issue- There is a provision which basically states that the new buyer has to pay 35% tax on the debt that has been discounted by the committee of creditors. Assume there is a company A which owed 100 crores rupees to the committee of creditors. And the committee of creditors is decided to sell this particular company to a buyer in the market that is B at a discounted price of 60 crores rupees.
Here the company B has bought an asset whose value is 100 crores or at a value of 60 crores rupees. He is now expected to pay 35% tax on these particular savings or the profit of 40 crores rupees in this case. This provision has been extensively debated and opposed by varied stakeholders.
Moratorium issue- Experts feel that the moratorium period should be fixed at 270 days instead of 180 days and thereafter extra time period of 90 days could be given. This increase in the moratorium period will increase the recovery of the creditors and will also reduce the non-performing assets in the market.
In conclusion, we can see that the insolvency and Bankruptcy Code is a revolutionary reform that will reduce the non-performing assets since there is a time-bound insolvency resolution process provided under this. Secondly, it will give control in the hands of the creditors and thirdly will prohibit malfeasance in case of the insolvency resolution process.
But at the same time, it should be also noted that the process is suffering from certain issues which the government of India must address to ensure that the insolvency resolution process is conducted smoothly and efficiently and the recovery rate is increased over a period of time.
-Edited by Samarth Pathak
(Editor, The Legal State)
[1] http://documents1.worldbank.org/curated/en/704231513810603813/pdf/121478-Revised.pdf
[2] ‘Insolvency and Bankruptcy code 2016’ https://www.ibbi.gov.in/
[3] “85% drop in insolvency cases in September quarter”, Business today, April 1,2021, https://www.businesstoday.in/current/corporate/85-drop-in-admitted-insolvency-cases-in-september-quarter/story/423859.html
[5] https://ibbi.gov.in/service-provider/information-utilities
[6] Manish Kumar v Union of India writ petition (C) No. 333/2020