All about the Bankruptcy code

Note4Students

Bankruptcy code addresses the larger issue of ease of doing business. Economic survey 2016 talked about chakravyuha problem of Indian business ecosystem. In this context bankruptcy code is important topic to examine.

Introduction

  1. Hitherto India was lacking the legal and institutional machinery for dealing with debt defaults as per the global standards.
  2. The recovery proceedings by creditors, either through the Contract Act or through special laws such as the Recovery of Debts due to Banks and Financial Institutions Act, 1993 and the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, has not had desired outcomes.
  3. Similarly, action through the Sick Industrial Companies (Special Provisions) Act, 1985 (SICA) and the winding up provisions of the Companies Act, 1956 have neither been able to aid recovery for lenders nor restructuring of firms.
  4. Laws dealing with individual insolvency, the Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920, were almost a century old. This has hampered the confidence of the lender and development of the credit markets in India. Resultantly, credit by banks is the largest component of the credit market in India and corporate bond market has not yet developed to the desired level.

Analysis

Highlights of the Code

  1. The Code creates time-bound processes for insolvency resolution of companies and individuals.  These processes will be completed within 180 days.  If insolvency cannot be resolved, the assets of the borrowers may be sold to repay creditors.
  2. The resolution processes will be conducted by licensed insolvency professionals (IPs).  These IPs will be members of insolvency professional agencies (IPAs).  IPAs will also furnish performance bonds equal to the assets of a company under insolvency resolution.
  3. Information utilities (IUs) will be established to collect, collate and disseminate financial information to facilitate insolvency resolution.
  4. The National Company Law Tribunal (NCLT) will adjudicate insolvency resolution for companies.  The Debt Recovery Tribunal (DRT) will adjudicate insolvency resolution for individuals.
  5. The Insolvency and Bankruptcy Board of India will be set up to regulate functioning of IPs, IPAs and IUs.

Positive Aspects

  1. The new law aims to consolidate the laws relating to insolvency of companies and limited liability entities (including limited liability partnerships and other entities with limited liability), unlimited liability partnerships and individuals, Presently contained in a number of legislations, into a single legislation and provide for their reorganization and resolution in a time bound manner for maximization of value of their assets.
  2. Such consolidation will provide for a greater clarity in law and facilitate the application of consistent and coherent provisions to different stakeholders affected by business failure or inability to pay debt.
  3. This law will thus promote entrepreneurship, availability of credit and balance the interest of all stakeholders.
  4. It is true that some business ventures will always fail, but such failures will be handled rapidly and swiftly. Entrepreneurs and lenders will be able to move on, instead of being bogged down with decisions taken in the past.
  5. The Code empowers the operational creditors (workmen, suppliers etc.) also to initiate the insolvency resolution process upon non-payment of dues. In order to develop the credit market in India, in case of liquidation, financial debts owed to unsecured creditors have been kept above the Government’s dues in the list of priorities (waterfall).
  6. Facilitating early resolution and exit is as important as facilitating investment.
  7. The essential idea of the new law is that when a corporate entity defaults on its debt, control shifts from the shareholders/promoters to a committee of creditors, who have 180 days (extendable by 90 days in deserving cases) to evaluate proposals from various players about resuscitating the company or taking it into liquidation.
  8. When decisions are taken in a time-bound manner, there is a greater chance that the corporate entity can be saved as a going concern, and the productive resources of the economy (labour and capital) can be put to the best use. This is in complete departure from SICA regime where there were delays leading to destruction of the value of the firm.
  9. The Code separates commercial aspects of the insolvency proceedings from judicial aspects.
  10. While Insolvency Professionals (IPs) will deal with commercial aspects such as management of the affairs of the corporate debtor, facilitating formation of committee of creditors, organising their meetings, examination of the resolution plan, etc.,
  11. judicial issues will be handled by proposed Adjudicating Authorities (National Company Law Tribunal / Debt Recovery Tribunal). One more important institution created under the Code is the ‘Information Utility’ which would store financial information and data and terms of lending in electronic databases. This would eliminate delays and disputes about facts when default does take place.
  12. The Code also provides a fast track insolvency resolution process for corporates and LLPs. This will be an enabler for start-ups and small and medium enterprises (SMEs) to complete the resolution process in 90 days (extendable to 45 days in deserving cases).
  13. The Code also addresses the important issue relating to cross border insolvency by providing the enabling mechanism on the subject. The Government, at an appropriate time, will come out with a detailed framework for cross border insolvency.

Key Issues

  1. In relation to corporate persons, the Code looks to wrap up the game in 180 days.
  2. It warrants a notice of dispute to be issued followed by a response period of 10 days for the corporate debtor, failing which the creditor is entitled to file an insolvency application before the National Company Law Tribunal (NCLT).
  3. Within 14 days from filing, the application must be admitted. Upon admission, the moratorium period (freezing of bank accounts, prohibition on foreclosures in relation to financial debts, etc.) commences.
  4. At this stage, the existing management of the company loses complete control and all powers vest with an interim resolution professional, who has merely 30 days to put together all the relevant information and call for a meeting of the financial creditors.
  5. Once the financial creditors meet, they must appoint a resolution professional who will put together an information memorandum of the company that forms the basis for a resolution applicant to propose a resolution plan for the company.
  6. The Code fails to define a resolution applicant. All such resolution plans are placed before the financial creditors. When at least 75% of the financial creditors approve, the plan is implemented by way of an order by the NCLT. If the financial creditors fail to arrive at a consensus, the default plan is to liquidate the company.
  7. The Code rides substantially on the unquestionable word of the creditors. Neither does the corporate debtor have an opportunity to put forth his/her case nor is there any scope of discretion provided to the adjudicating authority itself.
  8. At various stages — of admission of the insolvency proceedings, of appointing the insolvency professional, of finalising the resolution plan — the Code fails to provide any opportunity to the corporate debtor to make a representation, at the very least.
  9. In this manner, the Code ignores rights enshrined in the Constitution. (In Maneka Gandhi v. Union of India, 1978, the Supreme Court observed that it is the duty of the authority to give reasonable opportunity to be heard, even where there is no specific provision for showing cause when a proposed action affects the rights of the individual.)
  10. The Code is also deficient in providing a yardstick for the qualification of the interim and of the final insolvency resolution professionals.It allows for any person to access the information memorandum put together by the insolvency professional without restricting competitors or imposing any confidentiality obligations.
  11. This allows for any person to access proprietary information of the corporate debtor and misuse the same, given that there is no law protecting confidentiality and vitiates the fundamental right to business under Article 19(1)(g).
  12. The Code prohibits withdrawal of the application once the same has been admitted.
  13. This means that there is no scope whatsoever for settlement.
  14. This is despite the recent ruling of the Supreme Court in Lokhandwala Kataria Construction (P) Ltd. V. Nisus Finance and Investment Managers LLP (2017), wherein a settlement proposal was taken on record and the appeal was disposed of. However, this cannot be held as a precedent.
  15. Further, the unrestricted access of any person without mandatory contractual obligations in relation to confidentiality vitiates the fundamental right to business under Article 19(1)(g).
  16. Time-bound insolvency resolution will require establishment of several new entities.  Also, given the pendency and disposal rate of DRTs, their current capacity may be inadequate to take up the additional role.
  17. IPAs, regulated by the Board, will be created for regulating the functioning of IPs.  This approach of having regulated entities further regulate professionals may be contrary to the current practice of regulating licensed professionals.  Further, requiring a high value of performance bond may deter the formation of IPAs. 
  18. The Code provides an order of priority to distribute assets during liquidation.  It is unclear why: (i) secured creditors will receive their entire outstanding amount, rather than up to their collateral value, (ii) unsecured creditors have priority over trade creditors, and (iii) government dues will be repaid after unsecured creditors.
  19. The Code provides for the creation of multiple IUs. However, it does not specify that full information about a company will be accessible through a single query from any IU.  This may lead to financial information being scattered across these IUs.
  20. The Code creates an Insolvency and Bankruptcy Fund.  However, it does not specify the manner in which the Fund will be used.

Conclusion

The Insolvency and Bankruptcy Code is

a comprehensive and systemic reform, which will give a quantum leap to the functioning of the credit market. It would take India from among relatively weak insolvency regimes to becoming one of the world’s best insolvency regimes. It lays the foundations for the development of the corporate bond market, which would finance the infrastructure projects of the future. The passing of this Code and implementation of the same will give a big boost to ease of doing business in India.

Question

Q.) “Bankruptcy code is a greater step towards the business friendly India.” Comment

Q.) What are the features of the bankruptcy code. Do think certain provisions undermine the fundamental right to carry out any profession

Source

The Hindu

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