Insolvency and Bankruptcy Code

Can the insolvency code handle the aftermath of the corona crisis?

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Committee of creditor, difference between financial and operational creditors etc.

Mains level : Paper 3- Issues in the IBC and suggestion to improve it.

The article is about the aftermath of Covid-19 for the Indian business. Though the government has announced the slew of relief packages, one expects a significant spike in the number of bankruptcies. Will India’s Insolvency and Bankruptcy Code be able to deal with this new normal? Some pressing issues that could arise and solutions are discussed here.

Rise in the pending cases with NCLT

  • Since the commencement of the IBC and setting up of the National Company Law Tribunal (NCLT), 12,000 cases have been filed.
  • Around 4,500 cases have been settled before resolution, with a settlement amount of almost ₹2 trillion.
  • 1,500 cases have been admitted and 6,000 cases are waiting in the queue.
  • The covid-19 epidemic will only increase this traffic jam.
  • Increasing the capacity of NCLT: The pile-up of cases needs to be addressed by increasing capacity of the NCLT, and by ensuring that as many cases as possible are settled without going to the IBC.

Every issue mentioned here is important from Mains point of view. IBC has been a significant step by the government to streamline the process of insolvency and bankruptcy.

Need for a relook at section 29A(c) of IBC

  • What is section 29A(c) of IBC? This provision makes ineligible the defaulting person (promoter) from bidding for the asset (buying back) if it has been NPA for a year or more.
  • What was the purpose of section 29A(c): The intent of section 29A is to prevent persons who, by their misconduct or fraudulent motives contributed to the default of the corporate debtor, from “buying back” the corporate debtor from the creditors, potentially at steep discounts.
  • What’s the issue? While this is clearly a justifiable objective, the short window of one year has prevented even genuine promoters who faced major setbacks on account of unforeseen circumstances from being given a second chance.
  • Even though such promoters are often in good the best position to revive their businesses.
  • In view of the current force majeure, we recommend that the grace period of one year under section 29A(c) be extended to two years.
  • And further extensions should be made possible on the approval of a supermajority (i.e. 75%) of the Committee of Creditors.
  • Further, the newly introduced Section 12A allows the bank, which was the insolvency applicant, to exit the insolvency process.
  • Which brings the promoter back in control—provided 90% of the Committee of Creditors agrees and the public bidding process has not commenced.
  • The requirement for exit should be reduced to 75% of the committee.

Extension of timelines

  • Recently, the Supreme Court did well by passing a suo-moto order on the extension of limitation generally.
  • Based on these SC orders, the National Company Law Appellate Tribunal has ordered that such extension also apply to the outer limit of 330 days for the resolution of corporate insolvency cases.
  • This could be further extended once the gravity of the situation becomes clear over the next few months.
  • The moratorium period on debt financing recently announced by RBI should also be extended to cover money market instruments.

Need for providing more financing options to corporate debtors

  • While the IBC does provide for interim finance with a preferential position for a corporate debtor, there are known limitations and residual risks on the provision of such finance.
  • The government would do well to look at expanding the market by making changes.
  • The changes could include permitting interim funding by asset reconstruction companies even without being creditors.
  • And making provisions for a minimum return even in case of liquidation, and extending the enhanced priority standing given to interim financiers in the IBC phase to the pre-IBC phase.
  • Post the lockdown, incremental working capital support upto, say, 25% of existing working capital exposure could be allowed in deserving cases even if the account is in default or NPA.
  • This can be deemed to be priority lending to also protect bankers’ interests.
  • The provision could also be made for the extension of concessional finance within limits based on demonstrated export potential.
  • For example- order, short lead-time business, margin adjustments) in order to contribute to the recovery of exporting industries.

Equitable treatment of operational creditor

  • In the Swiss Ribbons judgment, the Supreme Court urged equitable, though not equal, treatment of operational creditors.
  • The need to protect the interests of operational creditors in bankruptcy proceedings is all the more critical in difficult market conditions where credit would be hard to obtain.
  • Some broad guidelines appear to be desirable.
  • For instance, one could stipulate that in the absence of quality issues, two operational creditors belonging to the same sub-class in terms of the type of product or service sold, should be treated equally.
  • This should be irrespective of group relationships or continuity in the business of the resolved entity.

Facilitating resolution outside the corporate insolvency resolution process

  • On the issue of closing a case before the onset of insolvency proceedings, there was a case for doing this even before the corona outbreak, and even without the paucity of processing capacity.
  • The labelling of a company as insolvent or bankrupt has a chilling effect on its already dim prospects.
  • Vendors, customers and employees start having second thoughts about associating with this company.
  • Certain rules get triggered—for instance, the rule barring an infrastructure company from accepting new orders.
  • The current outbreak amplifies the case for facilitating resolution outside the corporate insolvency resolution process.
  • At the same time, there is a need to streamline the process to ensure enhanced proceeds.

Conclusion

All institutions of the economy will need to fire together in order to maximize the prospects of recovery. A suitably modified bankruptcy framework has a crucial role to play.


Back2Basics: Difference between financial and operational creditors

  • Financial and operational creditors are different in the sense that their liabilities arise from different origins.
  • Where a financial creditor is liable because of a contract such as a loan or debt and operational creditor is liable because of operational transactions.
  • The difference between a financial creditor and an operational creditor is that a financial creditor is an individual whose relationship with the entity is solely based on financial contracts, such as a loan or debt security.
  • Whereas, an operational creditor is an individual whose liabilities from the entity comes in the form of future payments in exchange for goods or services already delivered.
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