From UPSC perspective, the following things are important :
Prelims level : Insolvency and Bankruptcy Code
Mains level : Insolvency and Bankruptcy Code, shortcomings and proposals to address the gaps
- The introduction of the Insolvency and Bankruptcy Code (IBC) in 2016 brought about a structural change in the resolution architecture in the country. However, despite its promise, the IBC, in its functioning, has fallen short of expectations. Last week, the Ministry of Corporate Affairs invited comments on a fresh set of changes it is considering to bring about in the Code. This is a welcome step.
What is Insolvency?
- Simply speaking, insolvency is a financial state of being one that is reached when you are unable to pay off your debts on time.
- Insolvency is essentially the state of being that prompts one to file for bankruptcy. An entity a person, family, or company becomes insolvent when it cannot pay its lenders back on time.
What is Bankruptcy?
- Bankruptcy, on the other hand, is a legal process that serves the purpose of resolving the issue of insolvency.
- Bankruptcy is a legal declaration of one’s inability to pay off debts. When one files for bankruptcy, one obliges to pay off what is owed with help from the government.
What is the Insolvency and Bankruptcy Code 2016 (IBC)?
- The IBC was enacted in 2016 to simplify insolvency and bankruptcy proceedings, safeguard interests of all stakeholders (the firm, employees, debtors and especially creditors), and resolve non-performing assets.
- From a ‘debtor in possession’ regime, it was a shift to a ‘creditor in control’ one.
- IBC provides for a time-bound process for resolving insolvencies.
- The Insolvency and Bankruptcy Board of India (IBBI) is the regulator implementing the code and overseeing the functioning of stakeholders.
Why the IBC introduced?
- Increasing Non-Performing Assets: In 2016, at a time when India’s Non-Performing Assets and debt defaults were piling up, and older loan recovery mechanisms were performing badly, the IBC was introduced to overhaul the corporate distress resolution regime in India.
- Time bound mechanism: To consolidate previously available laws to create a time bound mechanism with a creditor in control model as opposed to the debtor in possession system.
- Two positive outcomes: When insolvency is triggered under the IBC, there can be just two outcomes: resolution or liquidation. liquidation means the process of winding up a corporation or incorporated entity
What are the shortcomings in the code’s functioning?
- Timelines are not followed: Realizations of creditors have been lower than expectations, and the strict timelines prescribed in the Code for resolving cases have not been adhered to.
- Less realizable value: According to the most recent data, the total realisable value in cases resolved till September 2022 stood at only 30.8 per cent of the admitted claims.
- Average time is rising: The data also shows that 64 per cent of the ongoing cases have crossed 270 days. In fact, as per reports, the average time taken for cases to be resolved has risen, driven in part by more time being spent on associated litigation.
- Removing ambiguity and bringing the predictability: The changes aim to reduce the time for admitting cases and streamline the process by pushing for greater reliance on data with Information Utilities. Considering the delays in admitting cases, and the implications of recent judicial interventions, this proposal seeks to remove ambiguity, and bring about predictability in the process.
- Extending the pre-packed resolution to other firms: It has also been proposed that the pre-packaged insolvency resolution process that was introduced for micro, small and medium enterprises now be extended to other firms as well. While such a proposal should be appealing, so far very few cases have been admitted under this.
- A clear distinction between the real estate projects: A distinction is now being made between a particular real estate project and the larger corporate entity. The government’s rationale for doing so is that this could allow the corporate entity to continue on other projects, while the stressed project can be tackled separately.
- Changes to the manner in which proceeds will be distributed: Creditors will receive proceeds up to the liquidation value in line with the priority as prescribed under section 53 of the Code, and any surplus over such liquidation value will be rateably distributed between all creditors in the ratio of their unsatisfied claims.
- Attempts to improve IBC’s functioning are welcome. But some of the proposals need more careful examination. Changes to the Code should, after all, be driven by the objective of improving its functioning, and outcomes. This should be done keeping in mind the incentive structures of all stakeholders.