Insolvency and Bankruptcy Code

Why does India need a Bankruptcy law? The Insolvency and Bankruptcy Code has been hailed as an excellent reform for India that will pay a critical role in improving the ease of doing business.

Insolvency and Bankruptcy Code

EoDB at risk if issue of appointments to tribunals is not resolved

Note4Students

From UPSC perspective, the following things are important :

Prelims level : NCLAT, NCLT

Mains level : Read the attached story

While hearing a challenge to the Tribunal Reforms Act, 2021, the Supreme Court came down heavily on the government of India for vacancies not being filled on time. This could severely impact the ease of doing business in India, said the court.

Background

  • The government has lauded the role of the Insolvency and Bankruptcy Code, 2016 (IBC), for improving India’s ranking on the “Ease of Doing Business” index over the last couple of years.
  • However, the SC’s observation is spot-on as vacancies in the tribunals have slowed down insolvency resolution due to the huge pendency of cases.
  • When the SC made its observations, the NCLT had only 30 members against a total strength of 63.

About NCLAT and NCLT

  • National Company Law Appellate Tribunal (NCLAT) was constituted under Section 410 of the Companies Act, 2013 for hearing appeals against the orders of National Company Law Tribunal(s) (NCLT) in 2016.
  • NCLAT is also the Appellate Tribunal to hear and dispose of appeals against any direction issued or decision made or order passed by the Competition Commission of India (CCI).
  • It is also the Appellate Tribunal to hear and dispose of appeals against the orders of the National Financial Reporting Authority.

Difference between NCLT AND NCLAT

NCLT

NCLAT

·         NCLT is established as per Section 408 of companies act, 2013 ·         NCLAT is established as per Section 410 of companies act, 2013
·         It holds primary jurisdiction on cases of insolvency and bankruptcy ·         It holds appellate jurisdictions over the cases judged by NCLT
·         NCLT accepts and analyzes the evidence from creditors and debtors ·         NCLAT accepts and analyzes the decision made by NCLT
·         NCLT collects facts and evidences ·         NCLAT analyzes facts and evidences

CJI’s reservations over Pendency

  • The NCLAT had a sanctioned strength of a chairperson plus 11 members but its functioning strength was of eight members.
  • Both the NCLT and NCLAT have been without chairpersons for several months respectively.
  • These vacancies are concerning because as of May 31, 13,170 insolvency petitions were pending before benches of the NCLT.
  • Of these, 2,785 petitions have been filed by financial creditors and 5,973 by operational creditors.

Note: The IBC created an institution called an information utility to be the repository of information on debts and defaults in India.  The sole utility in India at present is the National E-Governance Services Ltd. (NeSL).

Basis of these cases

  • The financial creditors are facing criticism for taking haircuts as high as 90 per cent against their claims.
  • A longer approval period would entail greater value erosion of a corporate debtor which would be an unattractive proposition for any prospective resolution applicant.
  • This uncertainty can be cured by a faster approval process by the NCLTs by the creation of more benches and filling up of current vacancies.

Why is the Supreme Court fuming over vacancies?

(a) Covid impact

  • The Indian economy is recovering from the adverse effects of the Covid-19 pandemic.
  • During the downturn, financial institutions and banks have suffered higher defaults than usual, impacting the robustness of the system.
  • Lending has decreased during this time and can only be encouraged now by shoring up the mechanism under the IBC to inspire confidence in creditors.

(b) Non-compliance by the govt

  • The SC had granted time to the government till September 13 to take substantial steps in this regard, which was partially complied with by appointing 18 members.
  • The government, however, failed to avoid embarrassment as the CJI expressed his anger at the appointment process which had ignored candidates recommended by the selection committee.

(c) Burden of pendency

  • There is a real risk of the court taking matters into its own hands by making appointments itself, or by taking harsher steps like transferring jurisdiction under the IBC to high courts.
  • One hopes that the situation is resolved quickly to make strict time-bound insolvency resolutions a reality.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

Government sets up ‘bad bank’ to clear the NPA mess

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Bad Banks

Mains level : Asset reconstruction initiaitives by the govt

Paving the way for a major clean-up of bad loans in the banking system, the Union Cabinet has cleared a ₹30,600-crore guarantee programme for securities to be issued by the newly incorporated ‘bad bank’ for taking over and resolving non-performing assets (NPAs) amounting to ₹2 lakh crore.

What is a Bad Bank?

  • A bad bank conveys the impression that it will function as a bank but has bad assets to start with.
  • Technically, it is an asset reconstruction company (ARC) or an asset management company that takes over the bad loans of commercial banks, manages them and finally recovers the money over a period of time.
  • Such a bank is not involved in lending and taking deposits, but helps commercial banks clean up their balance sheets and resolve bad loans.
  • The takeover of bad loans is normally below the book value of the loan and the bad bank tries to recover as much as possible subsequently.

Bad Banks to be established

  • The NARCL-IDRCL structure is the new bad bank.
  • The National Asset Reconstruction Company Limited (NARCL) has already been incorporated under the Companies Act.
  • It will acquire stressed assets worth about Rs 2 lakh crore from various commercial banks in different phases.
  • Another entity — India Debt Resolution Company Ltd (IDRCL), which has also been set up — will then try to sell the stressed assets in the market.

How will the NARCL-IDRCL work?

  • The NARCL will first purchase bad loans from banks.
  • It will pay 15% of the agreed price in cash and the remaining 85% will be in the form of “Security Receipts”.
  • When the assets are sold, with the help of IDRCL, , the commercial banks will be paid back the rest.
  • If the bad bank is unable to sell the bad loan, or has to sell it at a loss, then the government guarantee will be invoked.
  • The difference between what the commercial bank was supposed to get and what the bad bank was able to raise will be paid from the Rs 30,600 crore that has been provided by the government.

Will a bad bank resolve matters?

  • From the perspective of a commercial bank saddled with high NPA levels, it will help.
  • That’s because such a bank will get rid of all its toxic assets, which were eating up its profits, in one quick move.
  • When the recovery money is paid back, it will further improve the bank’s position.
  • Meanwhile, it can start lending again.

Why do we need a bad bank?

  • The idea gained currency during Rajan’s tenure as RBI Governor.
  • The RBI had then initiated an asset quality review (AQR) of banks and found that several banks had suppressed or hidden bad loans to show a healthy balance sheet.
  • However, the idea remained on paper amid lack of consensus on the efficacy of such an institution.
  • ARCs have not made any impact in resolving bad loans due to many procedural issues.
  • While commercial banks resume lending, the so-called bad bank, or a bank of bad loans, would try to sell these “assets” in the market.

Good about the bad banks

  • The problem of NPAs continues in the banking sector, especially among the weaker banks.
  • The bad bank concept is in some ways similar to an ARC but is funded by the government initially, with banks and other investors co-investing in due course.
  • The presence of the government is seen as a means to speed up the clean-up process.
  • Many other countries had set up institutional mechanisms such as the Troubled Asset Relief Programme (TARP) in the US to deal with a problem of stress in the financial system.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

New Code for Creditors (CoC) under IBC

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Code for Creditors (CoC)

Mains level : Various reforms under Insolvency and Bankruptcy Code (IBC)

The insolvency regulator has called for public comments on a proposal to introduce a code of conduct for Committees of Creditors (CoC), of companies undergoing insolvency proceedings under the Insolvency and Bankruptcy Code (IBC).

Before proceeding, try this PYQ first:

Q. Which of the following statements best describes the term ‘Scheme for Sustainable Structuring of Stressed Assets (S4A)’, recently seen in the news? (CSP 2017)

 

(a) It is a procedure for considering the ecological costs of developmental schemes formulated by the Government.

(b) It is a scheme of RBI for reworking the financial structure of big corporate entities facing genuine difficulties.

(c) It is a disinvestment plan of the Government regarding Central Public Sector Undertakings.

(d) It is an important provision in ‘The Insolvency and Bankruptcy Code’ recently implemented by the Government.

 

Post your answers here.
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About IBC

  • The IBC, 2016 is the bankruptcy law of India that seeks to consolidate the existing framework by creating a single law for insolvency and bankruptcy.
  • It is a one-stop solution for resolving insolvencies which previously was a long process that did not offer an economically viable arrangement.
  • The code aims to protect the interests of small investors and make the process of doing business less cumbersome.

Key features

Insolvency Resolution: The Code outlines separate insolvency resolution processes for individuals, companies, and partnership firms. The process may be initiated by either the debtor or the creditors. A maximum time limit, for completion of the insolvency resolution process, has been set for corporates and individuals.

  1. For companies, the process will have to be completed in 180 days, which may be extended by 90 days, if a majority of the creditors agree.
  2. For startups (other than partnership firms), small companies, and other companies (with assets less than Rs. 1 crore), the resolution process would be completed within 90 days of initiation of request which may be extended by 45 days.

Insolvency regulator: The Code establishes the Insolvency and Bankruptcy Board of India, to oversee the insolvency proceedings in the country and regulate the entities registered under it. The Board will have 10 members, including representatives from the Ministries of Finance and Law, and the RBI.

Insolvency professionals: The insolvency process will be managed by licensed professionals. These professionals will also control the assets of the debtor during the insolvency process.

Bankruptcy and Insolvency Adjudicator: The Code proposes two separate tribunals to oversee the process of insolvency resolution, for individuals and companies:

  1. National Company Law Tribunal: for Companies and Limited Liability Partnership firms; and
  2. Debt Recovery Tribunal: for individuals and partnerships

What is the recent development?

Ans. Code of conduct for Committees of Creditors (CoC)

  • A CoC is to be composed of financial creditors to the Corporate Debtor (CD) — or operational creditors in the absence of unrelated financial creditors.
  • Under the IBC, CoC is empowered to take key decisions, including decisions on haircuts for creditors, that are binding on all stakeholders, including those dissenting.
  • The CoC is also empowered to seek and choose the best resolution plan for a corporate debtor from the market, and its role is vital for a timely and successful resolution for a CD.
  • The IBBI noted that a code of conduct for CoCs would promote transparent and fair working on the part of CoCs.

What are the issues that the code of conduct is seeking to address?

  • Several cases in which certain lenders have withdrawn funds from a CD undergoing insolvency proceeding and contributed to delays in the insolvency process.
  • Delays in resolution are seen as contributing to the loss of value in corporate debtors and have become a key criticism of the IBC, with over 75 percent of proceedings having crossed the 270-day timeline.
  • The IBBI highlighted cases in which representatives of lenders have had to seek approval from seniors for decisions such as an appointment of resolution professionals.
  • IBBI has recommended that a code of conduct require that members of the CoC nominate representatives with sufficient authorization to participate in meetings and make decisions during the process.
  • The regulator also highlighted cases where lenders have withdrawn funds from a corporate debtor during insolvency or liquidation proceedings.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

Getting the perfect haircut from the IBC

Note4Students

From UPSC perspective, the following things are important :

Prelims level : IBC 2016

Mains level : Paper 3- Right timing in the use of IBC matters

Understanding the role of IBC 2016

  • For reasons sometimes a company may experience stress, that is, is unable to repay the debt in time — implying that it has assets less than claims against it.
  • So, when a company has inadequate assets, the claim of an individual creditor may be consistent with its assets while claims of all creditors put together may not.
  • In such a situation, creditors may rush to recover their claims before others do, triggering a run on the company’s assets.
  • The IBC provides for reorganisation that prevents a value-reducing run on the company.
  • It aims to rescue the company if its business is viable or close it if its business is unviable, through a market process.
  • Restructuring: The claims of creditors are restructured, which may be paid to them immediately or over time.
  •  In case of closure, the assets of the company are sold, and proceeds are distributed to creditors immediately as per the priority rule.
  • Reorganisation by financial creditor: The IBC entrusts the responsibility of reorganisation to financial creditors as they have the capability and the willingness to restructure their claims.

Why so much variation in haircut?

  • Where the company does not have adequate assets, realisation for financial creditors, through a rescue, may fall short of their claims known as haircut.
  • The IBC process yields a zero haircut (100% recovery of claimed amount) in one case and 100 per cent haircut (i.e. 0% recovery) in another.
  • Factors: It depends on several factors, including the nature of business, business cycles, market sentiments, and marketing effort.
  • It critically depends on at what stage of stress, the company enters the IBC process.
  • If the company has been sick for years, and its assets have depleted significantly, the IBC process may yield a huge haircut or even liquidation.
  • A haircut is typically the total claims minus the amount of realisation/amount of the claims.
  • But this formulation may not tell the complete story.
  • The realisation often does not include the amount that would be realised from equity holding post-resolution, and through the reversal of avoidance transactions and the insolvency resolution of guarantors — personal and corporate.
  • It also does not include realisations made in other accounts.
  • The amount of claim often includes NPA, which may be completely written off, and the interest on such NPA.
  • These understate the numerator and overstate the denominator, projecting a higher haircut.

Significance of IBC

  • A haircut should be seen in relation to the assets available and not in relation to the claims of creditors.
  • The market offers a value in relation to what a company brings on the table, not what it owes to creditors.
  • Value maximisation: So, the IBC maximises the value of existing assets, not of assets that probably existed earlier.
  • Market determined value: The IBC enables and facilitates market forces to resolve stress as a going concern.
  • Resolution applicants, who have many options for investment, including in stressed companies, compete to offer the best value.
  • If the best value offered by the market is not acceptable to creditors, the company is liquidated.
  • Maximum realisation: In addition to rescuing the company, the IBC realises, of the available options for creditors, the highest in percentage terms.

Conclusion

It is a tool in the hands of stakeholders to be used at the right time, in the right case, in the right manner.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)


Back2Basics: Avoidable Transactions in IBC 2016

  • The UNCITRAL Legislative Guide on Law of Insolvency defines avoidance proceedings as “provisions of the insolvency law that permit transactions for the transfer of assets or the undertaking of obligations prior to insolvency proceedings to be cancelled or otherwise rendered ineffective and any assets transferred, or their value, to be recovered in the collective interest of creditors.”
  • It is very important for the Resolution Professional (RP) or the liquidator to identify such transaction and file applications to avoid it so that creditors can collect their claims.
  • The Insolvency and Bankruptcy Code, 2016 (IBC) contains four types of avoidable transactions- preferential, undervalued, defrauding creditors and extortionate transactions.
  • Usually, the avoidable transactions should be made within the prescribed relevant time or look back period.
  • Look back period is the relevant time up to which an RP or a liquidator can go back to scrutinize an expected avoidable transaction.

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

First group insolvency proceeding points to larger weakness in IBC

Note4Students

From UPSC perspective, the following things are important :

Prelims level : CoC in IBC

Mains level : Paper 3- Issues with IBC

Context

National Company Law Appellate Tribunal (NCLAT) stayed the approval granted by the Mumbai bench of the National Company Law Tribunal (NCLT) to the resolution plan for the Videocon Group.

Concerns with resolution plan

  • Resolution plan submitted by Twinstar Technologies, provided for payment of Rs 2,962 crore — a mere 4.15 per cent of Videocon’s total admitted debt of Rs 64,838 crore.
  • Payment of debt not in fair and equitable manner:  Under the IBC (Section 30(2)(b)), the resolution plan must provide for payment of debts amongst creditors in a “fair and equitable” manner.
  • However, in the plan submitted by Twinstar, unsecured assenting financial creditors and operational creditors are getting a paltry 0.62 per cent and 0.72 per cent of their admitted dues.
  • Even the secured assenting and dissenting financial creditors had to settle for only 4.9 per cent and 4.56 per cent of their respective dues.
  • Confidentiality obligation concerns: Twinstar’s bid of Rs 2,962 crore is close to the liquidation value of the Videocon Group estimated at Rs 2,568 crore, thereby raising legitimate suspicion and concern over the confidentiality of the resolution process.
  • The I&B Regulations, 2016 state that the resolution professional must maintain the confidentiality of the fair market value and liquidation value of the corporate debtor and can only disclose the same to the CoC members after the resolutions plan have been submitted.
  • Time delay: Status-quo ante has been restored until the next date of hearing by which time more than three years would have passed since the Videocon group was admitted into insolvency proceedings.
  • This is way beyond the statutory timeline of 330 days.

Confidentiality rules need to be revised

  • The CoC members must, on receipt of the information, issue an undertaking of confidentiality.
  • But no such obligation falls on the resolution professional.
  • Further, Section 29(2) of the code provides that the resolution professional must disclose all “relevant information” to the resolution applicant and it is for the resolution applicant to ensure compliance with confidentiality obligations.
  • Again, there is no such duty imposed on the resolution professional.
  • Even under Section 25 of the code, titled “Duties of resolution professional”, the specific duty to maintain confidentiality of sensitive information is absent.
  • Clearly, the current regime does not have much deterrence value so as to ensure solemn adherence to confidentiality.

Conclusion

Videocon was one of the first test cases to examine the prospects of insolvency jurisprudence in India and the first one, for group insolvency proceedings.  However, almost four years and a 95 per cent haircut later, the call for an immediate course correction couldn’t be louder.


Back2Basics: Operational creditor and financial creditors

  • When a corporate defaulter is brought under the resolution process (Corporate Insolvency Resolution Process or CIRP), there can be two types of creditors to whom the corporate should give back money –
  • (1) the entities who gave loans or funds to the corporate.
  • (2) the entities from whom the corporate bought inputs and other services.
  • The financial creditors are basically entities (lenders like banks) that have provided funds to the corporate.
  • Their relationship with the entity is a pure financial contract, such as a loan or debt security.
  • On the other hand, business and other entities that have provided inputs and other materials and services and to whom the defaulted corporate owes a debt are called as operational creditors.
  • Both have claims on the defaulted corporate or the defaulted corporate owe payments to both these categories.
  • Rights for these categories under the resolution process are also different.
  • The IBC gives a clear preference to the claims of the financial creditors over the operational creditors through several procedures.

Haircut

  • A haircut is the difference between the loan amount and the actual value of the asset used as collateral.
  • It reflects the lender’s perception of the risk of fall in the value of assets.
  • But in the context of loan recoveries, it is the difference between the actual dues from a borrower and the amount he settles with the bank.

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

Who is a Registered Valuer?

Note4Students

From UPSC perspective, the following things are important :

Prelims level : IBC, Registered Valuers

Mains level : Financial frauds these days

A valuation report by a registered valuer is at the heart of the recent controversy surrounding a Rs 4,000 crore share allotment decision by PNB Housing Finance.

Who is a Registered Valuer?

  • A registered valuer is an individual or entity which is registered with the Insolvency and Bankruptcy Board of India (IBIBI) as a valuer in accordance with the Companies (Registered Valuers and Valuation) Rules, 2017.
  • Under Section 458 of the Companies Act, IBBI has been specified as the authority by the central government.
  • The concept of registered valuer was introduced in the Companies Act in 2017 in order to regulate the valuation of assets and liabilities linked to a company and to standardize the valuation procedure in line with global valuation standards.
  • Before the concept of registered valuer became part of the Companies Act, valuation was done in an arbitrary manner, often leading to question marks over the authenticity of the valuation.

What does the valuation report comprise?

  • As per the Companies (Registered Valuers and Valuation) Rules, 2017, the valuer should, in his/its report, state 11 key aspects including disclosure of the valuer’s conflict of interest, if any.
  • Among others, it must include the purpose of valuation; sources of information; procedures adopted in carrying out the valuation; valuation methodology; and major factors that influenced the valuation.

Who can become a registered valuer?

  • An individual needs to clear the Valuation Examination conducted by IBBI.
  • The rules state that an individual who has completed 50 years of age and has been substantially involved in at least ten valuation assignments of assets amounting to Rs 5 crore rupees or more, during the five years preceding the commencement of these rules, shall not be required to pass the Valuation Examination.
  • The individual should, however, have a postgraduate degree in the specified discipline (relevant for valuation of the class of asset for which the registration is sought) and should have at least three years of experience in the discipline thereafter.
  • As of March 31, 2021 there were 3,967 registered valuers in the country. Only 40 of them are registered entities; the rest are individuals.

For what assets can a registered valuer undertake valuation?

  • A registered valuer can get themselves registered for valuation of assets such as land and building; plant and machinery; and securities and financial assets.
  • They can get registered for valuation of all three classes, and can undertake valuation of only the assets for which they have got the registration.

Answer this PYQ in the comment box:

Q.Which of the following statements best describes the- term ‘Scheme for Sustainable Structuring of Stressed Assets (S4A)’, recently seen in the news? (CSP 2017)

(a) It is a procedure for considering the ecological costs of developmental schemes formulated by the Government.

(b) It is a scheme of RBI for reworking the financial structure of big corporate entities facing genuine difficulties.

(c) It is a disinvestment plan of the Government regarding Central Public Sector Undertakings.

(d) It is an important provision in ‘The Insolvency and Bankruptcy Code’ recently implemented by the Government.

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

Supreme Court says Personal Guarantors liable for Corporate Debt

Note4Students

From UPSC perspective, the following things are important :

Prelims level : IBC

Mains level : Asset reconstructions with IBC

The Supreme Court has upheld a government moves to allow lenders to initiate insolvency proceedings against personal guarantors, who are usually promoters of big business houses, along with the stressed corporate entities for whom they gave a guarantee.

What is the Judgement?

  • The judgment has allowed creditors, usually financial institutions and banks, to move against personal guarantors under the Indian Bankruptcy and Insolvency Code (IBC) was “legal and valid”.
  • The November 15, 2019 notification was challenged before several High Courts initially.
  • The apex court said there was an “intrinsic connection” between personal guarantors and their corporate debtors.

What is a personal guarantee? How do promoters use this route to get funds?

  • A personal guarantee is most likely to be furnished by a promoter or promoter entity when the banks demand collateral which equals the risk they are taking by lending to the firm, which may not be doing so well.
  • It is different from the collateral that firms give to banks to take loans, as Indian corporate laws say that individuals such as promoters are different from businesses and the two are very separate entities.
  • A personal guarantee, therefore, is an assurance from the promoters or promoter group that if the lender allows them the fund, they will be able to turn around the loss-making unit and repay the said loan on time.

Impact of the move

  • The apex court ruling will help banks go after those who have offered guarantees to recover dues in case the resolution amount is short of the claims filed by them in the National Company Law Tribunal.
  • Over the years, many companies have repeatedly defaulted in loan repayment and got banks to restructure the debt, often citing systemic issues.
  • But as part of the clean-up initiated five years ago, the IBC was enacted and banks were told to go after those who were not paying their dues.

About the Insolvency and Bankruptcy Code, 2016

  • IBC is the bankruptcy law of India that seeks to consolidate the existing framework by creating a single law for insolvency and bankruptcy.
  • It is a one-stop solution for resolving insolvencies which previously was a long process that did not offer an economically viable arrangement.
  • The code aims to protect the interests of small investors and make the process of doing business less cumbersome.

Key features of the code

(1) Insolvency Resolution:

  • The Code outlines separate insolvency resolution processes for individuals, companies, and partnership firms. The process may be initiated by either the debtor or the creditors.
  • A maximum time limit, for completion of the insolvency resolution process, has been set for corporates and individuals.

(2) Insolvency regulator:

  • The Code establishes the Insolvency and Bankruptcy Board of India, to oversee the insolvency proceedings in the country and regulate the entities registered under it.
  • The Board will have 10 members, including representatives from the Ministries of Finance and Law, and the Reserve Bank of India.

(3) Insolvency professionals:

  • The insolvency process will be managed by licensed professionals.
  • These professionals will also control the assets of the debtor during the insolvency process.

(4) Bankruptcy and Insolvency Adjudicator:

The Code proposes two separate tribunals to oversee the process of insolvency resolution, for individuals and companies:

  1. the National Company Law Tribunal for Companies and Limited Liability Partnership firms; and
  2. the Debt Recovery Tribunal for individuals and partnerships

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

How IBC is moving away from promotor averse approach

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Pre-pack in IBC

Mains level : Paper 3- Pre-packs for MSME in IBC

The Insolvency and Bankruptcy Code was amended recently taking into account its creditor centric approach.

Introducing pre-packs for MSMEs

  • IBC was amended last week, through an ordinance.
  • The amendment sought to address a structural weakness in India’s resolution architecture by introducing the concept of pre-packs for micro, small and medium enterprises (MSMEs).
  • The pre-packaged framework involves a privately negotiated contract between the promoters of a financially distressed firm and its financial creditors to restructure the company’s obligations.
  •  This contract is negotiated within the IBC architecture but before the commencement of insolvency proceedings.
  • Once accepted by creditors, the plan must be presented to the National Company Law Tribunal (NCLT) for approval.

How this framework is different from the existing framework

  • A firm’s promoters could have submitted a resolution plan even after it enters the insolvency proceedings, subject to restrictions imposed under Section 29A which clarifies all those who are ineligible for submitting the resolution plan.
  • So, the difference in the new framework essentially boils down to the following.

1) Control of the firm

  • Under the IBC, upon the initiation of insolvency proceedings, control of a firm is taken away from promoters, and a resolution professional is appointed.
  • Now, during the restructuring, the promoter, through the pre-pack, retains control over the firm.
  • So effectively, we have transitioned from a “creditor-in-control” model of resolution to a “debtor-in-control” model of restructuring.
  • This amendment, which creates a framework for restructuring, without the promoter losing control over the firm, addresses a lacuna in the IBC.

2) Issue of price discovery

  • In this arrangement, the is an absence of an open bidding process, such as during the resolution phase.
  • This might raise questions over price discovery, especially if value maximisation for creditors is the yardstick to measure the efficacy of IBC.
  • This marks a fundamental change in the IBC framework.

Why the changes were needed

  • The IBC, while it has strengthened the position of the creditors, had swung to an extreme.
  • The resolution architecture as it stood prior to this amendment was perceived as being too creditor-centric.
  • Wresting control from the “errant” promoter, comes with its own set of consequences.
  • The notion that all business failure is due to the connivance of promoters needs to be reconsidered.
  • Firms may be unable to pay their obligations simply because the economic cycle has turned.
  • Or projects have not materialised as expected.
  • Of the 2,422 cases closed since IBC came into being, 46.5 per cent of the firms have gone into liquidation, while a resolution plan has been accepted in only 13.1 per cent of the cases.
  • This indicates liquidation bias.
  • At a time when there aren’t enough buyers in the economy, the IBC process would lead to significant value destruction.

How it will benefit both creditor and promotors

  • Promoters get to hold on to their firms, and exit the process with more manageable obligations, making this an attractive proposition.
  • For creditors, considering the liquidation bias in IBC, as long as the value of the restructured obligation is greater than the liquidation value it makes sense to choose this option.
  • Moreover, this entire process remains outside the restructuring framework of the central bank.
  • And, considering that the pre-packs encompass all financial creditors, as opposed to RBI’s restructuring schemes which deal only with banks.
  • This takes into account the concerns of other financial creditors as well.

Consider the question “How far IBC has succeeded in improving the insolvency regime in India? How the concepts of pre-packs is different from the previous system?

Conclusion

This approach will help clarify issues, bring about greater certainty to the process. And, once the creases are ironed out, it will create a permanent mechanism for restructuring debts.

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

What is the Pre-pack under Insolvency and Bankruptcy Code?

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Swiss Challenge, Pre-Packs

Mains level : Debt recovery under IBC

The central government has promulgated an ordinance allowing the use of pre-packs as an insolvency resolution mechanism for MSMEs with defaults up to Rs 1 crore, under the Insolvency and Bankruptcy Code.

Read till the end to know about the ‘Swiss Challenge’.

What are Pre-packs?

  • A pre-pack is the resolution of the debt of a distressed company through an agreement between secured creditors and investors instead of a public bidding process.
  • This system of insolvency proceedings has become an increasingly popular mechanism for insolvency resolution in the UK and Europe over the past decade.
  • Under the pre-pack system, financial creditors will agree to terms with a potential investor and seek approval of the resolution plan from the National Company Law Tribunal (NCLT).
  • The approval of a minimum of 66 percent of financial creditors that are unrelated to the corporate debtor would be required before a resolution plan is submitted to the NCLT.
  • Further NCLTs are also required to either accept or reject any application for a pre-pack insolvency proceeding before considering a petition for a CIRP.

Benefits of pre-packs over the CIRP

  • One of the key criticisms of the Corporate Insolvency Resolution Process (CIRP) has been the time taken for resolution.
  • One of the key reasons behind delays in the CIRPs is prolonged litigations by erstwhile promoters and potential bidders.
  • The pre-pack in contrast is limited to a maximum of 120 days with only 90 days available to the stakeholders to bring the resolution plan to the NCLT.
  • The existing management retains control in the case of pre-packs while a resolution professional takes control of the debtor as a representative of creditors in the case of CIRP.
  • This allows for minimal disruption of operations relative to a CIRP.

What is the key motivation behind the introduction of the pre-pack?

  • Pre-packs are largely aimed at providing MSMEs with an opportunity to restructure their liabilities and start with a clean slate.
  • It provides adequate protections so that the system is not misused by firms to avoid making payments to creditors.
  • Pre-packs help corporate debtors to enter into consensual restructuring with lenders and address the entire liability side of the company.

How are creditors protected?

  • The pre-pack also provides adequate protection to ensure the provisions were not misused by errant promoters.
  • The pre-pack mechanism allows for a swiss challenge for any resolution plans which proved less than full recovery of dues for operational creditors.
  • Under the swiss challenge mechanism, any third party would be permitted to submit a resolution plan for the distressed company and the original applicant would have to either match the improved resolution plan or forego the investment.
  • Creditors are also permitted to seek resolution plans from any third party if they are not satisfied with the resolution plan put forth by the promoter.

Back2Basics: Swiss Challenge

  • A Swiss Challenge is a method of bidding, often used in public projects, in which an interested party initiates a proposal for a contract or the bid for a project.
  • The government then puts the details of the project out in the public and invites proposals from others interested in executing it.
  • On the receipt of these bids, the original contractor gets an opportunity to match the best bid.
  • In 2009, the Supreme Court approved this method for the award of contracts.
  • This method can be applied to projects that are taken up on a PPP basis but can also be used to supplement PPP in sectors that are not covered under the PPP framework.

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

IBC as an enabler

Note4Students

From UPSC perspective, the following things are important :

Prelims level : IBC 2016

Mains level : Paper 3- Analysing the working of IBC

The article analyses whether or not the Insolvency and Bankruptcy Code is delivering on its objectives.

Criticism of IBC

  • The Insolvency and Bankruptcy Code (IBC), 2016 was enacted to resolve the stress of companies.
  • However, the corporate insolvency resolution process (CIRP)  has been criticised as it rescues only about 25 per cent of companies and leads to liquidation for the rest.

Is IBC delivering on its mandate

Let’s analyse how Insolvency and Bankruptcy Code (IBC) 2016 is working towards value maximising outcomes.

1) It enables the market to attempt to resolve

  • The CIRP enables the market to attempt to resolve stress through a resolution plan whereby the company survives.
  • When it concludes that there is no feasible resolution plan to rescue the company, the company proceeds for liquidation.
  • The market usually rescues a viable company and liquidates an unviable one.
  • There are quite a few companies which have negligible assets and/or are defunct when they enter CIRP.
  • Many of these are beyond rescue for a variety of reasons, including creative destruction, and their continuation is a cost to the economy.
  • In such cases, the code enables liquidation to release available resources to alternate uses.
  • It is welcome, as it releases the assets as well as the entrepreneur stuck up in an unviable company, which is a key objective of the code.

2) Look at the total asset value not the number of companies

  • In terms of absolute numbers, 25 per cent of companies were rescued and 75 per cent proceeded for liquidation.
  • In value terms, however, 75 per cent of the assets were rescued and 25 per cent of assets proceeded for liquidation.
  • Of the companies sent for liquidation, 75 per cent were either sick or defunct, and of the companies rescued, 25 per cent were either sick or defunct.

3) Look at the overall impact, not just final numbers

  • Third, the stress that a company suffers is like an illness which can be treated by a variety of options.
  • Normally, recovery is better if diagnosis and treatment start early.
  • Likewise, the health of the company deteriorates if the resolution process is delayed.
  • The percentage of rescue at this later stage may not be significant.
  • The credible threat of CIRP that a company may change hands has redefined the debtor-creditor relationship.
  • Faced with the possibility of the CIRP, a debtor makes all-out efforts to prevent the stress, or resolve it much before it translates into a default, or settles the default.
  • Even after an application is filed, a debtor continues efforts to resolve the financial stress midway through settlement, review, mediation, or withdrawal to avoid the consequences of CIRP.
  • The number of companies that recover before filing the application as a percentage of those that get starts the insolvency process would give the fair idea about the efficacy of the IBC.

Consider the question “The IBC has often been criticised for liquidating the companies rather than rescuing them. Do you agree with this criticism? Give reasons in support of your argument.”

Conclusion

Liquidation or rescue is an outcome of the market forces; the law is only an enabler giving choices and nudging a company towards value maximising outcomes. The “invisible hands” of the market works towards the best outcome, which we should respect and accept.

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

What is Section 32A of IBC?

Note4Students

From UPSC perspective, the following things are important :

Prelims level : IBC

Mains level : Read the attached story

The Supreme Court has held that the bidders for a corporate debtor under the Insolvency and Bankruptcy Code (IBC) would be immune from any investigations being conducted either by any investigating agencies.

Q.Examine the impact of various amendments to the Insolvency and Bankruptcy Code (IBC) and suggest further improvements in the IBC.

Backgrounder: IBC

  • IBC was enacted on May 28, 2016, to effectively deal with insolvency and bankruptcy of corporate persons, partnership firms and individuals, in a time-bound manner.
  • It has brought about a paradigm shift in laws aimed to maximize the value of assets, providing a robust insolvency resolution framework and differentiating between impropriety and business debacle.
  • The predominant object of the Code is the resolution of the Corporate Debtor.
  • It has been amended four times to resolve problems hindering the objectives of the Code.

What is Section 32A?

  • In cases involving property of a corporate debtor, Section 32A covers any action involving attachment, seizure, retention, or confiscation of the property of the corporate debtor as a result of such Proceedings.
  • It provides immunity to the corporate debtor and its property when there is the approval of the resolution plan resulting in the change of management of control of the corporate debtor.
  • This is subject to the successful resolution applicant being not involved in the commission of the offense.

What were the challenges?

  • Since the IBC came into being in 2016, the implementation of the resolution plan of several big cases has been delayed because of various challenges mounted by its own agencies and regulators.
  • For example, a debt-laden company, admitted into insolvency in 2017, owes more than Rs 47,000 crore to banks and other financial institutions.
  • After a prolonged bidding battle, another won the rights to take over it with a bid of Rs 19,700 crore.
  • However, before it could move to take over, the ED/SEBI swooped in, and attached assets worth Rs 4,000 crore citing alleged fraud in a bank loan under the Prevention of Money Laundering Act (PMLA).

Observations made by the SC

  • In its judgment, the apex court upheld the validity of Section 32.
  • It said it was important for the IBC to attract bidders who would offer reasonable and fair value for the corporate debtor to ensure the timely completion of the corporate insolvency resolution process (CIRP).
  • Such bidders, however, must also be granted protection from any misdeeds of the past since they had nothing to do with it.
  • Such protection, the court said, must also extend to the assets of a corporate debtor which will help banks clean up their books of bad loans.
  • The apex court has, however, also said that such immunity would be applicable only if there are an approved resolution plan and a change in the management control of the corporate debtor.

Significance of SC’s intervention

  • With the Supreme Court upholding the validity of Section 32 A will give confidence to other bidders to proceed with confidence while bidding on such disputed companies and their assets.

Must read

[Burning Issue] Insolvency and Bankruptcy Code

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

Asset Reconstruction Companies

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Asset Reconstruction Company

Mains level : https://indianexpress.com/article/opinion/columns/insolvency-law-ibc-corporate-debt-resolution-bankruptcy-code-nirmala-sitharaman-6704399/

The article argues for the greater role to Asset Reconstruction Companies by allowing them to invest in the equity [shares] of the distressed companies.

Context

  • In a recently released paper “Indian Banks: A time to reform” Viral Acharya and Raghuram Rajan argued for a greater role for Asset Reconstruction Companies.
  • They argue that when there are fewer bids in a bankruptcy auction, the value on loans is better realised if read an asset reconstruction company takes over the borrower and places the firm under new management.

Current limits on the role of ARC

  • The RBI limited the role of  ARC to participation in resolutions under the Insolvency and Bankruptcy Code, 2016 (IBC) only by partnering with an equity investor, which is the resolution applicant.
  • If the application succeeds, the equity investor would acquire the shares, while the ARC trust would acquire the debt.

Background of the ARCs

  •  Some stakeholders are asking for extending the role of ARCs by allowing direct invest in the equity of distressed companies through IBC resolution just like private equity funds.
  • The RBI doesn’t appear to favour such an extended role for ARCs.
  • This is due to the uninspiring performance of the Asset Reconstruction Companies in the past.
  • At the time of the Asian Financial Crisis,  India’s non-performing assets stood at a whopping 14.4 per cent.
  •  It was in this context that the Narasimham Committee (1998) recommended setting up an ARC specifically for purchasing NPAs from banks and financial institutions.
  • Subsequently, the SARFAESI Act, 2002 created the legal framework for establishing multiple private ARCs.
  • This policy achieved only modest success.
  • The maximum average recovery by ARCs as a percentage of total bank claims stood at 21.5 per cent in 2010.
  • Since then, it has steadily declined and reached 2.3 per cent in 2018.
  • This low recovery could be the result of collateral disposal rather than genuine business turnarounds [i.e. operating the business and turning it profitable].

Need for extending the role of ARCs

  • In 2002, India lacked an effective bankruptcy system.
  • There was no market for corporate control of distressed firms.
  • ARCs were originally designed for this peculiar institutional ecosystem.
  • They were required to hand over the distressed business back to the original promoter once they had generated enough value to repay the debt.
  • Consequently, ARCs had little incentive to turn around distressed businesses.
  • This situation completely changed in 2016 as the IBC seeks to maximise the value of distressed businesses through a market for corporate control.
  • ARCs should be able to fully participate in this market and attempt successful turnarounds by acquiring strategic control over distressed businesses.
  • In a solvent company, shareholders have stronger incentives than creditors to maximise enterprise value.
  • This is because an increase in enterprise value automatically increases the value of its equity.
  • In contrast, creditors do not benefit from increases in enterprise value beyond their individual claims.
  • If ARCs could hold more equity instead of debt in the resolved company, they would also have a stronger incentive to take strategic control to ensure successful turnaround.

Way forward

  • The law should enable ARCs to invest in a distressed company’s equity, whether by infusing fresh capital or by converting debt into equity.
  • Effectively, an ARC should act more like a private equity fund, as Acharya and Rajan suggested.
  • This in turn would make the market for corporate control under IBC deeper and more liquid, improving ex-ante recovery rates for banks.

Consider the question “What are Asset Reconstruction Companies? How allowing the ARCs to invest in equity of distressed companies under IBC help successful turnaround of the distressed business?”

Conclusion

  •  If only ARCs are allowed to directly participate in IBC resolutions by infusing equity, they could emerge as the most efficient vehicle for turning around distressed Indian businesses.

Back2Basics: Difference between debt and equity

  • Debt market and equity market are two broad categories of investment available in the general investment milieu.
  • Equity markets trade in shares or stocks of the company listed on the stock exchanges.
  • A stock in a company indicates a unit in the ownership of the company.
  • As shareholders, you become part owners of the company.
  • The largest shareholder, with 50% or more shares, becomes the owner of the company.
  • Equity markets are riskier than debt markets.
  • Debt is a form of borrowed capital.
  • The central or state governments raise money from the market by issuing government securities or bonds.
  • In effect, the government is borrowing money from you and will pay interest to you at regular intervals.
  • The principal amount is returned on maturity.
  • In the same way, a company raises money from the market by selling debt market securities such as corporate bonds.
  • The debt market is made up of bonds issued by government authorities and companies.

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

Need for streamlining the Insolvency and Bankruptcy Code

Note4Students

From UPSC perspective, the following things are important :

Prelims level : IBC

Mains level : Paper 3- Impact of IBC

The article analyses the impact of Insolvency and Bankruptcy Code (IBC) on the insolvency resolution and on Indian economy.

Measures that will improve investment

1)  IBC: transforming insolvency resolution

  • IBC replaced inefficient bankruptcy law regime and has transformed insolvency resolution in India.
  • The IBC has focused on time-bound resolution, rather than liquidation.
  • IBC acts as an empowering tool to support companies falling within its ambit.
  • It has successfully instilled confidence in the corporate resolution methodology.
  • It has allowed credit to flow more freely to and within India while promoting investor and investee confidence.
  • The IBC is both flexible and dynamic, which makes it impactful, given how forward thinking the concept of an omnibus legislation of its nature actually is.
  • Through the Insolvency and Bankruptcy Board of India (IBBI), it has established an unprecedented organisation that both regulates and develops insolvency policy, and assesses market realities.

Impact of IBC

  •  According to the Resolving Insolvency Index, India’s ranking improved to 52 in 2019 from 108 in 2018.
  • Further, the recovery rate improved nearly threefold from 26.5% in 2018 to 71.6% in 2019
  • The overall time taken in recovery also improved nearly three times, coming down from 4.3 years in 2018 to 1.6 years in 2019.

2) Decriminalisation of minor offences

  • Criminal penalties including imprisonment for minor offences act as major deterrents for investors.
  • The Government of India is also working toward decriminalisation of minor offences.
  • This will significantly reduce the risk of imprisonment for actions or omissions that are not necessarily fraudulent or an outcome of mala fide intent.

3) Other legislative measures

  • Together with the IBC, following 3 reforms suggests major and multi-dimensional effort by the government.
  • 1) The rolling out of the commercial courts.
  • 2) Commercial divisions and the Commercial Appellate Divisions Act, 2015, to allow district court-level commercial courts.
  • 3) Removal of over 1,500 obsolete and archaic laws.

Way forward

  • There could perhaps be a look at institutionalising the introduction of a pre-packed insolvency resolution process.
  • This will also help resolve matters expeditiously, outside of the formal court system, and allow resolution even during the COVID-19 altered reality.

Consider the question “Examine the impact of Insolvency and Bankruptcy Code (IBC) on the insolvency resolution procedure and suggest the further improvements in the IBC.”

Conclusion

The IBC has provided a major stimulus to ease of doing business, enhanced investor confidence, and helped encourage entrepreneurship while also providing support to MSMEs. Its further streamlining and strengthening will surely instil greater confidence in both foreign and domestic investors as they look at India as an attractive investment destination.

B2BASICS

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

What are Pre-packs under the present insolvency regime?

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Pre-Pack

Mains level : Asset reconstructions process under IBC

The Ministry of Corporate Affairs (MCA) has set up a committee to look into the possibility of including what is called “pre-packs” under the current insolvency regime to offer faster insolvency resolution.

Practice question for mains:

Q.What are the key features of the Insolvency and Bankruptcy Code? Discuss how operationalization of IBC is hindered by the slower resolutions of insolvency cases. Suggest measures for faster resolution.

What is Pre-pack?

  • A pre-pack is an agreement for the resolution of the debt of a distressed company through an agreement between secured creditors and investors instead of a public bidding process.
  • This system of insolvency proceedings has become an increasingly popular mechanism for insolvency resolution in the UK and Europe over the past decade.

Why need Pre-packs?

  • Slow progress in the resolution of distressed companies has been one of the key issues raised by creditors regarding the Corporate Insolvency Resolution Process (CIRP) under the IBC.
  • Under the IBC, stakeholders are required to complete the CIRP within 330 days of the initiation of insolvency proceedings.

A case for India

  • In India’s case, such a system would likely require that financial creditors agree on terms with potential investors and seek approval of the resolution plan from the National Company Law Tribunal (NCLT).
  • This process would likely be completed much faster than the traditional CIRP which requires that the creditors of the distressed company allow for an open auction for qualified investors to bid for the distressed company.
  • The process needs to be completed within 90 days so that all stakeholders retain faith in the system and cases that take more than this time should be taken through the normal CIRP.

What are the other key benefits of a pre-pack?

  • Pre-packs would mostly be used for businesses that are running; the investors would likely need to maintain good relations with operational creditors.
  • In the case of pre-packs, the incumbent management retains control of the company until a final agreement is reached.
  • The transfer of control from the incumbent management to an insolvency professional as is the case in the CIRP leads to disruptions in the business and loss of some high-quality human resources and asset value.

Some limitations

  • The key drawback of a pre-packaged insolvency resolution is the reduced transparency compared to the CIRP.
  • Financial creditors would reach an agreement with a potential investor privately and not through an open bidding process.
  • This could lead to stakeholders such as operational creditors raising issues of fair treatment when financial creditors reach agreements to reduce the liabilities of the distressed company.

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

Faults in section inserted for the suspension of IBC amid pandemic

Note4Students

From UPSC perspective, the following things are important :

Prelims level : IBC

Mains level : Paper 3- Problems with IBC

Following the lockdown, the government announced the suspension of some provision of IBC to soften the blow of economic crisis. Section 10A was inserted to suspend the provision. But it giver rise to other questions. What are these questions? Read the article to know…

What changes were made?

  • In mid-May, the Finance Minister announced that the government was planning to bring in an ordinance to suspend provisions enabling filing of fresh insolvency cases for a period of one year..
  • Finally, on June 5, the government promulgated an ordinance which inserted Section 10A in the IBC.
  • The government said the ordinance was promulgated because the lockdown has caused business disruptions which may lead to default on debts pushing such companies into insolvency.
  • Therefore, it felt that suspending Sections 7, 9 and 10 of the IBC would be the right course of action.

What are the issues with section 10A?

  • Section 10A provides that “no application for initiation of corporate insolvency resolution process of a corporate debtor shall be filed, for any default arising on or after 25th March, 2020 for a period of six months or such further period, not exceeding one year from this period, as may be notified in this behalf”.
  • This means that these provisions shall remain suspended from March 25 till September 25, unless extended for another six months, which would extend the suspension up till March 25, 2021.
  • However, the proviso to the section states that no application for insolvency resolution shall ever be filed against a corporate debtor for any default occurring during the suspension period.
  • While the main Section 10A suspends such applications for a limited period, the proviso enlarges the scope to provide complete amnesty under the IBC for any default occurring during such period.
  • The role of a proviso in a statute is to restrict the application of the main provision under exceptional circumstances.
  • However, the proviso here expands the substantive provision in the main section.
  • Further, if the main provision is unclear, a proviso may be given to explain its true meaning.
  • In this case the main provision appears clear, only to be obfuscated by the proviso.
  • The proviso therefore does not appear to be legally tenable.
  • As creditors can still approach courts, and as banks/FIs can still approach Debt Recovery Tribunals, the protection given by this proviso seems illusory.
  • But Section 10A also suspends provisions of Section 10 of the IBC which enables voluntary insolvency resolution.
  • This is difficult to understand as such voluntary insolvency resolution should have been made easier for companies facing distress.

Painting all defaults with the same brush

  • The ordinance appears to consider every default occurring during the suspension period to be a consequence of the pandemic.
  • There could be cases where defaults were imminent due to other reasons, but which will now still enjoy this protection.
  • The ordinance should have protected only such defaults which may occur as a direct consequence of the pandemic or the lockdown and should have left this determination to the National Company Law Tribunal.
  • Also, a company defaulting on its payment obligations on March 24 (a day before the lockdown started) would not be provided any relief under the IBC as compared to a company defaulting on or immediately after March 25 due to similar reasons.
  • This makes the suspension, in the absence of definition of a COVID-19 default, prima facie arbitrary.

Issue with increasing the default amount limit

  • Earlier, the government increased the minimum default amount to trigger corporate insolvency resolution from ₹1 lakh to ₹1 crore.
  • This was purportedly done to protect MSMEs from insolvency petitions.
  • However, this also operates against such MSMEs because they will now be forced to approach civil courts to recover undisputed debts below ₹1 crore.
  • The suspension of these provisions would now impact even claims above ₹1 crore for at least six months to a year.

Conclusion

The ordinance has opened itself up to a legal challenge on grounds of arbitrariness and untenability of the proviso due to the flaw in its drafting. It is unfathomable how these flaws arose despite the government having ample time to think this through.

B2BASICS:

 Insolvency and Bankruptcy Code, 2015

The code contains a clear speedy mechanism for early identification of financial distress and initiates revival/re-organisation of the company if it is viable.

Timeline

  • The bill proposes a timeline of 180 days to deal with the applications for insolvency resolution with an option of extending it by 90 days for exceptional cases.

Insolvency Resolution Plan

  • The insolvency resolution plan has to be approved by 75% of the creditors. If the plan is approved, then the adjudicating authority will give its sanction. In case of rejection of insolvency resolution plan, the adjudicating authority will pass an order for liquidation.

Insolvency Professionals (IPs) & Insolvency Professional Agencies (IPAs)

  • 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.

Information Utilities

  • Information utilities (IUs) will be established to collect, collate and disseminate financial information to facilitate insolvency resolution.

Bankruptcy and Insolvency Adjudicator

  • The National Company Law Tribunal (NCLT) will adjudicate insolvency resolution for companies.  The Debt Recovery Tribunal (DRT) will adjudicate insolvency resolution for individuals.
  • The Debt Recovery Tribunal (DRT), which has jurisdiction over individuals and unlimited liability partnership firms. Appeals from the order of DRT shall lie to the Debt Recovery Appellate Tribunal (DRAT).

Insolvency regulators

  • The Insolvency and Bankruptcy Board of India will be set up to regulate functioning of IPs, IPAs and IUs.

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

New approach to economic revival: SNAP

Note4Students

From UPSC perspective, the following things are important :

Prelims level : IBC 2016 provisions.

Mains level : Paper 3- IBC provisions and need for novel approach to deal with the economic fallout of the pandemic.

In this article the author suggests a new approach to deal with multiple bankruptcies and stressed assets that would come up post COVID. So, what is the new approach and how it is different from the existing IBC? Read further.

Why is speed of resolution important?

  • First, because it is the only way to revive the economy.
  • As revenues have dried up cash flow problems have cascaded down the supply chain.
  • Firms will consequently be unable to restart production unless they first get credit to pay their suppliers and workers.
  • But impaired firms cannot get credit and impaired banks cannot provide it.
  • So, the entire economy will be stuck unless the balance sheet problem is sorted out.
  • Second, speed will also minimise the losses from the COVID crisis.
  • The value of bankrupt firms decays rapidly over time, and the bill for this loss will have to be borne ultimately by the government.
  • So, speed is necessary to contain the damage to the government’s financial position, which has been badly eroded by the COVID crisis.
  • But moving quickly will be difficult.
  • The only real mechanism that currently exists to handle stress and bankruptcy is the Insolvency and Bankruptcy Code (IBC) system, which has been suspended for six months.

Why the IBC cannot help much?

  • Many have therefore argued for bringing the IBC back into operation as soon as possible.
  • Why such a strategy would not be very effective? The system is slow, with many cases taking two years or more; it could easily become overwhelmed completely if it is forced to absorb a large new set of bankrupt firms.
  • In addition, the IBC envisages that banks maximise their recoveries by auctioning off the bankrupt firms to the highest bidder.
  • But in a nation and indeed a world, where all balance sheets are damaged, it is not obvious who would be able to buy these firms, or at what prices.
  • So recovery rates from sales could be low, undermining the objective of the exercise.
  • Even if strong bidders could be found, there is a fundamental political, even philosophical, question of whether it is really right to take these firms away from their promoters.
  • After all, many of these firms did nothing wrong; they got into financial difficulties because of the corona crisis.

So, what is the solution?

  • What is needed is a new set of procedures that can utilise much of the existing IBC framework, but are simple, straightforward, and prompt, with a built-in expiry clause.
  • Let’s Call them Special Non-Adversarial Procedures (SNAP).
  • As soon as the lockdown is largely over, the IBC creditor committees (CoCs) could meet to assess the new wave of NPAs.
  • The largest, most complex cases — say, those with debts exceeding Rs 10,000 crore — would be sent to the IBC for regular treatment.
  • But all other cases would be eligible under SNAP
  • After all, the wider the set of companies that are put back on their feet quickly, the stronger the recovery will be.

How would the SNAP work?

  • Under SNAP, CoCs would, over the next three months, examine delinquent firms’ financial records, checking to see whether they are actually viable.
  • If so, these firms would be designated as Lockdown Affected Enterprises (LAEs), eligible under SNAP.
  • Since the basis of the designation would be that the firm is fundamentally sound but because of COVID impact, an Insolvency Professional (IP) appointed by the CoC would work with existing management (who would continue to run the firm) to arrange for interim finance.
  • Then, the IP would assess how much of a debt reduction the firm needs, and within three months would present a specific proposal to the CoC.
  • If the CoC can reach a two-third majority in favour of the proposal, the promoter would keep the firm, while the firm would be granted immediately released from bankruptcy.
  • Since the National Company Law Tribunal (NCLT) is already overloaded, it would not be involved at all in SNAP.
  • If the CoC cannot reach agreement within the three-month deadline, or if at any subsequent point the firm defaults on its newly reduced debt, it would be sent to the IBC for resolution.
  • SNAP would be disbanded by end-December 2020.

Checks and balances under SNAP

  • Such a system would have a series of checks and balances, to prevent firms from securing undeserved debt reductions.
  • Banks would need to certify that defaulters are truly LAEs.
  • IPs would need to certify the size of the debt reduction.
  • A large majority of creditor banks would need to agree to the IP’s proposal.

What should be the role of the government in SNAP?

  • With these checks and balances in place, the government should then commit to two things.
  • First, it should provide some legal cover, ensuring that bankers would not be subject to investigations by the anti-corruption agencies, as long as they followed the LAE rules.
  • Second, the public sector banks would be compensated for the costs of the reduction in the value of the asset, automatically and fully.

Major advantage of SNAP

  • Besides speed, SNAP would have one further major advantage.
  • It would reduce the adversarial nature of the IBC process, arising because promoters are forced to cede their firms.
  • Under the proposed system, promoters would not only have incentives to cooperate; they would actually want to take the initiative, applying for LAE designation themselves, in the hopes that they could get back to business as soon as possible.
  • Such a system might seem difficult to envisage, but it is certainly feasible: It is a design feature under Chapter 11 of the American bankruptcy act.
  • If SNAP succeeds, some of the special procedures could be introduced permanently into the IBC framework, adding a new dimension: Not just liquidation and rehabilitation under new promoters but rehabilitation under existing management.

Way forward

  • After SNAP, repair of the financial system would have to go back to addressing the long-standing problems, which will have been aggravated by the crisis.
  • Firms that were unviable even before the COVID crisis would be sent directly to the IBC, but with the IBC reformed.
  • The government should issue guidelines focusing on the following three-
  • 1. Focusing the COCs on the goal of maximising value, disregarding non-commercial objectives.
  • 2. Directing the NCLT courts to focus on the CoCs’ adherence to the procedure rather than on the merits of their decisions.
  • 3. Increasing competition in the auction by allowing promoters to bid for their assets, as long as they have not been declared wilful defaulters.
  • For the power and real estate sectors, a sui generis approach via the creation of a bad bank is still the best way forward.
  • Real estate resolutions need to take into account the interests of home-owners, something that is almost impossible to do under the IBC.

Consider the question, “Economic revival after the pandemic would require some tweaks in the IBC as it was not designed to handle such situations. Suggest the ways to handle the bankruptcies more effectively and changes that are desired in the IBC.”

Conclusion

Introducing three-pronged strategy quickly would set the stage for the economic recovery of India:  1) Special, expedited, non-adversarial and time-bound bankruptcy procedures (SNAP) for COVID-affected firms 2) A reformed IBC focused squarely on loss-minimisation 3)Bad banks for stressed assets in the power and real estate sectors.


Back2Baciscs: What is Insolvency and Bankruptcy Code-2016?

  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.

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

Insolvency code should be suspended for six months to help companies recover

Note4Students

From UPSC perspective, the following things are important :

Prelims level : IBC, difference between operational and financial creditor, threshold limit to file insolvency case etc.

Mains level : Paper 3- Purpose and issues with IBC, its various provisions and changes that needs to be made in the wake of Covid-19.

This article argues the suspension of IBC for six months. The issues arising out of suspension like damage to the creditors are also dealt with here. Reading of this article will help us understand the finer details of IBC that are relevant from the UPSC point of view. We have also covered one article from livemint dealing with the same issue, but that article covered the issue in a broader sense.

Who are operational and financial creditors?

  • After the lockdown is over, several companies are likely to default on their dues to both operational and financial creditors.
  • Who is a financial creditor? The financial creditors include banks and others who have given financial assistance to a company in the form of loans and debentures.
  • According to a 2018 amendment to the Insolvency and Bankruptcy Code (IBC) 2017, flat purchasers are also deemed as financial creditors.
  • An operational creditor is just about anyone who has to receive money from a company.
  • The IBC provides a fast-track mechanism to deal with companies which are unable to repay their creditors and have become financially unviable.
  • Section 22 of the Code mandates the appointment of a Resolution Professional (RP) who is expected to miraculously turn around the company in 330 days.
  • If this attempt fails, the company goes into liquidation.

The two types of creditors were in the news, so pay attention to these terms.

Increase in threshold limit to file an insolvency petition

  • The IBC’s provisions have been extensively used by various creditors whose dues were not paid.
  • What was the threshold limit? Initially, the threshold limit was just Rs 1 lakh and the IBC became an effective recovery mechanism for all operational creditors.
  • What is the limit now? Just before the lockdown, the finance minister raised the threshold for invoking the insolvency provisions to Rs 1 crore.
  • This limit was raised to prevent proceedings being initiated against small and medium enterprises.

Possibility of the domino effect after the lockdown is over

  • After the lockdown, several enterprises, large, medium and small, might not be able to pay their dues, at least in the short-term.
  • The easiest way for a creditor to recover money is to initiate insolvency proceedings against the debtor company and threaten it with liquidation.
  • The shutdown of business after the lockdown could have a domino effect.
  • How would the domino effect come into play? If an auto-manufacturer has shut down its operations, the ancillary units will not get their dues.
  • This would then lead to non-payment to downstream vendors and service providers as well.
  • It might take at least three to four months for the situation to stabilise.

Steps that should be taken to avoid the domino effect

  • Moratorium on the IBC: The most important, and immediate, step that needs to be taken is to have a six-month moratorium on the IBC.
  • It may be necessary to promulgate an ordinance suspending the prospective operation of Sections 7 and 9 of the IBC so that no fresh petition is filed against a company.
  • Impact on creditors: While this could hurt some of the creditors, the damage that could be done to the corporate sector by invoking the IBC is likely to be far greater.
  • A distressed creditor is not without a remedy as he can always approach the civil courts for relief, which will not be so severe on a defaulting company.
  • If an insolvency petition is filed and the RP appointed, it is difficult to stop the insolvency process.
  • The IBC requires a financially-stressed company to be taken over by a financially-sound
  • For example, Essar Steel was taken over by ArcelorMittal and Bhushan Steel was taken over by Tata Steel.
  • In the current scenario, it will be difficult, if not impossible, for an RP to find a suitable buyer and the only option would be to liquidate the company.
  • Using the insolvency process to recover dues is contrary to the IBC’s objectives.

The objective of the IBC is not just insolvency but the reorganisation of companies, maximisation of value of assets and the need to balance the interests of all stakeholders. Pay attention to this point.

How the suspension of the IBC will be beneficial?

  • Suspending the IBC for a short period would enable several companies to return to normalcy.
  • It will help them function without the constant threat of an insolvency application and its Board of Directors and management being taken over by the RP.
  • Moreover, the National Company Law Tribunal benches will simply be unable to take any additional workload.

Conclusion

Suspending the IBC for six months would be a much-needed step to prevent further damage to the economy. It would be in the larger public interest. Indeed, at this critical stage, permitting the legal remedy of insolvency could be the last nail in the coffin of many companies.


Back2Basics: What is the Insolvency and Bankruptcy Code?

  • IBC provides for a time-bound process to resolve insolvency.
  • When a default in repayment occurs, creditors gain control over debtor’s assets and must take decisions to resolve insolvency.
  • Under IBC debtor and creditor both can start ‘recovery’ proceedings against each other.
  • Insolvency and Bankruptcy Code 2016 was implemented through an act of Parliament.
  • It got Presidential assent in May 2016.
  • The law was necessitated due to huge pile-up of non-performing loans of banks and delay in debt resolution.
  • Insolvency resolution in India took 4.3 years on an average against other countries such as United Kingdom (1 year) and United States of America (1.5 years), which is sought to be reduced besides facilitating the resolution of big-ticket loan accounts.

By Root

Caretaker @civilsdaily

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.

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

The real reform

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Not much.

Mains level : Paper 3-How IBC has fared so far?

Context

The IBC has started emerging stronger as it delivered on its promise, passed the constitutional muster, earned global recognition and became the preferred option for stakeholders in case of default.

Demystifying the myths surrounding IBC

Myths about recovery:

Most of the myths surround recovery. Consider the following example for quick appreciation.

  • M/s. Synergies Dooray was the first company to be resolved under the IBC. It was with the Board of Industrial and Financial Reconstruction (BIFR) for over a decade.
  • The realisable value of its assets was Rs 9 crore when it entered the IBC process. It, however, owed Rs 900 crore to the creditors.
  • How much did IBC recover? The resolution plan yielded Rs 54 crore for them.
  • Some condemned IBC because the resolution plan yielded a meagre 6 per cent of the claims of the creditors, disregarding the fact that they recovered 600 per cent of the realisable value of the company, which had been in the sick bed for over a decade.
  • If the company was liquidated, assuming no transaction costs, the creditors would have got at best Rs 9 crore — 1 per cent of their claims.

The myth that recovery under IBC is dismal

  • Let’s examine the myth that the recovery through resolution plans is dismal.
    • Two hundred companies had been rescued till December 2019 through resolution plans.
    • They owed Rs 4 lakh crore to creditors. However, the realisable value of the assets available with them, when they entered the IBC process, was only Rs 0.8 lakh crore.
    • The IBC maximises the value of the existing assets, not of the assets which do not exist. Under the IBC, the creditors recovered Rs 1.6 lakh crore, about 200 per cent of the realisable value of these companies.
    • Why creditors had to take a haircut? Despite the recovery of 200 per cent of the realisable value, the financial creditors had to take a haircut of 57 per cent as compared to their claims. This only reflects the extent of value erosion that had taken place when the companies entered the IBC process.
    • What is the conclusion? As compared to other options, banks are recovering much better through IBC, as per RBI data.

The myth that IBC is sending companies for liquidation:

    • What is the primary objective of IBC: Recovery is incidental under the IBC. Its primary objective is rescuing companies in distress.
    • More number of companies sent for liquidation: There is a myth that although the IBC process has rescued 200 companies, it has sent 800 companies for liquidation. The number of companies getting into liquidation is thus four times that of the companies being rescued.
    • The context for the numbers: Numbers, however, to be seen in context. The companies rescued had assets valued at Rs 0.8 lakh crore, while the companies referred for liquidation had assets valued at Rs 0.2 lakh crore when they entered the IBC process.
    • Looking from the value term angle: In value terms, assets that have been rescued are four times those sent for liquidation. It is important to note that of the companies rescued, one-third were either defunct or under BIFR, and of the companies sent for liquidation, three-fourths were either defunct or under BIFR.

The myth that IBC is resulting in huge job losses

  • The next myth is that the IBC is resulting in huge job losses through liquidation. It is misconstrued that 600 companies — for which data are available and which have proceeded for liquidation — have assets (and consequently employment) at least equal to the aggregate claim of the creditors — Rs 4.6 lakh crore.
  • Unfortunately, they have assets on the ground valued only at Rs 0.2 lakh crore.
    • Take the examples of Minerals Limited and Orchid Healthcare Private Limited, which have been completely liquidated. They owed Rs 8,163 crore, while they had absolutely no assets and employment.
    • What matters in this context is the assets a company has or the employment it provides — not how much it owes to creditors.
  • The IBC process would release the idle or under-utilised assets valued at Rs 0.2 lakh crore, which would have dissipated with time, for business and employment.
  • One also needs to consider the jobs saved through the rescue of 80 per cent of the distressed assets, and the job being created by these companies, post-rescue.

What changes IBC has brought?

  • Changed the behaviour of debtors: A distressed asset has a life cycle. Its value declines with time if the distress is not addressed.
    • The credible threat of the IBC process, that a company may change hands, has changed the behaviour of debtors.
  • Debtors are settling debt at an early stage: Thousands of debtors are settling defaults at the early stages of the life cycle of a distressed asset.
    • They are settling when the default is imminent, on receipt of a notice for repayment but before filing an application, after filing the application but before its admission, and even after admission of the application.
    • These stages are akin to preventive care, primary care, secondary care, and tertiary care with respect to sickness. Only a few companies, who fail to address the distress in any of these stages, reach the liquidation stage.
  • Value erosion at the liquidation stage: The value of the company is substantially eroded, and hence some of them would be rescued, while others are liquidated.
    • The recovery may be low at this stage, but in the early stages of distress, it is much higher — primarily because of the IBC.
    • The percentage of companies or distressed assets getting into liquidation is insignificant.
    • Stakeholders should increasingly address the distress in the early stages and the best use of the IBC would be not using it all.

Conclusion

Stakeholders who understand business and have the backing of sophisticated professionals are using IBC with open eyes after evaluating all options. There is no reason to doubt their commercial wisdom. The 25,000 applications filed so far under IBC indicate the value and trust that stakeholders place on the law — the ultimate test of its efficacy.

 

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

Right to carry on business

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Right to carry on business

Mains level : Issues over IBC

The Supreme Court has increased the time limit for the corporate resolution to extend beyond the mandated 330 days. The judgment is significant for India’s fledgling corporate resolution process under the Insolvency and Bankruptcy Code.

Time limits

  • As of now, the time limit for resolution process is mandatorily 330 days in all cases.
  • If debts are not resolved and the bankrupt firm cannot be brought back to its feet within this time-frame, the only option left is liquidation of its assets to pay creditors.
  • The court said that the provision saying the 330-day mark should be followed in the ‘ordinary course’.
  • Extension of time should be granted by the NCLT if parties are able to prove there is very little time left in the resolution process and the delay has been caused by ‘tardy’ legal proceedings.

Why extension?

  • A Bench led by Justice Nariman in a judgment, observed that many litigants suffer the prospect of liquidation for no fault of theirs.
  • Delay in legal proceedings leads to the resolution process being dragged beyond the 330-day mark.

How is Article 19 involved?

  • Justice Nariman said it would be arbitrary to let litigants suffer liquidation unnecessarily.
  • The court held the mandatory nature of the 330-day mark as a violation of Article 14 (right to equal treatment) of the Constitution and an excessive and unreasonable restriction on the litigant’s right to carry on business under Article 19(1)(g) of the Constitution.

Back2Basics

Article 19

According to Article 19, all citizens shall have the right—

  • to freedom of speech and expression;
  • to assemble peaceably and without arms;
  • to form associations or unions or co-operatives;
  • to move freely throughout the territory of India;
  • to reside and settle in any part of the territory of India; and
  • the right to acquire, hold and dispose of property (deleted after 44th CAA, 1978)
  • to practise any profession, or to carry on any occupation, trade or business.

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

[op-ed snap] The efficiency promise of the bankruptcy code

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Nothing much

Mains level : IBC - analysis

Context

It has been 3 years since the Insolvency and Bankruptcy Code (IBC) is passed, and it remains a work in progress. 

Background to IBC

  • It had envisaged a mechanism by which creditors could wholly or partially recover their dues from a company unable to pay back.
  • The insolvent business taken over is to be revived or sold off so that its assets could swiftly get back to generating value under new ownership
  • In theory, it’s about capital moving to the best hands. 

Updates – Online Bidding

  • Recent reports suggest the government may bring in a short, time-bound online bidding process to resolve corporate bankruptcy cases. 
  • This is likely to improve transparency and reduce litigation over business failures.
  • This would be an efficient way to deal, which is crucial for an economy to optimize its allocation of resources

Amendments

  • Last year, it was amended to protect homebuyers, placing them at par with financial creditors. 
  • 8 changes were made to ease the resolution process, the most important one being an extension of the maximum time that can be taken to a more realistic 330 days.

Outcomes – Drawbacks

  • At the heart of the IBC legislation was its time-bound approach to resolving insolvency cases. But the initial 270-day deadline proved inadequate
  • Several lenders unsure of their stance; some promoters trying every legal device to retain their firms, and the very process frequently getting caught in a judicial quagmire
  • Some high-profile cases have been plodding along for years now.
  • Bankruptcy courts have been stormed with realty cases because even a lone homebuyer can file one.
  • So far, creditors of a company undergoing insolvency proceedings have been at liberty to negotiate with bidders on a case-to-case basis. This leads to a drama of bids and counter-bids and bank officials are chased leading to litigation. 

What lies ahead – with new proposals

  • In case the assets or shares of a bust company are being auctioned, a clear time window would be specified for eligible bidders to place financial bids. 
  • Moving to bid online should speed up resolutions. 

What needs to be done

  • The tribunals that deal with IBC cases could do with stricter guidelines to distinguish between financial and operational creditors
  • Secured lenders need to be marked apart from unsecured lenders with greater clarity. 
  • Resolution orders should not end up casting the basis on which banks lend money in doubt.

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

Green Channel Combination

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Green Channel concept

Mains level : Mergers and Acquisition

  • Putting in place a speedier approval mechanism, Competition Commission has introduced a green channel route for clearing certain categories of mergers and acquisitions.

The Green Channel Concept

  • Mergers and Acquisitions (M&As) or combinations beyond a certain threshold are required to have mandatory approval from the fair trade regulator.
  • The green channel is aimed to sustain and promote a speedy, transparent and accountable review of combination cases, strike a balance between facilitation and enforcement functions, create a culture of compliance and support economic growth.
  • This concept recommended by the high level panel that reviewed competition law — would allow for an automatic system for speedy approval of combinations subject to certain conditions.
  • Under this process, the combination is deemed to have been approved upon filing the notice in the prescribed format.
  • Parties to a combination can avail the green channel route subject to various conditions, including that there is no horizontal overlap or vertical relationship.

Benefits of the move

  • The amended regulation provide for a single summary of the proposed combination.
  • Earlier, entities had to provide both a short as well as a long summary.
  • This system would significantly reduce time and cost of transactions.

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

[op-ed snap] Diluting the code

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Nothing Much

Mains level : impact of NCLAT's latest Judgement

CONTEXT

Last week, the National Company Law Appellate Tribunal (NCLAT) approved the resolution plan filed by ArcelorMittal for Essar Steel. But the two-member bench of the appellate tribunal modified the manner in which the proceeds from the sale would be distributed. Earlier, the resolution plan had proposed to pay financial creditors 92.5 per cent of their dues. But as per the order, both financial and operational creditors will recover 60.7 per cent each of their admitted claims.

Consequences of judgement

  • The judgement, which, in effect, places operational creditors at par with secured financial creditors at the time of settling claims, is likely to have far reaching consequences.
  • Under the Insolvency and Bankruptcy Code (IBC), Section 53 deals with the distribution of proceeds from the liquidation of assets.
  • It lists the hierarchy in which various claims against the firm would be settled. Under this waterfall mechanism, after the costs associated with the insolvency resolution process and liquidation are settled, dues owed to secured creditors and workmen have to be settled first.
  • This is followed by discharging dues of employees, unsecured creditors and governments, in this particular order.
  • After these claims have been settled, the balance is to be distributed among preference and equity shareholders, in that order.
  • Thus the structure draws a clear distinction between the claims of secured creditors and operational creditors in the liquidation process, with the former having the first right.

The distinction drawn by case

  • However, the judgement draws a distinction between claim settlement in the resolution and liquidation process.
  • It notes that as the case is not about “distribution of assets from the proceeds of sale of liquidation… the resolution applicant cannot take advantage of Section 53 for the purpose of determination of the manner in which distribution of the proposed upfront amount is to be made in favour of one or other stakeholders”

Conclusion

  • The consequences of this order stretch beyond this particular case.
  • To argue that claims of financial creditors can be treated at par with operational creditors would muddy the waters as it loses sight of the basic distinction between secured and unsecured creditors.
  • In fact, in its judgement on the constitutionality of the IBC earlier this year, the Supreme Court had justified the difference between financial and operational creditors, making a critical distinction between financial debts which are secured and operational debts which are unsecured.

 

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

RBI circular to banks on loan defaulters quashed

Note4Students

From UPSC perspective, the following things are important :

Prelims level : IBC

Mains level : Effectiveness of regulatory mechanism for stressed assets resolution

  • The Hon’ble Supreme Court has struck down a Feb-2018 RBI circular giving lender banks six months to resolve their stressed assets or move under the Insolvency Code against private entities who have defaulted in loans worth over Rs. 2000 crore.

About the RBI circular

  • Through a notification issued on Feb 12, 2018 the RBI laid down a revised framework for the resolution of stressed assets, which replaced all its earlier instructions on the subject.
  • Banks were required to immediately start working on a resolution plan for accounts over Rs 2,000 crore, which was to be finalised within 180 days.
  • In case of non-implementation, lenders were required to file an insolvency application.
  • RBI termed it necessary to substitute the existing guidelines with a harmonized and simplified generic framework for resolution of stressed assets.

What did the revised framework replace?

  • The circular went into effect on the same day that it was issued, and all existing schemes for stressed asset resolution were withdrawn with immediate effect.
  • The circular was ostensibly intended to stop the “evergreening” of bad loans the practice of banks providing fresh loans to enable timely repayment by borrowers on existing loans.
  • The RBI warned banks that not adhering to the timelines laid down in the circular, or attempting to evergreen stressed accounts, would attract stringent supervisory and enforcement actions.

Issues with the circular

  • The companies argued that the circular was arbitrary and discriminatory, and therefore, violative of Article 14 of the Constitution.
  • Several companies from the power and shipping sectors had challenged the circular, arguing that the time given by the RBI was not enough to tackle bad debt.
  • The government had earlier asked the RBI to make sector-specific relaxations in the timeline for the implementation of the circular.
  • Power producers, for instance, had argued that the RBI’s ‘one-size-fits-all’ approach was impractical since the sector had to confront external factors that were beyond its control.
  • These factors included the unavailability of coal and gas, and problems arising out of the failure of state governments to honour power purchase agreements.

Impact of SC’s relaxation

  • The order provides immediate relief to companies that have defaulted in repayments, especially those in the power, shipping and sugar sectors.
  • However, many financial sector experts argued that the verdict could delay the process of stressed assets resolution, which had of late picked up pace.
  • Since banks will have the choice of devising resolution plans or going to the National Company Law Tribunal under the IBC, the urgency that the RBI’s rules had introduced in the system could be impacted.

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

[op-ed snap] Deals to rules

Note4students

Mains Paper 3: Economy | Growth

From UPSC perspective, the following things are important:

Prelims level: Not much

Mains level: Positive handling of bad loans through IBC and other initiative.


NEWS

CONTEXT

India’s bad loan policy is finally moving in the right direction.

Reasons for high default

  • Not creating the fear of immediate, automatic and borrower-blind consequences for default is one reason why India’s credit to GDP ratio is a low 50 per cent (Arunachal is 1 per cent, Bihar is 17 per cent, 100 per cent is the average for rich countries).

Reforms in the right direction

  • But over the last three years, the new Insolvency and Bankruptcy Code (IBC) and the RBI’s Revised Framework for Resolution of Stressed Assets (RFRSA, issued on February 12 last year) have begun to show impressive results in recognition (we know the truth), deterrence (defaults are reducing), resolution (defaults are being cured) and speed (defaults are being cured faster).
  • This is great news for financial inclusion of the small, honest, and non-politically connected.

No difference with willful defaulter Tag

  • The “willful defaulter” tag is a distinction without a difference; banks face pain irrespective of whether a default is caused by Fraud , Competition , or Unsustainable Ambition.
  • Current court petitions by defaulting sugar, shipping and power companies against the IBC and RFRSA should be dismissed because they want pre-IBC bank behaviour (discretionary bad loan recognition via restructuring or evergreening) that created our pre-IBC regime (Eagle’s Hotel California, where you check in but never check out).

The effectiveness of new reforms

  • India’s new policy regime for defaults — IBC plus RFRSA — ensures a time-bound exploration of all business, capital and ownership restructuring options before liquidation.
  • It is working; bad loans went from 2.4 per cent in 2007 to 11.6 per cent in 2018 but may now be down to 10.2 per cent.
  • And the direct impact of RFRSA lies in annualised reduction in bad loans for recent quarters being the highest in recent years with a huge acceleration in two-way mobility between standard and non-standard loan classifications.
  • Of the 82 accounts resolved by the IBC, the average realisation by financial creditors was 48 per cent and average time taken for resolution was 310 days (versus World Bank estimates of 27 per cent and 1,580 days).
  • RFRSA fixed birth defects of past RBI interventions like SDR, S4A, JLF, CAP, etc by requiring weekly reporting by banks on all accounts in default anytime during the week with exposure greater than Rs 50 million, requiring all lenders to initiate steps to cure a default with any lender, requiring an independent credit opinion for resolution plans, and setting a 180-day implementation deadline for resolution plans in loans greater than Rs 2,000 crore.

Challenges

  • Litigation has choked the pipeline with resolution for only three of the RBI’s first IBC list of 12, only 63 of the total 1,484 cases admitted under the IBC have the highly desirable outcome of being withdrawn under Section 12A (withdrawal from insolvency prior to expression of interest stage with consent of 90 per cent of lenders).
  • recovery rates are still lower than global averages, and 31 per cent of the 898 ongoing insolvency cases at the end of 2018 have breached the 270-day deadline.

Learning from the mistakes of  China

  • China can teach us a lot about labour markets but not about banking.
  • Their share of bank lending to the private sector has shrunk by 80 per cent since 2013, total bad loans may exceed $3 trillion, and total debt now exceeds 300 per cent of GDP (most loans went to construction because China produced three times as much cement between 2012 and 2016 as the US did in the entire 20th century).
  • While China’s treatment of defaulters is tempting — they recently expanded restrictions on travel, buying homes, holding high-level jobs, kids school eligibility, etc for defaulters — these practices are inconsistent with a democracy.

Way Forward

  • Over the last three years, India’s bad loan policy moving from deals to rules means the long arc of economic history is finally bending towards justice.
  • This remarkable reform will not only recover Rs 3 lakh crore plus for banks but has hugely positive consequences for India’s productivity, wages and prosperity.

 

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

[op-ed snap]Resolution, at last: on Essar Steel case

 

Note4students

Mains Paper 2: Governance | Government policies and interventions for development in various sectors and issues arising out of their design and implementation.

From UPSC perspective, the following things are important:

Prelims level: Read the attached stories

Mains level: The issues discussed in the newscard regarding the IBC’s various aspects through Essar ruling.


NEWS

CONTEXT

Essar Steel case has clarified many aspects of the Insolvency and Bankruptcy Code process.

Significance of Case

  • The National Company Law Tribunal’s approval of ArcelorMittal’s bid for the insolvent Essar Steel Ltd. is significant for several reasons.
  • First, the ₹42,000-crore bid will be the largest single recovery of debt under the fledgling Insolvency and Bankruptcy Code (IBC) enacted in 2016.
  •  Second, the case, which took 583 days to resolve, compared to the 270 days provided under the Code, has tested several aspects of the law and set important precedents for the future.
  •  Among the aspects that have been clarified are the eligibility of those who have defaulted in repaying their borrowings elsewhere to bid, the time-limits for bidding and the place of unsecured, operational creditors under the resolution mechanism.
  •  In the event, the successful culmination of the Essar Steel case will be a big leg-up for the insolvency resolution process that is less than three years old.

Challenges 

  • The Code provides for an appeal to the National Company Law Appellate Tribunal and then to the Supreme Court, and it is unlikely that the promoters, who bid a much higher ₹54,389 crore, will let go without a fight.
  • The banks, though, will be hoping that the process ends in the next couple of weeks as they would want to account for the receipts from the resolution process within this financial year.
  • After all, only four cases (excluding Essar Steel) out of the initial list of 12 big defaulters referred by the Reserve Bank of India for resolution back in June 2017 have been successfully resolved till now.
  • Insolvency and Bankruptcy Board of India data also point to a pile-up of cases in the various benches of the NCLT.
  • As many as 275 companies, representing 30% of the total of 898 undergoing resolution, have exceeded the 270-day limit set for resolution under the Code.

Way Forward

  • The fact is that there is a need for more benches of the NCLT to clear the pile-up. The government would do well to look into this issue.

By Root

Caretaker @civilsdaily

Insolvency and Bankruptcy Code

Government submits resolution plan for IL&FS

Note4students

Mains Paper 3: Economy | Mobilization of resources

From UPSC perspective, the following things are important:

Prelims level: IL&FS crisis

Mains level: Too big to fail institutions and their risk of failing


News

  • The government has submitted the debt resolution plan for crisis-hit IL&FS to the NCLAT and also suggested the name of retired Supreme Court judge Justice D K Jain to supervise the entire process.

What is IL&FS Crisis?

  1. The IL&FS Ltd is an infrastructure finance company registered with the Reserve Bank of India as a ‘Systemically Important Non-Deposit Accepting Core Investment Company’, with over Rs.1,15,000 crore of assets and Rs. 91,000 crore of debt.
  2. IL&FS defaulted on a few payments and failed to service its commercial papers (CP) on the due date—which means the company has run out of cash or it is facing a liquidity crunch.
  3. The company piled up too much debt to be paid back in the short-term while revenues from its assets is skewed towards the longer term.

The Resolution Plan

  1. The entire resolution process would be based on the principles enunciated in the Insolvency and Bankruptcy Code.
  2. Under the plan, the government has categorised IL&FS group companies into green, amber and red based on their respective financial positions.
  3. The corporate affairs ministry has fixed September 30, 2018 as the cut-off date for entertaining the claims submitted by the lenders.
  4. During the conduct of the resolution process, payments will be permitted only to maintain and preserve the going concern status of the companies of the IL&FS group.

Declaring a bidder

  1. Upon receipt of the recommendations, a successful bidder would be declared, who will deposit the earnest money.
  2. Upon declaration of the bidder, documentation of the sale will be completed and the forwarded to National Company Law Tribunal for the final approval.
  3. According to the affidavit filed before the NCLAT, the classification of the IL&FS group companies is “based on a 12-month cash flow based solvency test”.

3 Categories

  1. Companies falling in the green categories are the entities, which will continue to meet their payment obligation.
  2. While companies falling in the amber category are those who are not able to meet their obligations but can meet only operational payment obligations to senior secured financial creditors.
  3. Amber category entities “are permitted to make only payments necessary to maintain and preserve the going concern”.
  4. Companies falling in the red category are the entities which can not meet their payment obligations towards even senior secured financial creditors.
  5. These companies would be permitted to make payment necessary to maintain and preserve the going concern status.

Asset Monetization Plan

  1. The distribution of the sale proceeds would be in accordance with the waterfall mechanism specified under section 53 of the IBC.
  2. Under Section 53 of IBC, senior secured creditors loans are cleared first and any surplus that remains thereafter is given to unsecured or subordinated creditors and thereafter to the equity owners.

For detailed reading on IL&FS crisis , navigate to the page:

[Burning Issue] IL&FS Crisis

By Root

Caretaker @civilsdaily

How is ease of doing business linked with the Insolvency and Bankruptcy Code?

In India, lack of resolution of insolvency is one of the significant factors for the failure of credit market in the country. The present legislations governing insolvency are fragmented, multi-layered and the adjudication of insolvency matters take place in multiple forum, resulting in an unpredictable regime.

The Insolvency and Bankruptcy Code has been hailed as an excellent reform for India that will pay a critical role in improving the ease of doing business.

Why does India need a Bankruptcy law?

Currently it takes, on an average, more than 4 years to resolve insolvency in India. The proposed Bankruptcy Code will replace over a century-old archaic insolvency act – The Presidency Towns Insolvency Act, 1909.

  • Delays in making decisions on the viability of business.
  • Sometimes, company promoters try to delay reorganisation or attempts to sell-off assets or change of management.
  • Delays in disposing off cases by Debt Recovery Tribunal.
  • Continued litigation at various levels and delays in appellate level.
  • Currently, there are 4 different agencies viz. the HC, the Company Law Board, the BIFR and the DRTs that handle insolvency-related cases.

How can a modern law help?

  • Speedy closure will help firms on the verge of brink in two ways, i.e. either restructure the firm or sell-off the assets to recover the money.
  • It will promote efficient allocation and greater availability of credits for businesses, as it frees up capital.
  • Development of financial markets such as bond market, due to clarity on repayment for debtors.

What is the international experience in this regard?

  • US Bankruptcy Code provides for fairly quick liquidation or reorganisation of the company.
  • In UK, once the cases are filed, then after 12 months, either the part of assets are discharged to pay-off debt or court-appointed administrators handle the case, if company can be turned around.

Was any committee formed to suggest Insolvency reforms?

  • The Bankruptcy Law Reform Committee (BLRC) was set up in August, 2014 under the chairmanship of Mr. T.K. Vishwanathan.
  • It was the first committee with the mandate of suggesting comprehensive and not incremental reforms.
  • The BLRC extensively studied the insolvency regime within India as well as various international jurisdictions.

What was the recommendation of the Committee?

  • The committee proposed an all-encompassing law for corporate and individual insolvency, reflecting the best practices from across the globe.
  • The corporates should assess the viability of an enterprise in the early stages of insolvency, such that the creditor and the debtors can negotiate a financial arrangement while preserving the economic value of the enterprise.
  • However, if the negotiations fail, then the enterprise is liquidated. The insolvency resolution is required to be done within a period of 180 days.
  • It also suggested fast track insolvency resolution for certain entities which is required to be completed within 90 days.

What are the provisions of draft Insolvency and Bankruptcy Code?

The code aims to bring modern framework to deal with bankruptcy and insolvency of variety of economic players, including individuals, but excluding financial firms.

  • It will restore some power to creditors, both financial and operational.
  • It will fast-track mechanism of insolvency resolution process may be applicable to certain categories of entities.
  • The corporate insolvency would have to be resolved within a period 180 days, extendable by 90 days.
  • It also provides for fast-track resolution of corporate insolvency within 90 days.
  • Debt Recovery Tribunals will be adjudicating authority over both individual & unlimited liability partnership firms.
  • National Company Law Tribunal will be adjudicating authority with jurisdiction over companies with limited liability.
  • It has a clause to provide for insolvency professionals who will specialize in helping sick companies. <These professionals will help revive control the management of distressed firm to revive it>
  • It also provides for information utilities that will collate all information about debtors to prevent serial defaulters from misusing the system
  • To setup Insolvency and Bankruptcy Board of India to act as a regulator for these utilities and professionals.
  • The bill also seeks to establish Insolvency and Bankruptcy Fund of India.

What about Financial Sector Insolvencies?

  • FSLRC recommended creation of a resolution corporation to monitor financial firms and intervene before they go bust.
  • The aim is to close-down the firms which can’t be revived or change their management to protect investors or depositors.

The reform is dubbed as 2nd most important reform after GST, as it will also improve the ease of doing business in India.


 

Published with inputs from Pushpendra

By Root

Caretaker @civilsdaily

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