How bankruptcy code could benefit both industry & financial services

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Updated: May 10, 2016 7:09 AM

Once implemented, the Insolvency and Bankruptcy Code will make it easier to exit or attempt revival of a business, thereby improving the NPA scenario for the financial services sector

In his Union Budget speech of 2014-15, the finance minister had announced the development of an effective bankruptcy code for easy exit. Following this announcement, the Viswanathan Committee was set up on August 22, 2014, to study the corporate bankruptcy legal framework in India. Commendably, within a short span of time, a comprehensive Insolvency and Bankruptcy Code, 2015, was introduced in Parliament, after public consultation; it consolidates individual insolvency, insolvency of LLPs (limited liability partnerships), unlimited liability partnerships and corporate insolvency.

The code was referred to a joint Parliamentary committee of both the Houses for scrutiny. The report was presented to the Lok Sabha on April 28, 2016, and laid down in the Rajya Sabha the same day. The committee has taken care of certain unaddressed issues in the code that was introduced in Parliament. These include provision for cross-border insolvency, participation of operational creditor in insolvency proceedings, inclusion of public financial institution under the definition of financial institution, rationalisation of time-lines with respect to various steps in the insolvency resolution process, rectification of drafting errors, removal of a clause relating to registration bond and performance security by an insolvency professional.

Based on the recommendations of the joint committee, the Lok Sabha passed the code on May 5, 2016. This will make it easier for financial institutions and banks to deal with non-performing assets (NPAs) arising out of failed corporate ventures; it also helps firms in easier revival process or painless liquidation. If approved by the Rajya Sabha, the law will ensure time-bound settlement of insolvency, enable faster turnaround of businesses and create a database of serial defaulters—all critical in resolving India’s bad debt problem which has crippled bank lending.

Repeal and reform

The code proposes to repeal the Presidency Towns Insolvency Act, 1909, and Provincial Insolvency Act, 1920, as well as amend 11 legislations, including the Companies Act, 2013; Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; Limited Liability Partnership Act, 2008, etc. Policy-related aspects are being addressed in the code and procedural aspects will be dealt under delegated legislations for flexibility.
The code has taken the positive attributes of the bankruptcy system in the US and the UK, such as providing for a moratorium period during the resolution process, time-bound insolvency process, etc. However, it is yet to address aspects such as lifting of moratorium in case of fraud, option for management of affairs by corporate debtor under supervision, etc. Furthermore, chapter 11 of the US Bankruptcy Code provides for debtor in possession concept, i.e. the debtor continues to manage the affairs of the company during the insolvency resolution process. The code proposes the management of affairs by an insolvency resolution professional similar to the UK bankruptcy laws.
In its report in 1999, the Justice Eradi Committee had identified 473 winding-up cases that were pending for more than 25 years. The analysis of companies under liquidation as on October 31, 2015, furnished by the Department of Financial Services indicates that there were 1,479 pending winding-up cases for more than 20 years, indicating relative triple-time increase in data of winding-up cases still pending. The causes may be due to delays in deciding on the viability of businesses, tactics employed by company promoters to delay reorganisation or attempts to sell off assets, changes of management or litigation that goes on endlessly—consequently, the drag on new business units, jobs, income generation and economic growth can be significant.

Currently, four different forums—High Courts, Company Law Board (CLB), Board for Industrial and Financial Reconstruction (BIFR) and Debt Recovery Tribunal (DRT)—have overlapping jurisdiction, which gives rise to systemic delays and complexities in the process. The code overcomes these challenges and would reduce the burden on the courts as all litigation will be filed under the code before the National Company Law Tribunal (NCLT) for corporate insolvency and insolvency of LLPs, and before DRT for individual insolvency and insolvency of unlimited partnership firms.

Curbing delays and NPAs

As the code attempts to create a formal insolvency resolution process (IRP) for businesses, either by coming up with a viable survival mechanism or by ensuring speedy liquidation, it will attempt to curb the number of long-pending cases substantially. The code envisages a new regulator—the Insolvency and Bankruptcy Board of India—while introducing professionals who will handle insolvency cases and insolvency professional agencies to oversee the overall supervision of the Insolvency Board. The code also proposes information utilities that would collect, collate, authenticate and disseminate financial information from listed companies and financial and operational creditors of companies. This will help make the IRP smoother by maintaining a range of financial information about companies.
The IRP could be initiated by a corporate debtor who has defaulted on dues or by creditors, whether financial or operational. When the IRP is on, creditors’ claims will be frozen for 180 days, during which time they will hear proposals for revival and decide on the future course of action. Within those 180 days, 75% of financial creditors must agree to a revival plan. If this minimum threshold is not met, the firm automatically goes into liquidation. If three-fourths of the financial creditors consider the case complex and feel it cannot be addressed within 180 days, the adjudicator could grant a one-time extension of up to 90 days on the process.

The code could ensure quicker resolution of NPA problems, especially in PSU banks. In fact, the Financial Stability Report issued by RBI in 2015 indicates that corporate sector vulnerabilities and the impact of their weak balance sheets on the financial system needs closer monitoring. The time-bound insolvency resolution process would definitely help the financial services industry function better.

Bankruptcy laws accept that business ventures can fail and allow entrepreneurs to make a new start. While facilitating failed firms to wind up painlessly, the code can pave the way to resurrection also.

The author is president, Institute of Company Secretaries of India (ICSI)

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