A pragmatic legislation
The Insolvency and Bankruptcy Code 2016 is a major overhaul of the existing framework dealing with insolvency of corporates, individuals, partnerships and other entities. Two experts discuss the provisions
The central government has enacted the Insolvency and Bankruptcy Code (IBC) 2016 to override other existing laws on matters pertaining to insolvency and bankruptcy. The code in fact aims at a ‘creditor in control’ regime with financial creditors exercising control. This is done through what is described as Insolvency Professionals in the event of a single default in repayment of any loan or interest. This will mean defaulting entities need to implement an accurate cash flow forecasting mechanism to identify mismatches of inflows with commitments on a timely basis.
“IBC enables the banks to place a corporate debtor into a resolution process that is time bound,” says Ashish Chhawchharia, partner - Restructuring Services, Grant Thornton Advisory. “If a resolution is not achieved within a maximum of 270 days, the corporate debtor enters liquidation. IBC enables the banks to pursue a resolution without the need for the consent of the promoter. It therefore provides a mechanism for the banks to proactively seek a solution to its NPAs,” he adds.
Prem Rajani, managing partner, Rajani Associates, holds similar views. Says he: “IBC offers a uniform and a comprehensive insolvency legislation, which is applicable to all companies, partnerships and individuals. One of the fundamental features of the code is that it allows creditors to assess the viability of a debtor as a business decision and agree upon a plan for its revival or a speedy liquidation. This will benefit not just the creditor and debtor companies, but also the overall economy because capital and productive resources will get reorganized relatively quickly.”
Rajani points out to a landmark judgment of the Supreme Court with regard to IBC in the matter of Innoventive Industries versus ICICI Bank and says the apex court has held that the courts and tribunals across the country should take notice of the exemplary shift in the law ushered under IBC.
“The judgment (of the Supreme Court) also clearly recognizes the object of the code as it provides a time bound regime on insolvency and bankruptcy which can ease to some extent the process of exit of companies in distress and also in preserving value of assets stuck in such distress situations. The overlapping legislations which would be inconsistent to the provisions of the code present a challenge and to that extent the ruling in Innoventive Industries is welcomed thereby clarifying the overriding nature of the code in case of inconsistency. Reading the non-obstante clause contained in Section 238 of the code in the widest terms possible and giving impetus to the strict timelines and objects of the code will bring certainty and make it difficult for defaulting debtors to take shelter under several prior or state legislations, in order to delay the insolvency process. This would clearly provide an impetus for resolution of plethora of distressed accounts in the Indian banking system through the regime introduced under the code,” he explains.
Rajani maintains that the earlier regime recovery proceedings by creditors, either through the agreements or through special laws such as the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 or the SARFAESI Act, 2002 - has not had the desired outcomes, leading to a fall of India’s ranking in ease of doing business. The winding up provisions of the Companies Act, 1956 have also not been able to provide an effective recovery of outstanding debts and neither restructuring of debts. “In this context, the code was introduced to plug the gaps. It also amends 11 important legislations. India now has a bankruptcy and insolvency framework which is comparable with international standards and this will go a long way in bringing an element of certainty and predictability to commercial transactions in the country and facilitating the ease of doing business,” says he.
Chhawchharia points out that the earlier regime did not provide the creditors (the banks) with sufficient leverage, nor was it time bound. “IBC is what is known as a ‘creditor in possession’ law, providing the banks with considerable say in the process. The maximum 270 days provides a suitable incentive to all stakeholders to be proactive,” he says.
HELPFUL TO BANKS
Chhawchharia is of the view that bank lending depends on many factors, including the balance sheet of the individual bank concerned, the lending prospects available to it and not the least the general economy. “One view is that a bank can get rid of many
of its NPA problems and it should be able to focus more on lending. Another view is that in the light of the directive of the RBI, it might make certain banks more risk averse when it comes to new lending.,” he adds.
Rajani is confident that banks can take advantage of the code to improve performance on a sustained basis to remain competitive. Instead of waiting for regulatory directions, banks can file insolvency proceedings on their own to realize promptly the best value for company’s assets. “I strongly feel that banks should strengthen their internal due diligence, credit mechanism and monitoring of loans to minimize the risks of such events, which eventually result in NPAs. This will in turn also help in growth of the economy. The code was a system put in place when the government and RBI flagged the bad loan crisis of the country. It will allow fast resolution of bad loans. The code debars wilful defaulters and existing promoters from bidding for stressed assets of companies undergoing insolvency proceedings,” says he.
Rajani mentions that recently, the National Company Law Tribunal (NCLT), Hyderabad, in the matter of SynergiesDooray Automotive approved a resolution plan under the code. The plan involved financial restructuring of the dues of financial and operational creditors, payment of dues to the government, and also infusion of capital (including equity) from the promoters. It also envisaged funding against receivables from other corporate debtors and through operations. The payments to the creditors and the government will be staggered over the next few years too. “This goes to show that the code does look into the aspect of taking out the corporates from the debt trap and also create further capital for the company. There have been other cases too, wherein resolution plans have been approved and in few cases liquidation order has also been passed’” says he.
He, however, feels that one of the key aspects of time-bound resolution is the infrastructure of the NCLT. Separate benches are needed for the IBC matters and also to increase the number of members. The government is planning to increase the strength of members and the various NCLTs which will streamline the process, says he.
Chhawchharia says many of the corporate debtors coming to IBC are very materially over-leveraged, so much so that the value of the enterprise is materially less than the total quantum of the debt. “In such circumstances the equity of the corporate debtor is arguably of negligible or nil value. It is therefore likely to be impossible for such debtors to attract new capital in the absence of a financial restructuring. One could also refer to their current debtservicing obligations as a noose around their necks. It is anticipated that one result of IBC resolutions will be corporate debtors with significantly lower debt obligations going forward, ie they will have to come out of the debt trap. This does not guarantee that there will be no problems in the future. However, with significantly lower debt, the corporate will at least have a much improved chance of making a full recovery,” he explains.
What about the provision in the law for even suppliers to proceed against entities in cases of default?
“If a supplier of goods or services to a corporate is not paid for such goods or services, then it should have recourse; it should be able to pursue payment through legal means,” avers Chhawchharia. “If having clearly established that a debt is due if it remains unpaid then it is not unreasonable to assume that the debtor has financial problems and may benefit from the IBC process. On one view, the bank is also a provider of services - the lending of money - so why should other suppliers not also be allowed to avail themselves of the IBC? Indeed, while many banks benefit from security for their loans and could take enforcement action, most other suppliers of goods or services are unsecured with no such option,” he counters.
Rajani explains the process under section 9 of the code where suppliers can initiate corporate insolvency resolution process in case a default is committed by corporate debtor: “An application can be made before the NCLT for initiating the resolution process by an operational creditor who will give a demand notice of 10 days to corporate debtor before approaching the NCLT. If corporate debtor fails to repay dues to operational creditor or fails to show any existing dispute or arbitration, then the operational creditor (supplier) can approach NCLT.”
He says the code in India is similar to the administrator-led regime in the United Kingdom and is in contrast to the U.S. Chapter 11 process, where the debtor retains possession of the business under the supervision of the U.S. Bankruptcy Court.
Chhawchharia concurs: “The IBC has many similarities to the primary UK insolvency legislation and that of other former Commonwealth countries - for example the ability to challenge antecedent transactions such as preferential treatment of certain creditors or avoidance of undervalued transactions. “However, there are also parts that are likely to be unique to India such as the disqualification of certain parties from being resolution applicants.”
Prem Rajani is confident that the Insolvency and Bankruptcy Code will facilitate ease of doing business in India
Ashish Chhawchharia points out to the ‘creditor in possession’ aspect of the new law, providing banks with considerable say