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Is CIRP under IBC a recovery mechanism

February 17, 2021
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CIRP

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This article is written by Soha Goyal, pursuing a Certificate Course in Insolvency and Bankruptcy Code from LawSikho.

Introduction

A corporate entity undertakes a plethora of liabilities while it’s functioning in various ways. Sometimes, the corporate entity may become so debt ridden, that it may raise questions on the existence and operations of the company and also endanger the huge financial interest of its creditors. Thus, to strike a balance between both, the government came up with reconstruction and rehabilitation mechanisms with a view to wipe off the entity’s debt while satisfying the creditor’s claim to its greatest interest, thus ultimately ensuring the entity’s survival.

The pre-existing statute, The Sick Industrial Companies (Special provisions) Act, 1985 (SICA) aimed at revival and survival of debt-ridden industrial companies was not doing much good. As of 2015, the Insolvency resolution in India took 4.3 years on an average. This is higher when compared to other countries such as the United Kingdom (1 year) and the United States of America (1.5 years). These delays are caused due to pendency of resolution cases in courts and confusion due to lack of clarity in the then bankruptcy framework.[1] The complications can be traced back to the lack of promising recovery mechanisms and incompetence of the existing ones.

Even with existing recovery statutes such as the RDBI Act, 1993 and SARFAESI Act, 2002, the recovery rates obtained in India are among the lowest in the world. When default takes place, lenders seem to recover only 20% of the value of debt, on an NPV basis.[2] Due to the low recovery rate, the creditors seemed to have an adverse outlook towards lending, resulting in slow market growth and industrial development. Thus, a Bankruptcy Legislative Reforms Commission was formed in 2014, which came up with a quintessential code aimed to overcome these drawbacks and deficiencies in the existing legal framework.

Enactment of IBC

The Insolvency and Bankruptcy Code, 2016 (IBC or Code), was enacted on 28th May 2016, which seeks to consolidate all the existing legal framework and fulfill the myriad of loopholes by forming one law for Insolvency and Bankruptcy. IBC focuses on consolidating and amending the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner, to promote entrepreneurship and availability of credit and to improve the ease of doing business and facilitate more investments leading to higher economic development.[3] 

Misuse of IBC

The soul of IBC is resolution of insolvency of an entity by continuation of its operations, maximizing its assets and balancing the interest of its stakeholders. Debt recovery process in contrast, merely recover the dues of the creditors by exhausting its assets, nothing may be left in due course. Thus, resolution keeps the firm alive, while recovery bleeds it to death.[4] The Code strives for resolution and discourages recovery in several ways. It encourages the creditor to wait throughout the insolvency resolution procedure and recover its dues from the future earnings of the entity, post-resolution.

Initiation of CIRP with malicious intent

In recent times, creditors have been observed to be maliciously initiating Corporate Insolvency Resolution Process (CIRP) in order to merely taint the reputation of the debtor and recover the debt owed to them. Applications filed under the IBC show a disturbing tendency of the law being misused by small creditors as a debt collection tool rather than for rehabilitation of non-performing assets by banks, thereby undermining its objective.[5] 

There are many inducements for a creditor to initiate CIRP under IBC rather than take recourse under other laws against the defaulters. The first being the cheap application fee under IBC, i.e. INR 2000 (two thousand) for an operational creditor as compared to massive litigation expenses for a civil suit. Secondly, CIRP under IBC is a time bound process unlike a civil suit which can not only stretch for an extensive period but is further delayed in its execution.[6] In the matter of Prowess International Pvt. Ltd., the Hon’ble NCLT held: “It is made clear that Insolvency Resolution Process is not a recovery proceeding to recover dues of the creditors. IBC, 2016 is an Act relating to reorganization and insolvency of corporate persons,…”[7]

Withdrawal of application

In accordance with the Rule 8 of The Insolvency and Bankruptcy (Adjudicating Authority) Rules, 2016 (Relevant Rules), the Adjudicating Authority has the  power to permit the corporate debtor to withdraw its application filed before it prior to its acceptance.[8] In addition to this, with the insertion of Section 12A to the IBC [9], an application against a Corporate Debtor can be withdrawn even after its acceptance by the Adjudicating Authority, with the accent of 90% (ninety percent) voting share of its Committee of Creditors (CoC).

In June 2019, out of the 2162 cases admitted, 101 have been withdrawn under Section 12A, while just 120 reached resolution.[10] Such rapid surge in the number of cases withdrawn implies that completing the CIRP was never the intention of such creditors. Thus, with gates opening for withdrawal of insolvency applications for initiating CIRP, the ordinary creditors are using the insolvency applications merely as a threatening tool as in most cases the corporate debtor steps in for settlement with creditors who then withdraw the application, thereby defeating its objective.

Legality of using IBC as a recovery tool

Although it is clear that the purpose of IBC is insolvency resolution and reconstruction of sick entities, there isn’t any explicit provision which forbids applications aiming for recovery only. Thus, the provision closest to this is Section 65 of IBC, which was incorporated in the Code to avoid the misuse of the provisions of the Code by any person, who has initiated the insolvency resolution process or liquidation proceedings, with a fraudulent or malicious intent, and for any purpose other than for the resolution of insolvency or liquidation[11], as the case may be. This implies that that an application filed with a purpose of recovery will be covered within the scope of malicious intention of proceedings.

Case laws

In the matter of Praveen Kumar Mundra v. CIL Securities Ltd.[12], the Hon’ble NCLAT judgement is a good instance where an application for initiating CIRP under Section 9 was rejected under Section 65 of the Code. It was found that the Respondent had taken a plea before the Adjudicating Authority that it is agreeable to pay the amount subject to the registration of the Operational Creditor under the GST Act, 2017. It further appeared that before the admission of the application, the Respondent was ready with the draft for the amount. However, the Appellant is not inclined to accept the same. Thus, the NCLAT held that “the Operational Creditor initiated the Corporate Insolvency Resolution Process with fraudulent and malicious intent for any purpose other than the resolution of insolvency or liquidation and therefore it was clearly covered under Section 65 IBC i.e. fraudulent or malicious initiation of proceedings.”

In the matter of Asset Advisory Services v. VSS Projects[13], the NCLAT has set an example to show how Section 65 has been applied in the past. The Tribunal reiterated that a person who initiates the CIRP for any other purposes apart from resolving insolvency actually misuses the provisions of the IBC. In the instant case, the financial creditor had lent a short-term loan of rupees two crore to the corporate debtor against a mortgage over three flats belonging to the latter.[14] When the corporate debtor attempted to sell these flats, the financial creditor managed to obtain a status quo order that prevented the sale of any flat. It also refused to accept registration of the flat in its favour. Instead, an application for initiation of CIRP was filed with the competent authority. The underlying motive for engaging in these tactics was to somehow get an insolvency professional appointed so that there would be a compulsion for distress sale of all the other flats of the corporate debtor that would amount to a whopping rupees ten crores to satisfy a small debt of rupees two and a half crores.[15]

As is the case generally with applications filed for mere recovery of debt, in this case too, the NCLT found that it would be premature to take the corporate debtor to be insolvent or bankrupt and initiate CIRP against it.[16] Evidently, it would be even more absurd to depict the corporate debtor in such a light considering that the net worth of the debtor was much in excess of the amount payable to the financial creditor. In view of the fact that there was no insolvency in the case, the Tribunal found it untenable to start the process of insolvency resolution.

Conclusion

The IBC was enacted in 2016 by the government, keeping the two most essential attributes in mind. The First, revitalization and reconstruction of sick entities along with satisfaction of creditor’s debts and the second being fast track completion of this process. Although in the last four years, the reviews and records of its operation have been promising, it has also been facing few problems. The delay in disposal of cases, from the stage of admission of application and to the stage of assessing viability, with the 270 day time limit for resolution of insolvency being exceeded in many cases.[17] As per the statistics released by the Insolvency and Bankruptcy Board of India, out of the 1484 cases that were admitted for the CIRP, only 586 were resolved as of December 2018, indicating that at least 898 cases are still ongoing.[18]

The NCLT has an important role in preventing conversion of insolvency law into debt recovery proceedings. With Section 65 in force, IBC has taken a step in this direction by penalising malicious initiation of proceedings. It is also pertinent for the authorities to define and expand the ambit of the word ‘malicious’ in order to realize the very purpose of the statute. Furthermore, it will prevent preferential payment made to creditors when the debtor has knowledge of the impending insolvency.

After filing of the insolvency petition by the creditor, it is a prevalent practice where the debtor succumbs to pressure and pays off the applicant creditor’s debt ahead of other creditors. The applicant creditors taking undue advantage of Rule 8 of the Relevant Rules, thereby withdraws its petition. The NCLT should not sanction withdrawal of the petition, and instead allow the other creditors to continue with the petition. Once this happens, the insolvency professional will be obliged to avoid the payment made to the original petitioner, and demand that all the funds received be refunded to the pool for distribution to all the creditors. The petitioner will then run the risk of losing any gains and face penal consequences. Insolvency practitioners also have a duty to dissuade their clients from using insolvency proceedings as a threat.[19] Banks too must step forward to become the principal consumers of the insolvency law, rather than small operational creditors. We will soon discover that the Code is rather a saviour than a plight.

References

[1] Sudipto Dey, The Insolvency and Bankruptcy Code, 2015: A Primer, BUSINESS STANDARD, (Dec. 15 2020, 6:20 PM), https://www.business-standard.com/article/economy-policy/the-bill-provides-for-a-time-bound-process-to-resolve-insolvency-116050700028_1.html

[2] Bankruptcy Law Reforms Committee, The Report of the Bankruptcy Law Reforms Committee Volume 1: Rationale and Design, at Ch 3.3.1 (4th November, 2015).

[3] Archan Shah, Objective of Insolvency Law: Resolution over liquidation, BUSINESS TODAY, (Dec. 15 2020, 6:20 PM), https://www.businesstoday.in/opinion/objective-of-insolvency-and-bankruptcy-law-ibc-resolution-liquidation/story/266337.html

[4] Dr. MS Sahoo, Resolution: The Sole of IBC, FROM THE DESK OF CHAIRPERSON, (Dec. 15 2020, 6:20 PM),https://ibbi.gov.in/Article%20Resolution%20The%20Soul%20of%20IBC%20in%20IBBI%20Newsletter%20October-December%202017.pdf

[5] Sumant Batra, Insolvency Resolution not a debt recovery tool, FINANCIAL EXPRESS, (Dec. 15 2020, 6:20 PM), https://www.financialexpress.com/opinion/insolvency-law-not-a-debt-recovery-tool/725216/

[6] Ibid.

[7] Parker Hannifin India Pvt. Ltd. v. Prowess International Pvt. Ltd., 2017 SCC OnLine NCLT 11998.

[8] Sharad Tyagi & Kartik Arora, IBC: Latest Position on withdrawal of application, THE MONDAQ, (Dec. 15 2020, 6:20 PM), https://www.mondaq.com/india/insolvencybankruptcy/728650/ibc-latest-position-on-withdrawal-of-an-application-by-creditors-post-settlement

[9] Insolvency and Bankruptcy Code (Act No. 31/2016) (India), §12A.

[10] Radhika Merwin, Rapid rise in cases withdrawn under IBC, BUSINESS LINE, (Dec. 15 2020, 6:20 PM), https://www.thehindubusinessline.com/companies/rapid-rise-in-cases-withdrawn-under-ibc-raises-concerns-over-the-misuse-of-section-12-a/article29518854.ece

[11] Insolvency and Bankruptcy Code (Act No. 31/2016) (India), §65(1).

[12] Praveen Kumar Mundra v. CIL Securities Ltd., 2019 SCC OnLine NCLAT 334

[13] Asset Advisory Services v. VSS Projects, CP (IB) No. 96/7/HDB (2017).

[14] Id, at 2

[15] Id, at 3

[16] Id, at 16

[17] Joel Rebello, With the IBC About to be 3, a Look At the Hits and Misses and the Road Ahead, ECONOMIC TIMES (Dec. 15 2020, 6:20 PM), https://economictimes.indiatimes.com/industry/banking/finance/banking/changeschallenges-and-interpretation-of-bankruptcy-slaw/articleshow/69017429.cms?from=mdr

[18] Ibid.

[19] Supra note 5.


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