This article is written by Anaya Jain, a student of BA.LLB(Hons) from NMIMS school of law, Bangalore. This is an exhaustive article which explains how insolvency and bankruptcy are regulated in India with the analysis of Insolvency and Bankruptcy Code, 2016.
“Help! I have got a lot of debt. What’s the best option? Bank consolidation or Bankruptcy?”
So, if this question is bothering you, then give a glance at this article to solve all your doubts related to insolvency. Before declaring ourselves as insolvent, first, we should check whether it is insolvency or bankruptcy because both are widely different. One can be insolvent without being bankrupt but cannot be bankrupt without being insolvent. The picture below clears it well:
It is smarter to have one systematized enactment than various ones to manage the defaults of an organization under one umbrella. This is the exact rationale behind the presence of The Insolvency and Bankruptcy Code in India which has been put to effect since 2016. The Insolvency and Bankruptcy code took birth by repealing SICA (Sick Industrial Companies Act), SICA was revoked with impact from 1 December 2016.
Slip-ups of the past were taken into account and The Insolvency and Bankruptcy code appeared with a broader reach, with a goal of addressing the issues through more efficient guidelines and executions. It is an act to amend and reform laws whose subject matter has problems of reorganization and insolvency resolution. In case of insolvency, the terms of the act should refer to the following:
- Partnership firms
- Limited liability Partnership
- Corporate persons
The purpose behind the code
Without an insolvency law, if an organization defaults on an advance to a creditor (for example becomes income indebted), each claimant would need to race to get a lot of the organization’s benefits. This battle among its claimants could drive the organization into liquidation regardless of whether it has, in any case, a sound plan of action. This would prompt superfluous demolition of the organization’s hierarchical worth and cause work misfortunes. The winner-grabs-it-all situation would make the business of extending credit riskier from the creditors’ perspective.
There has been a store of laws on indebtedness preceding the IBC that travelled every possible way but evidently neglected to resolve the mind-boggling insolvency issues. The laws were ranging from The Presidency Town Insolvency Act, 1909 to Provincial Insolvency Act 1920, the Sick Industrial Companies Act 1985 and many more. The code further amended various acts like the Indian Partnership Act, 1932, the Companies Act, 2013, Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, Limited Liability Partnership Act, 2008 etc. The journey was swift and full of potholes that unreservedly began, anyway later neglected to adhere to the very reason for which they were built up. Because of absence of required institutional and legal setup, the defaulters began considering India as a safe haven for such exercises which clearly portrayed incompetence with respect to our nation when contrasted with worldwide gauges.
Therefore, a sound structured insolvency and bankruptcy law was created in 2016 which will aid in erasing these problems.
The actual purpose of this law will provide:
- an aggregate strategy for indebtedness goals, and
- rules to control the opportunistic conduct of investors and directors in the region of indebtedness.
Objectives and outcome of Insolvency laws
There are 2 general objectives of insolvency laws:
The first objective is the predictable, equitable, and transparent allocation of risk among participants in a market economy.
The accomplishment of this objective plays a critical role in giving trust to the credit system and promoting economic growth for the benefit of all participants. For instance, as regards the creditor-debtor relationship, a creditor’s ability to initiate insolvency proceedings against a debtor as a means of enforcing his claim reduces the risk of lending and thus increases the availability of credit and investment making. An indebtedness law likewise serves to designate hazards among different creditors, additionally to assist borrowers. For instance, if the indebtedness law affords secured creditors uncommon treatment opposite to unsecured creditors, such treatment ensures the estimation of security, which might be especially significant for those account holders that, in view of their credit hazard, can’t get (or can’t manage) unsecured credit.
The second goal of an indebtedness law is to ensure and boost an incentive to serve every stakeholder and the economy at large.
Most evidently this goal is pursued during rehabilitation or restoration, where value is maximized by continuing a viable business. But it’s also a primary purpose of procedures that liquidate companies that can not be restored. The accomplishment of the value maximization objective is regularly promoted by the satisfaction of the target of equal distribution of risk. For instance, the annulment of fraudulent transactions that took place prior to an insolvency process guarantees that lenders are treated equally and thus increases the value of the debtor’s properties. A portion of the key policy decisions that need to be made when structuring an insolvency law identify how the above goals are adjusted against one another. Moreover, decisions should be made on who will be the recipients of the worth that is maximized.
It is important to avoid easy stereotypes when we find a way to strike the balance between the various targets described above. Indebted individuals aren’t always fraudulent or incompetent, and creditors aren’t always selfish and understanding. As borne out by ongoing experience, in spite of the fact that organizations may fail in view of incompetence, they may likewise come up short on account of financial challenges outside their ability to control.
The present framework in India
In the current scenario, India’s insolvency laws are governed by Insolvency and Bankruptcy Code, 2016. The 2016 Code applies to organizations and people. It accommodates a period bound procedure to determine bankruptcy. At the point when a default in reimbursement happens, creditors gain control over debtors’ assets and should make choices to determine indebtedness inside a 180-day time frame. To guarantee a continuous resolution process, the Code likewise gives immunity to borrowers from resolution claims of creditors during this period. The Code additionally combines arrangements of the current authoritative system to create a common platform to address insolvency for debtors and creditors of all groups.
Various institutions are formed by the court to facilitate the purpose of insolvency. These institutions are insolvency professionals, information utilities, insolvency professional agencies, insolvency and bankruptcy boards, etc.
There are 3 steps mentioned in the code to resolve insolvency. They are:
- The decision to resolve insolvency
The Procedure of the code is well depicted by the below diagram:
Drawbacks in present insolvency law
- The Code does not have sufficient protection to secure the company’s interests until handing the management over to the qualified resolution.
- It rides substantially upon the creditors’ undeniable word.
- It neglects to give any chance to the corporate account holder to make a representation at any phase of the resolution process.
- The Code also fails to provide criteria for the qualification of professionals in the interim and in the final insolvency resolution.
- The insolvency service agencies (IPAs) will be governed by the Bankruptcy Board (regulator) which will further control insolvency professionals (IPs). It is unclear the rationale behind multiple IPAs that oversee the functioning of their member IPs, rather than a single regulator. The presence of multiple IPAs operating at the same time could allow for competition in the sector.
- The Code sets out a priority order for the distribution of assets during liquidation. It is uncertain why:
(i) secured creditors retain their entire outstanding sum, rather than up to their collateral value;
(ii) unsecured creditors take priority over commercial creditors; and
(iii) government levy will be reimbursed after unsecured creditors.
Amendments done in the code
There have been a couple of times that the Indian government has made amendments to the IBC. First, it was witnessed through The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2017, and second was done by The Insolvency and Bankruptcy Code (Second Amendment) Bill, 2019. The 2017 amendment dealt with issues like expanding the scope of insolvency, eligibility criteria of resolution applicants that is to strengthen the insolvency resolution process and reliability of the process that is the trust of investors in the procedure. There were many other issues that remain unturned and were not addressed in this ordinance such as loss of jobs, voting rights of operation creditors in the committee of creditors, dues of public depositors, etc. As a consequence, the 2019 amendment which focuses on the promotion of entrepreneurship, amendment of laws relating to reorganization and insolvency resolutions of corporate persons, firms, and individuals, balancing the interests of all shareholders, steps to decrease the maltreatment by certain classes of creditors, etc was put to effect.
Need for a sound insolvency system
- A successful insolvency law, seen from the economic policymaker’s viewpoint, will play a crucial role in a variety of ways. In general, the control it imposes on a debtor increases the business sector’s productivity and encourages credit provision. More precisely, to the degree that the undertaking is state-owned, subjecting the undertaking to the application of the general insolvency law sends out a strong signal about the scope of public financial support. In this context, the recovery provisions of an insolvency law will effectively ensure that creditors contribute to solving state-owned financial issues, thereby restricting the public cost of recovery.
- As far as the financial sector is concerned, an effective insolvency law helps financial institutions to curb the depreciation in the value of their assets by providing them with a means of enforcing their claim. In that specific situation, it can likewise encourage the improvement of capital markets. For example, if an insolvency law is implemented with adequate predictability, a secondary market in debt instruments will grow that will allow financial institutions, among other things, to move their loans to other organizations specializing in the workout phase.
- At last, an effective insolvency statute may provide a valuable way of ensuring that private creditors contribute to the resolution of the crisis in the sense of a financial crisis in which the entire business sector is in distress. For instance, a rehabilitation process offers a means for opposing creditors to force a court-approved settlement arrangement on the objections.
Elements of a sound insolvency system
- The code must be powerful, decentralized, less expensive, comprehensive, and rapid.
- This would assist organizations to exit faster and cash-flow to be redeployed quicker to beneficial firms, along these lines improving financial yield and business.
- The code ought to support decentralization, decrease the job of courts or bankruptcy experts, and take into consideration a more market-friendly approach to take on a greater position.
- A successful insolvency law, seen from the economic policymaker’s viewpoint, will play a crucial role in a variety of ways. In general, the control it imposes on a debtor increases the business sector’s productivity and encourages credit provision. More specifically, to the extent that the company is State-owned, subjecting the company to the application
One can suitably say that the laws on Insolvency in India have been a mystery. There has been an ascent and fall of an indebtedness system where each came to duplicate the other, scarcely carrying anything new with them. The IBC came as a one-stop arrangement that followed a planned income approach having tough columns for its help, outperforming the current indebtedness system. In a limited span of time, the Code was built up and established its jurisprudence. However, the code expected changes to stay aware of the bankruptcy system over the globe and to enable the Indian economy to conquer territorial boundaries. The foundation of all downsides was that the Code appeared to be somewhat over-driven. So as to consolidate the pros of other country’s bankruptcy laws, the Code disregarded some genuine residential issues-particularly occupations and non-institutionalized investors as well as creditors. The changes proposed in the 2019 amendment will largely influence the professionals associated with it but the lacunae in the proposed amendments will be found in the forthcoming time.
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