This article is written by Pranjal Mishra, B.A. LL.B. (Hons.) student from Maharashtra National Law University Mumbai. In this article, the author does a comparative study of the Bankruptcy Laws of two fastest growing economies, India and China.

Introduction

In the era of Globalization, the nations are competing against each other to augment their economy. To promote such growth, legislations protecting the interests of the parties are being formulated. One such legislation is the bankruptcy laws of the nation that protects the interests of the stakeholders as well as promotes the business doing. The legislation not only preserves the trust between the parties in a transaction but it also assists the defaulter to restructure its business in cases of insolvency and bankruptcy. 

Insolvency laws are pivotal to maintain the economic interests of parties involved in financial or operational transactions as it safeguards the interests of the debtors, creditors and other stakeholders. These laws provide an institutional framework for regulation, adjudicatory mechanism and involvement of insolvency professionals who acts like a moderator, neutral and impartial to the interested parties and takes decisive steps in the resolution process.

Insolvency is a financial condition where the debtor is unable to pay the dues to the creditor and can no longer meet his financial obligation as his liabilities exceeds his realizable assets. Unlike insolvency, bankruptcy is a permanent situation where in no way the debtor can fulfill his financial obligations and liquidation of the assets is the only mode of repayment. In order to maintain the interests of the stakeholders, insolvency legislation would provide a collective procedure for insolvency resolution and promote entrepreneurship. 

Both India and China are the fastest growing economies in the world. Therefore, this article would compare the legislations on insolvency in India and China and further would analyze the differences. Part A would devolve into the applicability of both laws into their respective paradigm and role and nature of the adjudicating authorities in India and China. Part B elaborates and distinguishes the part of the intermediaries in the process of reorganization. Part C analyses the reorganization and settlement procedures of both regime and lastly, Part D concludes the article by emphasizing on the point of personal insolvency laws.

In India, insolvency process is covered under Insolvency Bankruptcy Code (‘IBC’ hereinafter) of 2016. This was an Indian economic reform which was aimed to simplify the procedure as the legislations prior to it, like Presidency Towns Insolvency Act of 1909 and Sick Industrial Companies Repeal Act of 2003 were complicating the procedure and thus, the relationship of trust or credit-worthiness between a debtor and a creditor was deteriorating. The preamble to IBC highlights the objective of the legislation as the reorganization of the procedure to promote entrepreneurship in the interests of all the stakeholders.

In China, Enterprise Bankruptcy Law of the People’s Republic of China (‘2006 EBL’ hereinafter) of 2006 governs the process of enterprise bankruptcy which aims at safeguarding the lawful rights and interests of the stakeholders and maintaining the order of the socialist market economy. The current Chinese Bankruptcy regime consists of 2006 EBL, various administration regulations, and judicial interpretations promulgated by the Supreme People’s Court of People’s Republic of China.

Applicability and Adjudicating Authority 

The 2006 EBL applies to corporate entities, financial institutions and state-owned entities but not to sole proprietors, individuals and partnerships. However, IBC is applicable to the following in cases of insolvency, liquidation, voluntary liquidation or bankruptcy:

1. Companies;
2. Limited Liability Partnership;
3. Partnership Firms;
4. Corporate Persons;
5. Individuals.

In addition, IBC segregates and lays down the procedure of filing of application for the creditors into 2 categories, financial creditors and operational creditors. It defines financial creditors as one to whom a financial debt is owed like loan, on the other hand, operational creditors are the ones to whom an operational debt of any goods or services is owed. However, the applicability of 2006 EBL is to the general connotation of creditor.

In circumstances where time is of essence, adjudicating authority plays the most significant role in any reorganization or insolvency procedure. The current regime of Chinese bankruptcy law involves people’s court of judicial nature as the adjudicating authority, whereas, the insolvency cases in India are primarily dealt by tribunals of quasi-judicial nature. Such tribunals with vested jurisdictions are incorporated specifically for corporate disputes, which reduces the multiplicity of litigation before different forums and courts and thus, lessens the time of litigation and provides faster justice. Indian regime has National Company Law Tribunals (NCLT) for corporate entities and debtors, and Debt Recovery Tribunals (DRT) for partnership firms and individuals. 

Like 2006 EBL, the Indian counterpart has defined the role of Adjudicatory Authority as vital, because the authority not only adjudicates the case but it also protects the interests of stakeholders by declaring moratorium and public announcement.

Under IBC, moratorium is defined as an order declared by the authority prohibiting the following against the corporate debtor till the completion of the corporate insolvency resolution process:

1. Institution of suits or continuation of pending suits in any court or forum;
2. Transferring or alienating any of its beneficial interest or legal right;
3. Any action enforceable under Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;
4. Recovery of any property by an owner or lessor where such property is occupied or possessed by corporate debtor.

This order acts as a calm phase where ample time is given for the corporate debtor and creditor’s committee to formulate a resolution plan for recovery of money. The objective is to keep the assets of the debtor intact during the corporate insolvency resolution process. Moreover, the authority also declares a public announcement to notify the situation into the public domain and calls the stakeholders to submit their claims against the corporate debtor. 

The most important goal of bankruptcy laws is to prevent a creditor’s race, which means that the first one will get paid before the other creditors. Moratorium in toto puts an automatic stay to this complication. However, 2006 EBL framework, as compared to IBC, is limited and lacking detailed rules. 

Article 19, 20, 75 and 92 of the 2006 EBL lays down the regime of automatic stay. During the process of reorganization, a foreclosure on security interests over specific property of debtor is not allowed under 2006 EBL. However, in the case where possible damage or depreciation to the value of the collateral may impair the secured creditor’s rights, an application may be made to a court to preserve the secured property. Thus, this implies that its application is seriously limited by court’s discretionary power. 2006 EBL framework is limited in the sense that it only covers judicial proceedings or arbitrations, not administrative proceedings or non-adjudicative proceedings such as mediations.

Intermediaries

IBC defines intermediaries in the insolvency process as insolvency professionals. For the purposes of a resolution process, insolvency professionals act as: 1) Interim Resolution Professionals; 2) Resolution Professional. In addition, during a liquidation process, insolvency professional also play the role of liquidators of the corporate debtors. 

The interim resolution professional undertakes the management of the company during the period between the commencement of the process and the appointment full-time resolution professional. This appointment is also required to be approved by the NCLT and is subject to the confirmation of the proposed resolution professional by the Insolvency and Bankruptcy Board of India, which is the regulator for overseeing insolvency proceedings and entities like Insolvency Professional Agencies, Insolvency Professionals and Information Utilities in India.

The 2006 EBL lays down the administrators as the intermediaries, designated by the people’s court. According to it, a liquidation team is composed of persons of the departments or authorities concerned or a law firm, a certified public accountant firm, a bankruptcy liquidation firm or any other public intermediary agency. In addition to it, 2006 EBL states that an administrator may, upon approval by the people’s court, employ the necessary workers. However, the said act does not define the qualifications and role of the workers in the process, as it could endanger the neutral and impartial status of the administrator towards the stakeholders. On the other hand, the IBC establishes a channel of approval which keeps checks and balances and maintains the fairness of the insolvency professional. 

In India, Insolvency professional appointed by creditors is responsible to manage the business during reorganization process. In China, court appointed administrator is responsible to manage the business during reorganization process, thus this further adds burden on the part of the court.

Modus Operandi

The important feature of the regime is to laying the procedures of reorganizing and settling the issue among the stakeholders. There are typically three different possible outcomes to a bankruptcy proceeding: Reorganization, Settlement and Liquidation.

Both regimes stipulate 180 days or 6 months as the time limit and extension of 90 days or 3 months to submit the draft of the resolution/restructuring plan, in order to initiate the bankruptcy proceedings. According to 2006 EBL, upon the receipt of proposed plan, the court convenes a creditors’ meeting for the draft to be approved by a majority of the numbers of creditors and representing two-thirds of the total claims in a particular voting group. The creditors are classified into the following voting groups:

1. Creditors with secured claims over specific properties of the debtors;
2. Employees;
3. Claims on outstanding taxes;
4. Unsecured claims.

The 2006 EBL sets out the following hierarchy of debts to determine priority of payment:

1. Bankruptcy Expenses;
2. Common Interest Debts of creditors;
3. Employee Claims;
4. Social insurance premiums and outstanding taxes;
5. Common unsecured claims.

As per IBC, the procedure of voting is prior to that Chinese counterpart. The committee of creditors first approves a resolution plan by a vote of not less than seventy-five per cent of voting share and then the resolution professional submits the same to adjudicating authority. If the authority is satisfied with the plan and has followed the compliances, it shall be binding on all the stakeholders involved in the resolution plan. 

The Indian regime lays out the following order of priority for distribution of assets:

1. Insolvency resolution process and liquidation costs;
2. Workmen s dues for 24 months, and debts owed to secured creditors, if the security has been relinquished;
3. Employees’ dues for 12 months;
4. Financial Debts owed to unsecured creditors;
5. Government dues, and unpaid dues to secured creditor, if the security has been realized;
6. Remaining debts and dues (which include, unsecured operational debts);
7. Preference shareholders, if any;
8. Equity shareholders or partners.

Throughout the bankruptcy procedure, IBC is more efficient than 2006 EBL on two grounds, firstly the establishment of a professional organization, Information Utility which collects financial information, get the same authenticated by other parties connected to the debt and store the same to provide access to the Adjudicating Authority, Resolution Professionals and to all the stakeholders in the Insolvency Resolution Process, so that the stakeholders can make decisions based on the same information. The role of such organization would provide symmetric and authentic information and thus, reduce the scope of forging the process.

Secondly, the 2006 EBL restricts the numbers of creditors to nine members in the creditors’ committee. The regime fails to reason out the same as the selected members could forge the process by placing their personal interest over the collective interest. Therefore, processes like bankruptcy and insolvency should include all the creditors affected where each is accountable for its interest.

Conclusion

In China, the insolvency laws have been introduced a decade ago, whereas in India, the legislation is still in its implementing stage. As businesses has evolved to include private, foreign interests and partnerships. The need for personal insolvency laws has heightened. In the UK, Germany, France, Japan and other developed countries, the personal insolvency system is an important part of the bankruptcy law. The major drawback of the 2006 EBL is the absence of the personal insolvency laws. However, the National Development and Reform Commission, issued the Reform Plan for Accelerating the Improvement of the withdraw System of Market Entity, which proposes to establish a bankruptcy system for individuals and focuses on solving the problem of joint liability of natural persons arising from bankruptcy of an enterprise. 

On the other hand, IBC contains the provisions of the personal insolvency laws for declaring insolvency of individuals and partnerships but the said provisions have not yet been notified by the Central Government through the official gazette. However, such a move is essential to the evolution of the institutional infrastructure.

---

LawSikho has created a telegram group for exchanging legal knowledge, referrals and various opportunities. You can click on this link and join: