In this blog post, Mohammad Farooq, a fourth-year law student at Institute of Law, Nirma University, provides an overview of the Insolvency and Bankruptcy Code, 2015.

Introduction

The Indian Parliament passed The Insolvency and Bankruptcy Code, 2015 on May 12, 2016 which may prove to be the long awaited and much needed panacea for the banks ridden with Non-Performing Assets (NPAs). For quite some time now, Indian PSU Banks have been suffering with the malaise of rising NPAs and suffering from the inordinate delays in recovering their debts due to the multiplicity of laws governing the bankruptcy laws.

An asset becomes non-performing when it ceases to generate income for the bank. A ‘non performing asset’ (NPA) was defined as credit in respect of which interest and/ or installment of principal has remained ‘past due’ for a specific period of time[2]. They are basically loans and advances on which the debtor has defaulted in repayment of loan.

Bankruptcy refers to legal process of liquidation of business entity which has not been able to repay its debts out of its current assets[3]. Insolvency on the other hand refers to a situation where individuals or companies are unable to repay their outstanding debt[4].

The Bankruptcy code was put forward by the Bankruptcy Law Reforms Committee (BLRC) in November 2015 headed by Dr. T K Viswanathan. The commission in its report identified that creditors in India are often powerless while trying to repossess their debts from the debtors.[5]The recovery rate in India is one of the lowest in the world i.e. just about 20% of the debt[6]. Under such circumstances, the lenders will not be willing to lend. As a result, most of the concentration of the lending is with only the huge corporate firms where probability of default is far lesser.

NON-PERFORMING ASSETS IN INDIA

Commercial banks are those institutions whose motive is to manage the business essentially on a profit basis. On one hand, banks accept surplus money from the people who are not using it. On the other hand, they lend to those who need it for productive purpose.[7]

The basic idea behind handing advances by banks is to generate income for the bank either through interest or installments. Hence, all advances are termed as “assets”. However, in certain instances a loan turns bad if the interest or a portion of it stays unpaid even after the due date — and transforms into a non-performing asset, or NPA, in the event that it stays unpaid for a period of more than 90 days.[8]

A standard asset is a performing asset. It regularly produces income for the bank. NPA are classified under the following heads:

1. Sub-Standard Assets : All those assets that is loans and advances which are considered as non-performing for a period of more than 90 days but less than 12 months are called as Sub-Standard assets. For less than 90 days, they are included in Special Mention Account.
2. Doubtful Assets: All those assets in the Sub-Standard Assets category which exceed the period of 12 months are called as Doubtful Assets.
3. Loss Assets: All those assets which cannot be recovered are called as Loss Assets.[9]

Further, because of the prevailing gloomy scenario in the public sector banks (PSBs), this sector, in the absence of debt secured by collateral, has become starved of credit. As of now, the banking system is under a lot of stress with 29 of the state owned banks writing off 1.14 lakh crore INR between 2013 and 2015[10]. According to the Financial Stability Report issued by RBI in December, 2015[11], the stressed assets of Public Sector Banks (PSBs) stood at 14.1% for September, 2015. The government estimated that around Rs. 1,80,000  crore is required over next four years up to FY 2018-19 to clean up the public banking system[12]. Needless to say, if there is a lack of cash flow or credit in the economy, it ultimately affects the overall condition of the economy. Robust credit financing is reflection of a healthy and thriving economy.

Financial Stability Report

As on March 31, 2016, the gross non-performing advances (GNPAs or bad loans) of banks stood at 7.6% of the loans that they have given out. It was at 5.1% as on September 30, 2016 and on March 31, 2015 it was at 4.6%.[13]

It shows that the banks especially the public sector banks have started recognizing bad loans. Till this time, they were merely postponing the recognition of bad loans as bad loans by passing them as restructured loans. Fundamentally a restructured loan means that the borrower has been given a relaxation in the original terms such as a moratorium during which he does not have to repay the principal amount. In some cases, the loans’ tenure has been increased.[14]

By restructuring of loans, banks have helped a large number of borrowers who were no longer in a position to repay the loans they had taken. Restructuring was just an activity to delay the recognition of bad loans. The condition of many borrowers was so severe that they could not repay their loans even after restructuring. A glance at the stressed advances ratio of the banks gives us the whole picture. The stressed advances figure is arrived at by adding the total bad loans to the restructured assets. This ratio has kept increasing at a fast pace as banks continue to restructure their loans time and again. A stressed asset ratio of 11.5% (March 31, 2016) was basically reached by adding bad loans of 7.6% to3.9% of restructured assets. The restructured assets had stood at 6.2% whereas there were 5.1% of bad loans, giving a stressed assets ratio of 11.3% (September 2015). This shows that banks are now being compelled to recognize bad loans as what they are that is bad loans and not disguise them as restructured assets like they were doing previously.[15]

This is a huge achievement for the RBI and the government. The crux of the problem lied with the public sector banks which handed out loans to various crony capitalists, which today they not in a condition to pay back.[16] The right step now would be to go after such borrowers and try and recover as much of the loans as they can. By ensuring more and more recovery of loans, the burden on government to provide capital to the banks to help them stand up on their feet would drastically reduce.

The Financial Stability Report suggests that “under the baseline scenario, the gross non-performing assets ratio may rise to 8.5 per cent by March 2017 from 7.6 per cent in March 2016. If the macro scenarios deteriorate in the future, the gross non-performing assets ratio may further increase to 9.3 per cent.”[17] In short, the worst is yet to come for the banks.

Inter alia, the financial stability report mentions the inability of large borrowers to repay the loans that they have taken on from banks. A large borrower is a borrower who has taken on a loan of Rs 5 crore or more as per the definition given by RBI. It is the large borrowers who are the major creators of NPAs and not the retail borrowers. Retail borrowers are the individual borrowers who take car loan, house loan, etc.

Asset quality in major sectors[18]

The above chart shows that the safest sector to lend is the retail sector which has only 1.8% of gross non-performing assets ratio. On the other hand, the riskiest is the industry sector with almost 12% of GNPA. This was the reason why 46% of lending carried out by banks between April 2015 and April 2016, has been retail lending. Between April 2014 and April 2015, 32.4% was retail lending of all the lending that took place.[19]

Further the stressed advance ratio of industry is almost 20% which means that approximately 1 out of 5 loans is a bad one. 58% of all the loans have been given to large borrowers but they are responsible for 86.4% of the bad loans. This shows the burden put by large borrowers on the banks. While recovering money from small borrowers is still possible and happens quite often, it is the big borrowers who escape the clutches of the law.[20]

It has now become imperative that banks go after the big fish that is the large borrowers as the major chunk of bad loans is due to their failure to repay. The need of the hour is to take strict measures and not give anyone any special treatment. Only when this happens can the recovery of NPAs be truly on track.

To make matters worse, earlier the resolution of insolvency process took several years because the courts took a lot of time in interpreting the laws like The Recovery of Debt Due to Banks and Financial Institutions Act, and Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) and Debt Recovery Tribunals under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (RDDBI Act), besides other provisions such as corporate debt restructuring and strategic debt restructuring. Furthermore, because of the inefficient implementation and court delays, under each of these laws, there was huge backlog of cases[21]. In fact, due to the inconsistencies in between these acts, courts had to involve themselves in settling the interpretation of law which further led to more delays[22].

Former governor of RBI, Dr. Raghuram Rajan in his speech on Saving Credit in Dr. Verghese Kurien Memorial Lecture cornered the reasons for delay in delivering judgment. According to him, it is the ignorance of the High Court, which continues to take up the matter before himself under article 226.[23] The aforesaid observation was made by the Supreme Court in the matter of Union of India vs. DRT Bar Association[24]wherein the court lamented –

“It is the matter of serious concern that despite the pronouncements of this Court, the High Courts continue to ignore the availability of statutory remedies under the RDDBFI Act and SARFAESI Act and exercise jurisdiction under Article 226 for passing orders which have serious adverse impacts on the right of banks and other financial institutions to recover their dues.”

It is not only the case lamenting on the role of DRT but the judgment of Standard Chartered Bank vs. Dharminder Bhohi[25] a crystal clear picture on the failure of DRT has been drawn. The court observed that the failure of timely disposal have the effect potentially of creating corrosion in the economic spine of the country. The other drawback witnessed is the Delaying Tactics adopted by numerous borrowers. The prime example of this is the debt racked up by Vijay Mallaya promoted Kingfisher Airlines. A consortium of banks, led by India’s largest lender State Bank of India, is fighting 20 cases across courts, including DRT.[26]The contention of delaying tactics have been taken in many cases that are – B. Shanmugam v. Union of India[27], Bishwanath Jhunjhunwala v. Bank of Maharashtra[28]. In Avtar Singh vs. Debt Recovery Tribunal[29] lamenting on the delaying tactics adopted by the borrower by asking remedy from high courts, the apex court observed –

“the high court should not exercise its discretion under Article 226/227 of the Constitution of India where an alternative remedy is available to the petitioner under the Act.”

The BLRC after having studied and identified these problems in their report stated out the objectives of the Committee which is to resolve insolvency with[30]:

1. Lesser time involved
2. Lesser loss in recovery
3. Higher levels of debt financing across instruments.

It is evident from the above that the basic purpose of this law is to strengthen the creditor’s rights in India. If the defaults are cleared to the creditors, then there is a complete balance in power between the equity holders and the debt holders.

This code seeks to do away with the inordinate delays, fast track the insolvency resolution process and facilitate the regulatory framework of bankruptcy laws. The major provisions of this code are[31]:-

1. The establishment of a Board as the Insolvency Regulator to exercise regulatory oversight over insolvency professionals, insolvency professional agencies and informational utilities.
2. Insolvency Adjudicating Authority such as the Debt Recovery Tribunal and the National Company Law Tribunal.
3. Insolvency Professional specialized in the insolvency resolution process who would be taking over the management of the company and assist in the liquidation process.
4. A time period of 180 days, extendable by 90 days to deal with resolving cases of Insolvency and Bankruptcy with provisions for force majeure and 1 time extension of 90 days as well as a fast track option with 90 day limit and single extension of 45 days. If insolvency is not resolved in this time period, the company will go in for liquidation of its assets and the creditors will be repaid from the sale proceeds.
5. Information Utilities in order to collect, collate, authenticate and disseminate financial information from listed companies and financial and operational creditors of companies.
6. Bankruptcy and Insolvency Processes for Individuals and Unlimited Liability Partnerships
7. Transition Provision: Under this, the Central Government shall exercise all the powers of the Regulator till the time the Regulator is established. This transition provision will enable quick starting of the process on the ground without waiting for the proposed institutional structure to develop[32].
8. Transfer of proceedings:Any proceeding pending before the Appellate Authority for Industrial and Financial Reconstruction or the Board for Industrial and Financial Reconstruction under the Sick Industrial Companies Act, 1985, immediately before the commencement of this law shall stand abated. However, a company in respect of which such proceeding stands abated may make a reference to Adjudicating Authority within 180 days from the commencement of this law.
9. Cross Border Insolvency : To redress the above issue of multi jurisdiction the Code tries to resolve by stipulating in the Code itself that there should be agreement entering by the Central Government with other countries for the compliance of the Code and further the Adjudicating Authority directs the Courts of other countries and aid with the information in relation with the assets of debtor outside India[33].

In addition to the above there are provisions to tackle cross-border insolvency so that repayment of debt can be considered with assets outside India if Indian property insufficient. Also, the creditors committee may choose to either revive a company or liquidate its assets for repayment of the debtor’s outstanding dues. In case of liquidation, the assets will be distributed based on an order of priority[34].

The code covers the scope of Corporate Insolvency and its Resolution Process, the Liquidation Process for both a corporate debtor and the individual debtor as well. Chapter IV of the code deals with the Adjudicatory Authority for the Corporate Persons wherein the corporate debtors would have to approach the National Company Law Tribunal for the matters relating to insolvency resolution and liquidation process.

The Bankruptcy Board will regulate insolvency professional agencies (IPAs). The primary function of the IPAs will be to regulate insolvency professionals (IPs) by conducting examinations to enroll them, and enforcing a code of conduct. The IPs will be responsible for carrying out the resolution process and managing the company during insolvency resolution[35].

However, certain issues still need ironing out for this code to be effective. The rationale behind multiple IPAs overseeing the functioning of their member IPs, instead of a single regulator is unclear. It may be argued that such a structure of regulation may lead to a conflict of interest for an IPA[36]. Further, the code provides for the creation of an Insolvency and Bankruptcy Fund[37] but it is unclear as to how this fund will be used. Also, since the DRT is already overloaded with thousands of pending cases, clarity is required about this additional burden will be carried under this code.

To conclude, The Insolvency and Bankruptcy Code 2015 is a welcome initiative for creditors, investors and debtors alike. The streamlining of procedures, simplification of the insolvency process and fast-tracking of recovery are hallmarks of the code which, if passed, will have a palpably positive affect on India’s lending climate[38]. The ease of doing business is one of the most important necessities in India and that India currently holds 130th position only. The new law also empowers the creditors to decide whether the said defaulter is declared insolvent or not. But such power is also controlled and governed by the courts in India. Ease of business and good governance are the two most business imperatives in the current situation of the state and this code goes a long way into achieving that.

[1] The author is 4^rd year student at Institute of Law, Nirma University.

[2]RBI Circular No. RBI/2010-11/45, accessed at https://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=5761, last seen on 14.05.2016

[3]Sonal Srivastava, An Overview of the Insolvency and Bankruptcy Code, 2015, accessed athttp://blog.ipleaders.in/overview-insolvency-bankruptcy-code-2015/, last seen on 13.05.2016.

[4]Sudipto Dey, The Insolvency and Bankruptcy Code 2015: A Primer, accessed at http://www.business-standard.com/article/economy-policy/the-bill-provides-for-a-time-bound-process-to-resolve-insolvency-116050700028_1.html, last seen on 14.05.2016.

[5]The Report of the Bankruptcy Law Reforms Committee Volume I: Rationale and Design, 8 (2012), available at http://finmin.nic.in/reports/BLRCReportVol1_04112015.pdf, last seen on 14.05.2016

[6] Ibid

[7] Muneeb Jamal: Functions Of Banks: Primary And Secondary, available at http://www.business-science-articles.com/articles/business/76-functions-of-banks, last seen at 7/8/16 18:25.

[8] Sandeep Singh: Meaning: Non-performing assets, available athttp://indianexpress.com/article/explained/meaning-non-performing-assets/, last seen at 7/8/16 18:32.

[9]Definition of ‘Non Performing Assets’, available at http://economictimes.indiatimes.com/definition/non-performing-assets, last seen at 7/8/16 20:25.

[10] Deborah Manzoori, India’s Insolvency and Bankruptcy Code 2015, accessed athttp://www.natlawreview.com/article/india-s-insolvency-and-bankruptcy-code-2015, last seen on 13.05.2016

[11] RBI Press Release dated 23.10.2015, accessed at https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=35812, last seen on 13.05.2016.

[12]Abhirup Ghosh, Shoiab Qureshi, Bagful of reforms to bring out the economy from the clutches of bulging NPAs, https://www.taxmann.com/Budget-2016-17/budget/t206/bagful-of-reforms-to-bring-out-the-economy-from-the-clutches-of-bulging-npas.aspx, last seen on 13.05.2016.

[13]Financial Stability Report – June 2016 available at https://rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=852, last seen at at 7/8/16 23:07.

[14] RBI stiffens loan restructuring norms for banks, available at http://www.moneycontrol.com/news/business/rbi-stiffens-loan-restructuring-norms-for-banks_886207.html?utm_source=ref_article, last seen at 7/8/16

[15]Vivek Kaul, The Clean Up of Public Sector Banks is On, but the Basic Problem Still Remains, available at https://www.equitymaster.com/diary/detail.asp?date=06/30/2016&story=2&title=The-Clean-Up-of-Public-Sector-Banks-is-On-but-the-Basic-Problem-Still-Remains&utm_source=archive-page&utm_medium=website&utm_campaign=vivek-kauls-diary&utm_content=story, last seen at 7/8/16.

[16] Vivek Kaul, The one assurance that Narendra Modi needs to give bankers, available at https://www.equitymaster.com/dailyreckoning/detail.asp?date=01/03/2015&story=2&title=The-one-assurance-that-Narendra-Modi-needs-to-give-bankers&utm_source=VKD&utm_medium=website&utm_campaign=e-letter&utm_content=VKD, last seen at 7/8/16.

[17] Supra Note 4

[18] Vivek Kaul, The Recovery of Bad Loans from Large Borrowers Will Be a Big Challenge for Modi Govt, available at https://www.equitymaster.com/diary/detail.asp?date=07/01/2016&story=2&title=The-Recovery-of-Bad-Loans-from-Large-Borrowers-Will-Be-a-Big-Challenge-for-Modi-Govt&utm_source=archive-page&utm_medium=website&utm_campaign=vivek-kauls-diary&utm_content=story, last seen at 7/8/16.

[19]Ibid

[20] Ibid

[21]Prerna R Saraf, Analysis of the National Bankruptcy Law, available at http://blog.ipleaders.in/analysis-national-bankruptcy-law/, last seen on 13.05.206

[22] Ibid

[23] Speech by Dr. Raghuram G. Rajan, Governor, Reserve Bank of India, at the Third Dr. Verghese Kurien Memorial Lecture at IRMA on 25^th November, 2014.

[24]Unknown.

[25] (2013) 15 SCC 341.

[26]What Prevents India’s Debt Recovery Tribunals From actually recovering bad debts?, BUSINESS STANDARD, 14/6/2015,www.business-standard.com/article/finance/what-ails-the-debt-recovery-tribunals-116031400407_1.html.

[27] 2007 SCC Online Mad 995.

[28]2015 SCC Online Bom 7960.

[29] 2012 SCC Online P&H 21877.

[30]Vatsal Khullar, Report Summary Bankruptcy Law Reforms Committee, , accessed at http://www.prsindia.org/administrator/uploads/general/1448943398_Report%20Summary%20-%20BLRC.pdf, last seen on 13.05.2016

[31] Press Information Bureau, Summary of the Recommendations of the Bankruptcy Law Reforms Commission, 4^th November, 2015,accessed athttp://pib.nic.in/newsite/PrintRelease.aspx?relid=130208, last seen on 13.05.2016

[32] India Juris, The Insolvency and Bankruptcy Bill, 2015, accessed at http://www.indiajuris.com/newsletter/pdf/bankruptcy-bill-2015.pdf, last seen on 13.05.2016

[33] Supra Note 1.

[34] Clause 52, 52, The Insolvency and Bankruptcy Code, 2016

[35]The Insolvency and Bankruptcy Code, 2016: Issues for Consideration, PRS Legislative Research, accessed at http://www.prsindia.org/uploads/media/Bankruptcy/IBC%202016%20-%20Issues%20for%20consideration.pdf, last seen on 13.05.2016

[36] Clause 204 & 205, The Insolvency and Bankruptcy Code, 2016

[37] Clause 224, The Insolvency and Bankruptcy Code, 2016

[38]Jyoti Singh, Vishnu Shriram, India: Insolvency and Bankruptcy code :Well Worth the Wait, accessed athttp://www.mondaq.com/india/x/462788/Insolvency+Bankruptcy/Insolvency+And+Bankruptcy+Code+2015+Well+Worth+The+Wait, last seen 15.05.2016