In this article, Anant Bakkliwal discusses recent changes in the Insolvency And Bankruptcy Code.
Introduction
The Insolvency and Bankruptcy Code, 2016 (Hereinafter referred to as ‘The Code’) was passed by the Parliament in May 2016 and became operational in December 2016. This code provides for a market-determined and time-bound insolvency resolution process which focuses on a creditor-driven insolvency process. A paradigm shift from the existing regime of ‘Debtor-in-Possession’ to ‘Creditor-in-Control. The relative effect could be seen on whole of the economy as capital and productive resources could now be redeployed relatively faster.
However, the empirical practice of the Code saw certain loopholes, which couldn’t be settled by just NCLT rulings, and thus the country witnessed The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2017. There has been a huge amount of Rs 25.26 Lakhs Crore of the NPAs which highlights on some of the shortcomings such as eligibility of resolution applicants but others are yet to be acknowledged, both of which can be explained in the following order.
Issues Addressed by the Amendment
Expanding the Scope of Insolvency
Previously, the Code’s application except on the Companies (established under Companies Act, 2013 and any other special Act) and Limited Liability Partnerships was limited only to ‘Partnerships and individuals’ but now Section 2(e) has been replaced. This amendment widens the Code’s implementation to include Personal guarantors to corporate debtors and all kind of firms such as proprietorship firms as well as partnership firms. Moreover, the Code also envisages to include other individuals which leave the scope to add any other entity as and when needed by the procedure.
Eligibility of Resolution Applicant
One of the major objectives of the amendment is to strengthen the Insolvency Resolution Process for the purpose of which certain prohibitions are introduced for the entities who can submit a resolution plan. These Changes are explained as follows:
- Definition: While the original definition of the ‘Resolution Applicant’ recognized any person who submitted resolution plan to the resolution professional, the amendment made the position of resolution applicant very specific. It stressed upon resolution applicant as an entity individual or joint who submits a plan only when an invitation has been sent to him by Resolution Professional under the amended Section 25(h) of the Code.
The government’s determination is clearly visible from the amendment made in the definition of Resolution Plan in Section 5(26) where for the purpose of accepting the plan, the word ‘any person’ was replaced by ‘Resolution Applicant’.
- Invitation Criteria: While in the previous regime of The Code, eligibility norms for resolution applicant were pretty facile, instances can be taken from Section 36 of the IBBI Regulation, 2016 which allowed the submission of resolution plan from ‘Any potential applicant’, which is a very vague worded expression and any person through hook or crook can become part of such touchstone.
Now by amending Section 25(2) (h), the situation where any person could put forward a resolution plan has been narrowed to only those entities who passes through the approval of the committee of creditors and keeping in view the scale and complexity of operations of business of the Corporate Debtor to avoid frivolous applicants.
- Introduction to Section 29A: The ordinance has also demarcated some additional requirements for the applicants before their plan is approved by the Resolution Professional. The important point to note here is that this condition also implies to Section 35(1)(l) which actually bar the promoters of companies undergoing the resolution process from bidding for their own companies, which includes some big shots such as Essar Steel, Bhushan Steel, Jaypee Infratech, ABG Shipyards etc. Some criteria of ineligibility are:
Wilful Defaulters are–
- Those individuals which have Non-Performing Assets for a period of one year or more has elapsed from the date of such classification;
- Those who have executed an enforceable guarantee in favor of a creditor, in respect of a Corporate Debtor;
- Those prohibited by Securities Exchange Board of India or convicted of any offence punishable for two or more years;
- This also includes connected persons to the above, such as those who are Promoters or in the management of control of the Resolution Applicant, or will be Promoters or in the management of control of Corporate Debtor during the implementation of the Resolution Plan, the holding company, subsidiary company, associate company or related party.
As a result of the newly introduced Section 29A of the Code, sister concerns of the debtor, as well as corporate guarantors will also be ineligible to bid for these companies.
Reliability of the Process
It is important for investors to have faith in the procedure and the government’s desperation to leave no stones unturned for this purpose against the wilful defaulters is quite clear from the changes made in Section 35(1)(l). This section deals with the sale of the movable and immovable property. Same eligibility criteria, which are laid down on the resolution applicant, are imposed on the buyers of such assets also, causing the promoters to not even be able to bid for such assets.
Promoters buying their own stressed assets is not justified to the creditors who can use those assets to set off the amount due to them. This has also been pointed out by Ranjish Kumar, chairman of the State Bank of India who said: “Promoters are within their rights to submit bids in the resolution process of stressed assets under Insolvency & Bankruptcy Code which is not justified.” However, the changes made in Section 35 will surely keep a check on the promoters and their related party using their shell companies in the process of liquidation for any kind of recovery of their assets.
Effects of Amendments
The government’s desperation to keep on edge, all the ineligible characters from the insolvency proceedings is quite visible from the changes made in Section 30(4). Not only Section 29A is imposed on any future resolution applicant but the same is bound to affect any and every resolution plan submitted which is not in compliance with Section 29A even when no other resolution plan is sought to be available.
Earlier the plan could be accepted by a simple majority of seventy-five percent but now the feasibility, as well as the viability of the plan needs to be kept in check in addition to the eligibility standards of the applicants. This is bound to affect approximately 300 insolvency proceeding across the nation.
Punishments and Penalties
Although offences and their respective penalties are laid down in Chapter VII of the code. But those penalties are very specific in nature and will not extend to any other individuals and hence, a lot of entities are not covered in Chapter VII. Instances can be taken from the Resolution Professional whose duties are carefully laid down in the code but in the case of any negligence or contravention, there is no provision for any deterrent action.
But now the ordinance has introduced Section 235A which extends to any person or offence for which no punishment is provided in the Act and gives the power to the IBBI to put a penalty up to Rs. 2 Crore.
Issues not addressed by the amendment
Regarding The Dues of Public Depositors
The Code has downright disregarded the presence of creditors other than financial creditors and operational creditors. Especially, credits like public deposits, defined under section 2(1)(xii) of the Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998 which holds a significant place in providing funds to a company. Public depositors are institutionally segregated as compared to other finances and unfortunately, do not have any legislative support to demand their claims as Insolvency and Bankruptcy Board of India Regulations, 2016 only provides for forms of submissions of claims by operational creditors and financial creditors.
Although Insolvency and Bankruptcy Board of Indian in its press release dated, 16th August 2017 has stated that there could be claims from a creditor who is not a financial creditor or an operational creditor and introduced specific form for submitting its claims but the same is vaguely worded and is not substantiated. Although the ordinance’s objective is to increase the reliability of the investors but no steps have been taken in order to curb this issue.
Voting Rights of Operation Creditors in the Committee of Creditors
It is unfortunate that despite the size of the debt due, the operational creditors’ role is limited to a mere spectator only. It is laid down in Section 21(2) that Committee of Creditors shall comprise of financial creditors only and if a person is financial as well as an operational creditor then that person is allowed to vote only till the extent of his/her financial debt. Moreover not all the operational creditors are allowed to attend the meetings of the CoC and only those who have an aggregate due of at least 10% of the total debt are sent the notice for the meeting. Although operational creditors have the right to put forward a resolution plan at the end of the day, the same has to be approved by a committee compromising of financial creditors only.
No Provision of Notice by Financial Creditors
One of the major issue, the Code as well as the ordinance failed to address is that the provision under Section 7 nowhere talks about servicing of notice to the corporate debtor, as in the words of Section 7 a financial creditor can directly approach the Tribunal. The only condition that needs to be satisfied is that he must show that the corporate debtor has defaulted on the payment of due debt and that too of an amount as small as Rs 1 lakh only.
This stands in clear violation of the principle Audi Alteram Partem that is a basic aspect of natural justice. Insolvency affects an entity to its very core and involves a lot of financial issues as well; therefore it is crucial that a notice is served to the corporate debtor before the admission of the application. The provision of notice would provide the opportunity to the corporate debtor to bring his side of the facts to the observation of the Adjudicating Authority as to whether any such default has actually occurred.
Loss of Jobs
The present insolvency law has taken into consideration many factors that were failed to be noticed before, but the one thing amongst that was been ignored is the loss of jobs. The Code addresses the claim of financial creditors, operational creditors (secured and unsecured), insolvency costs and others as well but completely overlooks the employees. It is estimated that during the Code’s operation 2400 employees have lost their permanent jobs.
Reallocation of the resources might have saved some of those jobs but the Committee of Creditors owing to their own interest and the Code’s stringent time limits are hardly observed to make an effort for the employees. The socio-economic harm caused by this is beyond the measure of any statistics.
Insolvency not to be a Substitution for Recovery
The Code’s major objective was of consolidation relating to Insolvency. In practice, it is something parallel to the process of winding up under the regime of Companies Act, which was prevalent before the inception of the Code. It is also submitted even when the Code was not in existence, winding-up petition was not a legitimate means for seeking to enforce payment of the debt.
It should also be noted that the Code provides a very strict deadline of 180 days (and a 90 days extension with permission) for completion of the corporate insolvency process. If the process is not effective then the only result that will follow is liquidation. This feature might be eulogized by the proponents but the legislative authority has conveniently overlooked the fact that Negotiating under constant threat of liquidation may lead parties not to consider any other recovery mechanism and would ultimately lead to wide going-concern fire sales (translating into creditor under-recoveries). The most unfortunate part is that the companies who have greater chance to survive if provided proper debt restructuring would be salvaged affecting jobs and livelihoods as well.
Cost of the Insolvency Process
The code provides for an industry of Insolvency Resolution Process regulated by a Board, as borrowed from the United Kingdom, where IRPs acts as an agent of the creditors, which for sure reduces the cost of the inter-creditor agency.
However, through empirical studies conducted on the UK bankruptcy regime, it is revealed that while adoption of the IRP model resulted in higher realizations, they also correspondingly increased costs of bankruptcy and thus did not materially improve creditor recoveries. Because of which the cost of insolvency and bankruptcy process burdens the insolvency company itself and a well-established IRPs industry can harm the overall success of the Code.
Conclusion
The code indeed proved to be an umbrella to have brought together all the proceedings and no wonder, the inception of the Code is often termed as ‘silver bullet’ by economists as it helped recover Rs 9 lakh Crore bad loans in the prescribed time. However, the root of all drawbacks was the Code seemed to be a bit over-ambitious. In order to combine to pros of other nation’s insolvency laws, the Code overlooked some serious domestic issues especially jobs and non-institutionalised investors as well as creditors.
Coming on to the ordinance which is overestimated as being brutal for the promoters of the company actually, it just focuses on keeping the wilful defaulters at bay and promoters when fulfilled their financial obligation are welcomed for liquidation and being an applicant as well.
On the other hand, the ordinance, still, in its entirety fails to address many other problems in the Code which if addressed properly would result in an efficient revival rather than salvation and would certainly enhance the ease of doing business in India.
Finally, it suffices to say that, although it is a strong political step against the entities that take huge loans and then fails to pay back owing to their mismanagement but economically it might lead to a downfall as a promoter, as bidders, would always inspire better bids.
