Theliberalization reforms of 1990’s dismantled the license-quota raj and removedthe barriers to start a new business. But one of the key measures to encouragebusiness is the freedom to exit. As per World Bank reports, the amount of timetaken to complete the bankruptcy process in India averages around 4.3 years incomparison to 0.
5-1.5 years in US, Singapore and Finland. Further thepercentage recovered is as low as 26% in India as compared to 78-92% in thedeveloped economies.
Further,the Indian banking sector is struggling through the crisis of bad debts. As percentral bank, the total stressed assets of the banks increased to 14.5% oftheir total loans at the end of December, 2015.
These stressed assets amount toINR 10 trillion which are hampering the business of the banks. Therehave been several laws in place such as Sick Industrial Companies Act, Recoveryof Debt Due to Banks and Financial Institutions Act, etc. but this largevariety of laws have posed as a problem for the banks, leading to failure inrecovery of the loans. In addition, with the increase in presence of globalinstitutions and investors in India, there have been serious concerns from theinternational investors on the regulatory risks and time taken for theresolution.
This calls for the need to create a single mechanism for thebusinesses to resolve the insolvency.TheInsolvency and Bankruptcy code (IBC)is a single law created to consolidate the existing framework. It acts as a onestop solution to the current process which is both time consuming and noteconomically viable by creating a framework which reduces both, time and costin attaining liquidity, initiating the recovery process and further improvesthe ease of doing business. The objective of the act is to maximize theeconomic value of assets of firms, individuals and corporates by increasing theavailable credit, and in due course of time, encourage the lenders for higherdebt financing and further to promote entrepreneurship. Prior to the Insolvency and Bankruptcy Code(IBC), 2016Lendershave been using solvency processes however, these processes been used toresolve smaller cases and are yet to do it in any large corporate account.
Another reason for lenders staying away is because the RBI hasn’t given anyclarification as to how the provisioning on accounts would work when they areunder the insolvency process.Theneed for such a law can be attributed to the fact a huge ofcompanies often file their appeals with the National Company Law Tribunal, butwithdraw these applications before the case could move further ahead. Thisshows the lack of trust companies have in the system and therefore they preferan out of court settlement because it helps them save on the amount of time andresources involved. Under all the previous acts implemented by the government,the issues remained unresolved for years.According to the Ministry of law, “Only 20 per cent ofall debts are recovered in India and globally, India ranks 136th intime taken for resolving disputes.
” Beforethe IBC code came into existence, India had numerous acts to punish thedefaulters1. Indian Contract Act, 1872This was the first law dealing withinsolvency enacted by Britishers during the colonial era. It was based on theprinciples of ‘English common Law’ and had simple and elementary rules relatingto borrowings.2.
Presidency-Towns Insolvency Act, 1910During the colonial rule, India had been divided intoPresidency towns for better administration. The PTI Act gave High Court thepower to decide matters relating to insolvency who also decided on allquestions pertaining to insolvency3. Recoveryof debts due to Banks and Financial Institution Act 1993The RDBFI act was set up to counter the ever-growing NPAproblems in India. This was followed by setting up a special Debt RecoveryTribunal (DRT) that could review the important cases. Before the enactment ofthis act, a lot of financial and non-financial entities were facing challengesin recovering debts from the borrowers. Since the courts were overburdened withlarge numbers of regular cases, they were neither able to prioritize theimportant cases nor expedite the existing cases.4. The Securitizations and Reconstruction of Financial Assetsand Enforcement of Security Interest Act, 2002 (SARFAESI Act)Even after the implementation of the RDBFI Act, thegovernment was unable speed up the recovery of debts and the balance sheet ofthe financial and non-financial institutions continued to be red.
“The SecuritizationAct aimed to expedite this problem by securitizing and reconstructing thefinancial assets through two special purpose vehicles viz. SecuritizationCompany (‘SCO’)’ and Reconstruction Company (RCO).” The aim of this act was tomake adequate provisions for the recovery of the loans and also to foreclosethe security. Priorto the Insolvency and Bankruptcy Code, banks dealt with stressed assets mainlyby way of Corporate Debt Restructuring(CDR) or through Joint Lenders Forum(JLF). However, CDR’s have only been able to revive 17% of the stressed assetsof banks in 2016 due to ineffective monitoring.TheRBI in 2015 provided the banks with the method of Strategic Debt Restructuring (SDR), which provided the lenders withthe authority to take control and run the business in order to revive them. However,this method did not seem to appeal much to the lenders. Hence, later on in June2016, RBI devised the method of S4A(Scheme for Sustainable Structuring of Stressed Assets), wherein controlremained with the promoter, provided 50% of their debt was ‘Sustainable’.
However, its eligibility was limited due to the presence of certain conditionslike short term cash flow visibility, and preventing change in repayment terms.The insolvency and bankruptcy problem was not controlled by any single law.This problem of corporate stressed assets required to be dealt with in acomprehensive and time bound manner, which led to the introduction of theInsolvency and Bankruptcy Code in 2016. Insolvencyand Bankruptcy Code (IBC), 2016TheInsolvency and Bankruptcy Code lays out clear differentiation betweeninsolvency and bankruptcy.
Insolvencyis based on short term view while bankruptcyis concerned with long term inability of the company to meet itsliabilities. Its major objective is to ensure faster and better debt recoveryprocess.Needfor the Code – · Address the NPA problem· Reduce the time period ofrecovery· Ensure better andeffective recovery process· Develop confidence ofinvestors· Allow sick businesses asecond chance for revival TheInsolvency Process -Thecorporate insolvency process as per the IBC Code has been simplified,structured and involves the following stages – Resolution Plan is implemented Thefinancial or operational creditors of the company may file an application withthe NCLT (National Company Law Tribunal) in case of default, i.e., the failureto pay either a part or whole of the amount due (installment or principal),with minimum default of INR 1lakh. The plea if accepted by the Tribunalappoints an Insolvency Resolution Professional (IRP) who is responsible to runthe company and prepare a resolution plan for the company within the next 180days (extendable up to 90 days). During this period, the promoters and board ofDirectors do not have any say in the operations of the company.
If the IRP isunable to revive the business within the moratorium period, the liquidationprocess of the sick unit is initiated to ensure recovery. Priorityof Claims -Theclaims against the company shall be met in the following order – · Liquidation andinsolvency resolution process costs· Secured creditors anddues of workmen (up to 24 months)· Dues of other employees(up to 12 months)· Claims of unsecured creditors· Government dues (up to 2years)· Unpaid secured creditors· Any remaining dues· Preference shareholders(if any)· Equity Shareholders KeyChallenges in Implementation –· Transformationof banking system – The banks need to movefocus from a lower cost policy to more professional judgement, identify theinefficiencies in the current model and alter their system accordingly which isa time-consuming process.· Legalmatters – Insolvency and bankruptcy is nowidentified as a commercial issue with various matters requiring approvals fromshareholders.· Timeconstraint – The 180-day moratorium period may actas constraint in case of insolvency of large or complex organizations.· Availabilityof Professionals – Professionals should be trainedand equipped with the skills required to be an insolvency professional andcarry out the process with integrity· Synchronizationof Norms – The various policy initiatives of theRBI such as the CDR, SDR, S4A nee to be aligned with the IBC Code. Analysisin the Global ContextIndianinsolvency code has many provisions adopted from UK’s insolvency code which isconsidered as the best working model of insolvency code but there are also somedifferences. In both the codes, there is a provision that both creditors ordebtors can file for the insolvency. In both the regimes, during liquidationpriority is given to the secured and preferential creditors while payment andbefore these payments liquidation costs are paid.
Inthe UK, the insolvency professional does not require any approvals regardingthe operations of the company during the insolvency process but in India, theinsolvency professional requires to get prior approvals from the creditors forsome actions. In the UK, the insolvency professional has to provide a bondwhose value depends on the value of the asset involved so that he or she doesnot get involved in any kind of fraudulent activity but in India, there is nosuch provision. Also under the UK regime, only an individual can be insolvencyprofessional while under India’s regime, insolvency professional can be anindividual or a partner organization. Under the UK’s code, both operational andfinancial creditors are included in the committee of the creditors and henceboth have the voting rights during the insolvency process but under India’sregime, only financial creditors are included in the committee of thecreditors. The India code specifies the moratorium period from 180 days with 90days of relaxation while in the UK, the moratorium period is not specified. Thisis the data for the time taken to resolve insolvency cases and the rate ofrecovery i.e.
cents recovered per dollar of loan issued in various countries. Country Time taken (Years) Recovery Rate (Cents/Dollar) USA 1.5 81.
5 UK 1.0 88.6 Russia 2 41.3 China 1.7 36.2 India** 4.
3 25.7 **means before implementation of IBC Cross-BorderInsolvency Provisions -TheIBC has many provisions adopted from UK’s insolvency Code as mentioned abovebut lacks in certain aspects from being global. It does not provide forCross-border insolvency, i.e., insolvency proceedings in foreign countriesrelating to foreign assets and foreign creditors.
It arises when Indian firmshave claims against global defaulting firms or vice versa.The Code only provides the Central government with the power to enforceprovisions of the Code by entering into agreements with foreign countries. The Bankruptcy Law Reform Committee (BLRC)was of the view that the UNCITRAL ModelLaw on cross border insolvency, adopted by 41 countries should beimplemented only after the effective adoption of the Insolvency Code, given thecomplexities involved in cross border cases. However, the committee hasrecognized its need in today’s global world. The Joint Parliamentary Committeewas of the view that absence of this provision shall lead to an ‘IncompleteCode’ and hence included two sections in this regard –· Sec234 – Agreements with Foreign Countries –which allows the Central Government to make bilateral agreements with foreigngovernments· Sec235 – Letter of Request to a country outside India in certain cases – The NCLTmay request the authority in the foreign nation to provide evidence in relationto the foreign claims of the debtor. Analysisin the Domestic ContextInIndia, before IBC, there were many laws for resolving insolvency such asCompanies Act 2013, Sick Industrial Companies Act 1985, Recovery of Debts Dueto Banks and Financial Institutions Act 1983, etc. It was a fragmented legislativeframework to resolve insolvency but IBC is a single law to resolve such casesfor both retail and corporate borrowers.
In the earlier regime, it took about4.3 years to settle insolvency proceedings in India but under IBC, this periodhas decreased significantly. Also, the recovery rate which was earlier around25.7 (cent/dollar) is expected to increase. In 2016, the non-performing assetswere 9.19% of total loans issued by banks. It is a huge burden on the bankingsystem and the economy.
After the implementation of IBC, the NPAs are expectedto come down. After the promulgation of IBC Act, the ease of doing businessranking of India has improved to 100th position. This can beattributed to the improvement in the ranking of one of the ten parametersconsidered by the world bank which is resolving insolvency, India’s ranking onthis parameter has improved from 136 to 103. RecommendationsInsolvencyand Bankruptcy code is a revolutionary reform which will reduce thenon-performing assets but it has certain issues and following are ourrecommendations to rectify those issues:· More than 1000 cases havebeen filed under IBC in the last one year and out of these, 32% cases have beenfiled by financial creditors (secured creditors) and 47% cases have been filedby operational creditors (unsecured creditors). So, more number of insolvencycases are filed by operational creditors but during the insolvency process onlyfinancial creditors form the committee of creditors and have the right to vote.We recommend thatthe committee of creditors should also include operational creditors so thatthey can also have voting rights during the insolvency process.
· Under the UK’s insolvencycode, the insolvency professional has to provide a bond with value equivalentto the value of the asset under consideration. This provision is implemented toprevent the insolvency professional from getting involved in any kind offraudulent activity. We recommend thatsuch provision should also be implemented in India to ensure that the decisionstaken by the insolvency professional during the insolvency process is withoutany vested interests. · The insolvency processinvolves the decision to either revive the business or shut down operations andfind a buyer for the sick company. In cases of decision of revival of business,the insolvency professional hands over the company back to the promoter.
However, this involves the bankers to take a haircut and forego certain amountsof their dues.Hence, ourrecommendation is that banks should not be pressurized to do so, it should bedone only in certain exceptional cases. The first step even in case of revivalshould be identification of surplus business assets as well as personal assetsof the promoters, which should be auctioned to release the money blocked.
Thismoney should be utilized for paying off the banks to the extent possible andthen ask them to take a haircut for the remaining amounts. This process shallhelp banks recover their NPA’s to a greater extent without hampering therevival process of businesses.· During the insolvencyprocess, assets which are under liquidation are generally sold at a value lessthan their market value. So, the banks or lenders have to accept a haircutwhile selling the assets. Some measures should be taken to avoid this.
One suchmeasure could be increasing the moratorium period from 180 + 90 days to agreater period to ensure better value is recovered for the assets of thecompany due to market fluctuations. This will give more time to the committeeof creditors to find a better resolution option and increase the recovery forbanks and lenders.