The Insolvency and Bankruptcy Code, 2016 (IBC) enacted on 28th May 2016, in the context of the increase in non-performing loans, to establish a consolidated framework for the resolution of corporate insolvency , partnerships and individuals in a limited manner, seeks to address the problem of non-performing assets (NPA) in two ways.
First, behavioral change on the part of debtors to ensure sound business decision-making and prevent business failures is encouraged. Second, it envisions a process by which corporations in financial difficulty are put through a process of rehabilitation and put back on their feet.
Under the IBC, India’s insolvency regime changed from ‘debtor in possession’ to ‘controlling creditor’. The controlling creditor model places control of the debtor in the hands of its creditors and relies on the managerial skills of a newly appointed management to take over a struggling business and ensure business continuity. In Swiss Ribbons Vs Union of India, the Supreme Court ruled that the main purpose of the IBC is to ensure the revival and continuation of the debtor business. Thus, the IBC has a greater public welfare consideration at stake.
The three class goals
The IBC defines three categories of people who can trigger the Business Insolvency Resolution Process (CIRP) – financial creditors, operational creditors and business debtors.
For an operational debtor, the Apex Court in Mobilox Innovations Vs Kirusa Software observed that operational debt should be free from any pre-existing litigation that cannot be dealt with summarily in insolvency proceedings. In terms of liability, in Lalit Kumar Jain Vs Union of India, the Supreme Court clarified that the liability of a guarantor is co-extensive with that of the principal debtor. As a result, parallel proceedings could be initiated against the guarantors.
Perhaps the most important aspect of the IBC is the speed of insolvency resolution. The Supreme Court in Kridhan Infrastructure Vs Venketesan Sankaranarayan, observed that insolvency resolution should not suffer from indefinite delay in completely abandoning the time limits set under the IBC.
Once an insolvency petition is admitted, a moratorium is introduced. In P Mohanraj Vs Shah Brothers Ispat, the Supreme Court ruled that a moratorium prohibits the institution and continuation of any proceedings against the debtor company during the CIRP. A moratorium is meant to prevent further depletion of the debtor company’s assets and therefore acts as a “shield”, but it does not protect the debtor company’s key management personnel who were responsible for the insolvency.
The BAC also prohibits certain individuals from submitting a resolution plan or participating in the insolvency resolution process. The Supreme Court in Chitra Sharma Vs Union of India has ruled that the purpose behind the bar against certain people is to ensure that the people responsible for the debtor company’s insolvency do not participate in the CIRP through an entry stolen.
Similarly, in Phoenix ARC Vs Spade Financial Services, it was observed that the IBC provides that any party related to the debtor company is not entitled to serve on a Committee of Creditors (CoC) . The purpose of such a provision is to prevent the decisions of the CoC from being sabotaged by parties related to the debtor legal person.
In addition to the power to undertake insolvency resolution proceedings, the National Company Law Tribunal (NCLT) has broad residual jurisdiction under the IBC to adjudicate all matters arising out of or in connection with the insolvency and liquidation of debtor companies. However, in the litigation process regarding a resolution plan, the Apex Court in the Jaypee Kensington case held that there was no possibility of interference with the commercial wisdom of the CoC. If a contracting authority discovers deficiencies in the resolution plan, it will then be returned to the CoC for resubmission.
The IBC has largely reformed the landscape of Indian insolvency law. He contributed to the development of disciplined borrowing among businesses. Developers fear losing control of their businesses in the event of default. A whopping 18,629 applications seeking more than ₹5,29,000 crore were reportedly resolved before even being admitted. After the implementation of the IBC, according to the World Bank report, India’s ranking in insolvency resolution fell from 136 in 2017 to 52 in 2020. Recovery rates under the IBC are low. In some cases haircuts of up to 95% are granted upon resolution of insolvency. Since 2016, lenders have taken on average a 61% discount on receivables.
The pending insolvency issues add to the problem. About 71% of cases have been pending for more than 180 days, which is a marked departure from the intention to resolve insolvency quickly. In terms of membership, as of September 2021, the NCLT was operating without a chairperson and was 34 members short of a total sanctioned membership of 62 members.
Another important challenge is the digitization of the IBC ecosystem. The lack of digitization has caused the insolvency process to be blocked with long delays well beyond the legal limits. Often, admitting cases into NCLT proved to be a task. In its report, a special parliamentary committee found that the NCLT and the National Company Law Appellate Tribunal (NCLAT) should be digitized. Virtual hearings should be scheduled to quickly deal with pending cases.
The path to follow
It is important that key stakeholders do their best to ensure that the power of the CIB does not diminish. The aim should be to fill in the gaps discovered and to move towards a more complex legal system over time. Statistics indicate that the majority of liquidations occur in cases where the debtor’s assets erode over time during a prolonged insolvency process.
Therefore, the speed of insolvency resolution is essential. The government should allocate appropriate budgetary allocations to the development of insolvency professionals, the improvement of court infrastructure and the digitalization of the insolvency resolution process.
The IBC has undoubtedly revived India’s insolvency regime. Not only has it successfully combated the growing threat of NPAs, but it has also benefited the economy in various nuanced ways, including improving credit discipline. According to reports, a total of ₹2.5-lakh crore was reintroduced into the banking system from 2016 when resolving insolvencies under the IBC.
However, like any other law, the BAC also has areas that can see remarkable improvement. India’s insolvency regime still has a long way to go to meet the standards of other mature global jurisdictions.
The authors are attorneys at Phoenix Legal, a law firm
February 20, 2022