By: Ramesh Vaidyanathan and Mansi Singh
Sixteen years after the Justice Eradi report recommended a new insolvency law for India and the setting up of the National Company Law Tribunal (“NCLT”), the constitutionality of NCLT being upheld by the Supreme Court of India and a new company law coming into force in 2014, the Insolvency and Bankruptcy Code (“Code”) finally came into effect on May 28, 2016.
The Code seeks to consolidate and amend the laws relating to reorganisation and insolvency resolution of companies, partnership firms and individuals in a time bound manner. The Code seeks to establish an Insolvency and Bankruptcy Board of India (“Board”). The highlight of the Code is that it provides creditors an option to revive the defaulting company by drawing up a resolution plan instead of directly aiming for liquidation.
Need for a new law:
India ranks an abysmal 136th out of 189 countries in resolving insolvency according to the “Doing Business 2016 report” of the World Bank.  Unsurprisingly, it is telling that India did not have a single law dealing with insolvency and bankruptcy before the Code. Rather, we had several laws that dealt with insolvency for companies such as the Sick Industrial Companies Act 1985, the Recovery of Debt Due to Banks and Financial Institutions Act, 1993 (“RDDB Act”) and Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. Then there were a couple of laws dating back to the British era that dealt with individual debtors (the Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920). As a consequence, multiple authorities such as the high courts, the Company Law Board, the Board for Industrial and Financial Reconstruction and the Debt Recovery Tribunals (“DRTs”) had overlapping jurisdiction resulting in procedural delays and inefficient processes. There were 62,000 cases pending before the DRTs as of December 2014 and as of 2015 insolvency resolution in India took 4.3 years on an average, as against an average of 1.5 years in developed countries such as the United Kingdom and United States of America.
Prior to the Code, winding up of companies was under the supervision and control of the High Courts. After passing an order of winding up, the concerned High Court would appoint the liquidator who would then take charge of the affairs of the company and carry out the process of winding up in a time consuming manner.
Besides repealing the Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920, the Code seeks to amend 11 laws, including the Companies Act, 2013 and RDDB Act. The Code is expected to be a game-changer in drastically overhauling the insolvency resolution framework and improving the ease of doing business in India.
The highlights of the Code are as follows:
Time-bound process for insolvency resolution
Corporate entities: When companies and limited liability partnerships default, the resolution process can be initiated by the debtor or creditor and be administered by an insolvency professional. Insolvency process has to be completed within a period of 180 days, with an extension of up to 90 days if 75 percent of creditors agree. If insolvency cannot be resolved within the above timeframe, the assets of the borrowers would be sold to repay the debts. There is also a fast-track 90 day corporate insolvency process.
Individuals and partnership firms: In the case of insolvency resolution of individuals and partnership firms, negotiations between the debtor and creditors will be supervised by an insolvency professional. If negotiations succeed, a repayment plan agreed upon by a majority of the creditors will be submitted to the adjudicator. If they fail, the matter will proceed to bankruptcy resolution. The resolution process for individuals and partnership firms shall also be completed within a span of 180 days or 270 days (if extension has been sought).
Initiation of the insolvency resolution process: Where any corporate debtor commits a default in payment of debt, insolvency resolution process under the Code can be initiated by a financial creditor (a person to whom a financial debt is owed such as amount payable under a credit facility, note, etc.), an operational creditor (a person to whom an operation debt is owed such as a claim in respect of the provision of goods and services) or by the corporate debtor itself by filing an application in the NCLT. The minimum amount of default to initiate proceedings against individuals and partnership firms is INR 1,000 (Indian Rupees One Thousand) while it is INR 1,00,000 (Indian Rupees One Lakh) for companies and limited liability partnerships.
Professional Insolvency resolution framework and infrastructure:
The Code completely overhauls the existing regulatory framework to facilitate insolvency resolution.
Insolvency professionals: The Code provides for insolvency professionals (“IPs”) who are enrolled with an insolvency professional agency (“IPAs”) and registered with the Board. These IPs will be specialised licensed professionals with qualifications and experience in the field of finance, law, management, insolvency and related fields. The IPs will administer the resolution process, constitute a committee of creditors, manage the assets of the debtor and obtain information from the Information Utilities (“IUs”) to assist in the process of decision making. The Board will regulate the IPAs, who in turn will regulate IPs by conducting examinations to enrol them, and enforcing a code of conduct.
IUs: IUs will be established to collect, collate and disseminate financial information to facilitate insolvency resolution besides storing facts about lenders and terms of lending in electronic databases. This is expected to eliminate delays and disputes about facts if any default takes place as the insolvency professionals and creditors can obtain information about the liabilities of the debtor from such IUs. It remains to be seen whether this will merge and bring together the existing Central Registry of Securitisation Asset Reconstruction and Security Interest of India and Central Repository of Information on Large Credits.
Priority for distribution
The Code provides an order of priority to distribute assets during liquidation which is significantly different from the earlier regime. The Code proposes to protect the workers in case of insolvency, paying their salaries for up to 24 months. Central and state Government dues rank below the claims of secured creditors, workmen dues, employee dues and financial debts owed to unsecured creditors.
The NCLT will adjudicate insolvency resolution for companies and limited liability partnerships. The DRTs will adjudicate insolvency resolution for individuals and partnerships. Appeals against orders of these tribunals may be filed before their respective Appellate Tribunals and further before the Supreme Court with special leave.
Insolvency and Bankruptcy Fund (“Fund”)
The Code creates a Fund for the purposes of insolvency resolution, liquidation and bankruptcy of persons. Deposits to the Fund will include: (i) grants made by the Central Government, (ii) amount deposited by persons as Fund contribution, and (iii) interest earned on investments made from the Fund. While the Code is silent on the manner of use of the Fund, it states that any person may withdraw up to the amount of his deposit if insolvency proceedings are initiated against him for specific purposes.
The Code provides a moratorium period during the insolvency resolution process when no proceedings can be taken against the debtor. During such period, the IPs are required to take over the management and powers of board of directors of the debtor. This is a welcome provision as it will provide the debtors the time and space to revive the company rather than being hounded by litigations from all sides. This provision, introduced in India for the first time, has been modeled on the UK practices where the insolvency professional controls the process during the insolvency resolution as against the US approach wherein the debtor remains in possession and control of the business even during the resolution process.
Cross Border Insolvency
The Code touches upon cross-border insolvency empowering the government to enter into bilateral agreements with foreign countries for enforcing the Code. It further gives the IPs the authority to write a letter to the courts and/or authorities of other countries with which reciprocal arrangements have been made for seeking information or requesting action in relation to the assets of the debtor situated in such country.
While the Code is a welcome step, it will take a few years for the infrastructural framework to be built and work in a seamless and robust manner, ensuring easy exit for businesses. As the already over-burdened DRTs are now being assigned with the additional responsibility of adjudicating insolvency cases of individuals and partnerships, the DRT infrastructure will have to be substantially increased and improved to achieve what the Code desires. Further, even though the Code suggests mechanisms to deal with cross border insolvency, a proper framework needs to be brought in place to deal with this issue. Bilateral agreements proposed by the Code may take a very long time to negotiate with each country and such agreements may differ from country to country. Overall, with the compulsory insolvency resolution process aimed to revive the company and having a moratorium in place, the Code goes a long way in revamping the insolvency resolution process in India.