The ultimate guide to understanding the Insolvency and Bankruptcy Code


Insolvency and Bankruptcy Code
Image credits: livemint.com

[Updated on 1st December 2017]

The Parliament passed the Insolvency and Bankruptcy Code on 11th May 2016. It was done to consolidate all the existing laws related to insolvency in India and to simplify the process of insolvency resolution.

[Insolvency is the inability of the individuals or corporates to repay their debts. Bankruptcy is nothing but a legal declaration of insolvency.]

What is the need for Insolvency and Bankruptcy Code in India?

There was no single law dealing with insolvency and bankruptcy in India. The liquidation of companies and individuals were handled under various Acts (around 12 in number). Some of them were:

  • Presidency Towns Insolvency Act, 1909
  • The Provincial Insolvency Act, 1920
  • Sick Industrial Companies Act
  • The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (also known as the Sarfaesi Act)
  • Companies Act 2013
  • Recovery of debts due to banks and financial Institutions Act

It led to an overlapping jurisdiction of different authorities like High Court, Company Law Board, Board for industrial and financial reconstruction  (BIFR) and Debt recovery tribunal.

This overlapping jurisdictions and multiplicity of laws made the process of insolvency resolution very cumbersome in India.

Nearly 60,000 bankruptcy cases are pending in India’s courts. As per the World Bank data, it takes an average 4.3 years to wind up a company in India. It is easier to start a business than to exit it.

The new Insolvency and Bankruptcy Code seeks to cut it to 1 year.

Also, the recovery of the debt under is just 25.7 cents on the dollar in India.

The new code seeks to help banks and other creditors from recovering their loans from the bankrupt companies in a timely and efficient way.

What are the salient features of the Insolvency and Bankruptcy Code?
  • The Insolvency and Bankruptcy Code 2016 is a comprehensive law and covers all individuals, companies, Limited Liability Partnerships (LLPs) and partnership firms.
  • The adjudicating authority is National Company Law Tribunal (NCLT)  for companies and LLPs and Debt Recovery Tribunal (DRT) for individuals and partnership firms.
  • The insolvency resolution process can be initiated by any of the stakeholders of the firm: firm/ debtors/ creditors/ employees. [As on 1st Dec 2017, more than 1000 cases have been filed with the NCLT]
  • If the adjudicating authority accepts, an Insolvency resolution professional or IP is appointed. [Out of the 1000 cases filed, 400 cases have been admitted by the NCLT]
  • The power of the management and the board of the firm is transferred to the committee of creditors (CoC). They act through the IP.
  • The IP has to decide whether to revive the company (insolvency resolution) or liquidate it (liquidation).
  • If they decide to revive, they have to find someone willing to buy the firm.
  • The creditors also have to accept a significant reduction in debt. The reduction is known as a haircut.
  • They invite open bids from the interested parties to buy the firm.
  • They choose the party with the best resolution plan, that is acceptable to the majority of the creditors (75 % in CoC), to take over the management of the firm.

To summarise the above, the IP has to decide whether to carry out insolvency resolution process or liquidation. They decide to do Insolvency resolution when the firm can be made economically viable.  They find a new buyer for the firm to allow it to continue its operations. The creditors accept a haircut.

Note that a haircut is better than recovering nothing or a minimal sum.

  • The law prescribes that this insolvency resolution process have to be completed within 180 days. It can be extended by 90 days if the case is complex. If a decision is not reached within the time frame, the firm will be liquidated. [10 companies have reached the liquidation stage].

[Update: The Government passed an ordinance in November 2017 to amend the insolvency and bankruptcy code. It barred wilful defaulters and the people associated with defaulting firms (promoters etc.) from participating in the insolvency process. [Wilful defaulters are people who have defaulted despite their ability to repay the loan]

It means that the promoters of the defaulting firm are not allowed to buy back its own firm.

This is because it creates moral hazard. The promoter may wilfully default on his loans and run the company into bankruptcy because it can bid to buy back his company later at a discount (reduction of the loan amount to be repaid).

But, there are concerns that the new amendment may be counter-productive for the creditors. There will be a lesser number of people to take part in the resolution process to buy the company. It will cut competition and the IP may have to accept a lesser price. This will lead to bigger haircuts for creditors (banks etc.)

Also, the default could be due to genuine reasons and the promoters may be better experienced to manage the company than the new buyer.]

Things to note:

  • Insolvency professionals (IP) will be members of Insolvency Professional Agencies (IPA) created under the Bankruptcy Code. The IPAs will certify the IPs.
  • The code will also address cross-border insolvency through bilateral agreements with other countries.
  • Information utilities have also been created to collect, collate and give all information about debtors to make a database about serial defaulters.
  • Insolvency & Bankruptcy Board will be set up to regulate insolvency professionals, insolvency professional agencies and information utilities.
What are the potential benefits of the Insolvency and Bankruptcy Code?

For a free market economy to work in an efficient way, ease of exit is just as important as ease of entry. Easy exit ensures the survival of the fittest in the market and leads to optimum allocation of capital.

The ancillary benefits of the code are:

  • It will improve India’s ranking in the World Bank’s ‘Ease of Doing Business’ index. On the measure of resolving insolvency, India is ranked at 136th among 189 countries. The bankruptcy code is expected to improve this ranking. (Read: India Jumps to 100th Rank in Ease of Doing Business Report)
  • It will promote investment and entrepreneurship in the economy.
  • It will help to resolve India’s bad debts problems. Banks will be able to recover their loans from the bankrupt companies in a timely manner. The code could reduce the chances of another case like Kingfisher in India.
  • Timely resolution of companies will free up bank’s resources and increase credit availability in the economy. In other words, it has the potential to solve India’s twin balance sheet problem. (Read: The Twin Balance Sheet Problem Explained)

In June 2017, the RBI directed the banks to file insolvency applications for 12 large accounts that had defaulted on their loans The timetable set by the law implies that these accounts must be resolved or the companies liquidated by April 2018 at the latest.

This will be beneficial for the banks. It will clean up their books. But, it will also mean acceptance of a significant reduction in debt and suffer huge losses. This will lead to capital depletion. This is one of the reasons the Government decide to recapitalise the banks by Rs.2.11 lakh crores.

(Read: The Bank Recapitalisation Bond – Explained)

The Insolvency and Bankruptcy code will help all stakeholders involved in an insolvent company. As a statement by the Finance Ministry puts it ” Some business ventures will always fail, but they will be handled rapidly and swiftly. Entrepreneurs and lenders will be able to move on, instead of being bogged down with decisions taken in the past.”

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References:

Indian Express

The Economist Explains

Livemint

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Have any Question or Comment?

4 comments on “The ultimate guide to understanding the Insolvency and Bankruptcy Code

Suman

We should learn the direction of writing from you. I am expecting, in near future economyria would consume most of my day and night.
Thanks Mridu

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Mridusmita

Thanks 🙂

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Vinay

Explained beautifully. Thanks.

Reply
Mridusmita

You are welcome 🙂

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