Critical Thinking

The around 4.3 years in comparison to 0.5-1.5

The
liberalization reforms of 1990’s dismantled the license-quota raj and removed
the barriers to start a new business. But one of the key measures to encourage
business is the freedom to exit. As per World Bank reports, the amount of time
taken to complete the bankruptcy process in India averages around 4.3 years in
comparison to 0.5-1.5 years in US, Singapore and Finland. Further the
percentage recovered is as low as 26% in India as compared to 78-92% in the
developed economies.

Further,
the Indian banking sector is struggling through the crisis of bad debts. As per
central bank, the total stressed assets of the banks increased to 14.5% of
their total loans at the end of December, 2015. These stressed assets amount to
INR 10 trillion which are hampering the business of the banks.

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There
have been several laws in place such as Sick Industrial Companies Act, Recovery
of Debt Due to Banks and Financial Institutions Act, etc. but this large
variety of laws have posed as a problem for the banks, leading to failure in
recovery of the loans. In addition, with the increase in presence of global
institutions and investors in India, there have been serious concerns from the
international investors on the regulatory risks and time taken for the
resolution. This calls for the need to create a single mechanism for the
businesses to resolve the insolvency.

The
Insolvency and Bankruptcy code (IBC)
is a single law created to consolidate the existing framework. It acts as a one
stop solution to the current process which is both time consuming and not
economically viable by creating a framework which reduces both, time and cost
in attaining liquidity, initiating the recovery process and further improves
the ease of doing business. The objective of the act is to maximize the
economic value of assets of firms, individuals and corporates by increasing the
available credit, and in due course of time, encourage the lenders for higher
debt financing and further to promote entrepreneurship.

 

 

Prior to the Insolvency and Bankruptcy Code
(IBC), 2016

Lenders
have been using solvency processes however, these processes been used to
resolve 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 any
clarification as to how the provisioning on accounts would work when they are
under the insolvency process.

The
need for such a law can be attributed to the fact a huge of
companies often file their appeals with the National Company Law Tribunal, but
withdraw these applications before the case could move further ahead. This
shows the lack of trust companies have in the system and therefore they prefer
an out of court settlement because it helps them save on the amount of time and
resources 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 of
all debts are recovered in India and globally, India ranks 136th in
time taken for resolving disputes.”

 

Before
the IBC code came into existence, India had numerous acts to punish the
defaulters

1.      Indian Contract Act, 1872

This was the first law dealing with
insolvency enacted by Britishers during the colonial era. It was based on the
principles of ‘English common Law’ and had simple and elementary rules relating
to borrowings.

2.      Presidency-Towns Insolvency Act, 1910

During the colonial rule, India had been divided into
Presidency towns for better administration. The PTI Act gave High Court the
power to decide matters relating to insolvency who also decided on all
questions pertaining to insolvency

3.     
Recovery
of debts due to Banks and Financial Institution Act 1993

The RDBFI act was set up to counter the ever-growing NPA
problems in India. This was followed by setting up a special Debt Recovery
Tribunal (DRT) that could review the important cases. Before the enactment of
this act, a lot of financial and non-financial entities were facing challenges
in recovering debts from the borrowers. Since the courts were overburdened with
large numbers of regular cases, they were neither able to prioritize the
important cases nor expedite the existing cases.

4.      The Securitizations and Reconstruction of Financial Assets
and Enforcement of Security Interest Act, 2002 (SARFAESI Act)

Even after the implementation of the RDBFI Act, the
government was unable speed up the recovery of debts and the balance sheet of
the financial and non-financial institutions continued to be red. “The Securitization
Act aimed to expedite this problem by securitizing and reconstructing the
financial assets through two special purpose vehicles viz. Securitization
Company (‘SCO’)’ and Reconstruction Company (RCO).” The aim of this act was to
make adequate provisions for the recovery of the loans and also to foreclose
the security.

 

Prior
to the Insolvency and Bankruptcy Code, banks dealt with stressed assets mainly
by 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 assets
of banks in 2016 due to ineffective monitoring.

The
RBI in 2015 provided the banks with the method of Strategic Debt Restructuring (SDR), which provided the lenders with
the 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 June
2016, RBI devised the method of S4A
(Scheme for Sustainable Structuring of Stressed Assets), wherein control
remained with the promoter, provided 50% of their debt was ‘Sustainable’.
However, its eligibility was limited due to the presence of certain conditions
like 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 a
comprehensive and time bound manner, which led to the introduction of the
Insolvency and Bankruptcy Code in 2016.

 

 

Insolvency
and Bankruptcy Code (IBC), 2016

The
Insolvency and Bankruptcy Code lays out clear differentiation between
insolvency and bankruptcy. Insolvency
is based on short term view while bankruptcy
is concerned with long term inability of the company to meet its
liabilities. Its major objective is to ensure faster and better debt recovery
process.

Need
for the Code –

·        
Address the NPA problem

·        
Reduce the time period of
recovery

·        
Ensure better and
effective recovery process

·        
Develop confidence of
investors

·        
Allow sick businesses a
second chance for revival

 

 

The
Insolvency Process –

The
corporate insolvency process as per the IBC Code has been simplified,
structured and involves the following stages –

 

 

 

 

 

 

 

 

 

 

 

 

Resolution
Plan is implemented

 

 

 

 

 

 

The
financial or operational creditors of the company may file an application with
the NCLT (National Company Law Tribunal) in case of default, i.e., the failure
to 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 Tribunal
appoints an Insolvency Resolution Professional (IRP) who is responsible to run
the company and prepare a resolution plan for the company within the next 180
days (extendable up to 90 days). During this period, the promoters and board of
Directors do not have any say in the operations of the company. If the IRP is
unable to revive the business within the moratorium period, the liquidation
process of the sick unit is initiated to ensure recovery.

 

Priority
of Claims –

The
claims against the company shall be met in the following order –

·        
Liquidation and
insolvency resolution process costs

·        
Secured creditors and
dues of workmen (up to 24 months)

·        
Dues of other employees
(up to 12 months)

·        
Claims of unsecured creditors

·        
Government dues (up to 2
years)

·        
Unpaid secured creditors

·        
Any remaining dues

·        
Preference shareholders
(if any)

·        
Equity Shareholders

 

Key
Challenges in Implementation –

·        
Transformation
of banking system – The banks need to move
focus from a lower cost policy to more professional judgement, identify the
inefficiencies in the current model and alter their system accordingly which is
a time-consuming process.

·        
Legal
matters – Insolvency and bankruptcy is now
identified as a commercial issue with various matters requiring approvals from
shareholders.

·        
Time
constraint – The 180-day moratorium period may act
as constraint in case of insolvency of large or complex organizations.

·        
Availability
of Professionals – Professionals should be trained
and equipped with the skills required to be an insolvency professional and
carry out the process with integrity

·        
Synchronization
of Norms – The various policy initiatives of the
RBI such as the CDR, SDR, S4A nee to be aligned with the IBC Code.

 

Analysis
in the Global Context

Indian
insolvency code has many provisions adopted from UK’s insolvency code which is
considered as the best working model of insolvency code but there are also some
differences. In both the codes, there is a provision that both creditors or
debtors can file for the insolvency. In both the regimes, during liquidation
priority is given to the secured and preferential creditors while payment and
before these payments liquidation costs are paid.

In
the UK, the insolvency professional does not require any approvals regarding
the operations of the company during the insolvency process but in India, the
insolvency professional requires to get prior approvals from the creditors for
some actions. In the UK, the insolvency professional has to provide a bond
whose value depends on the value of the asset involved so that he or she does
not get involved in any kind of fraudulent activity but in India, there is no
such provision. Also under the UK regime, only an individual can be insolvency
professional while under India’s regime, insolvency professional can be an
individual or a partner organization. Under the UK’s code, both operational and
financial creditors are included in the committee of the creditors and hence
both have the voting rights during the insolvency process but under India’s
regime, only financial creditors are included in the committee of the
creditors. The India code specifies the moratorium period from 180 days with 90
days of relaxation while in the UK, the moratorium period is not specified.

This
is the data for the time taken to resolve insolvency cases and the rate of
recovery 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-Border
Insolvency Provisions –

The
IBC has many provisions adopted from UK’s insolvency Code as mentioned above
but lacks in certain aspects from being global. It does not provide for
Cross-border insolvency, i.e., insolvency proceedings in foreign countries
relating to foreign assets and foreign creditors. It arises when Indian firms
have claims against global defaulting firms or vice versa.
The Code only provides the Central government with the power to enforce
provisions of the Code by entering into agreements with foreign countries. The Bankruptcy Law Reform Committee (BLRC)
was of the view that the UNCITRAL Model
Law on cross border insolvency, adopted by 41 countries should be
implemented only after the effective adoption of the Insolvency Code, given the
complexities involved in cross border cases. However, the committee has
recognized its need in today’s global world. The Joint Parliamentary Committee
was of the view that absence of this provision shall lead to an ‘Incomplete
Code’ and hence included two sections in this regard –

·        
Sec
234 – Agreements with Foreign Countries –
which allows the Central Government to make bilateral agreements with foreign
governments

·        
Sec
235 – 
Letter of Request to a country outside India in certain cases – The NCLT
may request the authority in the foreign nation to provide evidence in relation
to the foreign claims of the debtor.

 

 

 

Analysis
in the Domestic Context

In
India, before IBC, there were many laws for resolving insolvency such as
Companies Act 2013, Sick Industrial Companies Act 1985, Recovery of Debts Due
to Banks and Financial Institutions Act 1983, etc. It was a fragmented legislative
framework to resolve insolvency but IBC is a single law to resolve such cases
for both retail and corporate borrowers. In the earlier regime, it took about
4.3 years to settle insolvency proceedings in India but under IBC, this period
has decreased significantly. Also, the recovery rate which was earlier around
25.7 (cent/dollar) is expected to increase. In 2016, the non-performing assets
were 9.19% of total loans issued by banks. It is a huge burden on the banking
system and the economy. After the implementation of IBC, the NPAs are expected
to come down. After the promulgation of IBC Act, the ease of doing business
ranking of India has improved to 100th position. This can be
attributed to the improvement in the ranking of one of the ten parameters
considered by the world bank which is resolving insolvency, India’s ranking on
this parameter has improved from 136 to 103. 

 

Recommendations

Insolvency
and Bankruptcy code is a revolutionary reform which will reduce the
non-performing assets but it has certain issues and following are our
recommendations to rectify those issues:

·        
More than 1000 cases have
been filed under IBC in the last one year and out of these, 32% cases have been
filed by financial creditors (secured creditors) and 47% cases have been filed
by operational creditors (unsecured creditors). So, more number of insolvency
cases are filed by operational creditors but during the insolvency process only
financial creditors form the committee of creditors and have the right to vote.

We recommend that
the committee of creditors should also include operational creditors so that
they can also have voting rights during the insolvency process.

·        
Under the UK’s insolvency
code, the insolvency professional has to provide a bond with value equivalent
to the value of the asset under consideration. This provision is implemented to
prevent the insolvency professional from getting involved in any kind of
fraudulent activity.

We recommend that
such provision should also be implemented in India to ensure that the decisions
taken by the insolvency professional during the insolvency process is without
any vested interests.

·        
The insolvency process
involves the decision to either revive the business or shut down operations and
find 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 amounts
of their dues.

Hence, our
recommendation is that banks should not be pressurized to do so, it should be
done only in certain exceptional cases. The first step even in case of revival
should be identification of surplus business assets as well as personal assets
of the promoters, which should be auctioned to release the money blocked. This
money should be utilized for paying off the banks to the extent possible and
then ask them to take a haircut for the remaining amounts. This process shall
help banks recover their NPA’s to a greater extent without hampering the
revival process of businesses.

·        
During the insolvency
process, assets which are under liquidation are generally sold at a value less
than their market value. So, the banks or lenders have to accept a haircut
while selling the assets. Some measures should be taken to avoid this. One such
measure could be increasing the moratorium period from 180 + 90 days to a
greater period to ensure better value is recovered for the assets of the
company due to market fluctuations. This will give more time to the committee
of creditors to find a better resolution option and increase the recovery for
banks and lenders.

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