What is it?
- Bankruptcy is a legal status usually imposed by a Court, on a firm or individual unable to meet debt obligations.
- India’s new Bankruptcy Bill attempts to create a formal insolvency resolution process (IRP) for businesses, either by coming up with a viable survival mechanism or by ensuring their speedy liquidation.
- The Bill envisages a new regulator — the Insolvency and Bankruptcy Board of India.
So who can initiate the IRP?
- One, a business or debtor who has defaulted on dues can initiate the IRP.
- Two, lenders and creditors to a firm, including employees — either secured or unsecured — can do it too.
- When the IRP is on, creditors’ claims are frozen for 180 days, during which they will hear proposals for revival and decide on their future course of action.
- Within those 180 days, 75 per cent of the creditors must agree to a revival plan. If this minimum threshold is not met, the firm automatically goes into liquidation.
- If three-fourths of the creditors decide that the case is complex and cannot be addressed within 180 days, the adjudicator can grant a one-time extension of up to 90 days on the process.
- The Bill vests the insolvency professionals tasked with the job, with substantial powers.
- Criminal charges will apply if they notice any asset stripping by the promoters or responsible parties.
- The Code creates time-bound processes for insolvency resolution of companies and individuals. These processes will be completed within 180 days.
- If insolvency cannot be resolved, the assets of the borrowers may be sold to repay creditors.
What is the institutional mechanism prescribed in the code?
- The resolution processes will be conducted by licensed insolvency professionals (IPs). These IPs will be members of insolvency professional agencies (IPAs). IPAs will also furnish performance bonds equal to the assets of a company under insolvency resolution.
- Information utilities (IUs) will be established to collect, collate and disseminate financial information to facilitate insolvency resolution.
- The National Company Law Tribunal (NCLT) will adjudicate insolvency resolution for companies. The Debt Recovery Tribunal (DRT) will adjudicate insolvency resolution for individuals.
- The Insolvency and Bankruptcy Board of India will be set up to regulate functioning of IPs, IPAs and IUs.
- Passed in Lok Sabha.
- All the Recommendations of the Joint Parliamentary Committee was accepted by the government.
- passed in Rajya Sabha
What is the need for an insolvency and bankruptcy code 2016?
- Indian banks are sitting on a huge pile of bad debts. The total Non Performing Assets (NPAs) is around 4 Lakh Crore and a huge amount of restructured loans also. Thus the total stressed assets (Bad Debts) amount to 11% of the total lending.
- As a percentage of total loans, the bad loans grew from 3.49% (2013) to 8.3%(2015).
- Corporate bad loans constitute 56% of the total bad loans of state-run banks.
- At present, there are around 70000 pending liquidation.
- It takes almost 4 years to wind up an ailing company in India (Almost the double the time taken in other countries like China etc.
- There are around 12 laws (Some of which are more than 100 years old) to tackle Insolvency.
World Bank’s ease of doing business/Resolving Insolvency Ranking:
- Ease of doing Business – India is presently ranked 130 (Out of 189 countries) in 2015.
- Resolving Insolvency – India is presently ranked 136 (Out of 189 countries) in 2015.
Existing Mechanisms to deal with the issue:
- Currently, there is no single law dealing with insolvency and bankruptcy in India.
- Liquidation of companies is handled by the high courts, individual cases are dealt with under the Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920.
- Other laws which deal with the issue include :
- SICA (Sick Industrial Companies Act), 1985
- Recovery of Debt Due to Banks and Financial Institutions Act, 1993
- SARFESI (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest) Act, 2002 and
- Companies Act, 2013.
- Debt Recovery Tribunals
What is the problem with existing mechanisms?
- There is no integrated institutional system/mechanism to resolve the insolvency
- High courts, the Company Law Board, the Board for Industrial and Financial Reconstruction (BIFR), and the Debt Recovery Tribunals (DRTs), have overlapping jurisdiction
- Their inefficeincy and ineffectiveness is reflected in the rising NPA’s and bad loans due to systemic complexity to resolve the issues
- It is largely inadequte and results in delays
- There is lack of coherent coordination
Details of the Code:
- The Code seeks to provide for designating National Company Law Tribunal (NCLT) and Debt Recovery Tribunal (DRT) as the adjudicating authorities for corporate persons and firms and individuals, respectively, for resolution of insolvency, liquidation and bankruptcy.
- Till the Insolvency and Bankruptcy Board of India is set up, the central government will exercise the powers of the Board or designate any financial sector regulator the powers and functions.
- The bill also provides for priority with regard to distribution of proceeds following liquidation of the company.
- In the order of priority, the first charge will be insolvency resolution process cost and liquidation costs to be paid in full.
- Liquidation proceeds will then be used to clear debts owed to people in the following order:
- secured creditors, and then to pay
- workmen’s dues for 12 months
- .unpaid dues to employees other than workmen
- .financial dues owed to unsecured creditors
- .Government taxes for two years, other debts, preference shareholders and equity shareholders will receive last priority for payment.
- Workers’ salaries for up to 24 months will get first priority in case of liquidation of assets of a company, ahead of secured creditors.
- It also provides for monetary penalty and jail term of up to five years for concealment of property, defrauding creditors and furnishing false information.
- The Code also provides for fast track corporate insolvency resolution process to be completed in 90 days.
- Bankruptcy applications will now have to be filed within three months rather than the earlier six months.
- Anyone declared bankrupt will be barred from holding public office, thereby ensuring that politicians and government officials cannot hold any public office if declared bankrupt
- It will replace the existing bankruptcy laws and cover individuals, companies, limited liability partnerships and partnership firms. It will amend laws, including The Companies Act, to become the overarching legislation to deal with corporate insolvency.
Comparison of US Bankruptcy code with India’s Bankrutpcy code:
- In the US, there are two main bankruptcy procedures for corporations
- The liquidation code provides for the appointment of a trustee by the court to oversee the liquidation of the company
- The business is closed down before sale and the assets auctioned.
- The code allows a firm to remain in operation while a plan of reorganisation is worked out with creditors.
- The Indian Code provides for quick identification of financial distress and a 180-day plan, extendable by 90 days, to revive a company, following which the company becomes insolvent.
- With regard to management control, under the US code, the company retains the management control while working to achieve pre-agreed goals within a certain timeframe.
- The Indian code provides for management control to pass over to resolution professionals with significant powers, once an insolvency resolution is underway.
- Address cross-border insolvency through bilateral agreements with other countries
- Shorter time frames for every step in the insolvency process—right from filing a bankruptcy application to the time available for filing claims and appeals in the debt recovery tribunals (DRTs), National Company Law Tribunals (NCLTs) and courts.
- Having a robust insolvency resolution mechanism can help creditors recover a larger part of their investment faster, allowing them to re-invest in other businesses, thereby facilitating the efficient flow of capital across the economy
- Creation of a new class of insolvency professionals that will specialize in helping sick companies.
- Creation of information utilities that will collate all information about debtors to prevent serial defaulters from misusing the system.
- Ensure time-bound settlement of insolvency, enable faster turnaround of businesses and create a data base of serial defaulters—all critical in resolving India’s bad debt problem which has crippled bank lending.
- Improve India’s position in the World Bank’s Doing Business ranking.
- There will be one single law in place of multiple laws and remove the overlapping jurisdiction
Critique of the bankruptcy code:
- Time-bound insolvency resolution will require establishment of several new institutional mechanisms. The current capacity of debt recovery tribunals may be inadequate to take up the additional role.
- IPAs, regulated by the Board, will be created for regulating the functioning of IPs. This approach of having regulated entities further regulate professionals may be contrary to the current practice of regulating licensed professionals. Further, requiring a high value of performance bond may deter the formation of IPAs.
- The order of priority to distribute assets during liquidation is unclear. For instance – why secured creditors will receive their entire outstanding amount, rather than up to their collateral value; why unsecured creditors have priority over trade creditors? and why government dues will be repaid after unsecured creditors?
- The Code provides for the creation of multiple IUs. However, it’s possible that complete information about a company may not be available through a single IU. This may lead to financial information being scattered across these IUs.
- The Code creates an Insolvency and Bankruptcy Fund. However, it does not specify the manner of usage of the fund.
- It is a progressive step towards improving the investor confidence and ease of doing business
- The possible demerits can be addressed through discussions and consensus building
- If implemented earnestly, it will give a boost to the job creation promise through skill development mission ( to create 40 cr jobs by 2022) and also provide the required ecosystem for the success of “Make in India”.
- This will be a positive step and provide impetus to good governance and uphold rule of law, as , the people who file for bankruptcy will have to repay their debts.
Keywords: Insolvency, Bankruptcy, Liquidation, Bankrutpcy code, Debt recovery tribunals, Skill development ,Make in India. Approach to Civil Services Mains Exam: GS2:
- Governance policies and interventions
- Good governance
- Resolving NPA’s
- Impact of NPA’s on banking
- Systemic causes and consequences of NPA’s
- Case study based on some firms/individuals fleeing India without repaying debts
- Ethical aspects of banking regulation
- Corporate governance
Other related Links: 1)Parliament clears insolvency and bankruptcy code 2016 2) New era of reforms Practice Question: 1)It is believed that the new bankruptcy and insolvency code 2016 is touted as a game changer to boost investor confidence. How far do you agree? Justify your stand.