Interface between Insolvency and Bankruptcy Code and Company Law

Abstract

Doing business in the form of a company has always been the best option as it gives an opportunity to the members to limit their liabilities. The corporate personality doctrine grants the company certain rights and liabilities. But if the liabilities on the assets of the company exceed its income then the company may at times even collapse. In order to give such companies an option to revive themselves, there were several laws in force in India. The Indian insolvency resolution regime underwent a complete overhaul consolidating several pre-existing laws and providing a single law for insolvency and bankruptcy-related matters. In May 2016, the Indian Parliament enacted the Insolvency and Bankruptcy Code 2016 (IB Code) that became effective in December 2016. The IB Code 2016 covers the insolvency resolution process as well as the liquidation process for individuals and corporate debtors. This paper seeks to critically analyse the new law and its applicability in the last year of its enforcement, in the light of past lessons and a series of reforms, to ascertain the effectiveness and future prospects of the reformed insolvency law in India.

Introduction

From time immemorial, capital and debt markets have been the foundation of the Indian economy. They created a comfortable speciality for small industries, large corporations and even MNCs to establish their business in India. Reputed banks finance the debt market by adopting exceptionally proficient banking measures under the aegis of the Central Bank, RBI.

On the premise of credit shortcoming and feasibility for acknowledgement of the debts, the assets are arranged basically into two classes: Standard Assets and Non-performing Assets:

‘‘Standard Assets are assets in which there has been timely payment of interest and instalments. Non-performing Asset is defined as an asset whose interest or principal is overdue for a period of one hundred eighty days or more from the due date of contract between the lender and borrower.’’

The data asymmetry existing among banks with regard to credit facilities, deteriorating industries and fraudulent practices engaged by the industrialists have encouraged the creation of ‘‘bad loans’’ or ‘‘stressed assets’’ or ‘‘non-performing assets’’ (NPA). When the company becomes bankrupt, the banks are left with no other option but to write off the loans. Throughout the years, this heaping up of NPAs bottlenecked the development of the economy. Ensuing to this, the Government passed two major statutes to recoup the debts – the Recovery of Debts Due to Banks and Financial Institutions Act 1993 (DRT Act) and Securitisation of Assets and Reconstruction of Financial Assets and Enforcement of Security Interests Act 2002 (SARFAESI Act 2002) to recover the bad loans. The passing of these two enactments enhanced the level of the debt recovery process in India as enforcement of security interest created in favour of the creditor is now possible without the interference from the courts, with the drawback that this mechanism only provides relief to secured creditors.

Despite the legal machinery set up, there were still a large number of cases where the corporate debtors did not repay their debts. Acknowledging this situation, with the aim of achieving a better ranking in the World Bank’s Ease of Doing Business, after years of battling the Government finally brought the Insolvency and Bankruptcy Code 2016 (IB Code) subsuming around 13 existing laws (IB Code 2016 repealed two legislations and amended 11) with the aim of significant worth expansion and accelerating the debt recovery process.

In the present situation, creditors (Financial/ Operational) have numerous alternatives to recover debts. The IB Code gives an extra alternative to resolve insolvency. The first case in India under the IB Code was filed by ICICI Bank against Innovative Industries Ltd. The applicant of insolvency resolution process is also required to propose a plan for resolution, however, regardless of the resolution process applicant, the resolution plan requires the sanction of financial creditors constituting the committee of creditors. Another imperative part of the Code is that it gives criteria for establishing that default has been made (under Companies Act 1956/2013, the only criteria given was the inability to pay debts to the corporate debtor) i.e. Rs. 1 Lakh. This gives a chance to the defaulting corporate debtor to think of alternative solutions in the initial phase of default preventing accumulation of default amount to risky extents. Secondly, unless totally avoidable, the corporate debtor is kept from defaulting as a result of dread of losing control over the company. This will diminish the frequency of default and swelling of NPAs.

The second case is of Bharati Defence and Infrastructure Ltd against which Edelweiss Asset Reconstruction Co filed insolvency resolution process in the National Company Law Tribunal (NCLT) under the IB Code to pre-empt winding-up petitions by unsecured creditors. This step by Edelweiss has been possible due to the repeal of SICA that dissolved the Board for Industrial and Financial Restructuring (BIFR). Though recently, Bharati Defence and Infrastructure (formerly Bharati Shipyard) has been given support by the creditors, led by Edelweiss BSE 0.46% Asset Reconstruction Co, as they have proposed a revival package under the IB Code 2016.

World Bank provides ten objective parameters to determine the ease of doing business in different countries, out of which insolvency is one of the parameters. India’s last year’s ranking was poor in most of the parameters at 136 among 190 countries in the recent World Bank ‘‘Doing Business’’ report because of its low recovery rate and tedious insolvency resolution process. This ranking has improved drastically from 136 to 100 in the last year after several Government initiatives, one such initiative being enactment and implementation of the consolidated insolvency and bankruptcy regime. India is the first such country that has shown such improvements in such a short span.

Evolution of Insolvency & Bankruptcy Reforms in India

Meaning

Insolvency can be defined as ‘‘a state that prompts one to file for bankruptcy’’. An entity—a person, family, or company ends up as an insolvent when it cannot pay its loan back on time. In general, this occurs when the entity’s cash flow in falls beneath its cash flow out. For individual debtors, this implies that their incomes are too low for them to pay off their debts. For companies, this implies that the money flow into the business and its assets are less than its liabilities.

Bankruptcy is not precisely the same as insolvency. In fact, bankruptcy occurs when a court has determined insolvency, and given orders for its resolution. Insolvency describes circumstances where the debtor is unable to meet their commitments of repaying debts. Bankruptcy is a legal procedure through which an insolvent debtor seeks relief.

The fundamental explanations behind insolvency are principally poor management and financial constraints. The following can be the reasons for the same:

  1. The situation of the market changes and the company did not perceive the need for change as per market requirements.
  2. Bad debts.
  3. The failure on the part of the management to acquire adequate skills, imprudent accounting practices and absence of data frameworks.
  4. Loss of long-term finance or lack of cash flow.
  5. Other reasons can be knock on effect, i.e. from other insolvencies or other factors such as exorbitant overheads and so on

It is, however, observed that the bigger the organisation, the better the shot of survival and of getting remedial treatment and of paying creditors.

Insolvency Laws in India

The Insolvency laws in India have their origin in English Law. The provisions that dealt with insolvency law were initially found under ss.23 and 24 of the Government of India Act 1800. In 1828, a Statute was passed marking the beginning of insolvency specific legislation in India. This statute applied to Presidency towns namely Bombay, Madras and Calcutta. Then the Indian Insolvency Act 1848 was enacted that made distinction between traders and non-traders. The jurisdiction relating to insolvency was transferred to High Courts, limiting its jurisdiction to presidency towns. In 1909, the Presidency Towns Insolvency Act 1909 was passed. Till 1907, there was no legislation dealing with insolvency in no presidency areas, therefore, in 1907, the Provincial Insolvency Act was passed which was later replaced by the Provincial Insolvency Act 1920. These two legislations continued in force until recently and were repealed by the IB Code.

As ‘‘Bankruptcy & Insolvency’’ is in the Concurrent List in the Indian Constitution, both Centre and State Governments have power to legislate on this subject. Entry 43 of List I deals with incorporation, regulation and winding up of trading corporations, including banking, insurance and financial corporations, but not including co-operative societies whereas Entry 44 of List I deals with ‘‘incorporation, regulation and winding up of corporations, whether trading or not, with objects not confined to one State, but not including universities’’. Entry 32 of List II deals with ‘‘incorporation, regulation and winding up of corporations, other than those specified in List I.’’ With these powers given under the Union List, the Parliament enacted the first legislation dealing with corporate insolvency in India viz. the Companies Act 1956. However, the Act did not refer to insolvency or bankruptcy of corporates it only referred to its ‘‘inability to pay debts’’.

The Companies (Amendment) Act 2003 proposed several changes to the provisions relating to insolvency under the Companies Act 1956. However, these could not be notified due to legal challenges. In 2013, the new Companies Act was passed introducing a number of changes in the corporate insolvency procedure most of which could not be notified for a long time. The Companies Act 2013 also introduced Ch.XIX that dealt with the revival and rehabilitation of sick companies. The idea behind the incorporation of this chapter under the company legislation was to widen the scope of revival and rehabilitation mechanism including within its scope all kinds of companies unlike SICA that only provided for rehabilitation mechanism for ‘‘sick industrial’’ companies. This chapter has now been repealed as the entire revival/rehabilitation procedure or mechanism of corporate debtor (or sick companies) is now covered under the IB Code.

With the globalisation of the economy, corporate insolvency has attained great significance. A need was therefore felt to bring about reforms in the sphere of insolvency laws. The main objectives for bringing about reforms in the laws of insolvency were:

  1. to restore the debtor company to profitable trading where it is practicable;
  2. to expand the return to creditors as a whole where the company itself cannot be spared;
  3. to build up a fair and even-handed framework for the positioning of claims and the dispersion of assets among creditors, including a redistribution of rights;
  4. to give an instrument by which the causes of failure can be identified and those guilty of mismanagement brought to book;
  5. placement of the assets of the company under external control;
  6. substitution of collective action for individual pursuits; and
  7. Evasion of certain transactions and fraudulent conveyances, dissolution and winding up etc.

Recent Evolution

The present law in force on insolvency and bankruptcy in India has evolved over a period of time after the recommendations and suggestions given by different committees constituted from time to time. Some of the relevant and recent committees are as follows.

Tiwari Committee

In 1981, the RBI showed deep concern over blocking of huge funds and non-performing assets of sick industrial companies that led to loss in production, revenue as well as employment. To address this, a committee was constituted under the chairmanship of T. Tiwari. The committee came up with suggestions to secure the timely detection of sick and potentially sick industrial companies, speedy determination of the preventive and remedial measures and enforcement of such measures recommending the enactment of the Sick Industrial Companies (Special Provisions) Act 1985 (SICA). A Board for Industrial and Financial Reconstruction was established which failed to fulfil the purpose in the long run.

Justice V.B. Balakrishna Eradi Committee

The Tiwari Committee was followed by the recommendations of Justice V.B. Balakrishna Eradi Committee Report in 1999, setting up of a National Company Law Tribunal (NCLT in short) to be vested with the functions and power with regard to rehabilitation and revival of sick industrial companies. It also suggested amendments to be made in the Companies Act 1956 that were enacted but not notified. Other recommendations were adoption of UNCITRAL Model Law for Cross Border Insolvency; need to encourage voluntary winding up of companies and criteria of sickness of companies to include inability to pay debts. N L Mitra Committee. In 2001, the Advisory Group on Bankruptcy Laws was constituted under the chairmanship of Dr N L Mitra. This committee was appointed by the RBI which gave several suggestions on bankruptcy law reforms, one such significant proposal was the consolidation of all the scattered bankruptcy laws into a separate code. However, no steps were taken.

J. J. Irani Committee

Then the J.J. Irani Committee Report in 2005 was constituted to review and revise primarily Company Law and especially establish a transparent framework for insolvency and restructuring procedures of international level. The Committee recommended changes in the law to make the restructuring and liquidation process expeditious. The recommendations Then the J.J. Irani Committee Report in 2005 was constituted to review and revise primarily Company Law and especially establish a transparent framework for insolvency and restructuring procedures of international level. The Committee recommended changes in the law to make the restructuring and liquidation process expeditious. The recommendations were directed at providing a single framework for resolving insolvency of corporates through a specialised adjudicatory authority.

Bankruptcy Law Reforms Committee (BLRC)

Headed by Mr T.K. Viswanathan, this committee’s report was in two parts: The first part dealing with the rationale and design/recommendations; and the second was a comprehensive draft Insolvency and Bankruptcy Bill covering all entities. The report suggested major changes to the existing framework. The Insolvency and Bankruptcy Code 2016 is the outcome of these recommendations.

Features & Challenges of The Insolvency & Bankruptcy Code 2016

There were multiple overlapping laws and adjudicating bodies dealing with corporate and individual insolvency in India. There were four major legislations that dealt with corporate insolvency: the Companies Act 1956/2013, Sick Industrial Companies (Special Provisions) Act 1985 (SICA), the Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (SARFAESI) and Recovery of Debts due to Banks and Financial Institutions Act 1993 (RDDBFI Act). Therefore, there were four different adjudicating bodies: the High Courts, the Company Law Board, the Board for Industrial and Financial Reconstruction (BIFR), and the Debt Recovery Tribunals (DRTs) that had overlapping jurisdiction and caused systemic delays and complexities in the process.

On the lines of Bankruptcy Code of US, India also aimed to introduce an integrated legislation on insolvency. As has already been covered above, the insolvency and bankruptcy laws in India went through series of amendments/ attempts to address the immediate problems with no element of foreseeability. The most recent attempt was the constitution of BLRC and its result in the form of the IB Code 2016.

The Code is a comprehensive insolvency legislation encompassing all companies, partnerships and individuals (other than financial firms). Until now, in India the process of winding up of companies was regulated by the Companies Act 1956 and was under the supervision of the court. After the enactment of the Companies Act 2013 and the enforcement of the IB Code 2016 the winding up procedure is now under the supervision of National Company Law Tribunal (NCLT).

The insolvency and bankruptcy code repealed two pieces of legislation: the Presidency Towns Insolvency Act 1909 and the Provincial Insolvency Act 1920 and amended 11 others:

Section of

IB Code

2016

Amended Act Schedule of IB Code

2016

245 Indian Partnership Act 1932 I
246 Central Excise Act 1944 II
247 Income- tax Act 1961 III
248 Customs Act 1962 IV
249 Recovery of Debts due to

Banks and Financial

Institutions Act 1993

V
250 Finance Act 1994 VI
251 Securitisation and

Reconstruction of Financial

Assets and Enforcement of

Security Interest Act 2002

VII
252 Sick Industrial Companies

(Special Provisions) Repeal Act

2003

VIII
253 Payment and Settlement

Systems Act 2007

IX
254 Limited Liability Partnership Act

2008

X
255 Companies Act 2013 XI

 

One of the key highlights of the Code is the declaration of moratorium followed by a public announcement. This gives an opportunity to the creditors of the company to determine the viability of a corporate debtor and agree upon a revival plan and if not revival then its speedy liquidation.

The Code also provides for time bound speedy resolution processes. With the enactment of the Code, the ambiguities regarding overlapping of jurisdictions have been done away with. Now there is a single authority NCLT for corporates and DRT for individuals

The Code provides for two-stage processes:

The first stage is the insolvency resolution process – The application for insolvency resolution can be made by either the financial creditors, operational creditors or by the corporate debtor itself. To initiate the insolvency resolution process the default should be of at least Rs. 1 Lakh (which may be extended up to Rs. 1 Crore by the Government). Before the enactment of the Code, insolvency was not as such defined and the only criteria to initiate winding up procedure under the Companies Act 1956 and 2013 was the inability to pay debts of the company.

The second stage is the liquidation process in case the insolvency resolution plan does not work out or the financial creditors of the company decide to wind up the company then the liquidation procedure is followed.

The Code provides for institutional framework, consisting of a new regulator, i.e. the Insolvency and Bankruptcy Board of India, insolvency professional agencies, insolvency resolution professionals, information utilities and adjudicatory mechanisms. These are the regulators and intermediaries that will facilitate a formal and time bound insolvency resolution process and liquidation.

Though the Code has introduced new essential changes in the insolvency/liquidation regime, there are certain practical ramifications in the implementation of the Code such as balancing the interests of different categories of creditors, e.g. financial and operational, secured and unsecured etc. ensuring speedy debt recovery or winding up, whichever is feasible; management of accumulated NPAs; another hurdle can be the provisions that provide for prior consent of creditors before the insolvency professionals sell the assets of the Corporate Debtors which may pose difficulty in the proper discharge of their functions. It is yet to be seen if the safeguards provided under the Code are sufficient in practice to serve the purpose with which it has been enacted.

Moratorium Under the IB Code 2016

A number of conflicts arise between the debtor and creditors when the debtor defaults on payments. While it is best for both parties to negotiate to maximise value, the difference in their objectives leads them to take individual action to protect their investments. It has been observed that enforcement of individual interests leads to stripping of assets of the debtor and makes the situation even more chaotic and unstable. The IB Code provides for a legal recourse to both the creditor and the debtor but now in an organised and orderly manner which would be regulated and taken care of by a neutral third party. Chapter II of the IB Code 2016 deals with provisions relating to corporate insolvency resolution process. Once an application for initiation of corporate insolvency resolution process is admitted the adjudication authority shall declare moratorium period. Section 14 of the Code deals with the effects of declaration of moratorium which include the prohibition of the following:

‘‘(a) the institution of suits or continuation of pending suits or proceedings against the corporate debtor including execution of any judgment, decree or order in any court of law, tribunal, arbitration panel or other authority;

(b) transferring, encumbering, alienating or disposing of by the corporate debtor any of its assets or any legal right or bene- ficial interest therein;

(c) any action to foreclose, recover or enforce any security interest created by the corporate debtor in respect of its property including any action under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;

(d) The recovery of any property by an owner or lessor where such property is occupied by or in the possession of the corporate debtor.’’

The rationale behind the introduction of declaration of a moratorium or ‘‘calm period’’ as per the Bankruptcy Law Reforms Committee is to provide a reasonable time for assessing the future of the company. During this time, all the creditors of the corporate debtor shall stay their claims, on one hand, giving the company a better chance to survive as a going concern and on the other, avoiding individual enforcement actions by creditors which would unnecessarily lead to chaos.

The scope and extent of the provisions relating to moratorium is uncertain as the same have not been subjected to judicial scrutiny yet. The Supreme Court in Innovative Industries Ltd v ICICI Bank Ltd (2017) observed that the intent behind the moratorium was ‘‘to provide the debtors a breathing spell in which he is to seek to reorganize his business’’.

The moratorium period is similar to s.22 of the SICA that provided for automatic stay of all legal proceedings against the sick company that had to undergo revival. But unlike s.22 of SICA that provided excessive protection to sick industrial companies leading to delay in winding up of such companies, the provisions relating to moratorium specify a time limit of 180 days which may be further extended by an order of the Adjudicating Authority, but not exceeding 90 days during which as mentioned above there will be stay on all creditors’ claims, Board’s powers will be suspended and the management of the company will have to report to the insolvency professional.

After the coming into force of IB Code 2016, the SICA stands repealed leaving no option for sick industrial companies to approach BIFR now the only option available to such corporate entities is to apply for an insolvency resolution plan under the IB Code.

Guarantors and the moratorium period under the Code

One issue that has recently come up is the liability of guarantors in cases of companies undergoing moratorium under the IB Code. In two recent cases, the appellate tribunal (NCLAT) upheld NCLT’s opinion that the moratorium should not extend to a third party, including a guarantor of a Corporate Debtor. In Alpha & Omega Diagnostics (India) Ltd v Asset Reconstruction Co of India Ltd, the security given to the creditor banks were the promoter’s property. The question before the NCLT was whether the properties, other than the corporate debtor’s, would come within the meaning of moratoriums under the Code. The NCLAT held that the moratorium would not be applicable to any assets that do not belong to the Corporate Debtor as s.14 (1) (c) refers to the property of the corporate debtor. In another appeal26 to NCLAT, a similar question arose regarding personal property that was given as security to the creditor. The NCLAT restated that the moratorium under the Code is only applicable to the property of the Corporate Debtor. Whereas, the Allahabad High Court in Sanjeev Shriya v State Bank of India, stayed proceedings against guarantor of corporate debtor before a Debt Recovery Tribunal taking into account the purpose of the Code to ensure that the Code is practically enforced, reason being that excluding guarantors from the ambit of moratorium will make it difficult to harmonise the provisions of the Code and defeat its purpose of resolving insolvency process within a time bound mechanism. But at the same time including them would also mean that the guarantees of the corporate debtor would then be superfluous. In view of the above, it is therefore, now required that the scope of the moratorium or the calm period be determined with precision to avoid any further litigation.

To some up it can be said that the purpose of the moratorium is to stabilise the assets of the Corporate Debtor thereby giving the creditors clarity regarding the financial health of the Corporate Debtor and providing them with an opportunity to formulate a resolution plan so that it helps in maximum recovery of debts.

Effects of IB Code 2016 on Sick Companies and the Insolvency Resolution Process

The first legislation that dealt with revival of sick companies in India was the Sick Industrial Companies Act 1985 which was, of course, an appreciable step but had its own flaws. One of the major drawbacks of this legislation was that it was concerned with the revival of only ‘‘industrial companies’’. In the words of Arun Jaitely, the SICA experiment turned out to be an absolute failure as the revival of a company in India is a cumbersome process defeating the very objective of revival or even liquidation. Amendments were made to the Companies Act 1956 along with the SICA (Repeal) Act 2003 which was never notified. When the Companies Act 2013 was passed an entire Ch.XIX was incorporated and devoted to ‘‘Revival and Rehabilitation of Sick Companies’’. This too was not notified and after the enactment of the IB Code this chapter has now been repealed from the Companies Act 2013.

It is interesting to note that SICA overrode the RDDBFI Act, SARFAESI overrode SICA providing relief to secured creditors by letting them enforce their interest without the intervention of courts and now IB Code repeals SICA. The Code has taken away the protection enjoyed by companies/borrowers or rightfully the defaulters which apparently declared their company’s net worth as eroded, keeping away all the lenders by seeking unjustifiable relief before the BIFR (s.22 discussed above). The IB Code has dissolved the BIFR making companies vulnerable to winding up petition if no implementable revival plan is finalised within the time frame provided. As the Code covers a wide range of creditor-applicants (Financial/operations/secured/unsecured), the insolvency resolution procedure can now be initiated on an applicant even from unsecured creditors unlike the old regime. The new law provides relief to all categories of creditors seeking redressal for their grievance but the ultimate power to approve (75% voting in favour) the revival plan or to go ahead with the winding up of the corporate debtor is with the financial creditors (committee of creditors). This could be considered as a positive step for companies that are honestly seeking to resolve their financial stress and for others this law can prove as a motivator to either pay up their debts or lose ownership of the company.

Conclusion and Suggestions

The failure of some business plans is integral to the process of the market economy. In case of such failures, the most sensible and practical approach would be to have a speedy mechanism that would help financiers to negotiate and work out a new arrangement. If this is not a viable option, then the best outcome for the financiers, as well as the society, is liquidation. When such arrangements are made functional, the debt recovery process will work smoothly. But as has been observed from the experiences in the past it is required that the present NPA problem be addressed separately since resolving insolvency and managing non-performing assets are two inter-related but distinct issues. It is therefore suggested that the need of the hour is to develop a distressed asset trading market in India.

The IB Code no doubt has a lot of significance and relevance in the present scenario since it has overhauled the obsolete regime relating to insolvency and bankruptcy in India. It can be concluded that now we have a consolidated and comprehensive law (in the form of now existing framework for time–bound resolution for debts) that is at par with the international standards. This will go a long way in bringing an element of certainty and predictability to corporate transactions and facilitating in improving India’s ranking in World Bank’s ‘‘Doing Business’’ report. The prerequisite for its success will be its diligent implementation.
Since the Code is still in its nascent phase, it is expected that the Code will be made functional in such a way so as to focus more on implementing the law rather than expeditiously operationalising it.

Need Bankruptcy Lawyers?

If you’re facing bankruptcy, one of your questions might be, ‘Can my wages be garnished?. First, you have to understand this term. Wage garnishment involves a court procedure that requires the employer to pay a portion of the employee’s wages to a creditor to whom the employee owes money. You can file for bankruptcy to stop this from happening. 

When you file a bankruptcy, the court issues an order called ‘automatic stay’ to stop wage garnishments, including foreclosures, evictions, and other debt-collection activities of creditors. But this automatic stay only applies to commercial debts like car loans, home loans, credit card bills, and medical bills. It doesn’t apply to stopping child support and delinquent state and federal taxes. 

The bankruptcy law in India can be comprehensive and hard to understand, especially for people without any legal background. Many companies risk impending bankruptcy because of inflation and economic fluctuations. So, it’s imperative to be legally knowledgeable.  

Continue to equip yourself with legal knowledge, such as learning about insolvency and bankruptcy code interfacing with the company law. That way, you can make more intelligent legal decisions concerning your company and personal legal security. Don’t hesitate to consult a bankruptcy lawyer for more detailed legal interaction and case assessment.