Insolvency and Bankruptcy Code, 2016-Basics

After a public consultation process and recommendations from a joint committee of Parliament, both houses of Parliament have now passed the Insolvency and Bankruptcy Code, 2016. Under the existing legal framework, the primary onus to initiate a resolution process lies with the debtor, and creditor may pursue separate actions for recovery, security enforcement and debt restructuring.

The highlights of the code are summarized below:

1. Corporate Debtors: Two-Stage Process

To initiate an insolvency process for corporate debtors, the default should be at least INR 100,000 (USD 1495) (which limit may be increased up to INR 10,000,000 (USD 149,500) by the Government). The Code proposes two independent stages:

Insolvency Resolution Process, during which financial creditors assess whether the debtor’s business is viable to continue and the options for its rescue and revival; and

Liquidation, if the insolvency resolution process fails or financial creditors decide to wind down and distribute the assets of the debtor.

(a) The Insolvency Resolution Process (IRP)

The IRP provides a collective mechanism to lenders to deal with the overall distressed position of a corporate debtor. This is a significant departure from the existing legal framework under which the primary onus to initiate a re-organisation process lies with the debtor, and lenders may pursue distinct actions for recovery, security enforcement and debt restructuring.

The Code envisages the following steps in the IRP:

(i) Commencement of the IRP

A financial creditor (for a defaulted financial debt) or an operational creditor (for an unpaid operational debt) can initiate an IRP against a corporate debtor at the National Company Law Tribunal (NCLT).

The defaulting corporate debtor, its shareholders or employees, may also initiate voluntary insolvency proceedings.

(ii) Moratorium

The NCLT orders a moratorium on the debtor’s operations for the period of the IRP. This operates as a ‘calm period’ during which no judicial proceedings for recovery, enforcement of security interest, sale or transfer of assets, or termination of essential contracts can take place against the debtor.

(iii) Appointment of Resolution Professional

The NCLT appoints an insolvency professional or ‘Resolution Professional’ to administer the IRP. The Resolution Professional’s primary function is to take over the management of the corporate borrower and operate its business as a going concern under the broad directions of a committee of creditors. This is similar to the approach under the UK insolvency laws, but distinct from the “debtor in possession” approach under Chapter 11 of the US Bankruptcy Code. Under the US Bankruptcy Code, the debtor’s management retains control while the bankruptcy professional only oversees the business in order to prevent asset stripping on the part of the promoters.

Therefore, the thrust of the Code is to allow a shift of control from the defaulting debtor’s management to its creditors, where the creditors drive the business of the debtor with the Resolution Professional acting as their agent.

(iv) Creditors Committee and Revival Plan

The Resolution Professional identifies the financial creditors and constitutes a creditors committee. Operational creditors above a certain threshold are allowed to attend meetings of the committee but do not have voting power. Each decision of the creditors committee requires a 75% majority vote. Decisions of the creditors committee are binding on the corporate debtor and all its creditors.

The creditors committee considers proposals for the revival of the debtor and must decide whether to proceed with a revival plan or liquidation within a period of 180 days (subject to a one-time extension by 90 days). Anyone can submit a revival proposal, but it must necessarily provide for payment of operational debts to the extent of the liquidation waterfall.

The Code does not elaborate on the types of revival plans that may be adopted, which may include fresh finance, sale of assets, haircuts, change of management etc.

(b) Liquidation

Under the Code, a corporate debtor may be put into liquidation in the following scenarios:

(i) A 75% majority of the creditor’s committee resolves to liquidate the corporate debtor at any time during the insolvency resolution process;

(ii) The creditor’s committee does not approve a resolution plan within 180 days (or within the extended 90 days);

(iii) The NCLT rejects the resolution plan submitted to it on technical grounds; or

(iv) The debtor contravenes the agreed resolution plan and an affected person makes an application to the NCLT to liquidate the corporate debtor.

Once the NCLT passes an order of liquidation, a moratorium is imposed on the pending legal proceedings against the corporate debtor, and the assets of the debtor (including the proceeds of liquidation) vest in the liquidation estate.

Priority of Claims

The Code significantly changes the priority waterfall for distribution of liquidation proceeds.

After the costs of insolvency resolution (including any interim finance), secured debt together with workmen dues for the preceding 24 months rank highest in priority. Central and state Government dues stand below the claims of secured creditors, workmen dues, employee dues and other unsecured financial creditors. Under the earlier regime, Government dues were immediately below the claims of secured creditors and workmen in order of priority.

Upon liquidation, a secured creditor may choose to realise his security and receive proceeds from the sale of the secured assets in first priority. If the secured creditor enforces his claims outside the liquidation, he must contribute any excess proceeds to the liquidation trust. Further, in case of any shortfall in recovery, the secured creditors will be junior to the unsecured creditors to the extent of the shortfall.

2. Insolvency Resolution Process for Individuals/Unlimited Partnerships

For individuals and unlimited partnerships, the Code applies in all cases where the minimum default amount is INR 1000 (USD 15) and above (the Government may later revise the minimum amount of default to a higher threshold). The Code envisages two distinct processes in case of insolvencies: automatic fresh start and insolvency resolution.
Under the automatic fresh start process, eligible debtors (basis gross income) can apply to the Debt Recovery Tribunal (DRT) for discharge from certain debts not exceeding a specified threshold, allowing them to start afresh.
The insolvency resolution process consists of preparation of a repayment plan by the debtor, for approval of creditors. If approved, the DRT passes an order binding the debtor and creditors to the repayment plan. If the plan is rejected or fails, the debtor or creditors may apply for a bankruptcy order.

3. Institutional Infrastructure

(a) The Insolvency Regulator
The Code provides for the constitution of a new insolvency regulator i.e., the Insolvency and Bankruptcy Board of India (Board). Its role includes: (i) overseeing the functioning of insolvency intermediaries i.e., insolvency professionals, insolvency professional agencies and information utilities; and (ii) regulating the insolvency process.

(b) Insolvency Resolution Professionals
The Code provides for insolvency professionals as intermediaries who would play a key role in the efficient working of the bankruptcy process. The Code contemplates insolvency professionals as a class of regulated but private professionals having minimum standards of professional and ethical conduct.
In the resolution process, the insolvency professional verifies the claims of the creditors, constitutes a creditors committee, runs the debtor’s business during the moratorium period and helps the creditors in reaching a consensus for a revival plan. In liquidation, the insolvency professional acts as a liquidator and bankruptcy trustee.

(c) Information Utilities
A notable feature of the Code is the creation of information utilities to collect, collate, authenticate and disseminate financial information of debtors in centralised electronic databases. The Code requires creditors to provide financial information of debtors to multiple utilities on an ongoing basis. Such information would be available to creditors, resolution professionals, liquidators and other stakeholders in insolvency and bankruptcy proceedings. The purpose of this is to remove information asymmetry and dependency on the debtor’s management for critical information that is needed to swiftly resolve insolvency.

(d) Adjudicatory Authorities
The adjudicating authority for corporate insolvency and liquidation is the NCLT. Appeals from NCLT orders lie to the National Company Law Appellate Tribunal and thereafter to the Supreme Court of India. For individuals and other persons, the adjudicating authority is the DRT, appeals lie to the Debt Recovery Appellate Tribunal and thereafter to the Supreme Court.
In keeping with the broad philosophy that insolvency resolution must be commercially and professionally driven (rather than court driven), the role of adjudicating authorities is limited to ensuring due process rather than adjudicating on the merits of the insolvency resolution.

CONCLUSION

With rise in the non-performing assets and corporate loans on the rise, the Code is seen by many as a means to reform the high number of insolvency cases under the Indian economic regime. The weak insolvency regime structures of India with its weak enforcement, rising PSU’s cost India’s weak insolvency regime is credited with present weak and distressed state of credit markets in India today. The Code promises to bring about reforms with a thrust on creditor driven insolvency resolution focusing on early identification of financial failure and maximising the asset value of insolvent firms and its assets management.
The Code also has provisions to address cross border insolvency through bilateral agreements and reciprocal arrangements with other countries.
The laws have been made more stringent and the legislature has made an attempt to make the laws including the Code more dynamic.