Bankruptcy Code is good news for investors in India

By Kumar Saurabh Singh and Dhwani Shah, Khaitan & Co

One of the biggest predicaments facing the banking and finance market in India in the past few years has been the alarming levels of increase in non-performing assets. While the spurt in stressed assets has largely been a result of a slowdown in the economy, financial indiscipline has also been incentivized by factors including multiplicity of laws, protection against legal action by virtue of the regime under the Sick Industrial Companies (Special Provisions) Act, 1985, and indefinite delays in recovery proceedings.

Kumar Saurabh Singh Partner Khaitan & Co
Kumar Saurabh Singh
Khaitan & Co

To tackle these issues, the Government of India has been working towards a simplified regime on insolvency resolution that can ease the burden on courts, as well as speed up the recovery process and boost the lending market. With this objective in mind, the Insolvency and Bankruptcy Code, 2016 was approved by the parliament on 28 May 2016. The code was notified in stages and has amended and repealed several other pieces of legislation that were overlapping in nature.

With India ranked at 136 on the World Bank’s ease of resolving insolvency index, the code is a timely and comprehensive piece of legislation consolidating the laws relating to insolvency, reorganization and liquidation/ bankruptcy of all classes of legal persons under one umbrella, pertaining not just to companies and limited liability partnerships but also to individuals and partnerships.

Under the code, the corporate insolvency resolution (CIR) process can be triggered for any default of payments in excess of ₹100,000 (about US$1,500) by the corporate debtor itself, or any financial creditor or operational creditor.

Modelled on UK law, the code provides for a time-bound period of 180 days (further extendable up to a period of 90 days) from the date of admission of the debtor in the CIR process for resolution of defaults, the initiation of which results in handing over the reins of the distressed corporate debtor to the interim insolvency resolution professional (IRP) appointed by the National Company Law Tribunal (NCLT), and imposition of moratorium against any legal proceedings to which the corporate debtor is a party.

Once the CIR process is initiated, a public announcement is made inviting claims from creditors of the entity. A committee of creditors (COC) is then constituted by its financial creditors and vested with decision-making powers regarding the affairs of the company during the CIR process, including raising any interim finance, creation of security on the assets of the corporate debtor, change of capital structure or management of the corporate debtor, etc.

The COC is also required to finalize the resolution plan in consultation with the IRP, with a majority of 75% by value of the COC. The resolution plan passed by the COC is required to be approved by the NCLT, following which the resolution plan becomes binding on all the stakeholders.

In the event that the COC cannot agree on a workable resolution plan within the insolvency resolution period, the company is required to be put under liquidation. In case of liquidation, the liquidator appointed by the NCLT takes control over the assets of the corporate debtor, which are to be sold and distributed in the manner set out in the code.

Dhwani Shah Associate Khaitan & Co
Dhwani Shah
Khaitan & Co

The time-bound process of insolvency resolution and compulsory liquidation, at the end of the period of moratorium in case of failure to finalise a resolution plan, is expected to create financial discipline, which has been singularly lacking in India.

The wide powers given to the resolution professional and the COC during the resolution process overcome the difficulties of the “debtor in possession” regime, which placed an unfair advantage in the hands of the borrower, who exploited the loopholes in the regime and used delaying tactics to thwart insolvency and recovery proceedings.

Under the code, the claims of secured creditors rank high in the order of priority for distribution, second only to any costs incurred towards the insolvency resolution and liquidation process, and government dues are now placed below even the claims of unsecured creditors. This is intended to encourage unsecured lending and act as a stimulus for bond markets.

There are certain challenges in the country that need to be overcome for smooth implementation of the code. The code requires strong infrastructure support in terms of a pool of trained insolvency professionals, information utilities that are required to hold credit information of financial creditors, and NCLT benches with adequate strength all over the country to meet strict timelines prescribed under the code.

The liability of insolvency professionals also needs to be limited and the buyers/investors in stressed assets need to be protected against future claims, in order to instil confidence in them to deal with stressed credit through this regime.

Having said this, India now has a bankruptcy and insolvency framework that is comparable with international standards, and this will go a long way towards bringing an element of certainty and predictability to commercial transactions in the country, and facilitating the ease of doing business.

KUMAR SAURABH SINGH is a partner and DHWANI SHAH is an associate at Khaitan & Co’s Mumbai office

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