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Mains Articles

Insolvency and Bankruptcy Code

An effort to improve the ease of doing business in India
By IT' Mains Articles Team
May 28, 2016

Contents

  • Introduction
  • The bill introduced as a money bill
  • What is Insolvency?
  • What is Bankruptcy?
  • Bankruptcy laws across the world
  • Why does India need a bankruptcy law?
  • Previous Bankruptcy Laws in India
  • The Bankruptcy Law Reform Committee
  • Salient Features of the Insolvency and Bankruptcy Code, 2015
  • What about financial sector insolvencies?
  • Critical Analysis of the Code
  • Importance of the bankruptcy code
  • End Note

 

Introduction:

The Parliament has recently passed the Insolvency and Bankruptcy Code Bill, 2016. It was first passed in Lok Sabha and later in Rajya Sabha in the month of May, 2016.

  • The billwill replace the existing bankruptcy laws to make it easy for investors to exit within a fixed time frame, in an effort to improve the ease of doing business in India.
  • The Code creates time-bound processes for insolvency resolution of companies and individuals. 

 

The bill introduced as a money bill:

The Insolvency and Bankruptcy Bill, 2015 was introduced as a money bill in the Lok Sabha.

  • In case of money bills, the Rajya Sabha can only make recommendations that are not binding on the Lok Sabha.
  • The president has no power to return a money bill.

 

What is Insolvency?

  • Simply speaking, insolvency is a financial state of being – one that is reached when you are unable to pay off your debts on time.
  • Insolvency is essentially the state of being that prompts one to file for bankruptcy. An entity – a person, family, or company – becomes insolvent when it cannot pay its lenders back on time.
  • Typically, those who become insolvent will take certain steps toward a resolution. One of the most common solutions for insolvency is bankruptcy.

 

What is Bankruptcy?

  • Bankruptcy, on the other hand, is a legal process that serves the purpose of resolving the issue of insolvency.
  • Bankruptcy is a legal declaration of one’s inability to pay off debts. When one files for bankruptcy, one obliges to pay off what is owed with help from the government.
  • In general, there are two main forms of bankruptcy –
Insolvency, Bankruptcy and Liquidation
Insolvency, Bankruptcy and Liquidation
  1. Reorganization: Under reorganization bankruptcy, debtors restructure their repayment plans to make them more easily met.
  2. Liquidation bankruptcy: Under liquidation bankruptcy, debtors sell certain assets in order to make money they can use to pay off their creditors.

It should be noted here that while insolvency is a financial situation and bankruptcy is a legal condition. Insolvency may or may not lead to bankruptcy.

 

 

Bankruptcy laws across the world:

US:

  • The US has a Bankruptcy Code that provides for fairly quick liquidation or reorganisation of business with what is popularly known as Chapter 7, with cases being filed in bankruptcy courts; Chapter 11, which deals with reorganisation of businesses; and Chapter 15, on cross-border insolvencies. Individual bankruptcies are dealt with separately.

UK:

  • In the UK, once cases are filed for bankruptcies, after 12 months, there is either discharge with part of the assets being used to pay off debts, or, in situations where companies can be turned around, court-appointed administrators handle cases.

Germany:

  • The German insolvency law is applicable to both individuals and firms, with independent court-appointed insolvency practitioners helping in realising assets or reorganising the business.

 

Why does India need a bankruptcy law?

  • India is a capital starved country and therefore it is essential that capital isn’t frittered away on weak and unviable businesses. Quick resolution of bankruptcy can ensure this.
  • Today, bankruptcy proceedings in India are governed by multiple laws — the Companies Act, SARFAESI Act, Sick Industrial Companies Act, and so on. The entire process of winding up is also very long-winded, with courts, debt recovery tribunals and the Board for Industrial and Financial Reconstruction all having a say in the process.
  • According to the World Bank’s Doing Business 2016 report,
  1. On average, secured creditors in India recover only 25.7 cents for every dollar of credit from an insolvent firm at the end of insolvency proceedings. This contrasts poorly with the OECD countries where creditors recover 72.3 cents.
  2. The whole insolvency process takes 4.3 years to conclude in India whereas it takes just 1.7 years in OECD countries.
  3. Because of the above reasons, India ranks an abysmal 136 out of 189 countries with respect to “resolving insolvency”.

 

Previous Bankruptcy Laws in India:

  • There are, several laws that deal with insolvency for companies, such as the Sick Industrial Companies Act, the Recovery of Debt Due to Banks and Financial Institutions Act, and Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI).
  • There are also a couple of laws dating from the time of the British Raj for dealing with individual debtors like Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920.

 

The Bankruptcy Law Reform Committee:

  • To fix the issues with the current insolvency regime, the government had set up a high level Bankruptcy Law Reform Committee (BLRC) in August 2014 under T. K. Viswanathan.
  • This committee had submitted its report in November 2015 while suggesting new institutions and structures to modernize the present outdated system.
  • After consultation with stakeholders about the committee recommendations, government prepared a draft bill and introduced it in the Parliament.

 

Salient Features of the Insolvency and Bankruptcy Code, 2015:

The bill contains a clear speedy mechanism for early identification of financial distress and initiate revival/re-organisation of the company if it is viable.

Timeline:

  • The bill proposes a timeline of 180 days to deal with the applications for insolvency resolution with an option of extending it by 90 days for exceptional cases.

Insolvency Resolution Plan:

  • The insolvency resolution plan has to be approved by 75% of the creditors. If the plan is approved, then the adjudicating authority will give its sanction. In case of rejection of insolvency resolution plan, the adjudicating authority will pass an order for liquidation.

Insolvency Professionals (IPs) & Insolvency Professional Agencies (IPAs):

  • 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:

  • Information utilities (IUs) will be established to collect, collate and disseminate financial information to facilitate insolvency resolution.

Bankruptcy and Insolvency Adjudicator:

  • The National Company Law Tribunal (NCLT) will adjudicate insolvency resolution for companies.  The Debt Recovery Tribunal (DRT) will adjudicate insolvency resolution for individuals.
  • The Debt Recovery Tribunal (DRT), which has jurisdiction over individuals and unlimited liability partnership firms. Appeals from the order of DRT shall lie to the Debt Recovery Appellate Tribunal (DRAT).

Insolvency regulators:

  • The Insolvency and Bankruptcy Board of India will be set up to regulate functioning of IPs, IPAs and IUs.

 

What about financial sector insolvencies?

The Financial Sector Legislative Reforms Commission (FSLRC) has recommended the creation of a resolution corporation to monitor financial firms, and intervene before they go bust.

  • The aim is to either close firms that can’t be revived, or change their management to protect investors or depositors.
  • This is important because the failure of large banks or institutions imposes costs on taxpayers in the form of bailouts or capital infusion.
  • The proposal is to promote the Deposit Insurance and Credit Guarantee Corporation (DICGC) as resolution corporation.

 

Critical Analysis of the Code:

  • Time-bound insolvency resolution will require establishment of several new entities.  Also, given the pendency and disposal rate of DRTs, their current capacity 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 Code provides an order of priority to distribute assets during liquidation.  It is unclear why:
  1. Secured creditors will receive their entire outstanding amount, rather than up to their collateral value,
  2. Unsecured creditors have priority over trade creditors, and
  3. Government dues will be repaid after unsecured creditors.
  • The Code provides for the creation of multiple IUs. However, it does not specify that full information about a company will be accessible through a single query from any 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 in which the Fund will be used.

 

Importance of the bankruptcy code:

The Insolvency and Bankruptcy Code would provide such environment to ensure easy exit for sick companies and help the country to improve its position in easy of doing business.

  • The bankruptcy code will make it easier for companies to wind up failed businesses and bring India on a par with developed nations in terms of resolving bankruptcy issues.
  • A stated objective of the new law is to promote entrepreneurship, availability of credit, and balance the interests of all stakeholders.
  • Once the code will come into place it will minimize the problem of delay as there are strict timelines within which the case has to be disposed off.
  • The code will also consolidate the existing laws thus making the process simpler.
  • Quick disposal of cases will maximize the recovery amount.
  • Establishment of information utilities will help in creating a database to provide information on the insolvency status of individuals. In addition to this, specialized insolvency professionals will help in guiding through the process.
  • Easy process of claim by the creditors also encourages financial institutions to extend credit facilities thus strengthening the financial markets with increased availability of credit for business.

 

End Note:

  • However, enactment of the code is just a beginning. For effective results, the government will have to ensure that its so-called pillars — insolvency professionals, information utilities, a strengthened adjudication mechanism, and a regulator — are institutionalised.

 

[Ref: Indian Express, The Hindu, PRSIndia]

 

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