The Insolvency and Bankruptcy Code of 2016 happens to be a game-changer for the insolvency and bankruptcy resolution process. The major idea behind introducing this code was to consolidate the laws and procedures for both, Insolvency and Bankruptcy into one. The bill became an act after it received the president’s assent on 28 May, 2016.
It is important to keep in mind that both the terms are not synonymous or interchangeable! Insolvency does not necessarily result in bankruptcy. That is to say, before turning into bankruptcy, the situation may be halted through processes such as debt restructuring for instance by changing the interest rate chargeable upon credit advanced, selling of assets or through restructuring of the company by let’s say changing the management or processes of mergers and so on.
Insolvency occurs when the liabilities and debts of a person or company are greater than the assets (‘balance sheet’ method) or when the person or company is unable to repay its creditors when they are due (‘cash flow’ method). It is not necessary that both these conditions must be met. There may be cash flow insolvency without balance sheet insolvency where the individual/firm may possess non cash assets that are surplus as compared to the debts. Again, there may be balance sheet insolvency without cash flow insolvency wherein the individual/firm is able to fulfill its immediate financial obligations by relying on its revenues.
Bankruptcy occurs when the person or the company approaches the appropriate court to declare himself or the company as bankrupt. It can therefore be deduced that bankruptcy amounts to an official recognition of the lack of an individual’s or a company’s to meet his or its financial obligations. Accordingly, bankruptcy proceedings may be started against the bankrupt individual or company and appropriate procedures such as liquidation may be taken up after a proper assessment. Remember liquidation can occur both in and outside the bankruptcy. Where it takes place outside bankruptcy, usually after repayment of debts to the creditors, the shareholders get whatever is left. On the contrary, when liquidation takes place in bankruptcy, the shareholders often end up getting nothing.
Before the enactment of this law, there were several authorities with overlapping jurisdiction through different pieces of legislations such as, the Companies Act of 2013, the Sick Industrial Companies Act (‘SICA’), 1985, the Micro Small and Medium Enterprises Development Act, 2006, the Recovery of Debts due to Banks and Financial Institutions Act (‘RDDBFI’), 1993 and the Securitizations and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 (‘SARFAESI’). Also there were several shortcomings like, the RDDBFI and SARFAESI act applies only banks as creditors and does not take account of other stakeholders and the main motive behind these two enactments was recovering debt rather than evaluating the prospect of sustaining the business. Meanwhile, the SICA applied only to ‘industrial’ companies having a minimum of fifty workers. Bankruptcy procedures against individuals and partnerships (other than limited liability partnerships) were possible under two archaic acts; the Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920.
Previously, the ongoing proceedings under different acts meant a considerable depreciation of assets the entire time adding on to the credit strain. This piece of legislation ensures that where viable, appropriate action be undertaken and where un-viable, resolution proceedings are completed within the time framework directed. The act recognizes the collective rights of all stakeholders at a single forum. It realizes that business and ventures cannot be put on hold merely because of the claims of a few lenders. Also, creditors cannot be left running from pillar to post to get back their dues. It also provides options for easy exits to startups and new ventures and brings all entities; Individuals, partnership firms, companies, MSMEs, under its ambit.
The Procedure for Individuals and Partnerships (other than LLPs) is different from that of the Companies.
Under the code, either the debtor or the creditors and other stakeholders such as the workmen and employees other than the workmen, can initiate the resolution process against a valid claim by approaching the appropriate authority mentioned under the act. The authority in case of individuals and partnerships (other than an LLP) is the Debt Recovery Tribunal (DRT) whereas in case of a company, is the National Company Law Tribunal (NCLT) set up under the Companies Act. In case of default of a valid claim, an application before the appropriate authority with proof and name of a proposed Resolution Professional may be sought.
In case of a company, the NCLT may decide to either accept or reject the application within 14 days. The default amount in case of companies is a minimum of Rs. 1 lakhs which may be revised by the Central Government, but may not be higher than Rs. 1 crore. This is the criteria for Financial Creditors. However, for operational creditors, where the debtor company is unable to pay the amounts claimed within ten days of notice on due, the criteria for filing the application is met. In case the application is accepted, within 30 days, the Resolution Professional’s appointment has to be confirmed.
Now, it is mandatory for the entire resolution process to be completed within 180 days. A further extension of up to a maximum of 90 days may be provided where the procedure appears complex. This time period is supposed to be a moratorium during which no proceedings may be instituted against the individual/company by lone creditors. The moratorium period is supposed to provide an opportunity to both the parties to carry out effective negotiations regarding their line of action or evolving of a Resolution Plan. Of course, the plan is drafted after considering the viability of running the business. The entire negotiation process is overseen by the Resolution Professional also termed as an Interim Resolution Professional (IRP). The IRP constitutes the Committee of Creditors (which includes Financial creditors or those to whom financial debt is owed and Operational creditors or those who provide goods and services such as the employees) and acts as its agent by suspending the powers of the board or management and assuming them. The Committee will comprise of a maximum of 18 largest operational creditors. Thus, it is in fact the Committee of Creditors that takes over the management and indirectly runs the affairs through the IRP. The regime has therefore changed from a ‘debtor in possession’ to one of ‘creditor in control’.
However, this process ends either by efflux of time or when the stakeholders fail to make any headway in the resolution. The Resolution Plan also when evolved must be accepted by 75% of the creditors (operational creditors do not enjoy voting powers) BY VALUE and subsequently presented before the appropriate authority such as the NCLT. If the resolution plan is rejected either by the NCLT or fails to garner the approval of 75% of the creditors by value, or there is no headway made or the time period comes to an end, Liquidation proceedings commence.
Liquidation can also commence voluntarily when the decision is taken so at a general meeting by a special resolution. During the process of liquidation, the Resolution Professional assumes the role of the Official Liquidator usually appointed by the High Courts or the Debt Recovery Tribunals. The Insolvency Resolution Professionals act as trustees in the process who will consolidate the assets and verify and evaluate the value of the claims. Appeals from the NCLT and the DRT orders are possible to their respective appellate authorities NCLAT and DRAT.
The Liquidation and repayment of claims takes place on a priority basis in the following order;
- The first priority is given to the costs incurred under the Insolvency Resolution Process, such as the costs incurred by the Resolution Professional while managing the affairs of the corporate debtor,
- the second priority is given to both secured creditors (who hold collaterals) and workmen’s salary for the past 24 months prior to liquidation,
- the third priority is given to salaries of employees other than workmen for the past 12 months prior to the initiation of liquidation,
- the fourth priority is given to unsecured creditors,
- the next priority is given to dues owed to the state or central governments for the past 24 months prior to liquidation and unpaid dues to the secured creditors after realization from the collateral amount,
- finally, if the assets remain after discharging all debts and dues, the rest will be distributed between the shareholders.
It is important to note that the act under Chapter IV also provides for a fast track corporate insolvency resolution process for less complex companies; where the assets and income of the corporate debtor are below a level specified by the central government or where the central government notifies that a particular class of corporate debtors must undertake the fast track process for resolution, the same route may be undertaken. Here, the moratorium period is fixed at 90 days and only under certain circumstances with the consent of 75% of the value votes from the committee of creditors can the time period be extended by another 45 days.
While considering the insolvency situation of individuals and partnership firms (Except LLPs) the minimum amount of default must stand at Rs.1000 which may be revised to a higher amount by the Central Government but not more than Rs.1 lakh. Here, there are two procedures. First, the Fresh Start Process and second the process mentioned above. The Debtor may make an application to the DRT for a fresh start, i.e. for discharge of his debt subject to such acceptance by the DRT, again within 14 days. This acceptance is contingent on factors like whether he has been issued a Fresh Start order previously, whether his aggregate debts are more than Rs. 35,000, whether his aggregate assets exceed Rs. 20,000, whether his gross anual income exceeds Rs. 60,000 and certain other declarations supplanted in his affidavit. The debtor in case of a partnership firm may initiate insolvency proceedings through an application jointly made by all or majority of the partners in the firm.
The Act contemplates the setting up of an Information Utility (IU) to prevent asymmetry of information. Multiple IUs are contemplated under the act which possess information regarding the indebtedness of a company. Simply speaking they are databases storing lending-borrowing information. While making any application before the NCLT, the financial creditor will be required to furnish evidence of such indebtedness that are on record with the IUs.
The Act also contemplates the setting up of Insolvency Professional Agencies (IPAs) for the purpose of training the IRPs and vesting in them the required qualifications and ethics. However the question here lies whether the government has been able to bring about the required infrastructure in place?
Further, the act envisages the Insolvency and Bankruptcy Board of India (IBBI) which acts as a regulator over the other bodies and is also involved in accrediting IPAs and IRPs and the emplyoment of IRPs. The IBBI also enacts model bye-laws for the functioning of these institutions.
The legislation also provides for cross border insolvency cases, as in where the assets of a debtor under bankruptcy proceedings lies in another country, the central government can execute agreements and treaties with the governments of foreign countries for purposes of enforcing the code. The Adjudicating authority may send a letter of intent to a court of competent jurisdiction in such country where the property is located.
There are several provisions regarding penalties for offences such as wrongful trading- where the director of the company did not take due diligence in minimising losses to the creditors in spite of knowing that a Insolvency Resolution Process was in the way, and fradulent trading where the persons who are party to the debtor’s business (which is in fact a broad term) fradulently carry on their business to defraud the creditors. While the punishment for defaulting companies are a maximum of 5 years imprisonment or fine of up to Rs. 1 crore or both, that for defaulting individuals involve an imprisonment sentence up to a maximum of 6 months or fine upto Rs. 1 lakhs or both.
Finally, it remains to be said that under all conditions of insolvency and bankruptcy, this act has an overriding effect over all other legislations meanwhile acts like the SICA and both the acts regarding individual insolvency have been repealed.