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  • 5 important changes to India’s Bankruptcy law

    Publish date: 11th June, 2018

    Recently, you may have read headlines about how home buyers have been given more power against builders. Some other buzzwords you’ll come across commonly are bad loans, bankruptcy proceedings, insolvency, etc.

    Almost all of this can be traced to a single Law – The Insolvency and Bankruptcy Code, 2016 (IBC). And recently, the law got a facelift with an ordinance that brings about three key amendments.

    The key amendments made are:

           1.   Home buyers brought on par with financial creditors

           2.   Owners of failed MSMEs permitted to buy back their company

           3.   Voting requirements for a turnaround plan reduced

           4.   More financial companies can bid for a failed company

           5.   Guarantees by the company to not be suspended during IBC process

    Why this matters to you?

    You may be wondering why you need to understand the Insolvency and Bankruptcy Code (IBC). There are many reasons, one of which is especially crucial to you as an investor—Taking care of exit options is as important as easing the rules for investing in companies and institutions. This can help liquidate a company and distribute the proceeds better.

    This is equally important for all parties involved. After all, no company works in isolation and there are many other stakeholders who stand to suffer a loss in case a company fails. These include:

           -  &nbsp Customers who bought their products and services and depend on their continuation

           -  &nbsp Employees whose livelihood comes from the company

           -  &nbsp Lenders who extended credit to the company in good faith, with a belief that the company will pay them back

           -  &nbsp Investors who banked upon the company to be a ‘Going concern’

    Not just that, some of you may have invested in the stocks of banks and lenders. With a clear law in place, banks and lenders have a better chance of recovering their bad loans. This can help improve their profitability too.

    What is the Insolvency and Bankruptcy Code (IBC)?

    In case a company fails, the IBC suggests a way to try and restructure the company for a turnaround. If that does not work, the IBC lays down the path to liquidate the company in a manner that safeguards the interest of the stakeholders. This means selling the company’s assets to raise money.

    A failing company need not file for proceedings under IBC themselves. Any of their financial creditors can do the sane if they believe that the company is no more in the position to pay them back.

    What happens as per IBC?

    Once a creditor files an insolvency petition with the National Company Law Tribunal, the company is given six months to devise a plan for a turnaround, in conjunction with Committee of Creditors (CoC). But if no such plan can be agreed upon, the tribunal can force the company to be liquidated to make the due payments to the creditors and other stakeholders.

    Example of a company’s liquidation under IBC:

    In 2017, the Reserve Bank of India had directed banks to file insolvency petition against the major defaulters to resolve the NPAs. In December 2017, such a petition was filed by SBI against Videocon Industries.

    While the company seems to have been working on a turnaround plan, nothing had been approved by the shareholders and CoC within the stipulated six-month period since December.

    On June 6, 2018, the tribunal initiated bankruptcy proceedings against Videocon. It would now decide on the next steps that Videocon Industries will have to take.

    What does the amendment change?

    Here are the key amendments made to IBC and its impact:

  • Home buyers will now be treated as financial creditors and will be part of the committee of creditors.

    Impact: Over the last few years, delayed and cancelled projects from failed real estate developers had eroded home buyers’ trust. Giving home buyers a representation on the credit committee and making them a part of the decision-making process can help protect their rights and correct the trust deficit. Now, home buyers will be able to file for bankruptcy proceedings in case a housing project falls through and they are unable to recover their investments.

  • Pure-play financial institutions such as asset reconstruction companies, venture capital funds etc. can bid for the failed company, even if they were related to the said company.

    Impact: Pure-play financial institutions may be related to a failed company solely because of the business they do. They may even own a NPA because they have bought out a failing company, and are engineering a resolution there. They cannot be punished for this, and this alone cannot be a reason to bar them from bidding for another failed company. An expert panel headed by corporate affairs secretary Injeti Srinivas had recommended to make an exception for such institutions and the amendment has implemented the same.

  • Owners of a failed MSME, unless found to be wilful defaulter or disqualified for a reason other than the default itself, can now bid for the failed company.

    Impact: Allowing promoters of MSMEs to buy back their failed company helps protect their rights as well, while providing monies to payback other stakeholders. This will encourage more entrepreneurs to take the risk of starting a company.

  • Voting requirement lowered to 66% for major and 51% for routine decisions.

    Impact: It is always preferable that a failing company is turned around rather than liquidated. For a turnaround to happen, shareholders and CoC must approve the turn-around plan within 6 months of filing for proceedings. By lowering the threshold of the votes needed for this, IBC has made implementing a turn-around plan easier.

  • Guarantees offered by the company will not be suspended while the IBC process is being undertaken

    Impact: Customers buy a product or service based on guarantees provided by the seller. Therefore, not upholding these is a breach of trust and infringement on the customers; rights. While other legal proceedings will be suspended when IBC proceedings are ongoing, guarantees will still have to be honoured by the company involved.

What next?

Did you know, the RBI has been pushing for companies to start bankruptcy proceedings too? This could have many implications for bank stock investors, for starters. Read more here.
Alternatively, you can read up more about the Insolvency and Bankruptcy Code and its lasting implications for the economy.