Insolvency and Bankruptcy Code

The ease of doing business in a country is judged by the entry options for a business, the level playing field created for running a business and the exit option available for a business.

In India, reforms of the 1990s focused on the freedom to start a business whereas those of the 2000s were focused on freedom of continuing the business. Over the years, investors, including those belonging to the international community, have expressed concerns over providing finance to and/or investing in India. Before IBC, there were a number of challenges in the then-existing framework regarding the timely resolution of insolvency and the certainty of recovery.

IBC, enacted on May 28, 2016, seeks to address these issues by consolidating and amending the existing judicial framework; and ensuring certainty and clarity in all aspects of the process to achieve speedy resolution and higher recoveries and ultimately encourage lenders to increase the amount of debt financing.

What is the need for insolvency and bankruptcy laws?
In case an individual, corporation or partnership is deemed to be insolvent, the laws provide a legislative framework for liquidation of assets of the aforesaid persons and distribution of the proceeds in a fair and orderly manner amongst the creditors.

These laws also provide a mechanism for insolvent businesses to avoid bankruptcy by negotiating repayment arrangements with the creditors by restructuring the debt agreements and reorganising the financial affairs of the business

Source: World Bank Report

As per World Bank, the average time taken for completion of the bankruptcy process was 4.3 years in India (prior to IBC), whereas China, Singapore and United States take just 0.8–1.7 years. Also, the recovery percentage in India prior to IBC was as low as 26%, whereas this ranges from 78% to 92% in the developed world.

Key changes introduced through IBC

Before After
  • Multiple judicial forums, resulting in obscurity and ambiguity in jurisdiction
  • IBC aims at consolidating all existing insolvency-related laws as well as amending multiple legislation, including the Companies Act.
  • The Code would have an overriding effect on all other laws relating to insolvency and bankruptcy.
  • Different and often competing rights for all credit-side stakeholders without a singular regulatory process to determine the priority of claims
  • IBC has a clearly defined ‘order of priority’ or the waterfall mechanism.
  • The waterfall to render government dues junior to most others is significant.
  • No repository of adequate and credible data regarding the assets, indebtedness and security situation of companies
  • Antecedent transactions can be investigated and in case of any illegal diversion of assets, personal contribution can be ordered by the court.
  • IBC introduces a qualified insolvency professional (IP) as an intermediary to oversee the process.
  • Delays in the closure of unviable businesses due to the pro-revival approach of the judicial system; average litigation time of more than 4 years in India
  • The Code aims to resolve insolvencies in a strict time-bound manner — the evaluation and viability determination must be completed within 180 days.
  • The company’s insolvency professional has a moratorium period of 180 days (extendable up to 270 days) to take over the management of the company.
  • As per RBI, large amounts of stressed assets (advances) either restructured or NPAs with low recovery rates as a result of lack of environment enabling the enforcement of creditor rights
  • The Insolvency and Bankruptcy Board has been established as an independent body for the administration and governance of the insolvency and bankruptcy law, and Information Utilities have been established as depositories of financial information.

The Insolvency and Bankruptcy Code (Amendment) Bill, 2017 was passed on December 29, 2017. As per the amendment, wilful defaulters and existing promoters have been debarred from bidding for stressed assets of companies undergoing insolvency proceedings. Further, it prohibits the sale of property of a defaulter to such persons during liquidation.

Governance and process

Source: EY Report – The Insolvency and Bankruptcy Code, 2016 – An overview

For the first time, India has moved into the top 100 in the World Bank’s Ease of Doing Business global rankings on the back of sustained business reforms, which include the introduction of IBC.

Status of cases with the Insolvency and Bankruptcy Board:

Since the inception of the Code, around 2,434 new cases have been filed before the National Company Law Tribunal (NCLT – the adjudicating authority for IBC) apart from the 2,304 cases that have been transferred from various High Courts. Out of these, a total number of 2,750 cases have been disposed of and 1,988 cases are pending (as on December 1, 2017).

The resolution of the first set of 12 big corporate defaulters will be a key determining factor for the success of NCLT judgements. These 12 accounts constitute 25% or one-fourth of the system’s bad loans and are mainly into the steel, power and energy, construction and real estate, textile and automotive sectors.

Source: Ministry of Corporate Affairs Website

Important observations from NCLT’s judgements

Case 1: Leading private banks vs. manufacturing giant for default on debt repayment –

  • “The state law cannot stand in the way of the insolvency code”
  • “Once an interim resolution takes control of the company, its erstwhile management loses its right to appeal”

Case 2: Homebuyers vs. mega property developer –

  • “Position of homebuyers akin to financial creditor since they were guaranteed assured returns”
  • “Representatives of homebuyers association to take part in meetings of Committee of Creditors”

For the first time, the Government and the RBI are in agreement for the effective resolution of the bad debt recovery issue and enhancing the overall financial discipline in the way business is conducted in India. Effective implementation of the Code will enhance the confidence of foreign investors in India, which will result in higher FDI levels.

India now has a bankruptcy and insolvency framework that is comparable with international standards and that allows failed firms to wind up painlessly while giving them a chance to make a new start. This will go a long way towards bringing an element of certainty and confidence in the investors, creditors and other stakeholders.