Strengthening the Bankruptcy Code in India: Hit or Miss?

India’s insolvency and bankruptcy regime is rapidly shaping up to become one of the most comprehensive legislations in the recent past. But is there more to the Insolvency and Bankruptcy Bill of 2015 than meets the eye?

Earlier this week, the Rajya Sabha passed the Insolvency and Bankruptcy Bill, 2015 (IBC) following Lok Sabha’s approval last week. The final draft comes after incorporating the recommendations made by the Joint Committee (Committee).

All that is left is Presidential assent.

The IBC seeks to create a unified framework for resolving insolvency and bankruptcy in India by implementing an insolvency resolution process which may be initiated by either the debtor or the creditors.

Following its passage, the IBC will repeal the Presidency Towns Insolvency Act, 1990 and Provincial Insolvency Act, 1920. In addition, the IBC will amend eleven laws, including the Companies Act, 2013, the Recovery of Debts due to Banks and Financial Institutions Act, 1993 and the  Sick Industrial Companies (Special Provisions) Repeal Act, 2003, amongst others.

However, while the changes introduced might appear to be good on the face of it, there just might be some latent defects.

Among the several changes introduced, the Committee has taken a note of views of various stakeholders and included operational creditors (workmen, employees, suppliers) in the committee of creditors. They will not be given any voting rights but will now have a chance to present their views.

However, here is a reason why should it be more about ‘representativeness’ over ‘comprehensiveness’.

While a firm is likely to have a finite set of finance creditors (which means it’s easier to collate this data for the Resolution Professional), the number of operational creditors will be reasonably infinite, (making it difficult for the Resolution Professional to collect data for all these parties).

This may establish a case for disputes and judicial interference and resultantly, go against the 180-days target which the IBC seeks to achieve.

Further, priority has been given to workmen’s dues in the event of liquidation. Bringing the duration of workmen dues at par with dues to the Central and State Government, they will now be given for a period of twenty-four months preceding liquidation commencement date instead of the existing twelve months.

Now, the draft bill had provided for three months, which got extended to twelve in the final version. This may seem like a noble measure but the devil lies in the detail.

How so?

If you’re a worker in a company who has not been paid salary for three months, you will have two options: a) You can leave the company or; b) you can go to court and trigger the bankruptcy of the company.

As someone who worked on the draft bill notes, the whole point of giving a time threshold to the workers is for them to take action before that period gets over. The question that begs to be asked is why should two years be provided for this process?

By increasing workers liquidation rights to twenty-four months, neither will the company have a timely liquidation nor will it have enough funds to cover workers dues for twenty four months. By  protecting them for two years, the IBC could end up delaying the inevitable by two years and incentivising the employees to wait longer before they take any action.

Another point which calls upon some amount of dissent is the removal of requirement for Resolution Professionals to post a performance bond and performance security deposit. This was because the Committee felt that the Resolution Professionals are anyway sufficiently well regulated by the Insolvency and Bankruptcy Board (Board) and also, the difficulties which the professionals will face if they have to provide such a huge sum.

Here’s why presenting a bond isn’t and shouldn’t be very difficult.

Firstly, the extent of the bond need not be equal to the value of the institution, if its a 1,000 crore institution, you may furnish a 100 crore bond of say, a bank guarantee which will cost around say 0.25% (If its a big company the banks will be happy to lend it and if its a small one the cost will be higher). In the near future when the insurance market is more developed, there will be insurers who will be happy to provide insurance for this.

And in the event it is not easy to present a bond, it’s probably only for the good. Instead  deterring professionals from joining, it is more likely to bring the right people into the profession, who have the ability to bond. This is like earnest money; and if it is removed, it has the possibility of bringing in unscrupulous players into the profession.

However, silence doesn’t amount to prohibition. The law is now silent on the provision relating to bond. Silence is not negative action, so tomorrow if the regulator thinks the bond is a good thing, since the legislation is silent on it, the regulator will bring it back.

One of the most noteworthy changes introduced relates to cross border insolvency. Given that many corporate transactions and businesses today involve an international and cross border element, the implications of cross border insolvency cannot be ignored for too long.

There are two elements to cross border insolvency:

The first element is domestic insolvency. On that point, what is the right of a foreign creditor? If one looks at the provisions of the IBC, it did not distinguish between a foreign creditor and a domestic creditor, it only differentiated between a financial creditor and an operational creditor. The IBC never said that rights of foreign creditors cannot to be activated.

The second element is what happens when bankruptcy has been invoked for a company which has assets offshore. Now IBC cannot address that alone, it has to become part of other relevant international conventions where one country recognises the jurisdiction of another country in such situations.

As such, the provisions introduced in the IBC somehow fail to address the question of assets offshore. Even the initial draft did not say that foreign creditors in a domestic entity cannot invoke bankruptcy. The IBC has done nothing but explicitly state that foreign creditors rights are equal to domestic creditors. There was nothing disabling an entity from entering into agreements with other countries in the first place

Following are some of the other key highlights

  • Public financial institutions will now be included in the definition of  financial institutions, as defined in the Companies Act, 2013;
  • The IBC gives the Adjudicating Authority the power to reject an application on a minor defect without giving an opportunity to the applicant to correct the defect in the application. It is recommended that the applicant should be given the opportunity to remove such defects within a stipulated time frame;
  • Resolution Professionals are authorised to raise interim finance under certain conditions. One such condition is that no security can be created over any encumbered property of the corporate debtor without prior consent of the creditors whose debt is secured over such encumbered property. It has been observed that as a result, creditors might unreasonably withhold their consent if their interest is over secured. To tackle this issue, it has been recommended that when the encumbered property is twice the value of the amount of debt, consent of the creditor will not be required;
  • Various provisions of the IBC authorise the Committee of Creditors to replace the Resolution Professionals/Bankruptcy Trustees on the grounds mentioned therein. Considering the professionals are well regulated by the Board as well as Insolvency Professional Agencies (IPA), the Committee has made changes to ensure that grounds which may affect their career have been removed;
  • In order to strengthen the monitoring process, the resolution professional now has a liability to ensure the proper implementation and of the plan;
  • All sums due to any workman or employee from the provident fund, the pension fund and the gratuity fund will be considered as priority dues and is not to be included in the liquidation estate assets and estate of bankrupt;
  • The Resolution Professionals are now prohibited from replacing themselves in the event they are unable to represent themselves for a meeting. Further, the authority given to creditors to appoint an additional resolution/replace an existing professional during implementation phase has been withdrawn;
  • The constitution of the selection committee-which is responsible for the appointment of all members (other than ex office) of the Board – has now been provided for.

Other than the above, the Committee also made a set of general recommendations, which inter alia include:

  • Establishment of adequate Benches of the adjudicating authorities/appellate authorities;
  • Civil courts and adjudicating authorities to be located and set up within one complex to the extent possible;
  • Inclusion chapter relating to insolvency, liquidation and bankruptcy in the curriculum of law/commerce/accountancy/ management degree/ higher level courses;
  • Expedition of the procedure of establishment of the Board;
  • Promoting one Nodal Ministry/ Department to be in-charge of the administration of the IBC.