Insolvency & Bankruptcy Code 2016: Opening gambit

Jyoti Structures Limited, Mumbai, a Rs 116-crore company, is the first of 12 large defaulters against which banks have proceeded under the Insolvency and Bankruptcy Code 2016, following Reserve Bank of India directions.

The National Company Law Tribunal (NCLT) recently admitted bankruptcy proceedings against the Mumbai-based company, a move which could result in either new owners or liquidation. No longer would company managements be able to make investors lose their money, because the new regulations check a loss-making organisation much before it hits rock bottom.

All along, the country lacked the mindset to tackle corporate debt and never clamped down on debtor companies at the earliest signs of financial distress. Under the new insolvency regime, the company board’s divine powers  are suspended and the management needs to report to the insolvency professional.

In a tectonic shift, the government’s newly introduced Insolvency and Bankruptcy Code 2016 has transformed the debtor-creditor dynamic under Company Law. Earlier, the Sick Industrial Companies Act (SICA) 1985 proved an ineffective mechanism to revive a company bogged down in debt.

According to the Ministry of Finance, the Indian banking sector has over Rs  9 lakh crore of public money stuck in bad debts or non-performing assets, as on December 31, 2016. the bulk of which are insolvent companies. This only proves the point that the earlier system was unsuitable for a dynamic market-driven economy, such as new-age India..  

The requirement under SICA 1985, for initiation of insolvency proceedings, was a total net-worth erosion, and the under the Companies Act 2013, there was failure to pay to 50% or more secured creditors. However, under the 2016 Code, any financial default would trigger an insolvency application.

Hence, an application can be filed by a financial creditor such as a bank or an operational creditor, such as an employee, because unpaid employees or suppliers are the first signs of financial distress.

The default is actually the outcome of stress. A sense of urgency arises at this point of time, and requires detection at the earliest possible stage to preserve value. This first sign of default or stress should be used as an indicator to really assess as to what is going on with a company. If the NCLT accepts an application under the 2016 Code, then a resolution professional, known as insolvency professional, will be appointed to oversee the resolution process. This resolution process must be completed within 180 days, which is extendable by a further 90 days. The next step is liquidation.

During the 180-day period, there shall be a moratorium or a ‘calm’ period in place wherein no creditor can file a claim against the debtor company. Also, the power of management exclusively enjoyed by the Board of Directors, stands suspended and the management reports to the resolution professional for all its decisions. A Committee of Creditors is then constituted, which will decide and approve the revival plan, and the NCLT shall have the final say in cases of any conflict over the committee’s plan and the management.

The 2016 Code is reflective of the fact that there is a shift in the regime from recovery and revival to a predominantly resolution-driven process. Under the 2016 Code, the very first financial default is treated as the trigger. Therefore, the resolution committee does not really have to wait for the 50% of the secured creditors to come together or net worth of the company to erode.

It attempts to revive the company and put it back on profitability track, before it sinks further. This provision provides a huge relief to the banking sector who have monumental level of their assets tied up in NPAs.

The paradigm shift under the code disrupts the balance of power from equity to debt, as the company’s management and the Board lose their powers to the resolution professional and the committee of creditors.

Also, creditors have been clubbed together as “secured” and “unsecured” both of whom have a say in the Committee — proportionate to their exposure. Therefore, the divine right which promoters or the Board of Directors enjoyed over the company’s destiny is terminated.

The pendulum has swung in the other direction and transcends a legal change and spills over to a cultural change for India Inc where promoters and majority shareholders closely control and manage a company. Considering a particular company was mismanaged that resulted in poor financial health and sometimes even non performing debt demands a new team to run its affairs.

Therefore, it becomes imperative to appoint an insolvency professional to steer the company from loss to profitability. In reality, family run businesses would find it difficult to loosen their tight control over management to an outsider.

The mechanism of bankruptcy and insolvency the world over is either Debtor-in-Possession or Creditor-in-Possession. The Indian position had been Debtor-in-Possession, so far. However, under the 2016 Code it has shifted to Creditor-in-Possession. There is a great deal of value attached to both concepts, which   are not perfect. Debtors are those who have run businesses and know their industry. Creditors who step in and take over the business operations only lend capital but lack industry expertise.

Under the 2016 Code, these creditors are empowered to run the business which is a complex operation during the  period of moratorium. This transition at such a stressful phase has the potential to pose a serious business challenge and could adversely impact a company’s prospects.

However, it also needs to be understood that the insolvency professional has to work with the Committee of Creditors and the Board would also report to the former. Only if all of these stakeholders, namely the insolvency professional, the Board of Directors and the Committee of Creditors would  be in sync with each other  it would amount to a harmonious management in the best interest of all stakeholders.

(The author is an Assistant Professor at School of Law, Christ University)