Code is welcome, but has its pitfalls

The current bad debt scenario has coxswained to an abysmally irreversible situation, where a dispiriting mesh of courageously rising loan defaults, declining investments and production, a collage of ineffective and archaic bankruptcy laws, extremely slow-paced debts recovery and liquidation processes and the consequent scaling down of credit market has baffled the banking economy of the country.

The crash in commodity prices and the slowdown in infrastructure projects affecting the corporates’ balance sheet and their capacity to settle debts, with the non-performing assets at the end of December 2015, being 6% of total loans, which is said to have doubled in the past three years, has intensified the current bad loans problem of the country.

Amid the bitter pursuit of the rolling legal tussle between the stifled state-run banks and the Kingfisherian debt fugitive to recover some $1.3 billion of debt, the Parliament comes with a major breakthrough in its quest for economic reforms introducing the country’s first national bankruptcy law, the Insolvency and Bankruptcy Code 2016 (the Code) while confirming the urgency to deal with the upsurging bad debts scenario facing India.

Essence of the code

The importance of the bankruptcy law lies in promoting efficient allocation of resources within an economy, greater availability of credit for businesses while encouraging investments and entrepreneurship, development of financial markets with clarity on repayment for debtors.

The Code envisages repealing and consolidating some of the assorted century old laws governing bankruptcy into a single piece of legislation while amending some important laws which deal with debt recovery and winding up procedures. The Code is set to ensure a strict time bound process of winding up of insolvent company or limited liability entities, individuals and other entities (setting forth 180 days to complete the insolvency resolution process which can be extended by 90 days if more than 75% of the creditors agree), a ‘fresh start process’ for debt laden individuals under a defined threshold and temporary transfer of management of the troubled entity into the hands of the resolution professionals.

A prima facie reading of the Code highlights its potential to rectify the procedural flaws in the extant statues and execute the insolvency and bankruptcy processes smoothly to balance the interests of all the stakeholders including alteration in priority of payment in government dues. However, the proof of the pudding lies in its effective interpretation of the laws and implementation of the regulatory infrastructure.

The Code comprehensively deals with the insolvency resolution and liquidation process for corporate persons, bankruptcy process for individuals and partnership firms, establishment of the Insolvency and Bankruptcy Board of India which is geared to regulate the cadre of insolvency professionals, agencies and information utilities.

The major changes envisaged by the Code are the introduction of the concept of corporate insolvency resolution process (CIRP), and the fast track corporate insolvency resolution process (FTCIRP).

Under CIRP, the corporate debtors and the financial creditors would try to negotiate on and draft a repayment plan. Once the successful negotiation receives the assent of the financial creditors and the corporate debtor, the distressed company can be protected from liquidation. However, when a corporate debtor defaults in his payments, the process of corporate insolvency resolution can be initiated by an operational creditor or the debtor himself.

Under FTCIRP, the application for initiating fast track insolvency resolution may be filed by a creditor or the corporate debtor himself in case of default in repayment plan envisaged under CIRP, well established by conditions of eligibility for the fast track resolution process and mandated to be completed within 90 days from the insolvency commencement date.

Issues persist

Another significant provision in the Code is the waterfall provision whereby, amongst the priority list of creditors in the liquidation process, the government monies appear among the last in the queue after secured creditors, workmen’s dues for 12 months, employees other than workmen and unsecured creditors are paid their dues. This is quoted as the most welcoming change from what exists under the Companies Act 2013. Though the Code is heralded as a welcome leap forward in economic reforms, it is shrouded with several shortcomings. The arrangement of the Code mandates a rigorous inspection as it is bound to create slipups with overlapping jurisdictions of the forums and regulatory bodies.

The successful implementation of the Code will crucially rest upon the creation of a cohesive eco-system including the insolvency professionals, information utilities and repositories, a bankruptcy regulator and a highly equipped and informed adjudication infrastructure. Unless these four pillars are established upon a fortified infrastructure with massive instructive scriptures, the Code is bound to collapse. Mere introduction of the insolvency resolution professional (IRP), a concept borrowed from the bankruptcy practices of the United Kingdom, will not lead to higher credit recoveries as it involves huge realisation costs. Hence the adoption of the IRP model warrants scrutiny from a practical tonality.  

Moreover, the Code fails to make the proposed Creditor’s Committee more representative as it excludes operational creditors from the Committee. The Code also fails to create an inclusive voting rule for the Creditors’ Committee, evident from the approbation of 75% in value of creditors to sign off a proposed resolution plan.

This can potentially create the risk of the minority creditors being disenfranchised. Furthermore, the Code appears to be inconsistent with the corporate governance norms as each class of creditors should be given a right to vote and not merely attend the Creditors’ Committee meetings as ‘inactive observers’. Finally, a reduced deadline for completion of corporate insolvency process may push other recoverable companies into liquidation, disrupting markets and affecting jobs ad livelihood.

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