IBC: A BETTER TOOL TO SAFEGUARD THE INDIAN BANKING SECTOR
INTRODUCTION
Insolvency and bankruptcy are two different terms. They may seem to mean the same thing but they are not the same. A person can be called insolvent without actually being bankrupt. If a person is not able to pay his debts when they are due he may be declared insolvent. A person may be insolvent but not necessarily bankrupt, but if a person is bankrupt he is insolvent. Insolvency can be called a state of economic turmoil while bankruptcy is a court ruling directing the insolvent person to handle his liabilities. Bankruptcy spoils one's credit score and requires the insolvent person to sell his assets to repay the debt.
India has often been berated over for failing to keep pace with global trends in terms of the growth of its corporate economy. India has always struggled with the rise in insolvency and bankruptcy matters and increasing non-performing or stressed assets. Stressed assets are those assets which are more likely to be not realized and become bad debts. The problem of NPAs (Non-performing Assets) has always been a challenge to India’s economy. Since 2016, India has witnessed a rapid growth in the rate of resolving insolvency cases. The code has completely restructured the insolvency process. The government has repealed 2 Acts and amended 11 Act so that IBC and these Acts could work together without overlapping each other and creating any confusion. The difference between the prevailing laws and IB Code is that the IB code is a “resolution mechanism” whereas the other legislations were “recovery mechanisms”.
The difference between the two is that of
HISTORY OF INSOLVENCY LAWS IN INDIA
India has always had a questionable distinction in handling Insolvency and bankruptcy-related cases. The rules on insolvency in India were first stated in sections 23 and 24 of the Government of India Act, 1800, the Indian Insolvency Act, 1848 and the Presidency-towns Insolvency Act, 1909. In 1920, the Provincial Insolvency Act was passed. For years, the Acts of 1909 and 1920 dealt with individuals' problems regarding insolvency and bankruptcy. But no clear laws were covering the insolvency and bankruptcy of companies or corporations. The Companies Act was passed in the year 1956 and became the first insolvency law governing the companies and corporate or financial firms. Later, several laws entered into effect, keeping in mind the issues encountered by the insolvency process. Laws were introduced which contained insolvency and bankruptcy provisions for companies and financial firms like the “Sick Industrial Companies (Special Provisions) Act, 1985” (SICA), “the Recovery of Debt Due to Banks and Financial Institutions Act, 1993” (RDDBFI), “the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002” (SARFAESI) and “the Companies Act, 2013” (CA, 2013). “SICA” focused on strengthening the rights of the debtors whereas “RDDBFI” Act and the “SARFAESI” Act focused on strengthening the rights of the creditors. The Reserve Bank of India also stepped in and put forward multiple schemes and introduced “debt restructuring”, “joint lenders forum” with strategic debt restructuring and sustainable structuring of stressed assets, to reduce the cases of default of the loan and non-performing assets and so that maximum loan amount could be recovered.
The Presidency Insolvency Act, 1909 and Provincial Insolvency Act, 1920
The application of these two British-era Acts was divided based on the territory of states. The 1909 Act applied only to the Presidency states i.e., Bombay (Mumbai), Calcutta (Kolkata) and madras (Chennai) and the Act 1920 to the rest of the country except for these three states. The provisions of both the Acts were almost similar for insolvency of individuals. The Acts were in effect even after the IBC of 2016 was enacted. Initially, only Part I and Part II of the Code were notified which only dealt with corporate firms and not individuals or partnership firms. Both the Acts were functional until the notification dated December 1, 2019, was announced, stating the provisions for insolvency and bankruptcy of individuals firms, partnership firms and other individuals, i.e., Part III of the Code. The reason the Acts were not good enough and were repealed was that they did not provide a proper streamlined process for bankruptcy as provided for entities that fall under the IBC.
The Sick Industrial Companies (Special Provisions) Act, 1985
The Act was the result of Tiwari committee formed by the RBI, headed by Mr T. Tiwari. The Act of 1985 was passed keeping in mind the prompt identification of the companies belonging to industrial undertakings, which were “sick” or had the potential of being 'sick'. 'Sick' here means companies that could cause financial risks to the economy. A sick industrial unit under the Act was defined as the one which had been there for five years, and at the end of any financial year had accrued losses equivalent to or above its overall net worth. SICA, 1985 was a critical piece of legislation that resolved India's endemic industrial sickness crisis. It was the first legislation that focused exclusively on the restructuring of the companies. The scope of the Act, though, was to include only the “industrial companies” that were reported as “sick”. The Act was implemented in India to diagnose unviable/sick or possibly sick companies or businesses and, if necessary, assist with their recovery or, if not, their closure. For an industrial unit to be sick there could be various internal as well as external reasons like mismanagement, poor labour-management relationships, poor project implementation, energy crises, raw material shortage, global market force, etc. The Act provides for the creation of two bodies, to be quasi-judicial – the Board for Industrial and Financial Reconstruction (BIFR) and Appellate Authority for Industrial and Financial Reconstruction (AAIFR). The Board was set up to tackle the problem of industrial sickness, including the restoration and reconstruction of possibly “sick” units and the liquidation of non-viable companies or businesses. But instead of addressing sickness in the industry, the Board for IFR itself became a sick institution and a refuge for defaulting borrowers who tried to exploit the indefinite Sick IC Act moratorium. The directors of the company were responsible to report if there is any ‘sick’ industrial unit, within two months from the date identification of the company as “sick”. Unlike in the Companies Act, 1956, where once the sickness was identified, the stay had to be granted at the discretion of the High Court, the stay on all the suits or proceedings against the unit was automatic, under “SICA”.
The Act focused on strengthening the debtor’s rights. It allowed the debtor firms to manage its assets and activities even after adjudication of sickness. Another problem with the Act was that it overlapped some of the provisions of the Companies Act. The Act said that once the adjudicating authority, i.e., “BIFR” has declared a company to be sick, it could recommend the winding-up of the same whereas the CA, 1956 provided that the winding-up could only be issued by the High Court. The High Courts have repeatedly revived and reconsidered the winding-up proposals made by the “BIFR” and even reversed them, triggering undue delays and subsequent reductions of the firm’s value. According to a study of Board for IFR in 2014, there were about 5,800 cases reported between the years 1987 and 2014, out of which more than 50% of the cases were abated or suspended, 22% of cases were referred for liquidation, 9% of the cases faced the implementation of a rehabilitation plan and the remaining 15% were still pending. And, on an average, time taken by each case to resolve is around 5.8 years. According to a report from Live mint dated January 2017, there still 700 cases pending in “BIFR”. Although the law was well written, there were certain discretionary powers given to the board which resulted in an unreasonable extension of time. This hampered the company's chance to recover.
In 2003, the Act of 1985 was replaced by SIC (Special Provisions) Repeal Act. The main reform in the Act was that it prevented cases where the companies could not declare sickness solely to circumvent the legal responsibilities and be granted with concessions from banks or financial institutions. It was completely repealed, in part, on December 1, 2016. The reason behind this was that it still overlapped certain provisions of the CA, 2013.
The Recovery of Debt Due to Banks and Financial Institutions Act, 1993 (RDDBFI)
The Act was the result of the Narsimham Committee I formed in 1991. The Act focused on the rapid realization of the debts due to banks and financial institutions. Since recovery from civil courts took more time than expected and because of unreasonable delays, separate adjudicating authorities were established, known as "Debt Recovery Tribunal" (DRT) and "Debt Recovery Appellate tribunal" (DRAT). DR Tribunal was set-up under section 3 of the Act and section 8-11 deals with the establishment of DR Appellate Tribunal, qualification and term of the chairperson. Suits or cases filed before DR Tribunal must be resolved within six months of filing. Despite this provision, there was no improvement in the speed of disposing cases. The reason behind this was that appeal could be filed against the judgment of the DR Tribunal and there are only 5 DR Appellate Tribunals against 39 DR Tribunals. The Act applies cases where the debt amount due to banks or financial institutions is more than Rs 20 lakh. Although, as for the realization of debt the Act was efficient in itself its objective ("speedy recovery of debts") was not met in the manner it was desired. Same was the case with SICA – not enough revival of industrial units took place and hence the purpose of both the Acts was achieved. Failure of these two Acts led to an increased number of NPAs and hence lowered the worth of a bank's balance sheet. Therefore, more proper and efficient legislation was required to cope with the increasing number of NPAs in the economy.
The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act)
The foundation of the Act was the formation of "Narsimham Committee II" in 1998. The committee's decision contributed to the enactment of the Act. The Act gives power to banks or financial institution to raise money by selling the property which was kept as collateral. The Act also gives the right to the debtor to file a suit in DRT. It was enacted so that the banks or FIs could recover the loan amount without the interference of the courts. It permits the creditors i.e., the banks or FIs to seize the asset on default of repayment. The Act only applies to loans which are Non-performing assets and are likely to remain so. It also provides for the establishment of Asset Reconstruction Companies (ACR) where the firms could sell their NPAs.
The Act only talks about the secured creditors whereas I&B Code covers both secured as well as unsecured creditors. If the case is filed under both, SARFAESI Act and I&B Code then the I&B code will prevail. Again, the Act was efficient enough but only talked about secured creditors and the rate of recovery has declined overtime worsening the situation.
The Companies Act, 1956 and Companies Act, 2013
The Companies Act of 1956 (CA, 1956) was the first law to be enacted which dealt with the insolvency of corporate firms. Prior to the introduction of the New Code, the Act of 1956 and 2013 contained a provision regarding the voluntary liquidation of a company or a corporate entity. Section 38 of the 1956 Act and section 20 of the 2013 Act dealt with the voluntary liquidation of a corporate firm. These sections were later omitted in 2016 and 2017 and similar relevant provisions were included in Part II Chapter V and sections 35-53 (Chapter III and VII) of the New Code. The Code, in total, have brought 36 changes to the Act of 2013. The Code has deleted all the voluntary liquidation provisions from the Act. Therefore, this makes the Code only legislation with the provision of both voluntary liquidation and corporate debt recovery. The Code is the most effective and efficient legislation available for insolvency proceedings. Its importance has been made clear by the Supreme Court in Innovative Industries Ltd. and ICICI case by mentioning -
“There can be no doubt, therefore, that the Code is a Parliamentary law that is an exhaustive code on the subject matter of insolvency in relation to corporate entities. … It will be noticed that whereas the moratorium imposed under the Maharashtra Act is discretionary and may relate to one or more of the matters contained in Section 4(1), the moratorium imposed under the Code relates to all matters listed in Section 14 and follows as a matter of course…. It is precisely for this reason that the non-obstante clause, in the widest terms possible, is contained in Section 238 of the Code, so that any right of the corporate debtor under any other law cannot come in the way of the Code.”
Banking regulations and schemes
Corporate Debt Restructuring (CDR) – This was introduced by the RBI in the year 2001. It's objective to restructure the corporate debt of companies and in a time-bound manner. It was completely based on the contract or agreement between the debtor and the creditor for resolving the matter out of the court. Its mechanism was such that it helped the debtor firm with multiple creditors to ease the situation by negotiating with each creditor.
Joint Lender’s Forum (JLF) – The scheme was laid down by the RBI in 2014 addressing the increase in NPAs in the banking sector. The coming together of the banks and forming a body who, have extended credit to the debtor was known as JLF. This step by the regulator was taken to manage the stressed assets properly. JLF was also abolished by the regulator in March 2018 and ordered the lenders to come up with a resolution plan for the pending transactions. The new framework directed towards the proceedings under the IBC.
Strategic Debt Restructuring (SDR) – It was considered the improved face of the CDR scheme. It allowed the banks (creditors) to turn a part of the loan/debt into equity of the debtor company. But soon after its introduction, it was considered a failure.
S4A – The scheme was laid down by the RBI in June 2016 to lessen the bad debts of the banks. The scheme financially restructured a project and allowed the banks or lenders to acquire that project.
The current status of these schemes is 'not active'. Since the RBI saw the insolvency and bankruptcy procedure is stabilizing in the country, it recently decided to disband these schemes as they were mostly exploited and taken advantage of by the debtors and has asked the banks to try the debtors under the New Code.
The implementation of IBC was necessary because of the major problems that existed in the prevailing legislation and also because of a lack of clear laws relating to the current insolvency and bankruptcy process. The problem, such as the multiplicity of laws, conflicting jurisdictions and the restricted ties between the current statutes, led to a delay in the disposition of cases, which frustrated the creditors. The schemes were misused by the debtor firms and the right of the banks to realize the loan money was put in damaged.
INSOLVENCY AND BANKRUPTCY CODE, 2016
The Code got the President’s assent in the year 2016. In over two years’ of its existence, the Code has shown its effectiveness of IBC in a good measure. The “Insolvency and Bankruptcy Code, 2016” (herein referred to as 'New Code'/'the Code'/'IBC') was introduced by the Narendra Modi government in order the settle the claims which involved the insolvent companies. The Code has brought together all the prevailing laws which dealt with insolvency and bankruptcy of individuals, limited liability partnerships, partnerships (unlimited), and corporate insolvency. It gives a separate resolution process of insolvency for different entities. For companies, the resolution process is supposed to be over within 180 days which could be stretched by 90 days and for small businesses, the insolvency resolution must be completed within 90 days which could be stretched by 45 days more. But now the time limit has been set to 330 days by amending the Code. All entities, whether corporate firms, individuals or partnership firms, comes under the purview of the Code. All commercial banks and financial institutions also fall under the purview of the Code. Initially, the code did not have any resolution or restructuring provisions for the Non-Banking Financial Companies (NBFC) and Financial Service Providers (FSP) but later in 2019 through a notification both were included under the purview of the Code.
The Code lays down the process to revive and rehabilitate the debtor company without damaging the rights of its creditors. It was designed to acknowledge and resolve the issue of bad loans that relentlessly attacked the country’s banking sector. Since the year of its commencement, the New Code has succeeded in preventing corporates and now individuals and partnerships from defaulting on their loans. According to the late finance minister Arun Jaitley, “IBC has changed the debtor-creditor relationship.” IBC has turned out to be a crucial and much needed economic reform, by helping to contain the rising problems of non-performing assets (NPAs). The primary motive of the Code was to overcome the loopholes/discrepancies of the existing statutes or laws. To do that, the central government have repealed two legislations and eleven legislations have undergone the amendment process to date. The preamble of the Code clearly states its objectives and are as follows:
“to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time-bound manner;
maximization of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues;
establish an Insolvency and Bankruptcy Board of India, and for matters connected therewith or incidental thereto.”
IB Code provides for two adjudicating authorities- NCLT and DRT. NCLT for companies and LLPs and DRT individuals and partnerships. The Code also provides for the formation of information utilities (IUs), professional insolvency agencies (IPs) and adjudicating authorities for speedy, effective and proper recovery. It focuses on revival debtor companies timely and protection of the creditors as well as stakeholders.
PROGRESS OF IBC
In 2019, it was recorded that the recovery rate under IBC was the most i.e., 43%, when compared with other foundations like SARFAESI, 2002, Lok Adalats, DR Tribunals, etc. There has been an increase of 27% in resolution cases in the same year. In the FY19, Rs. 7,08,190 was the total amount that was recovered under the Code.
According to a report published by the Ministry of Corporate Affairs in December 2019, the progress of IBC has been significant. From the date of commencement of the Code total 21,136 applications were filed under the Code, out of which more than 9600 cases have been disposed-off pre-admission stage involving a total amount of approximately Rs. 3,74,931 Crore. Out of 2838 cases admitted in CIRP, 306 are either withdrawn or closed by review or appeal. Total Rs 1,56,814 amount was realized from 161 cases that were resolved. According to the World Bank Doing Business Report 2020 – Resolving Insolvency Index, India’s rank has jumped to 52 in 2019 from 108 in 2018. That makes it 56 places in a year. The recovery has also significantly gone above from 26.5% (2018) to 71.6% (2019). The average time taken for recovery in 2018 was 4.3 years and in 2019 it got reduced to 1.6 years.
IBC has succeeded in achieving the results which the earlier legislation failed at. It has brought a major rise in decreasing the NPAs. In the financial year 2019 (FY2019) December, the gross NPAs stood at 9.1%, while the rate was 11.2% in FY2018. Net NPAs were at 3.7 and 6 in the FY2019 and FY2018, respectively. The public sector gross NPA dropped to 11.6% in FY2019 from 14.6% in FY2018. This was a big success in decreasing the rate of NPAs. The private sector’s NPA rose to 5.3% inFY2019 from 4.7% in FY2018. Overall there has been an improvement in resolution of NPAs since the Code was introduced.
The Banking Sector which was suffering the most because of the failure of the debtor to repay on time and increasing stressed assets has finally come to a better state. The recovery of money parked in the insolvent companies has taken place through 3 methods. Firstly, after the introduction of section 29(A), companies are paying up their loans in anticipation of not being referred to NCLT, if they cross the red line. This has resulted in banks receiving money from debtors who pay in anticipation of default. Defaulters know well that once they get into IBC, they surely will be out of the management because of section 29(A). Secondly, once creditor’s petition is filed before the NCLT, debtors are paying at the pre-admission stage so that declaration of insolvency does not take place. Thirdly, many major insolvency cases have already been resolved and many are on the way of resolution. Those that cannot be resolved move towards liquidation and the banks receive the liquidation value.
The recent changes in the Code like the inclusion of NBFCs and FSPs and making Part III of the Code functional will also help the banking sector in decreasing the stressed assets.
NBFC and FSP now included
Non-Banking Financial Companies and financial Service Providers were not included under the Code because both forms of organization involved the money of the public and their inclusion could bring economic instability. But now through a notification dated November 15 and 19, 2019 both type of entities will also fall under the purview of the New Code. Only those NBFCs can whose asset size is equal to Rs. 5 billion or more. Also, only on the direction from the RBI, insolvency application can be initiated against NBFCs before NCLT.
Individuals Insolvency and Partnership insolvency
Earlier, out of five, only two Parts of the Code were functional which only talked about the corporate insolvency. On December 1, 2019, the Central Government by notification made Part III of the Code also functional. Part III of the Code covers the insolvency and bankruptcy of individual and partnership firms.
CONCLUSION
The Code got the President’s assent in the year 2016. In over two years’ of its existence, the Code has shown its effectiveness of IBC in a good measure. India has already made significant progress in disposing of the insolvency and bankruptcy cases, timely, speedily and properly. The Code has made great efforts to rebuild the entire credit environment in India by reviewing and eliminating the old laws of the bankruptcy and insolvency process. The Code is expected to result in extensive reforms, with a focus on debt-focused reforms. It aims to detect the early financial failure and increase the value of the assets of the debt-ridden company. The consolidated plan provides for a structured, long-term liquidity and liquidation process that will significantly increase debt collection and stimulate the corporate market in India. The condition of the banking sector has also improved over time. The NPAs or stressed assets seems to be reduced in numbers for good. As there will sooner resolution of proceeding, the money involved would be recovered sooner allowing the banks to lend to more and more persons.
The introduction of the Code has been a win-win for the banking sector as they can recover the debts on time. Also, the debtors pay up the creditors without any default to avoid getting tried under IBC and going to the court. Many cases are getting resolved outside the courts. That is the biggest success as they try to resolve things among themselves which reduce the burden of the judiciary.
Developing and implementing the Code will not only improve India's geographic footprint in terms of ease of doing business but will also improve debt markets, GDP, foreign direct investment and the overall business environment. However, the success of the code will depend on how it is used. There is enough evidence that the law is in the right place, and the number of successful solutions has reached double digits in less than two years. However, with this challenge, people should not be complacent. These issues are discussed further above and there are legal, logical and procedural barriers. The coming months will be crucial in ensuring that the challenge meets the few existing legal remedies. However, we cannot forget the success of the Code because there are some drawbacks. The growth path outlined by the Code indicates that India's extinction program has improved significantly.
REFERENCES
Gupta, Ankeeta. (2019). Insolvency and Bankruptcy Code, 2016: A Paradigm Shift within Insolvency Laws in India. The Copenhagen Journal of Asian Studies. 36. 75. 10.22439/cjas.v36i2.5650.
Sengupta, Rajeswari & Sharma, Anjali & Thomas, Susan. (2016). Evolution of the insolvency framework for non-financial firms in India
Ajay Shaw, Ashish Pahariya & Shoham Mookherjee, “The Viewpoint: Government of India announces key amendments to the Insolvency and Bankruptcy Code, 2016”
Year-End Review -2019 of Ministry of Corporate Affairs, https://ibbi.gov.in/uploads/whatsnew/0610123bdd4ffc191a3ea05a847e1307.pdf
SUBMITTED BY:
RAGESHWARI CHUNDAWAT,AMITY LAW SCHOOL, NOIDA