In May 2016, the Indian parliament passed the Insolvency and Bankruptcy Code 2016 (the Code), finally paving the way for the introduction of a much-needed modern framework to deal with insolvency and bankruptcy of corporate entities and individuals in India. The journey of the Indian insolvency reforms has been painfully slow and incremental. The legal framework for insolvency remained fragmented and ineffective for decades even as reforms in the other areas of economic law moved rapidly after the liberalisation of the Indian economy in 1991. To attract foreign investment, the policy-makers focused heavily on reforming the entry laws but neglected improvements in exit law, underestimating the role the insolvency system plays in winning investor confidence. The key principles that form a sound insolvency law were missing or were lost in the complex interplay between the multiple legislations forming part of the insolvency system. The restructuring and liquidation proceedings were cumbersome and marred by lengthy court processes. The average life of cases recommended for restructuring was between four and eight years and those recommended for winding up even longer, while it is only 1.7 years in high-income OECD1 countries. India continued to fare badly in the World Bank's Ease of Doing Business2 ranking for many consecutive years, with Closing a Business (now known as Resolving Insolvency)3 in India being one of the key negative indicators. In 2016, the ranking moved up to 130 but in Resolving Insolvency, India continued to score poorly, having been placed at 136.4
In the absence of an effective insolvency law, the non-performing assets of the Indian banks started accumulating. The stressed assets in the banking system peaked at approximately US$150 billion (about 15 per cent of gross advances).5 A high level of non-performing assets can severely affect the economy in many ways. Management and financial resources are diverted towards the resolution of non-performing assets, causing an opportunity loss for productive use of resources, thereby causing continued economic and financial degradation. This results in a credit crunch and generally signals an adverse investment climate.
While the Indian banks have a legal right to enforce their security interest without court intervention, some of the most important lenders operating in the economy are not banks. They are the dispersed mass of households and financial firms that buy corporate bonds. The lack of power in the hands of a bondholder has been one (though not the only) reason why the corporate bond market has not flourished. This, in turn, has far-reaching ramifications, such as the difficulties of infrastructure financing. There was a pressing need for a very long time to introduce an efficient insolvency framework in the country that would help in the resolution of non-performing loans and benefit creditors other than banks and financial institutions. For a country seeking to attract international investors, low scoring on the World Bank's Doing Business report card is a major hurdle in attracting capital.
The speed with which the Code was enacted and the supporting rules and regulations developed has surprised many. The government moved at an unprecedented pace to put the Code into operation. The Bankruptcy Law Reforms Committee (BLRC), chaired by T K Viswanathan, was set up in August 2014. The BLRC submitted its final report in November 2015 and the Indian parliament passed a law based on its recommendations in May 2016. Less than six months after the enactment of the Code, subordinate legislation was finalised and the corporate insolvency law made majorly operational before the end of 2016. All this happened in less than two years, occasionally inviting criticism of inadequate stakeholder engagement and consultation. The government has not yet notified the provisions relating to bankruptcy of individuals.
The Code introduces significant legal and structural changes in the insolvency framework. By the end of March 2017, most provisions of the Code relating to corporate insolvency had been put into operation, institutions that are part of the new ecosystem became functional and filing of insolvency applications began. The Code contains many new principles and concepts alien to the Indian market on which neither any best practices nor recorded precedents exist. Direct legal jurisprudence on them is also scarce. For example, the Code introduces a shift from the ‘debtor in possession' regime to a ‘creditor in control' regime, making it a creditor-friendly legislation. The law establishes a new discipline of insolvency professionals. An insolvency professional will perform crucial functions in the corporate insolvency process, including management of the debtor's enterprise as a going concern. His or her role will be crucial in determining the outcome of insolvency proceedings.
The Code has designated the National Company Law Tribunal (NCLT) as the adjudicating authority to provide an oversight of insolvency cases. A new regulator - the Insolvency and Bankruptcy Board of India - has also been established by the Code.
The Code is based on the United Kingdom's administration procedure, although a few provisions have been customised for India:
- The role of the court has been reduced.
- Creditors have been provided with greater powers to approve decisions made by the resolution professional appointed as office-holder in the corporate insolvency resolution process.
- Strict timelines have been provided for resolution and liquidation, shorter even than what is provided in English law.
An understanding of the experiences under English law, where similar provisions have been in practice for a long time, will help in the development of best practices for the Indian market. Various institutions have been set up - the regulator, insolvency professionals, information utilities and the adjudicating authority - which will play a crucial role in the insolvency process.
A corporate insolvency resolution process can be initiated in respect of a company that has committed a default. A default would have occurred when the debtor fails to pay the whole or any part or instalment of the amount of debt (see below for definition) that has become due and payable. While a financial creditor is required to present a record of default before the NCLT for initiation of the corporate insolvency resolution process, an operational creditor must issue a statutory notice to a corporate debtor in the manner provided in the Code.
What is a debt?
The Code defines ‘debt' as a liability or obligation in respect of a claim, which is due from any person and includes financial debt and operational debt.
A ‘claim' means (i) a right to payment, whether or not such right is reduced to judgment, fixed, disputed, undisputed, legal, equitable, secured or unsecured; or (ii) a right to remedy for breach of contract under any law for the time being in force, if such breach gives rise to a right to payment, whether or not such right is reduced to judgment, fixed, matured, unmatured, disputed, undisputed, secured or unsecured. The corresponding obligation of the debtor to pay may arise out of a financial debt or an operational debt.
Broadly, ‘financial debt' means a debt with interest, if any, which is disbursed against the consideration for the time value of money. An ‘operational debt' means a claim in respect of the provision of goods or services, including employment or a debt in respect of the repayment of dues arising under any law for the time being in force and payable to central government, any state government or any local authority.
Who can initiate the process?
The process for initiating a corporate insolvency resolution may be led by a financial or operational creditor, or a corporate debtor. However, the following are disqualified from initiating the process:
- a corporate debtor undergoing a corporate insolvency resolution process;
- a corporate debtor who has completed a corporate insolvency resolution process 12 months preceding the date of making of the application;
- a corporate debtor or a financial creditor who has violated any of the terms of a resolution plan that was approved 12 months before the date of making of an application; or
- a corporate debtor in respect of whom a liquidation order has been made.
Admission of application
The NCLT has to make a decision on an application filed before it within 14 days. Where the NCLT admits an application for commencement of corporate resolution process, it shall pass an order:
- granting a moratorium;
- appointing an insolvency professional as interim resolution professional; and
- cause a public announcement of the initiation of the corporate insolvency resolution process to be made and call for the submission of claims.
The order declaring a moratorium prohibits the following:
- the institution of suits or continuation of pending suits or proceedings against the corporate debtor, including execution of any judgment, decree or order in any court of law, tribunal, arbitration panel or other authority;
- transferring, encumbering, alienating or disposing of by the corporate debtor any of its assets or any legal right or beneficial interest therein;
- any action to foreclose, recover or enforce any security interest created by the corporate debtor in respect of its property, including any action under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; and
- the recovery of any property by an owner or lessor where such property is occupied by or in the possession of the corporate debtor.
The order of moratorium does not affect the supply of essential goods or services to the corporate debtor, which shall not be terminated or suspended or interrupted during the moratorium period. The order of moratorium is effective from the date of order until the NCLT approves the resolution plan or passes an order for liquidation of the corporate debtor.
Interim resolution professional: appointment, tenure, power and duties
An insolvency professional appointed as interim resolution professional plays a key role. The person to be appointed as the insolvency professional is proposed by the party initiating the process. The term of the interim resolution professional shall not exceed 30 days from the date of his or her appointment.
Management of affairs of a corporate debtor
Following the appointment of the interim resolution professional, management of the affairs of the corporate debtor vests in the interim resolution professional from the date of his or her appointment. The powers of the board of directors are suspended and exercised by the interim resolution professional. The officers and managers of the corporate debtor report to the interim resolution professional and are required to provide access to such documents and records of the corporate debtor as may be required by the interim resolution professional.
The duties of the interim resolution professional are to:
- collect all information relating to the assets, finances and operations of the corporate debtor for determining the financial position of the corporate debtor, including information relating to business operations for the previous two years; financial and operational payments for the previous two years; a list of assets and liabilities as on the initiation date; and such other matters as may be specified;
- receive and collate all the claims submitted by creditors to the interim resolution professional, pursuant to the public announcement;
- constitute a committee of creditors;
- monitor the assets of the corporate debtor and manage its operations until a resolution professional is appointed by the committee of creditors;
- file information collected with the information utility, if necessary; and
- take control and custody of any asset over which the corporate debtor has ownership rights as recorded in the balance sheet of the corporate debtor, or with the information utility or the depository of securities or any other registry that records the ownership of assets.
Duties of interim resolution professional
The Code provides that the interim resolution professional shall make every endeavour to protect and preserve the value of the property of the corporate debtor and manage the operations of the corporate debtor as a going concern. For this purpose, the interim resolution professional has been provided with the authority to:
- appoint accountants, legal or other professionals as may be necessary;
- enter into contracts on behalf of the corporate debtor or to amend or modify the contracts or transactions that were entered into before the commencement of the corporate insolvency resolution process;
- issue instructions to personnel of the corporate debtor as may be necessary for keeping the corporate debtor as a going concern; and
- take all such actions as are necessary to keep the corporate debtor as a going concern.
Committee of creditors
The Code provides for the interim resolution professional to constitute a committee of creditors after collation of all the claims received against the corporate debtor and determination of the financial position of the corporate debtor. The formation of the creditor committee is designed to facilitate active creditor participation in the insolvency proceedings. The committee of creditors shall comprise all financial creditors of the corporate debtor. However, a related party to whom a corporate debtor owes a financial debt shall not have any right of representation, participation or voting in a meeting of the committee of creditors.
Powers of committee of creditors
The committee of creditors shall, inter alia, have the right to:
- appoint the resolution professional in its first meeting, and to replace the resolution professional at any stage;
- require the resolution professional to furnish any financial information in relation to the corporate debtor at any time during the corporate insolvency resolution process. When so requested, the resolution professional must make available any financial information within a period of seven days;
- approve the resolution plan; and
- approval certain actions of the resolution professional.
Prior approval of the committee of creditors by the resolution professional is required for the following actions:
- to raise any interim finance in excess of the amount as may be decided by the committee of creditors in their meeting;
- to create any security interest over the assets of the corporate debtor;
- to change the capital structure of the corporate debtor, including by way of issuance of additional securities, creating a new class of securities or buying back or redemption of issued securities in the case of the corporate debtor being a company;
- to record any change in the ownership interest of the corporate debtor;
- to give instructions to financial institutions maintaining accounts of the corporate debtor for a debit transaction from any such accounts in excess of the amount as may be decided by the committee of creditors in their meeting;
- to undertake any related party transaction;
- to amend any constitutional documents of the corporate debtor;
- to delegate its authority to any other person;
- to dispose of or permit the disposal of shares of any shareholder of the corporate debtor or their nominees to third parties;
- to make any change in the management of the corporate debtor or its subsidiary;
- to transfer rights or financial debts or operational debts under material contracts otherwise than in the ordinary course of business;
- to make changes in the appointment or terms of contract of such personnel as specified by the committee of creditors; and
- to make changes in the appointment or terms of contract of statutory auditors or internal auditors of the corporate debtor.
The resolution professional is required to seek the vote of the creditors prior to taking any of these actions at a meeting of the committee of creditors convened by him or her. The committee of creditors must approve these actions by a vote of 75 per cent of the voting shares.
Decision-making by committee of creditors
The Code requires that all decisions made by the committee of creditors shall be taken by a vote of not less than 75 per cent of the voting shares of the financial creditors. Where a corporate debtor does not have any financial creditors, the committee of creditors shall be constituted and comprise such persons to exercise such functions in such a manner as may be specified by the Insolvency and Bankruptcy Board of India (the Board) .
Resolution professional: appointment, removal, powers and functions
The committee of creditors may, in the first meeting (and by a majority vote of not less than 75 per cent of the voting shares of the financial creditors), either resolve to appoint the interim resolution professional as a resolution professional or to replace the interim resolution professional by another resolution professional.
Conducting the corporate insolvency resolution process
The resolution professional is responsible for the conduct of the corporate insolvency resolution process and manages the operations of the corporate debtor for the duration of the corporate insolvency resolution process. It is the duty of the resolution professional to preserve and protect the assets of the corporate debtor, including its continued business operations. For this purpose, the resolution professional must undertake the following actions:
- to take immediate custody and control of all the assets of the corporate debtor, including the business records;
- to represent and act on behalf of the corporate debtor with third parties, and exercise rights for the benefit of the corporate debtor in judicial, quasi-judicial or arbitration proceedings;
- to raise interim finances subject to the approval of the committee of creditors, wherever required;
- to appoint accountants, legal or other professionals in the manner specified by the Board;
- to maintain an updated list of claims;
- to convene and attend all meetings of the committee of creditors;
- to prepare the information memorandum as discussed above;
- to invite prospective lenders, investors and any other persons to put forward resolution plans;
- to present all resolution plans at the meetings of the committee of creditors; and
- to file an application for avoidance of transactions, if any.
Another key function of the resolution professional is to prepare an information memorandum for formulating a resolution plan, namely the information required by an interested person to make the resolution plan for the corporate debtor. This shall include the financial position of the corporate debtor, all information related to disputes by or against the corporate debtor, and any other matters pertaining to the corporate debtor as may be specified.
An applicant may submit a resolution plan to the resolution professional prepared on the basis of the information memorandum. A resolution plan means a plan proposed by any person for insolvency resolution of the corporate debtor as a going concern.
The resolution professional shall examine each resolution plan received by him or her to confirm that each plan:
- provides for payment of the insolvency resolution process costs in a manner specified by the Board as priority over the repayment of other debts of the corporate debtor;
- provides for the repayment of the debts of operational creditors, which shall not be less than the amount to be paid to the operational creditors in the event of a liquidation of the corporate debtor and shall be paid within 30 days from sanction of the plan;
- provides for dissenting financial creditors to be paid ahead of creditors voting in favour of the plan but on liquidation value;
- provides for management of the affairs of the corporate debtor after approval of the resolution plan;
- provides for the implementation and supervision of the resolution plan;
- does not contravene any of the provisions of the law for the time being in force; and
- conforms to such other requirements as may be specified by the Board.
Approval of resolution plan by the creditors
A resolution plan, which conforms to the conditions referred to above, must be placed before the committee of creditors by the resolution professional for its approval. The committee of creditors may approve a resolution plan by a vote of not less than 75 per cent of voting shares of the financial creditors. The resolution applicant may attend the meeting of the committee of creditors in which the resolution plan of the applicant is considered. However, the resolution applicant shall not have a right to vote at the meeting of the committee of creditors unless the resolution applicant is also a financial creditor.
Approval of the resolution plan by the NCLT
The resolution plan as approved by the committee of creditors must be presented by the resolution professional to the NCLT for approval. If the NCLT is satisfied that the resolution plan as approved by the committee of creditors meets the relevant requirements plan, as above, it shall, by order, approve it. The resolution plan approved by the NCLT shall be binding on the corporate debtor and its employees, members, creditors, guarantors and other stakeholders involved in the resolution plan. As a consequence of the order of approval, the moratorium order passed by the NCLT shall cease to have effect.
Rejection of the resolution plan
If the NCLT is satisfied that the resolution plan does not confirm to the stated requirements, it may, by an order, reject the plan.
Time limit for completing insolvency resolution process
The corporate insolvency resolution process must be completed within a period of 180 days from the date of admission of the application to initiate the process. The period of 180 days can be extended by the NCLT up to a maximum period of 90 days. Therefore, the total period for resolution of corporate insolvency, including the extended period, can be up to a maximum of 270 days.
An extension can be granted by the NCLT once an application is filed by the resolution professional, but only if instructed to do so by a resolution passed at a meeting of the committee of creditors by a vote of 75 per cent of the voting shares, and if the NCLT is satisfied that the subject matter of the case is such that the corporate insolvency resolution process cannot be completed within 180 days.
Appeal before the National Company Law Appellate Tribunal
An appeal by a person aggrieved by an order approving the resolution plan by the NCLT may be filed before the National Company Law Appellate Tribunal (NCLAT) on any of the following grounds:
- the approved resolution plan is in contravention of the provisions of any law for the time being in force;
- there has been material irregularity in the exercise of powers by the resolution professional during the corporate insolvency resolution period;
- the debts owed to the operational creditors of the corporate debtor have not been provided for in the resolution plan in the manner specified by the Board;
- the insolvency resolution process costs have not been provided for repayment as a priority over all other debts; or
- the resolution plan does not comply with any other criteria specified by the Board.
Every such appeal shall be filed within 30 days. The NCLAT may allow an appeal to be filed after the expiry of 30 days if it is satisfied that there was sufficient cause for not filing the appeal, but this period shall not exceed 15 days.
Appeal before the Supreme Court of India
Any person aggrieved by an order of the NCLAT may file an appeal to the Supreme Court on a question of law arising out of the order under the Code within 45 days from the date of receipt of the order. The Supreme Court may, if it is satisfied that a person was prevented by sufficient cause from filing an appeal within 45 days, allow the appeal to be filed within a further period not exceeding 15 days.
India is in the process of laying the foundations of a mature market economy. The Code is an endeavour to provide one critical building block of this process. If implemented effectively, it has the potential to significantly change the way business is done in India.
The total time frame of 180 days provided for corporate rescue sets a high expectation for the market. It would be challenging to meet this time frame due to the numerous processes and participating stakeholders involved, unless adequate infrastructure and capacity is created in the involved institutions. The discipline of insolvency professionals is a new phenomenon and the market does not have a sufficient number of qualified and experienced insolvency professionals. Completing the process in such a short time will be immensely challenging for resolution professionals, who will have to manage the affairs and assets of the company while gathering information, settle claims, and invite resolution plans from potential investors and other interested persons. The government, NCLT and the private sector must work in close coordination to ensure that timelines are observed and the Code is successful.
The Code is largely a sound piece of legislation, though it has its flaws. History has shown that reforms rarely contain all the solutions needed to resolve all the problems of a legal system. The success of the Code will depend on how effectively it is implemented. The Code will have to sail through rough currents that may be created by implementation issues. We will need to wait patiently to find out whether the Code will lead to the development of a robust corporate debt market and unlock the flow of capital.
The missing piece in the Code is the cross-border insolvency framework. It was widely expected that India would adopt the UNCITRAL Model Law on Cross-Border Insolvency or provide for an alternate framework to deal with cross-border insolvency issues as part of the Code. That did not happen. Many global companies have investments in India. Indian companies are fast-growing and multinational in character and have made high-stake acquisitions abroad. A number of foreign companies have subsidiaries or branches in India; similarly, Indian companies have set up business entities overseas.
Foreign banks and creditors have financed Indian assets and Indians banks have exposures overseas. The market expectations for a cross-border insolvency framework were only fair.
While considering the Insolvency and Bankruptcy Code Bill 2015, the Joint Parliamentary Committee also expressed the need to address the cross-border insolvency issues. Two provisions were included in the Code to deal with cross-border issues: section 234 to provide for agreements with foreign countries and section 235 to provide for a letter of request to a country outside India in certain cases. The reciprocity-based provisions lead to recognition of inbound requests but not outbound requests. A bilateral treaty is not the most efficient way of achieving cooperation between jurisdictions. A dynamic legal framework and rules are needed to deal with cross-border issues, which a treaty cannot substitute.
Stakeholders do not see these provisions as being adequate to administer cross-border insolvency issues. Most sophisticated economies have well-developed cross-border insolvency laws. To provide a fair, efficient, transparent and predictable mechanism to deal with cross-border issues, it is necessary to address the key tenets of cross-border insolvency - access, recognition, relief and cooperation by way of a comprehensive legislative and regulatory framework. For investors and companies alike, it is important to know what is going to happen when things go wrong from a financial perspective in a particular country. In cross-border insolvency situations the need for transparency and predictability is even more compelling. In those situations, a company or investor needs to understand not only the relevant substantive laws and rules in the country where they are investing and how they apply in practice, but also if and how these relevant substantive laws and rules of country are recognised in other relevant countries.
The UNCITRAL Model Law on Cross-Border Insolvency (Model Law) is the most widely accepted blueprint to effectively deal with cross-border insolvency issues while ensuring the least intrusion into each country's internal insolvency and bankruptcy laws. The Model Law is designed to assist countries to equip their insolvency laws with a modern, harmonised and fair framework to address more effectively instances of cross-border proceedings concerning debtors experiencing severe financial distress or insolvency. The Model Law allows determination when a foreign insolvency proceeding should be accorded ‘recognition' and what the consequences of recognition may be. It provides the person administering a foreign insolvency proceeding with access to the courts of the enacting country, thereby permitting the foreign representative to seek a temporary ‘breathing space', and allowing the courts in the enacting country to determine what coordination among the jurisdictions or other relief is warranted for optimal disposition of the insolvency. It permits courts in the enacting country to cooperate more effectively with foreign courts and foreign representatives involved in an insolvency matter; authorises courts in the enacting country and persons administering insolvency proceedings in the enacting country to seek assistance abroad; provides for court jurisdiction and establishing rules for coordination where an insolvency proceeding in the enacting country is taking place concurrently with an insolvency proceeding in a foreign country; and establishes rules for coordination of relief granted in the enacting country to assist two or more insolvency proceedings that may take place in a foreign country regarding the same debtor. Over 43 countries in 45 jurisdictions, including key economies such as the US, the UK, Australia, Singapore and Japan, have adopted the Model Law.
Recognising the need for a law to deal with cross-border insolvency issues, a Cross-Border Insolvency and Bankruptcy Bill 2017 (CBIB) is currently under active consideration by the government.
In today's world, business and trade are increasingly international. As a result, investors and companies frequently transact business in more than one sovereign jurisdiction. Adoption of the UNCITRAL Model Law is a necessity and not an option. Most sophisticated economies have well-developed cross-border insolvency laws. India should fall in line soon. Hopefully, it will.
- The Organisation for Economic Co-operation and Development is a forum comprising many of the world's most advanced countries, from North and South America to Europe and Asia-Pacific, which works ‘with governments to understand what drives economic, social and environmental change ... and set international standards on a wide range of things'. www.oecd.org.
- Doing Business: Equal Opportunity for All is the World Bank Group flagship annual report measuring the regulations that enhance business activity and those who constrain it. The report presents quantitative indicators on business regulations that can be compared across 190 economies - from Afghanistan to Zimbabwe - and over time. The report measures regulations affecting 11 areas of the life of a business: starting a business, dealing with construction permits, getting electricity, registering property, getting credit, protecting minority investors, paying taxes, trading across borders, enforcing contracts and resolving insolvency. www.doingbusiness.org.
- Ibid. This topic identifies weaknesses in existing insolvency law and the main procedural and administrative bottlenecks in the insolvency process.
- World Bank Doing Business Report, 2016, page 5. www.doingbusiness.org/reports/global-reports/doing-business-2017.
- Ernst & Young, Corporate Insolvency in India, November 2016.