BASIC UNDERSTANDING OF THE INSOLVENCY
AND BANKRUPTCY CODE (IBC)
Ease of Doing Business in the world is one of the most important report viewed by investors and corporations before deciding to open a venture in a new country. The report ranks companies and considers various parameters like starting a business, dealing with construction permits, registering a property, getting credit, protecting minority investors, paying taxes, trading across borders, enforcing contracts, labor market regulations and last but not the least is resolving insolvency.
What do we mean by Resolving Insolvency?
Resolving insolvency involves understanding Time, cost, outcome and recovery rate for a commercial insolvency and the strength of the legal framework for insolvency. In-order to improve India’s rank in the Ease of Doing business in the world and move closer to be in the top 50 countries in the world to do business. For the first time, India jumped a record 30 places from 132 in 2008 to 100 in the Ease of Doing Business report for 2018, which is an influential 190-country barometer of competitiveness that many businesses likely consider for investment decisions.
The Insolvency and Bankruptcy Code of India (IBC) was put into effect in May, 2016 and the authorities began to invoke the act after six months, in December that year. The IBC was introduced to aid lenders in timely and effective recovery or restructuring of the defaulted assets and to mitigate the stress on the Indian credit system. The Code is a welcome overhaul of the existing framework dealing with insolvency of corporates, individuals, partnerships and other entities. It paves the way for much needed reforms while focusing on creditor driven insolvency resolution. It provides a time-bound process for resolving insolvency in companies and among individuals. The code help India rank improve from 136 to 103 in the parameter of resolving insolvency. Strength of insolvency framework index increased from 6 to 8.5.
What is Insolvency?
Insolvency is when an individual or organization is unable to meet its outstanding financial debt towards its lender as it become due. Insolvency is a short-term inability to meet liabilities during the normal course of business, Insolvency can be resolved by way of changing the repayment plan of the loans or writing off a part thereof. If it cannot be resolved, then a legal action may lie against the insolvent and its assets will be sold to pay off the outstanding debts. Generally, an official assignee/liquidator appointed by the Government of India, realizes the assets and allocates it among the creditors of the insolvent.
What is Bankruptcy?
Bankruptcy is a concept slightly different from insolvency, which is rather amicable. A bankruptcy is when a person voluntary declares himself as an insolvent and goes to the court. On declaring him as ‘bankrupt’, the court is responsible to liquidate the personal property of the insolvent and hand it out to its creditors. It provides a fresh lease of life to the insolvent.
The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2017 was promulgated on November 23, 2017. It amends the Insolvency and Bankruptcy Code, 2016.
The ordinance has been initiated as a response to the mounting pressure of Non Performing Assets (NPAs) that is building on the banking sector. The Reserve Bank of India has identified 12 such accounts that form 25% of the NPAs in the Banking Sector.
The ordinance suggests certain changes in the IBC primarily in relation to the eligibility of the promoters in the resolution process of the insolvent company. A promoter is disqualified from participating in the resolution process if:
i)he is an undischarged insolvent (individual unable to repay his debt),
(ii) he is a wilful defaulter identified by the Reserve Bank of India,
(iii) his account has been identified as a non-performing asset for more than a year, (iv) he has been convicted of an offence punishable with two or more years of imprisonment,
(v) he has been disqualified as a director under the Companies Act, 2013,
(vi) he has been prohibited from trading in securities,
(vii) he has indulged in undervalued or fraudulent transactions,
(viii) he has executed an enforceable guarantee in favour of a person who is a creditor to a defaulter undergoing a resolution process,
(ix) he is connected to any such person mentioned above (including promoters or people in control of the defaulting firm during the implementation of the resolution plan), or
(x) he has indulged in any of these activities outside India.
The reason for laying down specific eligibility criteria for promoters is that India doesn’t have a well-developed distress asset investment market. Because of this, the lenders are constrained to give the company back to the inefficient promoters at huge discounts, adding to the burden on the Indian credit system. At the same time, the IBC doesn’t want to discourage genuine promoters who haven’t defaulted voluntarily and thus must be given a second chance.
The Code unambiguously states that the trigger for an insolvency petition is a single default (more than INR1 lakh) which, if approved, will result in the lenders taking over the management of the defaulter through an Insolvency Professional.
The Code proposes two independent stages:
Insolvency Resolution Process, during which financial creditors assess whether the debtor’s business is viable to continue and the options for its rescue and revival; and
Liquidation, if the insolvency resolution process fails or financial creditors decide to wind down and distribute the assets of the debtor.
The code lays down detailed process for filing for insolvency & bankruptcy. The IBC has been well received by the banking sector but with a sense of caution. They are of the view that exclusion of the promoters may make the bidding process less competitive and they would have to suffer hair cuts.
As the chief of State Bank of India puts it, “We don’t mind haircut but we don’t want to be bald.” The full implications of the amended IBC would be realized once the ordinance is approved and enacted.