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Insights
06 May 2016

The changing face of insolvency laws

According to the World Bank’s Ease of Doing Business report, it takes more than four years on an average to resolve insolvency in India. A person on the ground would confirm that it takes much more time than that. The proposed insolvency and bankruptcy law seeks to cut down the time to less than a year. Over the years, many concerns have been existing and/or raised amongst international investors on the regulatory and country risks while providing financing to and/or investing in India. The proposed legislation will not only improve the ease of doing business in India, but also facilitate a better and faster debt recovery mechanism in the country. It is widely believed that this legislation, when implemented in letter and spirit, will change the negative perception of NPAs, recovery and litigation associated with India.
 
The Government has formulated a plan to refurbish the prevailing bankruptcy laws and replace them with one that will facilitate stress-free and time-bound closure of businesses. The draft legislation, since the report issued in November 2015 by a panel headed by former law secretary Mr. T.K. Viswanathan, has gone through various changes, including changes recommended by the Joint Parliamentary Committee in April 2016. The Insolvency and Bankruptcy Code, 2016 (“Code”) has now been passed by the Lok Sabha and would be presented to Rajya Sabha shortly.
 
The proposed bankruptcy legislation seeks to address the issues faced currently in the context of insolvency and winding up. The provisions of the Code are applicable to companies, limited liability entities, firms and individuals (i.e. all entities other than financial service providers).
 
The Code provides for an Insolvency and Bankruptcy Board of India (“Board”) to be set up as the regulator under the Code. Under the oversight of the Board, the Code proposes to regulate insolvency professional agencies and resolution professionals. The adjudicating authority under the Code is the Debt Recovery Tribunal (“DRT”) with jurisdiction over individuals and partnership firms other than Limited Liability Partnerships (“LLPs”) and the National Company Law Tribunal (“NCLT”) having jurisdiction over companies and other limited liability entities (including LLPs).
 
Under the Code, the insolvency resolution process (“IRP”) may be initiated by the corporate debtor itself, the financial creditors or operational creditors. For the purpose of the Code, financial creditors and operational creditors include persons resident outside India. The Code provides for stringent timelines for completion of the entire IRP within 180 days from commencement and a one-time extension of 90 days only. Couple of the most significant features of the Code are the timelines and the grant of moratorium during which creditor action will be stayed. The moratorium is not automatic and has to be granted by the adjudicating authority on the recommendation of the resolution professional.
 
Upon completion of the IRP, liquidation proceedings may be initiated, (i) upon recommendation under the resolution plan; (ii) on account of failure to submit the resolution plan within the prescribed period or contravention of the resolution plan; or (iii) based on vote of majority of the creditors. For the purpose of the liquidation process, a liquidation estate is proposed to be formed which includes assets of the debtor which are held by and belong to the debtor. Assets will be distributed by the liquidator in the manner of priorities laid in the law. Individual claimants or those claiming to have any special rights on assets of the debtor will form part of the liquidation process.
 
  1. The priority of creditors at the time of distribution of assets after liquidation has seen a significant change under the Code. The priority is as follows:
    Insolvency Resolution cost and liquidation cost;
  2. Debts to secured creditor (who have relinquished their security interest) and workmens’ dues (for 24 months before commencement);
  3. Wages and unpaid dues to employees (other than workmen) (for 12 months before commencement);
  4. Financial debts to unsecured creditors and workmen’s dues for earlier period;
  5. Crown debts and debts to secured creditor following enforcement of security interest;
  6. Remaining debts;
  7. Preference shareholders and
  8. Equity Shareholders or partners.
The priority being given to secured creditors relinquishing security needs specific attention, especially on account of the same having the potential to be misused, especially if the debtor and the secured creditor can collide and impair the collateral.
 
Given that many corporate transactions and businesses involve an international element, the Code attempts to address this by including provisions for cross border insolvency. The Code provides that the Central Government can enter into agreements with any country outside India for enforcing provisions of the Code and notify applicability of the same from time to time. Further, assets of the debtor located outside India (in countries with whom India has reciprocal arrangements) may also be included for the purpose of the insolvency resolution process and/or liquidation before the Adjudicating Authority. It is also relevant to note that the definition of ‘property’ under the Code includes ‘money, goods, actionable claims, land and every description of property situated in or outside India’.
 
Impact on International Creditors and Funds
The Code seeks to achieve certainty for recovery and enforcement proceedings and to this extent, it will specifically be a useful tool for international creditors and investors from the perspective of PE funds continuing to grow their investments in India and financial institutions increasing their exposure to Indian entities. Over the years, many concerns have been existing and / or raised amongst international investors on the regulatory and country risks while providing financing to and/or investing in India. This Code in specific will, when implemented in letter and spirit, provide a major boost to the India economy.
 
In contrast to the current regulatory landscape, the Code does not make any distinction between the rights of international and domestic creditors or between financial institutions and funds. Specific attention is to be drawn to the rights of unsecured and secured creditors in the priority of their claims and therefore the level playing field for their access to an effective insolvency resolution.
 
In addition, all financial creditors will, in general, be entitled to participate in the Insolvency resolution process irrespective of the size of their debt. The strict timelines for resolution of insolvency and liquidation proceedings would definitely be an incentive.

NOTE: This article was first published in VCCircle