DECEMBER 01, 2015

By Sudipto Banerjee, Senior Legal Editor

IT is so ironic that while on the one hand India is projecting itself as the future investment destination and financial hub of the world, yet all these years India never had something as basic as uniform bankruptcy code. The innate relationship between a developed credit market and transparent simple insolvency proceedings neither needs any emphasis nor elaboration. While India has insolvency laws in existence, but like many other framework this too remains extremely complicated and scattered across plethora of laws and subordinate legislations. A quick look at the present position would show that the corporate insolvency in India is governed by Companies Act, 2013, Sick Industrial Companies (Special Provisions) Act, 1985 (SICA), and Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act Act, 2002 (SARFAESI Act) and many other legislations. Coming to the position of individuals, proprietorship, partnership firms, the governing law is contained in Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920 respectively. In other words, so many laws getting enforced in so many forums coupled with limited institutional capacity, lack of expertise has only resulted in a complex insolvency mechanism which has always eaten away the economic value of the debt by the time they are recovered. But it is not the case that the need for consolidation was never felt because way back in 1964 the 26th Law Commission Report made strong and detailed recommendations for merging the existing insolvency legislations. Then in 2001, the L.N.Mitra Committee Report made recommendations for a comprehensive bankruptcy code. But the matter was kept in the back burner. Again, in 2014, the need for a consolidated bankruptcy legislation picked up, when there was a huge hue and cry revolving around the willful defaulter cases, especially when the UB Group Chairman Mr. Vijay Mallya was tagged as a wilful defaulter. In this backdrop, the final report on Bankruptcy Law Reforms Committee (BLRC) along with a draft bill called the "THE INSOLVENCY AND BANKRUPTCY BILL, 2015" (Bankruptcy Bill or Bankruptcy Code) proposing a uniform legal framework for easier exit of failed entities and individuals came last month.

WHY CHANGE IS NEEDED?

One may question what great objective we would achieve by having a single legislation or why is there so much stress on having a single code? To answer this, it must be first understood that while failing of business ventures is an inevitable phenomenon, we need a clear and transparent recovery proceedings, so a creditor is rest assured about his extent of recovery and most importantly, the timelines to protect the net productive value of the assets. Secondly, the balance of convenience is mostly tilted in favour of the Indian debtors when it comes to the credit market. Thirdly, our economy, particularly, the banking sector is plagued by the Non Productive Assets (NPAs) which compels the Govt. to make additional recapitalization in these PSU Banks, which in turn further widens the fiscal deficit. Besides, the creditors in India have always felt uncertainity due to the absence of quick and easy exits of failed enterprises, and this has been conveniently misused by the debtors to the fullest extent. There are umpteen reports which establishes that loan recovery rate in India is as low as mere 20% of the value of debt. The World Bank report states that the average time to complete insolvency proceedings in India is a staggering period of atleast 4-5 years compared to 0.8 years in Singapore and 1 year in London. This certainly goes a long way to explain the dismal ranking of India in terms of "ease of doing business in India". Whatever credit market exists in India, it is the secured credit i.e., with collaterals, yet creditors face difficulties in enforcing their claims at the time of defaults. Therefore, it is needless to mention that the Indian bond market remains underdeveloped, unlike the developed nations where most of the infrastructure and mega corporate financing is funded through bonds. The practice of looking at the cash flows of the enterprises and giving loan is virtually non-existent in India because the creditor is scared of doing so. Therefore, many companies which has a descent and consistent cash flow is deprived of funding, if it does not have enough tangible assets for debt financing. In short, lack of a robust insolvency proceedings where unsecured creditors rights are not duly protected adversely effects the debtors as well.

OVERVIEW OF THE CODE

As India is poised to join the club of nations having a consolidated bankruptcy code, lets briefly understand what exactly this draft Code is going to change or offer us. The Code applies to all individuals, companies, LLPs, partnerships firms and other legal entities registered in India, except for those with a dominantly financial function. Such financial firms are covered under the Indian Financial Code, proposed by the Financial Sector Legislative Reforms Commission. Part II of the Code deals with the insolvency resolution and liquidation of corporate persons, whereas Part III of the Code deals with bankruptcy of individuals and partnership firms. The Code also proposes to establish a Insolvency and Bankruptcy Board of India (Board) which will be the chief body for regulating the functions of the insolvency resolution agencies and insolvency professionals who will supervise all the proceedings under the Code. The Board will also handle the centralized database to be created under this Code which will maintain records relating to insolvency and bankruptcy cases and also disseminate information relating to such cases. The Code introduces the concept of insolvency professional agencies who would have on their panel insolvency professionals like lawyers, Chartered Accountants, Company Secretaries,valuers, etc. These professional have to be registered with the Board and can render services with respect to resolution of insolvency and also act as liquidators in case of liquidation of such failed company.

The Adjudicating Authority, in relation to insolvency resolution and liquidation for corporate persons, including corporate debtors, shall be the National Company Law Tribunal (NCLT) having territorial jurisdiction over the place where the registered office of a company is located. Once the Code comes into operation , all the powers of the DRTs would be vested with the NCLT. Whereas, the Adjudicating Authority with respect to the insolvency resolution and bankruptcy of individuals and partnership firms would be Debt Recovery Tribunals (DRTs). Another interesting feature of the Code is that while the secured creditors always had specific rights to recover their dues under the SARFAESI Act, but the proposed Code grants rights to both secured and operational creditors to initiate insolvency resolution process. This has been explained later in the article.

INFORMATION UTILITIES - CAN TECHNOLOGY MAKE A DIFFERENCE ?

It must be understood that broadly there are twin aspects of any bankruptcy legal framework. First, the precise definition of failure or default and secondly, how a failed enterprise or individual can be salvaged. If one analyses the entire insolvency proceedings, all disputes and litigations revolve around these two aspects. First, the debtor disputes the debt and secondly, arriving at a mutually agreed resurrection plan for timely realization of assets remains an arduous task. Taking up the first aspect, the constant information asymmetry between the creditor and the debtor is ingrained in our system which is the source of all litigation. The conflict of interest between the debtor and the creditor is obvious because the creditor wants to realize the assets at the earliest, whereas the debtor wants to hold on to which results in the erosion of the realizable value of the debt. Therefore, it is essential that for an insolvency and the bankruptcy resolution process information must be available when it is required. The law must ensure that access to this information is made available to all creditors to the enterprise, either directly or through the regulated professional. For addressing this issue, the draft Code contemplates creating a regulated industry of "information utilities" a fine-grained national database about the working of every bankruptcy and insolvency transaction in the country. This will include case histories of every transaction, and the working of each insolvency professional. This database would collect, collate, authenticate and disseminate financial information from listed companies and financial and operational creditors of companies. An individual insolvency database is also proposed to be set up with the goal of providing information on insolvency status of individuals. Presently, there is no centralized point of access to this information and whatever limited information is available, it is all scattered, courtesy multiple legislations and authorities. The Code specifies that if the NCLT is able to locate the record of the liability and of default with the registered Information Utilities, a financial creditor needs no other proof to establish that a default has taken place and this can greatly expedite the process of insolvency resolution or liquidation. The US Treasury has built an "Office for Finance Research" (OFR) which holds a comprehensive live database about the activities of all financial firms. In nutshell, the objective for creating such information utility is that in future, when a financial firm may approach failure, this centralized database will yield complete and up to date information about liabilities, exposures and counterparties which will not only reduce the scope of litigation but also expedite the resolution or liquidation process, as the case may be.

CORPORATE INSOLVENCY RESOLUTION & LIQUIDATION

Under the Code, both creditors (which includes secured ones as well as operation creditors ) and debtors can trigger the insolvency resolution process by making an application before the NCLT. Under the existing provisions of Companies Act, 2013, only when there is a default in majority of value of the creditors , a company can be considered "sick" for initiating the revival proceedings as opposed to the Code where default to any financial creditor can trigger the insolvency resolution process. The event of default can be established from the information available in the Information Utility which will reduce the scope for debtors to contest every event of default only to prolong the process unnecessarily. The draft Code provides that in case of operational creditors, if the claim is not disputed and remains unpaid for 10 days, the insolvency process may be initiated thus placing the said category of creditors at equal footing with the secured creditors. If the application is accepted by the NCLT, the resolution process starts. It must be noted here that for the first time the operational creditors who could also be workmen, employees, etc have been given the right to trigger the insolvency resolution process which will help them to settle their dues fast unlike the present situation where they have to wait for years to recover such dues.

The NCLT also appoints the insolvency professionals who inturn constitutes the creditors committee. The committee holds meetings with the debtors for arriving at a mutually agreeable arrangement to revive the company. Once this process is kicked in, a moratorium or calm period is also triggered automatically, during which all creditor actions will remain stayed. This comfort period will be granted to the debtors so as to protect them from asset stripping and thereby insulating the resolution process from any external interferences. This is going to be a positive change because under the Companies Act, 2013, there is no such provision of automatic moratorium which may be granted by the NCLT only for a period of 120 days.

The Code provides a clear and stringent timeline of 180 days to complete the resolution process during which the moratorium period operates. The resolution plan has to be submitted within this timeline by the creditors committee to NCLT after obtaining approval of 75% of the creditors, else the resolution fails, in other words, the liquidation process will be triggered. The liquidation process can also be initiated if it is recommended in the resolution plan by the creditors. The extension of timeline of 180 days can be granted only once by the NCLT for a period of 90 days, if the creditors arrive at the conclusion that the situation is too complex and requires more time. This is different from the present position under the Companies Act, 2013 where extensions are sought every now and then by the promoters of the companies only to drag the process endlessly. The draft Code lays down great responsibility on the insolvency professionals to ensure smooth carrying out of both resolution process or liquidation, as the case may be. Any delay tactic or diversion of assets or non-cooperation by the debtors have to be encountered by these professionals who have powers to take strict action against such errant debtors and file complaints before the NCLT. Not only this, action can be initiated against the insolvency professional as well for any misconduct or misrepresentation, etc. All in all, attempt has been made to ensure all parties to the process act responsibly for an efficient insolvency resolution or liquidation process.

Once liquidation process is triggered, the insolvency professionals will now play the role of liquidator, unless they are replaced by the NCLT. A liquidation trust will be created which will hold all the assets of the failed enterprise for distributing the same in the order of priority as given in the Code. Interestingly, the Code has placed the unsecured creditors above the statutory dues of the State and Central Govt. This change has been brought specifically to boost the bond market and encourage unsecured financing in India. It must be noted that liquidators in India are often known for prolonging the liquidation process as they feel incentivized to do so to earn more fees. To plug this loophole, the draft Code suggests a fees mechanism under which the liquidator fee must be based on decreasing function of time. In other words, the realisation of assets obtained in the second year will mean a smaller fee for the liquidator than the fee for the realisation in the first year.

REALISATION OF DEBT BY SECURED CREDITORS

Clause 53 of the Code incorporates the classic principle understood over the decades in India that a secured creditor may either relinquish security interest and force his claim on the overall liquidation trust assets, or may opt to realise security interest outside the winding up process. Clause 53(4) permits the secured creditor to realise security interest according to such law as may be applicable thereby preserving the process of self-help realisation under the SARFAESI Act. However, there will be reference to the liquidator for the purpose of the liquidator identifying the asset. This section, however, brings a very important balance in the process of repossession outside the liquidation process under SARFAESI Act, by requiring the secured creditor to return the excess realised by him to the liquidator.

JURISDICTION CLARITY

Under the present provisions of Companies Act, 2013 the registered office of the debtor decides the jurisdiction of the company Court. But under the DRT Act and SARFAESI Act, the jurisdiction of DRT is decided by the place where the cause of action has arisen partly or wholly. This caused great confusion and difficulties resulting in conflicting jurisdictions and orders by the DRT and the courts. Under the draft Code, the jurisdiction of the NCLT will be clearly vested based on the location of the registered office of the debtors and for bankruptcy proceedings, the jurisdiction of DRT will be decided according to the place where the debtors resides or works.

ENHANCED ACCOUNTABILITY - PUSH FOR RE-ENGINEERED E-FILING AND CASE REPORTING

The BLRC has made certain important recommendations i.e., mere computerization of the filing process is not sufficient, but the e-filing process has to be reengineered so as to create an effective and intelligent system with minimum or zero interface between the litigants and the officers of the Tribunals. The Committee has also suggested word limits so better quality of drafting can be expected and the rules of the Tribunal should also provide for pre-hearing conferences to help ascertain if all the prerequisites for a judicial hearing have been met for saving the precious time of the Tribunals. The Indian courts and the Tribunals are notorious for their poor case management and reporting practices. The Committee has strongly recommended that after filing of a matter, the status, relevant documentation, schedules of hearings etc. should be automatically managed by a case management software. Every order of the Tribunal must be immediately made available online. All performance statistics like pendency rate, disposal rate etc. must be published and the entire data set must be made available in proper format. Every instance of matters not being disposed off within a reasonable time frame must also be reported. The Committee has made these recommendations based on the system already in place in U.S, U.K. and Australia and if these technological improvements are made in our set-up, they will certainly compel the Tribunals to raise their accountability. We can hope that if every single minute detail would be thrown open to the public for scrutiny, this should help us in overcoming the vicious cycle of pendency currently plaguing the DRTs.

ACCOUNTABILITY FOR BREACHING TIMELINE

Delays in settling the liquidation process has become a rule rather than an exception and a substantial portion of this delay is also attributable to the functioning of the Tribunals. In an attempt to change this grim situation, Clause 64 of the Code provides that the NCLT and the NCLAT have to take their timeline very seriously and in case there is any breach of the same in disposing of any matter, the President or the Chairman shall record reasons in writing.

SCHEME OF THE CODE FOR INDIVIDUALS

Coming to the case of default by individuals, the Code has borrowed the concept of Fresh Start Order (FSO) from countries like US and UK. This is a process by which individuals with assets and income lower than specified amounts will be eligible for a discharge from their qualifying debts. The aggregate of such debt must not exceed Rs 35,000; the debtor should not own a residential property; his annual gross income must be less than Rs.60,000; and aggregate asset value must be less than Rs.20,000. Their debts will be written off, giving such debtor a fresh start. But both the default and the FSO will be recorded in the individual's credit history. The application shall be made before the DRT and a resolution professional will be appointed who will examine the situation and submit the report to the DRT. If the DRT accepts the application, the FSO order will be issued, and with that the moratorium period of 6 months will also kick in. A fresh start process is akin to a one-time waiver of debt , based on the adjudication of the DRT.

The second is the Insolvency Resolution Process, which will involve a process of negotiation between debtors and creditors supervised by a resolution professional. The formal oversight of the process of negotiation by the resolution professional under the shadow of the law with no long term adversarial effects to the debtor is a critical step towards a modern insolvency framework. If the negotiation succeeds, it will lead to a repayment plan which the resolution professional will execute. This gives the debtor an "earned start". The debtor gets a discharge but only as per the terms of the negotiation. The debtors are required to file a "statement of truth" and if any information in the application is found to be misleading or fraudulent, the debtor would have to face criminal penalties. Further, during the pendency of proceedings, the debtor cannot travel abroad without the permission of the DRT.

Finally, if the resolution negotiations fail, then the matter will proceed to "bankruptcy resolution process" which is led by a bankruptcy trustee appointed by the DRT. All the assets of the debtor would be taken over by the bankruptcy trustee who shall distribute the same to the creditors in the order of priorities laid in the law.

FINAL OBSERVATIONS

The Indian policymakers took lot of time to realize that delay in decision making i.e., whether to shutter a firm or to try to revive it causes destruction of value for all involved. But then it is still better to be late, than never. If this crucial decision making process is expedited, it will bring a great relief to the banking industry and the economy as a whole. Bankruptcy law is a complex statute and no nation can claim to have a perfect law. The draft Code seems to be impressive on paper, but several complications and unforeseen challenges may arise once it comes into operation. There are several appreciable concepts which have been imported from countries like the U.S, the U.K. and Australia and transplanted in the draft Code, yet the challenge would be to execute them in our set up, especially, when Indian debtors are known for their overwhelming tendency to default and get away without paying much. Moreover, if we can manage to create a robust mechanism as theoretically proposed under the Code, it will go a long way in substantially improving the global status of India in terms of doing business here.

The success of the proposed Code seems to hinge on four broad factors first, proposed independent regulator, expert insolvency professionals, curing information asymmetry through information utilities and Tribunals acting as adjudicating authorities. While such independent boards have been created in the past as well, what we need to focus is on capacity building and experts which have always been a scarce resource in India. Same suggestion squarely applies to the Tribunals, which are already over flooded with the pending cases. In my view, the role of insolvency professionals and information utilities assumes great importance. If we manage to create a robust database which is the idea behind the information utilities, we will be able to scale down the contesting and disputes to a large extent and settle the matters at the very start. This will result in out of court settlements through negotiation between debtors and creditors in an administrative set-up under the supervision of expert insolvency professionals. This is what is already being practiced and promoted in developed countries, because it protects the value of the assets from getting eroded and destroyed. India has to adopt this path and avoid court room action , if it wants to develop its unsecured credit financing like the bond market. The draft Code makes several amendments to the existing provisions of the Companies Act, 2013 whose impact can be gauged only when the Code comes into operation. Lastly, the most important parameter which will decide the success of the architecture of the INSOLVENCY & BANKRUPTCY BILL is whether we are able to change the present situation where liquidation orders are passed yet the recovery process drags on infinitely. If yes, then we have rebooted the bankruptcy law structure in India, otherwise we have another paper tiger to please ourselves.