What’s the big deal about bankruptcy law?

(This post narrates the background of introducing the ‘bankruptcy law’ and in what way the new law is likely flags the problem loans and protects the interest of lenders.)

The ‘Insolvency and Bankruptcy Code, 2016’ bill will be shortly enacted as an ‘ACT’ which will be dealing with resolutions of insolvency and bankruptcy. The fundamental consideration of the new law is to recognize and flag the ‘problem loans’ at a sufficiently early stage and protect the interest of lenders. It also aims to balance the interest of all the stakeholders like workers, employees, and other creditors including alteration in the priority of payment of government dues. The newfangled law supports the banks to take the early decision in respect of viability of the enterprises for allowing them to be rescued or the unviable one be liquidated swiftly to minimize the losses.

Background:                                                                                                                  

Most of the large borrowers in India have been asserting on their heavenly right to stay in control of the business despite their unwillingness to put in fresh money in the troubled enterprises. The workers, employees, lenders, shareholders became the hostage of such promoters who threatens to run their business into the ground unless the government, banks, and regulators make the concessions that are necessary to keep their business alive. On the other hand, the lender banks in many occasions indulge in pushing the problems of bad loans into the future, hiding their stressed assets in one or the other way. They try to hide because they have to make provisions if they recognize them as bad loans. When hidden bad loans cannot be disguised anymore, the disclosure of such huge amount of NPAs (Non- Performing Assets) at one shot massively hit the bank’s income and balance sheet. This is why the banking industry was the worst performer in the last financial year 2015-16. More so, the public sector banks were worst sufferers with 13 of them reporting losses and seven out of the other eight have shown just hairline profits, underlining the extent of the bad debts plaguing the industry.

Why does it happen?

There is no law available in India that directly deals with resolutions of insolvency and bankruptcy at present. The individual cases are currently dealt under the ‘Presidency Towns insolvency Act 1909’ or ‘Provincial Insolvency Act, 1920, the High-Courts are handling the cases of liquidations of companies. Additionally, we have prevalent laws like SICA, 1985; Companies Act, 2013, and other mechanisms like Debt restructuring or CDR to solve the insolvency problems of companies. The RDDBFI act 1993, under which Debts Recovery Tribunals (DRTs) were set up, specifies that the cases before the DRTs should be disposed-off in 6 months. Nevertheless, only about a fourth of the cases pending at the beginning of the year are disposed-off by DRTs in the whole year. The numbers of new cases filed with them learnt to be one and half times of the cases disposed- off during the same period. The SARFAESI Act, 2002 enables the banks and financial institutions to enforce their security interest and recover dues even without approaching the DRTs. Further, the section 11118 of the RDDBFI Act is intended to prevent higher constitutional courts from intervening routinely in DRT judgments. The reality is that the High-Courts in general disregard the availability of statutory remedies to banks under the RDDBFI Act and SARFAESI Act and exercise their jurisdiction to admit appeals under Article 226. Therefore, all the above prevailing acts, rules, and mechanisms are in many ways inadequate, ineffective, and the process usually takes lot of time (10-20 years) for the resolution to pass. The backlogs and delays are growing, not coming down. The outcome of the delays in obtaining judgments due to repeated protracted appeals indicates  that the security offered to the loan has been stripped clean of value when the recovery actually takes place. In view of the above, the big and powerful borrower gains the upper hand in the bargain and offers for an early settlement of dues with the banks for the pittance. The banks confronted with such lopsidedness of power sense helplessness and as a result in many cases, they are tempted to cave in for accepting the unfair deal.

How the new law works?

The ‘Insolvency and Bankruptcy Code, 2016’ bill recently passed in the Parliament, was based on the recommendations from the report of the Bankruptcy Law Reform Committee. The reform committee has recommended the following specifics for the resolution of insolvency within a time frame.

The new law provides priority of contracts, giving creditors a greater share and greater control when the enterprise is unable to pay. As per the legislation, the corporate insolvency would have to be resolved within a period of 180 days, extendable by a further period of 90 days. The tribunals need to keep up the time lines. In case they were unable to stick to the timelines they have to provide the reasons for the same. The new Act as well provides for fast-track resolution of corporate insolvency within 90 days. It also provides shutting down of the businesses that have no hope of creating value, while reviving and preserving those that can add value.

When the enterprise is unable to pay its dues and statutory obligation, the stake holders in the enterprise like the workers/employees or lenders or creditors are allowed to trigger a resolution under the provisions of the ‘Act’. The quick engagements in triggering the resolution will be protecting the interest of the stake holders. Equally, the value of the company’s asset is also protected from siphoning off by the promoters because of early resolutions.

In terms of Companies Act, 2013, the secured creditors can initiate rescue proceedings if the company has defaulted on 50 percent default of its outstanding debt. However, according to draft for ‘Insolvency and Bankruptcy Code’, the creditors representing 25 per cent of the outstanding debt can initiate rescue proceedings against the debtor company.

The new legislation has many provisions that forbid the promoters indulging in issues where the enforcement of claims could be delayed. The lender can enforce the liquidation process within 180 days, at the most 270 days and the company goes to liquidation, if the borrower can’t arrive at a resolution plan. The newfangled law further provides that the transactions which are two year old can also be reviewed, cancelled and nullified. This clause means, it halts the promoters from destroying/ siphoning off the company’s assets during the intervening period.

The resolution process begins immediately with the takeover of the management by the professional turn-around agents (ARCs) who can step in the place of promoters when the lenders trigger a resolution. The company’s ‘Board’ of directors will be suspended and the creditors’ committee comes into operation. The tribunals do not have much scope to interfere into the resolution plan or process arrived at by the creditors committee.  The market conditions are also judged by the creditors’ committee and in this context the judges act only like the umpires in a cricket match. Should the creditors’ committee decide so, they may even infuse more funds in the operation of the company so that the company could continue as growing concern.

The new code proposes to setting up of an ‘Insolvency and Bankruptcy Board of India’ which will regulate professionals, agencies and information utilities engaged in resolution of insolvencies of companies, including partnership firms and individuals. The Code also proposes to establish a fund  called ‘the Insolvency and Bankruptcy Fund of India’, for the purposes of payment of salaries, allowances and other remuneration of the members, officers and other employees of the board and expenses on objects and for purposes authorized by the Act.

Matter of concern:

It is a matter of serious concern that despite various laws already exist in our country to deal with the bad loans; our judiciary system is unable to offer quick statutory remedies for the problems of lenders. The bankruptcy law coupled with sweeping reforms in removing the judicial bottlenecks and delays, without compromising on due process, will be crucial for financial reforms in India. If properly structured, the designated regulator ‘Insolvency and Bankruptcy Board of India’ will help bringing clarity, predictability, and fairness to the recovery process of distressed enterprises; as well it will considerably reduce the NPA levels of banks and financial institutions. So as not to, the new bankruptcy law will be another addition in the series of ineffective laws that exist in our legal system.