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27 July 2016

Corporate Insolvency Procedure – A Comment

by Anup Koushik Karavadi

Background and need

From the Justice Eradi Committee report of 1999 to the Department of Financial Services’ indicator of October 2015, the pendency of winding-up cases in India has been piling up to reach an alarmingly high level of backlog [see end note 1]. The World Bank has ranked India on the 130th position among 189 economies as it takes more than four years on an average to resolve insolvency in India [see end note 2].

The Finance Minister had announced the development of an effective bankruptcy code for the facilitation of a stress-free and time-bound disclosure of business in his budget speech of 2014-15, following which the Viswanathan Committee [see end note 3] was set up on 22nd August, 2014. The Committee, in November 2015, came up with a comprehensive report on Insolvency and Bankruptcy which has undergone a number of changes since then. The Committee has taken care of certain unaddressed issues in the code that was introduced in the Parliament. It seeks to cut down the time of proceedings to less than a year and ultimately improve India’s global image in this scenario.

Objective of the Code

Some of the primary objectives with which the Code has been conceptualized for are:

  1. to consolidate the laws relating to reorganization and insolvency resolution of all persons, including companies, individuals, partnership firms and Limited Liability Partnerships (LLPs) under one statutory umbrella and amending relevant laws;
  2. time bound resolution of defaults and seamless implementation of liquidation/ bankruptcy and maximizing asset value;

Authorities Involved: 

  • The Code seeks to constitute Insolvency Professional [see end note 4] who will be the licensed quasi-administrator to carry out the insolvency resolution process. Such Insolvency Professionals will be the members of Insolvency Professional Agency [see end note 5] which shall in turn prepare model code of conduct for Professionals and also for redressal of customer grievances against the Professionals.
  • The Code also envisages formulation of Information Utilities [see end note 6] for collection, classification, storage and distribution of all the relevant data pertaining to the debtors.
  • There shall be an Insolvency and Bankruptcy Board of India (Insolvency Regulator) [see end note 7] which will function as the regulator for all matters pertaining to insolvency and bankruptcy and oversee the regulation of the Insolvency Regulator, Insolvency Professional Agencies and Information Utilities.
  • The Code specifies that National Company Law Tribunal [see end note 8] (NCLT/Adjudicating Authority) to be the Adjudicating Authority to entertain the insolvency process for the companies/LLPs. Further, the Debt Recovery Tribunal shall be the Adjudicating Authority in case of individuals and partnership firms.

Corporate Insolvency Resolution Process

The following persons could initiate the corporate insolvency resolution process, on the commission of a default by the corporate debtor [see end note 9]:

  1. A financial creditor (by itself or jointly with other financial creditors)
  2. An operational creditor or
  3. The corporate debtor itself

Given the fact that the insolvency proceedings could be initiated in the event of default, it becomes relevant to understand the said term in detail. The term ‘Default’ herein refers to the financial debt owed not only to the applicant financial creditor but to any other financial creditor of the corporate debtor [see end note 10].

The Code distinguishes between a Financial Creditor and Operational Creditor and lays down different procedure for initiating the proceedings by each of them. Further, a Financial Creditor [see end note 11] is a creditor to whom a financial debt is owed and includes anyone to whom such debt is assigned or transferred whereas, an Operational Creditor [see end note 12] is the one to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.

It is noted from the Code that the Financial Creditor will have to move an application before the Adjudicating Authority showing them the proof of default and praying for an interim Insolvency Professional [see end note 13] to be appointed. Upon receipt of such application, the NCLT is obligated to ascertain the existence of default from the records as maintained by the Information Utilities or on the basis of the other evidence furnished by the creditor.

It is relevant to note that if an Operational Creditor wishes to initiate the insolvency proceedings, then, such Operational Creditor will have to first serve a demand notice along with the proof of default, giving the debtor ten days to respond to dispute the claim. If the claim remains undisputed, then the Operational Creditor can file an application before the Adjudicating Authority [see end note 14].

Time bound insolvency resolution process - Explained

  1. The Insolvency resolution process could be initiated by filing an application upon commission of a default by the corporate debtor;
  2. Within fourteen days of filing of such application, the Adjudication Authority shall accept or reject the application.
  3. In case of acceptance of the application, the corporate insolvency process shall be commenced from the date of admission of the application. However, if rejected, then the applicant will have seven days to rectify the error [see end note 15] as pointed out by the Adjudicating Authority.
  4. Within 14 days from the date of commencement of the insolvency procedure, the Adjudicating Authority is obligated to appoint an Interim Resolution Professional (IRP) whose term shall not exceed 30 days from the date of appointment [see end note 16].
  5. Immediately after the admission of the Application for insolvency, the Adjudicating Authority is obligated to order public announcement [see end note 17] of the initiation of corporate insolvency proceedings stating information as required under Section 15 of the Code.
  6. In the meantime, after admission of the application, the Adjudicating Authority shall declare a moratorium [see end note 18] which is one of the most significant features of the Code. It is relevant to note that through moratorium, the Adjudicating Authority could stall and prohibit many activities as mentioned in Section 14 of the Code. It is relevant to note that moratorium can be ordered on the basis of the recommendations of the IRP.
  7. The IRP is required to collate the details of all the claims against the corporate debtor and determine its financial position. The IRP is also required to constitute a Committee of Creditors (COC) [see end note 19].
  8. It is noted that the first meeting of the COC is to be held within 7 days after constitution of the COC [see end note 20]. In the first meeting, the COC need to decide by majority voting of 75% to replace the IRP with another Resolution Professional or to make the IRP their (final) Resolution Professional.
  9. The Resolution Professional so appointed by COC shall conduct the corporate insolvency process [see end note 21]. For the meetings conducted, Resolution Professional shall give notice to the members of COC, Operational creditor or their representative, members of Board of Directors, of which the directors, partners, representatives of the operational creditor shall not vote [see end note 22].
  10. The Resolution Professional is required to formulate an Information Memorandum containing all relevant information as specified by the Boards for formulating the resolution plan [see end note 23]. The Applicant of the Insolvency proceedings may submit a resolution plan to the Resolution Professional prepared on the basis of the information memorandum which shall be scrutinised by the Resolution Professional.
  11. With respect to the Resolution Plan, the COC can either reject or accept with 75% majority of the financial creditor. The Resolution Professional shall, in case of acceptance, send the approved plan to the Adjudicating Authority [see end note 24].
  12. If Adjudicating authority is satisfied that the resolution plan accepted by the COC meets the requirements under section 30(2), then it shall approve the plan which will be binding on corporate debtor and its employees, creditors, members, guarantors and other stakeholders. On the other hand, if the adjudicating authority is satisfied that the plan does not confirm to the requirements, then it may reject it [see end note 25].
  13. This entire process of Insolvency resolution is required to be completed within a period of 180 days from the date of admission of Application for insolvency [see end note 26]. In cases where the Adjudicating Authority is satisfied that the subject matter cannot be completed in 180 days, then it can order extension of time for a period not more than 90 days [see end note 27] beyond the stipulated 180 days.

Liquidation Process

[see end note 28]Where the Adjudicating Authority rejects the resolution plan or the Creditors’ committee fails to agree on a workable resolution plan within the Insolvency resolution period (i.e. 180 days + 90 days) or the aforesaid Committee decides to liquidate the company or the corporate debtor contravenes provisions of the resolution plan, then, the Adjudicating Authority shall pass an order requiring liquidation of the corporate debtor and also required to make a public announcement of the same.

The Insolvency Professional acting as the resolution professional shall, upon commencement of liquidation shall be appointed as the liquidator for the process, unless replaced by Adjudicating Authority [see end note 29].

Stumbling Blocks for Implementation:

With regard to specific provisions, the following are the issues which require an immediate review:

  1. The Code envisages setting up of various new entities. It is yet to set out the manner in which some of these entities would be set up. The Code’s success in achieving its objectives is heavily dependent upon the smooth establishment and functioning of these entities.
  2. It is noted that the term “Insolvency Resolution Process” is used exhaustively but is not really defined under the code. Such use of an undefined term clearly leave uncertainty and tremendous scope for interpretations.
  3. As per Section 17 of the Code, the Interim Insolvency Professional appointed by the Adjudicating Authority will replace the management of the Company immediately upon his appointment. It sounds absolutely against the interest of a company as the management is replaced by a stranger just by an order overnight.
  4. The Code is silent about the rights of the management of the Corporate Debtor after the appointment of the insolvency Professional. More so, it is relevant to note that the Corporate Debtor is not put on notice even before an application requesting the Insolvency process to be initiated is accepted.
  5. Code does not contemplate as to whether the corporate debtor will have a chance to represent its case before the Adjudicating Authority during the insolvency process.
  6. It is pertinent to note that the Adjudicating Authority does not have an option but to order for liquidation of the corporate debtor immediately after the Resolution Plan is either rejected or that COC fails to arrive at a resolution plan.
  7. On an average a winding up petition which is filed before the Hon’ble High Court as on date requires 2 to 3 years for finalisation. Such timeline is proposed to be reduced approximately into days through the Code. Therefore, only implementation will have to through light as to how effective the Code could operate.
  8. The proceeds from the sale of the liquidation assets are to be disbursed in the following priority:
    1. IRP costs and liquidation costs in full
    2. Workmen’s dues for the preceding 24 months and secured creditors
    3. Workmen’s dues and employee dues
    4. Unsecured Creditors
    5. Government dues
    6. Equity owners

It remains to be seen as to why the cost of the Insolvency Professional is given priority over any other liability of a corporate debtor. More so, the fact that the unsecured creditors are given preference over the Government Dues may cause loss to government exchequer.

Concluding Remark:

The Code as a whole, is definitely a move towards establishing effective regulatory framework to deal with insolvency and bankruptcy. However, it needs to cross various practical and logistical hurdles and set up the required infrastructure to serve its objective. More so, the Code as on date sounds as a deterrent to the Companies from taking loans instead of being a protective measure for the Creditors.

[The author is a Principal Associate, Lakshmikumaran & Sridharan, Hyderabad] 

End Notes:

  1. Report of the High level Committee on Law relating to insolvency and winding up of companies, 2000, Accessible at reports.mca.gov.in, last viewed on 15th July, 2016.
  2. Doing Business Report, 2016: Measuring Regulatory Quality and Efficiency, 13th Edition. Can be accessed at www.doingbusiness.org, last viewed on 15th July, 2016.
  3. The Report of the Bankruptcy Law Reforms Committee, November 2015. Accessible at finmin.nic.in, last viewed on 15th July.
  4. Section 3(19) of the Code.
  5. Section 3(20) of the Code.
  6. Section 3(21) of the Code.
  7. Section 3(1) of the Code.
  8. Section 5(1) of the Code.
  9. Section 6 of the Code
  10. Section 7, Explanation.
  11. Section 5(7) of the Code
  12. Section 5(20) of the Code
  13. Section 7 of the Code
  14. Section 8, 9 of the Code
  15. Section 7(5) of the Code
  16. Section 16 of the Code.
  17. Section 13(1)(b) of the Code.
  18. Section 13(1)(a) of the Code
  19. Section 18 of the Code
  20. Section 22(1) of the Code.
  21. Section 23(1) of the Code.
  22. Section 24(4) of the Code.
  23. Section 5(26): "Resolution plan" means a plan proposed by any person for insolvency resolution of the corporate debtor as a going concern in accordance with Part II.
  24. Section 30(6) of the Code
  25. Section 31 of the Code
  26. Section 12(1) of the Code
  27. Section 12(3) of the Code.
  28. Section 33 of the Code
  29. Section 34(1) of the Code

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