Weak Insolvency Regime?

Context

• The Supreme Court recently ruled that Section 7(5) (a) of the Insolvency and Bankruptcy Code (IBC) grants the adjudicating authority, i.e. the National Company Law Tribunal (NCLT), discretionary power to admit an application under the Code by a financial creditor for the initiation of a corporate insolvency resolution process (CIRP).
• With its aforementioned finding, the Apex Court deviated from the long-established view that once the Adjudicating Authority is satisfied that a default has occurred, the application must be admitted unless it is incomplete.

Relevance

GS Paper 3: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

Mains Question

Analyze the progress made in resolving stressed assets since the passage of the Insolvency and Bankruptcy Code (IBC). (250 words)

The Supreme Court decision

• Case ruling: In Vidarbha Industries Power Ltd. v. Axis Bank, the Supreme Court ruled that the NCLT cannot accept an insolvency application filed by a financial creditor simply because a financial debt exists and the corporate debtor has defaulted in its repayment.
• Additional grounds: Instead, the NCLT must take into account any additional grounds raised by the corporate debtor in opposition to such admission.
• Importance: This interpretation has the potential to fundamentally reshape a critical innovation in the IBC framework.

Concerns and Issues

• NCLT hesitancy: Even if the NCLT is convinced that a financial debt exists and that the corporate debtor has defaulted, it may refuse to admit the case for resolution if the corporate debtor objects on any other grounds.
• Misuse by debtors: Corporate debtors are likely to take full advantage of this precedent in order to avoid admission into the IBC.
• Broader implications: The latest ruling is likely to result in more litigation and delay at the admission stage, increasing the risks of value destruction in the underlying distressed business.
• Another failure: Unless the NCLT consciously limits its own discretion at the admission stage, the IBC may end up looking like the defunct Sick Industrial Companies Act (SICA).
  • SICA Facts: SICA 1985 was a critical piece of legislation enacted in India to detect unviable (“sick”) or potentially sick companies and assist in their revival, if possible, or closure, if not.
  • Importance: This action was taken to free up investment trapped in failing businesses for productive use elsewhere. The failure of SICA, on the other hand, was an unintended consequence of this pro-revivalist judicial approach.
  • Tribunal: The SICA established the Board for Industrial and Financial Reconstruction (BIFR) as a specialised tribunal to expedite the resolution of distressed industrial companies.
  • Failure: The BIFR became a haven for companies seeking years of protection from creditors, with managers syphoning off assets in the interim.
  • Findings: A study found that a series of judicial innovations aimed at facilitating the rescue of distressed companies benefited some stakeholders at the expense of others, particularly institutional creditors such as banks.

Insolvency determination

• Balance-Sheet Test: This is a legal procedure used to determine whether a company is insolvent. A court decides how much a company’s prospective and contingent liabilities are worth. This includes deferred payments or potential litigation decisions against a company, allowing for a more precise arrangement.
• Downside: This test is vulnerable to the quality of accounting standards. As a result, the Bankruptcy Law Reforms Committee opposed this test in the Indian context.
• Twin-test: The Bankruptcy Law Reforms Committee recommended that a filing creditor provide a record of the liability (debt) as well as evidence of the corporate debtor’s default on payments.
• Importance: This twin-test was designed to reduce litigation at the admission stage, allowing for faster resolution of distressed businesses.

Concerning the Corporate Insolvency Resolution Process (CIRP)

• It is a creditor recovery mechanism. If a corporation becomes insolvent, CIRP may be initiated by a financial creditor, an operational creditor, or the corporation itself. The CIRP may include steps to resurrect the company, such as raising new funds for operations and seeking a new buyer to sell the company as a going concern.
• CIRP in a case under the Insolvency and Bankruptcy Code, 2016 (IBC) should be completed within 180 days or the extended period of 90 days, and must be completed within 330 days, including any extensions, including time spent on litigation.

Insolvency and Bankruptcy code

• Legislation: In 2016, the Insolvency and Bankruptcy Code was enacted in order to address the growing problem of bad debts and to favour creditors, such as banks, in recovering debts and avoiding bad loans during the resolution process.
• Scope: India’s bankruptcy law applies to all businesses, partnerships, and individuals (other than financial firms).
• Time frame: The Company is subject to a moratorium of 180 days (which can be extended up to 270 days). For startups and small businesses, the resolution time frame is 90 days, which can be extended by 45 days.
• Four-pillar institutional framework: The IBC consists of NCLT and NCLAT, the adjudicating authorities; the Insolvency and Bankruptcy Board of India (IBBI), the regulator of insolvency professionals and insolvency professional agencies; insolvency professionals, the class of regulated persons responsible for the efficient execution of the IBC processes; and information utilities, a new industry that electronically stores facts about lenders and terms of lending.

IBC Objectives

• All existing insolvency laws in India should be consolidated and amended.
• To make insolvency and bankruptcy proceedings in India easier and faster.
• To safeguard the interests of a company’s creditors and stakeholders.
• To resurrect the company in a timely manner.
• To encourage entrepreneurship.
• To provide necessary relief to creditors and, as a result, increase the credit supply in the economy.
• To devise a new and timely recovery procedure for use by banks, financial institutions, or individuals.
• To establish an Indian Insolvency and Bankruptcy Board.
• Maximization of the value of corporate assets.

Insolvency and Bankruptcy Code (IBC) Success

• The IBC has sparked a cultural shift in the relationships between lender and borrower, promoter and creditor. It was crucial in changing the behaviour of borrowers.
• Prior to the IBC, lenders had access to recovery mechanisms such as Lok Adalat, Debt Recovery Tribunal, and SARFAESI Act. While previous mechanisms resulted in a low average recovery of 23%, recoveries have increased to 43% under the IBC regime.
• Since the implementation of the IBC, India has improved its ‘Resolving Insolvency’ ranking to 108 in 2019 from 134 in 2014, where it had remained stagnant for several years.
• In 2018, India was named the most improved jurisdiction by Global Restructuring Review.
• According to a January 2018 IMF-World Bank study, India is moving toward a new state-of-the-art bankruptcy regime.
• Insolvency law has resulted in financial system stability.

Conclusion

• To be fair, the Supreme Court’s interpretation and application of the IBC has been extremely pragmatic. Even in the most recent ruling, the court correctly cautioned that the NCLT’s discretionary power should not be used arbitrarily.
• However, this choice may have opened a Pandora’s box. Policymakers would be wise to take notice before history repeats itself.
• Furthermore, the law must clearly state the grounds for admitting an insolvency application against a corporate debtor.
• This could reduce litigation and speed up the resolution of the distressed business. Clearly, objective legal admission criteria are essential for an effective corporate insolvency law.