Corporate Insolvency Process in India: An Analysis
INTRODUCTION
Before Insolvency and Bankruptcy Code, 2016, the corporate insolvency procedures in India were governed by the following three legislations, i.e., – the Companies Act 2013, Companies Act 1956 and Sick Industrial Companies Act, 1985 (“SICA”). Resolving insolvency issues has proved to be a in multi-layered framework of legislation that proves inadequate, for, it involves a complex procedure and various tribunals.
The present Code, has consolidated the law governing insolvency into a single Code and thereby repealing the Presidency Town Insolvency Act, 1909 and The Provincial Insolvency Act, 1920, further amending Central Excise Act, 1944; Income Tax Act, 1961; Indian Partnership Act, 1932; Recovery of Debts due to Banks and Financial Institutions Act, 1993; Customs Act, 1962 ; Finance Act, 1994 ; Sick Industrial Companies (Special Provisions) Repeal Act, 2003; Payment and Settlement Systems Act, 2007; Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; Limited Liability Partnership Act, 2008; Companies Act, 2013. The Code, differentiates between Financial Creditor and Operational Creditor, providing different procedures for initiation of Corporate Insolvency Resolution Process. Present article discusses Chapter II of Part II of the Code which deals with Corporate Insolvency Resolution Process, substantiated by recent judgments of various Courts and Tribunals which strengthens the structural framework of this budding law.
HISTORICAL BACKGROUND
As discussed before, a need was felt to amend the corporate and individual insolvency procedure and subsequently form an efficient working system for bankruptcy and liquidation process. Consequently, the Bankruptcy Law Reform Committee (BLRC) was appointed by the Ministry of Finance under the chairmanship of T.K Vishwanathan. On 4th November, 2015, the draft bill was submitted to the Ministry.
The draft bill suggested a speedier and transparent procedure in identifying financial distress at an early stage and then the re- establishment of viable businesses. BLRC proposed the setting up of a procedure viable for both the creditors and debtors in case of default.
Initially, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) was formulated to protect the interest of creditors by ensuring easy exit of business. SARFAESI Act provided easy mechanism without the involvement of courts and was an addition to the existing frameworks for resolving insolvency. However, it empowered the debtors to challenge such an action within the time frame of 45 days.
The Bankruptcy Code, 2016 sought to protect both the secured and unsecured creditors by the procedure of collective insolvency than mere debt recovery. World Bank has defined the recovery rate to be a function of the cost, time and outcome of insolvency proceedings of a local company at an average of 1.7 and 2.6 years in OECD high income countries and South Asia respectively. However, in India, the average recovery rate is 4.3 years, where only 25.7 cents on every dollar can be recovered by the creditors. The case proceedings in an insolvency case are time consuming as the assets depreciate, therefore, low returns are incurred. Consequently, this leads to accumulation of Non-Performing Assets (NPA).
The Insolvency and Bankruptcy Code was passed by Lok Sabha on 5th May, 2016 and by Rajya Sabha on 11th May, 2016. It got the Presidential assent on 28th May, 2016 and has commenced from 28th May, 2016.
CREDITORS:MEANING AND KINDS
Section 3(10) of the Code defines “Creditor", as a person who owns a debt including an operational creditor, a financial creditor, an unsecured creditor, a secured creditor and a decree holder. The definition is inclusive in nature.
A financial Creditor is an individual to whom a financial debt is owed, additionally, it incorporates an individual to whom such debt is allotted. The term financial debt is characterized in sub section 8 of Section 5 of the Code as a debt, which is dispensed against the consideration for the time value of money. The articulation 'time value of money' depends on the possibility that money accessible right now is worth more than a similar sum later on owing to the depreciating nature of value of money. The essential idea that the expression ‘time value of money’ captures is that of a ‘borrower-lender relationship’, where a loan that has been provided, has to be returned with interest or return of some kind. In ascertaining whether a transaction is financial debt, it is the underlying nature of the transaction, which needs to be looked at. In Nikhil Mehta v. AMR Infrastructure (Company Appeal (AT) (Insolvency) No. 07 of 2017), the applicant had loaned to the defendant, a real estate developer, the price of the premises under construction, in the pretext that until complete possession was acquired by the creditor, the defendant would have to pay a fixed price every month, wherein, NCLAT observed that the underlying object of the contract was not mere buying and selling of the premises but was a transaction where monies had been advanced against the consideration for a guaranteed return, therefore, clothed as a financial debt. All lenders who have given out any sort of advances, financial credit or guarantees are covered within its ambit.
Operational Creditor is another kind of creditor. Operational Creditor is a creditor who owns an operational debt and includes a person to whom such debt is legally assigned or is transferred (section 5(20)). The term ‘Operational debt’ (section 5(21)) is:
- a claim that provides for goods or services, including employment services, or
- a debt with respect to repaying the dues under a legal obligation that which is payable to the Central Government, any State Government or any local authority.
The expressions ‘goods’ and ‘services’ are not defined in the IBC, and the jurisprudence on this is yet to evolve. One of the significant early decisions in this regard is by the NCLAT in Pawan Dubey v. JBK Private Developers Limited (Company Appeal (AT) (Insolvency) No. 40 of 2017), in this case, the allottees of private and business premises were held not to be operational creditors as the exchange didn't include 'goods' or 'services'.
The definition of Creditor includes Secured Creditors. A ‘Secured Creditor’ (section 3(30)) is a creditor in favour of whom security interest is owed.‘Security Interest’ (section 3(31)) means title, right, interest or a claim to property, including mortgage, charge, hypothecation, assignment, etc.
The term ‘debt’ is defined in Sub-Section 11 of Section 3, including operational and financial debt. Where, debt can mean to act as an obligation or liability with respect to a claim that is due from an individual.
The classification of creditor is made because their rights and duties vary accordingly. Where only the financial creditors form the committee of creditors and operational creditors are not part of the committee.
CORPORATE INSOLVENCY RESOLUTION PROCESS:
After the commencement of Insolvency and Bankruptcy Code, a company may be wound up through the process of Corporate Insolvency Resolution Process (CIRP). Section 6 of the Code deal with the category of persons who can initiate CIRP. It includes a financial creditor and an operational creditor. A corporate debtor may itself voluntarily start CIRP. The only requirement under Section 6 to start CIRP is commitment of default by corporate debtor. The term ‘default’ has been defined in Section 3(12) of the Code, thereby, meaning non-payment of debt when it has become due and payable either whole or any part or instalment of debt by a debtor.
A CIRP may be initiated by:
- Financial Creditor
- Operational Creditor
- Corporate Debtor
CIRP by Financial Creditor:
- Section 7 deals with initiation of CIRP by financial creditor. Application under this Section can be made either by a financial creditor itself or jointly with other financial creditor. Application has to be made on occurrence of default by corporate debtor before the adjudicating authority. Section 5(1) defines adjudicating authority as NCLT. Further, explanation to Section 7(1) says that a default includes default in respect of debt owed to applicant financial creditor or any of the financial creditor of the CD.
- Rule 4 of Application to Adjudicating Authority Rules, 2016 prescribes the manner in which an application has to be made by the financial creditor. A copy of application has to be sent to the corporate debtor. A format of such application is given in Form 1 of the said rules.Along with the application a financial creditor has to submit
- Record of default.
- Name of resolution professional
- Any information which is specified by the board.
Within the 14 days of receiving of such application, the NCLT has to ascertain the existence of default.
- Section 7(5) says that on satisfaction that the default has occurred and the application is complete and no disciplinary proceeding is pending against the resolution professional, it may admit the application and vice versa. However, NCLT makes a provision of 7 days to be granted to the applicant in order to correct the mistakes of the application. Then, it is after rectification that the application is accepted and CIRP commences.
- The code does not ask the applicant to provide notice to corporate debtor. However, in M/s Innoventive Industries Ltd vs. ICICI Bank and Anr (Company Appeal (AT) (Insolvency) No. 1 & 2 of 2017) the NCLAT held that it is the duty of NCLT to provide a notice to the other party before admitting the case. NCLAT cited Sree Metaliks Limited and Anr v. UOI and Anr (WP 7144(W) of 2017), wherein, it was held the adjudicating authority is bound to issue a limited notice to the corporate debtor before admission of the case.
CIRP by Operational Creditor:
Section 8 deals with initiation of CIRP by operational creditor. On occurrence of default, a demand notice has to be sent to the debtor, demanding the unpaid operational debt along with the invoice demanding payment of amount in default. A format of demand notice is given in Form 3 and format of invoice in Form 4 of the Application to Adjudicating Authority Rules, 2016. It is the duty of the operational debtor to bring to the notice of operational creditor the existence of dispute, if any and the repayment of unpaid operational debt within 10 days of receiving of demand notice or invoice demanding repayment.
Explanation to Section 8(2) states that demand notice is a notice which is given to the operational debtor from the operational creditor in order to recover the default amount. Process of initiation of CIRP by operational creditor and financial creditor is different. A demand notice is pre requisite before initiating CIRP by operational creditor. However, there is no such condition under the Code in case of financial creditor.
In Macquarie Bank Limited vs Uttam Galva Metallics Ltd (Decided on 17th July, 2017), it was held by NCLAT that a demand notice in Form 3 must be sent through a person holding a position with or in relation to creditor. This is so because the debtor will understand the seriousness of the notice. Therefore, a lawyer cannot send a demand notice under Section 8 since he is not holding any position in the company. However, if the lawyer is authorized by BOD, he may issue such demand notice.
Section 9 deals with application for CIRP by operational creditor. Under this Section, if a corporate debtor fails to repay the defaulted amount within 10 days of receiving of demand notice or invoice, the operational creditor may file an application before NCLT for CIRP. Along with the application copy of invoice or demand notice and an affidavit that there is no notice given by the corporate debtor regarding the dispute of unpaid operational debt and copy of certificate from financial institution and of any record with information utility which maintains the creditor’s accounts, confirming non- payment of unpaid operational debt by the corporate debtor, attached along with. The default amount must be more than or equal to Rs 1 Lac, but the amount was increased during the COVID pandemic to Rs. 1Cr.
CIRP by Corporate Applicant:
Under Section 10 of the Code, a corporate debtor may itself make an application if a default has been committed by him. The term corporate applicant is defined in Section 5(5). It includes a corporate debtor and,
A member or partner of corporate debtor,
Person in charge of managing the operations and resources of the Corporate Debtor,
Person in control and supervision over the affairs of corporate debtor.
An application under Form 6 of Application to Adjudicating Authority Rules, 2016 is to be made before NCLT. Along with application, the Corporate Applicant must furnish its books of account and propose a resolution professional. NCLT within 14 days either admit or reject the application. However, before rejecting the application, NCLT must give a chance to corporate applicant to rectify its mistake in application within 7 days.
The Insolvency Code was drafted to make the winding up of company in a time efficient manner. For this, a provision is made in the Insolvency Code, i.e., section 12(1), CIRP must be completed within 180 days of admission of application. However, this period can be extended to a further period not exceeding 90 days if the resolution professional makes an application to NCLT and if such application is backed by a resolution passed by meeting of committee of creditors by a vote of 75% of the strength.
MORATORIUM:
The NCLT, after the admission of application for initiation of CIRP shall declare moratorium and by order cause a public announcement of the initiation of CIRP and appoint an interim resolution professional. Moratorium prevails as per Section 14 of the Code. During the moratorium following things shall be prohibited:
a. Any legal proceeding against corporate debtor.
b. Transfer, alienation, or disposition of any assets or legal right or beneficial interest by corporate debtor.
c. Any recovery of any property which is in the possession of corporate debtor, by the owner or lessor.
The moratorium will continue till the completion of CIRP.
The public announcement of initiation of CIRP shall contain following information:
1. Name and address of the corporate debtor.
2. Authority of the corporate debtor who has been incorporated or registered.
3. Closing date of submission of such claims.
4. Interim professional resolution details.
5. Penalties to be prescribed in case of false & misleading claims.
6. Closing date of CIRP.
Committee of Creditors:
Section 21 talks about constitution of committee of creditors (CoC), as per which interim resolution professional is empowered to constitute a CoC after collation of all claims received against the Corporate Debtor. The CoC will comprise of all the financial creditors. And if a person is financial creditor as well as operation creditor, then the voting share of such person as financial creditor will be to the extent of financial debt owed to him by corporate debtor and will be considered as operation creditor to the extent of operational debt owed to him.
If an operational creditor has legally transferred or assigned operational debt to a financial creditor, then the assignee or the transferee will be considered as an operational creditor to that extent.
All the decision of the CoC will be taken by a vote not less than 75% of voting share of financial creditor. And if a corporate debtor does not have any financial creditor then the CoC shall be constitute of persons as specified by the Board.
During any time CIRP, the CoC has the power to require the resolution professional to furnish any financial information in respect of corporate debtor. This is to be done within 7 days of such requisition.
The first meeting of CoC will be held within 7 days of the constitution of CoC. All the meetings of CoC will be conducted by resolution professional. The directors, partners & one representative of operational creditor can attend the meeting of CoC. However, they will not have any voting rights.
There are certain actions for which prior approval of CoC is required, which has been laid down in section 28 of the Code, few of which include:
1. Raise any interim finance in excess of the amount decided by CoC.
2. Creating security interests on the resources of corporate debtor.
3. Change the capital structure of corporate debtor.
4. Undertake any related party transaction.
5. Delegate its authority to any other person.
6. Make any adjustment in the administration of the corporate debtor or its auxiliary.
7. Transfer rights or financial debt or operational debts.
RESOLUTION PLAN:
Section 30 of the Code which provides for submission of resolution plan, in accordance with which an applicant (such applicant may attend meetings of CoCs but shall not have right to vote unless the applicant is also an FC) can submit a resolution plan to be formulated by a resolution professional, who shall then review the plan formulated and confirm that such a plan:
1. Provides payment of IRP costs.
2. Should make a provision for the repayment of debts owed to creditors in case of liquidation of the debtor under section 53, and for payment of debt of those financial creditors who do not vote in favour of RP, which should not be less than the amount paid to such creditors as per section 53.
3. After the approval of plan, it provides for managing the affairs of corporate debtor.
4. Provides a procedure on supervising and implementing such a plan.
5. Does not contravene any other law.
The resolution plan if approved by the CoC by vote of not less than 66% of voting share of FCs, shall be submitted to NCLT. If NCLT is satisfied with the resolution plan, then it will approve the resolution plan which will be binding on the corporate debtors. In the event that the NCLT is satisfied that the resolution plan doesn't conform to the pre-requisites set out in Section 30, it may, reject the resolution plan. On approval order of resolution plan, Moratorium imposed under section 14 shall cease to be operational.
Importance of insertion of Section 29A in the Insolvency and Bankruptcy Code 2016
The Insolvency and Bankruptcy Code (Amendment) Act, 2018 inserted Section 29A with retrospective effect from November 23, 2017.
Concisely, section 29A of the Code sets a disqualification criterion for the applicants of resolution, which includes:
a. undischarged insolvent
b. Wilful defaulter under Banking Regulation Act, 1949
c. Promoter of the company or has an account of a corporate debtor under management of such promoter, classified as non-performing asset under BRA, 1949, for at least a year before commencement of CIRP. (However, not applicable where such account was acquired pursuant to approved prior resolution plan.)
d. A convict punished with imprisonment of a specified term as per section 29A(d).
e. Disqualified director under CA, 2013 ( inapplicable to connected person).
f. Prohibited by SEBI from trading;
g. Guarantor for CD in favour or a Creditor
h. Connected person to those mentioned above, among others.
Before the Code was amended, section 5(25) allowed ‘any person’ to contend for a resolution and be the resolution applicants. This paved way for the promoters of the corporate debtors to submit a resolution plan in the CIRP for their insolvent company and at the same time be the applicants. This defeated the purpose of the Act, as the promoters at default could buy the assets of the insolvent corporate debtor at high discounts. Therefore, in order to prevent such misuse, section 29A was added, which served the purpose of preventing people with mala fide intent from contesting to revive a company under the CIRP.
CONCLUSION:
With the legislation of Insolvency and Bankruptcy Code (IBC), 2016, India has ushered in a new age of individual and corporate insolvency. As per the Code, companies prior to taking the path of liquidation are mandatorily brought under IBC. The time frame of the procedure has been cut down to the relief of the promoters and stakeholders. Similarly, decision making has been conferred on an expert tribunal for an efficient decision. While in theory IBC has raised hopes. However, it hasn’t been enforced and implement with an equal amount of zeal or enthusiasm, as noted by delays and litigation courses sought. Therefore, the Code is yet to be interpreted to its highest extent and more developments are likely to be witnessed in the future.