Banks generate credit by the circulation of money after setting aside various reserves as mandated by the Reserve Bank of India. The circulation of money takes place by granting of loans to various individuals and companies, promoters who are obliged to return the money on time. These loans when not paid back leaves the banking sector crippled. In short, the working capital of the banks gets blocked. This kind of loans is known as Non-performing assets.
The NPA’s are the most important scale of asset quality. Stressed asset is a broader concept compromising of NPAs, restructured assets and written off assets. By provisional estimates NPAs stood at about Rs. 10.35 Lakh crore in 2018. There were several laws like the Debt Recovery Tribunals, Lok Adalats, SARFAESI 2002 dealing with bankruptcy but they failed to address the menace of bad loans which had begun to cripple the financial sector. Insolvency resolution took almost 4.3 years in India compared to 1.5 years in USA and 1 year in UK, thus NPA’s kept on increasing. Delays were caused due to time taken by court, lack of clarity in bankruptcy framework etc.
To address this menace the government finally came up with Insolvency and Bankruptcy Code in 2016 which is a consolidation of the existing acts regarding insolvency and NPA’s (SARFAESI ACT 2002, Sick Industrial Companies Act, Financial Institution Act) for time bound process to resolve insolvency. The code has acted as deterrent in dealing with the delays and negligence on the part of debtors.
What does the insolvency and bankruptcy code aim to do?
The 2016 code applies to both companies and individuals. As mentioned earlier it provides for a time bound process to resolve insolvency. A creditor is person who is supposed to get back the money from the debtor. When a default in payment occurs the creditor or creditors gain control over the debtor’s asset and according to the law they must take decision to resolve insolvency within 180 days.
Whenever an individual is unable to pay his dues due to lack of funds, he is said to be insolvent. When the same person is declared so by an adjudicating authority through a bankruptcy order, he is officially declared a bankrupt.
The adjudicating authority would be the National Company Law Tribunal in case of companies and limited liability partnership and Debt Recovery Tribunal in case of individual and firms.
Various facilitating institutions under the code:
- Insolvency professionals: a specialized cadre of licensed professionals is proposed to be created. These professionals are proposed to be created to administer the resolution process, manage the asset of the debtor during the insolvency period and provide information to the creditors to assist them in decision making.
- Insolvency professional agencies: these agencies will act as registrar for the insolvency professionals. They will certify the insolvency professionals and enforce a code of conduct for them.
- Information utilities: it will be an information network which will store financial information data like borrowings, default and security interest among other firms. They would specialize in collecting, maintaining and supplying financial information.
- Adjudicating authorities: the proceedings of resolution process will be adjudicated by the National Companies Law Tribunal for companies and Debt Recovery Tribunals for individuals. Their duties would be to initiate the resolution process, appoint insolvency professions and approve final decisions of creditors. The appellate tribunals are National Companies Law Appellate Tribunal (NCLAT) and Debt Recovery Appellate Tribunals (DRAT).
- Insolvency and Bankruptcy Board: the board will regulate insolvency professionals, insolvency professional agencies and information utilities set up under the code. The board will consist of representatives from RBI, Ministry of Finance and Corporate Affairs and Law.
A Robust Mechanism to Solve Insolvency
When a default occurs the resolution process may be initiated by a debtor or creditors, the IPs administer the process. The process last for 180 days and any legal action against the debtor is prohibited during this period. The IP forms a committee of the financial creditors who had lent money to the debtor. The committee would be responsible to take decisions regarding the future of the outstanding debt owed to them, they can either restructure it or sell the assets of the debtors to repay the loan. If the decision is not taken within 180 days, the debtor’s asset goes into liquidation. If the debtors asset goes into liquidation the insolvency professional administers the liquidation process and proceeds are distribute in the following order of precedence i) Insolvency resolution cost including IP’s remuneration ii) secured creditors iii) unsecured creditors iv) dues to the government v) priority shareholders vi) equity shareholders.
The code has been revised and amended from time to time to address certain loopholes and to meet the needs of the changing times
In 2017, Section 29(4) was introduced to bar promoters from bidding for their companies. They were discouraged from regaining control of their companies at a cheaper value.
To create a credit culture that discourages defaults and also to exclude all defaulters from bidding, persons who have remained in the management or control of an account that has been NPA for 12 months are barred from bidding.
Smaller creditors were also given a voice by making it mandatory for resolutions to be approved by 75 percent of the creditors; it makes the resolution process more participating. This 75 percent was later brought down to 66% in 2018 so that more insolvency process can reach resolution.
In 2018, Section 12 A was introduced to the insolvency procedure if agreed by 90% of the creditors. In this case the promoters could offer settlement to the creditors, the creditors could withdraw the application within 30 days of the petition.
To address the problem of finding buyers for small companies for small companies, promoters of MSME’s were allowed to bid for their companies.
There was a slew of cases where the real estate developers defaulted not only banks but also their customers who had made advance payments. To give them voice, it was also proposed that the real estate buyers would be treated as financial creditors. Unnecessary disqualification criteria were done away with by allowing financial entities who are not related to the company but have acquired a stake to bid.
There were more amendments in 2019 to make the code more effective.
The bill of 2019 addressed 3 issues first it strengthens, provisions related to time limits. Second, it specifies minimum payouts to operational creditors in any resolutions plan. Third it specifies the manner in which the representative of a group of creditors should vote.
The code provides that the resolution plan must ensure that the operational creditors receive an amount which should not be less than the amount which he would receive in case of liquidation. The bill amends this to provide that amounts to be paid to the operational creditors must be higher than
- amount receivable under liquidation
- the amount receivable under resolution plan.
The amendment bill provides that if the NCLT doesn’t find the existence of default on receiving resolution applications within 14 days it must record the reasons in writing.
The last thing that the bill introduces that the if the debt owed to a class of creditors beyond a specified number, the financial creditors will be represented by authorized representatives, they will vote on behalf of the creditors as per their instructions.
The IBC has been successful in various ways. Many business entities are paying their dues before being declared insolvent or the start of insolvency proceedings because once their case falls under IBC they would lose management control. Many cases have been resolved before being referred to NCLT.
4452 cases were dismissed at the preadmission stage.
Nearly 80000 cases have been realized by creditors.
Banks have recovered Rs. 25.28 lakh crore in 2017-18 compared to just Rs. 38500 crore in 2016-17.
Many cases have been settled outside the court reducing the burden of judiciary
The IBC proceedings are free from political interference thus making it impartial and Transparent and promoting good governance.
The financial sector in the lifeblood of an economy. The banks are prized source of finance that get invested in production units that generate employment and in turn demand driven by increase in purchasing power of the individuals. If the banks are left devoid of money the whole system gets influenced and the economy might see a downturn. Money supply may have greater implications with regards to the inflation, growth and overall credibility of the nation’s sovereign credit ratings. The IBC not only resorts to the liquidation but also tries to save the companies by providing a restructuring plan if it finds the company is viable.