Insolvency & Bankruptcy in India
India's Insolvency and Bankruptcy Code is relatively new. It was enacted by the Indian Parliament on 28th May 2016, and came into effect from 1st December 2016. The Bankruptcy Code has many nuances, so it is important to engage a bankruptcy lawyer at an early stage of the process. A bankruptcy lawyer can help you determine your protect yourself and your assets to the extent of the law allows.
Synopsis of India's Bankruptcy Code
While the Code is intended to govern all artificial and living persons, presently corporations, limited liability partnerships and individual guarantors of corporate debtors are made subject to its provisions, it will, in due course be extended to individuals and firms. Prior to the Code, insolvency and bankruptcy of corporations was governed by the Companies Act, 2013, and, prior thereto, the Companies Act, 1956.
Insolvency of individual and firms continues to be governed by the Presidency Towns Insolvency Act, 1909, or the Provincial Insolvency Act, 1920, based on territorial jurisdiction. Statutes such as the Sick Industrial Companies (Special Provisions) Act, 1985, Recovery of Debt Due to Banks and Financial Institutions Act, 1993, the Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002, also, in part, provide for restructuring of corporations and persons in certain circumstances. However, the Code overrides them, as well any other related law.
The Code's principal objectives are to:
- consolidate, streamline and simplify insolvency and bankruptcy law and process,
- provide a legal framework for timely resolution of bankruptcy, insolvency and
- maximize the value of assets,
- prevent erosion of net worth, encourage entrepreneurship, and support and develop
- healthy credit markets, and
- effect a paradigm shift from 'debtors in possession', to 'creditors in control'.
Scheme of the Code
Scheme of the Code
- Part I – Introduction and Definitions,
- Part II – Corporate Insolvency Resolution and Liquidation Process
- Part III – Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms
- Part IV - Regulation of Insolvency Resolution Professionals, Agencies and Information Utilities.
Bodies Under The Code
Insolvency and bankruptcy are regulated under the Code through the (principal) Adjudicating Authority (AA), that is, the National Company Law Tribunal constituted under section 408 of the Companies Act, 2013 (NCLT), the Insolvency and Bankruptcy Board of India (IBBI), Insolvency Professionals (IP), the Insolvency Professionals Agency (IPA), and Information Utilities (IU), who (briefly) perform the following functions:
- AA – exercises jurisdiction over insolvency and liquidation processes,
- IBBI – regulates and controls IPs and IPAs,
- IPAs – specialized agencies who register and regulate IPs,
- IPs – persons or entities who drive the insolvency process at ground level, as resolution
- professionals, liquidators, and trustees in bankruptcy. IPs are also commonly known as
- resolution professionals (RPs),
- IU– collate and disseminate financial information in relation to insolvencies and
To following key definitions will provide a better understanding of the Code:
- Corporate Debtor - a corporate person who owes a debt,
- Debt - a liability or obligation, being either a ‘financial debt' or an ‘operational debt',
- Financial Debt – a debt (with or without interest), disbursed against consideration for the time value of money. ‘Time value' is the price associated with the length of time that an investor must wait until an investment matures or related income earned,
- Operational Debt - a debt payable against the provision of goods or services. It includes
- employment debts, and statutory liabilities,
- Financial Creditor - a person (or his transferee) to whom a financial debt is owed,
- Operational Creditor - a person (or his transferee) to whom an operational debt is owed.
Corporate Insolvency Resolution Process
The corporate insolvency resolution process (CIRP) for a Financial Debt or Operational Debt, is initiated upon the NCLT admitting an application made by a Financial Creditor or Operational Creditor.
The adjudication process, once a application is admitted, is similar for both Financial Debt and Operational Debt. However, prior to admission an Operational Creditor has to take one additional steps as outlined below.
Initiation By A Financial Creditor
A Financial Creditor may initiate CIRP when a debt is due and unpaid. More than one Financial Creditor can join in such process. The filing process is fairly straight forward and involves an application being made under the Code which is a standard format. If the NCLT is satisfied, after examining the application or evidence produced by the Financial Creditor, that the Corporate Debtor is in default of payment of a Financial Debt, it will admit such an application. Principally the Financial Creditor has to produce evidence of the existence of the Financial Debt which would include contractual documents, notices, evidence of dishonor of cheques, etc.
Initiation By An Operational Creditor
Unlike a Financial Creditor, notice has to be first given to a Corporate Debtor in respect of an outstanding or unpaid Operational Debt. Such notice may be either in the form of notice demanding payment or by delivery of an invoice demanding payment. Within a period of ten days from receipt of a notice a Corporate Debtor must either produce evidence that the Operational Debt has been paid or allege that a dispute exists over the same which may include the pendency of existing judicial or quasi-judicial proceedings. Such dispute or proceedings should have been in existence before receipt of the notice as a prerequisite. After the expiry of the notice period, if the Operational Creditor does not either receive payment, or notice of a dispute or proceedings, it may commence CIRP by filing an application before the NCLT under the Code. On the Application being filed, the NCLT has to either admit, or reject, within fourteen 14 days. On admission CIRP commences.
On admission of the application by either a Financial Creditor or an Operational Creditor, the NCLT will order a moratorium in respect of the Corporate Debtor and appoint an interim RP under the CIRP. Under the Code a CIRP is required to be completed within a maximum period of 330 days (CIRP Period) from the Insolvency Commencement Date (being the date of admission). Accordingly, ‘time is of the essence' in relation to a CIRP, and by the expiry of this period the Corporate Debtor either has to be rehabilitated or ordered to be liquidated.
An RP plays a significant role in CIRP as it manages the operations of the Corporate Debtor as a going concern under directions of a committee of creditors (solely comprising of Financial Creditors). The RP effectively assumes the position of the board of directors in the case of a corporation and designated partner in an LLP. Its powers and functions are duo fold. On one hand it has to continue managing the affairs of the Corporate Debtor and deal with all issues, administrative matters, etc., and on the other hand it is required to facilitate the CIRP process. Some of the key functions of an RP include:
- raising finance and creating security interests;
- making efforts to revive the Corporate Debtor;
- inviting claims from Operational Creditors and Financial Creditors;
- collecting information relating to assets, finances and operations of the Corporate
- Debtor, for determining its financial position;
- constituting the committee of creditors (COC) and conducting their meetings;
- managing assets and operations;
- appointing professionals; and
- preparing an information memorandum (IM) in respect of the Corporate Debtor, based
- on its financial position, for formulating a resolution plan.
Revival Of A Corporate Debtor
After claims have been received from Operational Creditor and Financial Creditor and all other necessary information has been compiled by the RP, the IM, comprising such information will be published inviting offers from any persons interested in reviving the Corporate Debtor. A person who is interested will submit a resolution plan which must provide for payment of CIRP costs, management of the affairs of the Corporate Debtor after approval of the plan, and implementation and supervision of the plan.
If the plan is approved by the COC, and the NCLT is satisfied that it meets statutory requirements, the NCLT will pass an order approving it, which order will be binding on the Corporate Debtors all its employees, all creditors, guarantors and other stakeholders.
LIQUIDATION PROCESS If there is no resolution plan received by the expiry of the CIRP Period, a resolution plan is rejected by the NCLT, RP notifies the NCLT that the COC has decided to liquidate the Corporate Debtor, or the resolution plan that was approved and ordered is breached by the Corporate Debtor pursuant to an application being made by an affected person, as ordered by the NCLT, then the Corporate Debtor may be ordered to be liquidated by the NCLT.
In such a case the liquidation process of the Corporate Debtor will commence by sale of its assets DISTRIBUTION OF SALE PROCEEDS ON LIQUIDATION: When a Corporate Debtor is ordered to be liquidated there is a set waterfall mechanism under the Code which sets out the priority of payments arising out of the sale of assets. Broadly the same is as follows: cost of the CIRP process and cost of liquidation, workmen's dues for a twenty-four month period preceding liquidation commencement, debts owed to a secured creditor who have relinquished their security interests and claimed in the CIRP, wages and dues owed to employees other than workmen, for a twelve-month period preceding liquidation commencement, financial debts payable to unsecured creditors, liabilities due to the Central Government, and State Government (including amounts due on account of the Consolidated Fund of India and the Consolidated Fund of a State, if any), in respect of the whole, or part of a period of two years preceding liquidation commencement all balance debts and liabilities, paid-up face value of preference shares, and paid-up face value of equity shares, or partners' capital contributions.
The Code being new law, its interpretation and enforcement has been subject matter of a number of judicial pronouncements. A few relevant judgments are cited below. Mobilox Innovations Private Limited v Kirusa Software Private Limited1 (An intricate definition of word “existence of dispute”)
In this Case the Supreme Court held that in the case of an operational debtor it is not required for a judicial or quasi-judicial proceedings to have been instituted or pending before a demand notice is served by the Operational Creditor and merely correspondence raising a dispute would be sufficient and would fall within the definition of ‘dispute’ under the Code. The court observed that the NCLT is merely required at the stage of admission or rejection of an application, whether there is a plausible contention which requires further investigation and the ‘dispute’ raised by the operational debtor is not a patently feeble legal argument or an assertion of facts unsupported by evidence. Therefore, NCLT is not required to satisfy itself as to whether the dispute has merit, as long it truly exists and is not spurious, hypothetical or illusory. The Supreme Court also hold that the definition of ‘dispute’ under a Code is inclusive, and not only deals with suits or arbitration proceedings but must fall within three categories, that is, a disputed debt or a dispute over quality of goods or services or breach of representation or warranty.
Innoventive Industries Ltd. (Corporate Debtors) v ICICI Bank & Anr2 (Code Laws v State Laws) In this case the Supreme Court was faced with the question as to whether a state law would prevail over the Code in a conflict. It held that the Code would prevail, highlighting that time is of essence in a bankruptcy. It also held that in the case of a financial debt, the question of a dispute does not arise and all that a financial creditor is required to produce is evidence of non-payment. Pioneer Urban Land Infrastructure Ltd & Anr v Union of India3 (home buyers included as financial creditors)
In this challenge to an amendment to the Code in 2016, deeming purchasers in real estate projects as ‘financial creditors’, on grounds that it infringes the Constitution of India, the Supreme Court upheld the amendment recorded that the Real Estate (Regulation & Development) Act, 2016 was to be read harmoniously with the Code, and that aggrieved real estate purchasers possessed remedies under both laws.
To say that the Code has been a success, from its introduction three years ago, would be an understatement. Striking fear in the minds of errant debtors, it has brought about many a settlement, which is a sea change from the days when hapless creditors had no option but to initiate long and costly court battles to recover their dues. The Code has also standardized and streamlined the insolvency process, creating an efficient legal framework for timely resolution that is available to everyone irrespective of resources and reach.
It remains to be seen how the Code will evolve over time, and whether it will maintain its efficiency, particularly with judicial pronouncements and its extension to non-corporate debtors. Whichever side of the fence one may sit on, no one can dispute that the Code has changed the way business is conducted and is required for maintaining a healthy economy, particularly in the background of the substantial bad debt plaguing lenders.
Disclaimer: This article is provided for informational purposes only and is not legal advice. For more advice on the topic, please contact us.