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18 Jan 2017

Corporate Insolvency under the Insolvency and Bankruptcy Code, 2016

The Insolvency and Bankruptcy Code notified on 28th May, 2016 (“Code”), lays down the structure for a unified insolvency and bankruptcy resolution mechanism in India. This is an important legislation for corporate India because the term “insolvency” has not previously been defined under India’s corporate law framework, although Section 433 of the erstwhile Companies Act 1956 provided for grounds of winding up a company that is “unable to pay its debts”. [Black’s Law Dictionary defines the term “insolvency” as “the condition of being unable to pay debts as they fall due or in the usual course of business”][1].

The importance of this Code stems from the fact that it provides a mechanism for orderly and time-bound resolution of insolvency issues by way of liquidation, voluntary liquidation or bankruptcy of companies (incorporated under Companies Act 1956 or Companies Act, 2013 or any other specific act), limited liability partnerships, partnership firms and individuals.

The Code is described as  “An Act to consolidate and amend the laws relating to REORGANISATION AND INSOLVENCY RESOLUTION of CORPORATE PERSONS, PARTNERSHIP FIRMS AND INDIVIDUALS in a time bound manner for maximisation of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of government dues and to establish an insolvency and bankruptcy board of India, and for matters connected therewith or incidental thereto.

This article covers the following aspects of the Code:

  • when such corporate insolvency is triggered;
  • who can apply for corporate insolvency resolution;
  • what is the process of insolvency resolution; and
  • what are the exemptions?

Corporate Creditors

The Code distinguishes two distinct classes of corporate creditors:[2] :

  1. Financial Creditors (includes both secured and unsecured creditors having claims against the companies with respect to financial debt such as loan, guarantee, indemnity etc.); and
  2. Operational Creditors (includes creditors having claims with respect to provision of goods and services including employment)

The Code lays down different procedure for initiating the proceedings for corporate insolvency resolution based on the class of creditors:

  1. A Financial Creditor has to move an application before the National Company Law Tribunal (“NCLT”) after furnishing proof of default and proposing an interim Insolvency Professional who shall be appointed by the NCLT. The NCLT will then ascertain the existence of default from the records of an information utility (established for the purpose of collecting, collating and furnishing information of the Corporate Debtors to Insolvency Professionals) or on the basis of other evidence furnished by the creditor.
  2. An Operational Creditor is required to deliver a demand notice to the Corporate Debtor along with a copy of the invoice, demanding payment of amount involved in default. The Corporate Debtor is obligated to respond within ten (10) days by furnishing the Operational Creditor with proof of either:

 (i) existence of dispute and record of pendency of suit or arbitration proceedings before the receipt of demand notice or invoice copy from the Operational Creditor; or

(ii) repayment of the amount demanded by the Operational Creditor in the demand notice or the invoice.

If the Operational Creditor does not receive either of the above within the ten (10) day notice period, he can file an application before the NCLT.

Who is eligible to file an application for corporate insolvency resolution?

When any corporate person (Company/LLP/any other incorporated entity with limited liability) (“Corporate Debtor”) owing  money to any person, commits a default in payment of such money owed, then an application to NCLT for initiating insolvency resolution process can be made by any one of the following:

  1. the Corporate Debtor itself or any member or partner or person in control of the operations or financial affairs of the Corporate Debtor who is authorized by the Corporate Debtor under a special resolution;
  2. Financial Creditor; or
  3. Operational Creditor.

Process of corporate insolvency resolution

The process of insolvency resolution for Corporate Debtor under the Code may be divided into three stages:

Initiation: The corporate insolvency resolution process may be initiated by the Corporate Debtor or Corporate Creditor by filing an application with NCLT in the manner described above.

Insolvency Resolution: After the application for corporate insolvency resolution is accepted by NCLT, the following shall occur:

  1. a. The NCLT shall appoint an Insolvency Professional who shall administer the entire process of resolution of insolvency.  
  2. The Insolvency Professional shall form a Committee of Creditors consisting of the Financial Creditors.
  3. The Committee of Creditors committee shall take decisions regarding the future of the outstanding debt owed to them based on financial and other data of the Corporate Debtor furnished by the Insolvency Professional. Such data will be obtained by the Insolvency Professional from the information utilities.

The Code does not provide for any plans or methods to resolve insolvency. The Committee of Creditors has the power to decide and approve the final resolution by majority vote in the negotiations. The majority vote requires approval of such number of financial creditors who own an aggregate of 75% of the financial debts incurred by the Corporate Debtor out of the total financial liabilities of the Corporate Debtor. The Insolvency Professional shall manage the Corporate Debtor’s assets during this period.

Liquidation: The insolvency resolution process shall last for one hundred and eighty (180) days (which may be increased by another ninety (90) days if so decided by majority vote of the Committee of Creditors). If the Creditors’ Committee is unable to take a decision within the stipulated timeframe (one hundred and eighty (180) days, along with extension, if any), then the NCLT shall liquidate the assets of the Corporate Debtor.[3]

During the liquidation process an Insolvency Professional is appointed to administer the liquidation process. This Code further provides for the order in which the proceeds of liquidation shall be distributed. It is to be noted that this Codes gives more importance to dues of the unsecured creditors than the dues to government of the Corporate Debtor.[4]

 Exemptions

The Code specifically exempts corporate insolvency where the amount of default is less than INR 1,00,000/-. The Central Government has been given the power to increase this threshold upto INR 1,00,00,000/- by notification.

This corporate insolvency resolution is currently not applicable to financial service providers such as MFIs, NBFCs and financial service providers (regulated under SEBI, PFRDA, IRDA etc. as the case may be). However, the Code provides the Central Government the power to make provisions in future for bringing such financial service providers into the purview of the Code on a case to case basis after due consultations with the relevant regulator.

Conclusion

The Insolvency and Bankruptcy Code is an important piece of legislation. It is a comprehensive and systemic reform, which will give a big boost to the functioning of the credit market. It is expected to also significantly alleviate the problem of Stressed Assets or Non-Performing Assets (NPA).

The Code repeals various archaic laws like the Presidency Towns Insolvency Act 1909 and the Provincial Insolvency Act, 1920. It makes major amendments to 11 laws including the Companies Act, 2013 and the Recovery of Debts due to Banks and Financial Institutions Act, 1993, Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) etc.

The Code introduces new entities like the Insolvency and Bankruptcy Board of India, the Insolvency Professionals Associations, Insolvency Professionals, information utilities etc. The smooth working of the Code and therefore, effective insolvency resolution shall depend on the efficiency of these new entities.  It is widely expected that the introduction of the Insolvency and Bankruptcy Code will play a major role in improving the ease of doing business in India.

[1] Black’s Law Dictionary by Garner page no. 811.

[2] The Code also provides for cases where a creditor has financial transaction as well as operational transaction with the entity. In such a case, the creditor shall be considered a financial creditor to the extent of the financial debt and an operational creditor to the extent of the operational debt.

[3] The Code provides for a fast track corporate insolvency resolution process for entities with less complex structuring or businesses, assets and liabilities, amount of debt and other criteria as may be prescribed by the Central Government. The fast track insolvency process is required to be completed within a period of ninety (90) days with a one – time extension of ninety (90) days.

[4] Proceeds from the sale of the Corporate Debtor’s assets are distributed in the following order of precedence: i) insolvency resolution costs, including the remuneration to the insolvency professional, ii) secured creditors, whose loans are backed by collateral, dues to workers, other employees, iii) unsecured creditors, iv) dues to government, v) priority shareholders and vi) equity shareholders.

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