OVERVIEW OF THE INSOLVENCY AND BANKRUPTCY CODE, 2016

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1. INTRODUCTION

The Insolvency and Bankruptcy Code (IBC) was enacted in 2016 following the recommendations which suggested improvements in the earlier insolvency regime.  Earlier, no powers were given to the banks as such to recover their loans. Banks could give loans but when it came to recovery, the banks could not sell the mortgaged property. Banks as such were not given any powers. Following which in the year 1985, Sick Industrial Companies Act was enacted in order to facilitate the resolution process and help the banks recover their money. But the same proved to be fundamentally wrong as the banks, under the said act could approach the company when it has absolutely nothing i.e. negative revenue. Then in the year 1993 Recovery of Debt Due to Banks and Financial Institutions Act  was enacted and a new forum namely Debt Recovery Tribunal was established. But the same proved to be conceptually wrong as the banks had to wait in long queue as an ordinary litigant. Banks did not require the permission of the courts to advance loans but had to approach the court to recover the same. In 2002, to combat the problems faced by the early insolvency resolution process, the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) was enacted which somewhat introduced a creditor-in-control regime. However, under the aforesaid act, the entire process, from declaring Non-Performing Assets (NPAs) to seeking reply took nearly six months (6 months) and which could have been extended. Then an integrated Code namely IBC, was enacted in 2016 which introduced a creditor-in-control regime (with a focus on empowering financial creditors), a time-bound resolution process and reduced scope for judicial intervention. This Code has consolidated and amended the laws relating to reorganization and insolvency of corporate persons, partnership firms and individual firms.

2. IMPORTANT DEFINITIONS

Under the Code there are two types of creditor i.e. the Operational Creditor and the Financial Creditor.

a. FINANCIAL CREDITOR

Financial Creditor is a one whose relationship with the debtor is a pure financial contract, where an amount has been provided to the debtor against the consideration of time value of money. A financial creditor is defined under Section 5(7) of the IBC to mean

“A person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred“.

A financial debt is defined under Section 5(8) of the IBC to mean:

“A debt along with interest, if any, which is disbursed against the consideration for time value of money and includes-

  • Money borrowed against payment of interest;
  • Any amount raised by acceptance under any acceptance credit facility or its de-materialized equivalent;
  • Any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument;
  • The amount of any liability in respect of any lease or hire purchase contract which is deemed as a finance or capital lease under the Indian Accounting Standards or such other accounting standards as may be prescribed;
  • Receivable sold or discounted other than any receivable sold on non-recourse basis;
  • Any amount raised under any other transaction, including, any forward sale or purchase agreement, having the commercial effect of borrowing;
  • Any counter-indemnity obligation in respect of a guarantee, indemnity, bond, documentary letter of credit or any other instrument issued by a bank or financial institution;
  • The amount of any liability in respect of any of the guarantee or indemnity for any of the items referred to in sub-clauses (a) to (h) of this clause“

b. OPERATIONAL CREDITOR

An operational creditor is defined under Section 5(20) of the IBC to mean:

“Any person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred“.

An operational debt is defined under section 5(21) of the IBC to mean:

“A claim in respect of the provisions of goods or services including employment or a debt in respect of the repayment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority”.

c. DISTINCTION BETWEEN THE OPERATIONAL CREDITOR AND THE FINANCIAL CREDITOR

The distinction between the two debts can be drawn from the Insolvency and Bankruptcy Code Reform Committee in paragraph 5.2.1 of its final report[i] which states:

“Here, the Code differentiates between financial creditors and operational creditors. Financial creditors are those whose relationship with the entity is a pure financial contract, such as a loan or debt security. Operational creditors are those whose liabilities from the entity comes from a transaction on operations…The Code also provides for cases where a creditor has both a solely financial transaction as well as an operational transaction with the entity. In such a case, the creditor can be considered a financial creditor to the extent of the financial debt and an operational creditor to the extent of the operational debt.”

The distinction between the two is important as the maintainability of the application  for initiating corporate insolvency resolution process chiefly depends on the applicant first satisfying the Tribunal that it falls either within the definition of ‘Financial Creditor’ or ‘Operational Creditor’ under the IBC.

3. IMPORTANCE OF THE CODE

The four fold reasons behind implementation of the Code are:

  • Need for a unified Code
  • Reduce the amount of NPAs.
  • Easy Exit for the Corporates.
  • Ensure revival before liquidation.

Importantly the Code focuses on revival as its primary duty because at the time of liquidation the assets of the company are sold at a very low rate and the creditors will not be able to realize their dues even after the liquidation.

4. WORKING OF THE CODE

The Code provides a mechanism to initiate the resolution process in the event a debtor is unable to pay its debt. Unlike the SARFAESI Act, 2002, the creditor does not have to wait for 90 days where the advance is first classified as NPAs and then a notice is sent and a reply is sought. In order to fasten up the resolution process, under the Code, if there was a default, the next day itself the notice can be sent to the defaulter. Authorities that facilitate the Insolvency Resolution Process under the Code are as under:

  • Insolvency Professionals
    • administer the resolution process
    • manage the assets of the debtors
    • provide information to the creditors  
  • Insolvency Professional Agency
    • Insolvency Professionals are registered with the above agency
  • Information Utilities
    • It collects, collates, maintains and supply financial data to businesses, financial institutions, adjudicating authorities, insolvency professionals and other relevant stakeholders.
  • Adjudicating Authorities
    • National Company Law Tribunal- For Companies
    • Debt Recovery Tribunal- For Individuals
  • Insolvency and Bankruptcy Board
    • Regulates the Insolvency Professionals, Insolvency Professional Agency and the Information Utilities.  

5. PROCEDURE TO RESOLVE INSOLVENCY UNDER THE CODE

A. INITIATION

The insolvency resolution process can be initiated by the financial creditor or the operational creditor. However, under the Code there is a difference when the process is initiated by the Financial Creditor and when it is initiated by the Operational Creditor. The Financial Creditor may by itself or jointly with other financial creditors or any other person on behalf of the financial creditor, as may be notified by the Central Government, seek to initiate Insolvency Resolution Process by filing an application before the NCLT, once a default has occurred[ii] and this does not require a notice to be served on the debtor. However, the Hon’ble SC has made it mandatory for the notice to be served to the debtor and provide the debtor the right to be heard.[iii] But when the process is initiated by the Operational Creditor, firstly a demand notice is to be sent to the debtor and when the debtor does not reply within 10 days of the receipt of the notice the operational creditor may file an application before the NCLT.

B. INSOLVENCY RESOLUTION PROCESS

The NCLT within 14 days of the application would appoint an Interim Resolution Professional (IRP) and continuation and initiation of all legal proceedings against the debtor are suspended for a period of 180 days which can be extended by 90 days in case of delay only by the approval of the NCLT. And during this period of 180 days, the debtor is not permitted to alienate, encumber or sell any asset with the approval of the Committee of Creditors (CoC)[iv] and the management vests with the IRP. The term of the IRP is to continue until an RP is appointed under Section 22.[v]

The power to allow withdrawal after admission of an application seeking initiation of insolvency was not permitted under the Code until a recent amendment which added section 12 A allowing the withdrawal of applications admitted for insolvency resolution subject to an approval of 90% of the voting share of the CoC.  

C. REVIVAL WITHOUT APPROACHING LIQUIDATION

A primary objective of the enactment of the Code is to aid a debtor in resolving an insolvency situation without approaching liquidation, by finalizing an insolvency resolution plan.[vi] The Resolution Plan could be presented before the committee of creditors by any person, without any restrictions or stipulations on eligibility (“Resolution Applicant”), based on the information available in the information memorandum. However, an amendment to the Code in December 2017 (vide the Insolvency and Bankruptcy Code (Amendment) Act, 2017), put in place certain eligibility criteria to be satisfied for a person to qualify as a Resolution Applicant. Once a person meets all the eligibility criteria and submits a Resolution Plan, in the event the same is not approved by the committee of creditors or by the NCLT, the NCLT may direct the debtor to be liquidated. A debtor may even be directed to liquidation if the Resolution Plan is implemented irregularly, upon receipt of a complaint from a person affected by such irregular implementation.[vii] Under the Code, the liquidator shall create an estate, i.e. a corpus, of all assets of the corporate debtor which can be utilized and distributed subsequent to liquidation. The liquidator is then required to receive or collect all claims from the creditors within a period of thirty days from the date of commencement of the liquidation process. And after a recent amendment the liquidator may even adopt a new methodology for the realization of assets, namely, “to sell the corporate debtor as a going concern.”[viii]       

6. LEGAL FRAMEWORK OF THE CODE

All proceedings under the Code in respect of corporate insolvency are to be adjudicated by the NCLT and in respect of the individuals are to be adjudicated by the DRT, which have been designed as the special one window forum which can tackle all aspects of insolvency resolution. The NCLT is referred to as the Adjudicatory Authority in relation to insolvency of corporate persons under the Code. Appeals from the orders of the NCLT lie before the National Company Law Appellate Tribunal (“NCLAT”).[ix] All appeals from orders of the NCLAT lie to the Supreme Court of India.[x] The jurisdiction of civil courts is explicitly ousted by the Code with regard to matters addressed by the Code.[xi] Additionally, it is now established that the Limitation Act, 1963 shall be applicable to proceedings under the Code.[xii] Thus, time-barred claims are outside the purview of insolvency.

7. CONCLUSION

Insolvency Bankruptcy Code (IBC) which is still in a transitory phase remains hot potato for media and corporate world in these days. Since the code was implemented it was flavored partly through the constructive interpretation of judiciary and partly by amendments. The interpretation of section 238 IBC is seen that the code has an overriding effect and aims to achieve objective points like faster recovery, quicker resolution, and maximization of value of the asset.

[i] Financial Creditor and Operational Creditor under the IBC, 2016 by Aarohee Gursale and Sana Khan available at: https://www.mondaq.com/india/insolvencybankruptcy/607738/financial-creditor-and-operational-creditor-under-the-insolvency-and-bankruptcy-code-2016  

[ii]  Section 7, Insolvency and Bankruptcy Code, 2016 (As amended by the Insolvency and Bankruptcy (Amendment) Ordinance, 2018.

[iii] Metaliks Limited and Another v. Union of India and Anr., 7 April, 2017 W.P. 7144 (W) OF 2017; Standard Chartered Bank Ltd. v Essar Steels Ltd, IA 153/2017 with C.P. (I.B) No. 39/7/NCLT/AHM/2017

[iv] The RP appointed by the NCLT would constitute a committee of creditors comprising of all the Financial Creditors of the corporate debtor (“Committee of Creditors”). This would incentive a creditor to favor a collective approach towards insolvency resolution rather than proceeding individually.

[v]  According to Section 22(2) of Insolvency and Bankruptcy Code 2016 (As amended by the Insolvency and Bankruptcy Ordinance, 2018): The committee of creditors, may, in the first meeting, by a majority vote of not less than sixty-six per cent of the voting share of the financial creditors, either resolve to appoint the interim resolution professional as a resolution professional or to replace the interim resolution professional by another resolution professional

[vi]  Section 30 of the Insolvency and Bankruptcy Code 2016

[vii]  Section 33 of the Insolvency and Bankruptcy Code 2016

[viii]  Regulation 32, Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 (As amended by the Insolvency and Bankruptcy Board Of India (Liquidation Process) (Amendment) Regulations, 2018.

[ix] Section 61, Insolvency and Bankruptcy Code, 2016

[x] Section 182, Insolvency and Bankruptcy Code, 2016

[xi] Section 231, Insolvency and Bankruptcy Code, 2016

[xii] Section 238A, Insolvency and Bankruptcy Code, 2016 (As amended by the Insolvency and Bankruptcy (Amendment) Ordinance, 2018

REFERENCES

BY: HITESH VACHHANI [FOUNDER MEMBER, JURISTIC LEGAL]

DECLARATION

This is an original work of the Author and is result of author’s own intellectual efforts and is only for academic purpose. The matter embodied has been properly referenced and acknowledged to avoid any kind of copyright issues.

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