Insolvency and Bankruptcy Code

Borrower Beware

The latest total NPA figures of banks in India has reached a whopping Rs. 7.10 Lakh Crores, which is clearly alarming.  Banks which have breached the thresholds set by the Government of India have been placed under PCA (Prompt Corrective Action). 

Many defaulting borrowers have enjoyed interest concessions, partial/full write off of debts which have greatly harmed the balance sheets of banks. NPAs and provisioning have steadily eroded their capital at a time when they are gearing up to meet the stiffer Capital Adequacy norms under BASEL III.  

What has led to this sorry pass? There has been no dearth of legislations:  a) Civil Procedure Code 1908, b) Sick Industrial Companies (Special Provisions) Act 1985 c) Recovery of Debts due to Banks and Financial Institutions Act. 1993. d) Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (SARFAESI). But these laws have proved ineffective in combating the menace of NPA.  With their gaping loop holes, they have given a lee way to erring borrowers to get away at the cost of banks. 

Even the Corporate Debt Restructuring mechanism failed miserably to address the issue. Rather it was instrumental in postponing the date of declaration of NPA.  The ineffective laws combined with a lack of political will proved unequal to the task of tackling mounting NPAs.

Some legal remedies looked fine on paper but were utterly impractical such as vesting the management of the ailing companies with promoters.  The provision of SARFAESI to convert the debt into equity by the lenders and takeover of the management have not found favour with bankers due to their obvious lack of expertise in running the business. This eventually came a cropper, leading to mismanagement, dilution of securities, siphoning of funds by promoters, which damaged the prospects of recovery.

However, there is a new ray of hope. Keeping the health of the banking industry in view, the Government of India has passed the Insolvency and Bankruptcy Code on 28^th May 2016.  This Code has repealed/ amended 11 existing laws and endeavours towards initiating Insolvency Proceedings against defaulters. Some of the distinct features of this code are:

a.     Failure to Pay:  The Code enables banks to take early recovery action – insolvency proceedings can now be initiated on the very first instance of default.  This is a remarkable change from the earlier position where action could be taken only after the account is declared NPA.

b.     Time bound resolution: Once the application for insolvency has been accepted, the promoters need to come out with a revival plan within a maximum period of 180 days. The period can be extended by another 90 days in exceptional cases. However, if this time limit is not adhered to¸ the management will be taken over by the ‘Insolvency Management Professional’.

c.      Banker’s Dues: Earlier, statutory dues took precedence over all other dues. The Code has made a major change by placing the bank dues ahead of dues to the government. Dues to banks occupy SECOND position in seniority of payment as against the FIFTH Position of statutory dues.

d.     Unsecured Creditors: The Code provides a level playing ground by for both secured and unsecured creditors by making no distinction between them.  Even unsecured creditors can initiate Insolvency proceedings.  

e.     Operational Creditors: The Code recognizes the right of Operational Creditors like Workers, Employees and Suppliers of goods, by providing them with a fair opportunity to get paid from the sale proceeds of the company’s assets in case of insolvency. 

f.       Adjudicating/ Appellate Authority: The National Company Law Tribunal and Debt Recovery Tribunals will be the adjudicating authorities for corporate and non-corporate borrowers respectively.  Likewise, the appellate authority will be National Company Law Appellate Tribunal and Debt Recovery Appellate Tribunal. The appeal against the awards of these appellate authorities lies only with the Supreme Court.  

g.     Taking over of Management:  Once the insolvency application is admitted, if financial creditors do not make intelligible choices for maximizing the economic value of business or promoters fail to take proper steps for proper management of cash flows within the scheduled time, the management control will automatically transfer to the Insolvency Management Professional.

h.     Stoppage of all proceedings: Once the insolvency application is admitted, both secured and unsecured creditors will lose their rights to enforce security.  Even lessors cannot claim back leased property.  This is a good step as it would ensure prudent management of assets and would provide better value than straight liquidation after preservation of assets.

In order to give some more teeth to this, Government of India has issued an Ordinance inserting 2 sections to Banking Regulation Act. 1949, wherein it has empowered RBI to issue necessary instructions to the banks to initiate Insolvency proceedings against  the defaulters and also RBI has been empowered to monitor the top NPA accounts at its level by way of Overseeing Committees formed at its end.

This code is still evolving.  Recently the NCLT has ruled that the Law of Limitation is not applicable to this code as it is not a recovery law, but a resolution mechanism.  So it may take some time to get the benefit.  

The ball is now in the banks’ court. They need to quickly get down to business and make proper use of the the Insolvency and Bankruptcy Code which has brought in landmark changes.