Suspension of Insolvency and Bankruptcy Code 2016, amidst Covid-19

With the world facing an economic slowdown amid Covid-19, the loss of finances is inevitable. And as a result of this many well-established businesses are also on the verge of collapsing and insolvency. This article helps to understand the basics of Insolvency and Bankruptcy Code 2016. It talks about the suspension of the code in light of Covid-19. It also addresses the concerns related to the suspension of the code. The article speaks about the need and process of IBC in a normal scenario. It works its way to the conclusion pondering upon the better way forward with preserving the code in a post-pandemic situation.

Introduction

What are insolvency and bankruptcy?

Insolvency [1] is a state at which a person or a legal entity in existence is unable to repay their debts at the time of maturity.

If a person or entity is in such a position they are termed as insolvent.

When an insolvent person or entity seeks relief from all of their debts through a legally established procedure, such a process is called Bankruptcy [2].

For instance, let’s assume there is a manufacturer named A, he has taken a loan from a bank “B”, and bought goods on credit from a vendor named “C”. Now, in this situation A is the ‘debtor/borrower’, Bank B and vendor “C” are the Creditors.

Now if it so happens that A is unable to pay his debt or A’s finances are finished. It will be known as Insolvency, and A will be known as Insolvent.

Now, that A cannot pay back his debt, he can approach a legal framework to solve the issue of insolvency.  As the authorities get involved in this matter, this will now be known as bankruptcy.

Insolvency and Bankruptcy Code, 2016 (IBC)

In 2016 the several laws which regulated insolvency resolution in India including:

  • Sick Industrial Companies Act, 1985,  
  • Recovery of Debt Due to Banks and Financial Institutions Act, 1993 (DRT Act),
  • Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI),
  • Companies Act, 2013,
  • Presidency Towns Insolvency Act, 1909  
  • Provincial Insolvency Act, 1920

The Code seeks to consolidate the existing framework by repealing the Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920. With the addition to it amends 11 existing laws on the same.

The Code provided NCLT and the Debts Recovery Tribunal (DRT) as the Adjudicating Authorities for resolution of insolvency, liquidation and bankruptcy.

The publication of the code was done in the Gazette of India on 28.05.2016. However, provisions of the Code were brought into effect from different dates in terms of the proviso to Section 1(3) of the Code.

The Insolvency and Bankruptcy Code, 2016 (31 of 2016) came into effect with the assent of the President of India on 28th May 2016. The Central Government constituted 11 benches of the National Company Law Tribunal (NCLT) in different states through a notification dated 1st of June, 2016.

The Central Government established the Insolvency and Bankruptcy Board of India on 1st October 2016 which has regulatory authority over the Insolvency Professionals, Insolvency Professional Agencies and Information Utilities needed for execution of the Code (as per powers conferred by sub-Section (1) and (3) of Section 188 of the Code). [3]

Need of IBC

  1. The Multiplicity of laws (as listed above), different laws present for corporate and retail needed to be simplified.
  2. The long procedures of Insolvency resolution take around an average of 4.3 years to conclude. And even if the cases resolved the recovery rate was as low as 25.7 cents per dollar.
  3. Non-performing Assets piling up, even after various regulations into effect.  As per the government reports the Non-performing Assets (NPA) amounted to 2.6% in 2011 and rose to 9.1% in 2016 before IBC came into effect.
  4. As per the ‘Ease of doing Business Report’ by the World Bank before IBC came into effect in 2016, India ranked 136th and after IBC the rank rose to 103rd in 2018’s report.

Process of IBC

As per the provisions of the code:

  • As the regulating authority, IBBI (Insolvency & Bankruptcy Board of India) is set up.
  • To act as an intermediary and help ill units and financial institutions including banks by the way of smooth takeovers or liquidation processes appointment of Insolvency professionals were done,
  • To store all the information and data, Information utilities are set up, and
  • Adjudicatory mechanisms are also set up to facilitate a time-bound insolvency resolution procedure and liquidation if necessary.

To initiate the insolvency resolution either the creditor or debtor approaches the adjudicating authority that is DRT and NCLT (National Companies Law Tribunal authorities).

Then insolvency professional (IP) is appointed then a performing Committee of Creditors consisting of the financial creditors of the debtor.

The committee will deliberate and choose something of the two options either the assets are to be liquefied to recover loses in a particular ratio or dissolution of the entity in question.

The procedures are given a cap of 180 days and an extra 90 days in the moratorium period [4] which are on the discretion of the IP in charge. This is to be done by the voting or consensus. If no conclusion can be derived from the committee, then the adjudicating authority may order the liquidation of the company. Insolvency resolution insists that the creditor might sell the assets to another by also known as resolution applicant. [5]

Suspension of IBC

The Union cabinet cleared the proposal to suspend Insolvency and Bankruptcy Code for debt defaults arising on or after 25 March 2020 for 6 months and with the provision of possible extension up to one year.

Through an Ordinance, Section 10A was inserted, staying operations of Sections 7, 9 and 10. Sections 7 and 9 allow financial and operational creditors respectively to initiate the resolution process, while Section 10 facilitates voluntary insolvency by corporates. 

This was done in the light of present circumstances as the economy is facing a huge recession during the worldwide lockdown. As a result of this recession and lock down all the businesses are facing a deep slow down and fall.

The companies were and are still facing significant destruction due to the nationwide lockdown among other covid-19 related measures imposed.

With the relief in action defaults between March 25 and December 24, 2020, are knocked permanently out of the IBC radar. Predictably, it didn’t excite creditors and critics, who believe that such a blanket prohibition incentivises willful defaults permanent protection.

The suspension prevents two things—high scale sale of companies driven by the recession and economic slowdown due to the pandemic and saves NCLTs from getting overwhelmed with cases.

Bankruptcies are bound to rise not only nationally but also globally. Perhaps this was the major logic behind compelling the government towards an all-hands-to-the-pump approach i.e. helping everyone as a team.

In addition to this, the government is also working on a special resolution framework for Micro, Small and Medium enterprises. There are huge companies who are in the association of such Micro, Small and Medium enterprises. If such companies are declared bankrupt due to the downfall during covid-19, this will hamper the MSMEs and the gross production of the nation as well.

So to handle the situation of insolvency the threshold for triggering of starting or initiating the insolvency process has been increased substantially. That is the level at which one can declare insolvency or one can initiate the process of insolvency has been extended so that less and fewer companies or people or individuals or entities are declared insolvent.

The RBI has also allowed a moratorium to all term loan instalments till August 2020 end. 

Such decisions are designed to extend to relieve to businesses in these extraordinary times.

However, in any case, creditors can initiate action against defaulters with the help of debt recovery tribunals, civil courts and even the Sarfaesi Act.

The implementation of the IBC, was one of the biggest reforms in recent years and it must be preserved once the economy returns to the normal IBC framework. It would be required to relocate the capital from weaker firms to more productive ones.

If this is delayed, the pace of recovery would be delayed.

In the context of the IBC, the government must involve the RBI and large banks in the process of making decisions.                                                                                                                

They should collectively decide on the ground rules with the utmost care and clarity. [6] [7]

Concerns related to the suspension

There were some major concerns raised with the suspension of IBC some of which are listed below:

  • What will happen if the repayment is not initiated? The banks are worried, that the moratorium period on repayment of loans could affect the credit culture, that is, it will hamper the faith of creditors and it will then, as a result, hamper the investment culture.
  • The suspension might as well lead to higher Non-performing Assets which will make the problems for banks even worse, which are already quite significant.
  • The suspension lacks clarity, for example, if a company which has been declared bankrupt before the lockdown, what will be the resolution process for that. It wasn’t told very clearly because one might argue that the company which has been already been declared bankruptcy in February, no further ado should be done to help recover or revive it.
  • Also the criteria for differentiating borrowers hurt by covid-19 and those who are impacted by other factors should be specified, for example, the sectors which have no impact from covid-19 or very less impact from covid-19. If they declare insolvency bankruptcy what should be the grounds for them? It should also be clarified.
  • And what will happen to the firms that have already defaulted and lenders were preparing to start the proceedings under IBC was a big question.
  • To simply put a blanket suspension would not work as those who might be facing difficulties and they want to file for bankruptcy and insolvency resolution wouldn’t be able to be helped out. [8]

Conclusion: Is there a “Better way ahead”?

From the above article, we have learnt about the infamous Insolvency and Bankruptcy Code 2016 and its suspension and its impacts. Earlier when a debtor used to file insolvency, he still had the possession of his assets. Now as per the new IBC if the creditor loses faith in the debtor he can simply file an application to initiate an insolvency resolution process against the debtor. Once the case is accepted the insolvency expert shall have the possession of the assets.

There is also an involvement of two quasi-judicial bodies that is DRT for individuals and partnerships and NCLT for companies and LLP. The insolvency resolution process has a cap of 180 days. While in this process there can be no cases against the debtor and no other legal proceedings can be initiated during this period.

It can be understood that a large number of firms may not be in a position to repay loans even after the moratorium period. It is thus while expected that RBI would allow a one-time restructuring of Debt.

Therefore, the government will need to work with the RBI in framing the IBC suspension and preservation mechanism.

In due-time the Non-performing assets are likely to arise internally because of the economic disruption. But policymakers must make sure that the banking system is not put under excessive pressure this is imperative because otherwise it would threaten the country’s financial stability and affect economic recovery.

It must also be seen that IBC suspension does not end up affecting government efficacy in the time being.



FAQs

What are Insolvency and Bankruptcy?        

Insolvency is a state at which a person or a legal entity in existence is unable to repay their debts at the time of maturity.

If a person or entity is in such a position they are termed as insolvent.

When an insolvent person or entity seeks relief from all of their debts through a legally established procedure, such a process is called Bankruptcy.

                                                 
What is IBC and when and how it came into existence?

IBC stands for Insolvency and Bankruptcy Code of 2016. The Code seeks to consolidate the existing framework by repealing the Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920. With the addition to it amends 11 existing laws on the Insolvency and Bankruptcy.

The publication of the code was done in the Gazette of India on 28.05.2016. However, provisions of the Code were brought into effect from different dates in terms of the proviso to Section 1(3) of the Code.

The Insolvency and Bankruptcy Code, 2016 (31 of 2016) came into effect with the assent of the President of India on 28th May 2016. The Central Government constituted 11 benches of the National Company Law Tribunal (NCLT) in different states through a notification dated 1st of June, 2016.

The Central Government established the Insolvency and Bankruptcy Board of India on 1st October 2016 which has regulatory authority over the Insolvency Professionals, Insolvency Professional Agencies and Information Utilities needed for execution of the Code (as per powers conferred by sub-Section (1) and (3) of Section 188 of the Code).

What was the need of IBC?

  1. The Multiplicity of laws (as listed above), different laws present for corporate and retail needed to be simplified.
  2. The long procedures of Insolvency resolution take around an average of 4.3 years to conclude. And even if the cases resolved the recovery rate was as low as 25.7 cents per dollar.
  3. Non-performing Assets piling up, even after various regulations into effect.  As per the government reports the Non-performing Assets (NPA) amounted to 2.6% in 2011 and rose to 9.1% in 2016 before IBC came into effect.
  4. As per the ‘Ease of doing Business Report’ by the World Bank before IBC came into effect in 2016, India ranked 136th and after IBC the rank rose to 103rd in 2018’s report.

Why was it suspended?

The suspension of IBC was done in the light of present circumstances, as the economy is facing a huge recession during the worldwide lockdown. As a result of this recession and lock down all the businesses are facing a deep slow down and fall.

The companies were and are still facing significant destruction due to the nationwide lockdown among other covid-19 related measures imposed.

With the relief in action defaults between March 25 and December 24, 2020, are knocked permanently out of the IBC radar. Predictably, it didn’t excite creditors and critics, who believe that such a blanket prohibition incentivises willful defaults permanent protection.

The suspension prevents two things—high scale sale of companies driven by the recession and economic slowdown due to the pandemic and saves NCLTs from getting overwhelmed with cases.

Bankruptcies are bound to rise not only nationally but also globally. Perhaps this was the major logic behind compelling the government towards an all-hands-to-the-pump approach i.e. helping everyone as a team.

What is the way ahead in the post pandemic and post lockdown scenario?


From here forward, the government will need to work with the RBI in framing the IBC suspension and preservation mechanism.

In due-time the Non-performing assets are likely to arise internally because of the economic disruption. But policymakers must make sure that the banking system is not put under excessive pressure this is imperative because otherwise it would threaten the country’s financial stability and affect economic recovery.

It must also be seen that IBC suspension does not end up affecting government efficacy in the time being

References

  1. https://en.wikipedia.org/wiki/Insolvency
  2. https://en.wikipedia.org/wiki/Bankruptcy
  3. https://ibclaw.in/short-note-on-insolvency-and-bankruptcy-code-2016/#:~:text=Legal%20framework%20of%20Insolvency%20and%20Bankruptcy%20Code%2C%202016%
  4. https://www.business-standard.com/about/what-is-moratorium
  5. https://www.youtube.com/watch?v=ZobbFTRJaN4
  6. https://www.youtube.com/watch?v=1PenkX015Ko
  7. https://www.newindianexpress.com/opinions/editorials/2020/sep/28/ibcsuspension-andits-consequences-2202804.html
  8. https://www.youtube.com/watch?v=1PenkX015Ko

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