Ease of lending business

BAD bank loans have soared to almost Rs 8 lakh crore. Rogue promoters and wilful defaulters like Vijay Mallya had been exploiting the Indian banking system for years because of their political clouts. 

The Insolvency and Bankruptcy Code (IBC) has been enacted to take action against such defaulters. In June this year, the Reserve Bank of India recommended to creditors to initiate insolvency action against 12 large defaulters, responsible for a quarter of the total bad loans.  

One of the first insolvency cases under the new code, however, faced a problem when promoters of corporate borrower Synergies Dooray allegedly tricked creditors. As a safeguard from such manipulations, the government recently issued an ordinance that barred wilful defaulters and their associates from reclaiming assets of the ailing companies.

Background 

The Insolvency and Bankruptcy Code is intended to be a radical reform. Earlier, various provisions of the Companies Act provided for liquidation of an insolvent through a court (later, the National Company Law Tribunal, NCLT). It was, however, an imperfect situation. A judicial body may not necessarily possess the business acumen to decide whether a company has the potential to revive or should it be liquidated. Even the revival process was cumbersome and it was not binding on all stakeholders. 

Then came another major change in the form of the Sick Industrial Companies Act, 1986 (SICA). Under the law, the Board for Industrial and Financial Reconstruction (BIFR) was set up to sanction schemes for rehabilitation of “sick” companies. BIFR became a safe haven for wilful defaulters. Rogue borrowers eagerly rushed to declare themselves sick to thwart any legal action against them. This shield was available to them so long as the matter was pending in the Board. Consequently,  many cases deliberately lingered for years.

The bad publicity generated by the Mallya episode was perhaps the last straw. The phenomenal pile of non-performing assets (NPAs) also strengthened the government’s resolve to implement an effective and decisive law to deal with rehabilitation or liquidation of ailing entities. 

The last resort 

Liquidation or winding up is the most drastic solution where a company is shut down and its assets sold to pay creditors. But, what if the company could be revived to earn enough in the future and retire all debts? Liquidation is not always the best solution because of low value of already depreciated and obsolete assets. Often, there is a possibility of rehabilitation. Possibly a management change may turnaround a company.

Unintended consequences

The government amended the newly enacted code to close loopholes that had emerged in this freshly minted law. It barred wilful defaulters and their associates from participating in the ongoing insolvency and bankruptcy processes in NCLT. According to FM Jaitley, “for the first time in the country, government has put in place a clean and effective system through which wilful defaulters of bank loans may be kept away from the management of their business and timebound recovery effected from them”. 

The ordinance, however, has some unintended consequences. It takes away the discretion of the committee of creditors to include or exclude participation of the borrower or its associates in the resolution process. The message is clear — powerful promoters of debt ridden companies must not be allowed to influence creditors, mainly banks, and subvert insolvency resolutions in their favour.

But, all insolvencies are not due to fraudulent action of promoters. Success of a business also depends on the market conditions and regulatory environment. Sometimes the erstwhile promoters, with their business acumen, may be the best placed to revive the company. And, what if the erstwhile promoters are the only ones willing to put in a resolution plan?

The question of whether erstwhile promoters should be allowed to be resolution applicants is obviously a sensitive one, and one which has different answers in differing circumstances. It remains to be seen whether the ordinance was justified to prevent a subversion of the insolvency resolution process, or an overreaction which has the effect of preventing potential resolution solutions. 

The code, however, is not adequately equipped to handle cross-border insolvency. This handicap might have an adverse impact in recovering debt from defaulters like Mallya, who have huge assets abroad. Tribune News Service

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CHANGE FOR BETTER

Time is money

The Code provides for specific timelines, missing in previous legislations. Significantly, in cases of no resolution, liquidation cannot be stopped beyond 270 days. Thus, stakeholders are forced to work together in a constructive manner to avoid liquidation.

No courtship 

Earlier, a court would determine the fate of a company. Under the new Code, this is now the privileged of the financial creditor. Ultimately, any resolution plan has to be approved by the committee of creditors holding 75% of the financial debt. 

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IBC Decoded 

The Insolvency and bankruptcy code  protects lenders’ interests by assuring a time-bound resolution of insolvency cases. Creditors can approach the National Company Law Tribunal (NCLT) for default cases exceeding Rs one lakh. 

Who can approach NCLT

• Financial creditors (banks, financial institution)
• Operational creditors (employees, workers, vendors, government)

What happens at NCLT 

• NCLT may admit a debtor into corporate insolvency resolution process (CIRP)
• Interim Resolution Professional (IRP) appointed to take management control
• IRP verifies claims of creditors and forms a Committee of Creditors (COC) including all financial creditors within 30 days
• COC appoints a Resolution Professional (RP) for the remainder period, who could also be the same person as IRP
• Within 180 days from the CIRP, a resolution plan to revive the company needs to be approved by financial creditors holding 75% of the debt. NCLT can extend the period by another 90 days
• Liquidation of the company is ordered if no resolution plan is approved. A liquidator will be appointed by COC to sell assets and distribute proceeds