When India liberalized its economy in 1991, the goal was to ensure that the erstwhile License Raj is dismantled and competition among businesses is increased to boost innovation and efficiency in the economy. Barriers to entry and exit are one of the primary reasons for the lack of competition in a market. While with liberalization the barriers to enter a market were removed, the barriers to exit remained intact.
Before the introduction of the Insolvency and Bankruptcy Code, 2016, India had a labyrinth of rules and laws for companies and individuals to follow when they were insolvent. Due to the complexity and ambiguity of these laws, the defaulters who failed to make repayments faced no repercussions or consequences from the banks or authorities and were largely able to control their assets. Thus, a culture of wilful defaulting came into place. Politically connected debtors were extended new loan agreements with the “hope” that they would pay later.
In the 1990s, a government report stated that it was "impossible to liquidate and wind up an unviable firm". In 2001, another report characterized the agency required to process insolvency actions as "notoriously dilatory"; the third report in 2015 concluded that owing to lack of threat to imminent liquidation, debtors felt no compulsion "to resolve their financial distress".
All of this led to a credit crunch in the economy resulting in slower growth of the gross domestic product (GDP), a huge mounting pile of non-performing assets (NPAs) and bad loans, recapitalization of state-run banks by taxpayers’ money and therefore, a strain on the union budget. Since most of the distressed corporations were in this position because of the corrupt and irresponsible management of their founders or promoters, it led to the former RBI Governor Raghuram Rajan to say “there are a lot of sick companies in India but, no sick promoters."
The Insolvency and Bankruptcy Code, 2016 (IBC) was presented as a solution to this serious economic problem. It was formulated with an intent to consolidate and amend the existing framework by creating a single law for insolvency and bankruptcy with a time-bound process thereby, simplifying and expediting the insolvency and bankruptcy proceedings in India.
It was hoped that by creating a clear and time-bound pathway to the resolution of loans of corporations, credit availability would be increased in the economy helping the banks clean up their balance sheets and it would also lead to a revival of the company.
According to the Code, bankruptcy proceedings can be initiated by a creditor or the debtor themselves when they default on their repayments. Once, the initiation of the process is approved by the adjudicating authority - the National Companies Law Tribunal (NCLT), an Insolvency Professional (IP) is appointed to take control of the company and its assets from the board and draft a resolution plan as per the Committee of Creditors (CoC). The CoC is a committee comprising of the financial creditors who lent money to the debtor within 180 days, extendable by 90 days. To ensure an uninterrupted resolution process, any legal action against the debtor is prohibited during this period.
Several institutions have been created to facilitate the resolution of insolvency:
Insolvency Professionals: These professionals will manage the assets of the debtor, administer the resolution process, and provide information for creditors to assist them in decision making.
Insolvency Professional Agencies: Each Insolvency Professionals will be registered with an Insolvency Professional Agency. The agency is to conduct examinations to certify Insolvency Professionals and enforce a code of conduct for their performance.
Information Utilities: Creditors will report financial information on the debt owed to them by the debtor. Such information will include records of debt, liabilities, and defaults. This is done to increase access to information key to decision-making and promote transparency among the creditors.
Adjudicating authorities: The proceedings of the resolution process will be adjudicated by the National Companies Law Tribunal (NCLT), for companies; and the Debt Recovery Tribunal (DRT), for individuals. The duties of the authorities will include approval to initiate the resolution process, appoint the insolvency professional, and approve the final decision of creditors. They are there to ensure that due process is followed in the resolution process and that the decision is fair for all stakeholders and is not felonious.
The Insolvency and Bankruptcy Board of India (IBBI) has been constituted under this law to promote transparency and governance in the administration of the IBC. It is set up to develop the necessary infrastructure and regulate the Insolvency Professionals, Insolvency Professional Agencies, and Information Utilities set up through this Code. The Board will consist of representatives from the Reserve Bank of India (RBI), and the Ministries of Corporate Affairs, Finance, and Law.
After the initiation of the bankruptcy proceedings, the CoC will have 270 days (180+90) to decide on a resolution plan which can involve a revival of the debt owed to them by changing the repayment schedule, selling the company, selling its assets or a hybrid of these arrangements to get their money back. If a decision is not taken, the debtor’s assets go into liquidation (sale of assets).
If the debtor goes into liquidation, an insolvency professional administers the liquidation process. Proceeds from the sale of the debtor’s assets are distributed in the established order of precedence.
Issues with IBC :
Missing Deadlines: There is a delay in obtaining approval from the CoC.
Lack of Judges and Benches: The NCLTs and DRTs are not functioning at the prescribed strengths of judges and benches – delaying the adjudication of the resolution plan.
Haircuts: Through the resolution process, banks are having to write off loans to get the company back on track. This is a loss that cannot be recovered by the banks.
Frivolous lawsuits by promoters disrupt and delay the resolution process.
Failed implementation of the resolution plan: The Code does not take into account what would happen if a resolution plan fails to be implemented.
Rishabh Ahuja is an undergraduate student of Cluster Innovation Centre, University of Delhi. He is interested in International Relations, Public Policy and Philosophy. E-mail ID: Ris.email@example.com
India’s bankruptcy code collides with reality, The Economist, https://www.economist.com/business/2019/04/17/indias-bankruptcy-code-collides-with-reality
Raghuram Rajan wants defaulting promoters and their 'friends, cronies' out of NCLT proceedings, Business Today, https://www.businesstoday.in/wef-2018/news/raghuram-rajan-defaulters-promoters-nclt-proceedings-davos-wef-2018/story/268812.html