Need for Insolvency and Bankruptcy Code: Social, Legal, Economic and Financial Perspectives

21st July 2021 0 By indiafreenotes

Insolvency and Bankruptcy Code (Amendment) Ordinance, 2019 was issued on 28-12-2019. This has been converted into Insolvency and Bankruptcy (Amendment) Act, 2020 w.r.e.f. 28-12-2019.

The purpose is to give the highest priority in repayment to last mile funding to corporate debtors to prevent insolvency, in case the company goes into corporate insolvency resolution process or liquidation, to prevent potential abuse of the Code by certain classes of financial creditors, to provide immunity against prosecution of the corporate debtor and action against the property of the corporate debtor and the successful resolution applicant subject to fulfilment of certain conditions, and in order to fill the critical gaps in the corporate insolvency framework.

As per preamble to the Insolvency Code, the purpose of this Act is as follows:

  • Consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals
  • In a time, bound manner
  • For maximisation of value of assets of such persons
  • To promote entrepreneurship
  • Availability of credit
  • Balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues
  • Establish an Insolvency and Bankruptcy Board of India (IBBI)

Introduction of this Code has done away with overlapping provisions contained in various laws:

  • Sick Industrial Companies (Special Provisions) Act, 1985
  • The Recovery of Debts Due to Banks and Financial Institutions Act, 1993
  • The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002
  • The Companies Act, 2013.

The provisions of the Code shall apply for insolvency, liquidation, voluntary liquidation or bankruptcy of the following entities:

  • Any company incorporated under the Companies Act, 2013 or under any previous law.
  • Any other company governed by any special act for the time being in force, except in so far as the said provision is inconsistent with the provisions of such Special Act.
  • Any Limited Liability Partnership under the LLP Act 2008.
  • Any other body being incorporated under any other law for the time being in force, as specified by the Central Government in this regard
  • Partnership firms and individuals

The major amendments are as follows:

  • Immunity from prosecution of corporate debtor for offence committed prior to CIRP, if there is change of management [section 32A(1)]
  • Protection to property of corporate debtor in relation to offence committed prior to CIRP, if there is change of management [section 32A(2)]
  • Scope of ‘interim finance’ enhanced to provide for last mile funding to prevent insolvency [section 5(15)]
  • Minimum number of applicants under section 7(1) in case of numerous small financial creditors (like holders of public deposits or debentures or home buyers).
  • Licenses, quotas, essential supplies cannot be cut during period of moratorium, so long as current dues are paid [section 14]
  • Corporate debtor can file CIRP against another corporate debtor [section 11]
  • Insolvency Professional must be appointed on the insolvency commencement date itself [section 16(1)]

Social Perspectives

From a social efficiency point of view bankruptcy proceedings cannot be mingled with other legal cases, as illustrated by the arguments above. The following section focusses on some of the salient features of the Code which explicitly or implicitly address the issues raised in the preceding section.

  • To consolidate and amend the laws relating to re-organization and insolvency resolution of corporate persons, partnership firms, and individuals.
  • To fix time periods for execution of the law in a time-bound settlement of insolvency (i.e. 180 days).
  • To maximize the value of assets of interested persons.
  • To promote entrepreneurship
  • To increase the availability of credit.
  • To balance all stakeholder’s interest (including alteration). Balance to be done in the order of priority of payment of Government dues.
  • To establish an Insolvency and Bankruptcy Board of India as a regulatory body for insolvency and bankruptcy law.
  • To establish higher levels of debt financing across a wide variety of debt instruments.
  • To provide painless revival mechanism for entities.
  • To deal with cross-border insolvency.

Legal Perspectives

Legal framework: complex, fragmented. No concept of time value of money.

  • Insufficient institutional capacity: courts, professional services, information systems. No capacity to deal with the demands of a growing economy. Laws such as RDDBFI and SARFAESI did not improve recovery.
  • Unclear priority between laws and between fora. Conflicts are decided by litigation. Lack of clarity causes delays.
  • Arbitrage: differential access, varied procedures. Forum shopping. Stacked in favour of banks and FIs.
  • Economic Perspectives.

Concern

  • Low predictability of resolution
  • High pendency
  • High cost, poor recovery.

In failure, limited liability should be respected.

  • Limited liability company is a contract between equity and debt.
  • As long as debt obligations are met, equity owners have complete control, and creditors have no say in how the business is run.
  • When default takes place, control is supposed to transfer to the creditors; equity owners have no say.
  • Speed of resolution is important so that capital and labour can be put back to work quickly.
  • Insolvency and bankruptcy resolution should be an economic decision; not a judicial decision

A combination of limited liability and strong insolvency process allows firms to undertake risky ventures while protecting creditors’ rights. The bargain:

  • Firms’ shareholders accept disclosure
  • They agree to work with lenders in insolvency
  • In return their liability gets capped

Financial Perspectives

The rise of limited liability needs to be accompanied by:

(a) Strong recovery laws

(b) Strong insolvency law

Where lenders can enforce repayment, there is:

(1) Higher credit access

(2) At lower price

(3) With longer maturity

(4) Lower collateral requirement

(5) From a greater number and variety of lenders