13 December, 2015
The Finance Minister, Mr. Arun Jaitley, in his Budget Speech 2015-16, had identified ‘Bankruptcy Law Reforms’ as a key priority for improving the ease of doing business and had announced that a comprehensive Bankruptcy Code, meeting global standards and providing necessary judicial capacity will be brought in. Accordingly, the Government constituted a Bankruptcy Law Reforms Committee under the Chairmanship of Dr. T. K. Viswanathan to look into various bankruptcy related issues. Bahram Vakil, Founding Partner, AZB & Partners was appointed as a member to the Bankruptcy Law Reforms Committee.
The Bankruptcy Law Reforms Committee submitted its report on November 4, 2015 (‘BLRC Report’), which has been prepared in two parts – Volume I of the BLRC Report sets out the “Ra- tionale and the Design” and Volume II of the BLRC Report contains a comprehensive draft of the Insolvency and Bankruptcy Code (‘Code’) covering all entities. The process of insolvency resolution and liquidation under the Code is predicated on the following institutional infra- structure: (a) a regulator namely, the Insolvency and Bankruptcy Board of India (‘Regulator’); (b) a cadre of regulated insolvency professionals and regulated information utilities; and (c) the adjudicating authorities, namely the National Company Law Tribunal (‘NCLT’) which gov- erns corporate entities and the Debt Recovery Tribunals which governs individuals. As a result, the Code proposes to cover the full spectrum of entities, being not only corporate entities and limited liability partnerships, but also individuals, and prescribes processes for dealing with bankruptcy related issues for each of the aforesaid entities.
The Code proposes replacing the extant corporate insolvency laws by a single comprehen- sive law that (a) empowers all creditors (whether secured, unsecured, domestic, international, financial or operational) to trigger resolution processes; (b) enables the resolution process(es) to start at the earliest sign of financial distress; (c) provides for a single forum to oversee all insolvency and liquidation proceedings; (d) enables a calm period where new proceedings do not derail existing ones; (e) provides for replacing existing management during insolvency pro- ceedings while maintaining the enterprise as a going concern; (f) offers a finite time limit with- in which the debtor’s viability can be assessed; and (g) lays out a linear liquidation mechanism.
We have set out below the key features of the insolvency resolution process (‘IRP’) and liq- uidation as contemplated in the Code:
1. Distinction between financial and operational creditors: The Code makes a dis- tinction between financial creditors (both secured and unsecured, who have extend- ed credit for interest, rather than in exchange for the provision of goods and services) and operational creditors (creditors who have extended credit in exchange for goods and services). This distinction has been made in order to (i) treat both, the secured and unsecured creditors, at par for the purposes of initiating an IRP and providing an opportunity to participate in the decision making process; (ii) empower an op- erational creditor to trigger an IRP, but not participate in the decision-making since such operational creditors would be paid the liquidation value at the least.
2. Trigger: The primary principle of the Code is to detect distress as soon as possible and resolve it. To this end, it enables the IRP to be triggered by the occurrence of a single default. The process is slightly varied for debtors, financial creditors and op- erational creditors and is briefly explained below:
Financial Creditor Trigger: A financial creditor may trigger the IRP by filing an application with the NCLT upon the occurrence of a payment default for amounts owed to them or any other financial creditor.
Operational Creditor Trigger: An operational creditor may trigger the IRP by is- suing a notice to the debtor upon the occurrence of a payment default. Following the issuance of such notice, the debtor may either repay or demonstrate existence of a genuine dispute. If the debtor has not repaid or demonstrated the existence of any dispute after the lapse of 10 (ten) days from the issuance of the notice, the op- erational creditor will be entitled to file an application with the NCLT for initiating the IRP.
Debtor: Significant shareholders, management personnel and any other employee or service providers of a company, who are capable of producing detailed audited financial information, may file for an IRP upon the occurrence of a default.
The Code prescribes penalties for false and frivolous triggers in order to dis- incentivise creditors triggering IRP for extraneous reasons.
3 Debtor Not In Control During IRP: An insolvency professional who is registered with the Regulator can be appointed by the adjudicator during the IRP (‘Resolution Professional’). Such Resolution Professional is empowered to effectively run and manage the entity and the assets of the entity as a going concern during the period that the IRP is pending. This is to prevent the possibility of asset-stripping or siphon- ing during the IRP period. The Code also provides for the suspended management of an entity to cooperate with the Resolution Professional. Under the Code, the Regula- tor is responsible for registering the Resolution Professional and prescribing qualifi- cations and reporting requirements for the Resolution Professional as well as perfor- mance monitoring of such Resolution Professionals.
4 Moratorium: During the IRP, there is a time bound moratorium of 180 (one hundred and eighty) days against debt recovery actions and any new cases filed against the debtor. The moratorium can only be extended by a further period of 90 (ninety) days in exceptional circumstances. This helps assure creditors and the impugned debtor that the assets are protected while they negotiate and assess the viability of the entity. During such moratorium, a regulated insolvency professional controls the assets un- der the supervision of the NCLT.
5 Business Decisions by a Creditor Committee: All decisions on matters of business are to be taken by a committee of financial creditors. The matters on which decisions can be taken by such committee include evaluating proposals to continue operations of the entity as a going concern, decisions about the sale of business or units, retiring or restructuring of existing debt. The debtor will be a non-voting member on such creditors’ committee, and will be invited to all meetings. The decisions taken by the creditors’ committee will be by way of a majority of 75% (seventy five percent) of the creditors and will be calculated on the basis of the value of the financial debt owed to them by the debtor.
6 Insolvency Resolution through Managed, Time-Bound Negotiations: When an agreement has been reached on the manner in which the entity will be maintained as a going concern, the NCLT will close the case for insolvency. If there is no agreement upon conclusion of negotiations, or if the manner concluded by such negotiations con- travenes any applicable law or does not meet the criteria prescribed in the Code, the NCLT may pass an order declaring the entity insolvent and notifying the period during which the liquidation will be deemed to have commenced (‘Period of Liquidation’).
7 No Prescriptions on Solutions to Resolve the Insolvency: The Code provides flex- ibility in the manner in which the entity will be continued to be operated as a going concern and such process is to be decided and voted on by the creditors’ committee. There are no constraints set out in the Code on the proposals that the Resolution Professional can present to the creditors’ committee. The Resolution Professional is tasked with putting together an information memorandum and facilitating discus- sions among parties to make proposals to the creditors’ committee. Other than the majority vote of the creditors’ committee, the Resolution Professional is required to confirm to the NCLT that the final solution voted on by the creditors’ committee com- plies with the following three requirements:
- the proposed solution must explicitly require the repayment of any interim fi- nance availed of by the entity. Further, costs of the IRP are required to be paid in priority over other payments;
- the plan must explicitly include payment to all creditors that are not members of the creditors’ committee, within a reasonable period after the solution is imple- mented; and
- the plan must comply with existing laws applicable to the entity while implement- ing the solution.
8 An Irreversible, Time-Bound Liquidation with Defined Payout Prioritization: If the creditors cannot agree on a solution within a period of 180 (one hundred and eighty) days (being the IRP period), the NCLT will automatically pass a liquidation or- der along with accompanying orders to: (i) appoint a liquidator recommended by the Regulator; (ii) move assets into a liquidation trust, which will be managed by the liq- uidator; and (iii) to change the name of the entity reflected in the registration records to include the phrase “in-liquidation” to its original name. The board of such entity is to be replaced by the aforementioned committee of creditors. Under the Code, there is a clear responsibility on the liquidator to maximise the value of the assets of the entity in the most efficient manner of disposal. All realisations from such sales will be made to the liquidation trust, and will be distributed to creditors according to the prescribed waterfall set out in the Code, as briefly described in paragraph 10 below.
9. Liquidation: The Code sets out the following triggers for liquidation:
- rejection of a resolution plan by the NCLT, if it fails to meet the necessary condi-
- tions set out above;
- failure of the creditors’ committee to reach an agreement during the period stipu-
- lated above;
- a decision of the creditors’ committee to proceed with liquidation during the IRP;
- failure of the debtor to adhere to terms of the resolution plan approved by the NCLT.
10. Distribution Waterfall: In terms of the waterfall envisaged in the Code, the costs of the IRP (including any interim finance raised) and liquidation have first priority, fol- lowed by secured creditors, who share the second priority on a pari passu basis with dues owed to workmen for a defined period of 3 (three) months. The brief particulars of the distribution waterfall set out in the Code are set out below:
- costs of IRP (including any interim finance raised) and liquidation;
- secured creditors and workmen dues (capped up to 3 (three) months from the
- start of IRP);
- employees’ salaries (capped up to 3 (three) months);
- dues to unsecured financial creditors and debts payable to workmen in respect of the period beginning 12 (twelve) months before the commencement of liquidation and ending 3 (three) months after the date of commencement of liquidation;
- any amount due to the relevant State Government and/or the Government of India in respect of the whole or any part of the period of 2 (two) years prior to the date of commencement of liquidation;
- any debts of secured creditors for any amount unpaid following the enforcement of security interest;
- any remaining debt; and
- remaining surplus to be distributed to shareholders.
All distributions as per the above waterfall will be net of the liquidator’s fees, which will be deducted proportionately from each stage of the waterfall in order to incentivise the liquidator to ensure quicker recovery for each class of recipient. The liquidation process is an irreversible process after the expiry of a specified period from the passing of a liquidation order. An appeal to stay the liquidation may be be considered by the Appellate Authority (NCLAT) only on very limited grounds.
11. Penalties: The Code additionally prescribes penalties for fraudulent and wrongful trading by the promoters of the entity in the period leading upto liquidation. This is the first time that such a provision has been introduced.
For further information, please contact:
Zia Mody, AZB & Partners
zia.mody@azbpartners.com
