India – 15 Months Of The Insolvency Code: Learnings For Lenders.

 

30 March, 2018

 

 

1 Introduction 

 

1.1 More than a year has passed since the Insolvency and Bankruptcy Code, 2016 (the “Code”) came into effect. The impact of the Code has been widely felt across the spectrum, involving companies, their trade and other counterparties , employees, lenders, guarantors, promoters, credit funds, financial investors, strategic investors, insolvency professional s and advisors. It would be fair to say that market participants have been taken by surprise both with the degree of impact the Code has had, and also the pace of change and development of law and practice surrounding the Code. 

 

1.2 In this note, we aim to take a step back and make sense of how the Code impacts financial institutions in the context of their “business as usual” lending, and the key issues to be mindful of, both on day one when advancing funds and at a subsequent stage, when signs of financial difficulty begin to emerge. 

 

Usage of the Code – some facts 

 

1.3 Initial proceedings under the Code were slow. In the quarter ending on 31 March 2017, only 38 companies1 were undergoi ng the corporate insolvency resolution process (“CIRP”) under the Code indicating reluctance of the creditor community to proceed under a relatively untested law. The number of companies put under the Code by the creditors increased exponentially after the Reserve Bank of India (“RBI”) directed the banks to initiate proceedings under the Code against twelve large companies 2 (pejoratively named the ‘dirty dozen’). This was followed by a second list of another 28 companies where the RBI asked banks to either put in place a resolution plan or refer the companies for 

 

CIRP under the Code3. 

 

1.4 The RBI has since issued a general circular4 to banks providi ng that as soon as there is a default on any account, the lenders must initiate steps to cure the default in the form of a resolution plan. For accounts where the aggregate exposure of the lenders is INR 20 billion or more , the RBI has specified that the resolution plan must be implemented by the later of 6 months from the date of default and 30 September 2018 failing which the lenders must refer the borrower for CIRP under the Code within 15 days. For smaller accounts, the RBI proposes to announce the timeframe for implementation of resolution plans or a reference under the Code within the next two years. This means that there is potentially a huge number of companies which may be referred under the Code by financial creditors this year and shortly thereafter. 

 

1.5 Another key trend which has been seen since the Code was brought into effect is that operational creditors form a significant percentage of those referring companies under the Code, and to some extent have been able to use this as an effective tool to get overdue payments from companies. 

 

1.6 The ability of operational creditors to institute CIRPs and effectively enforce a moratorium and the threat of liquidation has been a source of worry both for corporates and financial creditors. One key issue which corporates were grappling with was whether a “dispute”, the existence of which is a defenc e against an operational creditor proceeding with a CIRP, can only be a formal dispute before a court or an arbitrator. This issue was finally settled by the Supreme Court in Mobilox Innovations Private Limited v. Kirusa Software Private Limited, where the court held that the dispute need not necessarily be before a court or arbitrator, which was widely welcomed by corporates. 

 

1.7 At the time of writing this note, around 607 companies have been subjected to CIRP under the Code.5 

 

2 Key Issues Affecting Financial Creditors 

 

2.1 Guarantees and security – impact of moratorium 

 

One of the most vexing issues emerging from the interpretati on of the Code is in relation to the treatment of guarantees and security provided to lenders. The following scenarios need consideration: 

 

(a) The lender has advanced a loan to the borrower, B, which has been guaranteed by the guarantor, G. G may be a company (in which case the guarantee is classified as a corporate guarantee, or an individual, in which case the guarantee is classified as a personal guarantee); 

 

(b) The lender has advanced a loan to B, which has been guaranteed by G and G has also provided security over its assets; 

 

(c) The lender has advanced a loan to B, for which a third party (either an individual, or a corporate) has provi ded security, but no guarantee has been provided; and 

 

(d) The lender has advanced a loan to B, which has been guaranteed by a bank. 

 

In any of the above scenarios, it may be that: (i) a CIRP has been admitted against both B and G (provided G is a company) 6 (“Scenario 1”); or (ii) a CIRP has been admitted against B but not G (“Scenario 2”); and (iii) a CIRP has been admitted against G but not B (“Scenario 3”). The question that arises is whether such guarantees and security can be invoked in light of Section 14 of the Code. Section 14 restricts suits and proc eedings against the corporate debtor, as well as any action to foreclose, recover or enforce any security interest created by the corporat e debtor in respect of its property including any action under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”). 

 

(a) Scenario 1 – Both Borrower and Guarantor in CIRP 

 

Since G is subject to a moratorium, it is clear that any steps for enforcement of security over the assets of G are restricted during the period the moratorium is in force. It is also clear that no legal proceedings can be instituted or proceeded with against B or G during that period. However, the question of whether a demand can be made under the guarantee still remains given that the language of Section 14 does not extend to making of a demand (unless, in a scenario where G has also provided security, the demand is construed as the first step in enforcing security7). As we will see below in Scenario 3, a number of decisions have held that invocation of a guarantee provided by company in CIRP has been interpreted as being restricted by Section 14. 

 

(b) Scenario 2 – Only Borrower in CIRP 

 

Guarantees 

 

There have been differing judgments from different benches of the NCLT, the NCLAT and High Courts on this issue. 

 

In IDBI Bank Limited v. BCC Estate Private Limited, the Ahmedabad bench of the National Company Law Tribunal (“NCLT”) held that insolvency resolution proceedings that have commenced against a principal debtor will not restrict insolvency resolution proceedings being initiated against the corporate guarantor for the default of the guarantee debt, given that the guarantor is an independent entity. 

 

However, in State Bank of India v. Sanjeev Shriya, where a CIRP had been admitted against a borrower, the Allahabad High Court did not permit separat e proceedings against the guarantor. The court’s reasoning was that: (i) the liability of the borrower had still not been crystallised, and accordingly it was not possible to proceed against the guarantors; and (ii) once proceedings under the Code had commenced against the borrower and the creditor was participating in such proceedings, separate proceedings against the guarantors were not tenable.8 

 

In V. Ramak rishnan v. M/s Veesons Energy Systems Private Ltd. v. State Bank of India, the Chennai bench of the NCLT held that once the liability of a borrower is paid by the guarantor, under law, the guarantor in effect acquires all the rights of the creditor and steps into his place pursuant to subrogation. This amounts to encumbering the assets of the borrower with respect to whom the moratorium is imposed. Since creation of encumbrances is barred by the moratorium provisions of the Code, the guarantor cannot be proceeded against until the moratorium is lifted. This decision was appeal ed to the National Company Law Appellate Tribunal (“NCLAT”), which upheld the ruling that the moratorium against the corporate debtor’s assets also extended to the personal guarantor. The ruling of the NCLAT does not go into the rationale adopted by the NCLT in relation to subrogation, but merely states that on a reading of Section 14 and since a resolution plan is binding on the personal guarantor (who was the promoter of the corporate debtor in this case), the moratorium extends to the personal guarantor. 

 

Bank guarantees 

 

Outside of the Code, courts have consistently held that bank guarantees are independent obligations undertaken by banks and can be enforced without reference to the underlying obligations, subject to absence of fraud in obtaining the guarantee or where invoking the guarantee leads to irreparable harm. In Nitin Hasmuk hlal Parik h v. MGVCL, the Ahmedabad bench of the NCLT held that bank guarantees provided towards a security deposit to be provided by the corporate debtor to MGVCL (a customer of the corporate debtor) cannot be encashed by the customer, while performance bank guarantees provided by banks on behalf of the corporat e debtor can be encashed. The rationale adopted by the NCLT is that “performance guarantees” have been specifically carved out of the definition of “security interest” in the Code, but other bank guarantees have not. 

 

Third party security 

 

In Alpha & Omega Diagnostics (India) Limited v. Asset Reconstruction Company of India Limited, the NCLAT upheld the decision of the NCLT bench at Mumbai that the moratorium in respect of a corporate debtor does not extend to the properties of a guarantor, which have been mortgaged (and sought to be enforced by the lender) since the Code refers to “its” assets, being the corporat e debtor’s assets. A similar judgment was passed by the NCLAT in the case of Schweitzer Systemtek India Pvt. Ltd. v. Phoenix ARC Pvt. Ltd. and Ors. 

 

Impact of rulings 

 

The impact of the above rulings is that the ability of lenders to rely on having immediate recourse to the credit of guarantors9 where the borrower is in financial difficulty has been called into question, which is at odds with the rationale behind obtaining a guarantee in the first place. The wording of Section 14 is fairly clear in that it applies to security interests over the assets of the corporate debtor. The rulings of the NCLTs and now even the NCLAT do not consider that a guarantee given by a third party is not a security interest over the assets of the borrower. The decision of the Chennai bench of the NCLT that subrogation results in creation of a new encumbrance ignores the fact that subrogation places the guarantor in the same position as a transferee of debt during the moratorium10, which is clearly contemplated and permitted under the Code. The fact that the moratorium is being extended by NCLTs to bank guarantees (relying on the unwarranted carve out for performance guarantees in the definition of security interest under the Code) without regard to the long standing jurisprudence in relation to the independence of bank guarantees is another area of concern. There appears to be little heed paid to the distinction in the language between the Code and section 22 of the Sick Industrial Companies (Special Provisions) Act, 1985, (“SICA”) which now stands repealed. Under section 22 of SICA, promoters were for decades able to evade paying on their guarantees once a company was declared as a sick, which was seen as a significant problem for creditors. This very fact ought to guide the decisions of the NCLTs in relation to treatment of guarantees under the Code, but it has not. It is also unclear as to why the NCLAT has adopted different positions in relation to guarantees and third party security. Finally, some of the decisions have cited the provisions of the Code in relation to personal guarantors (that bankruptcy proceedings for individuals who have provided personal guarantees for the debt of a corporat e debtor in a CIRP are to be heard by the NCLT), but it is unclear if they are making a distinction between personal guarantees and corporate guarantees on this basis. 

 

(c) Scenario 3 – Only Guarantor in CIRP 

 

Rulings 

 

The definition of “financial debt” in the Code clearly includes guarantees of financial debt. No distinction has been made between financial creditors claiming under an ordinary debt and those claiming under a guarantee debt11. However, the New Delhi bench of the NCLT (whose decision has been followed by the Allahabad and Kolkata benches)12 has interpreted the definition of the term ‘claim’ under the Code to exclude any claims under a guarantee by a beneficiary unless the guarantee has been ‘invoked’ and a demand has been made on the guarantor. Consequently, if a CIRP is initiated against the guarantor, then the beneficiary must necessarily invok e the guarantee before the petition is admitted and the moratorium comes into effect. The NCLT has also held that invocation of a guarantee provided by a company is restricted once a CIRP is admitted against that company. These decisions have been appealed to the NCLAT and no rulings have been passed at the time of writing this note. 

 

Impact of rulings 

 

The impact of these rulings may well be that lenders to a company which has provided a guarantee and has gone into a CIRP, where the lenders have not invoked the guarantee before admission of the CIRP, will not be to entitled be part of the committee of creditors despite the fact that the guarantee constitutes financial debt. This will mean that the lenders will not have a vote in relation to the resolution plan adopted in relation to that company. The question then arises as to whether they are then bound by the resolution plan – Section 31 of the Code provides that the resolution plan will bind “the corporat e debtor and its employees, members, creditors, guarantors and other stak eholders involved in the resolution plan”. It would appear patently unfair for a lender having the benefit of a guarantee from the corporate debtor to have no say in the resolution plan, to not be allowed to dissent and to receive liquidation val ue like other financial creditors, but be bound by the resolution plan. 

 

It is unclear why the NCLT has adopted different treatment of a guarantee debt and an ordinary debt. This creates an artificial distinction between classes of creditors – i.e. that creditors claiming as lenders to the guarantor need not evidence acceleration of, or demand under, loans for their claim to be accepted whereas beneficiaries of a guarantee must perform an additional step of ‘invoking’ such guarantees. It is also unclear as to why invoking a guarantee, which in practical terms means issuing a notice of demand under the guarantee , is restricted under Section 14, given that a notice of demand for payment is neither a legal proceeding nor enforcement of a security interest over the assets of the guarantor. 

 

However, given the current scenario, lenders will need to carefully consider the events of default in their financing documents in relation to a corporate guarantor ’ s insolvency, since admission of a CIRP against the guarantor may leave the lenders where they can neither invoke the guarantee nor be a part of the committee of creditors. 

 

(d) Third party security provider insolvency 

 

Where a company has provided third-party security to a lender13 but has no payment obligation to the lender, such lender: (i) cannot initiate a CIRP against that company, since that requires a “default” on payment of either financial or operational debt; (ii) cannot be part of the committee of creditors since it will not be a financial creditor; and (iii) cannot file a claim as a creditor, since no amount will be due to it from the company. Admission of the CIRP will not of itself have any impact on the validity of the security, but the moratorium will restrict enforcement of the security. In terms of the resolution plan, it is worth noting that the Code and the Insolvenc y and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (the “CIRP Regulations”) contemplate that a resolution plan can provide for disposal of assets whether or not subject to a security interest, and for satisfaction or modification of any security interest. However, it is also unclear whether, in such a scenario, the lender will be bound by the resolution plan since it is not a creditor, nor will it be involved in the resolution plan. The Code and the CIRP Regulations are silent on how the interests of the beneficiaries of security interests who are not creditors are to be dealt with. 

 

Given the uncertainty which prevails on this issue, lenders should consider seeking guarantees or including ‘covenant to pay’ clauses under third party security documents so that the creditor is able to evidence the existence of debt to the resolution professional.

 

Commercially, the security provider may be unwilling to the guarantee the debt as a whole, and often the solution proposed is to cap the guarantee at the amount recovered from the enforcement of the security provided. However, this does not do away with the uncertainties associated with guarantees discussed under paragraphs 2.1(a) to (c) above, since the moratorium will restrict enforcement in the first place. 

 

2.2 Other forms of credit enhancement 

 

Other than the corporate debtor itself, the CIRP can be initiated under the Code only by a financial creditor14 or an operational creditor15 on evidence of a default of a financial debt16 or an operational debt17 respectively. However, the Code seemingly recognises a wider category of creditors. Section 3(10) of the Code defines a creditor to mean “any person to whom a debt is owed” and includes financial creditors and operational creditors. Some provisions in Part II of the Code relating to corporat e insolvency process (including the provisions on who can file claims before the insolvency resolution professional once a CIRP is admitted against a corporate debtor) include referenc es to ‘creditors’ rather than ‘financial creditors’ and ‘operational creditors’. Beneficiaries of third party security without guarantees discussed under paragraph 2.1(d) above, for example, would fall in this category. Such creditors (not being financial or operational creditors) are permitted to register their debts/claim with the resolution professional, but cannot initiate a CIRP. It is also worth noting that that they cannot be on the committee of creditors which votes on the resolution plan, and, unlike in the case of operational creditors18 and dissenting financial creditors19, there is no requirement for the resolution plan to provide for liquidation value to such creditors. Such creditors can however participate in the liquidation process20 if the CIRP fails, in which case they should receive their liquidation value in accordance with the liquidation waterfall21.

 

The division of creditors into financial, operational and other creditors under the Code potentially impacts the rights of lenders where credit enhancement provided is in a form other than financial guarantees, since the rights of the lenders under these arrangements may not allow them to be classified either as financial or operational creditors. 

 

(a) Put options 

 

Structures where lenders or investors rely on a put option on a promoter or related party of the borrower (either with respect to the loan or debentures in question or in many cases, shares that are pledged to the lenders) instead of a guarantee or direct asset security have been fairly common in the Indian market as it commercially achieves a result that is similar to a guarantee. While there has always been a potential legal distinction between the obligations of a guarantor and that of a put option obligor (depending on the nature of the option), under the Code, this distinction has become quite important. 

 

While a lender with the benefit of a guarantee woul d qualify as a financial creditor of the guarantor, the position could potentially be different for a lender that only has the benefit of a put option and would depend on whether an obligation to pay for a purchase of loan or debentures or shares (as opposed to an obligation to pay under a guarantee) would qualify as a financial debt or operational debt or neither. 

 

(b) Sponsor support arrangeme nts and equity commitment letters 

 

It is also quite common for shareholders and promoters to agree with lenders to provide funding to the borrower (either for the purpose of payment of the loans, or for the purpose of the borrower’s business including project completion costs). The rights of the lenders against the shareholders under such arrangements, even when reduced to a claim for payment of an amount, do not appear to fall within either financial or operational debt under the Code. 

 

2.3 Intercompany debt 

 

Groups often borrow funds in a particular group company and on-lend the proceeds to other group companies where the funds may be needed. Depending on where the lenders are sitting in the group, different considerations may become relevant under the Code. The definitions of “debt”, “financial debt” and “operational debt” do not distinguish between intra-group debt and third party debt. The Code does however provide that where any financial debt is owed to a related party as defined in the Code, the related party cannot participate in or vote in the creditors committee. It also provides for a longer claw-back period for preferential transactions and transactions at an undervalue (being two years prior to the insolvenc y commencement date as compared with one year prior to the insolvency commencement date in the case of transactions with unrelated parties). 

 

(a) Security over intercompany debt 

 

Where an assignment or charge over intercompany debt forms a part of the security package available to the lender, and the underlying intercompany borrower goes into a CIRP, a question arises as to what rights the lender who has the benefit of the security over such debt has. If the lender were to step into the shoes of the intercompany lender which is a related party of the underlying intercompany borrower by enforcing the assignment, the restriction on voting ought to fall away since the restriction is with reference to the identity of the creditor. 

 

However, in India it is not always possible to take a security assignment over debt because of stamp duty considerations, and the form of security typically used is to take a charge over the intercompany receivables and a power of attorney to collect such receivables. In such a scenario, it is unclear if the lender can exercise any rights in a CIRP of the underlying intercompany borrower as the power of attorney entitles the lender to act in the capacity of the intercompany lender. 

 

Lenders will need to bear in mind these issues when considering the value of intercompany debt as part of the security package. 

 

(b) Permitting group company debt at the borrower 

 

It is common for borrowers to ask for intra-group debt as an exception to restrictions on incurrence of debt. This is normally accepted by lenders on the basis that such intra-group debt will be subordinated. Subordinati on terms usually include no or limited payments on the intra-group debt, and subordination on insolvency. Thes e types of provisions are untested at this stage and it remains to be seen as to how insolvency resolution professionals and NCLTs deal with contractual subordination terms for the purposes of the resolution plan where the borrower is in a CIRP. However one key point to note is that unless the subordinated lender is a related party of the borrower as defined in the Code, it will be a financial creditor which can participate in, and vote on, the committee of creditors (and as a result, will have influence on the resolution plan, including on how the intercompany debt is treated in the resolution plan22). It is therefore important that group entities permitted to lend on a subordinated basis must qualify as related parties for the purposes of the Code. 

 

2.4 Trade finance structures 

 

The issues arising from the definitions of “debt”, “financial debt” and “operational debt” discussed in paragraph 2.2 above also affect certain trade finance structures, which may not necessarily qualify as financial debt. 

 

(a) Prepayments 

 

Companies in the manufacturing sector often avail prepayments from their consumers (export advances if the consumers are located abroad) to finance the production of goods. In some cases, the prepayment s are used for working capital purposes or (under specific conditions) to refinance the company ’s debt. The prepayments may be funded using facilities provided by lenders to the relevant buyer (who in turn lends on the basis of the credit standing of the manufacturer). The question which arises is, if a CIRP is admitted against the manufacturer, what is the position under the Code of the manufacturer’s obligation to discharge the prepayment through delivery of goods (and also the obligation to refund the prepayment in certain events including insolvency of the manufacturer). It could be argued that the term of the prepayment is relevant to the analysis of whether it has the commercial effect of borrowing and a longer term prepayment should therefore be treated as financial debt. It is also not clear if the claim of the buyer can be classified as operational debt – the buyer’s claim is not for goods supplied by the buyer – it is for the refund of a prepayment for goods to be supplied by the manufacturer. 

 

(b) Non-recourse discounting of receivables 

 

Trade finance facilities are often provided in the form of discounting of receivables or factoring on a non-recours e basis. The receivables are usually amounts due to a company for goods or services provided by it, which are assigned to the lender against an upfront discounted payment by the lender. In a CIRP of the company which has assigned the receivables, the lender ought not to be affected since the receivables will not form part of the assets of the corporate debtor. In a CIRP of the underlying obligor, the nature of payment due to the lender will be payment for goods or services (although not delivered by the lender) on which basis such receivables ought to be treated as operational debt. This remains untested at this stage. 

 

2.5 Limitation period for proceedings under the Code 

 

Under the Code, a creditor (financial or operational) can initiate insolvency resolution proceedings upon the corporate debtor defaulting on the payment of a debt or invoices issued. The term ‘default’ is defined to mean non-payment of debt when the whole or part of the debt has become “due and payable”. 

 

Typically, legislations in India either: (a) provide for bespoke limitation periods; or (b) prescribe for the Limitation Act, 1963 (the “LA 1963”), to be applicable to proceedings initiated under such legislations. While the Code provides for bespoke time periods with respect to other situations23, there are no specific provisions under the Code either: (i) providing for provisions of LA 1963 to be applicable to proceedings under the Code; or (ii) restricting creditors to file claims or initiate proceedings under the Code on the basis of time-barred debts. 

 

Lack of clarity on these issues under the Code has led to development of inconsistent jurisprudence on this issue by the NCLT and NCLAT. The NCLAT, in various cases, has held that: 

 

(i) the provisions of LA 1963 are not applicable to the proceedings under the Code as there are no provisions specifically stipulating so;24 

 

(ii) even if LA 1963 is held to be applicable, the limitation period would be calculated as per Article 137 of LA 1963 (“Article 137”) – a residual clause providing a limitation period of 3 years for all proceedings not specifically set out. Since the limitation period under Article 137 is calculated from the date on which right to apply accrues, the NCLAT held that the right to apply under the Code will commence from 1 December 2016 (being the date on which Code came into force); and 

 

(iii) while provisions of LA 1963 will not be applicable, the doctrine of limitation, delay and laches will be applicabl e to proceedings under the Code – consequently, if there has been delay after which the creditor has filed the application under the Code, then NCLT should ensure that the applicant is able to sufficiently explain the reason for delay before considering the application for admission.25 

 

Adopting the above line of reasoning will have unintended consequences. For instance, a creditor of a debt that was time-barred in 2010 would be able to initiate proceedings under the Code by filing an application before 1 December 2019. Surely, it was not the legislative intent to offer the Code as a means for a creditor to initiate insolvency resolution proceedings for debts in respect of which no actions for recovery was undertaken until the Code came into existence. From a corporate insolvency

perspective, Indian courts (under the Companies Act 1956 (“CA 1956”)) have in the past held that a petition for winding up can be maintained against a company on the ground of inability to pay debts, only if the underlying debt is recoverable (i.e. not time-barred) as at the date of filing of the petition. The position under the Code ought to be the same as under the CA 1956 given that liquidation may be an outcome of the insolvency resolution process and is similar to the winding up process prescribed under CA 1956. Permitting proceedings under the Code to be initiated on the basis of time-barred debts would have an unintended effect of resuscitating such debts. 

 

As on the date of this note, based on the above decisions, the NCLT and NCLAT will have the discretion to determine if the applicant is sufficiently able to explain the delay in filing the petition. This is likely to lead to development of inconsistent jurisprudence and more importantly, resulting in the NCLT and NCLAT expending their judicial capital in determining this preliminary issue that can otherwise be expressly provided for in the Code. 

 

From a lender’s perspective, it will continue to be important to ensure that annual acknowledgments are obtained from the borrower, of the debt, to ensure that limitation period is sufficiently extended such that the issue of limitation is not raised by the corporate debtor at the time of initiation of insolvenc y resolution process under the Code. 

 

2.6 Cram-down under a resolution plan – secured creditors 

 

The Code provides for a resolution plan approved by 75% of the financial creditors (by value) to be binding on all creditors and stakeholders involved in the resolution plan. This is a key risk for creditors whose interests are not aligned with the majority. The CIRP Regulations provide that any dissenting financial creditor will need to be paid its liquidation value prior to the other financial creditors (who have consented to the resolution plan) making any recoveries under the resolution plan. No specific provisi on has been made with respect to how the liquidation value of a secured financial creditor should be calculated vis-à-vis that of an unsecured financial creditor. The provisions in relation to determination of liquidation value in the context of formulation of a resolution plan speak of the overall liquidation value of the assets of the corporate debtor as determined by registered valuers. It stands to reason that the liquidation value of a secured creditor should be calculated on the basis that it will not relinquish its security and cannot be the same as the liquidation value of an unsecured financial creditor or another secured financial creditor with a different security package. However, this point has not been provided for clearly in the Code, and will need 

to be tested in resolution plans if they have not provided for liquidation value for dissenting secured financial creditors taking into account their security. 

 

2.7 Information utilities 

 

One of the main features of the Code is the accelerated timeline for action. In this context, information is key and the Code provides for the infrastructure around information utilities (“IUs”), which are centralised platforms where creditors can submit financial information in relation to corporate debtors and access such information, including in relation to default by the corporat e debtor on its debt. The Insolvency and Bankruptcy Board of Indi a has registered National E-Governance Services Limited (“NeSL”) as the first information utility under the Code. The Code provides that financial creditors “shall” and operational creditors “may” submit financial information26 in accordance with the regulations. The Insolvency and Bankruptcy Board of Indi a (Information Utility) regulations, 2017 (the “IU Regulations”) provide for the format in which the information is to be provi ded to IUs but does not lay down clear rules on when informati on should be submitted, and which entities are bound to submit such information. The RBI has issued a circular to banks, all – India financial institutions, non-banking financial companies and asset reconstruction companies asking them to submit information in accordance with the Code and the IU Regulations . SEBI has not yet issued a similar instruction to debenture trustees. It is also unclear as to whether offshore creditors are required to (and indeed can, given the information needed to register with NeSL requires details such as AADHAR number and PAN) file such information and what the consequences of non-filing or incorrect filing are. The IU Regulations provide that information of default which has been filed with the IU should be made available to creditors of the corporate debtors which are registered users. 

 

One important thing to note is that while the IU Regulations require any information submitted to a UI to be authenticated, it does not specify the process for it. The process followed by NeSL27 requires any financial information submitted by any party to a debt needs to be authenticated by all other parties to that debt, e.g. information submitted by a financial creditor needs to be authenticated by the corporate debtor before it can be hosted by NeSL. However, there is no legal obligation on the corporat e debtor to authenticate such financial information in a time bound manner. Under the process followed by the NeSL, any financial information that remains pending for authentication by a corporate debtor for more than 7 days is sent back to the financial creditors for resolution. This could negatively impact the ability of financial creditors to rely on IUs in relation to a CIRP application, especially where the financial information pertains to defaults. Given the stated purpose of IUs in the context of CIRPs, it is critical that the regulations provide more clarity on this aspect. 

 

3 Conclusion 

 

The importance of the Code in the process for financial sector reform in India cannot be overstated. It has set in motion sweeping changes in the way creditors can enforce their rights, and has forced borrowers and promoters to realign their perspective on debt and how it can affect their business and continued existence. Against this backdrop, the principles of interpretation of the Code developing now will have a profound effec t on the conduct of financing business in India for decades to come, and it is therefore important to get it right. Some of the decisions of the NCLTs and NCLAT have been contrary to established legal principles and need to be revisited. It is hoped that the Supreme Court will, in continuation of what it has been doing, play a key role in correcting these and establishing sounds principles for interpretation of the Code. Equally, the financial community will need to play its role in providing its practical feedback to the Government and the IBBI and discussing legal, commercial and practical issues under the Code to ensure that a strong foundation is laid for the protection and enforcement of creditors ’ rights.