7 April, 2016
1. Introduction
The draft Indian Insolvency and Bankruptcy Code 2015 (the "Code"), if implemented in its current form, would introduce sweeping changes to the current regulatory regime governing restructurings, bankruptcies and insolvencies in India.
The Indian government is introducing the Code with the specific objective of tackling the problems that have plagued corporate debt restructurings and insolvencies in India in the past, namely:
- mismanagement, fraud and/or lack of co-operation on the part of the promoter group (coupled with an unwillingness on the part of domestic financial institutions to restructure defaulted loans thereby removing any incentive on the part of the promoter group to engage in a restructuring process); and
- the absence of a comprehensive, binding and effective statutory framework to undertake corporate debt restructurings in India coupled with the systemic delays typically faced by any creditor seeking to enforce its contractual rights through the Indian courts.
The Code is a manifestation of the clear preference expressed by the Reserve Bank of India (the "RBI"), India’s fiscal regulator, currently headed by US-educated Governor Raghuram Rajan (a strong proponent of developing a market for distressed debt in India) that Indian corporates that are faced with an inability to pay their debts should restructure their debts promptly. In recent years the RBI has:
- introduced new regulatory tools to make restructurings more efficient (see boxed text below); and
- sought to limit the flexibility previously enjoyed by Indian banks in making provisions for bad debts.
RBI Initiatives on Debt Restructurings: Some Highlights
Empowering lenders in a default situation to convert their outstanding loans into a majority equity stake in the debtor and bring in management of their choice to replace the existing promoters (under the "Strategic Debt Restructuring" route)
Sanctions against debtors and promoters who commit a "wilful default" on their loans
Increase in the ceiling of foreign investment permitted in asset reconstruction companies as part of an effort to build a "marketplace" for distressed debt in India (Further regulatory measures to encourage ARCs were also announced in the Indian Budget 2016)
Requirement for promoters to give personal guarantees and contribute to the loss suffered by lenders in a default scenario as a precondition to the lenders benefiting from favourable provisioning norms in respect of the defaulted debt
This trend is in direct contrast to the generally protective approach towards Indian companies that Indian regulators have taken in the past and is reflective of the slow but consistent efforts being taken by the Indian government to enhance the ease of doing business in India.
The introduction of the Code is timely given that corporate debt restructurings are expected to continue to increase in India over the next few years as a result of, among other things, unpredictable global financial conditions and the general economic slowdown in India which has been further exacerbated by factors such as the steep depreciation of the Indian rupee against the US dollar. The IMF estimated in 2014 that Indian borrowers are among the most highly leveraged in the Asia-Pacific region and in 2015 concluded that Indian borrowers are among the most vulnerable to the continuing appreciation of the US Dollar (IMF Report on "Spillovers from Dollar Appreciation, July 2015). We have already seen a number of examples in the recent past of international funds specialising in stressed and distressed debt pursuing or expressing their willingness to pursue investment opportunities in India.
2. Overview of the Code
2.1. Highlights of Restructuring Process
The key highlights of the process are:
- A default on the payment of a debt entitles a creditor (whether financial or operational) to apply to the National Company Law Tribunal (the "Authority") to initiate a restructuring process known as a "corporate insolvency resolution process" (the "Restructuring Process"). The National Company Law Tribunal is the quasi-judicial authority which will also supervise all corporate law matters under the Indian Companies Act and is expected to be constituted in 2016.
- The Restructuring Process (and the business of the debtor company during the Restructuring Process) will be subject to the overall supervision of a professional specialising in insolvency and restructuring matters (the "Restructuring Professional").
- All Restructuring Professionals will, in turn, be subject to a new regulatory authority to be set up under the Code known as the Insolvency and Bankruptcy Board of India, (the "Regulator").
- All key decisions in relation to the restructuring of the company’s debt during the Restructuring Process will be taken by the financial creditors of the company.
- If the Restructuring Process does not result in a plan to restructure the company’s debts (the "Restructuring Plan") that is agreed to by 75% of the financial creditors of the company within a specified timeline, the company will be put into liquidation.
- A debtor company is also entitled to apply for the initiation of a Restructuring Process.
2.2. Key aspects of the Code
Key aspects of the Code to highlight from this perspective are:
- Streamlining – Repeal of existing legislation and establishment of a new regulator: The Code aims to be the exclusive legislation dealing with restructurings and insolvencies going forward. It will repeal the existing multiple provisions across different Indian laws. In addition, the industry will be subject to the overall supervision of the Regulator and the Authority will take over substantially all of the jurisdiction of civil courts on corporate debt restructuring matters.
- Timebound process: The Code requires the Restructuring Process to be completed in 180 days and the Authority is only permitted to grant a single extension of 90 days if requested by 75% of the financial creditors in cases where the restructuring is complex.
Imposition of a Moratorium and vesting of management powers in the Restructuring Professional: The Code provides for the following to occur automatically upon the initiation of a Restructuring Process:
- the imposition of a moratorium on creditor litigation in respect of outstanding debts (similar to what happens under a Chapter 11 process in the United States) and on any disposal of the debtor’s assets; and
- the powers of the Board of Directors of the debtor becomes vested in the hands of the Restructuring Professional.
Creditor-led restructuring with supervision by Insolvency professionals: The Code provides for the Restructuring Process to be led by a Restructuring Professional and for key decisions in relation to the debtor and any proposal to restructure debts to be approved by financial creditors holding 75% of the debt.
3. What the Code Means for International Creditors
(A) The Code will be an extremely useful tool for international funds and financial institutions who are looking to invest either in new money financings or in distressed debt situations in India as it levels the playing field. In contrast to the current regulatory landscape, the Code does not, on its face, make any distinction between the rights of international and domestic creditors, between financial institutions and funds and between unsecured and secured creditors or their access to an effective restructuring medium. In addition, all financial creditors will, in general, be entitled to participate in the Restructuring Process irrespective of the size of their debt.
(B) However, the Code will not override product-specific rules that apply in India and which limit the contractual rights of international creditors in certain instances. One such example is the requirement under the External Commercial Borrowing (ECB) guidelines that loans advanced by offshore lenders to Indian borrowers must have a minimum average maturity and that prepayments of such loans at times earlier than this require approval from the RBI (which approval process is generally perceived to be opaque and time-consuming). Foreign lenders have more flexibility in relation to advancing funds for refinancing an existing debt under the Non-Convertible Debentures (NCD) guidelines and to an extent, under the new Track 3 route pursuant to the ECB guidelines but as these are Rupee-denominated instruments, lenders have to bear foreign exchange risk.
(C) The Code could become law in the near future. The Indian finance minister has, in his speech on the Indian budget 2016 delivered on 29 February 2016, re-iterated the Modi government's commitment to getting the Code passed in the Indian Parliament. However, it will take a while for the legal eco-system that is contemplated by the Code to be established. Until this is done, several process-related provisions of the Code will not be fully effective. In addition, changing the law is the start but not the end of the process. Changing attitudes and implementing the processes contemplated will be key in ensuring that the Code meets its objectives.
(D) While the Restructuring Professional will have sweeping powers during a Restructuring Process to ensure that the debtor continues to operate as a going concern until the restructuring is complete (akin to the powers available to judicial mangers in Singapore), its ability to raise interim financing from international sources could still be limited under other Indian laws relating to borrowings from overseas sources (e.g. the restrictions on end-use and investor classes for foreign currency borrowings under the ECB guidelines although these have been liberalised recently).
(E) The Restructuring Process requires, in certain cases, the active engagement of financial creditors to protect their interests. The Code includes strict timelines for the Restructuring Process but does allow for electronic meetings and for each creditor to appoint an insolvency professional to represent it at any creditor meetings.
(F) The Code preserves the commercial flexibility of financial creditors to agree on a Restructuring Plan of their choice. The only limitation under the Code is that the Restructuring Plan must provide for repayment of operational creditors and for such creditors to receive, at a minimum, the amount that they would receive upon the liquidation of the debtor.
(G) The Code has safeguards to prevent corporate debtors from "gaming" the system. Debtors who have violated the terms of a Restructuring Plan in the past or undergone a Restructuring Process in the last twelve months are precluded from initiating a Restructuring Process.
(H) The need to agree a Restructuring Plan within a defined timeframe is welcomed but, as other jurisdictions have shown (notably with the PKPU process in Indonesia) a timebound process can be a double edged sword, open to "gaming" and possibly less than optimal results (for creditors and debtors alike). The threat of automatic liquidation can create strange results.
