The enactment of the Insolvency and Bankruptcy Code is one of the significant reforms of the government introduced by the NDA administration in 2016, soon after coming into power. Since the late 1800s, various laws have been used to handle bankruptcies, but they have not been updated for a long time. Individual bankruptcy was handled by Presidential and provisional insolvency laws of colonial times, and corporate bankruptcy was handled by the Companies Act 1956. The government rarely acknowledged the significance of bankruptcy and insolvency, and the laws about these issues were never evaluated. The need for a significant legislative reform to address individual and corporate loan default became apparent as the economic reforms of 1991 were carried out. While individual insolvency is also covered under the Code, we only deal with the corporate side of the Code in the article.
Some legislations addressed the failure of businesses in the corporate sector started with the impractical Sick Industrial Companies Act 1985, which aimed to revive the failed businesses of the Companies. However, it ended as one of our nation's most failed legislative measures. This law created a Board for Industrial and Financial Reconstruction (BIFR) and an Appellate Authority for Industrial and Financial Reconstruction (AAIFR) that can be approached by the promoters/owners of any company whose business has failed for revival.
As this law's sole purpose is to revive failed businesses, this Act prohibited all activities from initiating recovery action by filing suits for recovery and proceeding with winding up companies that have preferred any application/filed a reference before the BIFR. The prohibitions also extended to the period when the appeal was pending before AAIFR. Later on, the Supreme Court even prohibited legal actions against the guarantors. With this Act, almost all the recovery actions against defaulter companies involved in most sectors came to a standstill. Most notable is the failure of the entire process outlined in the law to revive many companies successfully. Most industrialists took advantage of the law and stalled all the recovery action against them by approaching the Board. As the defaults accumulated, massive losses were made to banks and other lending institutions, leading to disastrous consequences.
Meanwhile, the Narasimha Rao government enacted a new law called "Recovery of Debts and Bankruptcy Act 1993” as part of the economic reforms. It also implemented other reforms to improve the bank's financial health, such as classifying defaulted accounts as non-performing assets (NPA) and the requirement to make provisions. These Debit Recovery Tribunals established under the said Act are supposed to conduct summary proceedings and decide the cases before them in a time-bound manner, i.e. six months. After the case is decided, a recovery certificate will be issued, informed by Recovery Officers acting as the Recovery rules framed under the Income Tax Act. This new system significantly improves the recovery by filing civil suits, etc. However, the desired outcomes were not achieved because of procedural failures, appointment delays, etc.
The Vajpayee government later introduced a new law called The Securitization and Reconstruction of Financial Assets Act and Enforcement of Security Interest Act 2002. (SARFAESI Act) which has two main parts. It facilitated the securitisation of the loans and issues of security receipts, the smooth creation and functioning of asset reconstruction companies. Most importantly, it empowered banks and financial institutions to enforce mortgages without filing any court case in Non-Performing Assets (NPA) accounts. It laid down a clear process for the same. The latter is a radical departure in Indian law.
Until then, all kinds of mortgages in India cannot be enforced without approaching the court and obtaining a judgment/degree. This new law took away that requirement for the first time in history. Some properties, like agricultural lands, were exempted. Some other equitable relief and protection were also given to the borrowers. There were also some modifications to the Sick Industrial Companies Act, diluting the restrictions on recovery action against the companies that had already approached the BIFR.
The SARFAESI Act has contributed immensely to recovering the dues by realising the mortgaged assets. The securitisation of financial assets, etc., is another topic to discuss another day.
However, there were still many issues in dealing with the defaults of large corporate borrowers. The provisions of the Companies Act 1956, such as provisions relating to winding up, failed to provide timely and satisfactory levels. The office of the official liquidator and the Company Courts established under the Companies Act 1956 were found to be insufficient to deal with these defaults.
Meanwhile, the Companies Act of 1956 was repealed, and a new Companies Act of 2013 was enacted. This was a long-pending reform that updated the law governing Indian corporations in a significant way. By this 2013 Act, the whole set of Company Courts was eliminated. A new National Company Law Tribunals, i.e. NCLT, along with the appellate tribunal NCLAT, were created by this new Companies Act 2013.
When the Modi government came to power in 2014 with a clear focus on economic development to improve the ease of doing business in Bharat, one of the main areas that needed immediate attention was enacting a suitable law to govern corporate and individual insolvency. A decade of UPA rule also left the banking sector with many corporate defaults and banks in dire situations. Hence, there was also a severe and urgent need to enact such a law. Of course, the Sick Industrial Companies Act was also required to be consigned to the dustbins.
The Insolvency and Bankruptcy Code 2016, enacted in this historical background, has addressed many legal issues in recovering corporate and other defaults. Some of the highlights and features of that code are as follows:
- The Code created a separate set of professionals with an independent professional body to prescribe such professionals' eligibility, examinations and Code of Conduct. The creditors are no longer dependent on the babus of the official liquidator's office or the recovery officers of DRT. These professionals will now have proper knowledge, managerial experience and capability.
- One of the Code's main features is removing promoter control on the Company once a claim is admitted by the NCLT and the appointment of an interim Resolution Professional immediately. The said professional will handle all company assets, management, etc. Once the regular Resolution professional takes over with the consent of the financial creditors (the promoters have no say on whom to appoint as a resolution professional. As this writer understands, this removal of control is in line with international practices. The promoters, often the sole reason for corporate defaults, can no longer have a say in the management of the Company and cannot loot the Company even after the recovery proceedings are initiated).
- The Code also prescribes strict timelines for each and every proceeding before NCLT. These timelines will force every stakeholder to act urgently while conducting the proceedings before the NCLT. This will ensure a much higher recovery to the creditors.
- The Code also provides for the nullification of suspicious transactions like the sale of assets of the Company just before the default, etc. This provision is not present in any earlier legislation.
- Another critical provision is the waterfall mechanism provided in the Code for the distribution of the proceeds of the sale of the Company or its assets by the Resolution professional. Before the Code, the lenders to the companies, workers for their dues and the state and union governments had to fight among themselves to distribute these amounts. These legal battles used to take years to come to a conclusion. This waterfall mechanism ended all that discord and made life easy for all creditors.
- With the notification of the Code, the Sick Industrial Companies Act was finally consigned to the dustbins as it should have been years back.
One of the main achievements of Modi administration is not just the enactment of this Code but also the quickness in creating new NCLTs, etc., and faster appointment of judicial and other tribunals. This ensured the effective functioning of the Tribunals in the areas of corporate defaults and general corporate administration. This sharply contrasts the delay in establishing the Debt Recovery Tribunals, etc. The Government of India and the boards are now responsive to coming up with modifications, etc., to occasionally fine-tune the law and rules.
Image source: The Daily Guardian
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