The Bankruptcy Bill seeks to ensure predictability of outcome for creditors, it also proposes to reduce possible delays in several ways, notes Aparna Ravi.
Last week, the Bankruptcy Law Reform Committee submitted its report, along with the proposed Insolvency and Bankruptcy Bill to the finance minister.
The draft Bill, which is now open for public comment, proposes a unified law to govern the insolvency resolution process and the liquidation of all types of corporate enterprises.
(The proposed Bill also deals with the bankruptcy of individuals and partnership firms, but these are not discussed in this article.)
The National Company Law Tribunal (NCLT) is to have jurisdiction over all insolvency-related legal proceedings for companies. To understand why such a law is long overdue, it is worth looking at how the current insolvency regime works.
Today, if an Indian company defaults on debt, there are at least four different legal routes available to the debtor and its creditors, each under a different law.
And, typically, all these routes tend to be used by different parties when a company is on the brink of insolvency.
A judgement of the Madras High Court, for example, included not one but five actions against the corporate debtor, each in a different legal forum.
One secured creditor filed an application in a debt recovery tribunal while another filed a winding-up petition in the high court.
Yet another secured creditor initiated enforcement action under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfaesi) Act, a law that permits secured creditors to enforce their security interest without the intervention of a court.
To complicate matters further, a trade creditor that had leased machinery to the debtor initiated proceedings under the arbitration clause in the contract and an unsecured creditor that had supplied a boiler to the debtor filed a claim in civil court.
Apart from the obvious inefficiencies and delays, such parallel proceedings have given rise to numerous situations of conflict between these laws.
Indeed, there have been situations where a creditor's recovery was challenged after its proceeding had closed, based on an action initiated by another creditor under a different legislation.
If one of the goals of insolvency law is to provide creditors with predictability of outcomes in the case of a default, the current system is clearly not the way to go.
The draft Bill addresses this issue by providing an organised process for insolvency resolution that can be initiated by either the debtor or its creditors.
Once an application for insolvency resolution is accepted, a 180-day moratorium comes into place during which no claims can be pursued against the debtor or its assets.
These provisions are a critical first step to ensuring predictability in process and also providing incentives for creditors to join the collective insolvency resolution process rather than initiate individual actions. The other well-known issue that plagues the current regime is, of course, delay.
Time is of the essence in insolvency proceedings as the net worth of a debtor in default tends to erode quickly over time.
Delays are particularly prevalent in liquidation where court-appointed official liquidators take years to complete the distribution of assets of the insolvent debtor.
Courts have done little to help this process as they have historically adopted a pro-rehabilitation stance and been reluctant to allow unviable enterprises to be liquidated.
There are even instances of courts reconsidering orders to wind up a company upon an application from the debtor's former management seeking another go at rehabilitation.
The draft Bill proposes to minimise the possibility of delay in several ways.
First, it stipulates strict timelines. The insolvency resolution process is to be completed within 180 days, with one extension of up to 90 days in exceptional cases.
Second, recognising that several delays arise from bottlenecks in court proceedings, the draft Bill seeks to minimise the role of the adjudicating authority.
The principal business decisions such as the economic viability of the debtor, will be determined through negotiations between the debtor and creditors - an exercise that will be facilitated by insolvency professionals. The role of the NCLT is primarily to ensure that the procedures are complied with and no illegality or fraud has taken place.
The draft Bill also abolishes the institution of the official liquidator, which by all accounts has been a failure in non-viable businesses. Instead, the functions of the official liquidator are to be performed by insolvency professionals. Of course, the devil lies in the details.
The draft Bill needs careful review, particularly on how the new law would interact with existing laws in this space, including the Sarfaesi Act and other debt recovery laws.
If these laws are not repealed (as it appears from the draft Bill), there must at least be a clear demarcation of when these laws would apply and of overriding provisions in cases of conflict with the code, if we are to avoid reverting to the old regime of chaos and uncertainty.
The proposed Bill is also quite ambitious in the creation of a new institutional architecture to deal with insolvency.
Among other things, it proposes the establishment of a new regulator, the creation of a new profession of insolvency professionals and the establishment of institutions known as information utilities that are designed to provide accurate information on defaults.
These institutions and practices will take time to establish and there need to be well thought out transitional arrangements in the interim.
Equally essential is significant training for insolvency professionals and judges if insolvency resolution and liquidation are to be the efficient and time-bound processes that the draft Bill envisages.
The proposed Insolvency and Bankruptcy Bill is only a starting point for easing exits for debtors in distress, preserving value and providing creditors with greater certainty in outcomes.
Yet, by providing for a linear, time-bound and collective process for insolvency resolution and liquidation, it is a step in the right direction.
Aparna Ravi is with the Centre for Law and Policy Research, Bengaluru, and is a member of the Bankruptcy Law Reform Committee.