INDIAN BANKRUPTCY CODE: A CLASSIC EXAMPLE OF FOOT IN
THE MOUTH SYNDROME
INDIAN BANKRUPTCY CODE: A CLASSIC EXAMPLE OF FOOT IN THE
MOUTH SYNDROME
BY PRITAM DEY & SANCHARI DEBNATH
The “Insolvency and Bankruptcy Code” is sine qua non for improving ease of doing
business, improving investment climate, augmenting private investments, providing quick
realization from liquidation of assets and quick exit route for the investors. In order to
improve the bludgeoning balance sheets of the corporate sector it is necessary that the code
functions properly. But the code passed by the parliament is a classic example of foot in the
mouth syndrome where the intent of the legislature is noteworthy but the fruit is bitter. The
code is fraught with structural, theoretical and philosophical defects which needs serious
reconsideration. The transplantation of U.S Bankruptcy model without understanding the
nature of Indian market will spell doom over the legislation.
This article gives a critical analysis of Insolvency and Bankruptcy Code, 2016 by focusing on
glaring defects in the law. The authors have based their arguments on three pedestals i.e.
creditor model of insolvency law, missing piece in the bankruptcy code and collateral in the
debt market. It indicates the portions where changes are required and in some cases also
provides for probable solution. The author reiterates that it opposes the legislation in current
form by showing glaring inconsistencies on its structural form.
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INDIAN BANKRUPTCY CODE: A CLASSIC EXAMPLE OF FOOT IN
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In a flawless expression of India‟s economic situation Chief Economic Advisor, Arvind
Subramanian described the journey of Indian economy rather succinctly when he said that
India moved from “socialism with restricted entry” only to embrace “capitalism without
exit”1. This view is concomitant with the long standing apprehension of the corporates and
business on the deficiency of satisfactory regulatory apparatus to deal with failed business in
the country. The consequence of which is that even after three years of Kingfisher Airlines
being grounded the creditors are still squabbling over the dues to be recovered by them2.
In fact, the much touted over-leveraged and bludgeoned balance sheets of Indian corporate
sector and banks can be partly accredited to the nonexistence of an effective bankruptcy
procedure in India. The reason for this is the unique business model followed by India that
obliterated the need for having a comprehensive bankruptcy code for the bust business3. The
ownership and shareholding pattern of most of the companies in India after independence can
be divided into two categories i.e. government owned companies and family owned
companies. In this concentrated ownership system, the need for having an insolvency law
was never felt as the governments and family provided cushion to the respective companies
in terms of capital and used to encompass the aftereffects of companies going insolvent. But
the purported shift in Indian economy in late 1980‟s and early 1990‟s from restricted market
to open market which resulted in the emergence of market forces, increase competition,
deregulation and privatization in the economy accentuated the rate insolvency of companies
in India4.
In order to provide an eco-system to cope with corporate defaults, the Government of India
appointed various committees like Justice Eradi Committee5, L.N. Mitra Committee6,
1
The
speech
of
Chief
Economic
Advisor,
Arvind
Subramanian.
Retrieved
from
http://www.livemint.com/Opinion/JnSMje73PRLgPOOnx45YfM/Reducing-the-barriers-to-exit.html
,
on
20/05/2016 on 5:00 p.m.
2
Retrieved from http://www.economist.com/news/business/21678773-long-awaited-bankruptcy-code-shouldhelp-owners-and-lenders-business-going-bust, on 20/05/2015 on 6:00 p.m.
3
Retrieved from http://www.business-standard.com/article/opinion/bhargavi-zaveri-shivangi-tyagi-missingpieces-in-the-bankruptcy-code-116022501159_1.html, on 20/05/2016 on 6:00 p.m.
4
Retrieved from http://www.business-standard.com/article/news-ians/no-change-in-indian-economic-policytrajectory-after-1991-jairam-ramesh-115100901269_1.html, on 20/05/2016 on 6:30 p.m.
5
Justice Eradi Committee on Law Relating to Insolvency of Companies, Retrieved from
http://pib.nic.in/focus/foyr2000/foaug2000/eradi2000.html, on 20/05/2016 on 6:40 p.m.
6
Report
of
the
Advisory
Group
on
Bankruptcy
Laws,
Retrieved
from
https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/20811.pdf, on 20/05/2016 at 7:00 p.m.
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INDIAN BANKRUPTCY CODE: A CLASSIC EXAMPLE OF FOOT IN
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Narasimham Committee7 which recommended enactment of special laws to deal with
corporate insolvency. The Government of India, enacted plethora of laws like The Sick
Industrial Companies (Special Provisions) Act, 19858; Recovery of Debts Due to Banks and
Financial Institutions Act, 19939; The Securitisation and Reconstruction of Financial Assets
and Enforcement of Security Interest Act, 200210 to deal with insolvency in financial sectors
and producer companies.
In ancient India, when a Hindu merchant was incapable to pay his debts, he would pronounce
his insolvency by lighting a lamp of ghee in his doorstep. In the face of embarrassment, he
used to leave his village by night with a wow of never to return. In the morning, the villagers
would could lookout the creditors swoop in to confiscate his house11. India‟s modern-day
bankruptcy processes are not as brutal and certainly not as instantaneous. On the
consideration of resolving insolvency, India stands at 136 out of 189 countries, according to
the Ease of Doing Business rankings of the World Bank. While it takes 4.3 years to resolve
insolvency in Mumbai with an abysmal recovery rate of 25.7 cents on a dollar, notes the
World Bank report, the corresponding figures for OECD (Organisation for Economic Cooperation and Development) high-income countries are 1.7 years and 72.3 cents on a dollar,
respectively12. These statistics clearly indicates the failure of India‟s insolvency laws and the
consequent regime.
Quick insolvency resolution is sine qua non for improving „ease of doing‟ business, attracting
foreign investment, accelerating domestic private investment, giving impetus to start-ups,
liquidations of assets, achieving going concern value of firms and realization of creditor dues.
In order to fructify the stated objective and to improve the investment climate, the Ministry of
Finance had appointed Bankruptcy Law Reforms Committee under the chairmanship of Dr.
T.K Vishwanathan13. The committee has consolidated all existing laws related to insolvency
7
Committee on Banking Sector Reforms (Narasimham Committee – II), Retrieved from
https://www.rbi.org.in/SCRIPTS/PublicationReportDetails.aspx?UrlPage=&ID=22, on 21/05/2016 at 11:00 a.m.
8
The Sick Industrial Companies (Special Provisions) Act, 1985 (No. 1 of 1986)
9
Recovery of Debts Due to Banks and Financial Institutions Act, 1993, (Act 51 of 1993)
10
The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002,
(Act 54 of 2002)
11
Retrieved from http://www.economist.com/news/business/21678773-long-awaited-bankruptcy-code-shouldhelp-owners-and-lenders-business-going-bust, on 22/05/2016 at 11:00 a.m.
12
Ibid. 1
13
Bankruptcy Law Reform Committee, under the Chairmanship of Dr. T.K Vishwanathan, Retrieved from
http://pib.nic.in/newsite/PrintRelease.aspx?relid=130200, on 22/05/2016 at 1:00 p.m.
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INDIAN BANKRUPTCY CODE: A CLASSIC EXAMPLE OF FOOT IN
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dispersed in different legislations into a single legislation. On the recommendation of the
committee ad with further changes, the parliament passed “The Insolvency and Bankruptcy
Code, 2016” which has been touted as one of the biggest economic reforms.
In all this brouhaha, the question that on the feasibility of the code nor its glaring loophole
has been looked into, the question arises “if the bankruptcy code is the answer to all the
panacea ailing the corporate sector”. Although, it is pertinent that the code is a welcome
development in cleaning up the corporate mess in the country but the code has failed to
substantially look into the reasons for the failure of insolvency resolution mechanism in the
country. This article has critically analysed “The Insolvency and Bankruptcy Code, 2016”
and have found out some glaring philosophical, theoretical and practical loopholes. The
authors believes that, without removing these deficiencies it will be very difficult for the act
to succeed and fulfil its objective and reasons.
The government has brought the code largely modelled on US Bankruptcy Law, albeit with a
good intention of timely resolution of corporate bankruptcy. But this transplantation of law
present in different jurisdiction into Indian jurisdiction without clearly giving reason for it
will ultimately result in foot in the mouth syndrome for the government. Although, many
laws like SICA Act, SARFESI Act etc., are there for resolution process nine of the act has
been able to stem the rot present in this debt sector. The Bankruptcy Code also suffers from
the same defect and unless necessary changes are made to it the legislative intent would
remain unfulfilled.
It is to be noted that the first fundamental flaws regarding the code would be adoption of
system of liquidation over continuation. Although, the bankruptcy code has followed the U.S.
creditor model of insolvency law, the code has adopted U.K. model in terms of results of
insolvency proceedings. In U.S.A, generally the insolvency proceedings support the
continuation of firms, where the management is given sufficient time to develop an
alternative model of business for the firm and chalk out its revival program. On the other
hand, the U.K insolvency law is based on the concept of liquidation of business over
continuation. As, Bankruptcy code in India is modelled on U.S.A, it would have been natural
if the code had borrowed the concept of continuation over liquidation. For a country like
India, where the regulatory and judicial system is not robust or quick in nature, the
continuation of the firm would have given desired results to the creditors and other
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stakeholders. The long-time taken for the liquidation of assets severely cripples the
businesses as it makes the investment a non-performing assets. Although, the code has given
a definite time period of 180 days which can be extended to 270 days in some circumstances,
it does not specify the time limit for the liquidation of assets in case the Insolvency
Resolution personnel and creditor committee decides to liquidate the company‟s assets14.
CREDITORS v. CREDITORS
The code has classified the creditors into operational creditors and financial creditors. A
financial creditor is a creditor to whom a financial debt is owed by the corporate debtor. An
operational creditor is a creditor who has provided goods or services to the corporate debtor,
including employees, central or state governments. Under the Code, where a corporate debtor
fails to pay a debt that is due, the corporate insolvency resolution process may be initiated by
a financial creditor or by an operational creditor or by the corporate debtor itself15.
The code has made some glaring differentiation between the financial creditors and
operational creditors which instead of creating ease of doing business will cause unease of
doing business. The first reason could be the Creditor‟s Committee provided by the code, the
committee has only financial creditor as its members which shall take decisions on resolution
process. But, in order to give a holistic and comprehensive process of insolvency the
operational or trade creditors should be made part of the committee, their views should also
be taken before finalizing resolution process. Although they should not have the right to vote.
The second issue would be the precedence or order of repayment of dues. In such order, the
trade creditors would get their dues after the unsecured creditors. This a gross injustice and
violation of principle of natural justice. The financial creditors provide the credit after
assessing the risk involved in such credit and due diligence. The operational creditor
especially the supplier of trade materials owing to their nature of business may not undertake
same level of risk management assessment like financial creditors. In such a scenario, it
becomes pertinent that the financial creditors be given due credence. The nature of priority
14
L.V.V Iyer, article on The Hindu, Retrieved from http://www.thehindu.com/business/Industry/is-bankruptcycode-flawed/article8660821.ece?w=alauto, on 23/05/2016 at 9:30 a.m.
15
Retrieved from http://timesofindia.indiatimes.com/business/india-business/Creditors-dues-find-precedenceover-tax-recovery-in-insolvency-bill/articleshow/50361378.cms?from=mdr, on 24/05/2016 at 10:00 a.m.
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also differs from the Companies Act, 201316 which provides for equal treatment of both
unsecured creditors and trade creditors. Similarly, in Australian, United Kingdom and United
States of America, the unsecured creditors and trade creditors are treated equally in matters of
distribution of assets during the period of insolvency.
The third issue would be the regarding the adjudication of operational debts and financial
debts. In case a corporate debtor is unable to pay a debt due to an operational creditor, the
creditor can demand payment of the same from the corporate debtor. Under the code, a time
limit of 10 days is given to a corporate debtor to repay the due amount, in case the debtor is
unable to repay the amount back within stipulated time, the operational creditor can initiate
corporate insolvency resolution process by filing an application before the adjudicating
authority17. But the difficulty lies in the fact that dispute regarding the debt would be
accepted or would be ascertained only when there will be a record of a suit or arbitration
proceedings before the demand of payment is made.
The corporate debtors would always dispute the operational debt by merely filing an
arbitration proceeding over the suit owing to the huge expenses required for the suit to be
filed. without really intending to pursue actual arbitration for resolving the dispute. Unlike,
U.S law, where the adjudicating authority has the right to examine whether the dispute
regarding the debt is genuine or not, the Indian adjudicating authority don‟t have this power.
In such a scenario, the operational creditor will be left saddled with lot of dues and frivolous
arbitral proceedings. The debtors will certainly go to higher courts, if the order of the
arbitration goes against them. The most plausible away to mitigate the situation is to give
power to the adjudicating authority for determining the bonafide nature of the suit.
But in case of financial debtors, they can straight away file an application to the adjudicating
authority which is big impediment for the continuity of the business. The rule that an
16
Pratik Datta & Rajeswari Sengupta, “A better bankruptcy regulator”, Retrieved from http://www.businessstandard.com/article/opinion/pratik-datta-rajeswari-sengupta-a-better-bankruptcy-regulator116010900715_1.html, on 25/06/2016 at 10:50 a.m.
17
Anirudh Barman & Suharsh Sinha, “Creating a competent insolvency professionals pool”, Retrieved from
http://www.financialexpress.com/article/fe-columnist/creating-a-competent-insolvency-professionalspool/181846/, on 26/05/2016 at 3:00 a.m.
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application for insolvency process shall be taken only after the determination whether the suit
id bonafide or not18.
Another important issue regarding the creditors is the order of distribution of assets. Under
the code, the creditors committee shall distribute the assets for repayment on the basis of
order of priority. If the creditor‟s committee decides to liquidate the assets of the company,
then the secured creditor can either opt to participate in the process and give up his right over
the collateral or sell the collateral and recover his dues. In such a scenario, the order of
precedence of secured creditors is above all other creditors except workmen dues of one
year19.
But the glaring problem is why the secured creditor will have priority in receiving his entire
outstanding amount, rather than the amount equal to the collateral value held by him. For
example, a secured creditor X extends a loan of Rs 2000 to a debtor Y, backed by a collateral
which is liquidated at a value of Rs 1250. Under the Code, when other assets of Y are
liquidated, X will get preference over other creditors for the remaining Rs 750 owed to him.
This provision is different from the United Kingdom, where a secured creditor would receive
priority in distribution of assets, only to the extent of collateral held by him.
The code also differs from giving dues to the government whose priority will come after
secured creditors, workmen, employees and unsecured creditors. The code differs from
Companies Act, 2013, where government dues are repaid after secured creditors and
workmen, but alongside employees and before other creditors (including unsecured financial
creditors).
MISSING PORTION OF FINANCIAL SERVICES SECTOR IN CODE
One of the biggest lacunae of the Bankruptcy code is the non-inclusion of financial services
sector under the new bankruptcy code. This means that the code, in its current form, does not
govern the insolvency of banks and other financial firms. It implies that the creditors of
financial markets infrastructure (such as depositories and exchanges), banks, funds, brokers
18
R. Jagannathan, “Bankruptcy Bill: The fight against crony capital now has two legs”, Retrieved from
http://www.firstpost.com/business/bankruptcy-bill-the-fight-against-crony-capital-now-has-two-legs2555738.html, on 26/05/2016 at 3:30 p.m.
19
Retrieved
from
http://www.business-standard.com/article/opinion/welcome-step-forward115122301085_1.html, on 28/05/2016 at 6:00 a.m.
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insurance companies, and all entities regulated by the financial regulators, will continue to
rely on the existing insolvency framework when such firms default on their debt. Such a
blanket exclusion of all financial firms from the Code is inappropriate and must be
reconsidered20.
Although due to unique nature of business of banks and financial institutions, it is pertinent
that they be put under separate bankruptcy legislation. But they should hold some special
characteristics on whom such legislations will be bestowed like the firms receiving deposits
from the public or organisations involved in insurance and pension fund business.
The insolvency of financial corporations which do not have the special features must be
administrated by the same instructions appropriate to non-financial firms. So, the bankruptcy
procedures of brokerages, asset managers, merchant banks and financial advisors of firms
which does not require special legislations must be governed by the Code. The Code
authorizes the central government to notify the financial firms that will be governed by the
code, in consultation with financial sector regulators21. However, this creates more problems
than it solves. It does not give the criteria that would allow the central government to choose
the firms which will be governed by the code.
COLLATERAL MARKET REFORM: ENABLER OF BANKRUPTCY REFORM
The most important tool in the hands of the lender is the collateral, which he uses in case of
non-payment of dues by the debtor. In India, in more than 50% of corporate loans and 60% of
retail loans land is used as the collateral. It is important to understand the complex nature of
land markets and distortion of land markets and their implications to credit generation in
India. The bankruptcy reform in the country cannot happen without the land reform or in
other words without having an efficient system that could monetize the land market in the
country22.
20
Bhargavi Zhaveri & Shivangi Tyagi, “Missing pieces in the Bankruptcy Code”, Retrieved from
http://www.business-standard.com/article/opinion/bhargavi-zaveri-shivangi-tyagi-missing-pieces-in-thebankruptcy-code-116022501159_1.html, on 28/05/2016 at 6:30 a.m.
21
Aparna Ravi, “Inconsistencies and Forum shopping in the Indian Bankruptcy Process”, Retrieved from
https://ajayshahblog.blogspot.in/2015/11/by-aparna-ravi.html, 29/05/2016 at 11:00 a.m.
22
K.P. Krishnan, Venkatesh Panchapagesan and Madalasa Venkataraman, “Land market reform is an important
enabler of bankruptcy reform”, Retrieved from https://ajayshahblog.blogspot.in/2016/01/land-market-reform-isimportant-enabler.html, 30/05/2016 at 11:30 a.m.
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In India, the land market is not homogenous in nature but a heterogeneous collection of
various state markets with varied laws and regulations. This is because the issues relating to
land falls under concurrent list of Indian Constitution. The biggest issue effecting the land
credit is the ownership of the land. In India ownership is not guaranteed by the state and
registration is not compulsory for every transaction which puts many land outside the
purview of legal titles. Land records in India is highly scattered with records in sub-registrar
office, revenue office and office of the survey department.
Another big problem involving the land is whether it has been pledged to other lenders. The
Central Registry of Securitisation Asset Reconstruction and Security Interest of India, or
CERSAI, was set up to consolidate information about mortgages against property. But this
agency does not work outside the purview SARFESI Act, 2002. In such a scenario, it is
possible that some unscrupulous element take advantage of this situation. Some other issues
like value of land, legal validity of the lands, the construction on the lands and dues paid to
the statutory authority. All these engulf the land credit market in the country23.
In the absence of proper land market, it is not possible for the bankruptcy law to function
well. Land market reform is essential and appreciated in and of itself. Given the eminence of
land as collateral in the operational of the Indian credit market, better working of the land
market is an imperative enabler of a better operational credit market and improved working
of the bankruptcy code.
CROSS BORDER INSOLVENCY
Cross-border insolvency is referred to insolvency of companies having its assets in more than
one jurisdiction. The L.N. Mitra committee report had recommended to include cross-border
insolvency in Bankruptcy code in 2002 on the basis of UNICTRAL Model of Insolvency
Law24. The BLRC committee had decided to defer the concept of cross-border insolvency,
even the code have not incorporated it. But this omission may be one of the glaring loophole
of the code. In India, the proliferation of Multi-National Corporations is increasing, even
Indian companies are now going global, in such scenario the assets are present in more than
23
Jason
Kilborn,
“Wholesale
Reform
of
Indian
Insolvency
Law”,
Retrieved
from
http://www.creditslips.org/creditslips/2015/11/wholesale-reform-of-indian-insolvency-law.html, at 30/05/2016
on 4:00 a.m.
24
UNICTRAL
Model
on
Cross-Border
on
Insolvency
Law,
Retrieved
from
http://www.uncitral.org/uncitral/en/uncitral_texts/insolvency/1997Model.html, at 31/05/2016 on 4:30 p.m.
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one country. In case of insolvency, it will be very difficult for the creditors to realize their
investment.
The story of Kingfisher should be an eye-opener for the government to incorporate Crossborder Insolvency Law. Like United States and U.K., the India should also incorporate the
provisions of UNICTRAL Cross-border Insolvency Law. The UNICTRAL model law
follows blend of both universalism and contractarian models, it keeps faith on national
judiciary and calls for international cooperation in areas of cross-border insolvency. The
whole model is based on four fundamental philosophies i.e. Access, Recognition,
Cooperation and coordination and Relief. The Indian government should ratify the
UNICTRAL model and incorporate its provisions in domestic law.
INSOLVENCY PROFESSIONAL AND AGENCIES
Under the code, Insolvency Professional Agencies shall regulate Insolvency Professionals.
Although the Insolvency and Bankruptcy Regulator of India shall be the super regulator of
this sector, it very unclear why there is a need for another layer of regulation of insolvency
professionals. Moreover, the code allows the presence of multiple IPA‟s which will increase
competition in the sector but will have huge conflict of interest as they will conduct the
examination of the IP and also enforce code of conduct. In order to have a good public image
they will never take actions against their own members. It is also not clear if Insolvency
Professional registered with one Insolvency Professional Agencies can work with other IPA.
The code should create a model bye-laws for the Insolvency Professional Agencies so that
there should not be any discrepancy in the functioning of different IPA‟s. Another important
discrepancy in the code is that it does not provide for professional stream for Insolvency
Professional, the minimum educational qualifications for the Insolvency Professional. The
code should provide for educational qualifications and streams from where IP‟s shall be
selected.
The regulations for insolvency professionals in quite different from other professionals like
Chartered Accountant, Lawyers or Company secretary who are directly controlled by their
regulators like Bar Council of India etc. This discrepancy should be removed by withering
away the provisions of Insolvency Professional Agencies, the Insolvency Professionals
should be directly under the Insolvency and Bankruptcy Board.
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ADJUDICATION
The bankruptcy reforms in this country will not fructify unless government follow it through
the judicial reforms. The two forums through which adjudication shall be done is the National
Company Law Tribunal for Corporate Insolvency and Debt Recovery Tribunal for Individual
insolvency. But this traditional system of adjudication will create multifarious problems as
seen in various tribunals and other quasi-judicial bodies.
The country is already reeling under the pressure of huge backlogs of cases. In DRT alone
more than 62000 cases are pending and they have the capacity to adjudicate only 10,000
cases each year. In such a scenario, burdening them with additional duty will only increase
pressure on the system. The NCLT is even not notified yet.
In such a scenario, it becomes important that systematic reforms be done in judicial and
quasi-judicial system along with bankruptcy law, then only intent of the code will fructify.
The government can either develop a parallel system of adjudication like Alternate Dispute
Resolution where the complex nature of the court is minimal or serious judicial reforms
should be undertaken to remove the difficulties in quick disposal of cases.
Apart from the above mentioned inconsistencies which are present in the code there are some
miscellaneous issues which requires some glaring changes like obliteration of Bankruptcy
Fund. The necessity of such fund is a big question as it involves voluntary contribution from
any person. The person will not get any additional benefit by contributing in such fund. The
present of such fund is an administrative nightmare. Apart from that, it must be very clearly
laid down in the Code that management of corporate debtor shall get expatriate only if
noteworthy amount says 20 – 25 per cent of the debt of the corporate debtor remains due and
unpaid. This rule shall protect the management from the threat of insolvency and there can be
continuity of the firm‟s business. Before ordering the liquidation of the corporate debtor it is
not clear whether the corporate debtor can be heard by the adjudicating authority for granting
any reliefs. This has to be clearly laid down. This principle is an integral part of natural
justice. The formation of Information Utilities needs to be clearly laid down. The utilities
shall be made interoperable so that there should be seamless transition of information form
one utility to another. As the information will be in the form of repository the Information
utility must give transparent and same information.
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The present code has some glaring inadequacies and deficiencies that need to be rectified
before the implementation of the act. One part of the reforms agenda is structural, and other
part involves change in the bureaucratic and administrative structure. Although, it involves
significant fiscal outlays, for cleaning up land titles, overhauling the land litigation system
and creating efficient stamp duty, improving the quality of land registry through digitisation
and registration processes. In addition, in the paper, we propose many modest, feasible and
less expensive reforms. To begin with, we must standardise information regarding
bankruptcy and create a repository of values‟ data that can be shared across lender. The long
term reforms in credit market, judicial reforms and cross border insolvency are sine qua non
for effective functioning of bankruptcy law.
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