Topic: SC upholds constitutional validity of Insolvency and Bankruptcy Code
Topic in Syllabus: GS Paper 3: Indian Economy
The Supreme Court recently upheld the constitutional validity of the Insolvency and Bankruptcy Code (IBC), 2016. The judgment was delivered by a bench of Justices R F Nariman and Navin Sinha, who said they have upheld the constitutional validity “in its entirety”.
More about on news:
- In an important judgment, the Supreme Court (SC) has upheld the constitutional validity of the Insolvency and Bankruptcy Code 2016 (IBC) under Article 14 of Constitution of India and dismissed that its provisions were discriminatory in nature.
- IBC, enacted to eradicate the malice of massive NPAs ailing and crippling India’s banking sector was has been facing enormous challenges in its implementation, mostly from the promoters of delinquent companies.
- These promoters have been challenging IBC and the processes thereunder on one ground or the other, from time to time, as they have been quite used to render all the earlier modes of recoveries ineffective under the legal routes prior to IBC enactment.
- They challenged the IBC provisions by asserting that by barring promoters from bidding for their own companies, IBC forces the sale of the company to new bidders. This system, the promoters alleged, was against the fundamental rights of promoters.
- Further, several operational creditors had also alleged IBC not making an intelligible differentia in classification of a financial creditor and operational creditor, thereby violating Article 14.
- Under IBC, the committee of creditors can only consist of financial creditors who assess and vote on resolution plans submitted by interested bidders.
- The operational creditors sought parity with secured creditors (e.g., banks and financial institutions) who have first claim over the money coming through the proceedings under IBC.
- The SC dismissed both these arguments.
- A bench headed by Justice R F Nariman upheld the constitutional validity “in its entirety” and dismissed the pleas to give operational creditors’ parity with financial creditors challenging the IBC.
- The SC also ruled that related parties in IBC should mean a person connected with the business.
- This decision has upheld Section 29A of IBC which bars promoters of a company facing insolvency proceedings from bidding to regain its control.
- The verdict would also be a setback for founders of delinquent companies like Essar Steel – the promoters had offered to clear all dues to regain control. This ruling is well in time before a decision by bankruptcy court on January 31.
The court made following observations regarding Intelligible Differentia:
- Most financial creditors, particularly banks and financial institutions, are secured creditors whereas most operational creditors are unsecured, payments for goods and services as well as payments to workers not being secured by mortgaged documents and the like.
- The nature of loan agreements with financial creditors is different from contracts with operational creditors for supplying goods and services.
- Financial creditors generally lend finance on a term loan or for working capital that enables the corporate debtor to either set up and/or operate its business. On the other hand, contracts with operational creditors are relatable to supply of goods and services in the operation of business financial contracts generally involve large sums of money.
- Financial creditors have specified repayment schedules, and defaults entitle financial creditors to recall a loan in totality. Contracts with operational creditors do not have any such stipulations.
- The forum in which dispute resolution takes place is completely different. Contracts with operational creditors can and do have arbitration clauses where dispute resolution is done privately. Operational debts also tend to be recurring in nature and the possibility of genuine disputes in case of operational debts is much higher when compared to financial debts.
Insolvency and Bankruptcy Code 2016:
One of the essential business supporting element is a mechanism to settle failed or bankrupt entities without causing damage to any players in the economy. Continuation of financially non-viable businesses leads to locking of funds and physical assets. Similarly, it may lead to stress for the lender who have provided loan to the distressed business entity. For this, a bankruptcy code in the form of set of laws for the resolution of failed entities/individuals is needed.
What is bankruptcy?
Bankruptcy is a financial condition where a firm/individual is unable to repay debts to creditors. Under India’s Insolvency and Bankruptcy Code 2016, a bankrupt entity is a debtor who has been adjudged as bankrupt by an adjudicating authority through passing a bankruptcy order.
Need for Bankruptcy Code:
- In every economy, there should be a legal procedure accompanied by institutions that collectively can resolve or settle the problems of failed institutions.
- An early resolution with sound principles will help the related parties like banks not to suffer from the failure of the business entity to whom they have provided a loan.
- Similarly, the Insolvency and Bankruptcy Procedures will help to ensure confidence of banks, foreign investors, and associated companies in crisis mitigation mechanism related to business entities in the country.
- A situation where investable money locked for a long time in litigations is the least preferred situation for business partners and lenders.
- Use of the bankruptcy procedure also may help the failing entity to resolve its problems early without going to a worst case scenario.
Insolvency and Bankruptcy Code 2016:
- For establishing an insolvency regulation related to entities and individuals, the Parliament has enacted Insolvency and Bankruptcy Code 2016.
- The Code offers a uniform, comprehensive insolvency legislation encompassing all companies, partnerships and individuals (other than financial firms).
- For financial firms like banks, insolvency is a much delicate issue and for this a separate resolution regime will be enacted later.
- The Code provides clear, coherent and speedy process for early identification of financial distress and resolution of entities if the underlying business is found to be viable.
- It suggests two options – a restructuring if the firm is viable and liquidation if it is not financially viable.
- Resolution should be done quickly and judiciously to ensure that business is not stuck.
- The new code will replace existing bankruptcy laws and cover companies, limited liability partnerships, partnership firms, other corporate persons, and individuals, and any other body specified by the Government.
- There are Sick Industrial Companies Act, the Recovery of Debt Due to Banks and Financial Institutions Act, and Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI).
- Besides, DRTs, Lok Adalats are also dealing with bankruptcy procedures. All these will be substituted/guided by the Insolvency and Bankruptcy Code on bankruptcy matters as it consolidates/improves the existing laws.
Features of Insolvency and Bankruptcy Code 2016:
- The Code specifies a timeframe — 180 days after the process is initiated, plus a 90-day extension — for resolving insolvency.
- A major feature of the Code is that it creates a four pillars of institutional infrastructure for administering the bankruptcy procedure. These entities/agencies are:
- Insolvency and Bankruptcy Board of India: is the regulator that will oversee the new entities.
- Insolvency Professionals: will conduct the insolvency resolution process, take over the management of a company, assist creditors in the collection of relevant information, and manage the liquidation process,
- Insolvency Professional Agencies: will examine and certify the insolvency professionals, and
- Information Utilities: collect, collate and disseminate financial information related to debtors,
- An important prerequisite for the success of the Code is the presence of sophisticated institutions and professionals who should facilitate the resolution procedure.
- Highly skilled insolvency professionals and matured institutions critical for making the entire process workable.
How insolvency procedures are conducted under the new law?
- As per the new law, when a loan default occurs, either the borrower or the lender approaches the NCLT or DRT (Debt Recovery Tribunal) for initiating the resolution process.
- The Code provides two options if a firm files insolvency: first is an Insolvency Resolution Process, during which creditors assess whether the debtor’s financial position is viable for him to continue and if so, they have to search options for the rescue of the firm. The second option is liquidation.
- The adjudicating authority for insolvency issues of a Company/LLP is prescribed to be the NCLT and National Company Law Appellate Tribunal (NCLAT), and for individuals and partnership firms, it is the extant DRT and Debt Recovery Appellate Tribunal (DRAT).
- Next step is that creditors appoint an interim Insolvency Professional (IP) to take control of the debtor’s assets and company’s operations, collect financial information of the debtor from information utilities, and constitute the creditors’ committee.
- Third step is that the committee has to then take decisions regarding insolvency resolution by a 75% majority. During the insolvency resolution period, the management of the debtor is placed in the hands of an resolution professional.
- Fourth step is that once the resolution is passed; the committee has to decide on the restructuring process through either a revised repayment plan or liquidation of the assets of the company. If no decision is made, the debtor’s assets will be liquidated to repay the debt.
- The final step is that the resolution plan will be sent to the tribunal for final approval, and implemented once approved.
- The bankruptcy code has provisions to address cross-border insolvency through bilateral agreements with other countries.
- The Code proposes shorter time duration for the completion of insolvency process. Filing for bankruptcy has to be done in three months and other procedures like filing claims and appeals are also to be done quickly. The entire process will be completed within 180 days
- Workers’ interests are highly protected under the law. Here, the money due to workers and employees from the provident fund, the pension fund and gratuity fund shouldn’t be included in the estate of the bankrupt company or individual.
- Similarly, in case of liquidation, workers’ salaries for up to 24 months will get first priority, ahead of secured creditors.
- Anyone who was declared is not allowed to hold public office, and politicians and government officials cannot hold any public office if they are declared bankrupt.
- Of about 1,500 cases admitted until December 2018, only 79 ended in an approval of the resolution plans and liquidation in a little over 300 cases.
- This shows that only fewer cases of corporate debtors are getting resolved.
- Also, many cases fail to stick to the prescribed timeline of 180 to 270 days to firm up a resolution plan with elaborate hearings at NCLT benches.
- Such delay goes against the basic premise of the law which is to ensure a swift resolution or closure.
- However, over time, the NCLT may be better tuned to these kind of summary proceedings with capacity building and training of professionals.
- But the challenge still lies in how quickly some of the large accounts referred to the insolvency court by the RBI, featuring huge outstanding claims, are resolved.
The Insolvency and Bankruptcy Code is thus a comprehensive and systemic reform that ensures speedy solution to insolvency and bankruptcy. Such a swift procedure will help creditors considerable as well as avoid distressed firms negatively affecting the economic and financial activities.
Critically examine how the Insolvency and Bankruptcy Code 2016 is big stride for ease of doing business in India?