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How India’s bankruptcy code will work


The Insolvency and Bankruptcy Code of 2016 legislation has been passed in the Lok Sabha. For startups, the proposed law should make it easy for investors to exit failed ventures. In case of companies with simple debt structures, the law should provide resolution within 90 days, as announced in the Startup India, Stand Up India event. 

The bill will now be taken up by the upper house. If approved by the Rajya Sabha, the law will ensure time-bound settlement of insolvency and enable faster turnaround of businesses. With the legislation, it would also create a data base of serial defaulters.

Here’s a lowdown of what the Insolvency and Bankruptcy bill is all about:

1. Whom does a business approach to declare insolvency? Chiefly, two organizations will adjudicate on behalf of corporate persons, firms and individuals. The mediation will be done by National Company Law Tribunal under Companies Act, 2013 (yet to be setup) and the Debt Recovery Tribunals (DRTs).

The NCLT will adjudicate  for companies and limited liability partnerships (LLP) while the DRTs will adjudicate cases for individuals and partnership firms.  

Other new entities and professionals to be set up under the legislation are:

  • Insolvency and Bankruptcy Board of India
  • Insolvency professionals (IPs)
  • insolvency professional agencies (IPAs)

The Insolvency and Bankruptcy Board of India will regulate IPAs who in turn will regulate the IPs. The IPs will be responsible for carrying out the resolution process and managing the company during insolvency resolution.

Until the Insolvency and Bankruptcy Board is established, a financial sector regulator such as the RBI, SEBI, IRDA and PFRDA will discharge its functions.

2. How long will it take? Insolvency has to be resolved within 180 days, extendable by 90 days once the application is approved by the NCLT or the DRT. It also proposes fast track resolution for corporate insolvency within 90 days with simple debt structures.

3. How the insolvency process occurs

Who can apply for insolvency: When a default happens, a corporate debtor or the creditors may initiate the insolvency process and apply in the NCLT or the DRT as is the case. The adjudicating authority, within 14 days of receiving the application, will ascertain the existence of default.  Once the application is approved, the debtor will be immune from creditors’ claims and lawsuits in the resolution period.

An interim IP is appointed: When the resolution process begins, an interim IP will be appointed who will take control of the company’s assets and operations. The IP will then collect information about the debtor and constitute a creditor’s committee.

Creditors committee: A creditors committee will constitute both secured and unsecured lenders. The creditors committee will take decisions by a 75% majority. It will oversee management of the debtor’s assets and appoint a permanent IP to conduct the resolution process.

Resolution: The committee can then decide to restructure the company’s debt or liquidate its assets to replay loans. If no decision is made during the resolution process, the debtor’s assets will be liquidated to repay the debt.

Approval: Once the resolution plan is approved, the IP will then submit the same to the tribunal for final approval.

4: Who gets priority in distribution of assets: The code proposes that the credit committee can choose to revive a distressed company or liquidate its assets to pay off outstanding dues. In case of liquidation, the order of priority is broadly as follows. The full priority list is given in the copy of the bill below

  • Fees of the IP and other costs during the resolution.
  • Secured creditors and worker dues for a period of 12 months.  A secured creditor may choose to participate in the process and give up his right over the collateral or choose to sell the collateral and recover his dues. If he participates in the process, he will be ahead of all other creditors (except workmen’s dues for one year) in receiving his dues.
  • Employee wages for up to 12 months.
  • Unsecured creditors which also includes trade creditors who supply raw material etc.
  • Dues to government and remaining debt owed to secured creditors.
  • Any remaining creditors.
  • And finally shareholders.

PRS Legislative Research points out that unsecured creditors are given preference over trade creditors. This is odd considering financial unsecured creditors extend money after assessing the risk involved, while trade creditors may not undertake the same level of assessment, owing to the nature of their business. A detailed report by PRS says that insolvency laws in the US and UK treat unsecured creditors and trade creditors on the same level.

5. Insolvency and Bankruptcy fund:

The Code creates an Insolvency and Bankruptcy Fund for the purposes of insolvency resolution proceedings. Sources of the fund will include grants from the government, voluntary deposits made by persons, and interest received from investments made from the Fund. Any person may withdraw up to the amount of his deposit if insolvency proceedings are initiated against him.

It is unclear why anyone would make voluntary contributions to the fund considering that they will not earn any interest on the monies contributed, as pointed out by PRS Legislative Research.

6. Fresh Start Process:

The Code provides a Fresh Start Process under which an individual will be eligible for a debt waiver of up to Rs 35,000. For an individual to be eligible for this process, he should have:

  • annual income of less than Rs 60,000,
  • assets under Rs 20,000,
  • no ownership of a house

7. How is bankruptcy being handled right now:  Currently, there are multiple laws which handle insolvency. Liquidation of companies is handled by the High Courts. Individual cases are handled under the Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920.

Other insolvency laws include SICA(Sick Industrial Companies Act),1985, Recovery of Debts due to Banks and financial Institution Act,1993, SARFAESI (Securitization and reconstruction of financial assets and Enforcement of security Interest) Act,2002 and Companies Act,2013.

Download: The bill passed in the Lok Sabha

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