The jury is still out on bankruptcy code

For the 220-odd cases that have been approved by the National Company Law Tribunal (NCLT) under the Insolvency and Bankruptcy Code 2016 (IBC), the clock has started ticking. The resolution under the IBC is time-bound —180 days with 90 days extension — failing which the corporate (borrower) would go into liquidation, a situation both lenders and borrowers are keen on avoiding.

The million dollar question is: Can the IBC deliver where earlier structures failed?

The IBC is indeed a giant leap forward from the earlier regime when there was no organised resolution process, and different stakeholders approached different forums to resolve the issue.

With the interests of all parties — lenders, borrowers and even operational creditors — addressed under a unified law under the IBC, resolution can be quicker and more efficient.

Judicial intervention and the inefficacy of the Debt Recovery Tribunals (DRTs) have prevented lenders and asset reconstruction companies (ARCs) from expediting recoveries under the earlier regime. Going by the recent rulings by various courts, in particular the Gujarat High Court verdict in the Essar Steel case that upheld the powers of the NCLT as the insolvency court, undue delay and efforts by defaulters to thwart legal proceedings seem unlikely.

There are however a host of issues and teething troubles that still need to be addressed if the IBC has to succeed in ridding the banking system of the huge pile of stressed assets.

The next 9-12 months will shape the fortunes of many debt-ridden companies that, along with lenders, are pinning their hopes on a meaningful resolution and recovery plan. Until then, the jury is still out on the bankruptcy code.

The main reason for the delay in the bankruptcy process so far had been the existence of multiple laws governing insolvency. The insolvency and bankruptcy code overcomes some of these challenges by creating a unified law.

While the NCLT has jurisdiction to hear and dispose cases for corporates and limited liability entities, DRT has jurisdiction over non-corporates and individuals. The biggest draw for all stakeholders under the IBC is that it is time-bound. But the success of the IBC will depend on its implementation.

The ARCs were set up under the Sarfaesi Act to enable faster recovery without intervention of the court. But in reality, judicial interventions and the inefficacy of the DRTs prevented a speedy recovery.

In this regard, recent rulings that seek to thwart borrowers’/promoters’ efforts to delay the recovery process have been heartening. Aside from the Essar Steel case, a landmark ruling by the Mumbai Bench of NCLT in the case of Schweitzer Systemtek India has set a precedent for many promoters who may resort to the IBC to delay the recovery efforts of lenders against their personal assets.

Hoping to escape liquidation of personal assets, Schweitzer Systemtek India had filed for insolvency to obtain a stay on recovery of their personal assets (collateral for the corporate loan).

But the NCLT ruled that the personal assets were outside the ambit of the moratorium (270 days) and the creditor (ARC in this case) can continue to recover by selling such assets of the promoter.

Given that nearly a third of the cases given a go-ahead by the NCLT have been filed by borrowers themselves, rulings such as these are important to retain the key essence of the legislation — preventing undue delay in the recovery process.

While the IBC has given more teeth to lenders, it has also ensured that defaulters’ interests are safeguarded under the principles of natural justice.

The ruling of the Calcutta High Court in the matter of Sree Metaliks is a case in point.

The court in its ruling stated that while the IBC is silent on whether a party respondent has a right of hearing before the adjudicating authority or not, it does not oust the principles of natural justice which must afford a reasonable opportunity of hearing to the corporate debtor. As the IBC evolves, it is evident that the principles laid down by the NCLT will ensure smoother implementation. There are however numerous other challenges that need to be addressed.

The IBC requires 75 per cent of all financial creditors by value — both secured and unsecured — to arrive at a consensus.

Under the code an operational creditor — supplier, employee and workman — can also initiate insolvency proceedings on a default of just more than ₹1 lakh. Ongoing restructuring or revival plans by banks to recover thousands of crores could be jeopardised if the operational creditor triggers insolvency for default of a couple of lakhs.

An operational creditor could possibly be looking at IBC only as a ‘recovery’ tool to achieve a quick settlement.

Given that the objectives of various stakeholders are different under the IBC, arriving at a consensus will require everyone to work constructively.

While operational creditors do not have a say in the approval of the resolution plan, getting them on the board, particularly critical creditors, will be imperative if the resolution plan has to be work.

The key factor that works in favour of the IBC is the pressure to deliver within 270 days; that can nudge various parties to push forth quick resolution.

In all of this, the role played by an insolvency professional (IP) is critical, who de facto becomes the CEO of the company once the NCLT gives a go-ahead for resolution.

The powers of the board are suspended and the IP takes over the reins of business. While the main objective of IPs is to drive a resolution plan, they have a broader responsibility to run the day-to-day operations of the company, ensuring that the value of the underlying assets of the business does not deteriorate during the resolution process.

The larger part of the job will involve managing cash flows, ensuring that all critical payments are being made, understanding the nuances of the business and complying with various laws and regulations. Remember, once the case is admitted in the NCLT, suppliers could stop offering credit and raising interim finance will be critical.

The question is can an IP — being a chartered accountant or a lawyer — rise to the occasion and tackle such complex multiple roles? In particular, can he take on big promoters, the likes of the Ruias or Singals? There is also the issue of lack of sufficient number of resources in terms of benches, judicial members and technical members at NCLT to resolve the huge pile of pending cases.

With the IBC still testing the waters it will take a while for the new structure to find its feet and ensure efficient resolution of stressed assets in the banking sector.