IBC - THE ROLLERCOASTER JOURNEY
This Guest Post is authored by Mr. Vidit Mehra, Associate at IndusLaw. The author was assisted by Mr. Dhawal Srivastava, a fourth-year student at Rajiv Gandhi National University of Law, Patiala.
When we talk about ease of doing business in India, debt recovery forms an equally important part of the business process to save the asset from being labelled and tagged as a non-performing asset (“NPA”). While there can be multiple hurdles in running a corporation, there are hurdles that are strong enough to bring the business to a complete halt. Since it opened in 1991, the Indian economy has grown by impressive numbers. Foreign corporations entered the Indian territory that was being tried and tested for the first time with the policy of globalization and clearly, it did not disappoint, apart from a few hiccups here and there. As we grew from having teething issues to more mature issues, there was a need for restructuring the business with strong legal support. A commercial need has to meet legal backing, but the same has to be done in a balanced manner. A legislature’s intent can never contradict the commercial needs of an economy. If anything, a legislature needs to support the growth of commerce. Working on these lines, India had put some laws in place such as the Sick Industrial Companies Act and 1985 (“SICA”) and Board for Industrial Financial Reconstruction (“BIFR”) to deal with sick, insolvent, and bankrupt companies. Although SICA and BIFT were bought into existence with the intention of saving sick companies and restoring the faith of the lenders, they did not achieve the said objectives due to complexity and lack of a straight procedure. Both SICA and BIFR were later repealed, along with a host of other local insolvency laws that were replaced by the much-celebrated Insolvency and Bankruptcy Code, 2016 (“IBC”) applicable to individuals, partnerships, and companies. The National Law Company Tribunal (“NCLT”), along with trying cases under the Companies Act, 2013, has been empowered to try cases under the IBC and the law has provided for sufficient measures to ensure that the legislation is not misused.
2. PURPOSE OF IBC
The Bankruptcy Law Reforms Committee (“BLRC”) invited suggestions from various professionals, committees and the public and BLRC designed a set of processes to streamline the insolvency and bankruptcy regime that we presently know as the Corporate Insolvency Resolution Process (“CIR Process”). While the IBC came into force with effect on 28th May 2016, provisions of the CIR Process came into effect on 1st December 2016. The purpose of the IBC that is reflected in the object statement also emphasizes expediting the simplifying the process of insolvency and bankruptcy by enabling a better ground for negotiation for the debtor and creditor, while preserving and maximizing the asset value. Further, the moratorium under IBC has been designed to protect the interest of the corporate debtor by protecting the assets of the corporate debtor. One of the biggest advantages of the IBC over erstwhile recovery laws is a stringent timeline for the resolution of cases that can either end up being resolved through an approved resolution plan or the entity faces liquidation as the last resort. However, the timelines although as much as it appears strict in the fine print, may not be that strict when it comes to the application and the delay cannot be attributed to just one reason.
3. IBC AND OTHER LAWS
While there have been a lot of developments that have led to the evolution of jurisprudence around IBC, it is worth noting that interpretation of IBC along with other laws has been interesting and worth discussing:
3.1 IBC AND SARFAESI
Debt Recovery Tribunals (“DRT”) were created under the Recovery of Debts due to the Banks and Financial Institutions Act, 1993 (“RDBFIA”) which was later renamed Recovery of Debts and Bankruptcy Act, 1993 (“RDBA”). Despite having these legislations in place, there was a need for another law that came to be known as the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI”). Once SARFAESI was enacted, DRT became the forum to try cases on the default of secured debt. One of the drawbacks of SARFAESI, compared to IBC, is the requirement of having collateral when a case for recovery is tried under SARFAESI. On the other hand, IBC can be enforced even in the absence of any collateral, but it is also to be understood that IBC is not a money recovery process, as much as one would like it to be but it is a measure to essentially bring the corporate debtor to its feet. While there have been instances wherein a question of law on whether IBC will supersede SARFAESI in the event of any inconsistency between the two legislations has arisen, Section 238 of the IBC has been interpreted to its truest meaning. As per the Hon’ble Supreme Court of India, the law is clear that once the process under IBC has been initiated, the proceedings under SARFAESI cannot be continued. Hon’ble Supreme Court has further interpreted the spirit of Section 238 of the IBC by stating that “the primary focus of the legislation is to ensure revival and continuance of the corporate debtor from its own management and from a corporate death by liquidation.”
3.2 IBC AND RERA
Real Estate (Regulation and Development) Act, 2016 (“RERA” was enacted for better regulation of a highly litigious industry; real estate. The core of RERA is to regulate real estate, the agents, and the redressal of disputes. An interesting intersection of RERA and IBC was observed when homebuyers or allottees were given the status of ‘financial creditors’ as per the second amendment (“Second Amendment”) to IBC, bringing the clarity in midst of conflicting judgments dealing with a similar issue. Simply put, the Second Amendment added an explanation to Section 5 of the IBC to include forward sale or purchase agreement as a ‘financial debt’. The genesis of the Second Amendment may be found in the Report of the Insolvency Law Committee that deliberated that the amounts raised as a means of financing the real estate project, are thus in effect a tool for raising finance and on the failure of the project, money is repaid based on the time value of money. Post the Second Amendment, the Insolvency and Bankruptcy Code (Amendment) Act, 2020 introduced joint filing of claims for the CIR Process whereby at least 100 (One Hundred) such allottees in the same class or 10% (ten percent) of the total allottees by quantum are required to initiate the proceedings under IBC. The quantum was introduced to prevent any potential misuse of the provisions of the IBC that was evident from the sudden surge in filing of the cases by the allottees against the real estate developers. An interesting take on IBC versus RERA proceedings may be seen from the fact that while IBC is a central legislation, RERA is particular to each state as land forms part of List-II of the Seventh Schedule of the Constitution of India, IBC may have a potential to even dilute the provisions of RERA that may result in non-favorable outcomes. However, Hon’ble Supreme Court has come to the rescue by solving the conflict between IBC and RERA. It held that IBC shall prevail over RERA and a resolution plan under IBC is not to be rejected on the ground of inadequate interest or compensation being granted to the homebuyers.
3.3 IBC AND PMLA
Another heavy legislation that has fought enough battles with IBC is the Prevention of Money Laundering Act, 2002 (“PMLA”). As the title itself states, the objective of the PMLA is to prevent instances of money laundering and attachment of properties that may be derived from proceeds of crime. The major conflict between PMLA and IBC is seen from the overlapping of the adjudication under these two legislations at the same time. While SARFAESI and IBC prioritize dues owed to the creditors, PMLA focuses on the attachment of the assets that might affect the outcome under SARFAESI and IBC. As asset maximization is one of the major objectives of IBC, if the assets are attached under such stringent provisions, it will be nearly impossible to attract a possible buyer for such an asset. The Hon’ble High Court of Delhi has observed that due to the presence of non-obstante clauses in PMLA, IBC and SARFAESI, there is no inconsistency between RDBA, PMLA, and IBC as their objectives are different from one another and that there is no inconsistency and the text and context of all three legislations are different and the court rejected the argument of the prevalence of the said laws over PMLA. Opposite to the observations provided by the Hon’ble High Court of Delhi, the NCLT Mumbai bench gave reference to the orders of the National Company Law Appellate Tribunal (“NCLAT”) that held that the adjudicating authority under PMLA could not have continued with the attachment after the declaration of moratorium under Section 14 of the IBC due to the application of Section 63 read with Section 238 of the IBC. Although PMLA and IBC both contain a non-obstante clause, the IBC will prevail as it was enacted at a later date. It is further observed that criminal proceedings under PMLA will take a long time as compared to the time-bound process of IBC, thereby eroding the value of the assets. Finally, the Hon’ble Supreme Court of India clarified the conundrum by upholding the validity of Section 32A of the IBC which states that jurisdiction and the authority under PMLA are legislatively mandated to cease once a resolution plan gets approved by the adjudicating authority. It was further contended that the liquidation process would make an impact on the value of the property as well as the interest that may be manifested by prospective applicants. A similar stand was reiterated by the apex court that settled the long pending question of whether statutory creditors, including central and state governments, are bound by a resolution plan, once it is approved by the adjudicating authority under Section 31(1) of the IBC and the Hon’ble Supreme Court of India has answered in affirmative.
4. CHALLENGES WITH IBC
Like any other legislation, IBC also has some challenges affecting its implementation, and the tribunals and the apex court have always taken up the mammoth task of developing jurisprudence around the law. The sudden workload of a new law such as IBC to the already existing load of cases pending with the Tribunals under the Companies Act has slowed down the working of NCLT and on average, it is taking anywhere between 6 (six) to 12 (twelve) months to even get the cases admitted under IBC, while the law prescribes a total period of 180 (one hundred and eighty) plus additional 90 (ninety) days to complete the CIR Process. Further, issues of shortage of members in the NCLT have resulted in a slow pace of adjudication of the matters that must be fixed at the earliest. The pandemic has further slowed down the functioning of the law as creditors are allowing some time for corporate debtors to either restructure their debt or extend an additional line of credit to navigate the tough waters. The pandemic also pushed the Ministry of Corporate Affairs to raise the erstwhile minimum default threshold of INR 1,00,000 (Indian Rupees One Lakh only) to INR 1,00,00,000 (Indian Rupees One Crore only) under IBC. The revised limit has brought in a conflict regarding whether such a revised threshold will have a prospective or retrospective effect and different NCLTs have given conflicting judgments on the matter. Another major challenge to IBC is the treatment of contingent claims, that is, claims of the creditors that are already sub-judice on the date of admission of the corporate debtor under insolvency and the treatment of the same. The Hon’ble Supreme Court of India, while upholding the clean slate theory under IBC, observed that once CIR Process ends, the corporate debtor starts with a clean history and all the past claims and liabilities extinguishes. It took a contrary view of the Fourth Dimension case by allowing an arbitration proceeding to continue post completion of the CIR Process and thereby contradicting the clean slate theory and opening door to multiple claims, post CIR Process litigations against the corporate debtor, going against the very nature of Section 14 and the core objectives of the IBC. The solution here must come from the Parliament, providing clarification on the treatment of contingent claims before a new breed of litigation is pursued, increasing the existing burden on the adjudicating authorities. Lastly, but more importantly, the current trend suggests that creditors are not getting the worth they should under the IBC. This is despite the fact that creditors are taking humongous hair-cut in the debt that is ranging from more than 90% (ninety percent) of the total debt. As per the data for the year 2021, out of 3,774 admitted cases under IBC, 43% (forty-three percent) of these cases have been closed by resolution, liquidation, or other means, and out of these cases, only 14% (fourteen percent) have been closed through a resolution plan, whereas the majority of 57% (fifty-seven percent) cases have ended in the liquidation or corporate death of these entities.
It is said that the devil is in the details. IBC is going through a development phase and countering all the curve balls thrown at it. We need to be mindful of the fact that IBC directly relates to the economics and NPA situation of India, and it is also a trust-building method to do away with the notion that it is impossible to approach recovery or bad debt in India. While it is important to get an investment in a country, it is equally important to provide investors with comfort. Whether it is raising the minimum default threshold or effectively weeding out existing promoters from re-bidding for the corporate debtor, the legislature has done an impressive job in keeping up the true nature of the IBC with a few hiccups here and there. From 2016 to date, we have seen tremendous growth in the legislation of insolvency that has even led to the operation of 2 (two) NCLATs forums from just 1 (one) bench of appellate body earlier. It is however imperative to note that the responsibility for the development of IBC is just not with the apex court of this country, but the evolving jurisprudence has to come from the grass-root level is NCLT itself. The law, however, has a lot of scope and many improvements are on the cards, it is safe to assume that financial institutions can operate with the faith that there is an answer to what if something goes wrong?