Recently that was hue and cry by banks on directive from RBI requiring them to create provision of 50% of the outstanding debt at the time of application to NCTL for initiating insolvency resolution process and balance 50% at the time order for liquidation of corporate for realization of debts due to Financial Creditors is passed by NCLT.

To ascertain whether RBI is justified in passing the order regarding provisioning in cases referred to NCLT under IBBC, 2016 or banks are justified in raising hue and cry, we will have to review the earlier provisions under various laws, provisions of IBBC 2016, their comparison, intention of the legislature in enacting this legislation, the infrastructure created in implementation of the same, risk mitigation through this mechanism and accordingly see the justification for this directive.

Earlier Laws on Insolvency and Winding up Mechanism thereunder:- 

Corporate Winding Up: Currently, the provisions of corporate winding up are provided in The Companies Act, 1956 as relevant provisions of Companies Act, 2013 are yet to be notified. Thus the law for corporate winding up has remained unchanged for 6 decades. It provides for winding up of companies which are unable to pay their debts. However for this, the debt should not be disputed and the High Court should be satisfied that there is no better option than to enforce liquidation.

If the borrower disputes debt, the case is usually transferred to a Civil Court. As such therefore, the time involved in getting winding up order from a Company Court is very high and during this time promoters retain control of management often leading to deterioration in corporate governance. Another issue is that in the priority of payments, statutory dues get priority over other creditors. Therefore, many times secured creditors may not find this route providing the best recovery ratio. In a nutshell, owing to teething problems in the law and lack of comprehensive mechanism, this route has largely not proved effective in enforcing debts.

Non-Corporate Liquidation: Hitherto the insolvency of individuals, partnerships etc. are covered by more than a century old The Presidency Towns Insolvency Act, 1909 for erstwhile presidency towns of Mumbai, Kolkata & Chennai and by The Provincial Insolvency Act, 1920 for the rest of India. The administration of personal insolvency laws is with Civil Courts. The remedies under these laws are time consuming and costly and are out of sync of progress made over time in Insolvency Laws in the developed economies.

Earlier Laws Relating to Recovery of Debt and Revival of Borrowers

The legislation with respect to recovery of debts has undergone a gradual shift in India over the decades. Before coming into force of IBBC, there were many options available to different class of creditors, as discussed below: –

CPC: A creditor could file a money recovery suit against a defaulting debtor under the Civil Procedure Code, 1908 (CPC) with jurisdictional Civil Court. However, owing to high backlog of cases and slow adjudication process, it used to take decades to obtain a decree against the debtor through this route.

SICA: The Board of Industrial & Financial Reconstruction (BIFR) was set up under Sick Industrial Companies (Special Provisions) Act, 1985 (‘SICA’). However, SICA principally was inclined towards helping revive sick companies rather than helping lenders to recover their dues. SICA provided moratorium from any action against the defaulting company till a revival plan was worked out. However, there was no time limit within which BIFR was to decide whether it is practicable for a sick industrial company revive again. Hence reference to BIFR became a safe harbour for defaulting companies to delay debt recovery. Further, substantial management powers that used to remain with failed promoters, lead to further irreparable loss to lender’s interest in most of the cases. Further, SICA was applicable only for industrial companies having existence of minimum 5 years and whose net-worth had eroded. Owing to these reasons BIFR route failed to achieve desirable results. The new Code has therefore repealed SICA wef 01.06.2016 and all matters pending with BIFR have been transferred to NCLT.

DRT: Debt Recovery Tribunals (DRTs) were established with enactment of Recovery of Debts Due to Banks & Financial Institutions Act, 1993. DRT were envisaged to provide dedicated and specialized mechanism for recovery of debts and obviate the need to go to Civil Courts. Though this was enacted with right intentions, here again there was no time limit prescribed for settlement of cases. Further, the infrastructure at DRTs remained much less in comparison to the number of cases being filed there for debt recovery. Currently, it took on an average 3 – 4 years for disposal of cases which is not in sync with international standards in this regard.

SARFAESI: The Securitization & Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 SARFAESI prescribes three alternative fast track methods for recovery of NPAs viz. securitisation, reconstruction of financial assets and enforcement of security. The SARFAESI Act provides quick resolution by allowing lenders to enforce security without reference to Court.

However, this remedy is only available to Scheduled Banks and Notified NBFCs against an account which has already turned NPA. From borrower’s perspective, the major lacuna of this mechanism is that unilateral security enforcement in many cases does not provide a fair chance to the borrower to revive, which in turn may permanently impair the business, thus adversely impacting the interest of other stake holders including unsecured creditors, employees etc. Thus one can say that while SICA was too lenient on the borrowers, with SARFAESI the pendulum has swung too extreme in favour of lenders.

CDR/JLF/SDR/S4A: The RBI has provided various voluntary resolution mechanisms in case of multiple or consortium lending relationships to decide on debt restructuring, repayment rescheduling, and conversion of debt into equity etc. As per guidelines, if 60% of creditors by number and 75% of creditors by value agree to a restructuring package, then that package becomes binding on remaining creditors However, this route has largely failed to achieve desirable results as lenders in general used the window to reschedule large accounts and postpone the inevitable. Another problem is that unsecured creditors not being part of the process generally file independent civil suits against distressed debtor and thus scuttle the revival process.

The fact that NPA levels of many Indian Banks today have reached double digits points to the reason for crippled credit markets in India. Lenders these days are wary of lending to industrial and infrastructure projects preferring rather to compete for low ticket mortgages. A need was therefore felt to attempt a complete overhaul of the debt recovery system. The Government has therefore enacted the Insolvency and Bankruptcy Code, 2016 on the recommendation of T. K. Viswanathan Committee. The Code repeals or overrides around 11 laws and promises to bring a sea change in how debt recovery and insolvency are handled in India, drawing from the current best practices in the West.

Distinguishing Features of the Insolvency & Bankruptcy Code

The preamble to the Act introduces the Act as “An Act to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximisation of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues…”.

Further as stated in the Government’s Press Release of 11 May 2016: The essential idea of the new law, i.e., the Insolvency and Bankruptcy Code, 2016 is that when a firm defaults on its debt, control shifts from

the shareholders/promoters to a Committee of Creditors, who have 180 days in which to evaluate proposals from various players about resuscitating the company or taking it into Liquidation. When decisions are taken in a time-bound manner, there is a greater chance that the firm can be saved as a going concern, and the productive resources of the economy (the labour and the capital) can be put to the best use.

Salient features of the code are as follows: –

1. Dedicated Adjudicating & Appellant Authority: The adjudicating authority for Corporates shall be National Company Law Tribunal (NCLT) and for others shall be Debt Recovery Tribunal (DRT). The first appeal shall lie with NCLAT & DRAT respectively and the final appeal shall lie with the Honorable Supreme Court. No other Court shall have any jurisdiction to grant any stay or injunction in respect of matters within the domain of NCLT, DRT, NCLAT and DRAT. This would provide a specialized mechanism to resolve stress accounts problem.

Further a separate regulator i.e. the Insolvency and Bankruptcy Board of India (Board) would be set up to regulate various matters under the Code.

2. Time Bound Process: The Code provides that the insolvency resolution shall have to be completed within 180 days (maximum one extension of 90 days allowed) from the date of admission of application for insolvency resolution. If no resolution is reached in the above time frame the code provides for automatic liquidation. Hence once default happens and insolvency resolution application is filed by any stakeholder, financial creditors would be forced to make intelligible choices so as to maximize economic value of business or face liquidation. At the same time, promoters should get sensitive about managing cash flows as default would straight lead to loss of control over business.

3. Preserving Value of Business: Once the application for insolvency resolution is admitted, there shall be complete moratorium till completion of insolvency proceedings. Board of Directors shall remain suspended and affairs of the company shall come under the control of the Resolution Professional. Though the entity shall remain a going concern. Creditors shall be precluded from taking any action against the Company including enforcement of security under SARFAESI Act during this period. Even a lessor cannot take possession of leased assets back during the moratorium period. Thus it shall provide an opportunity for the creditors to discuss sensible restructuring that can provide a better value than straight liquidation even while business and its assets are preserved during this period.

4. ‘Failure to Pay’ is the new Trigger: Existing mechanisms under SICA and Companies Act are tuned to provide for interjection when the borrower’s ability to pay is demonstrably impaired. Whereas under the Code, a creditor can trigger insolvency resolution process just on default. Thus a defaulter can be dragged

into insolvency resolution process without waiting for its net-worth to get eroded or for the account to be classified as NPA. This would be a big deterrent for able debtors to arm-twist small creditors. Therefore, the Code will have an effect of early identification of distress. It will instill discipline among promoters or else they will risk losing management control and also face liquidation.

5. Professionalization of Insolvency Management: The Insolvency Professionals shall be regulated and licensed professionals and will have a critical role in the process. During the process of Insolvency Resolution, the management of the borrower shall be taken over by the insolvency Resolution Professional. This will help preserve the value of business and assets of the debtor during the insolvency resolution process. Lenders will no longer be worried about mismanagement by promoters of distressed corporates. As of now the only option lenders had was to convert debt into equity and take over the management for which they may not be having the requisite competency.

6. New Priority Order of Payment: A welcome change brought in by the Code is that the statutory dues are relegated to the 5th position in the priority of payment from the current 1st position. Herein even unsecured financial creditors shall be paid before clearance of dues of the Central & State Governments. This provision is likely to boost corporate bond market as well as debt funding of SMEs and startups.

7. All Creditors empowered to trigger Insolvency: All creditors whether domestic or foreign, whether secured or unsecured and whether financial or operational can apply for insolvency resolution. The defaulting debtor himself may also apply. Thus for the first time a structured mechanism for redressal of defaults is being provided to operational creditors such as suppliers, employees etc. Similarly, the foreign

lenders and unsecured lenders shall find a mechanism to enforce their debts in a fair and transparent process. This no doubt will deepen the credit markets in India.

8. Enforcement of Personal Guarantees: If any corporate debt is secured by means of personal guarantee, then the bankruptcy of the personal guarantor shall also be dealt with by same NCLT rather than DRT. Thus, there will be a common forum for a creditor to enforce debt from both borrower and guarantor.

9. Information Utilities: There is an enabling provision to facilitate creation of Information Utilities which will house comprehensive credit data relating to debtors, their creditors and securities created. This will improve transparency and better decision making at all levels.

10. Fresh Start: A non-corporate debtor on finding himself unable to pay his debts may apply for a fresh start by discharge from certain debts, provided he satisfies the following conditions: –

  • Gross annual income of the debtor is not exceeding R60,000/-
  • Aggregate value of debtor is not exceeding R20,000/-
  • Aggregate value of debts is not exceeding R35,000/-
  • Debtor is not an undercharged bankrupt
  • Debtor does not own a dwelling unit (encumbered or not)
  • No Fresh Start Order in the last 12 months prior to the date of application

Hence, the Code provides a comprehensive and time bound mechanism to either put a distressed person on a firm revival path or timely liquidation of assets. The interests of all stakeholders have been taken care of. Further by putting the unrealized part of a secured creditor’s claim that enforces security interest outside liquidation, to a position subordinated to unsecured creditors, it gives a positive temptation to secured creditors to relinquish security interest and join the normal sequence in winding up.

Another mentionable point is that the contractual arrangements between creditors inter-se shall be disregarded i.e. there will be no consideration for second charge on security.

The Government has already notified some of the provisions of Code. Once the Code is fully operational, it is likely to help cure many ills of the credit sector. It will facilitate early, transparent and fair resolution of liquidity problems. It is also expected to help India climb many notches on the Ease of Doing Business Index and thus forward our march towards creation of a prosperous economy.

As per new paper reports, at the directions of RBI’s internal advisory committee (IAC), the banks have filed or in the process of filing reference under the Insolvency and Bankruptcy Code (IBC) against the following 12 largest defaulter accounts:-

Bhushan Steel (Rs 44,478 crore), Essar Steel (Rs 37,284 crore), Bhushan Power and Steel (Rs. 37,248 crore), Alok Industries (Rs. 22,075 crore), Amtek Auto (Rs. 14,074 crore) and Monnet Ispat (Rs. 12,115 crore), Lanco Infra (Rs. 44,364.6 crore), Electrosteel Steels (Rs. 10,273.6 crore), Era Infra (Rs. 10,065.4 crore) Jypaee Infratech (Rs. 9,635 crore) ABG Shipyard (Rs. 6,953 crore) and Jyoti Structures with a defaulted loan of Rs. 5,165 crore.

These borrowers have already started feeling the heat and results have started flowing in. Essar’s promoters have already expedited the sale of their stake in Essar Oil to Russian oil major Rosneft and the deal is likely to be closed soon.as per Chairperson of State Bank of India Mrs. Bhattacharya. Same is the position with Amtek Auto where talks are in progress with a number of buyers. Encouraging reports are likely to flow in other cases also.

From the foregoing, it is clear that the Code will facilitate early, transparent and fair resolution of liquidity problems. Hence, the position of lenders under the Code is much better compared to earlier laws as discussed above. Therefore, there is no justification whatsoever in RBI directive to banks to create provision of 50% of the outstanding debt at the time of application to NCTL for initiating insolvency resolution process and balance 50% at the time order for liquidation of corporate at the time order for liquidation of corporate for realization of debts due to Financial Creditors is passed by NCLT. Rather, the  RBI should dilute the existing provisioning guidelines in favour of lenders.  

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Qualification: CA in Practice
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Location: LUDHIANA, Punjab, IN
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One response to “Review of RBI directive regarding provisioning on debts referred to NCLT under IBC 2016”

  1. Roshan Mani says:

    Sir, This is a brilliant article, very insightful. Thanks for sharing.

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