Abstract
“An inefficient insolvency and bankruptcy system stymies the growth and development of credit markets. In 2016, India implemented the IBC to restructure its insolvency and bankruptcy system to lower the NPA burden and boost the economy’s credit and GDP growth rates. It was a transition toward a creditor-in-control system that promised to lower debt costs, increase credit supply, and drive businesses toward long-term loans. We used the Difference-in-Differences approach to examine the influence of IBC on credit networks, as well as on performance and innovation, via the transmission channel of ‘credit networks. We find that IBC has resulted in a considerable decrease in debt costs and an improvement in debt structure, as well as an improvement in the overall performance of distressed enterprises relative to non-distressed firms through these channels. The stated results are solid.
Keywords: Insolvency and Bankruptcy Law, creditor, debt cost, debt structure, difference-in-differences
Institutional barriers in general, and financial frictions in particular, have a significant impact on an economy’s poor performance in terms of investment, risk-taking, innovation, and overall development. Poor and out-of-date bankruptcy and insolvency legislation creates significant financial friction in the financial markets. The bankruptcy law governs the reorganization and liquidation of businesses if the parties involved fail to meet their contractual obligations. Bankruptcy law deals with two agents, creditors, and debtors, whose interests are at odds. A good bankruptcy law attempts to strike a perfect balance between the two and so provides” “explicit “regulations to improve efficiency (ex-ante, interim, and ex-post efficiency[1]). The law supports the withdrawal of the most inefficient enterprises from the market and the reallocation of production inputs to the most productive firms (thereby promoting creative destruction).
In India, bankruptcy law was plagued by issues such as complexity, a plethora of statutes and enforcement bodies, arbitrariness, considerable delays, and debtor-in-control tilt. According to the Economic Survey (2021), it takes around 1550 days for a business to be liquidated in India, even under regular conditions. The delay persisted even after the implementation of major reforms such as the formation of DRTs, the SARFAESI Act, and so on. As a result, the development of a unified insolvency and bankruptcy legislation was critical to enhance business, investment, FDI, and long-term economic growth.
The lack of uniform legislation also resulted in macroeconomic issues such as rising NPAs and declining credit growth, which harmed the potential for high growth rates. In this context, the Indian government established the Insolvency and Bankruptcy Code in 2016[2], to address the problem of NPAs in the short run and boost the ease of doing business and development in the medium and long term, respectively. The reform transformed the viewpoint of Indian bankruptcy law from debtor-in-control to creditor-in-control by boosting creditor rights during insolvency procedures. With the implementation of these reforms, several studies assessing the influence of changes on corporate behavior, firm performance, firm debt structure, access to financing, innovation, and investment emerged in the sector. These studies mostly address the demand side effects of bankruptcy changes in diverse circumstances. Some studies, on the other hand, look at the impact of bankruptcy changes from the supply side, such as the impact of Brazilian bankruptcy laws in 2005 [3]on the money and capital markets, as well as the cost of credit. Keeping in view” these impacts of the insolvency and bankruptcy laws, we try to examine the” “impact of IBC-2016 “on credit networks such as the cost of debt and debt structure in Indian cases using various data We also tested for the causal impact of IBC on the performance and innovation through the transmission channel of
credit networks. We find that IBC has resulted in a significant reduction in the cost of debt and an improvement in the debt structure of distressed firms vis-à-vis nondistressed firms[4]. These effects in turn have resulted in better performance of these firms and have also contributed to a significant rise in R & D expenditure.
Literature Review
A dynamic market economy is always in a state of flux, some firms exit from the market and some enter. Ideally, the forces of ‘creative destruction’ should ensure the orderly entry and exit of firms. However, in case there are distortions created by market imperfections such as coordination problems, incomplete contracts, and information asymmetries, the private market will not facilitate the exit of unproductive and unviable firms[5]. Therefore, the case for public intervention arises to facilitate the exit of unproductive and insolvent firms from the market to enhance efficiency.
The main parties involved are the creditors and debtors whose interests are in conflict with each other and an insolvency regime that favors the former leads to ‘too many’ liquidations and one that favors the latter, leads to ‘too many’ continuations. In a creditor-friendly insolvency regime, there is always a liquidation bias or inefficient liquidation because of the higher creditor tendency to liquidate firms even if the value is higher as a going-on concern. On the other hand, if the insolvency regime favors debtors, it can lead to the reorganizations of firms whose liquidation value is greater than the going-on concern. The debtors can also indulge in opportunistic behavior that can destroy the value of a firm at the expense of creditors. Therefore, a sound bankruptcy regime ensures the rights of both parties are protected and overall efficiency is attained.
The insolvency and bankruptcy framework is primarily designed to deal with distressed firms (because they are more responsive to its design. However, it has overarching effects on all firms. It aims to promote both ex-ante and ex-post efficiency. insolvency reforms which strengthened” creditor rights argue that it led to a reduction in the liquidation of distressed firms[6]. They also offer the ex-ante and ex-post incentive effect as an explanation for this kind of behavior. According to the authors, ex-ante incentives under creditor-in-control regimes have a disciplinary effect on the management which prevents them from taking decisions that can land the firm in financial trouble, while ex-post incentives reduce the agency costs for creditors and lead to more restructuring than liquidation. In addition, law and financial literature provide ample evidence of the impact of insolvency and bankruptcy laws. Credit Reform and Bankruptcy Reform”
“The implementation of IBC in 2016 signaled a change away from the debtor-in-control system and toward a creditor-in-control regime in which creditors have tremendous rights over the restructuring and liquidation of troubled enterprises. There is a wealth of literature on the effects of creditor-friendly regimes on corporate behavior, credit channels, and general macroeconomic growth. Financial frictions impede development efforts is not a new finding in financial and developmental research; stronger creditor protection leads to higher debt recovery, higher credit availability, and lower interest rates. Using the changes to evaluate the influence of liquidation and reorganization on business credit conditions and investment, researchers discovered that interest rates on bank financing increased by roughly 12 basis points following the 2005 reorganization reforms.
Research Methodology
With the aid of books, papers, doctoral theses, websites, and articles, as well as my knowledge and comprehension of the law, I conducted this strictly doctrinal research project. The process I used to write this dissertation involved reading books and articles, analyzing them, and then putting what I had learned into my own words. With due acknowledgment to the authors, several portions of the dissertation were entirely altered from the books and papers I had cited.
Challenges and interpretation of the Insolvency and Bankruptcy Code
The Code aimed at establishing time-bound processes and searching for a resolution to help save the companies from going bankrupt. The consolidation of laws governing insolvency had become a necessity due to the piling up of cases and delays in debt resolutions[7].
The Insolvency and Bankruptcy Code claims to facilitate the ease of doing business in India due” to its easy, quick, and time-bound resolution process.
“Individuals, as well as organizations, can apply for insolvency under the Code. It’s called corporate insolvency in the case of an organization and bankruptcy in the case of an individual. Not only that the creditors and the debtor can initiate the recovery proceedings against each other under the Act.
IBC intends to protect the interest of all the stakeholders in the company and to help revive the company in a time-bound manner.
Why is it difficult to interpret IBC
It’s been 4 years since the Insolvency and Bankruptcy Code has been introduced. In these 4 years, it has seen many ups and downs. The Code has been amended 5 times and there are various judicial pronouncements interpreting the Code, the latest one being the Insolvency and Bankruptcy Code (Second Amendment) Act, 2020 (with effect from June 5, 2020).
The rules and regulations governing have been amended from time to time. The Supreme Court and the high courts have pronounced landmark cases interpreting the clauses of the Code, questioning its constitutional validity, and settling grey areas in the Code. It is a challenge to implement the Insolvency and Bankruptcy Code effectively. There have been dozens of changes made to the regulatory framework under the Insolvency and Bankruptcy Code. These amendments and ordinances are passed to facilitate the smooth functioning of the processes.
To completely understand the Insolvency and bankruptcy code, one can study the latest and amended versions of the Act, orders, circulars, allied rules, and regulations, which are posted on the website of IBBI (Insolvency and Bankruptcy Board of India). Along with the judicial interpretations of the code. It is safe to say that the Insolvency law in India is yet developing, it is still a bit raw. The constant changes in the evolving law make it difficult to interpret and” understand.
Major shortcomings of the Insolvency and Bankruptcy Code
“IBC provides for a time-bound mechanism for creditors to recover their debts. It is known as the Corporate Insolvency Resolution Process (CIRP). When a company defaults in paying its debts to the creditor, the creditor can apply to CIRP to initiate a recovery action.
The corporate Insolvency Resolution Process is a time-bound process under the Code. Wherein Section 12 of the Code mandates the process to be completed within 180 days from the date of admission of such application.
The period for completion of such a process may be extended by the adjudicating authority only if at the meeting of creditors a resolution is passed having a vote of 66% of the voting share. Despite the resolution, the period to complete the Corporate Insolvency Resolution Process shall not be extended beyond 90 days.
The process however has to be compulsorily completed within 330 days including the extensions granted. The Section further provides for an extension of 90 days for proceedings that go beyond 330 days due to unavoidable delays.
The proportion of NCLT benches to the high number of cases is imbalanced and to add that the time limit of 330 days to complete CRIP is proving to be very difficult. Companies having a large number of creditors will have hindrances in the smooth functioning of the creditor’s committee.
Lack of sufficient infrastructure
According to the Minister of State for Finance and Corporate Affairs Anurag Singh Thakur in a written reply to the Rajya Sabha, 10,860 cases were pending before the NCLT as of September 2019. The lack of sufficient NCLT benches and the quantity by which the cases under IBC are rising. The increasing pendency of the cases will defeat the purpose of the quick resolution process.
At present, there are only 897 registered insolvency professionals. To be an insolvency professional one must either be a Chartered Accountant, a Company Secretary, or Cost Accountant or an Advocate with 10 years of experience, or a graduate with 15 years of experience. One must also pass the insolvency examination conducted by the IBBI[8].
Therefore, a resolution professional may not have experience in handling or managing a company. Due to the lack of need for minimum experience in handling and managing a company, one might question the ability of the resolution professional.
When a debtor fails to make payments, a lot of issues emerge between the debtor and creditors. While both parties should negotiate to maximize value, the differences in their objectives force them to take separate actions to protect their investments. Individual interest enforcement has been reported to result in the stripping of the debtor’s assets, making the situation even more chaotic and unstable. The IB Code allows legal recourse to both the creditor and the debtor, but in a more organized and orderly way that is governed and overseen by a neutral third party. 17 Chapter II of the 2016 IB Code contains provisions relevant to the corporate insolvency resolution process.
The adjudication authority18shall declares a moratorium period after an application for the beginning of a corporate insolvency resolution process is admitted. 19Section 14 of the Code deals with the consequences of a moratorium declaration, which include the restriction of the following:
(a) the institution of suits or the continuation of pending suits or proceedings against the corporate debtor, including the execution of any judgment, decree, or order in any court of law, tribunal, arbitration panel, or other authority;
(b) the “corporate debtor transferring, encumbering, alienating, or disposing of any of its assets or any legal right or beneficial interest” therein; and
(a) the “institution of suits or the continuation of pending suits or proceedings against the corporate debtor, including the execution of any judgment, decree, or order in any court of law, tribunal, arbitration panel, or other” authority;
(d) the recovery “of any property by an owner or lessor where such property is occupied or in the possession of the corporate” debtor.
Judicial Interpretations of the Insolvency and Bankruptcy Code of 2016
“The judicial interpretations are critical for understanding especially the evolving law of insolvency and bankruptcy. The interpretations of the code by the national company law tribunal, the supreme court, and the high courts give clarity to several procedural and conceptual concerns.
We shall now try and understand Insolvency and bankruptcy with the help of various judicial pronouncements and landmark judgments. We shall study how the courts have interpreted the provisions of the Insolvency and Bankruptcy Code, to eliminate” the issues and challenges.
According to Section 4 of the Insolvency and Bankruptcy Amendment Act of 2019, CIRP was “mandatorily” to be completed within 330 days from the commencement of the resolution process “The 330 days time limit would also include the extension of time granted and the time spent in the legal proceedings. Failing to complete the process within the said time limit would lead to the corporate debtor being referred for” liquidation.
“The hon’ble supreme court in the case of Committee of Creditors of Essar Steel India Limited through Authorised Signatory vs. Satish Kumar Gupta & Ors, CIVIL APPEAL NO. 8766-67 OF 2019, struck down the word “mandatorily” stating that the time taken during the legal proceeding should not affect the interest of the litigant.
The court further clarified that the resolution process must be completed within 330 days however the facts of the case in mind and the time occupied in the legal proceedings, the NCLT, or the” NCLAT can grant a further extension of time ( in exceptional cases).
“In the landmark case of the Committee of Creditors of Essar Steel India Limited through Authorized Signatory vs. Satish Kumar Gupta & Ors, 2019, the supreme court strengthened the role of the Committee of Creditors. The Hon’ble Court held that the Committee of Creditors (CoC) is the principal authority in deciding whether to rehabilitate the corporate debtor or not by way of” accepting the resolution plan.
“The resolution must be approved by a minimum vote of 66% of the voting shares. While approving the resolution plan the CoC takes into account the viability and feasibility of the resolution plan. Therefore CoC has the power to suggest alterations and modifications in the” resolution plan.
Role of a resolution professional
“The applicant must submit a resolution plan on receipt of such plan, the resolution professional shall examine the plan by Section 30(2)[9]. After which according to Section 30(3) the plan is to be presented to CoC for its approval.
Once the resolution plan is approved by the CoC, the plan is then forwarded to the adjudicating authority by the resolution professional.
In the case of ArcelorMittal the Supreme Court analyzed the role of a resolution professional AND held that the role of a resolution professional is to inspect all the resolution plans submitted to him by different applicants, before submitting the plans to the CoC. He is not to make any decision and his opinion regarding contravention of law is to be put before the committee of creditors. A resolution professional does not have the power to decide whether the resolution plan is violative” of any provision.
“Thus, the role of a resolution professional is to examine the resolution plan, conduct the necessary due diligence, ensure that the plan is complete, and report it to the CoC irrespective of whether the” plan is in contravention or not.
Financial and operational creditors
“In the case of Swiss Ribbons Pvt. Ltd. & Another Vs. Union of India & Others [(2019) 4 SCC 17][10], it was contended that the distinction made between the financial creditor and operational creditor was violative of Article 14 of the Constitution. Furthermore, the issue of exclusion of the operational creditors from the committee of creditors was also raised before the Hon’ble Supreme” court.
“The supreme court with the help of the Insolvency Law Committee (ILC), and the BLRC Report, made a clear distinction between financial creditors and operational creditors. The court held there is an intelligible difference between them. The most significant difference between them is the involvement of financial creditors in assessing the viability of the corporate debtor.
As for the issue of discriminatory treatment of operational creditors on the committee of creditors, the court held that the primary responsibility of the committee of creditors is to evaluate the viability and feasibility of any resolution plan. Financial creditors are banks and financial institutions, they are well-equipped to conduct the required detailed study of the market to evaluate the viability and feasibility of the resolution plan. Whereas on the other hand, operational creditors are only concerned with recovering the money paid for provided goods and services. Therefore they may not be well equipped to assess the viability and feasibility of the resolution plan. The Supreme Court, therefore, held that neither the operational creditors were not being discriminated” against on the committee of creditors nor was it violative of Article 14.
“Section 29 A[11] of the Insolvency and bankruptcy code provides for several disqualifications for any person submitting a resolution plan acting jointly with any other person or in concert.
The hon’ble supreme court in the case of ArcelorMittal resolved the issues around the interpretation of the ineligibility of resolution applicants to submit resolution plans.
The Supreme Court, in this case, held the following points:
The disqualification of a person from submitting a resolution plan under Section 29A (c) is attracted when the plan is submitted and not before that. It can be however removed under” Section “29A(c) if the person submitting the plan pays all the dues along with the charges and interest related to said non-performing asset before submitting the plan.
The court further placed reliance on SEBI Takeover Code and judicial precedents for interpreting” the phrases “persons acting in concert or jointly”.
“Furthermore in the case of Swiss Ribbons Pvt. Ltd. & Another vs. Union of India & Others [(2019) 4 SCC 17][12] constitutional validity of Section 29A (j) read with the definition of related parties was questioned. Wherein the Supreme Court upheld the constitutional validity of the” section.
“The court thought that after examining the definition of the related party under Section 5(24A) the person acting jointly or in concert must be related to the business activity of the resolution applicant. Therefore, the “relative” mentioned in the definition must be related or connected to the business activity of the resolution applicant. In the absence of such a connection, a person cannot” be disqualified under Section 29A(j) of the Code.
“Insolvency and Bankruptcy Code is umbrella legislation that is critical for the development of insolvency laws in India. It promises time-bound and efficient mechanisms for debt recovery. The Corporate Insolvency Resolution Process is a creditor-controlled model for the resolution of insolvency. The creditors have been given the power to take important decisions concerning the resolution process. There have been amendments and landmark judicial pronouncements to make the Insolvency and Bankruptcy Code more efficient and effective.
The failure of certain company strategies is an inevitable part of the market economy’s process. In the event of such failures, the most prudent and practical strategy would be to have a quick mechanism in place to assist financiers in negotiating and working out a new agreement. If this is not a possibility, the best consequence for the financiers and society is liquidation. When such mechanisms are put in place, the debt-recovery process will go smoothly. However, as previous experiences have shown, the current NPA problem must be tackled independently since resolving insolvency and managing non-performing assets are two interrelated but distinct concerns. As a” result, it is argued that the need of the hour is for India to build a distressed asset trading market.
The IB Code is undeniably significant and relevant in the current context since it has replaced India’s outdated insolvency and bankruptcy framework. It may be concluded that we now have a cohesive and complete law (in the form of the currently existent framework for time-bound debt settlement) that meets international criteria[13]. This would help to improve India’s standing in the World Bank’s “Doing Business” report by adding an element of certainty and predictability to corporate transactions. Its attentive implementation will be required for its success. Because the Code is still in its early stages, it is envisaged that it will be made functional in such a way that it focuses on implementing the law rather than quickly operationalizing it.
BY: Prathiksha Prabakar
4th Year BBA LLB(Hons)
PES UNIVERSITY
Bangalore
Karnataka
[1] Tensingh, E. and B., Dr.S. (no date) A study on the impact of insolvency and bankruptcy code, 2016 on Indian Commercial Banks- A pre and post-event analysis
[2] Ministry Of Corporate Affairs Notification 24th March, 2020,available at https://www.ibbi.gov.in/uploads/legalframwork/ 48bf32150f5d6b30477b74f652964edc.pdf.
[3] 2 Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, Amendment dated 29.03.20, available at https://ibbi.gov.in//uploads/press/92797aa5f444ab7215707834d4821409.pdf.
[4] the Insolvency and Bankruptcy Board of India (Liquidation Process) (Second Amendment) Regulations, 2020., Amendment dated 20.04.2020.
[5] The Insolvency and Bankruptcy Board of India (Liquidation Process) (Second Amendment) Regulations,2020, available at https:// www.ibbi.gov.in/uploads/legalframwork/51250311f7791102b612ff9c9810b997.pdf.
[6] 0 Megha Khandelwal and Ananya Ghosh Suspension of CIRP during Covid-19: A Boon or a Bane? https://indiacorplaw.in/2020/07/ suspension-of-cirp-during-covid-19-a-boon-or-a-bane.htm
[7] The Insolvency And Bankruptcy Code (Amendment) Ordinance, 202, Ordinance No. 9 of 2020 (w.e.f. 05-06-2020) https:// www.ibbi.gov.in/uploads/legalframwork/741059f0d8777f311ec76332ced1e9cf.pdf.
[8] Dr.Binoy J. Kattadiyil, Pandemic Priorities: Increased Insolvency Threshold Andits Economic Impact Internationaljournal Of MultidisciplinaryeducationalresearchISSN:2277-7881; Ic Value:5.16; Isi Value:2.286 Peer Reviewed: Volume:9, Issue:5(7), May:2020.
[9] www.indiacode.nic.in/show-data?actid=AC_CEN_2_11_00055_201631_1517807328273§ionId=809§ionno=30&orderno=35
[10] www.scconline.com/blog/post/2019/01/25/sc-validity-of-insolvency-and-bankruptcy-code-upheld-in-entirety/
[11] ibbi.gov.in/webadmin/pdf/legalframwork/2018/Jan/182066_2018-01-20%2023:35:29.pdf
[12] id
[13] Gazette of India Extraordinary Part III, Section 4 published
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