Introduction

Insolvency and Bankruptcy Code, 2016 (Code) was enacted when public sector banks and financial institutions in India were helpless chasing their over-stressed accounts in largely protracted legal battles. Some of the recent statistics suggests that the total stressed loans which also include non- performing assets and standard assets are currently growing at an alarming rate and the situation could worsen further by March 2018.

In the midst of rising stressed loans in banking system which poses a systemic risk to the country’s economic growth and the concerns that a defaulting promoter could grab back control of the company that is under insolvency at the cost of banks taking a severe haircut, the Union Government on November 23, 2017 amended the Code by pronouncing the Bankruptcy Code (Amendment) Ordinance, 2017 (Ordinance). The Ordinance amends various sections of Code and inserts two new provisions in terms of Sections 29A and Section 235A respectively providing the eligibility criteria for a ‘resolution applicant’. Resolution applicant is the person who proposes an insolvency resolution plan in a bankruptcy scenario. The Ordinance also provides a monetary penalty for violating the provisions of the Code where no specific penalty has been prescribed.

Purpose

The primary purpose of the Ordinance is to prevent certain categories of persons including the promoters of defaulting companies going through insolvency proceedings and their holding companies, subsidiaries and associate or related parties to be a ‘resolution applicant’ who are (a) undischarged insolvent; (b) has been a willful defaulter under the RBI guidelines; (c) being convicted for any offence bearing punishment exceeding two years; (d) disqualified directors under the companies act; (e) who have their accounts classified as non-performing for a year or more as per the RBI framework; or (f) those who have provided guarantee in respect of a corporate debtor under the bankruptcy resolution or liquidation process initiated as per the Code.

The Ordinance specifically empowers the Committee of Creditors or COC to reject a resolution plan, which is submitted before the pronouncement of Ordinance but is yet to be approved and where the resolution applicant is not meeting the test of eligibility criteria stated above. Further, the Ordinance expressly prohibits sale of any immovable property, movable property and actionable claims of the corporate debtor by a liquidator to any person who is not eligible to be a resolution applicant. Thus idea is to prohibit fraudulent and dishonest promoter and their connected persons or entities from participating in the insolvency resolution process.

Implications - Pros & Cons

The key objective of Ordinance is to put in place appropriate safeguards to prevent the promoters who are willful defaulters from misusing the Code for personal gains. The Ordinance provides for a robust diligence framework enabling the COC to make proper assessment of the solvency, integrity and credibility of a resolution applicant before approving a resolution plan keeping in view the scale, complexity, viability and feasibility of a resolution plan to avoid entry of frivolous applicants. Approval of any insolvency resolution plan by COC now requires 75 percent voting consent of the financial creditors. In this regard, recent decisions of Hyderabad and Mumbai bench of NCLT respectively are notable.  The Hyderabad bench in November last month in K. Sashidhar v. Kamineni Steel & Power India Pvt. Ltd. held that while exercising its discretion NCLT being the adjudicating authority has power to approve the resolution plan even though it had received the support of less than 75% of the financial creditors in value; on the other hand Mumbai bench in ICICI Bank Limited v. Innoventive Industries Limited questioned the jurisdiction of NCLT in interfering a decision taken by the COC. The stand taken by Mumbai bench appears to be more rationalistic due to the literal as well as the purposive intent behind the legislation. Besides, the Ordinance aims to protect the insolvency resolution process from any impurity or intoxication which had recently been seen in the matter of Synergies Dooray where the corporate debtor company got merged with a related party while Edelweiss ARC as a lender undertook nearly a 95% haircut on its recovery. The Ordinance prescribes penalty for violation of the Code which will ultimately prove to be a deterrence for frivolous applicants participating in the resolution process.

Whilst the Ordinance calls for a stringent examination on defaulters and non-compliant participants, there are few serious concerns on the adverse economic implications of Ordinance. To a large extent the Ordinance makes process to qualify as a resolution applicant arbitrary in the hands of the lenders even though they are mandated to follow the RBI guidelines for such determination. Due to its stringent qualifying criteria, the Ordinance disqualifies majority of the domestic and international aspirants from participation in the bidding process. This has the potential to further weaken an already depressed financial value of any resolution plan. Also, lack of clarity on retrospective or prospective implementation of the Ordinance brings substantial procedural uncertainty in the resolution process and makes it a subject matter of long drawn court battles and disputes between the parties. There are serious concerns in qualification criteria for bidders from foreign jurisdiction where the comprehensive eligibility conditions prescribed under the Ordinance may not be existing at all. The Ordinance eliminates a fundamental aspect that the promoter being the owner knows the real value of his business and if assets are sold to the same promoter, then they will generate higher value for the lenders compared to a new bidder who may consider it to be an unknown asset and therefore a risky proposition desiring a higher discount. The Ordinance also ignores the fact that every promoter may not be a willful defaulter or fraudster and a non-performing asset may be the end result of cyclical nature of business, market situation, government policies or for the reasons which are beyond any promoters’ control.

Conclusion & the Way Forward

The Code is still at the nascent stage and will need suitable adaptations before it gradually settles down. The basic premise on which the Code is designed is to distinguish genuine business failure from willful default or fraud, as all business failures are not fraud. The preamble of the Code suggests that its purpose is to maximize value of assets of insolvent persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders. The Ordinance goes against this principle by viewing the business failure and fraud with the same lenses. The need of hour is to define the term willful default and fraud in a scientific manner. Hopefully these concerns will be addressed, once the Ordinance is tabled in the ongoing winter session of the parliament.