Role of IBC in development of Credit Market in India – By Mr. Siddharth Addy and Mr. Aditya Chakraborty

The Insolvency Bankruptcy Code(IBC) is heaven light to guide the business venture which are at the verge of dissolution, and needs a substantial plan to survive or otherwise exit the market with least possible damage to its variables, owing to the changing times in the market balancing the stakeholders interest is of paramount importance to any business venture, the authors study the development of IBC over the period of time and analyses “HOW” the change has benefited the Credit market industry. They further intend to make its readers aware of the “Twin purpose theory” which majorly focuses on value maximization and time bound recoveries, they also emphasis on the recent trend of IBC owing to the COVID19 Pandemic and determines the future potential of the code in structuring and strengthening the credit market in India.

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Role of IBC in development of Credit Market in India

“Bankruptcy law prevents a destructive race to the firm’s assets by offering a collective proceeding that freezes the rights of all investors in a firm, values them and then distributes these assets according to the priority scheme that the parties agreed would be used in the event that such a day of reckoning should come about.” – Douglas G. Braid[1]

-By Mr. Siddharth Addy, 4th year BBA LLB(h) & Mr. Aditya Chakraborty, B.com LLB(h) students of Amity Law school 

The Insolvency Bankruptcy Code(IBC) is heaven light to guide the business venture which are at the verge of dissolution, and needs a substantial plan to survive or otherwise exit the market with least possible damage to its variables, owing to the changing times in the market balancing the stakeholders interest is of paramount importance to any business venture, the authors study the development of IBC over the period of time and analyses “HOW” the change has benefited the Credit market industry. They further intend to make its readers aware of the “Twin purpose theory” which majorly focuses on value maximization and time bound recoveries, they also emphasis on the recent trend of IBC owing to the COVID19 Pandemic and determines the future potential of the code in structuring and strengthening the credit market in India.

1. Introduction: –

The insolvency and Bankruptcy code (IBC) is one of the most exhaustive reforms in the legal and economic sphere which have been enacted in the year of 2016 in India. The code per se is not a “recovery mechanism”, its main purpose is resolution of “stressed assets” as we observe in the case of Pioneer Urban Land & Infrastructure ltd & Ors V. Union of India & Ors[2]; the Supreme Court held in this case that the IBC was not a debt recovery legislation, wherein by some theory of indemnity or contribution debt owed to the Petitioners could be fastened on to public sector units.” The introduction of the code ensured good corporate governance in the company by balancing interest between stakeholder and company.

The Code have been a successful economic reform to revive corporate entities which would otherwise face liquidation of the company, they have therein brought a complete reversal in the existing policies whereby having a complete shift from recovery to revival. This Code therein per se have played a vital role in ensuring the development of credit market in India. However the question that comes to the readers mind is HOW? Well, the code serves as a regulator which facilitate the exit of a sick unit by liquidating them and at the same time ensuring revival of the viable business through resolution. The objective is reallocation of the scared resources to ensure the best possible outcome thereby ensuring reduced adverse effect of the social and economic impact due to the consequences thereto.

Prior to the introduction of IBC, 2016, the entry and exit in the market were not well defined and that time there were other laws which guided the resolution process which had overlapping effect and were inefficient to deal with the resolution process in long run, thereby the old regulatory framework was not effective which caused a strain in the credit system of the economy. While IBC, 2016 ensured a major injection of productive resources in the economy which ensured a boost of inflow of resources.      

Prior to the introduction of the code the cases of liquidation were piling up in the court, “whenever there was default in the business the debtors were dragged in the court for the recovery of the loss”. The already overburdened court thus, felt the sense of the need for separate adjudicating authority (A.A) and legislation was needed. One of the key objectives of the IBC Code was to generate credit in the market which would ensure inflow of resources in the economy, which would thereby create a positive impact in the overall economy.

However, in the recent times pandemic has caused a chaotic situation in and around the nation, this has resulted to a complete halt in the business activity’s consequential to which cases of bankruptcy increased. During the COVID – 19 pandemic an ordinance was passed by the Ministry of Law and Justice suspending the Sections 7, 9, 10 of the code for a period of six month[3], but owing to the greater benefit of the economy there is need to iniate IBC to its fullest potential for recovery of the economy post COVID times, and also lowering the cost of credit for the productive purpose, thereby achieving the key aim of ensuring faith in the credit markets in India.      

1.1 Credit Culture in India: –

The present government has introduced IBC, 2016 with the aim to strengthen the credit structure in the country. This was possible as with the introduction of the code more and more outstanding payment were being settled which had once turned into bad debt. The Reserve Bank of India (RBI) showed that the fear of losing control over the management due to the initiation of the resolution process lead to voluntary settlement of several claims, A report suggested hundreds of industrialist came forward voluntary to settle claims worth $40 billion dollar due to the fear of losing control over the company. [4]  In the matter of Essar Steel Case V. Satish Kumar Gupta[5], the court observed that the leading steel producers were being taken out of the grip of the original promoters and are being settled to the highest bidders. The present case highlighted the perseverance of discipline in the countries credit culture.

The introduction of non – banking financial institutions (NBFIs)[6] in the country’s bankruptcy code is a positive approach towards strengthening the credit market for India’s bank that are the largest lender because the IBC rule provides for the orderly resolution of a stressed company. IBC is not a silver bullet but it is a mechanism to which strives the best for the revival of the company and ensuring better credit culture in the business.

The Insolvency and Bankruptcy Code (IBC) ensures borrower “incentive to repay” the bad debt amount; banks have to lend money when the economy requires but they have to ensure that the lending is good; the default rates are higher in big ticket loans, therein the threat of choosing the company is high while the chance of default is low.

There are several other added benefits which over the year have been highlighted by the insolvency and bankruptcy code (IBC) over the span of years like i.e. check on banks. The IBC not only ensures check on promoters but also on banks which makes it difficult for the bankers to neglect the defaulters. The IBC acts as an instrument to draw bank’s attention to refer to specific cases of default against large borrowers for resolutions.  

   

Figure – I [Strengthen the Credit Market in Economy] 

The Insolvency and Bankruptcy code have been a “super success”[7] for the purpose of recovery of debt and ensured strengthened system of credit market for the economy, however we shall not forget the code is still in its nascent stage and over the time it will evolve further and so will the credit market as it is not an overnight phenomenon. The problem in hand is those who are benefiting from the existing framework and are willing to maintain status quo has no option but to adopt to the changing business environment for better infrastructure development and inflow of foreign direct investment (FDI) across the nation.   

2. Role of IBC:-

The Insolvency and Bankruptcy Code, 2016 (Code/IBC) can be regarded as one of the most path-breaking economic reforms introduced in India. It endeavors to resolve financial distress of companies within defined timelines whilst balancing the interest of all stakeholders. It further aims at value maximization of assets of the distressed company. Rarely has a law seen such speedy roll out and implementation. IBC is a law which is of the people, by the people and for the people.[8] The Code has been successful as an economic instrument to revive corporate entities facing liquidation.

3. Twin Purpose

There were large macroeconomic objectives at play such as solving the twin balance problem, developing a robust corporate bond market, improving the credit environment, and consequently providing a fillip to India’s competitiveness as a business destination.[9] It was designed to streamline the process of corporate insolvency resolution, which prevents value destruction in the event of a corporate distress. The resolution process is a representative action for the general body of creditors and not for the recovery of money of an individual creditor.

I) Value Maximization

One of the objectives of an insolvency law is to protect and maximize value for the benefit of all interested parties and in furtherance, the economy in general. This objective is pursued during rehabilitation, where value maximization is brought by continuing a viable enterprise. Value maximization is often furthered by the fulfillment of equitable risk allocation. For instance, nullification of fraudulent transactions occurring before an insolvency proceeding ensures equitable treatment to creditors and also enhances the value of the assets of the debtor. However, there can be friction between these objectives. For instance, nullification of prior transactions can extend to non-fraudulent transactions, thereby undermining the objective of predictability. Therefore, during the insolvency proceedings, in many countries the liquidator or the administrator depending on the nature of the proceedings is given the authority to interfere with the terms of a previously entered contract by the debtor and a counterparty. While the exercise of this authority provides an important means of maximizing the value of the assets of the debtor, it also undermines the predictability of contractual relations, which is critical to making investment decisions.

 II) Time Bound Recoveries

The Insolvency and Bankruptcy Code provides for a time-bound and market-linked resolution of stressed assets. In the event that the resolution does not happen, the concerned company goes for liquidation.

IBC remained the dominant mode of recovery in 2019-20, according to the report on trend and progress of banking released by Reserve Bank of India. A record 78 resolution plans were approved by bankruptcy courts in the first 9 months of 2020, according to Insolvency and Bankruptcy Board of India (IBBI) data.[10]

The table hereunder portrays the success of the Code, especially in the difficult times of the pandemic.

(₹ Crore)

Recovery Channel

2018-2019

2019-2020

Amount involved

Amount recovered

% of recovery

Amount involved

Amount recovered

% of recovery

Lok Adalats

53,484

2,750

5.1

67,801

4,211

6.2

DRTs

2,68,413

10,552

3.9

2,45,570

10,018

4.1

SARFAESI Act

2,58,642

38,905

15

1,96,582

52,563

26.7

IBC

1,45,457

66,440

45.7

2,32,478

1,05,773

45.5

Total

7,25,996

1,18,647

16.3

7,42,431

1,72,565

23.2[11]

Source: RBI

Generation of credit from the domestic market and drawing of investments from the international market, has been an objective of the Code. A culture of deterrence against default is pertinent for that objective. Dragging lenders to court for the sole purpose of delaying repayments of outstanding loans is gradually coming to a halt. The Code is ensures lenders get repaid on time thereby making India a lucrative investment destination.

The government amended the Insolvency and Bankruptcy Code in an attempt to speed up the corporate insolvency resolution process by setting a limit of 330 days, including the time taken for litigation.[12]

4. Corporate Restructuring

The Insolvency and Bankruptcy Code (Amendment) Act, 2019 provided more clarity on the permissibility of corporate restructuring schemes in consonance with upholding the position of financial creditors in relation to funds distribution as proposed by the applicant. It also clarified the applicability of resolution plan divulging on all statutory authorities.

Regulation 37 of the CIRP Regulations[13] permits a corporate debtor to be restructured by merger/consolidation or sale/transfer of assets belonging to the corporate. The Amendment Act clarified that a resolution plan may propose restructuring by way of merger, demerger and amalgamation but the same needs to comply with the provisions as provided in Sections 230-232 of the Companies Act, 2013 and the rules[14].

The Hon’ble Supreme Court, inInnoventive Industries Ltd. Vs ICICI Bank & Anr[15], stated that “it is settled law that a consolidating and amending Act like the present Central enactment forms a code complete in itself and is exhaustive of the matters dealt with therein”. However it should not be mandatory to follow the merger framework in order to implement the restructuring proposal as approved by NCLT. In any case either a legislative or a judicial clarification can enable the resolution applicants to think of a more spirited resolution plan for the purposes of value maximisation of the corporate debtors.

5. Priority Financing

For a distressed company the most sought after alternative is capital access with the help of banks and financial institutions ensuring minimum liquidity and continuation of operations. For reasons such as protecting an existing loan position or an opportunity to secure significant safe returns as a new lender, financial institutions lend out money to companies at the verge of bankruptcy.

Rescue financing is fairly new in the country. The US Bankruptcy Code under chapter 11 provides for various benefits, including super priority status to a creditor who provides financial aid to a company undergoing reorganization, through a mechanism known as debtor-in-possession financing.[16] Some of the landmark bankruptcies like General Motors[17]  and Chrysler[18] availed this mechanism in their restructuring framework.

Inclined to revive distressed companies the IBC under section 5(13) (a) categorises interim finance within insolvency resolution process costs (IRPC). The amended IBC under Section 5(15) defines interim finance as any financial or other notified debt raised by the insolvency resolution professional during the CIRP. [19]

The NCLAT in Edelweiss Asset reconstruction Company v. Sai Regency Power Corporation Pvt. Ltd.[20] reasoned that the ‘value of a going concern is much more than a non-functional plant or concern.’; therefore, deeming it unwise to let such an entity come to a ‘grinding haltit  allowed interim finance to be raise for input costs too. The lacunae that remains is that Regulation 31 and 32[21] remain incongruent with Section 14(2a)[22] of the IBC.

The amendment ordinance[23] introduced by legislature has widen the scope of interim finance but uncertainty remains particularly regarding the acknowledgment of various forms of finances disbursed by banks and non-banking finance companies as interim finance. Alongside collaborative efforts from the RBI and IBBI there is a need for tribunals and courts to approach analytically and proactively to ensure that interim finance lives up to its legislative intent. 

6. Conclusion

The IBC has successfully created a culture that discourages default. Companies now understand that when things turn sour there will not be a rescue package from the taxpayer’s fund.

The Code ensure a check not only on promoters but also on banks, Bankers had always shown a tendency in avoiding recognition of non-performing accounts and schemes like Strategic Debt Restructuring (SDR) were used for avoiding downgrade opposite to the actual intent of resolving the distress. The IBC ensures that banks should refer specific cases of default against big borrowers for resolution and information symmetry as provided by the Information Utility[24] makes it difficult for banks to neglect defaulters.

Covid-19 induced global lockdowns increased bankruptcies, the primary objective of the IBC post pandemic has been to build faith in credit markets in India. Confidence in the system to resolve bankruptcies enhances willingness of lenders to lend more with lower risk premiums for credit. From a lenders point of view the ease of resolving credit issues will encourage them to lend more at lower rates. Stressed credit markets are exactly where credit redressal mechanisms like IBC shine and deliver real value thereby contributing to the economy of the country.

As the country emerges from the dark clutches of the pandemic, it also emerges from the shackles of the ‘economic pandemic’. At this juncture an efficient credible credit market is vital for lenders.

For creditors the IBC has emerged as the preferred road of resolution. The rate of resolution is commendable and it is encouraging more creditors to opt IBC for effective non-performing asset resolution. It has not only provided them with a mechanism to manage their relationship with debtors but has also made an impact on refining the future credit scenario.

Lessons from the current credit markets and its duly incorporation into the IBC will further benefit the economy of our country in the future years.

Reference

[1] Baird G. Douglas (1996), “The Uneasy Case for Corporate Reorganisations” in J Bhandari and L Weiss (eds.), Corporate Bankruptcy (New York, Cambridge University Press, 1996), 339

[2] [2019] ibclaw.in 13 SC

[3] Insolvency and bankruptcy code Ordinance, (19th Jan, 2021), https://ibclaw.in/wp-content/uploads/2019/08/IBC-Ordinance-2020-05.06.2020.pdf.

[4] The credit Culture is changing in India, India Inc, (19th January, 2021), https://indiaincgroup.com/the-credit-culture-is-changing-in-india/.

[5] [2019] ibclaw.in 07 SC

[6] IBC for NBFCs created a positive economic growth, The Hindu,(19th January,2021),  https://www.thehindu.com/business/Economy/ibc-for-nbfcs-a-credit-positive-for-indian-banks/article30079374.ece.

[7] A road to success, Centrik, (19th January, 2021), https://www.centrik.in/blogs/3-years-since-ibc-a-road-to-success/.

[8] Dr. S K Gupta, Insolvency & Bankruptcy Code – Changing India’s Credit Culture (3rd November,2020), http://www.lawstreetindia.com/experts/column?sid=486#:~:text=The%20enactment%20of%20the%20code,credit%20culture%20that%20discourages%20defaults.&text=The%20objective%20of%20IBC%20was,drawn%20from%20the%20international%20market.

[9] Decoding the Code: Survey on Twenty One Months of IBC in India, Published by PricewaterhouseCoopers Private Limited (PwCPL) and Confederation of Indian Industry (CII) (August, 2018).

[10] IBC dominant mode of recovery in 2019-20, FE Bureau, Financial Express, December 30, 2020, https://www.financialexpress.com/industry/ibc-dominant-mode-of-recovery-in-2019-20/2160146/.

[11] ibid

[12] Time-bound e-bidding to speed up IBC resolution, The Economic Times (9th October, 2019), https://economictimes.indiatimes.com/news/economy/policy/time-bound-e-bidding-to-speed-up-ibc-resolution/articleshow/71496833.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

[13] The Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016

[14] The Companies (Compromises, Arrangements and Amalgamations) Rule, 2016

[15] [2017] ibclaw.in 02 SC

[16] Apoorva Upadhyay and Parthsarthi Srivastava, Super Priority Financing: An Opportunity in a Crisis, India Corp Law (6th May, 2020), https://indiacorplaw.in/2020/05/super-priority-financing-an-opportunity-in-a-crisis.html

[17] 407 B.R. 463

[18] 576 F. 3d 108

[19] THE INSOLVENCY AND BANKRUPTCY CODE (AMENDMENT) ORDINANCE, 2019

[20] 2019 SCC ONLINE NCLAT 92

[21] INSOLVENCY AND BANKRUPTCY BOARD OF INDIA (INSOLVENCY RESOLUTION PROCESS FOR CORPORATE PERSONS) REGULATIONS, 2016, Vide Notification No. IBBI/2016-17/GN/REG004, dated 30th November, 2016, published in the Gazette of India, Extraordinary, Part III, Sec.4, vide No. 432, dated 30th November, 2016 (w.e.f. 01-12-2016)

[22] 14(2A)- Where the interim resolution professional or resolution professional, as the case may be, considers the supply of goods or services critical to protect and preserve the value of the corporate debtor and manage the operations of such corporate debtor as a going concern, then the supply of such goods or services shall not be terminated, suspended or interrupted during the period of moratorium, except where such corporate debtor has not paid dues arising from such supply during the moratorium period or in such circumstances as may be specified.

[23] THE INSOLVENCY AND BANKRUPTCY CODE (AMENDMENT) ORDINANCE, 2019

[24] Information Utilities(IU) are entities which are registered with IBBI under Section 210 of Insolvency and Bankruptcy Code (IBC) as per the eligibility criteria, act as data repositories of financial information which receive, authenticate, maintain and deliver financial information pertaining to a debtor with a view to facilitate the insolvency resolution process in a time bound manner.


 

 

 


Disclaimer: The Opinions expressed in this article are that of the author(s). The facts and opinions expressed here do not reflect the views of IBC Laws (http://www.ibclaw.in). The entire contents of this document have been prepared on the basis of the information existing at the time of the preparation. The author(s) and IBC Laws (http://www.ibclaw.in) do not take responsibility of the same. Postings on this blog are for informational purposes only. Nothing herein shall be deemed or construed to constitute legal or investment advice. Discussions on, or arising out of this, blog between contributors and other persons shall not create any attorney-client relationship.


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