Insolvency and Bankruptcy Code- A Revolutionary Policy

22nd July, 2024 - 7:28 am Categories: IBC 0 Comments

Introduction

This is one of the most important case studies for a law student. As, we all know what happened to Kingfisher Airlines and if you remember these kind of defaults and thousands of crores in losses were not a new thing in India at all. In May, 2023, “Go First” has decided to file for bankruptcy[1]. But even “Go First India” was and still is struggling but somehow bankruptcy turned out to be a good thing for them and they are still in business. The question is how is this even possible?

India was facing a banking crisis in 2017 and 2018 because our banks were having thousands of crores in bad debt[2]. So, India was in such a critical situation that while on one hand our banks had thousands of crores in bad debt, we also had giant companies that were failing in such a way that the employees lost their jobs, creditors lost their money, and the shareholders lost their share value. This is the reason why in 2016 our former Finance Minister Arun Jaitley made an iconic announcement where he announced something called the Insolvency and Bankruptcy Code[3]. This one code alone has been so revolutionary for India, that it has saved 3.16 lack crores for our banks[4]. It has saved lakhs of job losses[5] and most importantly, today it has become one of the most important pillars of the Indian economy. This is the reason why if someone is a law student or an economic student, this Indian Bankruptcy Code is by far one of the most important policies they will ever study. So in this blog let’s try to understand that:-

1. What were the problems that were haunting the Indian banking system?
2. What is this Indian Bankruptcy Code?
3. Why is it considered to be one of the most revolutionary policies in Indian history?
4. How has it benefited ordinary people?

Why Do Companies Declare Bankruptcy?

In simple words, if a company is unable to pay its vendors, Banks and employees or, if it has more liabilities than assets then, companies usually declare bankruptcy. But before 2016’s IBC, there were many laws and mechanisms that were governing the companies. In total there was seven acts as you can see in this chart[6].

And because of these acts, the system was extremely messy.

Understanding the Complexities of the System before IBC.

Understanding the complexities of the entire system that was in place before 2016 using a simple story.

Let’s say “A” live in a large Housing Society with many apartments, common areas and Facilities. This Society is governed by multiple committees and each committee is responsible for different aspects of the society. So the garden committee is responsible for the gardens and the play area. The maintenance committee is responsible for making the building look neat and clean and the security committee is responsible for the safety of the citizens. Each committee is equally powerful as the other so the security committee cannot overrule the garden Committee just because they have a stupid name. But now there is a critical problem in the society, as it turns out there is a major water leak that is extremely dangerous for the structure of the building. If this water leak is not fixed, the building itself might collapse. As soon as this announcement is done, the garden commit is worried about the water coming into the gardens so they divert the water towards other areas of the society which then seeps into the foundation of the building which is making the building even more weaker. The maintenance committee does not have the engineering expertise so all they do is they apply POP to all the cracks in the building, so that the building looks neat and clean which is their job. The security committee is extremely worried about the safety of the citizens so what they do is they evacuate everyone from the building immediately saying that the building is going to collapse.

[Image Sources: Shutterstock]

Ultimately while all these committees were engaged in doing the right thing according to their job description, nobody is actually fixing the actual problem which is the water leak in the building. And since all these committees are equally powerful, the garden committee cannot command the maintenance committee to go and fix the leak. Similarly, the security committee cannot stop the garden committee from diverting the water. So eventually what happens, the building collapses and instead of spending a few lakhs into fixing the water leak because of this lack of direction and chaos, the residents faced crores in losses and they lost their houses.

Seeing this system from a macro standpoint, what does this system look like? It is a multi- department system where the departments act on their respective problem individually but do not solve the root cause of the problem, right? This is exactly how our bankruptcy system functioned before 2016 whereby just like the garden committee, maintenance committee and the security committee, India had the civil code, the debt recovery tribunal, and the company law board. So, the customers and the employees would go to the Civil Court, the investors would go to the company law board and the banks would go to the debt recovery tribunal. And there was seven acts that could be used to solve specific problems in the company.

While the Civil Court would handle claims like unpaid salaries or contracts, the debt recovery tribunal will only focus on loan recovery and lastly the company law board will work on resolving the disputes related to the rights of the shareholders. All three entities work individually in different angles but somehow nobody would focus on the root cause of the problem which is the financial distress of the company. Therefore, just like the building collapsed, the company would collapse and shutdown, the employees would lose their jobs, creditors would lose their money, and the shareholders will see their share value collapse to the ground. Therefore, nobody gets anything good out of this issue.

In fact in the real world, the problem was so complicated that in most cases the employees and banks would just let the company fail and still not complain at all. Why? Because if an employee went to the court the case remained pending for several years. If the banks registered a complaint then they were asked to show their bad loans record which was again dangerous for their shareholders and for their reputation. So it was just too messy and extremely complicated.

This is the reason why hundreds of companies in India faced a terrible end to their story, thousands of people lost their jobs, shareholders witnessed millions of dollars in losses and most importantly the creditors lost billions of dollars in this process and because of this and several other problems in our banking sector we were at the brink of a banking crisis in 2018. Therefore,  this problem was so critical that it used to take us 4.3 years on an average to resolve an insolvency[7] and if you look at a recovery rate it was just 26 cents on the dollar[8]. So if 1 lakh crores got stuck in these companies, we were only able to recover 26% or just 26,000 crores and 74,000 crores would just go down the drain. This is the reason why in 2016, the NDA government introduced something called the IBC or Insolvency and Bankruptcy Code. This was such a revolutionary concept that after 2016, India had done such an incredible job that their recovery rate by 2021 had shot up to 71.6 cents on the dollar[9]. So in 2021, if 1 lakh crore got stuck, we were recovering 71,500 crores, that is a 45,600 crores jump per 1 lakh crores in value.

Framework of The IBC

The question over here is what is so revolutionary about this Indian Bankruptcy Code and how did it cause such a drastic difference in our recovery? The answer to this lies in this framework of IBC.

So, let’s understand each step in simple words to understand the gist of the matter:-

1. Step 1 is Initiation- This initiation can be done by both operational creditors like company, employees or vendors and by Financial creditors like Banks or NBFCs. In fact anyone whom the company owes 1 crore can initiate the insolvency process in the NCLT or the National Company Law Tribunal.
2. Step 2 in this process just like the central authority of the Housing Society goes out there and examines the intensity of the problem and then decides to take action. In IBC, the NCLT examines if all the criterias are met to initiate the process of insolvency and then, the process of insolvency starts.
3. Step 3, Now, once this process starts, the companies put under something called the “Moratorium Period”, that means no legal action can be taken against the company during this period. So creditors cannot informally take any decision to recover their money during this moratorium period.
4. Step 4, during the same time there is a professional person called the “Interim Resolution Professional” or IRP who is appointed. This person is appointed by the NCLT and he will be responsible for the entire process of resolution. Now, this person is an Interim Resolution Professional, as in this post is temporary and during this entire time the control of the existing management is suspended.
5. Step 5, this IRP will ask all the banks to show proof as to how much does every bank have to recover? how much money is pending? and so on. Similarly, he will also go on to ask the vendors to tell him how much money is pending from the company and then based on this, the IRP forms a committee of creditors. Then these creditors appoint a resolution professional, this guy will handle the rest of the procedure. So both the committee of creditors and the resolution professional will keep the business operations running and now the control of the company will no longer remain with the promoter. These people will make sure that they pay all the vendors, they will pay the salaries to the employees and they will keep the operations of the company running.

Therefore, unlike before 2016, where the entire company is practically paralyzed, here, the companies kept running so that the revenue is still being generated in the company.

And this is why the game actually changes because the company keeps running instead of shutting them down with cases. 

The Solution IBC Brought

When the company is running there are two options of handling this situation:-

1. The first option is the CRIP process or Corporate Insolvency Resolution Process-whereby the resolution professional could find a buyer to sell the company off and then recover their debt. So, the creditors of Kingfisher could simply sell Kingfisher to Indigo or Air India and then recover their debt. And when this buyer comes in, the parties might actually come together for something called “debt restructuring” and this is done so that the company could become a sensible value proposition for the buyer. So, if Kingfisher gets caught up with a debt of 500 crores at a 12% interest to be paid in 10 years, then the creditors might come together and restructure the debt in such a way that they would decrease the interest to 6% and extend the tenure to 20 years. So this way in the first case while the company had to pay 71 lakhs per month in instalment after the restructuring they just have to pay 35 lakhs in instalment. This way, instead of losing the entire 500 crores, the creditors can take a haircut on their profit margin. And then after the company becomes financially lucrative, it can be sold and taken over by the new management.
2. But if there are no buyers at all, they can simply liquidate the company, sell the company’s assets and then use the money to pay off their debts. This is done after 180 days of the resolution process and could be stretched at max to 270 days. In simple words, if Kingfisher has three aircrafts worth 100 crores and an office worth 30 crores, then, they can sell these as to other companies and then recover 330 crores right away and take an exit now.

Notice that in all these cases, the company is functioning, the employees are paid, the vendors are retained and the creditors get their money. Otherwise in the first case, if the company simply shuts down due to pending bills and court cases then nobody gets anything. This is how the process of liquidation of sale is carried out in such a way that all the stakeholders get an exit.

Real life story as how IBC was implemented and thousands of crores were saved.

A classic story back in 2017, there was a company called “Bhushan steel”, and this company was suffering due to high debt, operational inefficiencies, and bad market conditions.

In total, if you see this graph, their total debt shot up from 15,000 crore in 2011 to 55,000 crore in 2017 and just the overdue principle and interest stood at 8,000 crores. This was an alarming situation. In 2017, the RBI clearly identified 12 large accounts that were in default and asked the lenders to file an application for corporate insolvency. The creditors submitted total claims amounting to 62,000 crore, then the IRP accepted claims worth 57,505 crores. Eventually, since they kept the company running, Tata Steel came in bid for Bhushan Steel and Tata Steel acquired 72.6 5% stake for a total of 35,200 crores which was around $5 billion. So in total, the creditors recovered 68% of their money[10] because instead of shutting down, Bhushan Steel was kept running until the Tatas could acquire it. Therefore, in just 1 year, Tata officially acquired Bhushan Steel through the insolvency resolution process. This is how the overall bankruptcy process in India after IBC increased our rate of recovery from 26.5% to 71.6% in 2021 and the time taken for resolving this insolvency reduced significantly from 4.3 years all the way down to 1.6 years till 2021[11].

IBC Is a Superpower for India

This revolutionary process brought in 3 incredible superpowers for India:-

1. Ease of doing business – It improved India’s ease of doing business. Now more investors are interested in investing in India because they know that even if the company does not perform, the insolvency can save their money from burning.
2. Cheap debt- So before IBC, companies had to pay high interest on loans because the lenders are worried that they wouldn’t get their money back if the company went bankrupt. But now the lenders are more confident because they be able to recover their money if something goes wrong using the IBC procedure.
3. Lastly, these thousands of crores that the banks were losing, it was not just the bank’s money but it was your money and my money which were deposited with the banks. Therefore, if a bank goes down, our deposits will go down with the bank. So in this context, IBC acted as a saviour for thousands of crores of depositors money.

This is how the Indian bankruptcy code has drastically changed the way Indian businesses fail and eventually saved jobs, money and the economy of India.

Challenges Faced By IBC

Today in 2024. IBC is facing three major challenges and if someone’s in the legal system have a look at the challenges:-

1. Even though the number of days for the entire process is expected to be less than 324 days, this number has now shot up to 653 days as of 2023[12]. Now even though this number is a drastic improvement from 1,570 days in 2017, the legal committee need to look into this matter, so that they can decrease the time of this process from 653 days to again less than 200 days. Because the competition is not the old version of India, the competition is at the international level with some of the biggest countries with some of the most advanced legal procedures in the world.
2. Secondly, India have very less judges[13] and less experienced judges[14] to handle these complex insolvency cases.
3. This gives rise to the third challenge whereby the average recovery rate has gone down to 32% on an average[15] and this is majorly because we have less judges to process these cases which again points towards a very big legal bottleneck in India.

This is a story of IBC, the problems it solved, the solutions it brought and the challenges that it is facing in 2024.

Author: Devansh Aeron, in case of any queries please contact/write back to us via email to chhavi@khuranaandkhurana.com or at  Khurana & Khurana, Advocates and IP Attorney.

[1] https://www.aljazeera.com/economy/2023/5/2/indias-go-first-airline-files-for-bankruptcy

[2] https://www.thebanker.com/The-state-of-play-India-s-banks-in-2017-1499068824

[3] https://www.business-standard.com/article/economy-policy/arun-jaitley-orders-immediate-action-towards-implementation-of-bankruptcy-code-116082301177_1.html

[4] https://www.business-standard.com/companies/news/missed-timelines-manpower-crunch-pose-challenges-for-insolvency-resolution-123123000184_1.html

[5] https://economictimes.indiatimes.com/industry/banking/finance/banking/view-indias-insolvency-law-as-creator-of-jobs/articleshow/69167701.cms?from=mdr

[6] https://blog.ipleaders.in/laws-on-insolvency-before-and-after-the-ibc/

[7] https://indianexpress.com/article/opinion/editorials/express-view-bankruptcy-codes-loose-ends-9047706/

[8] https://pib.gov.in/PressReleasePage.aspx?PRID=1775096#:~:text=The%20Union%20Minister%20of%20Commerce,insolvency%20resolution%20in%20the%20country.

[9] Ibid

[10] https://www.thehindubusinessline.com/companies/barring-essar-steel-and-bhushan-steel-recovery-from-top-7-ibc-cases-dips-to-34-per-cent/article30034344.ece

[11] https://prsindia.org/policy/report-summaries/implementation-of-insolvency-and-bankruptcy-code-pitfalls-and-solutions

[12] https://www.thehindu.com/business/falling-recovery-rates-and-increase-in-resolution-time-dent-ibcs-success-says-crisil/article67570542.ece

[13] https://www.businesstoday.in/latest/corporate/story/nclt-judges-bankruptcy-insolvency-ibc-104231-2018-04-25

[14] https://www.moneycontrol.com/news/business/nclt-is-finding-it-tough-to-get-qualified-judges-for-insolvency-cases-2366065.html

[15] https://www.thehindubusinessline.com/companies/ibc-recovery-rates-have-fallen-even-as-average-resolution-time-has-increased-crisil-ratings/article67569134.ece