By Suraj Nangia, Partner and Sandeep Jhunjhunwala, Partner, Nangia Andersen LLP

In an attempt to overhaul the insolvency and bankruptcy regime, India had enacted the Insolvency and Bankruptcy Code 2016 (Code) on May 28, 2016. Introduction of the Code amidst the financial distress faced by the Indian banking industry was a bold but appreciated move. Prior to the enactment of the Code, the insolvency and stressed debt resolution was paralysed under legal regime including statutes of the likes of Sick Industrial Companies Act, Recovery of Debt Due to Banks and Financial Institutions Act and Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act. The major challenges in these incumbent systems were lack of clarity on jurisdiction, fragmented systems for debtors and creditors and related inefficiencies and inconsistencies. With IBC, these complex and multi-layered systems were replaced by a modern insolvency regime that is proactive, market led and time bound.

Though the Code has gone through a roller coaster of its own, it has been hailed as a paradigm shift in India’s insolvency regime in terms of its design and architecture. This is also reflected in the World Bank’s latest Doing Business Report, where India has moved up by 14 positions to 63^rd rank in Ease of Doing Business (EoDB) and remarkably, India’s ranking jumped 56 places to 52^nd rank in Resolving Insolvency index and recovery rate increased from 26.5 percent in 2018 to 71.6 percent in 2019. Also, time taken in recovery improved from 4.3 years in 2018 to 1.6 years in 2019.

Unsurprisingly, from its inception, the Code has encountered numerous challenges and bottlenecks but the Government and Regulator have been following a valiant approach in ironing out such issues. The Code has already undergone five rounds of legislative amendments which have been a breakthrough in reinforcing its primary objective. The Judiciary has displayed an extraordinary dynamism in providing necessary clarity and certainty for implementing the Code. As with many new laws, the Code and all subsequent amendments have been challenged on grounds of constitutional validity. The Supreme Court without losing a minute delivered a landmark judgement upholding the constitutional validity of the Code in its entirety in the case of Swiss Ribbons. Taking cue from the jurisprudence set by courts multiple amendments have been made to the Code since its inception. Home buyers who earlier did not have recourse against developers under the Code, now enjoy the status of financial creditors who can initiate insolvency proceedings. Although this amendment provides hope to homebuyers, the interest of developers was protected by adding an additional condition that such proceedings can be initiated only by a group of atleast 100 homebuyers or 10 percent of total allottees, whichever is lower. This new condition blighted the sentiments of homebuyers as it restricts any individualistic actions. While the courts have been setting the right precedent for this evolving law, there have been instances of contradictory rulings and rulings which were in opposition to the provisions of the Code. NCLAT in the case of Essar Steel India Limited held that claim of operational creditors claims should be considered at par with those of financial creditors and that the Committee of Creditors was not empowered to decide the manner in which claims of creditors are to be dealt with. This judgement is averse to the Code which prescribes a waterfall mechanism for settlement of creditors and prioritizes financial creditors over operational creditors. The NCLAT ruling created ambivalence and negative sentiments that was finally put to rest by a clarification issued under the Code.

The Government has been working tirelessly to plug loopholes and prevent stakeholders from exploiting the provisions of the Code. Amendments were made to prevent recalcitrant promoters from regaining control in the company by enforcing strict eligibility conditions for becoming a resolution applicant and introducing multiple layers of checks and safeguards. Immunity against prosecution for offences committed prior to the commencement of the insolvency resolution process was also provided to companies. In lines with the objective of the Code to encourage resolution over liquidation, amendments were made to mandate continuous supply of critical goods and services and non-terminations of licenses and permits due to insolvency.

A significant milestone in the journey of the Code was notification of rules and regulations for insolvency and bankruptcy of personal guarantor. Generally, personal guarantees and corporate debts go hand in hand, as loans with sizeable amounts are only advanced based on the personal guarantee given by the promoters. The new rules enable an effective forum to enforce the personal guarantees, providing a level playing field to the creditors. However, the rules coupled with divergent rulings on personal guarantors to corporate debtors have opened a floodgate of ambiguities and divergent interpretations. What still remains unclear is whether simultaneous proceedings against guarantors and principal borrowers are maintainable in law. A sword is left hanging over the head of the personal guarantor even after insolvency resolution process of the principal borrower has been completed and a resolution plan is approved. It will be interesting to see how these uncertainties relating to personal guarantors are settled by the Supreme Court. The process of liquidation is painstakingly long and causes undue hardships to all stakeholders. In order to expedite the insolvency process, the regulators amended the relevant regulations to enable liquidators to assign or transfer a ‘not readily realisable asset’ to any person in consultation with the stakeholders’ consultation committee. This is a welcome move as it allows specialised buyers with fat purses to acquire such assets resulting in quick monetization and relieves the liquidator of the obligation to invest time and expenses in realising these assets.

The timely steps taken by the Government, regulators and the judiciary helped the market embrace and accept the new law. As the Code was taking off to newer horizons, it was hit by COVID-19 turbulence. The unprecedented disruption of business activities and the global economic slowdown forced entrepreneurs and investors to ruminate on the possibility of a permanent shutdown. Lending a helping hand to businesses, the Government first announced the increase in payment default threshold for initiation of insolvency resolution process from INR 1 lakh to INR 1 crore and later suspended the insolvency proceedings for a period of 1 year for defaults committed on or after March 25, 2020. Interestingly, with regard to the enhanced threshold, the Kochi bench of NCLT in the case of Tharakan Web Innovations Pvt Ltd vs Cyriac Njavally held that March 24, 2020 notification is applicable prospectively and therefore insolvency proceedings can be initiated against the defaults having taken place before COVID-19 pandemic. Albeit, the Kerala High Court has stayed the said NCLT order.

Acknowledging the impact of COVID-19 on businesses, many countries including India have proactively taken measures to prevent corporates and individuals from tipping into the insolvency and bankruptcy net. Most countries suspended their insolvency provisions which when lifted may see a steep upward curve in the number applications filed for initiating a resolution process. It is pertinent for the Government to chart out transitional measures such as special window for out of court settlements, hybrid frameworks etc to smoothen the kickstart of the economy. As we head towards normalcy, the Regulators should refocus on introduction of a special frameworks for MSMEs, cross border insolvency, group insolvency and work towards collaborative thinking, process improvements and capacity building. Technology based management in the IBC ecosystem and capacity building could go a long way in shrinking the prevalent judicial overload.