Indian Economy for IAS by Pratik Gupta

2023-24

INSOLVENCY & BANKRUPTCY CODE (IBC) 2016

In a growing economy like India, a healthy credit flow and generation of new capital are essential,
and when a company or business turns insolvent or “sick”, it begins to default on its loans. In
order for credit to not get stuck in the system or turn into bad loans, it is important that banks or
creditors are able to recover as much as possible from the defaulter and as quickly as they can.

The business can either get a chance, if still viable, to start afresh with new owners, or its assets
can be liquidated or sold off in a timely manner. This way fresh credit can be pumped into the
system and the value degeneration of assets can be minimised.

In 2016, at a time when India’s Non-Performing Assets and debt defaults were piling up, and older
loan recovery mechanisms such as the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act (SARFAESI), Lok Adalats, and Debt Recovery Tribunals were
seen to be performing badly, the Insolvency and Bankruptcy Code (IBC) code was introduced to
overhaul the corporate distress resolution regime in India and consolidate previously available
laws to create a time-bound mechanism with a creditor-in-control model as opposed to the
debtor-in-possession system.

When insolvency is triggered under the IBC, there can be two outcomes: resolution or liquidation;
all attempts are made to resolve the insolvency by either coming up with a restructuring or new
ownership plan and if resolution attempts fail, the company’s assets are liquidated.

How it’s working?

The new law created a new class of Insolvency Professionals who will help sick companies and
banks with a smooth takeover of the insolvent company and manage the liquidation process.

The Code proposed setting up of an entity, the Insolvency and Bankruptcy Board of India (IBBI),
which regulates insolvency professionals and information companies — those which will store all
the credit information of corporates.

The Bankruptcy Code provided two authorities to deal with insolvency. The National Company
Law Tribunal will adjudicate cases for companies and limited liability partnerships, while the Debt
Recovery Tribunal will do the same for individual and partnership firms.

How Will a Company Be Liquidated?

When a corporate debtor (CD), or a company which has taken loans to run its business, defaults on
its loan repayment, either the creditor (a bank or an entity that has lent money for operational
purposes) or the debtor can apply for the initiation of a Corporate Insolvency Resolution Process
(CIRP) under Section 6 of the IBC. Earlier, the minimum amount of default after which the creditor
or debtor could apply for insolvency was ₹1 lakh, but considering the stress on companies amid the
pandemic, the government increase the minimum amount to ₹1 crore.

To apply for insolvency, one has to approach a stipulated adjudicating authority (AA) under the
IBC— the various benches of the National Company Law Tribunal (NCLT) across India are the
designated AAs.

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The Tribunal has 14 days to admit or reject the application or has to provide a reason if the
admission is delayed. The CIRP or resolution process begins once an application is admitted by
the AA. The amended mandatory deadline for the completion of the resolution process is 330
days.

Once the application is admitted, the AA appoints an interim resolution professional (IRP),
registered with an insolvency professional agency (IPA). IRPs could be experienced and
registered chartered accountants, company secretaries, lawyers and so on. Once appointed by the
Tribunal, the IRP takes control of the defaulter’s assets and operations, collects information about
the state of the company from Information Utilities (repositories keeping track of the debtor’s
credit history), and finally coordinates the constitution of a Committee of Creditors or a CoC.

A CoC, comprising all (unrelated) financial creditors of a defaulting company, is the most
important business decision-making body in every CIRP, as it decides whether the defaulting
company is viable enough to be restructured and given a fresh start, or liquidated. It also appoints
an insolvency professional (IP), who can either be the same as the IRP or a new professional, who
looks after the operations of the company during the CIRP.

The IP invites and examines proposals for a resolution plan for a company, which could include
restructuring of debt, merger or demerger of the company. It submits eligible plans to the CoC,
which can approve a plan if it receives 66% of the voting share of committee members. If the CoC
fails to approve any resolution plan, the company goes for liquidation.

If a plan is approved, the CoC submits it to the Tribunal (before the maximum 330-day deadline),
which then approves the plan which the debtor is bound to implement. The AA can also reject a
plan.

How Much Time Will the Law Save?

The IBC was touted as a time-bound mechanism in the face of the often laggard states of older
mechanisms. Timeliness is key here so that the viability of the business or the value of its assets
does not deteriorate further. The IBC initially stipulated a 180-day deadline to complete the
resolution process, with a permitted 90-day extension.

The IBC was subsequently amended to further make the total timeline for completion 330 days—
almost a year. While in 2018, when the timeline was 180+90 days, most cases (from companies that
owed less than ₹50 crore to those which owed more than ₹1000 core) were completed in under 300
days. However, in FY22, it took 772 days to resolve cases involving companies that owed more than
₹1,000 crore. The average number of days it takes to resolve such cases increased rapidly over the
past five years.

Besides, when a resolution happens, it is envisaged that creditors can realise the maximum value
of the outstanding claims. On the other hand, when liquidation takes place, it is a piecemeal selling
of the company’s assets. This means the value realisable through resolution should be more than
through the last resort of liquidation.

But the gap between these two values has been narrowing over the years, and in the last quarter of
2022, the amount realised fell below what the assets would have fetched if they were liquidated.

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Haircuts under IBC

A haircut is the debt foregone by the lender as a share of the outstanding claim. The Parliamentary
Stan-ding Committee on Finance pointed out in 2021, that in the five years of the IBC, creditors on
an average had to bear an 80% haircut in more than 70% of the cases.

What recommendations have been made by experts and judicial authorities?

In order to address the delays, the Parliamentary Standing Committee suggested that the NCLT
should not take more than 30 days after filing, to admit the insolvency application and transfer
control of the company to a resolution process. Citing the more than 50% vacancy in the Tribunal
compared to the sanctioned strength, it suggested recruitment in advance based on the projected
number of cases.

It also recommended the setting up of dedicated benches of the NCLT for IBC cases. To reduce
case-loads, the Committee suggested that the pre-packs option be extended to all corporates after
review. This is because, under PIRP, unlike CIRP, the debtor continues to manage company
operations during the resolution process.

The IBBI has also called for a new yardstick to measure haircuts. It suggested that haircuts not be
looked at as the difference between the creditor’s claims and the actual amount realised but as the
difference between what the company brings along when it enters IBC and the value realised. It
asserts that a company may have already deteriorated significantly in value by the time it comes
under the Code’s process, so the value realised should pertain to the company’s existing assets
and not previous assets.

Some Important Terms related to IBC 2016 (Economic Survey 2018-19)

Inter-Creditor Agreement- अंतर-लेनदार समझौता ICA Framework is part of project ‘Sashak’. Under
it, lead lender (having highest exposure) will be authorized to formulate resolution plan for
operation turnaround of assets which will be presented to lenders for their approval. It will be
applicable to all corporate borrowers who have availed loans and financial assistance for
amount of Rs. 50 crore or more under consortium lending or multiple banking arrangements.
Each resolution plan will be submitted by lead lender to Overseeing Committee.

Prudential Framework for Resolution of Stressed Assets - The new guideline on resolution of
stressed asset is called Prudential Framework for Resolution of Stressed Assets Directions 2019.
It is a set of guidelines to banks for tackling their stressed assets. Significance of the Prudential
Framework is that it replaces the previous controversial/stringent and Supreme Court
squashed stressed asset resolution guidelines published in February 2018.

Corporate insolvency resolution process (CIRP)- Corporate Insolvency Resolution Process is a

recovery mechanism for creditors. If a corporate becomes insolvent, a financial creditor, an
operational creditor, or the corporate itself may initiate CIRP.

After making an application then CIRP is initiated. CIRP is the process through which it is
determined whether the person who has defaulted is capable of repayment or not.

Corporate Debtors - A corporate debtor under Insolvency and Bankruptcy Code, 2016 (IBC) is
the Corporate Person who owes a debt to any person. Corporate person is defined u/s 3(7) of
IBC which include

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• Companies defined Companies Act

• LLP defined under LLP Act
• Any other person incorporated with limited liability
But does not include financial services provider i.e. banks or NBFCs.

Operational Creditors - Operational creditor refers to a person to whom an operational debt is

owed and includes any person to whom such amount has been legally assigned or transferred
for goods or services done by them. Vendors and suppliers, employees, government etc. are
examples of operational creditors.

Financial Creditors - Financial creditor refers to any person to whom a business debt is owned
or a person to whom such amount is legally assigned or transmitted. Banks or other financial
institutions are examples of financial creditors.

National e-Governance Services Limited (NeSL)- NeSL is India’s first Information Utility and is
registered with the Insolvency and Bankruptcy Board of India (IBBI) under the aegis of the
Insolvency and Bankruptcy Code, 2016 (IBC). The company has been set up by leading banks
and public institutions and is incorporated as a union government company. The primary role of
NeSL is to serve as a repository of legal evidence holding the information pertaining to any
debt/claim, as submitted by the financial or operational creditor and verified and authenticated
by the other parties to the debt.

NeSL’s role is to facilitate time-bound resolution by providing verified information to

adjudicating authorities that do not require further authentication.

Global Restructuring Review (GRR)- GRR is a daily information service providing cross-border
insolvency and restructuring news, features and events.

Their mission is to keep the subscribers of GRR at the forefront of the international
marketplace, and to provide clear reports and analysis covering all the developments that
matter.

BAD BANK

What is National Asset Reconstruction Company Limited (NARCL)? Who has set it up?

NARCL has been incorporated under the Companies Act and has applied to Reserve Bank of
India for license as an Asset Reconstruction Company (ARC). NARCL has been set up by banks to
aggregate and consolidate stressed assets for their subsequent resolution. PSBs will
maintain51% ownership in NARCL.

What is India Debt Resolution Company Ltd. (IDRCL)? Who has set it up?

IDRCL is a service company/operational entity which will manage the asset and engage market
professionals and turnaround experts. Public Sector Banks (PSBs) and Public FIs will hold a
maximum of 49% stake and the rest will be with private sector lenders.

Why is NARCL-IDRCL type structure needed when there are 28 existing ARCs?

Existing ARCs have been helpful in resolution of stressed assets especially for smaller value
loans. Various available resolution mechanisms, including IBC have proved to be useful.

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However, considering the large stock of legacy NPAs, additional options/alternatives are needed
and the NARCL-IRDCL structure announced in the Union Budget is this initiative.

Why is a Government Guarantee needed?

Resolution mechanisms of this nature which deal with a backlog of NPAs typically require a
backstop from Government. This imparts credibility and provides for contingency buffers.
Hence, GoI Guarantee of up to Rs 30,600 crore will back Security Receipts (SRs) issued by
NARCL. The guarantee will be valid for 5 years. The condition precedent for invocation of
guarantee would be resolution or liquidation. The guarantee shall cover the shortfall between
the face value of the SR and the actual realisation. GoI’s guarantee will also enhance liquidity of
SRs as such SRs are tradable.

How will NARCL and IDRCL work?

The NARCL will acquire assets by making an offer to the lead bank. Once NARCL’s offer is
accepted, then, IDRCL will be engaged for management and value addition.

What benefit do banks get from this new structure?

It will incentivize quicker action on resolving stressed assets thereby helping in better value
realization. This approach will also permit freeing up of personnel in banks to focus on
increasing business and credit growth. As the holders of these stressed assets and SRs, banks
will receive the gains. Further, it will bring about improvement in bank’s valuation and enhance
their ability to raise market capital.

Why is it being set up now?

Insolvency and Bankruptcy Code (IBC), strengthening of Securitization and Reconstruction of

Financial Assets and Enforcement of Securities Interest (SARFAESI Act) and Debt Recovery
Tribunals, as well as setting up of dedicated Stressed Asset Management Verticals (SAMVs) in
banks for large-value NPA accounts have brought sharper focus on recovery. In spite of these
efforts, substantial amount of NPAs continue on balance sheets of banks primarily because the
stock of bad loans as revealed by the Asset Quality Review is not only large but fragmented
across various lenders. High levels of provisioning by banks against legacy NPAs has presented
a unique opportunity for faster resolution.
Is the guarantee likely to be invoked?

Government guarantee will be invoked to cover the shortfall between the amount realised from
the underlying assets and the face value of SRs issued for that asset, subject to overall ceiling of
₹30,600 crore, valid for 5 years. Since there shall be a pool of assets, it is reasonable to expect
that realisation in many of them will be more than the acquisition cost.

How will Government ensure faster and timely resolution?

The GoI guarantee will be valid for five years and condition precedent for invocation of
guarantee will be resolution or liquidation. Further, to disincentivize delay in resolution, NARCL
has to pay a Guarantee fee which increase with passage of time.

What will be the capital structure of NARCL and how much will Government contribute?

Capitalization of NARCL would be through equity from banks and Non-Banking Financial
Companies (NBFCs). it will also raise debt as required. The GoI guarantee will reduce upfront
capitalization requirements.

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What will be NARCL’s strategy for resolution of stressed assets?

NARCL is intended to resolve stressed loan assets above ₹500 crore each amounting to about ₹
2 lakh crore. In phase I, fully provisioned assets of about Rs. 90,000 crores are expected to be
transferred to NARCL, while the remaining assets with lower provisions would be transferred in
phase II.