The proposed code is a step in the right direction to bring about clarity in the legal framework and certainty and predictability in restructuring of debt and insolvency.
The one thing, which is commonly heard in the corridors of the financial world, is the looming concern as regards the huge NPA that banks are currently saddled with. Long drawn processes pertaining to insolvency has taken a toll on the credit realization in the country. The level of NPAs is alarming, unmanageable and stalling the growth of the credit market. This situation has arisen largely due to lack of robust legal and regulatory framework supporting a clear and cohesive action with respect to restructuring; debt recovery and security enforcement; and insolvency. Timely resolution of these matters are essential for easy access to credit. Without a healthy credit market, Make in India may not be realised to its optimum. With an objective of an overhaul and providing the required impetus to the credit market, the task to draft a suitable legal framework was assigned last year to the Bankruptcy Law Reforms Committee (Committee) chaired by Dr. T K Viswanathan. The committee submitted its report in November 2015, along with an Insolvency and Bankruptcy Code. This proposed code was tabled before the Lok Sabha in the winter session.
Existing Legal Framework Restructuring
A revival and rehabilitation (R&R) of industrial corporates is required to be implemented under Sick Industrial Companies (Special Provisions) Act, 1985 (SICA) by Board for Industrial and Financial Reconstruction (BIFR). A company can make reference for R&R under SICA, when it is deemed to be a sick company, i.e., the net worth of the company is entirely eroded. In connection with this reference, BIFR appoints an operating agency who presents an R&R scheme. The BIFR has power to either approve the R&R scheme or recommend winding up as per the Companies Act. Even before the industrial borrower becomes ´sick´, the lenders can consider debt restructuring for any corporate under the mechanisms prescribed by Reserve Bank of India (RBI), namely, Corporate Debt Restructuring (CDR) and Joint Lenders Forums (JLF) mechanisms. More recently, the RBI has permitted the lenders to acquire control of the debtor at the discretion of the lenders under a new framework commonly known as Strategic Debt Restructuring (SDR).
Recovery of Debt and Security Enforcement
The lenders can initiate recovery of their debt by approaching the Debt Recovery Tribunals (DRTs) under the Recovery of Debt Due to Banks and Financial Institutions Act, 1993 (DRT Act). Further, the secured creditors have been granted the right to enforce security without intervention of court under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act). For any issue arising under the SARFAESI Act, the DRT is the forum for adjudication. However, the remedies under the DRT Act and the SARFAESI Act are only available to the banks and notified financial institutions. Other creditors can only file civil suits in civil courts for recover of debt and enforcement of securities.
A liquidation/winding up of a company is governed by the Companies Act under the jurisdiction of the relevant High Court. A winding up petition under the Companies Act can be filed by any stakeholder for various reasons including debt default.
Issues with the Existing Legal Framework
The separate laws and the existence of various judicial forums for considering matters of restructuring, debt recovery and winding up have given rise to multitude of issues. Two major issues being conflict of laws and multiplicity of proceedings result in undue delays in recovery and liquidation. While the banks and financial institutions initiate recovery under the DRT Act and the SARFAESI Act, other creditors file summary suits and winding up petitions. Also, certain earnest attempt of restructuring under BIFR, CDR and JLF get impacted if the debt recovery and winding up proceedings run in parallel.
The reasons of the conflicts between SICA and debt recovery laws stem from the objectives of these laws. The primary objective of SICA is revival and rehabilitation of sick industrial companies. The DRT Act and the SARFAESI Act have been enacted with main objectives of assisting the lenders for expeditious recovery of debts and enforcement of security interest. Section 22 of the SICA provides for moratorium on all legal proceedings. Thus, under SICA, the revival of sick company takes precedence over debt recovery rights of creditors. Similarly, Section 34 of the DRT Act gives overriding effect to it over other legislations.
Thus, the scheme of SICA and the scheme of the DRT Act and the SARFAESI Act work in opposite directions, often raising questions of interplay and giving rise to conflict. The interplay of these provisions came for adjudication recently in 2014 before the Supreme Court in KSL Industries vs. Arihant Threads Ltd . In this Supreme Court observed that in the event of conflict between overriding provision of Section 22 of the SICA which purports to make proceedings for recovery of the debt against the sick company untenable and Section 34 of the DRT Act, the provisions of SICA shall prevail. This was decided on the consideration that R&R efforts should take priority over the recovery of debts.
SICA provides moratorium on all other legal proceedings once the reference is accepted by BIFR. However, under second proviso to Section 15 of SICA, the reference to BIFR cannot be made if the secured creditors have initiated action under the SARFAESI Act. Further, under third proviso to Section 15 of SICA, the reference which is pending can be abated if 75% of the secured creditors resolve so to initiate action under the SARFAESI Act. It is to be noted that there is no specific requirement of approval of 75% of the secured creditors under the said second proviso of Section 15. However, in Asset Reconstruction Co. India P. Ltd vs. Shamken Spinners Ltd , the Delhi High went a step further to interpret that the approval of 75% of the secured creditors will also apply if the reference to BIFR is to be prevented under the second proviso.
While, both DRT Act and the SARFAESI Act have been enacted to provide debt recovery rights to the lenders, the issues have arisen if two proceedings can be carried on simultaneously or if withdrawal of proceedings under the DRT Act is a condition precedent to taking recourse under the SARFAESI Act. While considering this issues, in Digivision Electronics Ltd. vs. Indian Bank , the Madras High Court held that as per Section 19 (1) of the DRT Act, the secured creditor is required to withdraw application pending before DRT to initiate action under the SARFAESI Act. However, in Transcore vs. Union of India , the Supreme Court took the opposite view holding that ´the remedies of enforcement of security interest under the SARFAESI Act and the DRT Act are complementary to each other and there is no inherent or implied inconsistency between these two remedies. Therefore, the doctrine of election of one proceeding over another has no application in this case.´
Whilst the informal restructuring under CDR, JLF and SDR finds support from the RBI as the same is implemented as per the guidelines prescribed by RBI, the success of the same often becomes difficult in scenarios where legal proceedings for debt recovery and winding up are initiated by other stakeholders including non-participating lenders.
It can thus be said that the restructuring exercise and recovery of debts including insolvency proceedings are required to be dealt holistically. The separate laws and legal forums give rise to friction between these proceedings, which promotes obstructionism by parties with vested interest and lead to undue delays in implementation. Further, availability of multiple remedies for different stakeholders give rise to multiplicity of proceedings, where one proceeding tend to work against another proceeding i.e. winding up and debt recovery. In an attempt to deal with these issues, it is proposed to replace the existing formal restructuring and insolvency framework with the Proposed Code.
Proposed Insolvency and Bankruptcy Code
The entire foundation of the Proposed Code is on two pillars i.e. insolvency resolution process (IRP) and liquidation process. IRP refers to an attempt at restructuring of debt where the creditors and debtor negotiate the possibility of restructuring of debt and viability of the debtor´s business as going concern.
This is akin to CDR/JLF framework of RBI in terms of process, but different for its requirement of mandatory participation of all creditors. If the negotiation process does not culminate in a concrete restructuring plan within 180 days, the debtor becomes subject to liquidation. The period of 180 days can be further extended by 90 days. Thus, the sword of liquidation is always hanging over the debtor if the debtor does not come to terms with the creditors.
The IRP can be initiated by a financial creditor, an operational creditor or by the debtor itself by making an application to the Adjudicating Authority.
A restructuring process can be fairly concluded if the business of the debtor is not affected by external factors. For this, the Proposed Code prescribes a declaration of moratorium, which prohibits any institution or continuation of litigation against the debtor, mandates maintenance of status quo of the assets by the debtor and requires the creditors to refrain from enforcing any security interest. During the resolution period, the entire management of the debtor and custody of the assets of the debtor are placed in the hands of a resolution professional to ensure the protection of the assets of the debtor. Thus, all secured creditors are required to make an attempt to find out solution before they resort to enforcement of their security.
The proposed code is a step in the correct direction to bring about clarity in the legal framework and to bring out certainty and predictability in processes involved in restructuring of debt and insolvency. In our view, certain aspects which require consideration to bolster the Proposed Code are discussed below.
The Proposed Code provides for a law for a restructuring mechanism and liquidation process and a special adjudication forum. The legal framework for security enforcement and recovery of debt will continue to be governed under the SARFAESI Act and the DRT Act, where DRTs will be adjudication forums. Winding up for various reasons except for debt default will continue to be governed by the Companies Act, 2013. The three aspects namely (i) restructuring; (ii) debt recovery and enforcement of security; and (iii) liquidation have to be dealt cohesively and not in a manner that leads to interpretational issues arising out of interplay of one enactment vis-a-vis the others and give rise to multiplicity of legal proceedings before different forums. A restructuring and insolvency law may not function well where conflicts between the recovery of debt and the insolvency resolution are considered by separate forums under different laws. Though, the Proposed Code contemplates the recognition of moratorium under the DRT Act and the SARFAESI Act by way of necessary amendments thereto Such amendments may not be sufficient for resolution of friction between laws and forums, where different forums have separate mandates and their ways often cross each other.
Therefore, in our view, we need a composite law governing the restructuring; debt recovery and security enforcement; and liquidation including a common forum to address these issues. Infact, the DRT Act, the SARFAESI Act and winding up provisions of the Companies Act, 2013 should be subsumed under the Proposed Code.
NCLT as Adjudication Forum
It is proposed that National Company Law Tribunal (NCLT) should play the role of the Adjudicating Authority for corporates´ insolvency. NCLT will be set up as adjudication forum for various subject matters under the Companies Act, 2013 which are currently handled by Company Law Boards (CLB). Liquidation/winding up is only one of them. Further, NCLT will also be vested with jurisdiction over LLPs under the Limited Liability Partnership Act, 2008. Considering this and the number of matters already pending before the CLB, it is fair to assume that NCLT would be burdened with a lot of work. It may be therefore be advisable to establish an adjudication forum which exclusively deals with restructuring, credit recovery and insolvency matters and achieves expertise without any hangover of the past.
Time-bound Disposal of Appeals
The Proposed Code prescribes strict timelines for insolvency resolution process. The insolvency resolution process and liquidation process will be supervised by NCLT. The appeals from any order of NCLT will lie in National Company Law Appellate Tribunal (NCLAT) and then, in the Supreme Court. It is well known that the security enforcement and winding up matters usually become subject to appeals which take years to be discharged. Appellate forums are often used as delay tactics by estranged management to derail the entire recovery process. The Proposed Code does not put any timeline for disposal of such appeals. Though the Supreme Court cannot be made subject to a timeline due to its power under the Constitution of India, the NCLAT´s appellate power can be mandated to adhere to strict timelines for adjudication on appeals which will go a long way in substantially reduction of the time period for recovery and liquidation.
An efficient law on recovery and insolvency requires to strike a balance between enforcement of creditors´ rights and larger economic interest of revival of viable businesses. While viable business should not be allowed to be stripped and fragmented, the creditors cannot be left to suffer fools. The level of coherence between the legal frameworks for recovery, restructuring and liquidation determines such efficiency.
Ajay Shaw is a Partner while Ashish Pahariya is a Manager with DSK Legal, Advocates and Solicitors. The views expressed in this article are their own. Authors can be reached at firstname.lastname@example.org and email@example.com.