Bankruptcy Code Dilemma and Challenges

Recent detailed order of June 13, 2022 of NCLT Allahabad in the matter of Rathi Graphic Technologies Limited Vs Rajkumar Rathi and Others, has tried to open up debate on appropriateness of the law introduced through the provisions of the Insolvency and Bankruptcy Code, 2016, in India, by observing that "we have departed from socialistic approach to capitalistic approach. Even the judiciary has adopted a hands-off approach based upon foreign jurisprudence qua economic legislation. In our view, there is urgent necessity to adopt a middle path i.e., somewhere between the creditors driven process and debtors in control process to really take care of interests of all stake-holders which include society at large".

In the light of observations of the Tribunal, we have tried to trace the history of the law to find out whether it was one of ideas or a well thought and considered action plan to deal with business failures and where the fault lies.

Tracing History Of The Law:

It was not one of the ideas to be tested, it was culmination of a journey which goes on.

Insolvency and Bankruptcy Code, 2016 (the Code) was introduced into the Indian Legal System to address challenges faced by entereprises in exiting business and to streamline the system dealing with business insolvency and insolvency of individuals. It was not as one of ideas that was sought to be experimented in India rather it was culmination of a long drawn process to arrive at a more effective way to tackle business failures.

Insolvency or Bankruptcy Law has been in practice for centuries. It is widely believed that the word 'bankruptcy' has its origin in Italian term 'banca rotta', which literally means 'break the bench'. A practice which was followed during medieval period in Europe. As per the practice on failure of a debtor to repay debt, creditors used to break the bench or counter on which the debtor used to do business. The law, as it gathered its root, was debtor centric as it focussed on debtor rather than the business. The law treated defaulters as criminals and provided penalties of default accordingly. Romans had most primitive way of dealing with the default under the Civil Law, which provided even death sentence and slavery as consequence of default. In England too, the Statute of Maribridge of 1267 provided for imprisonment for default. India, on the other hand, provided more civilised way to deal with the default. Ancient Hindu law passed on the obligation to repay the debt to son and to the people who inherited the estate of the deceased (Source: P N Sen, General Principles of Hindu Jurisprudence).

However, these were the situations where business activities were simple and moral standard high. As the business dealings grew complex, the law moved away from being a 'debtor' or 'crime' centric to more 'business centric'. English Bankruptcy Act, 1542 could be said to be a watershed event in evolution of the law as it provided two fundamental principles around which the modern bankruptcy law has evolved. It laid down the mechanism of collective approach in bankruptcy by way of 'appointment of a body of commissioners' and also 'compulsory administration and distribution of assets of defaulter among all the creditors on the basis of equality'. The law further developed and became 'business' centric in 1705 through the Statute of Ann of 1705 which for the first time provided mechanism for statutory discharge of debtor and finally the Act of 1883 laid the foundation for the modern concept of 'creditor in control' and management of the process of bankruptcy by the experts.

Indian Scenario:

Indian modern bankruptcy law has also followed a long process of evolution through recommendation by various committees such as J J Irani Committee, Tiwari Committee Report of 1984, Narasimham Committee report (1991), Sachar Committee Report (1978), the Eradi Committee report (2002). Eradi committee proposed two major recommendations to deal with a very slow judicial process: (i) creation of new company law tribunals and transferring adjudicatory jurisdiction from High Courts to these tribunals; and (ii) opening of the private market of liquidators for compulsory liquidation and finally, the Bankruptcy Law Reform Committee ("BLRC") headed by Shri T.K. Vishwanathan, which proposed the draft of Insolvency and Bankruptcy Code, 2015. It was followed up by the Report of the Joint Committee of the Indian Parliament on the draft bill and ultimately led to passing of the bill in the form of the Insolvency and Bankruptcy Code, 2016. Needless to mention that most of the provisions of the law are based upon English system and the UNCITRAL Legislative Guide which assimilated the best practices followed in different jurisdictions and which have succeeded in addressing the issue of business insolvency around the world.

Thus, great deal of history and evolution has gone into development of the modern law of Bankruptcy in India. While this may not be the end of evolution as the law has to keep pace with the development of business and forms it assumes. However, implementation of the law in India was not without challenges. Since 2016, Indian Judiciary, especially the Supreme Court had to interne time and again to re-emphasis on the basic principles underling the Code and this has led to passage of some landmark judgements.

The Dilemma:

The present discussion is focussed on the observations of Apex Court in the matter of Vallal RCK Vs SivaIndustries and Holdings Limited which was decided on June 03,, 2022 and National Company Law Tribunal, Allahabad order dated June 13, 2022 in the matter of Rathi Graphic Technologies Limited Vs Rajkumar Rathi and Others. As mentioned earlier, the Indian Apex Court has painstakingly focused on implementing the law in its spirit in the light of the scheme as conceived under the BLRC Report. This is reflected in series of judgements in cases of Swiss Ribbon, Essar Steel and many other landmark judgements. In its latest above mentioned judgement the Apex Court, while dealing with the powers of the adjudicating authorities under the Code has drawn emphasis form observations of the Supreme Court in the case of Arun Kumar Jagatramka Vs Jindal Steel and Powers Limited and Another, to the following effect: "….As we have noted earlier in the judgment, the IBC was introduced in order to overhaul the insolvency and bankruptcy regime in India. As such, it is a carefully considered and well thought out piece of legislation which sought to shed away the practices of the past. The legislature has also been working hard to ensure that the efficacy of this legislation remains robust by constantly amending it based on its experience. Consequently, the need for judicial intervention or innovation from NCLT and NCLAT should be kept at its bare minimum and should not disturb the foundational principles of the IBC....."

As against the above, following passage from the National Company Law Tribunal, Allahabad order dated June 13, 2022 is interesting, "Thus, it may not be a theoretical statement to state that in this process we have departed from socialistic approach to capitalistic approach. Even the judiciary has adopted a hands-off approach based upon foreign jurisprudence qua economic legislation. In our view, there is urgent necessity to adopt a middle path i.e., somewhere between the creditors driven process and debtors in control process to really take care of interests of all stake-holders which include society at large. From the recent developments which have been taken note of in our order, we hope that it will happen sooner."

While the Apex Court has been cautioning and emphasizing on the limited jurisdiction that NCLTs exercise in the context of the Scheme under the Code, Adjudicating Authorities, on the other hand, appear to be still grappling with understanding of the issues in its context. This, perhaps show the dilemma that quasi-judicial bodies show under Indian context. This recurring problem under the Indian judicial process also confirm the finding of Dr. Kristin van Zwieten on the corporate insolvency law reform in India to the effect that "The relationship between the NCLT and the superior courts should be closely monitored and subject to ongoing review. Like the BIFR, the National Company Law Tribunal (NCLT) is intended to deliver a swift resolution where the High Courts have failed to do so (for example, in company liquidation cases). The ability of the NCLT to deliver this will presumably depend on, among other things, its ability to be insulated from merits review by the superior civil courts. Otherwise, there would appear to be a risk of significant delays while the merits of decisions are re-agitated in other fora, and stakeholders may be perversely incentivised to litigate to achieve such delays."

The Challenges

This dilemma of the quasi-judicial process, is perhaps also the reason why after more than years of implementation of the Code, the system is still grappling with challenges which has led to massive pendency with NCLTs. As per the figures published by IBBI in January-March, 2022 issue of 'Insolvency and Bankruptcy News', as on March, 2022 about 1852 applications for corporate insolvency were pending and more than one thousand cases under liquidation process (both corporate liquidation and voluntary liquidation). These figures do not take into consideration the numerous interlocutory applications pending in such matters and applications filed for personal insolvency and litigations and cross litigation going on in that sphere of the law. The figures in the above IBBI Journal also reveal that only in 14% of the CIRP applications the process culminated through normal process by way of approval of resolution plan and in 47% of the cases ended up in liquidation. Withdrawal of the process also account for about 17% of cases. Further, about 66% of the cases took more than 270 days for Corporate Insolvency Resolution Process (CIRP) get completed. Position of liquidation process is also not that encouraging as, as on March 2022, about 1609 cases of CIRP ended up in liquidation. At liquidation stage too 51% of the case have taken two years time to conclude and it is only 6% of the cases which are getting concluded within the statutory period of one year time.

The delay at different levels of the process also bring in focus the observations of Dr. Kristin van Zwieten's findings that "Practice and procedure in corporate insolvency law cases should attract much more scrutiny, given the evidence that practice and procedure may have contributed significantly to the problem of delays under the existing law. ………. delays can reduce the scope for company liquidation law to perform a disciplinary function, and they may lead to reduced recourse to the procedure altogether – reducing the law's ability to perform a commercial morality function.

The present state of affairs of cases filed under the Code has posed a biggest challenge to banking sector in India, which has been heavily relying and banking upon the time bound mechanism under the Code to deal with the cronic issue of corporate default and its non-performing accounts. IBBI has not discussed two critical figures of time taken by the adjudicating authorities in admission of cases and approval of resolution plans, as these are the two factors which are most crucial for effectiveness of the system and its ability to perform a commercial morality function. If an application is admitted within the timeline specified for this purpose under the Code and resolutions plans are approved within a reasonable time, it will enable the system to address many problems affecting enterprise insolvency ranging from flow of credit to maximisation of value by way of timely exit. Time is the essence of the Code for maximisation of value as envisaged in the Code and if the major portion of the process is lost in admission of applications and thereafter in seeking approval of resolution plans that will slowly and surely wear away investor and buyers under CIRP.

There is another aspect where financial creditors have critical role to play. It is seen that most of the financial creditors do not have any clear policy on type of cases to be addressed through the mechanism under the Code and the procedure to handle the insolvency and bankruptcy process. Recovery of dues is the primary factor which guide them such matters. Role to be played by inexperienced officials as member of creditor committee is also another factor which create impediment in this objective and timely conclusion of CIRP. Smaller bank still toe the line adopted by the larger banks or the consortium leaders. This also explains the reason as to why the financial creditors have not utilised personal insolvency process despite the fact that the process offer more effective way to deal with guarantors to corporate debtors. Lack of policy level clarity has led to ad-hock approach, complications and delay in timely conclusion of CIRP and Liquidation process under the Code. Another factor which contribute to delays and complications in many cases is flip flop attitude of the financial creditors as regards priority of charges. As confirmed by Insolvency Law Reform Committee Report, the Code does not disturb the inter-se priority among the lenders but it is seen that in practice financial creditors take stand which suits them in that particular case in total disregard of the legal position and priority accepted by them at the time of creation of security. Further, most of the creditors do not have any guidelines to deal with the issue of money involved in avoidance applications especially huge amount of money siphoned of by the debtors and housed in their associates and subsidiaries abroad. It is seen that most of the financial creditors in public sector are shy of experimenting and looking for alternative mode of recovery of public money staked outside the country and they still prefer to follow the routine failed path. For various reasons, 'Compliance' rather than 'effectiveness' of action, is the criteria which determine the approach on such issues. Thus, while there are issues and challenges as regards timely culmination of the judicial process but the financial creditors and other stakeholder are equally responsible for the delays and complications that arise under the Code. Inexperience of financial creditors and lack of in-house expertise has also lead to delays and increased cost due to over reliance on outside expertise.

There are many issues which are needed to be addressed under the Code. Admission of cases on the basis of the record of default issued by the Information Utilities is still a distant dream. As per the practice followed in NCLTs, there is practically no closure of right to file reply by respondents, as is followed under the Commercial Court Act or the Civil Procedure Code. This could easily be achieved by inserting suitable provisions in Rule 4 of Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016. There is no attempt to control flood of interim applications that are filed by third parties.

Surprisingly, at present there is no statutory provisions under the code which declare the resolution plan binding on the resolution applicant. Section 31 of the Code only provides that on approval of the plan by the Adjudicating Authority, "it shall be binding on the corporate debtor and its employees, members, creditors, including the Central Government, any State Government or any local authority..". This gap was, to some extent, filled by the Supreme Court by way of judgement dated September 13, 2021 in the matter of Ebix Singapore Limited Vs Committee of Creditors of Educomp Solutions Limited & Anr., where the Apex Court was dealing with the issue of withdrawal of resolution plan which was recommended by the Committee of Creditors but lying for approval for nearly three years on account of various issues.

Even the pre-pack process which was introduced by way of Ordinance on April 4, 2021, to provide for a Pre-Packaged Insolvency Resolution Process for corporate Micro, Small and Medium Enterprises as an alternative insolvency resolution process to ensure quicker outcome, ended up as half-hearted attempt to address the problem. The process is riddled with complications an additional process (in addition to normal CIR Process) which has made it to be a non-starter. By doing so, the system appear to have missed a great opportunity which could have effectively addressed the issue in much more time effective manner.

There are other issues which deal with personal insolvency such as issue of interim moratorium which restrict right of a creditor to enforce its securities even though it has not relinquished its right to do so as required under the code or where it has not filed such an application and it does not intend to relinquish its right to enforce security outside the Code. Inexperience of majority of resolution professionals has also lead to bulging resolution cost as they tend to engage professionals even for advising on routine resolution process (not to talk of legal experts and advisors and other professionals need to handle litigations, accounting, and process advisors). This has also led to filing interim applications just to seek clarifications and also lead to cross litigations.

The challenges on the road of resolution are manifold and it nvolves multiple players thus, these challenges can hardly be addressed by legislative changes. It requires change in mindset and need more professional approach from the stakeholders including the adjudicating authorities. Financial Creditors being the largest players in the eco system and having biggest stake both in financial terms and key players as member of Creditor Committee, needed to adopt a concrete and robust internal mechanism by way of clear policies and empower its officials. Proper training needs to be imparted before officials are assigned responsibilities of attending meeting of Creditor Committee. On legislative and administration front more bold steps are needed so that delay at the stage of admission of applications and approval of resolution plans could be curtailed.

The stake holders and the administrators including the Tribunals need to ponder on the issue as to how a law which is successful in so many jurisdictions, is facing many challenges in our country. The need of the hour is not legislation but implementation.

The author is an IBC Expert and views are personal.