Jul 3, 2016

Going for Broke

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India’s debt recovery system is in a mess. Nothing shows this better than the crammed premises of Delhi’s Debt Recovery Tribunal, or DRT, on Parliament Street. In this claustrophobic office on the fourth floor of Jeevan Tara building, both petitioners and lawyers have to jostle for space, even as shortage of presiding officers leads to high pendency levels and years of waiting for lenders struggling to recover their money. In April, for instance, the three courts here disposed of just 158 out of 6,000 pending cases. Around 72,841 cases were pending in the country’s 33 DRTs as of April 2016.

The Bankruptcy And Insolvency Act, passed in the Budget session of Parliament this year, is meant to change this by mandating a new framework for debt recovery and time-bound resolution of cases, limiting the scope for judicial review, and laying a clear roadmap for how such cases are to be handled. But the change will not be easy, for several reasons. One, the country’s judicial infrastructure is not equipped for the tight deadlines the law mandates. For example, it is banking on the same overworked DRTs – which at present handle only debt recovery cases – for insolvency proceedings against individuals and partnership firms, too. The corporate cases will be handled by the National Company Law Tribunal or NCLT. Two, there is the issue of expertise, that is, whether those who get control of the defaulter company and steer it till it turns around or goes for liquidation will have the skills to run it without help from promoters. Three, the law is too ambitious, especially with regard to strict timelines, and has several ambiguities and grey areas still waiting to be cleared.

The government will have to iron out these issues if it is to succeed in its aim of reducing the huge stress in the financial sector that has built up because of banks’ inability to recover money from loans that turn bad. At the end of June 2015, for instance, the gross non-performing assets of Indian banks were Rs 3.3 lakh crore, or 4.49 per cent of total advances. What’s worse is their alarming rise, in 2014/15 as well as 2015/16, affecting banks’ ability to lend, hitting plans of companies looking to expand and slowing the pace of economic recovery.

How It Works

The new law is fundamentally different from existing ones in that it gives more power to creditors and stipulates a time frame for completing the insolvency process and starting the liquidation process. It also reduces the scope for judicial review – no civil court can entertain any matter over which the NCLT has jurisdiction.

Any creditor, whether financial or operational (such as vendors, suppliers and employees), will be able to start the insolvency process by giving a proof of default. If the adjudicating agency, either the NCLT or the DRT, gives the go-ahead, the entity will be taken over by a committee of creditors and insolvency professionals – a new class of professionals that will work under the proposed regulator, the Bankruptcy and Insolvency Board. The applicant creditor will prepare a resolution plan and submit it to the resolution professional. The plan will then have to be approved by 75 per cent creditors (by value) in the committee (operational creditors will not be in the committee).

The process has to be completed within 180 days of the takeover by insolvency professionals, though in some cases 90 more days can be provided. If the plan provides for action to ensure “continuation of corporate debtors as a going concern” and is accepted by the adjudicating agency, the debtor will survive if it complies with its provisions. If it is rejected, the entity will go for liquidation. There is no time limit for the liquidation process.


Mindset Change: The big challenge, say experts, is ensuring that the system is run by judicial experts who see bankruptcy as a commercial and not a legal problem. Harsh Pais, Partner, Corporate, Trilegal, says, “It is important to train judges as the law has a certain philosophy behind it. A judge or a lawyer, no matter how well-versed he is in legal matters, should not decide if a business survives or dies. It is the creditors who should decide that.”

“The principle of natural justice may not work in cases of insolvency and liquidation of companies where the debtor will seek to delay hearings. If you look at the working of DRT presiding officers (anyone qualified to become a district judge can become a DRT presiding officer), ?they wait for all the parties to present their case, ?despite knowing that the debtor is using delaying tactics,?” says a corporate lawyer, ?on condition of anonymity.

Building The System: Putting the system in place may take at least a year given that there is nothing on the ground till date. To implement the law, a set of rules will have to be framed, which can be done only after the constitution of the Insolvency and Bankruptcy Board. “While the board may be constituted by the end of the year, the rules can be framed simultaneously,” says Mamta Binani, President, Institute of Company Secretaries of India.

Misha, Partner, Shardul Amarchand Mangaldas & Co, says while there is an enabling provision that any other financial regulator can step in for the time being and that even the Central government can discharge the function of the regulator, it would not be in the spirit of the legislation to give any other regulator this kind of responsibility. “It is a huge task which needs specialised and focused attention,” she says.

The government also has to fix the other cogs in the wheel such as deciding who all should be eligible to become insolvency professionals. It also has to set up information utilities (credit information facilities on the lines of CIBIL) and fix the infrastructure at NCLTs and DRTs to ensure their smooth functioning.

The government, though, has already notified the formation of the NCLT and the National Company Law Appellate Tribunal or NCLAT. Retired Supreme Court Justice S.J. Mukhopadhaya has joined as Chairperson of the NCLAT while Justice M.M. Kumar has been appointed as the NCLT President.

DRTs, which handle recovery of dues to banks and financial institutions and have been in existence since 1993, will also have to be beefed up. Vivek Kumar Singh, President of the DRT Bar Association in Delhi, says one presiding officer handles as many as 70-80 cases a day. “With this additional work, you can imagine the kind of pressure they will be under,” he says.

However, a presiding officer at the Delhi DRT said the government had approved six new DRTs and would approve 10 more within a year.

No Clarity on New Professional Class: Insolvency resolution professionals will collect financial information about the debtor, verify the claims of creditors, form a committee of creditors, run the business of the debtor, and work out a rescue plan agreeable to both creditors and debtors. Given their centrality to the process, it is disconcerting to see the lack of clarity on who these professionals would be, what would be their qualification(s), and if they would have enough powers to accomplish the task at hand.

“So far, there is no code. We don’t know the type of people who will be eligible to become resolution professionals. You don’t want fly-by-night professionals as that will defeat the purpose of the Act,” says K.V. Karthik, Partner, Deloitte India.

Pawan Kumar Vijay, founder of corporate and legal advisory firm Corporate Professional, says while right now we have lawyers, chartered accountants and restructuring experts, resolution professionals will require all these skills to discharge their duties. “It is, therefore, difficult for an individual to discharge the duty of a resolution professional. We may require institutions to act as resolution professionals,” he says.

Aggressive Time Limits: The entire resolution process – gathering financial information, verifying creditors’ claims, a try at reviving the company, and preparing a resolution plan agreeable to 75 per cent creditors – has to be completed within 270 days. If this is not done, liquidation will follow. Many experts say this is ambitious considering the inadequate judicial infrastructure in India.

“This is an aggressive timeline in some ways. The resolution professional would have to not only coordinate for approval of a resolution plan but also manage the affairs of the company as a going concern with the Board of Directors being suspended. Further, there is no exemption from the operation of the law for companies which are suffering due to industry-wide distress – in such cases a resolution plan may not be viable. Are you going to liquidate all such companies of the affected industry?” asks Misha of Shardul Amarchand Mangaldas & Co?

In the US, the law gives the debtor 120 days to file a revival plan. This period can be increased or reduced by the court but in no case can it be extended beyond 18 months. If the debtor fails to file a plan within this period, the task is undertaken by the committee of creditors. The average time taken for completing insolvency proceedings there is a year and a half. In India, it is 4.3 years.

Such deadlines rarely work, say some. “The SARFAESI Act (under Section 17) empowers debtors to file an appeal against any action taken by creditors with the DRT, and the DRT is required to decide such applications within four months. There is not a single case that has been decided in four months,” says Singh of the Delhi DRT Bar Association.

Third Shot

The Insolvency And Bankruptcy Act is the latest attempt by the government to make the bankruptcy and liquidation process faster and more effective.

The existing laws – SICA (Sick Industrial Companies Act) and the SARFAESI Act (Securitisation And Reconstruction of Financial Assets and Enforcement Of Security Interest Act) – are tilted in favour of debtors and have failed to increase the pace of resolution of default/insolvency cases.

The aim of SICA, enacted in 1985, was to identify industrial sickness and its reasons, expedite the revival process and close units beyond revival. The government had set up the Board for Industrial and Financial Reconstruction (BIFR) to accomplish these goals. However, debtors have been using the loopholes in the Act, particularly Section 22, which prohibits any legal action against companies referred to the BIFR, to delay recovery. Besides, under SICA, a company can approach the BIFR only on erosion of its entire net worth, after which it is usually too late to revive a company.

So, in came the Recovery of Debts Due to Banks And Financial Institutions Act (RDDBFI Act), in 1993. Under it, debt recovery tribunals, or DRTs, were set up, but the system was marred by delays and inadequate infrastructure. To plug the loopholes in SICA and RDDBFI, in 2002, the government came out with the SARFAESI Act and took corporate debt out of the ambit of the BIFR. The SARFAESI Act is for only financial institutions.

There was a need for a more comprehensive law for addressing the issues of non-financial creditors and plugging other loopholes such as procedural delays. The result is the Insolvency And Bankruptcy Law.

Also, while the resolution process has a time limit, the liquidation process can go on forever. Ajay Tyagi, Additional Secretary (Investment), Department of Economic Affairs and a member of the committee that drafted the Bankruptcy Code, says, “The liquidation process depends on a lot of things, including market conditions. If a company’s assets are not getting the right value, how can you force someone to sell them within a stipulated time?”

Low threshold: The minimum single default for starting insolvency proceedings is just Rs 1 lakh. This can be an irritant as any employee or small vendor will be able to initiate insolvency proceedings even if the default is small. Tyagi says the committee deliberately kept the threshold low to empower even employees and small vendors. In the US, three or more creditors can start insolvency proceedings against a company if the latter owes them more than $12,300 (just over Rs 8 lakh as per the current exchange rates).

Creditor democracy: While experts have welcomed the shift in the balance of power in favour of creditors, a section believes that not allowing promoters to run the company during the resolution period can be a recipe for disaster. They cite the US model, where debtors remain in control of operations till the start of the liquidation process. However, in the UK, the control of the company is passed on to insolvency practitioners.

Kumar Saurabh Singh, Partner, Khaitan & Co, says there is not enough evidence that putting the entire faith in creditors will speed up the process or improve chances of efficient restructuring. “By cutting off equity holders from decision making, you are not creating enough stake in the game for them to be supportive of a viable resolution,” he says.

There is also no certainty that 75 per cent creditors will agree to the resolution plan. In corporate debt restructuring, a group of creditors is allowed to take a decision on restructuring, but here all financial creditors will be part of the process. “You are leaving a lot of room for people to punch holes in the system,” says Singh.

But asset reconstruction companies, or ARCs, are not complaining. As aggregators of debt, they will automatically qualify as creditors. Siby Antony, Managing Director and CEO, Edelweiss ARC, says, “The law provides for takeover by the creditors’ committee and the resolution professional. We take over loans of large financial creditors. If the value of the loan (taken over by the ARC) is more than 75 per cent, the ARC will be able to run the company along with the resolution professional, which is not so under the SARFAESI Act.” Under the SARFAESI Act, ARCs can take over only assets charged to them.

Some experts say that while the law is replacing the board with a resolution professional, it is not giving the latter enough power. The professional will have to seek approval from the creditors’ committee for almost everything – raising interim finance, changing the capital structure, undertaking affiliated/related party transaction(s), disposing of shares of a big shareholder, or making any change in the management.

Tyagi of the Department of Economic Affairs justifies the decision to give control to creditors and resolution professionals. “The US is a mature market where, unlike in India, the ownership of companies is not concentrated. As corporate governance improves, the law might be changed in future.”

Antony of Edelweiss has a different take on this. “The management or promoter who puts the company in a mess has no right to run it,” he says. He cites the example of Satyam Computers, which he says was the only company revived under the Companies Law. “The board was suspended. Professionals revived it. The same thing will be done now,” he says.

It is only when the system rolls out that we will know if it has the kind of impact its admirers are expecting. As they say, the proof of the pudding is in the eating.

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