Objective of insolvency law: Resolution over liquidation?

The Insolvency and Bankruptcy Code, 2016, in its brief history has created quite a shake-up in the corporate sector. No doubt that the enactment of the Code has been well intentioned. Due to the growing menace of loan defaults, it had long been felt to have some sort of disciplined insolvency and bankruptcy legislation to address this loan default issue, the problem which most of the banks are plagued with.

Understanding the reasons behind the increasing NPAs
If one were to study the nature of defaults, especially in the recent past, it can be understood that certain sectors have apparently been more afflicted with this delinquency. To name a few, such sectors are steel, cement, real estate and power. On further analysis, one interesting aspect can be deciphered from this is that most of these sectors are quite inter-related in the sense that a setback to one sector does adversely affect the other sector(s). This makes the issue more severe and calls upon the attention of the policy and lawmakers. It is not a hidden fact that the aforesaid sectors have witnessed substantial amounts of policy related controversies and in the end the sufferers are the entities engaged in those sectors and its stakeholders, not to mention the economy in the larger picture.

Until the Code came into force, lenders were exercising recovery proceedings through laws such as the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, or SARFESI Act 2002, SICA 1985 and also as per schemes of the RBI such as SDR, CDR and S4A. Earlier in the event of a default, the corporate debtor was subject to the BIFR/AAIFR proceedings under the SICA and or winding up proceeding under the Companies Act. However, the procedure under the said laws were prolonged and seemingly never ending.

The objective of the insolvency law

The Code intends to achieve these objectives such as to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner, to promote entrepreneurship and availability of credit and to improve the ease of doing business and facilitate more investments leading to higher economic development.

Reasons why certain cases have been pushed for liquidation over restructuring processes

It has been observed that, in the resolution process there are always chances where the promoters of the corporate debtor will hesitate to co-operate with the Resolution Professional ("RP") in running the affairs of the debtor due to which the RP will not be able to take complete control of the corporate debtor and achieve the noble intentions of the Code.

On the contrary it is also observed in certain cases that if the resolution plan is approved wherein a third party intends to buy particular asset or business undertaking of the corporate debtor, but the same is not adequate to restructure the total outstanding dues of the creditors. Thus, in such an event there are plausible chances that the corporate debtor may face liquidation.

Either ways, the Code provides that in case a resolution plan is not approved within the defined time period of 180-270 days, the NCLT may order liquidation of the debtor company. Recently, in the Innoventive case , since the Resolution Plan did not receive approval of at least 75% votes of the Committee of Creditors (CoC); NCLT ordered liquidation of the debtor company.

On the other side and in realism, NCLT's approach of the Code is to revive the stressed firms rather taking the extreme route of liquidation. The idea is to save the stressed firms by way of restructuring, and get either the existing promoters, with or without new partners/ entrepreneurs to come on board and make sure that the valuable assets and the fundamental existence of such stressed firms are preserved.

Recently, in the Prowess International case , NCLAT expressed its views by stating that- "it is made clear that Insolvency Resolution Process is not a recovery proceeding to recover the dues of the creditors."

Also, on a practical note, investing in stressed assets is always risky. The exposure is uncertain on the outcome. The biggest hurdle is creditors' unwillingness to take haircuts. The creditors may contemplate to take a call on distressed assets and further strengthen the corporate bond market, which will eventually give substantial returns.

Need to encourage restructuring rather than liquidation

In light of the cases approved under the Code wherein the resolution plan was approved by the NCLT, the first one being that of Synergies-Dooray Automative Ltd, it shows that the Code is well equipped for fast recovery and revival in an effective manner. This is the first case in the history of the Code whose Resolution Plan was well equipped by the creditors and the same was approved by NCLT. Thereafter, Mumbai Bench of NCLT in the case of Chapparia Industries Ltdand Hyderabad NCLT in the Kamineni case , respective resolution plans were approved. In the Kamineni case, the NCLT approved the resolution plan even when only 66.67 percent of the members of CoC voted in favour of the resolution. Thus, it is clear from the Kamineni case that the NCLTs are beginning to perceive insolvency cases with a view to restructure the stressed debtor rather than considering liquidation of assets. However, Mumbai NCLT in aforesaid Innoventive case have taken a contrary view and held that 75% vote approval is prerequisite and sacrosanct and that approval of creditors less than 75% is non-est in law. Both these cases have seen contradictory verdicts, but the Code is in its nascent stage and as one can say that lot is yet to come as the Code is yet get matured.

The Ordinance has further amended the Code. The Ordinance has further enhanced the eligibility requirements as to who can be a resolution applicant. This Ordinance has garnered tremendous attention and at the same time attained a controversial status. This Ordinance inter alia bars promoters being wilful bank loan defaulters as well as those with NPA accounts from bidding in auctions. The cardinal reason that the Ordinance has been criticized in some quarters is that it prohibits the promoters (who are having NPA), persons related to promoters and disqualified directors to bid for the corporate debtor, who are the heart and soul of the company. Since many believe that genuine promoters will become ineligible and there will be no competition between acquirers/ bidders and promoters and due to which creditors will not receive adequate consideration. Owing to the uproar created by the Ordinance, the government is considering to revisit blanket restrictions provided under the ordinance and is expected to announce certain relaxations to the 'harsh' eligibility requirements for the bidders (i.e. the resolution applicants). After the moratorium period commences, the RPs take charge of the debtor company with the sole objective of protecting its assets and the fundamental operations. Basically, it is one man show that runs the affairs of the debtor company.

Ashish Parwani, Rajeev Nair and Archan Shah are Partner, Principal Associate, and Associate in law firm Rajani Associates, respectively