Bankruptcy Code’s impact on ease of doing business

By Siddharth Srivastava and Kanika Kadam, Link Legal India Law Services
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The World Bank’s Doing Business Report, 2016, ranks India 130 among 189 economies on “ease of doing business”. One of the sub-indexes on which the ranking depends is resolving insolvency. It is interesting to note that even though India’s ease of doing business ranking rose from 134 in 2015, its ranking for resolving insolvency did not improve and remained at 136.

Siddharta Srivastava. Partner, Link Legal India Law Services
Siddharta Srivastava
Partner
Link Legal India Law Services

It takes an average of 4.3 years to resolve insolvency in India with a recovery rate of only around 20% of the net present value of the debt. To address this problem, the government introduced the Insolvency and Bankruptcy Code, 2016, based on the principles in the UNCITRAL Legislative Guide on Insolvency Law.

India’s current framework for dealing with insolvency and bankruptcy is highly fragmented, with overlapping legislation addressing the same issue. This gives companies an opportunity to delay insolvency proceedings by filing appeals against the decisions of the authorities in different forums, and delays the final outcome even when there are chances of revival, leading to deterioration of the value of the company’s assets.

With these issues in mind, the code provides for early identification of distress and a 180-day time limit (extendable by 90 days) for financial creditors to decide whether to approve a resolution plan or liquidate the company. If 75% of the financial creditors by value agree to a resolution plan, it becomes binding on all parties. If the creditors find the business unviable or they fail to reach a decision within the stipulated time, the company will go into liquidation.

The code also provides for fast-track insolvency, envisaging completion of the resolution process within 90 days (extendable by 45 days). This is aimed at enabling quick insolvency resolution for startups and small and medium-sized enterprises.

Strict timelines will increase the confidence of creditors in the Indian economy in the long term and pressurize the parties to reach a decision on the company’s future as soon as possible. However, automatic liquidation upon failure to agree on a resolution plan within the time period may act as a double-edged sword in the early days of implementation of the code. There may be a clash between the interests of creditors. Also, the performance of the new category of insolvency professionals in managing the business of a company is yet to be evaluated.

Companies currently get entangled in litigation, eroding their economic value by the time an arrangement is reached or the company is liquidated. The code’s focus is on assessing, at an early stage, the viability and economic value of a debtor company, which in turn is expected to provide better recovery rates for lenders. The code gives the parties a platform to discuss whether a financial rearrangement is possible, which could earn the creditors more than closing the business.

Further, in order to prevent asset stripping by defaulting borrowers, the management of the company is shifted to insolvency professionals as soon as the insolvency resolution process is initiated. This is also expected to discourage default by companies.

Kanika Kadam, Associate, Link Legal India Law Services
Kanika Kadam
Associate
Link Legal India Law Services

The number of forums having jurisdiction over insolvency matters has been reduced to prevent delays by way of appeals. The National Company Law Tribunal (NCLT) and debt recovery tribunals and their respective appellate authorities will be the adjudicating authorities for companies/limited liability partnerships and individuals/firms respectively. In order to have one forum for corporate bodies and their personal guarantors, the bankruptcy of a personal guarantor will be governed by the NCLT.

The code allows foreign creditors to apply to start a resolution process and also gives creditors the right to authorize an agent or trustee to act on their behalf in the committee of creditors to the extent of their voting share.

The ease with which insolvency is resolved is a critical factor affecting the ease of doing business in an economy. A good insolvency regime strengthens the confidence of investors and efficiently allocates resources. The code, in theory, provides a time-bound process, preserves economic value, and increases certainty of outcome. The code is expected to resolve insolvency within one year. The funds which will be freed post restructuring or liquidation will help improve the liquidity of lenders and can be invested in sectors such as infrastructure and the corporate bond market.

However, the legal eco-system needs to be developed. Regulations and bye-laws governing insolvency professionals, insolvency professional agencies and information utilities are yet to be notified. The evolution and proper functioning of these bodies along with the Insolvency and Bankruptcy Board and the adjudicating authorities is crucial in paving the way for effective implementation of the code.

Siddharth Srivastava is a partner and Kanika Kadam is an associate at Link Legal India Law Services.

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