Bankruptcy Code 2016: Why this time it is different?

Varun Gupta With the passage of the Insolvency and Bankruptcy Code, 2016 (Code), a lot has been and is likely to be written about the key features of the bill and rightfully so. With the passage of the bill in the Rajya Sabha, its implementation should be a big step forward in terms of ease of doing business in India. However, there are a few questions that’s needs to be answered, like • What will be the big changes once the code gets implemented?• What needs to be done to operationalise the code?The case for bankruptcy regulationSo why is it important for an economy like India to have strong bankruptcy regulation?The average time to resolve insolvency issues in India has been estimated at 4.3 years, as compared to eight months in Singapore and one year in London. India has the lowest recovery rate in the world at about 20 per cent of debt value as per a World Bank report (2014). The current set of regulations surrounding the bankruptcy process in India were borne out of multiple judicial reforms and with biased towards revival of industrial companies. Multiple laws provided relief to specific stakeholders like secured creditors, financial institutions, industrial companies, but lacks a common forum for resolution of insolvent situation. As a result, different stakeholders approach different judicial forums with concurrent or overlapping jurisdictions when a company defaults on its obligations. For example, it is not unusual to have banks taking the company through a Joint Lenders Forum or a Strategic Debt Restructuring process, while unsecured lenders would initiate winding up proceedings, where at the same time the tax authorities impose penalties on non-payment of dues. Consequently, secured and unsecured creditors, employees, regulatory authorities have different and often competing rights with no common regulatory process to determine the priority of claims. Lack of adequate and credible data regarding the assets, indebtedness and security situation of companies further accentuates the problems. The whole process is mired in uncertainty for the company and the creditors, often requires continuous litigation to find any sensible solution. Needless to say, as the Indian economy has evolved and integrated far more deeply within global capital markets over the last two decades, our bankruptcy laws however in some cases are a century old. Our approach to handling these situations to therefore evolve into a framework that is similar to other developed economies. At the least it should do the following:1. Define the threshold and the process a company is admitted into a formal bankruptcy process2. Enable a common process for all stakeholders to ensure that is fair and transparent3. Clearly specify the process through which insolvency and recovery proceedings can start in case there is limited prospects of the company surviving as a going concern Key changes that the code is to bring aboutAt a very fundamental level, the proposed regulation does four key things:1. It enables the system to detect stress far earlier in the process.In the current regime, by the time the system formally recognises that a company is going through significant stress and enforces corrective action, it can take two to four years. For instance, when a company starts facing initial stress, the first reaction is to elongate working capital by paying suppliers late. Next come delays in employee and workmen dues, then to the extent possible statutory dues are delayed and in the last case is bank debt defaulted on. Post default on the bank debt, there is a process that the banking system has to follow to evaluate the degree of stress which currently involves the JLF process, evaluation of turnaround options, etc. before finally enforcing a solution – which in the end may end up getting challenged in various judicial forumsWith the new regulation, financial creditors like Banks, lenders etc. or operational creditors like vendors, employees etc. can initiate insolvency process immediately upon event of default after giving notice of payment to the Company.2. It delivers a common process for all stakeholders to adhere to:It empowers all classes of creditors (secured and unsecured lenders, employees, and trade creditors, regulatory authorities) to trigger a resolution process in case of non-payment of a valid claim. On acceptance of the claim by the competent authority, the code enables immediate suspension of the board powers, appointment of an insolvency professional to take control of the companies’ affairs and a ‘stand-still period’ during which period stakeholders can arrive at a common resolution rather than running independent processes.It is important to note that all outcomes of a bankruptcy process need not result in liquidation. The intent is that if all stakeholders follow a common process and stress is detected early, a viable turnaround plan is far more likely to be realized rather than trying to attempt it when there is limited value is left in the business.In fact as part of this process, the existing creditors determine that fresh funding would be needed in the business to make it viable, there are provisions that allow fresh funding to come in as super priority over existing lenders claims.3. Defined hierarchy for all classes of creditorsIn case, however if a business is not viable as a going concern, then liquidation is the only option left. As per the code, the proceeds from the sale of assets shall be distributed in the following order of priority (after deducting insolvency related administration costs):• claims of secured creditors and workmen dues (capped up to 24 months prior to liquidation) • employees' salaries other than workmen (capped up to 12 months prior to the commencement of liquidation)• financial debt owed to unsecured creditors• any amount due to the relevant State Government or the Government of India ( capped at 2 years before commencement of liquidation) and unpaid dues to secured creditors after enforcement of security interest• Any remaining debts and dues.This distribution model is in line with international conventions on how proceeds for liquidation are distributed and makes pricing of default risk much easier when lenders are evaluating fresh disbursements4. Transfer of control of operations from management to the creditor committeeWith provisions such as finite time limit within which the debtor's viability can be assessed, a resolution process can be agreed upon and the commercial decision to revive or liquidate the company is on the creditors rather than the courts, making the code time-bound and accountable in nature. The new code takes a balanced approach between rehabilitation and recovery. It provides for compulsory liquidation of corporate debtors in the event the resolution has not been agreed within 180 days of the resolution process. So what is next?The central government needs to notify a date from which the code will become effective. However, before the notification date, the central government will need to create the infrastructure and ecosystem proposed under the code to make it effective. This is expected to include:Infrastructure surrounding the codeThis includes creation of the insolvency board, appointing judges and setting up of benches of the Adjudication Authority, identifying and licensing insolvency agencies, licensing information utilities, grandfathering of insolvency professionals to create capacities in the interim period and constituting an examination board to conduct exams for the licensing of insolvency professionals, amongst others. Operationalization of the code:Once the insolvency board is set-up, it will also have to set up rules and bye-laws for the orderly functioning and execution of the code. The rules need to be framed around functioning of the Adjudication Authority, the code of conduct for the Insolvency Professional, Guidance notes around the conduct of IRP such as the presentation and reporting of financial statements, management of the company during IRP, summoning a meeting of creditors, etc. Training of IPs and creating awareness amongst the judicial community, lenders and other stakeholders, should be taken up on a priority basis. Having said the above, I believe that the new code is a good starting point and is expected to significantly speed up the process of rescue or liquidation for companies under financial distress and facilitate time bound rehabilitation/liquidation. Author is – Partner, Deal Advisory at KPMG in IndiaThe views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG in India.