Key Components of the Insolvency and Bankruptcy Code for Corporate Debtors

The Insolvency and Bankruptcy Code, 2016 (IBC), was introduced by the Government of India as a landmark legislation to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms, and individuals in a time-bound manner. It aims to maximize the value of assets, promote entrepreneurship, ensure the availability of credit, and balance the interests of all stakeholders.

Key Objectives of the IBC

The Code primarily seeks to address the previously fragmented and inefficient framework for insolvency and bankruptcy in India. Before the IBC, the insolvency resolution process was scattered across various legislations, leading to prolonged and often unfruitful insolvency proceedings. The introduction of IBC marked a significant shift towards a unified and streamlined process. The key objectives outlined by the Code include:

1. Timely Resolution: One of the primary aims of the IBC is to ensure the resolution of insolvency cases within a stipulated timeline. Section 12 of the IBC mandates the completion of the insolvency resolution process within 180 days, extendable by a maximum of 90 days, thereby setting a strict timeline to expedite the resolution process. This is further supported by the Insolvency and Bankruptcy (Amendment) Act, 2019, which introduced a mandatory deadline of 330 days for completing the insolvency resolution process, including the time taken in legal proceedings.
2. Maximization of Asset Value: The Code focuses on maximizing the value of the debtor’s assets by ensuring that the business of the debtor continues during the insolvency resolution process. This approach not only helps in preserving the value of the debtor’s assets but also aids in better realization for creditors.
3. Promotion of Entrepreneurship: By allowing for a time-bound resolution of insolvency, the IBC aims to free up capital locked in unviable businesses and pave the way for new entrepreneurial ventures. The Code makes provisions for the corporate debtor to start afresh post the resolution process, thereby fostering an environment that is conducive to entrepreneurship.
4. Availability of Credit: The IBC seeks to boost the availability of credit by reassuring creditors of the timely recovery of their dues. The establishment of a creditor-driven insolvency resolution process ensures that creditors are at the centre of the decision-making process, thus enhancing creditor confidence and encouraging the extension of credit.
5. Balancing Stakeholders’ Interests: The Code aims to balance the interests of all stakeholders involved, including the corporate debtor, creditors, and employees, by ensuring equitable treatment. The priority of payment to operational creditors and workmen as per Section 53 of the IBC reflects the intent to protect the rights of all stakeholders.
6. Streamlining the Insolvency Process: The IBC establishes the Insolvency and Bankruptcy Board of India (IBBI) to oversee the insolvency proceedings and sets up a structured and professional framework involving insolvency professionals, insolvency professional agencies, and information utilities.
7. Promotion of a Resolution over Liquidation: The Code prioritizes resolution over liquidation, aiming to preserve the business as a going concern and maximize the recovery for creditors. It introduces innovative mechanisms like the “pre-packaged insolvency resolution process,” tailored for MSMEs, to emphasize resolution and maintain business continuity.

Corporate Debtors under IBC: A Detailed Analysis

Under the IBC, a “Corporate Debtor” is identified as a corporate person who owes a debt to any person under Section 2(8). The term “corporate person,” as defined in Section 3(7) of IBC it encompasses a broad category that includes companies as defined under the Companies Act, 2013, Limited Liability Partnerships as per the Limited Liability Partnership Act, 2008, and any other entity incorporated with limited liability under any applicable law.

It is critical to note that financial service providers are explicitly excluded from this definition, though they can be brought under the ambit of the IBC through specific notification under Section 227 for the purposes of their insolvency and liquidation proceedings.

The characterization of a corporate debtor establishes the entity against which insolvency proceedings under the IBC can be initiated, thereby triggering the mechanisms for resolution or liquidation as provided under the code.

Process of Declaring a Corporate Debtor Insolvent

The Corporate Insolvency Resolution Process (CIRP) is the procedure under the IBC to address the insolvency of a corporate debtor. Initiation of the CIRP can be undertaken by:

• A financial creditor, under Section 7 of the IBC,
• An operational creditor, under Section 9, or
• The corporate debtor itself or through a corporate applicant, under Section 10.

The threshold for initiating the CIRP against a corporate debtor was initially set at a minimum default amount of ₹1 lakh. However, in a significant move aimed at preventing the potential misuse of the insolvency process and easing the burden on the adjudicating authority, the minimum default limit was increased to ₹1 crore through a notification dated 24th March 2020 by the Government of India.

The CIRP commences with the submission of an application to the National Company Law Tribunal (NCLT), the adjudicating authority with jurisdiction over insolvency resolutions and liquidations for corporate entities. The application must be accompanied by evidence of default and, in the case of financial creditors, records of such default recorded with an Information Utility or other relevant evidence as specified under the IBC.

Operational creditors are additionally required to deliver a demand notice to the corporate debtor before proceeding with the application. Upon admission of the application by the NCLT, a moratorium period is initiated, an interim resolution professional is appointed, and steps towards resolving the insolvency or effecting liquidation are undertaken as per the laid down procedural and substantive legal framework under the IBC.

The IBC’s approach to handling corporate insolvency is designed to be time-bound, aiming to maximize the value of assets, promote entrepreneurship, ensure the availability of credit, and balance the interests of all stakeholders. The successful resolution of insolvency under the IBC not only salvages the corporate debtor but also stabilizes the credit market by reinstating faith in the mechanisms for the recovery of credit.

Comparative Analysis: Financial Creditors vs. Operational Creditors

The legal framework has significantly altered governance of insolvency and bankruptcy in India and introduced a consolidated mechanism for resolving insolvencies which prioritizes corporate revival and maximization of asset value. Within this framework, the distinction between financial and operational creditors stands out, primarily due to the different rights and procedural roles these two classes of creditors play in the insolvency resolution process.

Definition and Basis of Distinction

Financial Creditors are defined under Section 5(7) of the IBC as any person to whom a financial debt is owed. The financial debt is essentially money borrowed against the payment of interest or amount raised through any credit facility which has the commercial effect of a borrowing. This includes loans, bonds, and credit facilities extended by banks and financial institutions which are typically secured against collateral and have a predetermined repayment schedule.

Operational Creditors, as per Section 5(20) of the IBC, refer to persons to whom an operational debt is owed. Operational debt, detailed in Section 5(21), arises out of the provision of goods or services including employment or a debt in respect of dues payable to the government or any local authority. Essentially, these are creditors whose liabilities are incurred during the company’s operational transactions, often including suppliers, service providers, and employees.

Rights in the Insolvency Resolution Process (IRP)

Financial Creditors enjoy significant rights under the IBC, including the ability to initiate the IRP against the corporate debtor upon default. They play a key role in the Committee of Creditors (CoC), which decides the fate of the corporate debtor, including the approval of resolution plans and the decision to liquidate. Their claims often carry more weight due to their secured nature, directly influencing the resolution process.

Operational Creditors have a somewhat limited role. They can initiate the IRP, but their participation in the CoC is restricted. They do not have voting rights unless their aggregate dues are significant enough to warrant inclusion in the CoC as per the regulations prescribed by the IBC. This distinction sharply delineates their influence on the resolution process, reflecting their unsecured status and the nature of their claims.

Prioritization in Payment

Under the IBC’s waterfall mechanism, financial creditors, especially secured creditors, are prioritized over operational creditors in terms of debt recovery from the liquidation estate of the corporate debtor. This prioritization is based on the principle of securing the investment and ensuring the viability of financial markets. It recognizes the secured nature of financial debts and the critical role of financial institutions in the economy.

Conversely, operational creditors, often unsecured, rank below unsecured financial creditors and may receive a significantly lower proportion of their claims. This is reflective of their operational link to the company and the general unsecured nature of their claims.

Judicial Interpretations and Implications

The distinction between these two classes has been subject to scrutiny and interpretation by Indian courts, notably in the landmark case of Swiss Ribbons Pvt. Ltd. & Anr. v. Union of India & Ors., Writ Petition (CIVIL) NO. 99 OF 2018 (2019). The Supreme Court upheld the constitutionality of the distinction, recognizing the intrinsic differences in financial and operational debts. It emphasized the crucial role of financial creditors in assessing the viability of the corporate debtor and their vested interest in restructuring the debt as opposed to mere recovery of dues.

IBC Proceedings: Step-by-Step Process

The process of insolvency resolution in India provides for a systematic legal framework for the resolution of insolvency for corporate entities, partnerships, and individuals in a time-bound manner. This guide provides an in-depth analysis of the IBC proceedings, focusing on the CIRP, their roles within this framework, and the impact of the moratorium period.

Initiating the CIRP

The CIRP is initiated under Section 7 (by financial creditors), Section 9 (by operational creditors), or Section 10 (by the corporate debtor itself) of the IBC. The process commences with the filing of an application to the NCLT, which acts as the Adjudicating Authority. The application needs to demonstrate the occurrence of a default; the IBC sets the minimum default amount at INR 1 crore, as per the threshold revised by the Ministry of Corporate Affairs in March 2020.

Upon acceptance of the application, the NCLT appoints an Interim Resolution Professional to manage the corporate debtor’s operations, marking the commencement date of the CIRP. The objective is to collate all claims against the corporate debtor and form a Committee of Creditors (CoC) for deciding the future course of action, either to revive the corporate debtor or to liquidate its assets.

Role and Powers of the Interim Resolution Professional

The Interim Resolution Professional plays a crucial role from the commencement of the CIRP until the constitution of the CoC. As per Section 18 of the IBC, the Interim Resolution Professional is vested with wide-ranging powers to take control of the debtor’s assets, manage its operations, and collate all financial information relevant for the process. The Interim Resolution Professional is responsible for safeguarding and preserving the value of the corporate debtor’s property and managing its operations as a going concern.

The Interim Resolution Professional also has the authority to raise interim finance, to appoint accountants, legal or other professionals as needed, and to initiate the process of inviting claims from creditors.

Committee of Creditors: Composition and Functions

The CoC, constituted by the Interim Resolution Professional , plays a central role in the CIRP. Primarily comprising financial creditors (secured and unsecured), its formation is detailed under Section 21 of the IBC. Operational creditors can become part of the CoC if their aggregate dues are at least 10% of the debt.

The CoC decides on the resolution plan and may also replace the Interim Resolution Professional with a Resolution Professional (RP) for the continuation of the CIRP. It has the power to make key decisions regarding the insolvency resolution, including the sale of assets, management of the corporate debtor, and approval of the resolution plan to be submitted to the NCLT.

Moratorium Period: Implications and Restrictions

The declaration of a moratorium period is a significant aspect of the CIRP, as laid out in Section 14 of the IBC. Upon its declaration, a prohibition is imposed on the continuation of any pending lawsuits, the enforcement of security interests, the recovery of property by an owner or lessor, and the initiation of any new legal actions against the corporate debtor.

The moratorium aims to provide a breathing space for the corporate debtor to facilitate a viable resolution plan without any additional legal hurdles. However, it does not affect the supply of essential goods or services to the corporate debtor, nor does it impede the proceedings initiated by government authorities for tax dues and other statutory obligations.

Resolving Insolvency: Strategies and Solutions

Liquidation: When Resolution Fails

When efforts to resolve insolvency through restructuring or finding a resolution plan do not succeed, the IBC, 2016, mandates liquidation as the subsequent course of action. This drastic measure aims to sell the corporate debtor’s assets, allowing creditors to recover their dues in accordance with the priority defined by the Code. The process is governed by Sections 33 to 54 of the IBC, providing a structured approach to winding up a company that cannot pay its debts.

Initiation of Liquidation Process

Under Section 33 of the IBC, the liquidation process can be initiated in several scenarios: if the Committee of Creditors (CoC) decides with a 66% majority vote to liquidate the corporate debtor at any time during the insolvency resolution process; if no resolution plan is submitted within the prescribed timeline; or if the resolution plan submitted does not receive approval from the NCLT.

Appointment of the Liquidator

Upon the initiation of liquidation, the resolution professional (RP) appointed during the CIRP transitions to the role of a liquidator, as outlined in Section 34. The liquidator’s primary responsibility is to oversee the liquidation estate, comprising the corporate debtor’s assets, and conduct the liquidation process in a manner that maximizes value for the creditors.

Liquidation Estate and Assets

Section 36 details the formation of the liquidation estate, which includes the corporate debtor’s assets that will be liquidated to pay off creditors. The liquidator assesses and consolidates all claims against the company, ensuring that assets are sold and proceeds are distributed in accordance with the priority established by Section 53 of the IBC. This priority places secured creditors and insolvency resolution process costs at the top, followed by employee dues, unsecured financial creditors, government dues, and equity shareholders, respectively.

Distribution of Proceeds

The distribution mechanism is a critical aspect of the liquidation process, emphasizing fairness and transparency. After covering the costs of the liquidation process, proceeds from the sale of assets are distributed following the priority order mentioned earlier. This process ensures that all parties involved receive a fair and equitable portion of the available funds, considering their legal entitlement as per the Code.

Closure of Liquidation Process

The liquidation process concludes when the liquidator completes the distribution of proceeds to the creditors and applies to the NCLT for the dissolution of the corporate debtor. Upon approval, the corporate debtor is officially dissolved, marking the end of its legal existence. This final step is crucial as it provides closure to creditors and allows them to write off their losses legally.

Unique Cases under IBC: Personal Guarantors and Real Estate Considerations

Bankruptcy by Personal Guarantors to Corporate Debtors: A New Frontier

The IBC, 2016, marked a shift in how insolvency and bankruptcy are handled in India, particularly with its provisions relating to personal guarantors to corporate debtors.

The legal framework was further clarified when the Supreme Court of India upheld the validity of the government notification allowing creditors to move against personal guarantors under the IBC in the case of Lalit Kumar Jain v. Union of India & Others., W.P.(C) No. 283/2021. This judgment confirmed that personal guarantors, who are often promoters or directors of the corporate debtor, can be held liable for the financial obligations of the corporate debtor.

Section 60(2) of the IBC extends the jurisdiction of NCLT to adjudicate insolvency proceedings against personal guarantors of corporate debtors. This integration of personal guarantors into CIRP framework ensures a comprehensive approach to resolving insolvency, allowing creditors to simultaneously address the assets of both the corporate debtor and its guarantors.

The implications of this legal framework are profound. It allows for a synchronized insolvency resolution process wherein the assets of the guarantor can be considered in the repayment plan to creditors, ensuring a higher recovery rate and deterring reckless credit guarantees by closely associated individuals of the corporate debtor.

Can Banks and Partnerships Be Treated as Corporate Debtors?

The IBC initially designed its provisions with a focus on corporate entities, leaving some ambiguity around the inclusion of banks and partnership firms as corporate debtors. However, subsequent amendments and clarifications have shed light on these aspects.

For partnership firms, Section 2(1)(d) of the IBC, through the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Corporate Persons) Rules, 2016, specifies that a partnership firm operating as a corporate debtor can initiate an insolvency resolution process. This inclusion is pivotal, considering many Indian businesses operate through partnership models. It ensures that partnership firms have access to a mechanism for resolution or orderly winding up, aligning with the objectives of the IBC.

The scenario for banks, however, differs significantly. Given their critical role in the financial system, banks are excluded from the purview of the IBC concerning being treated as corporate debtors. This exclusion is anchored in the concern that allowing banks to be dragged into insolvency proceedings could trigger financial instability.

Instead, banks and other financial service providers are regulated and resolved under the framework of the Reserve Bank of India (RBI) and other specific statutes like the Banking Regulation Act, 1949. For instance, the RBI has the authority to initiate a resolution process for banks under the Prompt Corrective Action (PCA) framework, ensuring the stability of the banking sector is maintained.

The delineation provided by the IBC and subsequent legal interpretations ensure that while most corporate entities, including partnership firms, can seek resolution under its provisions, banks, as systemic entities, are safeguarded against potential financial turmoil that could arise from being treated as corporate debtors under the IBC.

Legal Challenges and Judicial Pronouncements

Landmark Cases and Their Impact on IBC Proceedings

Several eminent cases have tested the resilience and adaptability of the IBC framework. These cases not only challenge the statutory provisions but also set precedents for future proceedings.

1. Essar Steel India Limited Case (Arcelor Mittal India Private Limited v. Satish Kumar Gupta & Ors, (2020) 8 SCC 531: This case was essential in defining the rights of operational and financial creditors under the IBC. The Supreme Court’s judgment in this case clarified the distribution mechanism of the resolution proceeds among creditors, ensuring equitable treatment of different classes of creditors. The court emphasized the Committee of Creditors’ (CoC) discretion in approving resolution plans and the primacy of the CoC in the resolution process under Section 30(4) of the IBC.
2. Chitra Sharma & Ors. v. Union of India & Ors., W.P. (C) 744 of 2017: The Supreme Court’s intervention in this case protected the interests of homebuyers, recognizing them as financial creditors. This recognition, further solidified by the amendment to the IBC in 2018, allowed homebuyers to have a say in the resolution process of real estate developers, reflecting the IBC’s dynamic nature in addressing emerging economic and social challenges.
3. Bhushan Power Steel Ltd v. SEBI., Misc. Application No. 899 of 2022 : The Securities Appellate Tribunal addressed the issue of immunity for corporate debtors from past offenses once the resolution plan is approved. It ruled that successful resolution applicants cannot be held liable for offenses committed by the corporate debtor prior to the commencement of the insolvency resolution process. This decision, codified in Section 32A of the IBC, aims to attract more bidders by providing them protection from criminal liabilities linked to the corporate debtor’s past.

Contempt of Law by Corporate Debtors: Legal Recourse

Contempt of the IBC process by corporate debtors can significantly undermine the efficacy of the insolvency resolution process. The IBC provides several mechanisms to address non-compliance and ensure adherence to its provisions:

Section 70 of the IBC penalizes fraudulent or malicious initiation of proceedings, filing of false claims, or providing false proof. It acts as a deterrent against misuse of the IBC process.

Whereas, Section 236 gives the NCLT the powers of a civil court under the Code of Civil Procedure, 1908, for resolving IBC-related disputes. This includes the power to punish for contempt under Sections 425, 430, 431, and 433 of the Companies Act, 2013.

Conclusion

IBC, 2016, revolutionizes India’s approach to insolvency and bankruptcy, aiming to balance the intricate interests of creditors, corporate debtors, and the broader economic landscape. It establishes a legal framework that ensures time-bound resolution of insolvency cases, thereby maximizing the value of assets, promoting entrepreneurship, and ensuring credit availability.

Amendments, such as the threshold increase for initiating insolvency proceedings to INR 1 crore, reflect the Code’s adaptability to economic conditions and stakeholder needs, while the establishment of the NCLT and NCLAT as adjudicating authorities streamlines the resolution process. The distinction between financial and operational creditors under the IBC clarifies their claims and priorities, safeguarding their rights effectively.

Looking ahead, the IBC’s evolution underscores the importance of a responsive legislative framework that aligns with economic dynamics and judicial insights. The introduction of mechanisms like the pre-packaged insolvency resolution process (PIRP) for MSMEs highlights a move towards more collaborative and debtor-friendly resolution approaches. Continuous refinements to the IBC, potential incorporation of cross-border insolvency laws, and the alignment of India’s insolvency regime with global standards are critical for maintaining the equilibrium among stakeholders’ interests and fostering economic stability and growth.

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