Three Months Certificate Course (Online) in

Insolvency and Bankruptcy Laws and Procedure

Module 1: Introduction to Insolvency and Bankruptcy Regime in India

Unit-2: Need for Insolvency and Bankruptcy Code: Exploring the rationale and
objectives1

An Act to consolidate and amend the laws relating to reorganisation and

insolvency resolution of corporate persons, partnership firms and
individuals in a time bound manner for maximisation of value of assets of
such persons, to promote entrepreneurship, availability of credit and
balance the interests of all the stakeholders including alteration in the
order of priority of payment of Government dues and to establish an
Insolvency and Bankruptcy Board of India, and for matters connected
therewith or incidental thereto.2

The aforesaid preamble of the IBC 2016 provides the broad rationale of the Code. The
Report of the Joint Committee on the Insolvency and Bankruptcy Code 2015
reiterated the rationale and objectives of the Code as follows3:

The objective of the Insolvency and Bankruptcy Code, 2015 is to consolidate and
amend the laws relating to reorganization and insolvency resolution of corporate
persons, partnership firms and individuals in a time bound manner. There is no single
law in India that deals with insolvency and bankruptcy. As per the present legal
framework, provisions relating to insolvency and bankruptcy for companies can be
found in the Sick Industrial Companies (Special Provisions) Act, 1985, the Recovery of
Debt Due to Banks and Financial Institutions Act, 1993, the Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and
the Companies Act, 2013. Liquidation of companies is handled by the High Courts.
Individual Bankruptcy and Insolvency is dealt with by the Courts.

The existing framework for insolvency and bankruptcy is inadequate, ineffective and
results in undue delays in resolution. It has been mentioned in Statement of Objects
and Reasons that the Code seeks to provide an effective legal framework for timely
resolution of insolvency and bankruptcy which would support development of credit
markets and encourage entrepreneurship. It would also improve Ease of Doing
Business, and facilitate more investments leading to higher economic growth and
development.

1
Module written by Dr. Vijay Kumar Singh, Associate Professor & Head, School of Corporate Law,
IICA with assistance from Ms. Shefali Teotia, Consultant, IICA
2
Preamble to Insolvency and Bankruptcy Code (IBC) 2016
3
Para 3of the Report of the Joint Committee on the Insolvency and Bankruptcy Code, 2015, Sixteenth
Lok Sabha, April, 2016, available at
http://ibbi.gov.in/16_Joint_Committee_on_Insolvency_and_Bankruptcy_Code_2015_1.pdf

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Recently, Hon’ble Supreme Court in the matter of M/s Innoventive Industries4 “thought
it necessary to deliver a detailed judgment so that all Courts and Tribunals may take
notice of paradigm shift in the law. Entrenched managements are no longer allowed to
continue in management if they cannot pay their debts5.” The case decided on August
31, 2017 is nick in time when the module is being reviewed for the course. In fact the
decision is very exhaustive in terms of tracing the rationale and objectives of the Code
and what could be better than content of the unit coming from the decision of the
Hon’ble Supreme Court. The relevant paragraphs are reproduced accordingly.

Para 12: The Insolvency and Bankruptcy Code, 2016 has been passed after
great deliberation and pursuant to various committee reports, the most
important of which is the report of the Bankruptcy Law Reforms Committee of
November, 2015. The Statement of Objects and Reasons of the Code reads as
under:

“STATEMENT OF OBJECTS AND REASONS

There is no single law in India that deals with insolvency and bankruptcy.
Provisions relating to insolvency and bankruptcy for companies can be found
in the Sick Industrial Companies (Special Provisions) Act, 1985, the Recovery
of Debt Due to Banks and Financial Institutions Act, 1993, the Securitisation
and Reconstruction of Financial Assets and Enforcement of Security Interest
Act, 2002 and the Companies Act, 2013. These statutes provide for creation of
multiple fora such as Board of Industrial and Financial Reconstruction (BIFR),
Debt Recovery Tribunal (DRT) and National Company Law Tribunal (NCLT)
and their respective Appellate Tribunals. Liquidation of companies is handled
by the High Courts. Individual bankruptcy and insolvency is dealt with under
the Presidency Towns Insolvency Act, 1909, and the Provincial Insolvency
Act, 1920 and is dealt with by the Courts. The existing framework for
insolvency and bankruptcy is inadequate, ineffective and results in undue
delays in resolution, therefore, the proposed legislation.

2. The objective of the Insolvency and Bankruptcy Code, 2015 is to

consolidate and amend the laws relating to reorganization and insolvency
resolution of corporate persons, partnership firms and individuals in a time
bound manner for maximization of value of assets of such persons, to promote

4
M/s Innoventive Industries Ltd. vs. ICICI Bank & Anr., 2017 SCC Online SC 1025, decided on August
31, 2017 [Coram: R.F. Nariman and Sanjay Kishan Kaul, JJ]
5
In this case the Supreme Court held that “Once an insolvency professional is appointed to manage the
company, the erstwhile directors who are no longer in management, obviously cannot maintain an appeal
on behalf of the company. In the present case, the company is the sole appellant. This being the case, the
present appeal is obviously not maintainable.”

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entrepreneurship, availability of credit and balance the interests of all the

stakeholders including alteration in the priority of payment of government
dues and to establish an Insolvency and Bankruptcy Fund, and matters
connected therewith or incidental thereto. An effective legal framework for
timely resolution of insolvency and bankruptcy would support development of
credit markets and encourage entrepreneurship. It would also improve Ease of
Doing Business, and facilitate more investments leading to higher economic
growth and development.

3. The Code seeks to provide for designating the NCLT and DRT as the
Adjudicating Authorities for corporate persons and firms and individuals,
respectively, for resolution of insolvency, liquidation and bankruptcy. The
Code separates commercial aspects of insolvency and bankruptcy proceedings
from judicial aspects. The Code also seeks to provide for establishment of the
Insolvency and Bankruptcy Board of India (Board) for regulation of
insolvency professionals, insolvency professional agencies and information
utilities. Till the Board is established, the Central Government shall exercise
all powers of the Board or designate any financial sector regulator to exercise
the powers and functions of the Board. Insolvency professionals will assist in
completion of insolvency resolution, liquidation and bankruptcy proceedings
envisaged in the Code. Information Utilities would collect, collate,
authenticate and disseminate financial information to facilitate such
proceedings. The Code also proposes to establish a fund to be called the
Insolvency and Bankruptcy Fund of India for the purposes specified in the
Code.

4. The Code seeks to provide for amendments in the Indian Partnership Act,
1932, the Central Excise Act, 1944, Customs Act, 1962, Income-Tax Act,
1961, the Recovery of Debts Due to Banks and Financial Institutions Act,
1993, the Finance Act, 1994, the Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002, the Sick
Industrial Companies (Special Provisions) Repeal Act, 2003, the Payment and
Settlement Systems Act, 2007, the Limited Liability Partnership Act, 2008,
and the Companies Act, 2013.

5. The Code seeks to achieve the above objectives.” (Emphasis Supplied)

Supreme Court summarized thus “One of the important objectives of the Code is to
bring the insolvency law in India under a single unified umbrella with the object of
speeding up of the insolvency process. As per the data available with the World Bank in
2016, insolvency resolution in India took 4.3 years on an average, which was much
higher when compared with the United Kingdom (1 year), USA (1.5 years) and South

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Africa (2 years). The World Bank’s Ease of Doing Business Index, 2015, ranked India
as country number 135 out of 190 countries on the ease of resolving insolvency based
on various indicia.” (para 13). It has been observed that other nations have marched
ahead much before us citing examples from USA, UK and Australia.

Quoting the learned Finance Minister Shri. Arun Jaitley in para 15:

“SHRI ARUN JAITLEY: One of the differences between your Chapter 11

and this is that in Chapter 11, the debtor continues to be in possession.
Here the creditors will be in possession. Now, the SICA is being phased
out, and I will tell you one of the reasons why SICA didn't function. Under
SICA, the predominant experience has been this, and that is why a
decision was taken way back in 2002 to repeal SICA when the original
Company Law amendments were passed. Now since they were challenged
before the Supreme Court, it didn't come into operation. Now, the object
behind SICA was revival of sick companies. But not too many revivals
took place. But what happened in the process was that a protective wall
was created under SICA that once you enter the BIFR, nobody can recover
money from you. So, that non-performing investment became more non-
performing because the companies were not being revived and the banks
were also unable to pursue any demand as far as those sick companies
were concerned, and therefore, SICA runs contrary to this whole concept
of exit that if a particular management is not in a position to run a
company, then instead of the company closing down under this
management, a more liquid and a professional management must come
and then save this company. That is the whole object. And if nobody can
save it, rather than allowing it to be squandered, the assets must be
distributed -- as the Joint Committee has decided -- in accordance with the
waterfall mechanism which they have created.” (Emphasis Supplied)

Bankruptcy Law Reform Committee (BLRC)6:

The Bankruptcy Law Reform Committee (“BLRC” or the “Committee”) was set up by
the Department of Economic Affairs, Ministry of Finance, under the Chairmanship of
Dr. T.K. Vishwanathan (former Secretary General, Lok Sabha and former Union Law
Secretary) by an office order dated August 22, 2014 to study the “corporate bankruptcy

6
See The report of the Bankruptcy Law Reforms Committee Volume I: Rationale and Design, November
2015 [Chairperson Dr. T. K. Viswanathan], available at
http://ibbi.gov.in/BLRCReportVol1_04112015.pdf

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legal framework in India” and submit a report to the Government for reforming the
system7.

During the course of its deliberations, the Committee decided to divide the project into
two parts:
(i) to examine the present legal framework for corporate insolvency and suggest
immediate reforms, and
(ii) to develop an ‘Insolvency Code’ for India covering all aspects of personal
and business insolvency.

Supreme Court in M/s Innoventive Industries Case copiously quoted from the BLRC
Report of November 2015, “as these excepts give us a good insight into why the Code
was enacted and the purpose for which it was enacted”8.

“As Chairman of the Committee on bankruptcy law reforms, I have had the
privilege of overseeing the design and drafting of a new legal framework for
resolving matters of insolvency and bankruptcy. This is a matter of critical
importance: India is one of the youngest republics in the world, with a high
concentration of the most dynamic entrepreneurs. Yet these game changers and
growth drivers are crippled by an environment that takes some of the longest
times and highest costs by world standards to resolve any problems that arise
while repaying dues on debt. This problem leads to grave consequences: India
has some of the lowest credit compared to the size of the economy. This is a
troublesome state to be in, particularly for a young emerging economy with the
entrepreneurial dynamism of India. Such dynamism not only needs reforms, but
reforms done urgently.”

xxx xxx xxx xxx

“The limited liability company is a contract between equity and debt. As long as
debt obligations are met, equity owners have complete control, and creditors
have no say in how the business is run. When default takes place, control is
supposed to transfer to the creditors; equity owners have no say.
This is not how companies in India work today. For many decades, creditors
have had low power when faced with default. Promoters stay in control of the
company even after default. Only one element of a bankruptcy framework has
been put into place: to a limited extent, banks are able to repossess fixed assets
which were pledged with them.

7
Interim Report of the BLRC February 2015, available at
http://www.finmin.nic.in/sites/default/files/Interim_Report_BLRC_0.pdf
8
Para 16

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While the existing framework for secured credit has given rights to banks, some
of the most important lenders in society are not banks. They are the dispersed
mass of households and financial firms who buy corporate bonds. The lack of
power in the hands of a bondholder has been one (though not the only) reason
why the corporate bond market has not worked. This, in turn, has far reaching
ramifications such as the difficulties of infrastructure financing.
Under these conditions, the recovery rates obtained in India are among the
lowest in the world. When default takes place, broadly speaking, lenders seem to
recover 20% of the value of debt, on an NPV basis.
When creditors know that they have weak rights resulting in a low recovery rate,
they are averse to lend. Hence, lending in India is concentrated in a few large
companies that have a low probability of failure. Further, secured credit
dominates, as creditors rights are partially present only in this case. Lenders
have an emphasis on secured credit. In this case, credit analysis is relatively
easy: It only requires taking a view on the market value of the collateral. As a
consequence, credit analysis as a sophisticated analysis of the business prospects
of a firm has shrivelled.
Both these phenomena are unsatisfactory. In many settings, debt is an efficient
tool for corporate finance; there needs to be much more debt in the financing of
Indian firms. E.g. long-dated corporate bonds are essential for most
infrastructure projects. The lack of lending without collateral, and the lack of
lending based on the prospects of the firm, has emphasised debt financing of
asset-heavy industries. However, some of the most important industries for
India’s rapid growth are those which are more labour intensive. These industries
have been starved of credit.”

xxx xxx xxx xxx

“The key economic question in the bankruptcy process

When a firm (referred to as the corporate debtor in the draft law) defaults, the
question arises about what is to be done. Many possibilities can be envisioned.
One possibility is to take the firm into liquidation. Another possibility is to
negotiate a debt restructuring, where the creditors accept a reduction of debt on
an NPV basis, and hope that the negotiated value exceeds the liquidation value.
Another possibility is to sell the firm as a going concern and use the proceeds to
pay creditors. Many hybrid structures of these broad categories can be
envisioned.

The Committee believes that there is only one correct forum for evaluating such
possibilities, and making a decision: a creditors committee, where all financial
creditors have votes in proportion to the magnitude of debt that they hold. In the
past, laws in India have brought arms of the government (legislature, executive
or judiciary) into this question. This has been strictly avoided by the Committee.

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The appropriate disposition of a defaulting firm is a business decision, and only

the creditors should make it.”

xxx xxx xxx xxx

“Speed is of essence
Speed is of essence for the working of the bankruptcy code, for two reasons.
First, while the ‘calm period’ can help keep an organisation afloat, without the
full clarity of ownership and control, significant decisions cannot be made.
Without effective leadership, the firm will tend to atrophy and fail. The longer
the delay, the more likely it is that liquidation will be the only answer. Second,
the liquidation value tends to go down with time as many assets suffer from a
high economic rate of depreciation.
From the viewpoint of creditors, a good realisation can generally be obtained if
the firm is sold as a going concern. Hence, when delays induce liquidation, there
is value destruction. Further, even in liquidation, the realisation is lower when
there are delays. Hence, delays cause value destruction. Thus, achieving a high
recovery rate is primarily about identifying and combating the sources of delay.”

xxx xxx xxx xxx

“The role that insolvency and bankruptcy plays in debt financing

Creditors put money into debt investments today in return for the promise of
fixed future cash flows. But the returns expected on these investments are still
uncertain because at the time of repayment, the seller (debtor) may make
repayments as promised, or he may default and does not make the payment.
When this happens, the debtor is considered insolvent. Other than cases of
outright fraud, the debtor may be insolvent because of
 Financial failure – a persistent mismatch between payments by the
enterprise and receivables into the enterprise, even though the business
model is generating revenues, or ·
 Business failure – which is a breakdown in the business model of the
enterprise, and it is unable to generate sufficient revenues to meet
payments.

Often, an enterprise may be a successful business model while still failing to

repay its creditors. A sound bankruptcy process is one that helps creditors and
debtors realise and agree on whether the entity is facing financial failure and
business failure. This is important to allow both parties to realise the maximum
value of the business in the insolvency.”

xxx xxx xxx xxx

“Control of a company is not divine right. When a firm defaults on its debt,
control of the company should shift to the creditors. In the absence of swift and

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decisive mechanisms for achieving this, management teams and shareholders

retain control after default. Bankruptcy law must address this.”

xxx xxx xxx xxx

“Objectives
The Committee set the following as objectives desired from implementing a new
Code to resolve insolvency and bankruptcy:
1. Low time to resolution.
2. Low loss in recovery.
3. Higher levels of debt financing across a wide variety of debt instruments.
The performance of the new Code in implementation will be based on measures
of the above outcomes.

Principles driving the design

The Committee chose the following principles to design the new insolvency and
bankruptcy resolution framework:

I. The Code will facilitate the assessment of viability of the enterprise at a very
early stage.
1. The law must explicitly state that the viability of the enterprise is a matter of
business, and that matters of business can only be negotiated between creditors
and debtor. While viability is assessed as a negotiation between creditors and
debtor, the final decision has to be an agreement among creditors who are the
financiers willing to bear the loss in the insolvency.
2. The legislature and the courts must control the process of resolution, but not
be burdened to make business decisions.
3. The law must set up a calm period for insolvency resolution where the debtor
can negotiate in the assessment of viability without fear of debt recovery
enforcement by creditors.
4. The law must appoint a resolution professional as the manager of the
resolution period, so that the creditors can negotiate the assessment of viability
with the confidence that the debtors will not take any action to erode the value of
the enterprise. The professional will have the power and responsibility to
monitor and manage the operations and assets of the enterprise. The professional
will manage the resolution process of negotiation to ensure balance of power
between the creditors and debtor, and protect the rights of all creditors. The
professional will ensure the reduction of asymmetry of information between
creditors and debtor in the resolution process.

II. The Code will enable symmetry of information between creditors and
debtors.
5. The law must ensure that information that is essential for the insolvency and
the bankruptcy resolution process is created and available when it is required.

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6. The law must ensure that access to this information is made available to all
creditors to the enterprise, either directly or through the regulated professional.
7. The law must enable access to this information to third parties who can
participate in the resolution process, through the regulated professional.

III. The Code will ensure a time-bound process to better preserve economic
value.
8. The law must ensure that time value of money is preserved, and that delaying
tactics in these negotiations will not extend the time set for negotiations at the
start.

IV. The Code will ensure a collective process.

9. The law must ensure that all key stakeholders will participate to collectively
assess viability. The law must ensure that all creditors who have the capability
and the willingness to restructure their liabilities must be part of the negotiation
process.
The liabilities of all creditors who are not part of the negotiation process must
also be met in any negotiated solution.

V. The Code will respect the rights of all creditors equally.

10. The law must be impartial to the type of creditor in counting their weight in
the vote on the final solution in resolving insolvency.

VI. The Code must ensure that, when the negotiations fail to establish
viability, the outcome of bankruptcy must be binding.
11. The law must order the liquidation of an enterprise which has been found
unviable. This outcome of the negotiations should be protected against all
appeals other than for very exceptional cases.

VII. The Code must ensure clarity of priority, and that the rights of all
stakeholders are upheld in resolving bankruptcy.
12. The law must clearly lay out the priority of distributions in bankruptcy to all
stakeholders. The priority must be designed so as to incentivise all stakeholders
to participate in the cycle of building enterprises with confidence.
13. While the law must incentivise collective action in resolving bankruptcy,
there must be a greater flexibility to allow individual action in resolution and
recovery during bankruptcy compared with the phase of insolvency resolution.”

xxx xxx xxx xxx

“An application from a creditor must have a record of the liability and evidence
of the entity having defaulted on payments. The Committee recommends
different documentation requirements depending upon the type of creditor, either
financial or operational. A financial creditor must submit a record of default by

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the entity as recorded in a registered Information Utility (referred to as the IU) as

described in Section 4.3 (or on the basis of other evidence). The default can be
to any financial creditor to the entity, and not restricted to the creditor who
triggers the IRP. The Code requires that the financial creditor propose a
registered Insolvency Professional to manage the IRP. Operational creditors
must present an “undisputed bill” which may be filed at a registered information
utility as requirement to trigger the IRP. The Code does not require the
operational creditor to propose a registered Insolvency Professional to manage
the IRP. If a professional is not proposed by the operational creditor, and the
IRP is successfully triggered, the Code requires the Adjudicator to approach the
Regulator for a registered Insolvency Professional for the case.
In case the financial creditor triggers the IRP, the Adjudicator verifies the
default from the information utility (if the default has been filed with an
information utility, tit such be incontrovertible evidence of the existence of a
default) or otherwise confirms the existence of default through the additional
evidence adduced by the financial creditor, and puts forward the proposal for the
RP to the Regulator for validation. In case the operational creditor triggers the
IRP, the Adjudicator verifies the documentation. Simultaneously, the
Adjudicator requests the Regulator for an RP. If either step cannot be verified, or
the process verification exceeds the specified amount of time, then the
Adjudicator rejects the application, with a reasoned order for the rejection. The
order rejecting the application cannot be appealed against. Instead, application
has to be made afresh. Once the documents are verified within a specified
amount of time, the Adjudicator will trigger the IRP and register the IRP by
issuing an order. The order will contain a unique ID that will be issued for the
case by which all reports and records that are generated during the IRP will be
stored, and accessed.”

xxx xxx xxx xxx

“Steps at the start of the IRP In order to ensure that the resolution can proceed in
an orderly manner, it is important for the Adjudicator to put in place an
environment of a “calm period” with a definite time of closure, that will assure
both the debtor and creditors of a time-bound and level field in their negotiations
to assess viability. The first steps that the Adjudicator takes is put in place an
order for a moratorium on debt recovery actions and any existing or new law
suits being filed in other courts, a public announcement to collect claims of
liabilities, the appointment of an interim RP and the creation of a creditor
committee.” (Emphasis Supplied)

The aforesaid paragraphs quoted in the Supreme Court decision provides sufficient
rationale and objectives of the insolvency and bankruptcy laws. It is important to note
that the recommendations of BLRC builds upon a series of work already undertaken in

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this area since 1964. In the past, bankruptcy reforms had involved treating the broad
landscape of the bankruptcy process as given, and undertaking certain incremental
changes. The BLRC had the mandate of comprehensive reform, covering all aspects of
bankruptcy of individuals and nonfinancial firms. Here the term “non-financial firms”
included but was not restricted to limited liability corporations. The only element which
was not covered in the BLRC was the recent work of the Financial Sector Legislative
Reforms Commission (FSLRC), which has a comprehensive solution for the failure of
financial firms9.
Table 1.2.1: Government committees on bankruptcy reforms

Year COMMITTEE OUTCOME

Amendments to the Provincial
1964 24th Law Commission
Insolvency Act, 1920
Tiwari Committee (Department of
1981 SICA, 1985.
Company Affairs)
1991 Narasimham Committee I (RBI) RDDBFI Act, 1993.
Report of the Committee on
Onkar Goswami Committee (Min. of
1993 Industrial Sickness and
Finance)
Restructuring
1998 Narasimham Committee II (RBI) SARFAESI Act, 2002.
Companies (Amendment) Act,
1999 Justice Eradi Committee (GOI)
2002, Proposed repeal of SICA
Proposed a comprehensive
2001 L. N. Mitra Committee (RBI)
bankruptcy code.
Enforcement of Securities Interest
and Recovery of Debts Bill, 2011.
2005 Irani Committee (RBI)
(With amendments to RDDBFI and
SARFAESI).
Raghuram Rajan Committee Proposed improvements to credit
2008
(Planning Commission) infrastructure.
Draft Indian Financial Code
Financial Sector Legislative Re-
which includes a “Resolution
2013 forms Commission (Ministry of
Corporation” for resolving
Finance)
distressed financial firms

Legislative Competence10
The Parliament has the power to make laws with respect to any of the matters listed in
List I (Union List) and List III (Concurrent List) of the Seventh Schedule to the
Constitution of India, 1950 (“Constitution”). States also have the power to enact laws

9
Report of the Financial Sector Legislative Reforms Commission, Volume I: Analysis and
Recommendations, Government of India, March 2013 (Chairman: Justice B.N. Srikrishna),
http://dea.gov.in/sites/default/files/fslrc_report_vol1_1.pdf
10
Taken from the Interim Report of BLRC para 2.1

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on matters listed in List III, besides List II (State List). In case of repugnancy, or
conflict between laws made by the Parliament and State Legislature on a matter
relatable to List III, the parliamentary law prevails11. This is unless the State has sought
presidential assent for its law, in which case it prevails in that state only12. ‘Bankruptcy
and Insolvency’ is an item specified in Entry 9 of List III. Entry 43 of List I deals with
‘incorporation, regulation and winding up of trading corporations, including banking,
insurance and financial corporations, but not including co-operative societies’ whereas
Entry 44 of List I deals with ‘incorporation, regulation and winding up of corporations,
whether trading or not, with objects not confined to one State, but not including
universities.’ Further, Entry 32 of List II deals with ‘incorporation, regulation and
winding up of corporations, other than those specified in List I…’ While the entries in
List I do not raise any issues regarding the Parliament’s competence to pass a law on
such entries, the power of the State Legislatures to enact a law on a matter under Entry
32 of List II does not, in any matter whatsoever, affect the Parliament’s power to enact a
law under Entry 9 of list III.

It may be noted that Supreme Court in M/s Innoventive Industries elaborately discussed
the legislative competence issue to resolve a conflict (issue of repugnancy) between a
Maharashtra Act and the IBC 2016 (discussed in Module 1 Unit 1).

Principles behind the New Code

One useful benchmark is the UNCITRAL Legislative Guide on Insolvency13, which
states the following objectives for a collective insolvency resolution regime:
1. Provision of certainty in the market to promote efficiency and growth. 2.
Maximisation of value of assets. 3. Striking a balance between liquidation and
reorganisation. 4. Ensuring equitable treatment of similarly situated creditors. 5.
Provision of timely, efficient and impartial resolution of insolvency. 6. Preservation of
the insolvency estate to allow equitable distribution to creditors. 7. Ensuring a
transparent and predictable insolvency law that contains incentives for gathering and
dispensing information. 8. Recognition of existing creditor rights and establishment of
clear rules for ranking priority of claims. 9. Establishment of a framework for cross-
border insolvency14.

11
Article 254(1), Constitution of India 1950
12
Article 254(2), Constitution of India 1950
13
2005, available at https://www.uncitral.org/pdf/english/texts/insolven/05-80722_Ebook.pdf
14
BLRC Report

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These principles are derived from three core features that most well developed
bankruptcy and insolvency resolution regimes share:
 a linear process that both creditors and debtors follow when insolvency is
triggered;
 a collective mechanism for resolving insolvency within a framework of equity
and fairness to all stakeholders to preserve economic value in the process;
 a time bound process either ends in keeping the firm as a going enterprise, or
liquidates and distributes the assets to the various stakeholders

We have already noted above the seven principles driving the design of the Code.

The Problem of Multiple Fora, Parallel Proceedings and Conflicts15

The case of BHEL v. Arunachalam Sugar Mills (“ASM”) that was decided by the
Madras High Court16 provides a good illustration of this. ASM and its sister concern
defaulted on their credit facilities which gave rise to numerous proceedings by secured
and unsecured creditors alike:
 A bank, the main secured creditor, filed an application in the DRT for debt
recovery.
 Another creditor of ASM, filed a company petition for the winding up of ASM.
 Another secured creditor that had lent funds to ASM through a credit facility,
entered into an MoU with the bank for the bank to sell the debtor’s properties
and pay the secured creditor its due from the proceeds.
 A company that had leased machinery to ASM, initiated proceedings invoking
the arbitration clause in the agreement and filed an application in the High Court
restraining ASM from transferring/ selling its assets
 A secured creditor of ASM’s sister concern initiated proceedings under
SARFAESI Act, took possession of its assets and sold the same by auction.
 An unsecured creditor, which had supplied a boiler to ASM, filed a civil suit
against ASM for recovery of money due to it by sale of immovable properties of
ASM.

Salient Features of IBC 2016

IBC 2016 is a comprehensive Code to achieve a time bound resolution of insolvency
and bankruptcy of corporates, partnerships and individuals. As the provisions relating
to Part III have not been notified we focus on salient features from Part II which deals
with Corporate Insolvency. Part III would be discussed in Module 5.

15
Aparna Ravi, The Indian Insolvency Regime in Practice-An Analysis of Insolvency and Debt Recovery
Proceedings, WP-2015-027 (November 2015), http://www.igidr.ac.in/pdf/publication/WP-2015-027.pdf
16
BHEL v. Arunachalam Sugar Mills Ltd., (High Court of Madras), O.S.A. Nos. 58, 59, 63, 64 and 81 of
2011, decided on 12.04.2011

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INSOLVENCY AND BANKRUPTCY CODE 2016

 5 Parts / 255 Sections
 21 Chapters / 11 Schedules
Part IV
Part II Part III
Regulation of
Insolvency Insolvency and
Part I Insolvency Part V
Resolution and Bankruptcy for
Preliminary Professionals, Miscellaneous
Liquidation of Individuals and
Agencies and
Corporate Persons Partnership Firms
Information Utilities
Section 3 Section 5 Section 79
Definitions Definitions Definitions
3 Sections
including the 74 Sections 110 Sections 36 Sections
32 Sections
short title, (Sections 4 -77) (Sections 78- (Sections 188-
(Sections
extent and divided into 7 187) divided 223) divided into
commencement, 224-255)
Chapters into 7 Chapters 7 Chapters
application
Adjudicating Adjudicating
Authority: National Authority: Debt
Company Law Recovery Tribunal
Tribunal (NCLT) – (DRT) – Section
Section 60 179
Appeal to NCLAT
(Appellate Appeal to DRAT –
Tribunal) – Section Section 181
61
Appeal to Supreme Appeal to Supreme
Court – section 62 court – Section 182
Do not apply to
Whole of India Whole of India
J&K

The Code is unique as it contains three definition clauses in three different parts as
noted above. The Code has three distinct parts i.e.
Part II: Corporate Insolvency
Part III Bankruptcy of Individuals and Partnership Firms (not yet notified
as on 01.09.2017)
Part IV: Insolvency Resolution Infrastructure

Two Adjudicating Authorities: There are two different set of adjudicating authorities
for Part II and Part III of the Code. National Company Law Tribunal (NCLT) as
established under the Companies Act, 2013 is the adjudicating authority for part II
which deals with Corporate Insolvency and also the Guarantors to Corporate Debtors.
Appeal from the decisions of NCLT would lie to the National Company Law Appellate
Tribunal (NCLAT). Administratively, NCLT and NCLAT come under the Ministry of
Corporate Affairs (MCA).

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In case of Part III, DRT and DRAT are the adjudicating authority and appellate
authority. Administratively DRT and DRAT falls under the Ministry of Finance.

[The role of adjudicating authorities would be discussed in detail in Module 2 Unit 1]

Consolidated Code
IBC is a consolidated code in relation to the insolvency, liquidation, voluntary
liquidation or bankruptcy, as the case may be of:
Part III of the Code
Part II of the Code
(does not apply to
(whole of India) J&K)
Such other body
Company Any other A Limited
incorporated
under the Company Liability Partnership Firms and
notified by the
Companies Governed by a Partnership under Individuals
Central
Act, 2013 Special Act the LLP Act, 2008
Government

The IBC seeks to consolidate the existing framework by creating a single law for
bankruptcy and insolvency
Existing Mechanisms New Mechanism
Companies Act, 2013
Companies Act, 1956
The Recovery of Debts Due to Banks and Financial
Institutions Act, 1993 The Insolvency and
SARFAESI Act, 2002 Bankruptcy Code,
The Sick Industrial Companies (Special Provisions) Act, 2016
1985
The Presidency Towns Insolvency Act, 1909
The Provincial Insolvency Act, 1920
CDR/SDR/S4A // ARC

The IBC also makes amendments to the following legislations:

Section
Law Schedule
of IBC
The Indian Partnership Act, 1932 245 I
The Central Excise Act, 1944 246 II
The Income Tax Act, 1961 247 III
The Customs Act, 1962 248 IV
The Recovery of Debts Due to Banks and Financial 249 V
Institutions Act, 1993 (RDDBFI)
The Finance Act, 1994 250 VI
The Securitisation and Reconstruction of Financial Assets
and Enforcement of Security Interests Act, 2002 251 VII
(SARFAESI)
The Sick Industrial Companies (Special Provisions) Repeal 252 VIII
Act, 2003

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The Payment and Settlement Systems Act, 2007 253 IX

The Limited Liability Partnership Act, 2008 254 X
The Companies Act, 2013 255 XI

Other than the aforesaid, due to IBC, the following consequential changes have also
happened:
 The Enforcement of Security Interests and Recovery of Debts Laws and
Miscellaneous Provisions (Amendment) Act, 2016 amended four laws: (i)
Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002 (SARFAESI), (ii) Recovery of Debts due to Banks
and Financial Institutions Act, 1993 (RDDBFI), (iii) Indian Stamp Act, 1899
and (iv) Depositories Act, 1996
 Banking Regulation (Amendment) Ordinance, 2017 and the notification issued
thereafter by the Central Government empower RBI to issue directions to any
banking company or banking companies to initiate insolvency resolution process
in respect of a default, under the provisions of the Insolvency and Bankruptcy
Code, 2016 (IBC). It also enables the Reserve Bank to issue directions with
respect to stressed assets and specify one or more authorities or committees with
such members as the Bank may appoint or approve for appointment to advise
banking companies on resolution of stressed assets 17 . Pursuant to this, 12
accounts representing 25% of the NPA (non-performing asset) were identified
by the internal advisory committee of RBI for immediate reference under IBC.
In the second list about 30-40 entities have been shortlisted18.
 The Securities and Exchange Board of India (“SEBI”), in a move directed
towards faster resolution of stressed assets in India, has proposed via a press
release dated 21 June,2017 that acquisition of shares of a listed company which
is in distress by an investor would be made exempt (“Exemptions”) from
preferential issue requirements under SEBI (Issue of Capital and Disclosure
Requirements) Regulations, 2009 (“ICDR”) and from open offer obligations
under SEBI (Substantial Acquisition of Shares and Takeovers) Regulations,
2011 (“Takeover Code”). Presently, relaxations from preferential issue
requirements under ICDR and open offer obligations under the Takeover Code
are only available to lenders in cases where listed companies are being
restructuring through restructuring schemes provided under the guidelines of
RBI like the Strategic Debt Restructuring scheme. This has led to a situation
where every time the lender proposes to divest the shares of such listed company
to an investor, the investor has to make a mandatory open offer which has the
effect of reducing funds available for investment in the company. By way of the
Exemption, SEBI wishes to attract investors for acquisition of listed companies
in distress and reduce the burden of the lenders by way of facilitating their
divestment from such assets. However, the Exemption will be subject to certain
conditions like approval by the shareholders of the listed company by special

17
The Ordinance introduced two new sections to the Banking Regulation Act, Section 35AA and Section
35AB which enable RBI to direct banks to commence the Insolvency Resolution Process against the
defaulting company under the Insolvency and Bankruptcy Code, 2016 The RBI has also been granted the
discretion to set up one or more advisory/supervisory committees to advise banks on resolution of
stressed assets. See RBI Circular DBR.BP.BC.No.67/21.04.048/2016-17, dated May 5, 2017
18
http://economictimes.indiatimes.com/markets/stocks/news/rbi-to-releases-second-insolvency-list-next-
month/articleshow/60273931.cms

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resolution and lock-in of their shareholding of the investor for a minimum

period of three years19.

IBC proposed to repeal the Presidency Towns Insolvency Act, 1909 and the Provincial
Insolvency Act, 1920, once the Part III of the Code gets notified (Section 243 of the
Code). The IBBI has constituted a Working Group for recommending the strategy and
approach for implementation of the provisions of the Insolvency and Bankruptcy Code,
2016 to deal with insolvency and bankruptcy in respect of (i) Guarantors to Corporate
Debtors, and (ii) Individuals having Business, and drafting related Rules and
Regulations20.

Insolvency Resolution Infrastructure

The new legislation provides for the establishment of three new institutional structures
whose functioning will be critical for the smooth implementation of the IBC – (i) a
regulator, to be called the Insolvency and Bankruptcy Board of India (IBBI), (ii) a new
profession of insolvency professionals and insolvency professional entities regulated by
insolvency professional agencies and IBBI, and (iii) information utilities to collect and
store information on debts and defaults. The regulator’s mandate is to regulate
insolvency professionals, insolvency professional agencies and information utilities as
well as to frame regulations under the IBC. Insolvency resolution cases will be heard
by the National Company Law Tribunals (“NCLTs”), in the case of corporate debtors,
and the Debt Recovery Tribunals (“DRTs”), in the case of individuals, partnerships and
unincorporated entities.

Insolvency and
Bankruptcy Adjudicating
Board of India Authority
(IBBI)

Insolvency
Information
Professional NCLT DRT
Utilities
Agency (IPA)

Information
Professional Insolvency
Entitities (IPE) Professionals

[We discuss Insolvency Resolution Infrastructure in detail in Module 2]

19
www.nishithdesai.com/information/news-storage/news-details/newsid/4061/.../1.html
20
http://ibbi.gov.in/webadmin/pdf/press/2017/Jun/release_15June.pdf

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Triggering the Code

The code gets triggered on the basis of ‘cash test’, i.e. failing to pay a debt (specified
amount) on the debt failing due or make it secured or compound for it to the satisfaction
of the creditor, is deemed unable to pay its debts21 . The test under the Code is as
follows:

Part II of the Code Part III of the Code

Insolvency Resolution and Liquidation of Insolvency and Bankruptcy for Individuals
Corporate Persons and Partnership Firms
Section 4: minimum amount of default is Section 78: …the amount of default is not
one lakh rupees (which may be raised to less than one thousand rupees (which may
one crore rupees by notification) be raised to one lakh rupees by
notification)

In the case of financial debt, a financial creditor, such as a bank, a non-banking

financial institution or a debenture trustee, may file an application immediately upon a
default occurring, provided that the information on the default is available in the records
of an information utility or the applicant provides some other acceptable proof of non-
payment.
In the case of operational debt – debt owed to suppliers, vendors, payments owed to
employees, etc. – the operational creditor will need to deliver a demand notice to the
debtor. If the debtor fails to either pay the unpaid dues or prove the existence of a
dispute on the debt payment within 10 days of the demand notice, the operational
creditor may file an application for insolvency resolution. The IBC, thus, provides an
early trigger for insolvency resolution with limited grace periods for payment delays,
compared to earlier laws dealing with insolvency and debt recovery. SICA, for example,
requires a 50% erosion in a company’s net worth to trigger a requirement for the board
of the company to monitor and report the erosion, while the RBI guidelines requires
loans that are overdue for 90 days or more to be declared as NPAs. The rationale for
having the occurrence of a payment default as the trigger is that the early detection of
financial distress helps preserve value and increases the chances that a business can be
saved.

21
NL Mitra Committee noted the various other options about trigger operation for initiating bankruptcy
operation like
(ii) Solvency test: It is a test to challenge the petition for bankruptcy in which the management/promoters
are able to submit a certificate stating that the entity has ability to pay for its entire debt because its total
realisable assets are more than its total debt. Since it is a reversal test it is not beneficial as a market
signal. (iii) Net worth test: According to Section 3(1)(ga) of the SICA, net worth means the sum total of
the paid-up capital and free reserves. If the accumulated loss is equal or more than the entire net worth in
a financial year the company is sick requiring treatment. This known as Zero or Negative net worth test.
The members felt that this balance sheet driven test shows a symptom of entity in ‘red’ but is not a good
test for an entity as a going concern requiring treatment. (iv) Continuous asset depletion test: This is a
continuous loss test as well. If a company sustains continuous loss for a number of years, the company
may be in bankruptcy situation. This is not a necessary condition. In infrastructure projects there is a high
gestation period. But the depletion theory may not be operative due to special nature of the project and
project finance. (v) Irretrievable break down test: A company’s sub-stratum may be lost due to non-
viability of the objectives; technology obsolescence; complete market break down and for many other
such reasons. Any irretrievable break down will require an intervention of a bankruptcy system.

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Corporate Debtor may also file an application.

Moratorium: A 180-day moratorium comes into place during which time all pending
actions against the debtor are stayed and no new actions may be initiated. During the
moratorium period, the debtor will also be prevented from disposing of its assets out of
the ordinary course. The idea behind this moratorium is to provide a calm period for the
debtor and creditors to discuss their future course of action, without having to deal with
individual enforcement actions by creditors, which could lead to asset stripping and
chaos. The impact of such a provision on creditor rights is still to be examined and
ascertained. An important point to note is that Section 14(1)(c) of the IBC makes it clear
that the during the IRP, the IBC takes precedence over debt recovery laws and security
enforcement actions under SARFAESI. In other words, no new SARFAESI actions may
be commenced and any existing ones would have to be suspended during the
moratorium period22.

Shift in Control from Debtor to Creditor

The debtor ceases to have control of the business, which shifts to the committee of
creditors (COC). An insolvency resolution professional is appointed to manage the
business of the debtor on behalf of the committee of creditors with a view to preserving
its assets to the maximum extent possible and to coordinate the actions of the committee
of creditors. The resolution professional will also need to prepare an information
memorandum on the debtor’s business and financial condition to assist creditors in
drawing up a resolution plan.

[Module III would discuss the Corporate Insolvency Resolution Process in detail]23

Liquidation
If 75% in value of the financial creditors do not approve the resolution plan or if they
vote affirmatively to put the debtor into liquidation, the NCLT is required pass a
liquidation order. The insolvency professional who managed the IRP or a new
insolvency professional would then be appointed as liquidator to manage the winding
up process and the distribution of assets to creditors. The liquidator has also been given
powers to investigate into any fraudulent transactions of the debtor in the lead up to the
insolvency filing and apply to have such transactions unwound. The ground ‘inability
to pay debt’ no longer subsists under the Companies Act, 2013 and a creditor (financial
and operational) can initiate insolvency proceedings only before NCLT under IBC.

22
Insolvency and Bankruptcy Code, Samvad Partners, https://samvadpartners.com/wp-
content/uploads/2017/04/Samvad-Partners-Insolvency-and-Bankruptcy-Code_July-04-2016.pdf
23
For salient features of the Corporate Insolvency read EY’s document titled “Interpreting the Code:
Corporate Insolvency in India: January 2017, available at
http://www.ey.com/Publication/vwLUAssets/ey-interpreting-the-insolvency-and-bankruptcy-
code/$FILE/ey-interpreting-the-insolvency-and-bankruptcy-code.pdf

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It is important to note that the Insolvency and Bankruptcy Board of India has notified
the Insolvency and Bankruptcy Board of India (Voluntary Liquidation Process)
Regulations, 2017 on March 31, 2017. The New Regulations provides the process for
initiating voluntary liquidation by a corporate person i.e. companies, limited liability
partnerships and any other persons incorporated with limited liability. the Government
has repealed / omitted the provisions of voluntary liquidation as mentioned in CA 1956
as well as CA 2013 vide notification dated March 31, 2017 and May 28, 2016,
respectively.

[Module IV would discuss the Liquidation aspect of IBC in detail]24

24
For salient features of the Corporate Insolvency read EY’s document titled “Interpreting the Code:
Corporate Insolvency in India: January 2017, available at
http://www.ey.com/Publication/vwLUAssets/ey-interpreting-the-insolvency-and-bankruptcy-
code/$FILE/ey-interpreting-the-insolvency-and-bankruptcy-code.pdf

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