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“The worst bankrupt in the world is the man who has lost his enthusiasm. Let a man lose everything else in the world but his enthusiasm and he will come through again to success” says H W Arnold, a lieutenant general in the US army during World War II. And if his immediate reference was the army, the observation is equally true in other spheres of life, especially, in business.

Bankruptcy is an essential part of capitalism, says Joseph Stiglitz, the Nobel laureate in Economics. But then, borrowing Arnold’s words, bankruptcy is not the end of a business – the will power of the entrepreneur and his enthusiasm will give him chances to succeed. 

Maybe, this possibility of revival of an ailing business prompted the government, while documenting the Insolvency and Bankruptcy Code (IBC), to look into the process through which financially ailing corporate entities are put through a rehabilitation process and brought back up on their feet.

In reality, however, the main objective of the IBC turned out to be the rescuer of corporate debtors in distress. However, India took a long time to recognise bankruptcy as an essential part of the economic process and just about six years ago, in 2016 put bankruptcy under legal structure. The urgency for a legal bankruptcy framework began with the piling up of bad loans of banks.

Since the beginning of the last decade Indian banks were struck with increasing defaults in debt and the existing debt recovery laws were failing badly. It was realised that mere recovering of debt would not address the damage done by the increasing non-performing assets (NPAs). There was an urgent need for a pragmatic and long-lasting solution to address the NPA problem and ensure a healthy credit flow within the economy.

According to the estimates of the Reserve Bank of India, the gross non-performing assets of scheduled commercial banks were 7.5% of their gross advances in 2015-16 and they increased three times in the previous five years. The ratio of gross NPA to gross advances was 2.5% in 2010-11. The ratio of net NPA to net advances had increased four times during the period from 1.1% in 2010-11 to 4.4% in 2015-16. . It was estimated at 5.9% in 2021-22.

Insolvency and Bankruptcy Code

India was desperate to correct the malady of rising bad loans and the Insolvency and Bankruptcy Code, 2016 (IBC) was enacted on 28 May 2016. However, the IBC is not another debt recovery law in disguise. With the IBC, the incidence of failure of debts is sought to be tackled in two ways. Firstly, through a behavioural change on the part of the debtors to ensure sound decision-making to prevent business failures. Secondly, the IBC envisages a process through which financially ailing corporate entities are put through a rehabilitation process and brought back up on their feet.

But as time passed the Indian insolvency regime under IBC shifted from ‘debtor-in-possession’ to ‘creditor-in-control’. The creditor-in-control model hands control of the debtor to its creditors and relies upon the managerial skills of a newly appointed management to take over an ailing company and ensure business continuance.

To keep the reform abreast with upcoming challenges, the government has amended the Code six times during the last six years. The IBC Board has also made 84 amendments to its 18 regulations made under the Code till date.

The work process of IBC

The bankruptcy procedure begins with the Corporate Insolvency Resolution Process (CIRP).  In case a corporate entity becomes insolvent and fails to repay debt, the concerned creditor or the corporate entity itself, may initiate CIRP.

When a corporate body becomes insolvent and commits a default, a financial creditor, an operational creditor or the corporate debtor itself may approach the National Company Law Tribunal (NCLT) - the Adjudicating Authority for insolvency resolution of corporate persons - to hand-over an application for initiating CIRP against the defaulter. The basic purpose of initiating CIRP is to claim debt. Initially, a minimum debt was rupees one lakh to initiate CIRP. But after the amendment of 2020 the minimum debt limit has been increased to rupees one crore.

NCLT shall, within 14 days of the receipt of the application made, establish the existence of a default, through accessing the records of an information utility or as per other evidence provided by the financial creditor. If the same is not done within the time-limit, the Tribunal shall record its reasons for the same in writing.

After establishing the default and clarifying that there are no pending disciplinary proceedings against the proposed resolution professional, NCLT may, by its order, admit the application. If the Adjudicating Authority finds any discrepancies, it will, before rejecting the application, give seven days to the applicant to rectify that mistake. If admitted, NCLT will communicate the order to the financial creditor and the corporate debtor, and the resolution process shall begin from the date of admission of the application.

After a corporate debtor is admitted into the resolution process, an Interim Resolution Professional (IRP) is appointed by the Adjudicating Authority (NCLT) as proposed by financial creditors. The board of directors of the corporate debtor is suspended, and control of the corporate entity’s affairs is shifted into the hands of the IRP. The IRP shall receive assistance from the existing personnel of the corporate debtor, and his/her term will continue till  the appointment date of the Resolution Professional.

After the appointment, a public announcement shall be made stating the initiation of CIRP against the corporate debtor which would have details such as name and address of the corporate debtor, name of the IRP, and the date on which the CIRP would conclude.

The bankruptcy code has been drafted and designed to explore various revival opportunities for an ailing corporate debtor. Therefore, it gives opportunities to an individual, a trust or a corporate bidder to come forward, invest capital, acquire and purchase the concerned corporate entity which is under CIRP, and get the company back on its feet.

In case a resolution plan is approved within the period mentioned above and is sanctioned by NCLT, the plan would be binding on the corporate debtor and its members, employees, guarantors, creditors and other stakeholders involved in the resolution plan. If no plan is approved within the mentioned period, then the Adjudicating Authority is required to order the liquidation of the corporate debtor. After the approval of the same, the committee of creditors appoints the liquidator to sell off the assets of the debtor and distribute them among stakeholders.

Faltering timeline

As per the IBC the procedure involved in the CIRP should be completed within 180 days or within the extended period of 90 days and mandatorily be completed within 330 days including any extension and the time taken in legal proceedings. In short, the resolution procedure should be completed within 330 days, failing which the Adjudicating Authority will initiate liquidation procedure under Chapter III of the Code. 

The prescribed time limit has, however, been hardly met over the years. The average time taken for resolutions has been much more than the outer limit prescribed in IBC. The ministry informed the Lok Sabha on December 12, 2022 that as per the data from the IBC Board, in the current fiscal up to September 2022 some 57 cases were resolved and the average time taken was 679 days. In 2021-22 an average 560 days were taken to resolve 143 cases. In 2020-21 an average 468 days were taken to resolve 120 cases of liquidation.

Large haircuts defeat IBC’s rationale

Admittedly, the bankruptcy code has contributed to the development of disciplined borrowing amongst companies. Promoters are fearful of losing control of their enterprises in the event of a default. A huge 18,629 applications involving more than ` 5,29,000 crore have been resolved in the first five years even prior to being admitted. Post the implementation of IBC, as per the World Bank’s report, India’s rank in resolving insolvency went from 136 in 2017 to 52 in 2020. The recovery rates under the IBC are low. There are matters where haircuts of as much as 95% are being granted during the insolvency resolution. Since 2016, the lenders took an average of 61% haircut on claims.

Recovery falling below even the liquidation value of assets admitted under the Insolvency and Bankruptcy Code (IBC) process shows why the IBC ecosystem desperately needs fixing. As this newspaper reported on Friday, the recovery ratio for creditors has hit a record low of just 10.2% of admitted claims in January-March 2022. This is the second consecutive quarter of disappointing numbers—realisations in October-December 2021 were just 13.4%. While it is true that IBC’s performance shouldn’t be assessed based on the data of a couple of quarters and the size of realisations shouldn’t be the primary yardstick, the fact is that the overall realisations since the IBC came into effect are modest at 32.9%. 

According to the IBC Board the creditors have realised Rs.2.35 lakh crore through resolution plan in about 517 cases against the total claims of Rs.7.67 lakh crore till June, 2022.With liquidation value at Rs.1.31 lakh crore.

For every Rs.100 admitted for the claims under IBC the banks could realise only Rs.30 till June, 2022. That is, banks took a haircut of about 70% for admitted claims. However, this comes down to Rs.17 when it is considered relative to the value of assets.

This is reflected in the low recovery of banks’ written off loans. Only about 13% of the loans written off by the scheduled commercial banks during the last five years have been recovered, the finance minister told the Rajya Sabha last December. Limitations

Despite the fact that the IBC seeks to achieve its aims through prompt, efficient and impartial restructuring or resolution, there exists a significant contrast between the objectives and current occurrences principally due to increasing haircuts.

The most important reason for haircuts is the delay in the process of recovery under the IBC. The delay has been attributed to the large number of vacancies in IBC tribunals, incomplete knowledge of the stakeholders, and the piling of cases before the tribunal.

Although, the Code said otherwise, it fails to provide adequate safeguards to protect the rights of the company before handing over the management to the resolution professional. The Code often rides substantially on the unquestionable word of the creditors.

Another concern is that the code is heavily tilted in favour of creditors depriving debtors of fair participation in the process. The Committee of Creditors is made the all powerful authority in the resolution process. It can accept or reject revival plans of the debtor company but the committee will have none from the debtor’s side.  

The Code is only six years old and may be in due course of time these deficiencies will be rectified. What is important right now is that India finally has an Insolvency and Bankruptcy Code that will deal with bankruptcy within a defined legal framework.