Welcome changes to Bankruptcy Code

The new Code is ambitious, but needs a well-oiled machinery to implement it

The much awaited Insolvency and Bankruptcy Code received the President’s nod on May 28, 2016. The Code was a decently written piece of legislation with laudable but ambitious intentions. It is still not in effect and it will be a while before the different bodies are set up and relevant rules and regulations are framed.

The Code, among other things, deals with corporate debt of broadly two kinds: operational and financial. Operational debt is debt owed to, amongst others, trade creditors, employees, service providers and the government. Financial debt, as the name suggests, is in the nature of different borrowings availed from money lenders. Financial debt is further divided into secured and unsecured financial debt.

A marked departure in the Code from the existing regime is that no creditor can directly file for winding up. The first stage is an insolvency resolution process in which creditors must attempt to resolve problems and agree to a resolution plan. Corporate insolvency applications can be filed before the National Company Law Tribunal (NCLT) by any financial creditor if there is a default in payment of a financial debt.

Once NCLT admits the insolvency application, an insolvency professional is appointed who is responsible for forming a committee of creditors, which approves the resolution plan. The committee will comprise only financial creditors and will take decisions by a 75 per cent majority based on the quantum of debt owed. The benefit for unsecured creditors is that they are on the same footing as secured creditors in the committee.

Priority of payment

The Code significantly changes how the liquidation estate will be distributed. First, all insolvency resolution process costs and liquidation costs are to be paid. It is interesting to note that these costs include any interim financing raised by the insolvency resolution professional. Therefore, such interim financiers get priority over all other creditors.

Thereafter, debt owed to secured financial creditors who have relinquished security to become part of the liquidation process and dues owed to workmen in the 24 months preceding commencement of liquidation is paid on an equal footing. Once that is done, wages and unpaid dues to employees (not being workmen) for the last 12 months are paid out.

Then debt owed to unsecured financial creditors is paid. This is followed by debt owed to the Government for the 24-month period prior to the commencement of liquidation, together with any debt owed to a secured creditor who has been unable to recover his entire debt from security enforcement.

The above changes effectively give unsecured creditors’ financial debt priority over secured creditors’ financial debts which are not fully paid from security enforcement.

Further, the Code now clarifies that dues payable to the government are not paramount and they rank below unsecured financial creditors.

Similarly, other operational creditors (who may have been treated as unsecured creditors in the current regime) will now rank below all of the above.

Special arrangements

The Code states that any arrangements between two secured creditors which gives one secured creditor priority over another in liquidation may not be upheld. Further, the Code now requires secured creditors standing outside the liquidation process to deliver any surplus proceeds received on the assets to the liquidator.

Also, currently certain transactions done with the intent to defraud other creditors can be set aside. The Code expands their scope. It increases the time limit to two years for transactions with related parties and one year for those with others.

Another bold step favouring creditors is that the NCLT can set aside undervalued transactions entered into by the corporate debtor at any point in time (and not only in the last one or two-year period) if they were entered into with the intention of keeping the assets away from its creditors or adversely affecting their interests.

There will certainly be other points to consider for creditors once the rules and regulations are framed. The Code is certainly a step in the right direction and should enable availability of more credit to the cash-starved Indian economy.

But, unless a well-oiled machinery is put in place swiftly to implement it, the aspirations of its draftsmen will not be met.

The writer is Partner, J. Sagar Associates

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