The Insolvency and Bankruptcy Code, 2016- 101

Hi friends in my previous blog I wrote about the mighty “February 12th Circular” of the Reserve Bank of India and it implications which covered mostly the financial reporting perspective. I thank you for reading it and your valuable suggestions! In this blog I shall acquaint you with the newest addition in the changing theme of Corporate India- “The Insolvency and Bankruptcy Code, 2016”.

Why the subject?

Because of its economic importance. As per the latest report published by the Ministry of Finance, Government of India, the Government expects a recovery of almost Rs. 1 Lakh crore from the 12 cases referred by the Reserve Bank itself! The code empowers the creditors to take its control away from the erring owners. The impact of the recovery can be huge for the banks.

Why do we need such a code?

India never had a comprehensive law and a body to regulate and smoothen the exit of a business, which is very important as sick companies would use resources of a nation but won’t be able to materialize the same for example their workforce, natural resources etc. The previous laws like the Presidency Towns Insolvency Act, 1909, Provisional Insolvency Act, 1920, Sick Industries Companies Act, 1985, Recovery of Debts Due to Bank and Financial Institutions Act, 1993 were not efficient in handling the process. Problem also arouse because there was no single window clearance for the insolvency proceedings. As per the latest World Bank Ease of Doing Business Report a company takes an average four to five years to resolve the insolvency. Hence the Government decided to come up with a single insolvency rule.

Understanding the terms:

Let us first understand the terms associated with the name:

1) Insolvency: Refers to a situation when an individual or a body corporate is not able to pay the debt and the assets fall short of liabilities to be repaid. Hence it is just a state and not end i.e. not complete shutdown of business!

2)     Bankruptcy: Bankruptcy is an end. It is a situation where a debtor collapses completely. It is pertinent to note that Bankruptcy is a word used only for individuals for companies it is called Liquidation.

To whom does the code apply?

As per the Code the definition of to whom the code is applicable is quite wide, it covers almost everyone! But the definition has an exception clause, it shall not apply to Banks, Insurance Companies and Financial Institutions.

How does the Code work?

Let’s get down to business. But before we start with the actual working we need to know who the characters in the code are!

1) The Insolvency And Bankruptcy Board Of India: Big daddy of all. Parallels can be drawn between it and the ICAI or Bar Council.

2) Insolvency Professional: Person who will be responsible for the proceedings under the code.

3) Corporate Debtor: The troubled entity.

4) Financial Creditor: As the name suggests they include creditors for financing debts. They have a dominant position in the Committee Of Creditors (discussed below).

5) Operational Creditor: Creditors for operational expenses like creditors for expenses, machinery etc. They don’t have much say in the process.

6) National Company Law Tribunal and Debt Recovery Tribunal: The battlefield! The NCLT is for Companies and LLPs whereas the DRT will be for partnerships and individuals. In the blog they will hereinafter be referred to as NCLT.

As this is just a brief blog about the overview of the code I will keep the process very simple.

Step 1: Either the creditors (financial or operational) or the debtor will approach the NCLT for beginning of the proceedings of IBC.

Step 2: The NCLT shall appoint an Interim Resolution Professional (who should be an Insolvency Professional). The Board of Directors of the company is dissolved and the Interim Resolution Professional acts as interim CEO.

Step 3: The Interim Resolution Professional shall constitute a Committee of Creditors (CoC) which shall have all the financial creditors (case-1) and in the absence of Financial Creditors (case-2) i.e. if the company doesn’t have any financial creditors representative from operational creditors, employees and workmen. The CoC can be considered as the Board of Directors of the Company. In case 1 the financial creditors have an upper hand because only they have voting rights in the meetings of the CoC the operational creditors can only attend them. Case -2 is a rare phenomenon for which separate guidance is given in the Code.

Step 4: The CoC shall then appoint a permanent Resolution Professional (RP) (the CoC can continue the services of Interim Resolution Professional as Resolution Professional).

Step 5: The CoC and the RP shall prepare a resolution plan (which includes bids by other companies). The entire process of the Resolution has a timeline of 180 days which can be extended by 90 days.

Step 6: The Resolution plan is implemented. If it is not satisfactory to the Committee of Creditors then they can file for liquidation.

Let me tell you it is not as simple as it looks!

What if I have Equity Shares of such Companies?

Majority of these companies are listed. As per Companies Act, 2013 waterfall for payment of dues(hierarchical payment of dues) and as per revised waterfall under IBC, 2016 equity shareholders bear the highest risk i.e. they are paid when all the dues of other lenders, employees and government dues are paid. Therefore intrinsic value of such shares will mostly be zero. Furthermore when company is bankrupt the first thing that it will do is what we call in accounting terms- ‘internal reconstruction’ i.e. writing off the accounting capital. So accounting capital also decreases. Therefore both from value and accounting perspective the value of share is almost zero. The security which is traded in the market bears nothing. Moreover I cannot recollect any of the case where shareholders are given shares of the new entity! It is definitely an area to be looked into. Hence it would be prudent not to speculate in such companies!

Current Scenario and statistics.

Since its inception it has created a lot of buzz. But attention of all was only attracted when the RBI came up with 12 large accounts which compulsorily had to be brought to the IBC in June 2017. Since then two cases have been completed. Electrosteel Steels Limited and Bhushan Steel Limited. Though banks had to take a major haircut in the case of Electrosteel case (which is acquired by Vendanta Limited) banks were elated when Tata Steel Limited bought 72.65 % in Bhushan Steel Limited through a wholly owned subsidiary Bamnipal Steel Limited. Banks had to take a minimum haircut and they recovered the entire principal. For example Punjab National Bank Limited’s NPA will fall by Rs. 3,857.49 Crores (including a write back of provision) this may increase the bank's profit by Rs. 735.5 crores! Besides this PNB will also get nearly 12% stake in the company which it can sell once the company is again back to normal at attractive rate. In another case ArcelorMittal has deposited Rs. 7,000 Crores on behalf of Uttam Galva Steels Limited and KSS Petron Limited just to become eligible to bid for Essar Steel!

Another important thing is Credit Discipline. The constant fear of losing the company will prevent the notorious promotors from willfully defaulting loans and payables. Also as per IBC such willful defaulters will not have a chance to participate in the bidding process!

Hence it will unlock substantial amount of money from the system and infuse what I call credit intelligence.