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Insolvency And Bankruptcy Code (IBC) In India And How It Works?

by Tavaga Invest
Insolvency and Bankruptcy Code (IBC)

Can the bankruptcy code of India live up to its label of providing the much-needed relief for the banking sector post-pandemic?

By: Tavaga Research

A need for a time-bound process in the resolution of stressed assets is what led to the introduction of the Insolvency and Bankruptcy Code. Introduced by the NDA Government in 2015, the bill became an Act in May 2016 when it received the approval of the President of India. The average time of resolution before IBC was approximately four years. IBC’s primary aim was to speed up the process of resolution for defaulting firms and reduce the pressure of non-performing assets in the banking sector.

Who regulates and monitors the resolution proceedings?

The Insolvency and Bankruptcy Board of India regulate the IBC proceedings. The IBBI comprises of ten members, hosting representatives from the finance ministry, law ministry, and the RBI. The diverse board can take comprehensive and informed decisions for an efficient resolution. 

IBBI appoints Insolvency Professionals (IPs), who as licensed individuals facilitate the proceedings by managing the assets of the debtor and ensure the flow of information between the creditors and debtors for better decision-making.

The code, for adjudication of proceedings of the resolution, establishes two quasi-judicial authorities or tribunals for enforcing orders as per the interpretation of the Law. National Company Law Tribunal (NCLT) oversees the proceedings for companies and LLPs. Debt Recovery Tribunal (DRTs) achieve the same for partnerships and individuals. 

How does IBC work?

The code applies to corporations, partnerships, and individuals. Under IBC, both the creditors and the debtors can appeal for resolution. Once the application is accepted, the creditors take over the assets of the debtor. The said committee of creditors (CoC), which constitutes the lenders to the defaulter, is formed by the officials overseeing the resolution. CoC decides the future of the outstanding debt on the debtor’s balance sheet. The committee may choose to restructure the terms of the debt or recover a portion by selling the assets of the debtor. Following the initiation of the Corporation Insolvency Resolution process, the Board of Directors and the promoters lose control of the management and stand suspended. 

The time frame for completion of resolution for companies is 180 days (extendable by 90 days as per mutual agreement). In exceptional cases, the time frame may be extended at the discretion of the tribunal to the outer limit of 330 days. The time limit for startups or micro-enterprises with revenue of less than Rs 1 crore is 90 days (extendable by 45 days). Failure to achieve resolution or recovery within the stipulated time limit pushes the defaulter into liquidation. 

In case of liquidation, the insolvency professional decides to sell the debtor’s assets and recover the best possible price. The sale proceeds of the assets are distributed in the following order:

  • Insolvency Resolution costs and remuneration of IP
  • Secured creditors
  • Workers and other employees
  • Unsecured creditors
  • Government dues
Recovery Rate - Insolvency and Bankruptcy Code of India

Source: Business Standard, Tavaga Research

Analyzing the graphs tell us that the recovery rates are low as a percentage of claims but are high as compared to the liquidation value of the stressed assets. Some of the stressed firms have been in the system for over a decade and it is a feat of the IBC to yield such results. The number of firms ordered for liquidation is roughly four times the number of firms resolved. Putting the fact in context, the firms liquidated had assets valued at 25 percent of the assets valued for firms that were rescued. Therefore, the aggregate effect provided greater relief to the financial institutions associated with stressed firms. 

Average Recovery by Financial Creditors - Insolvency and Bankruptcy Code of India

Source: Business Standard, Tavaga Research

High-profile cases referred to IBC

  • Essar Steel: The final verdict paved the way for Arcelor Mittal and Nippon Steel Japan to form a joint venture and complete takeover of Essar Steel. The outstanding debt was Rs 49,000 crores to financial creditors. The recovery amount stood at a whopping Rs 40,000 crore.
  • Bhushan Steel: Tata Steel was selected as the highest bidder and acquired 73 percent of Bhushan Steel through its subsidiary Bamnipal Steel (BNPL). The amount owed was Rs 57,160 crore. Tata Steel acquired the stressed firm for Rs 35,200 crore, and the remainder of the debt was converted to equity. 
  • Jet Airways: Total amount owed to creditors is Rs 30,000 crores. The IBC proceedings have surpassed the time frame of 270 days. However, the NCLT had given an extension of another 90 days in March. CoC of Jet Airways is hesitant to enter liquidation as the coronavirus pandemic will not yield better prices for an asset sale. 
  • Reliance Communications: For the final verdict, Reliance Jio will undertake control of tower and fiber assets of Reliance Infratel. UV Asset Reconstruction Co Ltd (UVARC) will get a share of assets in RCom and Reliance Telecom (Spectrum). The total outstanding amount was Rs 33,000 crore, and the settled amount under IBC turned out to be Rs 23,000 crore. 
  • Dewan Housing: First financial service provider company referred to IBC by the central bank. The creditor’s claim stands at Rs 88,000 crore.

What are some recent developments around IBC?

An amendment to the Law has increased the threshold limit for initiating insolvency proceedings against the defaulting firm. The previous law allowed for the proceedings to be accepted following a default of Rs 1 lakh. The minimum limit to initiate insolvency proceedings against a debtor now is Rs 1 crore. This protects the interest of the smaller firms distressed by the global pandemic.

Another set of provisions in the same bill suspended sections of the Law allowing operational or financial creditors to initiate proceedings for a period of six months (extendable to a year) starting on March 25. The finance minister clarified that the amendment was situational and directed to protect the companies pushed into crisis due to pandemic-induced defaults. In light of these amendments, the Government on September 24 extended the suspension period of new filings under the IBC by another three months.

Despite an increase in the threshold limit for filing bankruptcy, larger corporations still admit to insolvency proceedings once the suspension period is lifted. Therefore, a burden may build up on IBC courts and professionals during the post-pandemic recovery. The next financial year will display a fairer picture of the aftermath of the pandemic and the damage done to the economic setup. Nevertheless, it is for reasons such as these that analysts believe that the banking sector stands last in line to experience recovery.

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