Tracing The Formation Of The Insolvency And Bankruptcy Code 2016 And What Makes It A Game-Changer

Somya Luthra

19 Nov 2020 5:30 AM GMT

  • Tracing The Formation Of The Insolvency And Bankruptcy Code 2016 And What Makes It A Game-Changer

    Members of a company have the option of limiting their liabilities, hence it has always been one of the most preferred forms of conducting business. A company is a registered association having perpetual succession, a separate legal entity, common seal whose shares are transferable having limited liability. In order to comprehend the Insolvency and Bankruptcy Code 2016 effectively and...

    Members of a company have the option of limiting their liabilities, hence it has always been one of the most preferred forms of conducting business. A company is a registered association having perpetual succession, a separate legal entity, common seal whose shares are transferable having limited liability. In order to comprehend the Insolvency and Bankruptcy Code 2016 effectively and to analyse its implementation critically, it is important to understand the pre-existing legal framework on Insolvency and Bankruptcy. Insolvency and Bankruptcy are two terms that are often used interchangeably but in fact, are not identical. Insolvency, if defined legally, is a state where a company or individual's liabilities exceed it's or his assets and when the debts or obligations become due for payment, the company or individual is unable to raise sufficient cash for payment. In layman's language, an Insolvency is a form of financial distress for a company or an individual in which it is not able to pay its debts when due. A number of factors can lead to insolvency for a business concern. These include improper maintenance of accounts and human resource management which may lead to a mis figured budget, increase in input costs, and lawsuits filed against a company. A company can deal with insolvency by taking corrective actions like straightforwardly negotiating with the creditors and restructuring the company's debt, creating a functional plan to bring down the overhead costs, and generating surplus cash et also that a situation of bankruptcy does not arise. Bankruptcy is a legalized procedure that companies, organizations, and individuals use to deal with insolvency. A company files a petition to being declared bankrupt, so as to become qualified for getting government aid when it is unable to pay off its liabilities. The two most common types of bankruptcy are Reorganization Bankruptcy and Liquidation Bankruptcy. Under Reorganisation Bankruptcy, the loan payable by the company is restructured to the debtor's advantage. Debtors sell off their assets in order to collect money to repay their debt. This is called Liquidation Bankruptcy. All 'bankrupt' individuals and companies are 'insolvent', but all 'insolvent' individuals and companies are not necessarily 'bankrupt'. Insolvency, most of the time is temporary and can be overcome by effective financial management.


    Insolvency and Bankruptcy finds a place in the concurrent list of the Indian Constitution (Seventh Schedule). Both State and Central governments can frame laws and regulations to govern Insolvency and Bankruptcy in their respective jurisdictions. The Concurrent List plays a central role in upholding the federal structure of the country. The United States shares a similar structure. In the United States, initially, insolvency comes under the subject matter of the state, but once the bankruptcy process commences, only federal laws become applicable. In spite of having dual control policies, there has not been a single case in post-independence India, in which states have practiced their legislative prowess in framing laws either for insolvency or bankruptcy and all responsibility regarding the subject has been left to the centre.

    India, in its early years, followed a socialist model of development in which more emphasis was paid on social welfare and equity. The aim was to industrialize the public sector and create a labour incentive economy. The number of private sector companies was low due to the cumbersome and strict licensing procedures and lack of entrepreneurship freedom. Hence, these limited private sector companies created a monopoly-like situation in the market and the resources were not being used efficiently. Losses were being made in many of these units and their net worth was fast falling. This led to dissatisfaction among the intellectuals and over the years, with changing governments and its policies, the economic structure of India became more and more liberalized and bigger and better private sector companies established themselves. Economic growth overtook social welfare in the ranks of government priorities. Kohli (2012) assigns that "this complex political shift to several underlying political realities including a growing realization that redistributive possibilities were increasingly limited, the negative impact that radical rhetoric had had on the corporate sector's willingness to invest, and low industrial growth during the 1970s." Finally, in 1991, India saw the aftermath of 'Balance of Payment' crisis of the 1990s, India opened its doors to the outside world and the Liberalisation, Globalisation, and Privatisation policy was introduced. The political and economic climate played a pivotal role in influencing the laws regarding Insolvency and Bankruptcy in India. The key developments in the Insolvency and Bankruptcy framework have been in some way or the other influenced by the social-political environment in India.

    Before the advent of the Sick Industrial Companies (Special provisions), Act, 1985, the Companies Act, 1956 was the only law governing Insolvency and Bankruptcy in India. Bhabha Committee was formed in 1950 and submitted its recommendations in 1952, which led to the formation of the Companies Act. Section 425 deals with involuntary dissolution as well as the voluntary dissolution of a company. Dissolution has been defined as "compulsory winding up" in the Companies Act, 1952. Procedures for the resolution process were included in Sections 433, 443, 444, 455, 463, 466, 481, and 488 of the Act. The Act was not able to effectively manage the insolvency proceeding in India, which led the majority of the cases to be relegated to the courts for resolution. The courts on seeing the increasing number of cases, appointed a legal representative, i.e. the liquidator with limited knowledge and understanding of its client's business prolonged the resolution process and affected the chances of fair compensation and recovery to the stakeholders. This dissuaded the companies and other affected parties and the need for a new legislative framework was felt as Companies Act 1956 proved to be inadequate.

    The Sick Industrial Companies (Special provisions) Act, promogulated in the year 1985, was a brainchild of various committees set up by the Reserve Bank of India and the central government since the year 1975. The Act played an important role in defining the concepts of a 'sick company' and a 'potentially sick company'. The Act defined the sick company as, "any company that existed for at least five years and the accumulated losses exceeded or equalled net worth of any financial year." Under Section 3(a) and 3(b) of the Sick Industrial Companies (Special provisions) Act, two quasi-judicial bodies were formed, the Board for Industrial and Financial Reconstruction (BIFR) and the Appellate Authority for Industrial and Financial Reconstruction (AAIFR). But this act also failed to provide the required relief because of the use of a balance sheet approach instead of the prospective cash flow approach in detecting sick units.

    Companies (Second Amendment), Act 2002 initiated to replace BIFR and AAIFR with National Company Law Appellate Tribunal (NCLAT) and National Company Law Tribunal (NCLT) as adjudicating bodies. BIFR and the AAIFR were finally dissolved by the Sick Industrial Companies (Special provisions) Repeal Act of 2003 although it was never notified as the formation of the Constitution of NCLT was delayed. The Recovery of Debts Due to Banks and Financial Institutions Act, 1993 ("RDDBI") brought in a revolution in the legal framework governing the Insolvency and Bankruptcy Code in India. Under this act, specialized tribunals, Debt Recovery Tribunals, and the Debt Recovery Appellate Tribunals which aimed to figure out how to recover money due to banks and financial institutions from the borrowers, so that the money could be further used productively for the development of the country. Debt Recovery Tribunals gave banks the power to file an application before it, for receiving a 'Certificate of Recovery'. This certificate had equal status and effect of a "decree of a civil court". What is seen unfortunate is that even RDDBI Act failed to make any significant improvement in the insolvency landscape due a number of reasons. First of all, SICA had precedence over RDDBI. DRT's failed to issue 'Certificates of Recovery' to cases pending before BIFR. Also, the number of cases pending before the DRTs' were huge, which overburdened it. The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) was introduced in 2002 by the government for the purpose of accelerating the resolution of non-performing assets. SARFAESI provided a "legal mechanism for expedited recovery of secured assets through empowering Banks and Financial Institutions to recover their non-performing assets without the intervention of the court." Even though SARFAESI did contribute to fastening the resolution process, the benefits were only limited to secured assets. As in the case of RDDBI, SARFAESI didn't hold the power or authority to restructure or reorganize. Also, there was a complete confusion regarding the jurisdictions of RDDBI and SARFAESI as they overlapped. A Corporate Debt Restructuring Scheme was introduced by the Reserve Bank of India during the time of inception of the SARFAESI Act with the aim of accommodating broad guidelines for banks to restructure debt. A 'working document' was created out of what was intended to be a statute, due to multiple amendments over fifteen years. At the same time, true competency of company laws was being assessed by various committees and there were cries for amendments to deal with insolvency and bankruptcy from all corners.

    The need for an all comprehensive, single law to handle all insolvency and bankruptcy-related matters was evident. In 2011, the Financial Sector Legislative Reforms Commission was set up, led by Justice Srikrishna. Another committee, led by T.K. Viswanathan was set up by the Ministry of Finance called the Bankruptcy Legislative Reforms Committee which came out with a two-volume report. Both the reports were incorporated into a Bill whose modified version as tabled in the Parliament in the winter session of the parliament. A Joint Parliamentary Committee was set up, whose report included a new draft of the law, that was later passed as what we call the Insolvency and Bankruptcy Code 2016. The new Bill was a much-awaited reform in the sector, as it overcame the inadequacies of the legal framework governing insolvency and bankruptcy all these years.


    Insolvency and Bankruptcy Code 2016 sets out the different bankruptcy settling procedures for companies, individuals, and other types of organizations. It allows both the debtors, as well as the creditors to initiate the procedure. The code sets out a maximum timeframe for finishing the insolvency resolution procedure for both individuals and corporates. On account of a company, the procedure must be completely finished in one hundred and eighty days, which can later be extended by ninety days just when a majority of the creditors license or concur. Then again, on account of start-ups (aside to the partnership firms), organizations having not as much as Rs 1 crore worth of assets, the resolution procedure would be satisfied within a time period of ninety days of starting the required that can be additionally extended by upwards of 45 days. The Code sets out that the Insolvency and Bankruptcy Board of India will supervise the procedures identified with insolvency in the country and furthermore control every one of the associations that have been registered by the board. The Insolvency and Bankruptcy Board will comprise of ten individuals, which would likewise incorporate the agents of the Law and Finance ministries as well as the RBI (Reserve Bank of India). The process of bankruptcy resolution will be administered by licensed insolvency professionals. They would likewise practice control on the debtor's assets during the insolvency procedure. The Code has presented two distinct courts for administering the procedure settling bankruptcy, for companies and individuals. These are "(i) the National Company Law Tribunal for organizations and Limited Liability Partnership companies; as well as (ii) the Debt Recovery Tribunal for overseeing insolvency resolution for individuals as well as partnership firms". An insolvency plea is given to the relevant tribunal (in corporate account holder's case it is NCLT) by the debtor or the creditor. The plea can be acknowledged or dismissed in at most a timespan of fourteen days. If the plea gets acknowledgment then the tribunal should rapidly appoint an IRP or Insolvency Resolution Professional for drafting a resolution plan within 180 days (that can be extended by ninety days). Following this, the court would start the way toward settling corporate bankruptcy. For that specific period, the organization's directors will stay suspended and the promoters will have nothing to do with the organization management. The Insolvency Resolution Professional can look for help from the management of the organization for dealing with ordinary activities. In the cases in which the CIRP is unfit to revive the organization, at that point, the procedure of liquidation will be started.

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