Debt Resolution Process - Indian perspective

In this blog, we shall discuss evolution of Debt Resolution process in India and provisions of three main debt resolution legislations. The blog is meant to present the subject in a nutshell, to any person who is interested in this subject.

Debt resolution or settlement is an arrangement whereby creditors settle their dues from the debtor / borrower for a certain reduced amount, which ensures that they are able to recover at least part of their dues as against the possibility of a total loss. Thus the process tries to protect and balance the interest of both creditors and debtors.

Historical perspective

Reference to the concept of debt resolution can be found in early Roman law doctrine of Cessio bonorum (Latin for "surrender of goods"). It meant a voluntary action by a debtor to surrender goods to the creditors. It did not include a discharge from liability unless the property ceded was sufficient for the purpose, but it secured the debtor from personal arrest. The creditors sold the goods as partial restoration of their claims. (Wikipedia)
 
In Indian context, organized debt relief can be traced back to British colonial times. Before the English came to India there was no codification of insolvency or debt resolution process. First instance of insolvency law can be found in certain provisions of Government of India Act, 1800, and then the Indian Insolvency Act, 1848, and the Presidency-towns Insolvency Act, 1909 (applicable only in the three “Presidency” towns of Bombay, Calcutta and Madras, which were the main trading centres for the British).and the Provincial Insolvency Act, 1920. The last two statutes governed Insolvency and Bankruptcy cases in the country till recently, when they were replaced by Insolvency and Bankruptcy Code, 2016.

After independence, the Companies Act, 1956 covered matters relating to a company’s winding up, without defining insolvency and bankruptcy. Statutory and worker’s dues were given precedence over secured creditors.
In 1980-81, Government constituted a committee under the Chairmanship of Sri T Tiwari, the then Chairman, of the Industrial Reconstruction Corporation of India. Based on its recommendations, Sick Industrial Companies Act (SICA),1985 was incorporated which mandated establishment of The Board of Industrial and Financial Reconstruction (BIFR).SICA had limited applicability as it was applicable only to companies and that too once they turned sick.

JJ Irani Committee constituted in 2005 for revising company law provisions for bankruptcy, suggested establishment of a separate ecosystem for dealing in commercial insolvency covering all corporates. This led to establishment of National Company Law Tribunal, taking away jurisdiction from High Courts (after amending the Companies Act, 2013). A need was felt for a comprehensive legislation covering all aspects of insolvency and bankruptcy for all segments and therefore in 2015, Bankruptcy Law Reforms Committee was constituted under the Chairmanship of Dr. TK Viswanathan. Based on its recommendations the Insolvency & Bankruptcy Code was introduced in Lok Sabha in December 2015. After deliberations by a Joint Parliamentary Committee the code was passed by both houses of parliament in May 2016 and became an Act after receiving President’s assent. The code came into effect on 1^st December, 2016.

Debt Resolution process

Banks offer “debt settlement” to a customer, after due evaluation of the customer’s business and available security. As mentioned at the beginning of this blog, debt settlement necessarily comes with a “haircut” whereby the creditor settles for a lower amount than the actual debt, because in the given circumstances recovering something may be better that loosing everything. It is generally through a single payment and the process is called OTS (One time settlement).
 
Resolution of the stressed entity has been further refined to include insolvencies and bankruptcies. Insolvency can be defined as a financial state where a person or an enterprise is unable to pay their debt. Bankruptcy is the legal process or declaration that the person or enterprise is unable to pay debt. Failure to pay debt leads to a situation which needs to be resolved to protect creditor’s interest and in the process explore if the insolvent enterprise continues as a going concern.

Debt Recovery Laws

The spirit behind debt recovery process and relevant legal framework is not only to help realization of dues of creditors but also to protect interests of a viable business if it is facing financial difficulty. Thus laws have evolved over the years taking into consideration interest of both debtors and creditors – the former can get relief in case of financial distress and later can be provided with a safe environment for recovery of their dues in case the transaction turns into a bad debt.
 
Debt Recovery Tribunals

The Recovery of Debts due to Banks and Financial Institutions Act, 1993 (Act no 51 of 1993) was enacted on 27^th August 1993 and came into force on 24^th June 1993. The Preamble of the Act states “An Act to provide for the establishment of Tribunals for expeditious adjudication and recovery of debts due to Banks and financial institutions and for matters connected therewith or incidental thereto.“

The Recovery of Debts and Bankruptcy Act, 1993 was the first legislative attempt in post independence India to provide a legal framework for recovery of dues by Banks and Financial Institutions. Debt Recovery Tribunals (DRTs) and Debts Recovery Appellate Tribunal (DRATs) were established under the Act, for providing an expeditious process for adjudication and recovery of debts. At present, 39 DRTs and 5 DRATs are functioning across the country.
The Act consists of 6 chapters and 37 sections. It applies to debts over Rs. 10 lacs and restricts jurisdiction of banking disputes to DRTS/DRATs. No other court can adjudicate on debt disunites except High Court and Supreme Court. When a Bank of Financial Institution files an application before a DRT having geographical jurisdiction, within a period of 30 days the tribunal issues a show cause notice to the defendant. The defendant gets a time period of 30 days to file their written statement presenting their case. The tribunal has the authority to appoint a receiver for management of properties belonging to the defendant and realization of dues therefrom.

After hearing both the parties as to their claims and counter claims, the tribunal may pass a suitable order and may issue a certificate of recovery in favour of the Banks / FIs . If the defendants feel aggrieved from tribunal’s order they can file an appeal before the Debt Recovery Appellate Tribunal (DRAT) within 30 days DRAT shall within a period of 6 months, conclude hearing both the parties and pass a suitable order either confirming or modifying or setting aside DRT’s order. At the time of filing an appeal before DRAT, the appellant has to deposit at least 50 % of the decreed amount. The Recovery officer may enforce the final decree through attachment and sale of borrower’s immovable properties. Secured creditors shall have the first priority for recovery of their dues from the realized amount followed by Government dues and unsecured creditors.
 

SARFAESI Act

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (Act No. 54 of 2002) was enacted on 17^th December, 2002, qnd came into force on 21^st June, 2002. The Preamble of the Act states “An Act to regulate securitization and reconstruction of financial assets and enforcement of security interest and to provide for a Central database of security interests created on property rights, and for matters connected therewith or incidental thereto.”
 
Before enactment of SARAFESI Act, there was no legal provision for facilitating securitization of Bank’s financial assets. Moreover, unlike international banks, Indian banks did not have power to take possession of securities and sell them. It was therefore felt necessary to enact a tougher legislation to help Banks as the existing provisions of Sick Industrial Companies Act 1985 (SICA) were found inadequate to protect institutional interests. The Act consists of 6 chapters, 42 sections and one schedule. However, it covers the following three major areas –Securitization, Enforcement of security interest and Asset reconstruction.

Securitization
Any Asset Reconstruction Company (ARC) can acquire right or interest in financial assets from any Bank or FI through issue of a debenture or bond. ARC will thus step into the shoes of the lender and all the rights of the lender shall get vested in the ARC. The lender may give notice of this acquisition to all concerned parties and thereafter the borrower has to make relevant payments to the ARC. 

Enforcement of Security Interest
Section 13 of the Act covers this aspect. A secured creditor (Bank/FI) can enforce the security directly, without intervention of Court or Tribunal, after giving 60 days notice, once the borrower has defaulted and the account has been classified as Non-Performing Asset (NPA).The borrower can make a representation to the secured creditor. The creditor may accept or reject and in case of latter may serve a 60 day notice on he borrower. Once the borrower fails to pay, the secured creditor can recover the debt either through taking possession of the asset or takeover of management of borrower’s business. If there are more than one creditor, then decisions require a majority of 60 % creditors value wise.

Secured creditor can either act on its own or through an ARC, against the borrower and /or guarantors. An aggrieved debtor can approach a DRT. Similarly, if a creditor cannot realize full dues through sale of assets, then they can also approach DRT for recovery of balance amount. Civil courts have been specifically barred from any jurisdiction in such matters.

Lenders can convert any part of the debt into equity, with the rider that once lenders take control of the company via this route,  the management of the company cannot be restored to the original owners / borrowers even after realization of entire dues.

Asset Reconstruction
The central theme underlying Asset reconstruction, is to transfer toxic assets from Bank’s Balance sheets to an independent entity like an ARC, so that the Bank’s Balance sheet becomes free for normal banking business. This can be done through issue of bonds or Security Receipts by ARCs in Bank’s favour. In such cases, Bank’s interest in the asset gets transferred to the ARC and latter steps into the shoes of the Bank. ARC can then take all steps necessary for realization of dues like takeover of management , sale or transfer of asset etc.

Central Registry
Section 20 of the Act mandates setting up of a Central Registry for registration of transaction of securitization and reconstruction of financial assets and creation of security interest. Under provisions of Section 25, ARC is required to notify the Central Registry once the security interest gets paid or satisfied. It is to be noted that the secured creditor gets priority over all other debts and revenues, taxes, cesses and other rates payable to the Central Government or State Government or local authority.

The Insolvency and Bankruptcy Code, 2016

The genesis of IBC, 2016 lies in the Bankruptcy Law Reforms Committee (BLRC) constituted by Ministry of Finance in 2014.The Committee under the chairmanship of Dr. TK Viswanathan made extensive recommendations on a comprehensive legislation on Insolvency and Bankruptcy which formed the basis of IBC, 2016. In December 2015, the Code was introduced in Lok Sabha and  IBC, 2016 (Act no 31 of 2016) was enacted on 28^th May 2016. Its Preamble explains the underlying philosophy very well “ An Act to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximisation of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues and to establish an Insolvency and Bankruptcy Board of India, and for matters connected therewith or incidental thereto.”

IBC reformed the process of insolvency and bankruptcy in India by laying down a time bound roadmap. Before IBC’s enactment, resolution of corporate bad debt was being undertaken through Board for Industrial and Financial reconstruction (BIFR) constituted under the Sick Industrial Companies Act (SICA), 1985. SICA’s basic infirmity that restructuring process could be initiated only when a company was diagnosed as “sick”, was removed by IBC which entailed initiation of resolution process on first signs of financial difficulty. Moreover IBC by laying down a time bound road map ensured that there are no delays, by excluding any judicial intervention once the resolution process gets started. If the parties feel aggrieved by the final order of the appellate tribunal under IBC, they can approach Supreme Court on a question of law.

IBC established National Company Law Tribunal (NCLT) and National Company Law Appellate Tribunal (NCLAT) to deal with cases of corporate insolvency while individual cases continued with DRTs and DRATs.

The Code is divided into five parts with 244 sections. Under IBC’s provisions, a financial or operational creditor or a debtor can initiate the resolution process. Under the code, value of default should be more than INR one lakh. Section 2 determines application of the code to any company, Limited Liability Partnership, partnership firm and individual, in relation to their insolvency, liquidation, voluntary liquidation or bankruptcy, as the case may be.

Financial Creditors can initiate corporate insolvency resolution process under section 7. The Adjudicating Authority (AA) shall ascertain existence of a default within 14 days. In case of operational creditors, in case of a default they are required to send a demand notice to the corporate debtor who has ten days to respond (section 8).  If payment is not received in this period, then the operational creditor can approach the AA with bank certificate. The AA has 14 days for either accepting or rejecting the claim. The resolution process has to be completed within 180 days, extendable by a further 90 days.

After the application is admitted, the AA shall declare a moratorium during which no judicial action can be initiated against the debtor. An interim resolution professional is appointed, who shall have a tenure of 30 days. The interim RP shall collate all financial information by the company, appoint a committee of creditors (COC) and shall look after company’s operations till COC appoints a full time RP.

Section 21 of the code mandates appointment of a Committee of Creditors (COC) comprising of all financial creditors with all decisions being taken with a minimum 75 % voting share. The COC shall appoint a Resolution Professional who shall conduct the entire corporate insolvency resolution process (CIRP) and manage operations of the corporate debtor during the process. The code doesn’t give unlimited powers to RP and he has to obtain COC’s prior approval in certain cases. The aggrieved party is required to present a resolution plan to the RP who after examining it and being satisfied shall take COC’s approval for the same. Thereafter, the resolution plan is presented to the AA who issues the final order binding the corporate debtor.

If a Resolution plan is not received or approved, the AA can order liquidation of corporate debtor and appointment of a liquidator. The latter takes control of the assets of the corporate debtor, verifies claims of creditors and sells moveabale and immovable assets of the debtor to settle the claims of secured creditors. IBC also provides for voluntary liquidation by a corporate.(Section 59).

Part III of the Code deals with Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms. A debtor, who is unable to pay his debt is also entitled to make an application for a fresh start through discharge of his qualifying debt. A moratorium period of 180 days comes into effect on the day of admittance of application during which period all other legal proceedings are deemed to be stayed. The insolvency resolution process can be initiated either by the creditor or the debtor. The debtor is required to submit a repayment plan to the RP. The repayment plan can be approved or rejected by a three/fourth majority of creditors. RP supervises implementation of the repayment plan.  
 
Chapter IV of the code deals with Bankruptcy for individuals and partnership firms. Section 121 mandates that an Application for Bankruptcy of a debtor can be made by a creditor or a debtor to the AA within a period of 3 months of insolvency resolution order. The AA is required to pass a bankruptcy order within 14 days of receiving the confirmation or nomination of the bankruptcy trustee.  The AA has to issue a public notice within 10 days inviting claims from creditors. The bankrupt is debarred from carrying out normal business activity.

Conclusion

Debt resolution process has evolved over the years but we never had an integrated approach till enactment of IBC, 2016. This has proven to be the proverbial game changer. IBC made the process transparent and quicker for both creditors and debtors. It is not a recovery but a resolution mechanism. But IBC is not able to deliver the desired results as the process under the Act is getting affected by endemic delays, games being played by the erstwhile promoters and a myriad other factors like worker’s issues. So we may see more and more companies going into liquidation instead of achieving resolution of debt. After implementation of IBC, it’s a moot question whether channel of DRTs should continue for non corporate entities or NCLT’s scope should be expanded to include all delinquencies or stress situations. But all said and done we have covered a long way, although we are yet to formulate a 100 % fool proof mechanism.