[Shreya Choudhary and Arnav Sinha are final year students of ILS Law College, Pune]
In the wake of recent developments involving the Insolvency and Bankruptcy Code of 2016 (IBC), it is important to explore the various alternatives to restructuring debt, dealing with stressed assets and furthering the economic growth in the country. The Finance Minister announced various changes to the IBC to enhance the ease of doing business, one of them being the exclusion of Covid-19 related debt from the definition of “default”. The threshold for triggering insolvency was also raised to Rs. 1 crore through the Ministry of Corporate Affairs (MCA) Notification No. S.O. 1205[E]. Giving further effect to the reforms posed by the Government, the Insolvency and Bankruptcy Code (Amendment) Ordinance of 2020 inserted section 10A that suspends section 7, 9 and 10 of the IBC for a period of time. The authors in this post seek to analyse various alternatives to restructuring or recovering debt in the existing legal framework, and suggest potential changes which could help strengthen the debt-resolution regime.
Debt Restructuring Mechanisms
Schemes of Arrangement under the Companies Act of 2013
Section 230 of the Companies Act of 2013 read with the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 provides for a scheme of compromise or arrangements with members and creditors. Such restructuring scheme aims at increasing the company’s productivity and profitability by rearranging its debt obligations towards its members and creditors. In a crisis like this, with increasing debts and the inability to pay, it becomes important for the debtors to remain in power while facilitating the debt-recovery regime. The temporary suspension of IBC will see a reverse trend from the “creditor-in-control” regime under the IBC to the “debtor-in-possession” regime under the Companies Act. However, introducing a provision like a moratorium or stay on other proceedings while filing an application before the National Company Law Tribunal (NCLT) will attract more businesses towards the scheme and protect them from multiplicity of proceedings. Additionally, amendments easing the procedural compliances or approvals and setting up stricter timelines for debt reorganization will facilitate an even more effective alternative.
Debt Restructuring Scheme for Micro, Small and Medium Enterprises
The micro, small and medium enterprise (MSME) sector plays a pivotal role in the growth of the Indian economy, by furthering businesses and creating opportunities. The major challenge plaguing the MSME sector has been the informal nature of operation. The Reserve Bank of India (RBI) in its circular dated January 1, 2019 sought “a one-time restructuring of existing loans to MSMEs classified as standard without a downgrade in the asset classification” with an object to restructure stressed MSME accounts. Keeping in mind the positive impact of formalisation of the MSME sector on the Indian economy, the RBI in its circular dated February 11, 2020, extended the deadline for MSMEs to benefit from one-time restructuring to December 31, 2020. This measure shall benefit the MSMEs in the current economic crisis by helping the stressed sector to continue operations while they work on improving their balance sheets. The RBI Governor, in his speech at the 15th ASSOCHAM Annual Banking Summit remarked that such an extension will “enhance the scope of the scheme by benefitting the eligible MSME entities which could not be restructured under the provisions of the circular dated January 1, 2019 as also the MSME entities which have become stressed thereafter”.
Prudential Framework for Resolution of Stressed Assets
The RBI issued the (Prudential Framework for Resolution of Stressed Assets) Directions of 2019, which made restructuring of non-performing assets (NPAs) by banks outside the framework of the IBC possible. The Prudential Framework envisages the implementation of a time-bound bank-led resolution plan before any insolvency proceeding under the IBC is commenced. Banks may use this for resolution of debt during the period of the suspension of the IBC. In the event that banks fail to come up with a resolution plan within the time limits of the Prudential Framework, they will be able to initiate the corporate insolvency resolution process under the IBC once the suspension is lifted. This essentially means that the Prudential Framework would provide an added step of resolution to avoid an eventual liquidation. However, the Prudential Framework is available only for RBI-regulated entities. As such, several classes of operational creditors may not be able to use the framework for the resolution of their NPAs. Therefore, enactment of a framework available to all classes of creditors on similar lines shall provide an even more efficient asset-restructuring alternative than the IBC.
Pre-packaged Insolvency Resolution Plan- A Hybrid Model of In-Court and Out-of-Court Restructuring
In April 2019, the MCA invited comments on the working of pre-packs in India, and an eleven-member panel headed by former SEBI Chairman, U.K. Sinha, was formed. A pre-pack is an arrangement between the stressed company and its creditors with the buyer for negotiation and sale of the company’s business or assets, prior to the appointment of an insolvency professional. It is a hybrid model of debt restructuring whereby the debtors could reach an arrangement with the creditors and the buyer prior to the insolvency filing under the IBC. Pre-pack would be a viable alternative in the present uncertain times because it will bring about certainty in the result of the resolution owing to the binding nature of the outcome. It would further minimize the time taken by the resolution plan, save costs and lessen the burden on the NCLT. A pre-pack regime premised on confidentiality of the resolution and increased control in the hands of the promoter, however, may result in the promoter carrying out preferential transactions with connected bidders, leaving behind operational and unsecured creditors. Therefore, it is important to rescue the operational creditors by providing them with the opportunity to raise objections once the pre-agreed resolution plan is filed before the NCLT. Further, thought must be put into value enhancement in the pre-pack regime in the absence of an open bidding process.
Debt Recovery Mechanisms
Debt Recovery under the SARFAESI Act of 2002
The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act of 2002 (SARFAESI Act) is a unique legislation enacted to provide two major avenues for secured creditors to realise their debts. Firstly, it involves a securitization process where NPAs are acquired by an asset reconstruction company (ARC) from a secured creditor, and is financed by issuing security receipts representing undivided interest in such financial assets or otherwise. Secondly, it provides for enforcement of the security interest by the secured creditor. The SARFAESI Act while providing an enabling framework of debt recovery, suffers from many fundamental flaws. The process does not automatically enable recovery and is a recourse available only to the secured creditors. Moreover, the Debt Recovery Tribunal (DRT) is relatively inefficient as an adjudicating authority and has proved to not effectively curb the growth of bad debts in the country. In light of the suspension of the IBC, there is a need to revisit the SARFAESI Act and bring about reforms in its framework to accelerate economic growth. The adequate capitalization of an ARC during the pandemic may help it buy the NPAs from secured creditors at market price without the banks having to sell at a lower rate. Consequently, the ARC will be able to revive the NPAs so acquired. Furthermore, the procedure before the DRT for enforcement of security needs to be expedited, and time limits need to be framed in lines of the IBC to make it a feasible alternative especially for secured creditors in present times.
Good Bad Banks
A “Bad Bank” is an entity which will buy the NPAs of the creditor, thereby isolating those NPAs from the books of the original creditor. A well set up Bad Bank can extract maximum value from the stressed assets. Therefore, a Bad Bank may be crucial in an economic crisis when NPAs are rising and IBC is suspended. The Indian Banks Association has recently submitted a proposal to the RBI to set up a bad bank in light of the inevitable rise of NPAs during the Covid-19 pandemic. India has been toying with the idea of a bad bank for a while. A committee headed by the former PNB Chairman, Mr. Sunil Mehta, comprising of representatives from all major banks had in 2018 submitted a report recommending the formation of a Bad Bank. The Committee projected the resolution of over Rs. 500 crores worth of NPAs with the help of the Bad Bank.
However, a Bad Bank structure is susceptible to failure. As was the case for the SARFAESI Act, transferring of assets from one entity to other will not necessarily solve the NPA crisis. The troubled economy may also deter buyers from buying the stressed assets. Therefore, picking the best operating model for a bad bank becomes paramount. It is required that the Government backs the bad bank with equity infusion, essentially creating a public sector ARC. With government ownership and management, the country can have a professionally run ARC (as a Bad Bank) to tackle the NPA problem. While the conundrum around finding buyers for the stressed assets during an economic slump may persist, a good Bad Bank does hold the potential answer to the NPA crisis banks will face during the suspension of the IBC.
A blanket suspension of the IBC without exploring alternatives to debt restructuring and debt recovery will merely aggravate the economic crisis. Corporate debtors will be unduly advantaged to accelerate the debt during the time period of suspension and get a permanent escape out of it. Therefore, it is important to look at the existing provisions in law regarding the resolution of debt that strikes a balance between the interests of all the stakeholders, bring amendments to deal with the lacunae in law and introduce measures to fast-track the resolution process.
– Shreya Choudhary & Arnav Sinha