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New Bankruptcy Code: Will It Work?

Published on Fri, Dec 04,2015 | 23:17, Updated at Mon, Dec 07 at 22:28Source : CNBC-TV18 |   Watch Video :

Over Rs 3 lakh crore of public money is stuck in bad assets or non-performing loans – many of them insolvent companies. The World Bank says resolving insolvency takes over 4 years in India and the average recovery is 25 cents to the dollar. The Sick Industrial Companies Act and the Board Of Industrial Financial Reconstruction have failed to speedily revive or liquidate companies and recover assets. And so a committee appointed by the government has proposed a new bankruptcy code.

(A)
Financial Default               ->             Insolvency Resolution Process
BANK                                                FINANCIAL CREDITOR    
EMPLOYEE SALARIES                            OPERATIONAL CREDITOR
SUPPLIERS DUES                                 CORPORATE DEBTOR
 
(B)
NCLT                                        ->            INTERIM RESOLUTION PROFESSIONAL
 
(C)
180 DAYS + 90 DAYS = MAXIMUM 270 DAYS
                                |
                If 75% creditors agree

(D)
180 DAYS MORATORIUM
 Stay on all creditors’ claims
 Board’s powers suspended
 Management reports to resolution professional

(E)
COMMITTEE OF CREDITORS               APPROVES REVIVAL PLAN/ LIQUIDATION
Secured + Unsecured
Vote proportionate to debt

Any financial default can trigger an insolvency resolution process. The applicant can be a financial creditor, an operational creditor or the company itself.  If the application is accepted by the NCLT, a resolution professional will be appointed to oversee the resolution process, which must be completed within 180 days, extendable by a maximum 90 days – or else the company goes into liquidation. In the interim - a calm period or moratorium will stay all creditors’ claims, the powers of the board of directors will be suspended and the company management will report to the resolution professional. A committee of creditors, comprising all financial creditors will decide on the revival plan or on liquidation and NCLT has the final say.

To discuss this new approach and features Menaka Doshi of CNBC-TV18 is joined by a veteran panel. Cyril Shroff, Managing Partner - Cyril Amarchand Mangaldas, Vinayak Bahuguna, CEO & MD of India’s largest asset reconstruction company Arcil , Alok Dhir, Managing Partner - Dhir & Dhir Associates, a law firm that specialises in restructuring and insolvency and MG Vaidyan, Deputy Managing Director of SBI and Head of the Stressed Assets Group.

                          ‘SICK’ Company Application
 
     SICA                                                   COMPANIES ACT, 2013
100% Networth Erosion                               Failure To Pay 50% Secured Creditors
 

                        PROPOSED BANKRUPTCY CODE
                         Any financial default

Financial Default               ->                Insolvency Resolution Process
BANK                                                  FINANCIAL CREDITOR    
EMPLOYEE SALARIES                              OPERATIONAL CREDITOR
SUPPLIERS DUES                                   CORPORATE DEBTOR


Sick Industrial Companies Act (SICA) requires total net worth erosion. The Companies Act requires failure to pay 50 percent or more secured creditors. However, the proposed bankruptcy code says any financial default will do to trigger an insolvency application. The application can be filed by a financial creditor such as a bank or an operational creditor such as an employee because unpaid employees or suppliers are the first sign of financial stress.

Dhir: “The default is actually the outcome of stress. So, the committee was of the view that the stress is already in the system. If debtors and creditors are already negotiating so the point of time when the default occurs is the point of time which is the urgency which is required. It is detection at the earliest possible stage to preserve value.”

Shroff: “It is a big change; it can be used as an indicator to really assess what is going on behind the thinking of the new proposed legislation. Firstly, what is does is it seeks to move the regime from a revival and a recovery mechanism which was the existing regime that exist today to more of a resolution process. So in order to start the journey because this only merely starts the journey, the financial default has been treated as the trigger. However, that is not the end of the story, then it sort of moves through a series of steps and those steps and that journey is quite different from what it was under the existing regime.”

Doshi: “Mr Vaidyan do you feel encourage by this change in approach the fact that you don’t need 50 percent of the secured creditors to come together to move an application for an insolvency process. You don’t need to wait for net worth erosion before the company is half dead to attempt to revive the company or put it back on the profitability track?”

Vaidyan: “This is one of the best parts of this legislation being thought of. I am sure that this will give a lot of comfort to the banks which are having significant amounts tied up in bad assets.”

Bahuguna: “Absolutely, dot on the spot here. I liked the urgency that this legislation will bring to the problem of growing distress and alarming levels of distressed loans in the market.”

The monumental shift proposed by the bankruptcy code is a shift in the balance of power from equity to debt as the company’s management and board lose their powers to the resolution professional and the committees of creditors. Also the creditor field has been leveled. All creditors secured and unsecured have a say in the committee proportionate to their exposure. The second change to the credit hierarchy is on liquidation.

EQUITY                                 ->                           DEBT
        Board’s Powers Suspended
        Management Reports To Resolution Professional
        Committee Of Creditors To Decide Revival/Liquidation
 
COMMITTEE OF CREDITORS                        
Secured + Unsecured
Vote proportionate to debt

Doshi: “What do you make of this shift in balance of power?”

Shroff: “This lies at the heart of what the change is in terms of rebalancing the power between the equity and the debt. This is not a journey that just started with this legislation. The journey started with Companies Act, 2013. In a sort of environment where such pre- ponderent proportion of our companies have a family controlled a promoter controlled enterprises there were just too much power and there is very little distinction between the shareholding, controlling body and the boards.

The first step in correcting that balance happened in the manner in which the Company Act 2013 turned out. This second blow I think is this in terms of re-balancing and making sure that the rights of the creditors and then therefore they should be no divine right which the promoters or the board should have to believe that they are the only ones who will have control over the destiny of the company.

The second point in terms of in the universe of debt, there are two big changes that have been made is that all financial creditors have been put together in one bucket. What that means is I think there is a big psychological issue over here because the earlier system of different classes of creditor where secured creditors voted separately unsecured creditors voted separately all that undergoes a fundamental change because now the denominator is much larger.”

Bahuguna: “I would just like to add one point here. You did mention the shift the balance shift and I think we have to recognize it in a sense that it is not perpetual. It is for a resolution purpose which sets the ground in motion which eventually at the end of it is trying to see that entities are stabilized. They continue to trade and are able to trade; which means eventually it should also benefit the equity shareholders.”

Dhir: “It is a very monumental shift. It just the pendulum has swung. The legislation in rescue and bankruptcy the world over are either debtor in possession or credit in possession. There are the two that is how the pendulum swings.”

Doshi: “We have been debtor in possession”

Dhir: “We have been so far the Indian juice prudence has been on the basis of debtors in possession and it is completely now being changed to creditors in possession. There is great deal of value to either concept. Neither of them is perfect. Debtors are the people who run businesses and they know how to run business. For somebody to step in on one fine day and say I am going to run the business which is very complex operation even during the clam period of 180 days is going to be a very immense challenge and serious destruction in value can happen.      

I am not saying one is good or the other is better. It is the question that needs to be debated across the board.”

Doshi: “May I ask that the debtors in possession concept has failed as so far?”

Dhir: “I personally believe that shifting at this stage there is no infrastructure. We don’t have insolvency professionals. Today you are saying I am going to handover the management to insolvency professional who has actually untried are we going to destroy value like this? Is there a compromise, is there a possibility of allowing the management to work under very serious controls of the creditors. This shifts the entire primacy of the entire process of resolution as well as the bankruptcy in to the hand of the creditors.   

Are we ready for it because under this provision as you are aware even the workers dues are being preserved only to the extent of one year? Is this something that will be acceptable to the political system in the country?  

Bahuguna: “Alok Dhir has raised very important point that said the debtor in possession hasn’t really worked for us in past and there is nothing that stops the administrator of the scheme and creditors who work with them to do the right thing whether it is to continue with the existing management or to bring other experts into the game to make it work.”

Doshi: “I don’t think he is replacing management. The bill says that the management will report to him that is the resolution professional and that the board’s power gets suspended and the management reports to him. Is this is going to be a big hurdle to get over?”

Shroff: “Somewhat the change of the centre of the power.”

Doshi: “I get this is a big cultural change but is it not required is my point?”

Bahuguna: “It is absolutely is because we know how things have worked in the past.”

Shroff: “I think it is was an either or.”

Bahuguna: “It had to be done like this. We have to make sure it works. It has to work with the management from the ground.”

Doshi: “Don’t forget the resolution professional will be working with equity creditors. So the creditors also want the best for the company and management is not going to be sacked overnight. Management will simply report to him and the boards power is suspended. So, all decisions will actually be taken by the creditors through resolution professional let us put it that way right?”

Dhir: “There is a serious calibration which is required. I think in abrupt change even in the centre of power as he is saying can be detrimental to the interest of the company. All that I am advocating is between these two debtor in possession and creditor in possession at least till the infrastructure has grown till the insolvency professionals have grown and we see how their performance will be a calibrated approach may have been better.

You know the strategic debt restructuring (SDR) mechanism has come in, five to six companies have been taken over. In none of these companies they have been able to engineer a change of management.”

Doshi: “Let me also tell you this there are some asset reconstruction companies that have now taken over larger assets for instances Bharati Shipyard or Leela Hotels and have brought in professional management from the outside to work with the incumbent management and revive the assets if I am correct. These are all experiments work in progress but these are efforts to revive as appose to asset strip and make 25 cents on the dollar as what the…”

Dhir: “As you know with respect to Bharati Shipyard it has taken them more than six months.”

Doshi: “More time, you are right. Even more time but because this is the first time it is an effort, right?”

Bahuguna: “The point that I want to sort of get into now and we can check with Mr Vaidyan also is the whole point about the rules about the hierarchies between creditors in this and we have some serious concerns there.”

Doshi: “Which are?”

Bahuguna: “This sort of legislation seems to suggest that everyone gets into one common melting pot which is good, its holistic, it was required to take care of everyone’s interest. However you see how creditor committee works? If you are working where your primary sort off mandate is to first figure out how to pay the operational creditors which may be suppliers, unpaid suppliers and the likes then the ability to sort of put out the best possible structure might get somewhat compromised in terms of cash usage and the likes.

Then within that if you are not going to differentiate between a different asset a sort of owners in terms of rights whether secured and unsecured it has the ability to sort of make the pot so big that it becomes a little difficult to manage.”

Doshi: “Are you suggesting that secured and unsecured must not get an equal footing if I have understood the gist of your comment.”

Bahuguna: “That is the rule of the jungle isn’t it at the end of the day.”

Doshi: “Mr Vaidyan your thoughts on A) the shift in balance between equity to debt. The fact that it is the creditor, committee of creditors and the resolution professionals that will in a sense run the company with help from the incumbent management during the resolution process and the re-ordering of hierarchy the equality between secured and unsecured creditors all of those thoughts.”

Vaidyan: “From the banks point of view to tell you some practical problems like we are secured creditors but when we go to sell the assets we find that there are no assets. Now we have given loans against inventory. We have given loans against receivables by the time the account goes bad the inventory while it is almost NIL the receivables are also NIL.

The other assets may be there, may not be there. Even if it is there it has deteriorated and may not be having any value. Our recourse finally comes down only to the collateral given by the promoters. Even there the today situation is that when we have gone through the legal process five years, six years, seven years and when we are able to auction the property then some notices will come from various agencies like income tax (IT), excise and various service tax and all and say that the status quo has to be maintained because the company has defaulted in all these things.   

So, ultimately what happens is that the sales cannot be executed the way it is expected. So, all these are the problems which even we being a secured creditor are going through. So, in this new legislation which has been though off it is so welcome in the sense that immediately the creditors whether they are secured or unsecured will have some say in the way the assets are managed. Otherwise whether secured or unsecured everybody ultimately will get nothing.”

Doshi: “So if I understand you correctly you are in favour of all the monumental changes that are happening here.”

Vaidyan: “Secured creditors are still number one and the dues to government and the other payments are not placed above the secured creditors whereas today it is not so. At least they can bring stay and the best part of the thing is that there is no other civil court or anybody has got a jurisdiction over this. So, all those innumerable numbers of stay orders which we are getting everyday in the debts recovery tribunal (DRT) process probably will vanish.”

Dhir: “I would like to react to this. We have to see entire hierarchy that has been defined under the new code in the context and the perspective in which it is defined. They have said that the early detection is what they are requiring so which means at the point of early detection the company has not so badly gone that it cannot preserve value for unsecured creditors.

Therefore at the initial stage, the first default is the perspective. At that stage there is possibility of retaining value for unsecured creditors. Therefore in the creditors committee the financial creditors sit in and their interests are watched. However, interestingly when a scheme is prepared you have to provide for such value for them as which is not less than what they will get in liquidation.

So, a scheme will be prepared, put to the committee and by 75 percent vote which includes secured and unsecured and it preserves value for the unsecured creditors to the extent they will get in liquidation so, that is the perspective. Coming down to the disturbing of the hierarchy, as Mr Vaidyan has said in fact the secured creditor continue to remain and have primacy at this stage after the initial 180 or 270 days of resolution process.

They come back into picture as the prima donna. They are the once who are entitled to keep their security out the pool or if they allow their security to remain within the pool they will get the value of their security first.

After that in fact different from what is happening today we had a pari passu charge with workmen and workmen dues used to accumulate to very large amounts particularly in closed units. Now under this new mechanism you are preserving only three months of dues at pari passu stage with secured creditor. So, secured creditors will end up getting a much larger pie.”

Shroff: “One further change which we haven’t talked about in the example that Alok Dhir gave once the secured creditor decides whether he is in the process or out of the process and relies on his security which is fine so that is not disturbed. However, if there is any short fall that remains then he is actually subordinated even to other unsecured creditors. So, the previous regime was that all unsecured creditors including the residue that is available to secured creditors is all pari passu that is no longer a case.”

                     INSOLVENCY & BANKRUPTCY BOARD
                |                                                      |
RESOLUTION PROFESSIONALS                   INFORMATION UTILITIES

The proposed new bankruptcy code relies considerably on a new class of professionals, resolution professionals to manage the company during the resolution process. It also proposes the creation of information utilities to supply real time financial information on the company and thus aid the resolution process. The eligibility criteria for both will be decided by the insolvency and bankruptcy board that will also regulate the bankruptcy process.

Dhir: “The development of insolvency professionals will take its own time. We have a lot of high quality professionals in the country whether they are lawyers whether they are accountants, secretaries.”

Doshi: “All the operating agencies worked in SICA, BIFR are not good enough?”  

Shroff: “Liquidators and receivers will have some of these expertise.”

Dhir: “What I would say is the operating agencies more in the nature of insolvency professional agency rather than insolvency professional. So, divisions within the banks which are dealing with these matters could then convert themselves into insolvency professional agencies. These agencies will be self regulating agencies. They will insist on certain qualifications and they will lay down criterias for training of people.”

Doshi: “Which the bankruptcy board will actually prescribe and these will all follow and self regulate.”

Dhir: “So, this will generate in turn a whole nation of professionals who will in turn mange this entire affair. The only concern is that it will take some time. So, what do you put the cart before the horse? Do you get to create this whole series of group of professional before you start the process or you are going to first start the process of implementing the code without having this qualitative infrastructure in your hand?

Similarly the entire code is based on the information, so they are wanting to ensure that the information asymmetry which is there between the debtors and creditors is actually removed by way of the information utilities which are going to be created under this. That itself will take a long time in creation and the information that has to be plugged into the information utilities will take even more time to create.”

Bahuguna: “Totally agree with Alok. It is a concern and on the other side a hope that if you were to make this code to work it must have gleaming  highways which allow us to work expeditiously and professionally. Training of people being able to pick the right kind of people and put them through the grill and the information utilities I see that has a huge challenge.”

Doshi: “More than huge challenge because today I think getting any financial information that is not all ready disclosed by companies, it takes days.  Here at least in the process prescribed in this bill the National Company Law Tribunal (NCLT) has two days to admit or reject a resolution application. In those two days it has to reach out to information utility and thereafter also in the process of resolution you need to have real time information coming in from the information utility on the financials of the company.”

Bahuguna: “Absolutely and don’t forget the government has a 30 year limitation period so people wake up after a while and put a claim in front of you and how do you deal with it? So, obviously all of this must come together on day one when people can then take informed calls.”

Doshi: “This is the valuable point. I think unfortunately and if I may point this out to you our laws have never lacked in the right intention. It is almost always the infrastructure that fails us. If we embark on this exercise before we put these highways in place are we setting ourselves up for failure? How do we put the horse before the cart?’

Shroff: “I think it is the chicken and the egg. I believe it has been a step proved that the chicken came first, so I think this legislation is the chicken and you have to take that call. That has been the case with everything. We look when the competition commission and the competition law started you had the same issue. So, where you first got the legislation then you build the capacity and now it is working fine.”

Doshi: “Mr Vaidyan you may be vegetarian but which one came first the chicken or the egg?”

Vaidyan: “Whatever it is let me say that these challengers that are in front of us deter us from not seeing the positive points that can come out of this legislation. Even for financial inclusion of all the families in the country there was a challenge but then when the challenge came the bankers stood up and then they ensured that all the households in this country has got bank accounts. So, similarly it will happen.”

Bahuguna:  “That is fair point but it is important to highlight the challenges because otherwise these tend go under the radar, transition day one issues when in it comes into force all creditors who want to jump and get into this how is that going to be managed.”

Shroff: “Mr Bahuhuna it’s not just the infrastructure with these professionals there is so much more going to come to the DRT. There is much more work going to come to the NCLT and National Company Law Appellate Tribunal (NCLAT) so there is a question of capacity building there as well. It is like building a new city like Amravati.”

Doshi: “Well at least 10 of them.”

Shroff: “And I think it is going to be another big issue in terms of the regulatory model that has been chosen for the professions or these new class of professionals is how they are going to manage conflicts. So, let us say if an accounting firm sets up one of these resolution professionals can they also be the auditor for that enterprise? I think this whole thing is going to be so ridden with conflicts that an…”

Doshi: “And which the bankruptcy board ideally will have to regulate.”

Shroff: “So, I think they will have to first take the issue of who is fit in proper? How to avoid conflict and what is code of conduct? I don’t think the self regulatory model is either the model they have chosen or is going to work. It will have to be a licensing model.”

                                         180 DAYS             
                                               MORATORIUM
Stay on all creditors’ claims, suits, court proceedings, asset transfers, foreclosures, property recovery…

180 DAYS + 90 DAYS = MAXIMUM 270 DAYS
                                |
                If 75% creditors agree

The proposed bankruptcy code mandates a calm period or moratorium during the 180 days resolution process in which the NCLT halts all suits, court proceedings, assets transfers for closures, property recovery etc. This was mandatory under SICA but not the Companies Act, 2013. As for the 180 or shall I say 270 day deadline well it is most critical to the success of this new code. But is it achievable?

Shroff: “There is only one huge missing factor in that which is court orders that can be passed in the mean time. India has a sort of a long history or particularly of our writ courts who may interfere along the way and how that will actually add to the timelines whether they will be clock stops or it is a hard period of 180 + 90 days is one of the thing which the judiciary will have to…”   

Doshi: “I would like to believe that may be that attitude is now changing in the judiciary. I would like to believe that with the introduction of things like commercial courts again which have hard stops and timelines that judiciary is coming to appreciate to move faster on things.”

Shroff: “You are right but the final word on this will be the judiciary and not anyone else.”             

Bahuguna: “The other point I just want to just bring in if you might is issues about who actually sets the ground. How does it stay in control of the creditor committee for voting because we also have parallel state legislated points like relief undertaking act and stuff and what happens to that and the ability of people to use that, that needs to be brought into.”

Doshi: “Give me an illustration so I can understand?”         

Bahuguna: “They are numbers of states in the country which have the power to legislate and have done so to bring the relief status for industrial undertakings which then puts all matters on hold effectively in terms of enforcement of creditor rights.”

Doshi: “So, will these have to subsequently get amended along with everything else or gets amended for this to work?”

Bahuguna: “As it was mentioned that there are so many other courts involved so all those checks and balances have to make sure that this process works and nobody interferes.”

Doshi: “You have a concern of the fact that 180 days, 270 days is all good for the first level of the process. There is really nothing spelt out for the appeal and the NCLT and there can be nothing spelt out for any final appeal at the Supreme Court so this could still become very long process.”

Bahuguna: “Without putting a date to the appeal process the timeline I think it just dilutes it quite significantly. In the question of further appeal process within the Supreme Court that is fine. In the right of equity that got to be allowed and it will take whatever time it takes but at least you cross the first hurdle if the appeal period at the NCLAT is defined.”

Vaidyan: “These 180 days and 270 days and nine months and four and a half months for the fast track it is four and a half month I think so this is too short a time on the face of it. My take on this is little different. With all the past legislation and procedures and all those things that we had how many years it used to take you for any source of resolution. Now this BIFR and other things and all so I will say in this six months time or nine months time even if small number of companies could find some resolution that itself is a big achievement I will say.”

Dhir: “Traditionally the courts have been very liberal in giving time and there is somehow a sense that debtors get the better of the creditors in courts in the country. There is certainly the courts tend to favour.”

Shroff: “A key message for the judiciary would be to stop seeing themselves only as resolvers of disputes but also as an instrument of economic policy.”
 
PROPOSED BANKRUPTCY CODE

Amend:
SICA Repeal Act
Companies Act, 2013
LLP Act
Sarfesi Act
Debt Recovery Act
Partnership Act
 
Tax Treatment?

The bankruptcy law reform committee has recommended amendments to the SICA Repeal Act, Companies Act, LLP Act, Sarfesi Act, the Debt Recovery Act, and Partnership Act. Maybe more will have to change including in tax law before this new bankruptcy code can work. The question is will it?

Vaidyan: “The big picture what I am seeing is that this will totally change the credit culture in the country. The borrower probably will not get a free hand in doing whatever he wants to do and for any number of years and going from one court to another court and bringing injunctions whenever he wants all those things probably will get adjusted with this.”

Bahuguna: “The importance is that capital needs to churn it can find new owners but perhaps that is all for the best because in the larger interests that works best for the country.”

Dhir: “In addition to giving us a better rescue and bankruptcy law in the country there are two very important aspects it also simultaneously considers. One – is that it will improve the ease of doing business in the country, the rankings will improve.

The second is that there is another benefit that this legislation seeks to bring in and that is to bring in a completely new corporate debt market in the country.”

Shroff: “On the intent I would give it a 10 on 10. On the macro conceptual points I would give it a 8 on 10 and on the detail I would give it a 5 on 10. I think they have under estimated some of the details. I think in order to make it operational there are going to be lot of things which could be exploited by debtors, borrowers and courts. So, a lot of uncertainties along the way but they can be easily fixed.”
 
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