Unlocking Bankruptcy Code
The law, it is said, is an ass. In India it has the characteristics of both a mule and a tortoise. The Insolvency and Bankruptcy Code (IBC) is a shining example. Legislated in December 2016, it was seen as a panacea for banks’ chronic NPA problem. Sadly, it hasn’t lived up to its early promise.
A recent judgement delivered by a bench of the National Company Law Appellate Tribunal (NCLAT), comprising Justices SJ Mukhopadhaya and Bansi Lal, introduced an additional speedbreaker in a process that has already been bedevilled by delays. The judgement places statutory dues of income-tax and GST squarely within the preview of operational creditors. Worse, the judgement will have retrospective effect, throwing the bankruptcy process into disarray.
This is what the two justices ordered: “… (the) income tax department of the central government and the sales tax department(s) of the state governments and local authority who are entitled for dues arising out of the existing law are operational creditors within the meaning of section 5 (20) of the Insolvency and Bankruptcy Code.”
Senior counsel tasked to help the NCLAT bench arrive at a clear judgement on the issue had concluded that tax dues cannot be defined as falling within the ambit of operational creditors. Counsel representing various companies involved in the case had advanced the same argument. The justices were unmoved and wrote in their order: “If the company is operational and remains a going concern, only in such a case the statutory liability, such as payment of income tax, VAT, etc. will arise. As income tax, VAT and other statutory dues arising out of the existing law arises when the company is operational, we hold such statutory dues have a direct nexus with operations of the company.”
The NCLAT judgement will delay the resolution process in a raft of pending cases. Settled cases may now be reopened. The income-tax department had wanted first charge on debt. That, however, has been denied in the NCLAT verdict. Inevitably the order will be challenged in the Supreme Court, creating further hurdles.
The apex court has played a positive role so far in maintaining the sanctity of the IBC process. In a key judgement in January 2019, a bench of the Supreme Court comprising Justices RF Nariman and Navin Sinha wrote forcefully: “We are happy to note that in the working of the code, the flow of financial resources to the commercial sector in India has increased exponentially as a result of financial debts being repaid. The provisions of Section 29A are intended to ensure that, among others, persons responsible for insolvency of the corporate debtor do not participate in the resolution process. Parliament rectified a loophole… which allowed a backdoor entry to erstwhile managements in the resolution process.”
The justices added: "It will be seen that the reason for differentiating between financial debts, which are secured, and operational debts, which are unsecured, is in the relative importance of the two types of debts when it comes to the object sought to be achieved by the Insolvency Code. We have already seen that repayment of financial debts infuses capital into the economy inasmuch as banks and financial institutions are able, with the money that has been paid back, to further lend such money to other entrepreneurs for their businesses. This rationale creates an intelligible differential between financial debts and operational debts.”
The essence of the IBC is speed. The bankruptcy code mandates a 270-day deadline for resolving insolvency cases. But the IBC had not accounted for the ingenuity – more accurately, cussedness – of Indian promoters. Every time an insolvency case nears resolution by banks and institutional lenders, promoters launch counter-bids, often after the deadline. The Arcelor Mittal-Essar Steel case is an example of how the IBC can be subverted.
Fortunately, the Supreme Court has kept an eagle eye out for such dilatory tactics. But it has a heavy work load and the multitude of cases before the NCLT and NCLAT benches makes micro supervision by the apex court itself a cause for delay. Conscious of this, the apex court in its recent judgement directed the government to set up NCLAT circuit benches across India within six months.
The IBC was meant to take the NPA crisis head on. Huge bank debts were piled up by Indian corporates in the boom years of 2005-08. But lax Reserve Bank of India (RBI) rules kept most of these debts off bank balance sheets. Complicit bank managements rolled over bad debts to keep NPAs artificially low. The toxic cycle was finally broken in 2015 when the RBI introduced strict new rules to recognise bad loans. Within a year, NPAs shot up as banks were forced to clean up their balance sheets.
The IBC was legislated to stop promoters treating bank loans cavalierly. Under the code, promoters stood to lose their companies if they didn’t pay up. Indeed, the IBC has helped resolve many cases even before the code kicks in as the fear of losing their firms forced promoters to settle out of court with banks accepting varying degrees of haircuts.
But as the IBC lumbers on, the paucity of NCLT and NCLAT benches, poor infrastructure and legal speedbreakers threaten to damage what was till recently regarded as one of the most progressive financial legislations of the NDA government. The task now for all stakeholders – lenders, creditors, resolution professionals, promoters and NCLT benches – is to protect the integrity of the IBC process. If delays occur due to artificial legal hurdles from defaulting promoters or intervention by statutory authorities, the very purpose of the IBC will be defeated.
Promoters have for too long milked the banking system. The IBC instilled fear in them. Capricious borrowing stopped and repayments surged as promoters fought to retain control of their companies. Bank NPAs, for the first time since 2015, have begun to witness a decline.
But if you give a defaulting promoter an inch, he will take a mile. That must not be allowed to happen or the IBC’s sanctity and the financial discipline it imposes will be lost forever.
