Now operational creditors can also seek for insolvency...

  •  Wednesday, 01 March, 2017

Insolvency is when an individual or organization is unable to meet its outstanding financial debt towards its lender as it become due. Insolvency can be resolved by way of changing the repayment plan of the loans or writing off a part thereof. If it cannot be resolved, then a legal action may lie against the insolvent and its assets will be sold to pay off the outstanding debts. Generally, an official assignee/liquidator appointed by the Government of India, realizes the assets and allocates it among the creditors of the insolvent.

Bankruptcy is a concept slightly different from insolvency, which is rather amicable. A bankruptcy is when a person voluntary declares himself as an insolvent and goes to the court. On declaring him as ‘bankrupt’, the court is responsible to liquidate the personal property of the insolvent and hand it out to its creditors. It provides a fresh lease of life to the insolvent.


The statistics show that, in India total bad debts amount to 11% of the total lending and it is seen to be increasing. In India compared to any other progressive economy, the time taken for resolving insolvency is much more, making it appear low on the list of countries with ease of doing business and resolving insolvency. Corporate bad debts constitute 56% of the total bad debts of nationalised banks. These are thousands of pending litigations for recovery of money, squarely due overlapping jurisdictions of various laws governing insolvency resolution and courts. Hitherto, there were about 12 laws concerning insolvency. In the current setup, records show that it takes on an average 4 years to wind up a company in India. Clearly, India is lacking appropriate institutional and legal machinery to deal with debt defaults as per global standards. The recovery proceedings by creditors, either through the Contracts Act or through special laws such as the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 or the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, has not had desired outcomes. Similarly, action through the Sick Industrial Companies (Special Provisions) Act, 1985 (SICA) and the winding up provisions of the Companies Act, 1956 have neither been able to aid effective recovery of outstanding debt, nor restructuring of debts. The Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920, dealing with individual insolvency, are almost a century old.

Considering the abovementioned reasons, the Government undertook a plan to replace existing insolvency laws with one consolidated and comprehensive law that will facilitate easy and time-bound closure of business. On 11th May, 2016 the Rajya Sabha passed the major Economic Reform Bill moved by the Government i.e. ‘Insolvency and Bankruptcy Code, 2016’. The Lok Sabha had already passed the Bill on 5th May, 2016. The Code received the President’s assent on 28th May, 2016. However, the date when the Code will come into effect has not been notified.

The Code

The Insolvency and Bankruptcy Code, 2016 aims to consolidate and amend the laws relating to insolvency resolution of companies and limited liability entities, partnerships and individuals, which are contained in various enactments, into a single legislation.The main focus of this legislation is at providing resurrection and resolution in a time bound manner for maximization of value of debtor’s assets. The Code has put forth an overarching framework to aid sick companies to either wind up their business or engineer a revival plan, and for investors to exit. Notably, the Code has also empowered the operational creditors (workmen, suppliers etc.) to initiate the insolvency resolution process if default occurs

Another important feature of the Code is that it does not make any distinction between the rights of international and domestic creditors or between classes of financial institutions. The Code has sought to balance the interest of all the stakeholders including alteration in the order of priority of payment of Government dues. The legislators have sought to bring in a law analogous to international standards which is guided by the broad philosophy that insolvency resolution must be commercially and professionally driven (rather than court driven). As such, the role of adjudicating authorities is limited to ensuring due process rather than adjudicating on the merits of the insolvency resolution

The Code repeals the Presidency Towns Insolvency Act, 1909, and Provincial Insolvency Act, 1920, as well as amends 11 legislations, including:

  • Indian Partnership Act, 1932
  • The Companies Act, 2013
  • Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;
  • Limited Liability Partnership Act, 2008,
  • Sick Industrial Companies (Special Provisions) Repeal Act, 2003

To avoid any further litigation in insolvency proceedings, the Code will have an overriding effect over all other laws.It is specifically provided that civil courts or authority not to have jurisdiction and also cannot grant any injunction. The Code as a new law, replacing over a dozen laws, when implemented post the infrastructure being put in place, will prove to be the most important step in evolving theregimen of recovery of bad debts. Moreover, there will be a definite surge in economic growth in view of the rigid timeframe prescribed in the Code for resolution of insolvency and liquidation proceedings.

The Bill has become a statute upon receiving Presidential assent. However, the Code provides that the provisions of the Code will come into effect on the date appointed by the Central Government and notified in this behalf. The news is that the Government has undertaken an exercise to fill up vacancies in the National Company Law Tribunal on priority basis. Once the tribunal is operational and the Insolvency and Bankruptcy Board is established and functional, there will be a surge in the credit market. The passing of this Code and implementation of the same will give a big boost to ease of doing business in India. However, in the absence sufficient infrastructure and insolvency practitioners, execution may take longer than anticipated.

As outlined earlier in this article, the Code not only repeals 2 statutes, but also amends 11 other statutes such as Companies Act, SICA, SARFAESI etc. for effectuating the provisions relating to insolvency and bankruptcy of all legal and natural persons under the Code. However, the interplay of provisions of the Code, the amended statutes and several other statutes (such as Negotiable Instruments Act, 1881) will be an important factor in determination of insolvency proceedings. It is of utmost importance that provisions of key recovery laws be synchronised in order to ensure that there are no discrepancies or overlap of jurisdictions so that multiplicity of remedies is not taken recourse to.

Perhaps, the Code has brought far too many changes at the same time, which has caused apprehensions. In India, where any change in the legal system are hard to enforce, this Code has proposed a massive overhaul of laws, procedures and infrastructure, whichis bound to be subjected to hangovers of previous regimen, resistance to rapid enforcement from the fraternity and ultimately dilution in its effectiveness. But, all this on one side, there is no doubt that once the Code is fully implemented, it is going to be one of the best initiatives by the legislatures and a boon to the economy in the broader sense.