The Insolvency and Bankruptcy Code, 2016 was enacted to provide a time-bound process to resolve insolvency among companies and individuals. Insolvency is a situation where an individual or company is unable to repay their outstanding debt. Last month, the government promulgated the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018 amending certain provisions of the Code. The Insolvency and Bankruptcy Code (Second Amendment) Bill, 2018, which replaces this Ordinance, was introduced in Lok Sabha last week and is scheduled to be passed in the ongoing monsoon session of Parliament. In light of this, we discuss some of the changes being proposed under the Bill and possible implications of such changes.
What was the need for amending the Code?
In November 2017, the Insolvency Law Committee was set up to review the Code, identify issues in its implementation, and suggest changes. The Committee submitted its report in March 2018. It made several recommendations, such as treating allottees under a real estate project as financial creditors, exempting micro, small and medium enterprises from certain provisions of the Code, reducing voting thresholds of the committee of creditors, among others. Subsequently, the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018, was promulgated on June 6, 2018, incorporating these recommendations.
What amendments have been proposed regarding real estate allottees?
The Code defines a financial creditor as anyone who has extended any kind of loan or financial credit to the debtor. The Bill clarifies that an allottee under a real estate project (a buyer of an under-construction residential or commercial property) will be considered as a financial creditor. These allottees will be represented on the committee of creditors by an authorised representative who will vote on their behalf.
This committee is responsible for taking key decisions related to the resolution process, such as appointing the resolution professional, and approving the resolution plan to be submitted to the National Company Law Tribunal (NCLT). It also implies that real estate allottees can initiate a corporate insolvency resolution process against the debtor.
Can the amount raised by real estate allottees be considered as financial debt?
The Insolvency Law Committee (2017) had noted that the amount paid by allottees under a real estate project is a means of raising finance for the project, and hence would classify as financial debt. It had also noted that, in certain cases, allottees provide more money towards a real estate project than banks. The Bill provides that the amount raised from allottees during the sale of a real estate project would have the commercial effect of a borrowing, and therefore be considered as a financial debt for the real estate company (or the debtor).
However, it may be argued that the money raised from allottees under a real estate project is an advance payment for a future asset (or the property allotted to them). It is not an explicit loan given to the developer against receipt of interest, or similar consideration for the time value of money, and therefore may not qualify as financial debt.
Do the amendments affect the priority of real estate allottees in the waterfall under liquidation?
During the corporate insolvency resolution process, a committee of creditors (comprising of all financial creditors) may choose to: (i) resolve the debtor company, or (ii) liquidate (sell) the debtor’s assets to repay loans. If no decision is made by the committee within the prescribed time period, the debtor’s assets are liquidated to repay the debt. In case of liquidation, secured creditors are paid first after payment of the resolution fees and other resolution costs. Secured creditors are those whose loans are backed by collateral (security). This is followed by payment of employee wages, and then payment to all the unsecured creditors.
While the Bill classifies allottees as financial creditors, it does not specify whether they would be treated as secured or unsecured creditors. Therefore, their position in the order of priority is not clear.
What amendments have been proposed regarding Micro, Small, and Medium Enterprises (MSMEs)?
Earlier this year, the Code was amended to prohibit certain persons from submitting a resolution plan. These include: (i) wilful defaulters, (ii) promoters or management of the company if it has an outstanding non-performing asset (NPA) for over a year, and (iii) disqualified directors, among others. Further, it barred the sale of property of a defaulter to such persons during liquidation. One of the concerns raised was that in case of some MSMEs, the promoter may be the only person submitting a plan to revive the company. In such cases, the defaulting firm will go into liquidation even if there could have been a viable resolution plan.
The Bill amends the criteria which prohibits certain persons from submitting a resolution plan. For example, the Code prohibits a person from being a resolution applicant if his account has been identified as a NPA for more than a year. The Bill provides that this criterion will not apply if such an applicant is a financial entity, and is not a related party to the debtor (with certain exceptions). Further, if the NPA was acquired under a resolution plan under this Code, then this criterion will not apply for a period of three years (instead of one). Secondly, the Code also bars a guarantor of a defaulter from being an applicant. The Bill specifies that such a bar will apply if such guarantee has been invoked by the creditor and remains unpaid.
In addition to amending these criteria, the Bill also states that the ineligibility criteria for resolution applicants regarding NPAs and guarantors will not be applicable to persons applying for resolution of MSMEs. The central government may, in public interest, modify or remove other provisions of the Code while applying them to MSMEs.
What are some of the other key changes being proposed?
The Bill also makes certain changes to the procedures under the Code. Under the Code, all decisions of the committee of creditors have to be taken by a 75% majority of the financial creditors. The Bill lowers this threshold to 51%. For certain key decisions, such as appointment of a resolution professional, approving the resolution plan, and making structural changes to the company, the voting threshold has been reduced from 75% to 66%.
The Bill also provides for withdrawal of a resolution application, after the resolution process has been initiated with the NCLT. Such withdrawal will have to be approved by a 90% vote of the committee of creditors.
Earlier today, the Union Cabinet announced the merger of the Railways Budget with the Union Budget. All proposals under the Railways Budget will now be a part of the Union Budget. However, to ensure detailed scrutiny, the Ministry’s expenditure will be discussed in Parliament. Further, Railways will continue to maintain its autonomy and financial decision making powers. In light of this, this post discusses some of the ways in which Railways is financed, and issues it faces with regard to financing. Separation of Railways Budget and its financial implications The Railways Budget was separated from the Union Budget in 1924. While the Union Budget looks at the overall revenue and expenditure of the central government, the Railways Budget looks at the revenue and expenditure of the Ministry of Railways. At that time, the proportion of Railways Budget was much higher as compared to the Union Budget. The separation of the Budgets was done to ensure that the central government receives an assured contribution from the Railways revenues. However, in the last few years, Railways’ finances have deteriorated and it has been struggling to generate enough surplus to invest in improving its infrastructure. Indian Railways is primarily financed through budgetary support from the central government, its own internal resources (freight and passenger revenue, leasing of railway land, etc.), and external resources (market borrowings, public private partnerships, joint ventures, or market financing). Every year, all ministries, except Railways, get support from the central government based on their estimated revenue and expenditure for the year. The Railways Ministry is provided with a gross budgetary support from the central government in order to expand its network. However, unlike other Ministries, Railways pays a return on this investment every year, known as dividend. The rate of this dividend is currently at around 5%, and also includes the interest on government budgetary support received in the previous years. Various Committees have observed that the system of receiving support from the government and then paying back dividend is counter-productive. It was recommended that the practice of paying dividend can be avoided until the financial health of Railways improves. In the announcement made today, the requirement to pay dividend to the central government has been removed. This would save the Ministry from the liability of paying around Rs 9,700 crore as dividend to the central government every year. However, Railways will continue to get gross budgetary support from the central government. Declining internal revenue In addition to its core business of providing transportation, Railways also has several social obligations such as: (i) providing certain passenger and coaching services at below cost fares, (ii) running uneconomic branch lines (connectivity to remote areas), and (iii) granting concessions to various categories of people (like senior citizens, children, etc.). All these add up to about Rs 30,000 crore. Other inelastic expenses of Railways include pension charges, fuel expenses, lease payments, etc. Such expenses do not leave any financial room for the Railways to make any infrastructure investments. 
In the last few years, Railways has been struggling due to a decline in its revenue from passenger and freight traffic. In addition, the support from the central government has broadly remained constant. In 2015-16, the gross budgetary support and internal revenue saw a decline, while there was some increase in the extra budgetary resources (shown in Figure 1). Railways’ internal revenue primarily comes from freight traffic (about 65%), followed by passenger traffic (about 25%). About one-third of the passenger revenue comes from first class passenger traffic and the remaining two-third comes from second class passenger traffic. In 2015-16, Railways passenger traffic decreased by 4% and total passenger revenue decreased by 10% from the budget estimates. While revenue from second class saw a decrease of 13%, revenue from first class traffic decreased by 3%. In the last few years, Railways’ internal sources have been declining, primarily due to a decline in both passenger as well as freight traffic. Freight traffic 
The share of Railways in total freight traffic has declined from 89% to 30% over the last 60 years, with most of the share moving towards roads (see Figure 2). With regard to freight traffic, Railways generates most of its revenue from the transportation of coal (about 44%), followed by cement (8%), iron ore (7%), and food-grains (7%). In 2015-16, freight traffic decreased by 10%, and freight earnings reduced by 5% from the budget estimates. The Railways Budget for 2016-17 estimates an increase of 12% in passenger revenue and a 0.26% increase in passenger traffic. Achieving a 12% increase in revenue without a corresponding increase in traffic will require an increase in fares. Flexi fares and passenger traffic A few days ago, the Ministry of Railways introduced a flexi-fare system for certain categories of trains. Under this system, the base fare for Rajdhani, Duronto and Shatabdi trains will increase by 10% with every 10% of berths sold, subject to a ceiling of up to 1.5 times the base fare. While this could also be a way for Railways to improve its revenue, it has raised concerns about train fares becoming more expensive. Note that the flexi-fare system will apply only to first class passenger traffic, which contributes to about 8% of the total Railways revenue. It remains to be seen if the new system increases Railways revenue, or further decreases passenger traffic (people choosing other modes of travel, such as airways, if fares increase significantly). While the Railways is trying to improve revenue by raising fares, this may increase the financial burden on passengers. In the past, various Parliamentary Committees have observed that the investment planning in Railways from the government’s side is politically driven rather than need driven. This has resulted in the extension of uneconomic, un-remunerative, yet socially desirable projects in every budget. It has been recommended that projects based on social and commercial considerations must be categorised separately in the Railways accounts, and funding for the former must come from the central or state governments. It has also been recommended that Railways should bring in more accuracy in determining its public service obligations. The decision to merge the Railways Budget with the Union Budget seems to be on the lines of several of these recommendations. However, it remains to be seen whether merging the Railway Budget with the Union Budget will improve the transporter’s finances or if it would require bringing in more reforms.
