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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.
Recently, the President repromulgated the Securities Laws (Amendment) Ordinance, 2014, which expands the Securities and Exchange Board Act’s (SEBI) powers related to search and seizure and permits SEBI to enter into consent settlements. The President also promulgated the Scheduled Castes and the Scheduled Tribes (Prevention of Atrocities) Amendment Ordinance, 2014, which establishes special courts for the trial of offences against members of Scheduled Castes and Scheduled Tribes. With the promulgation of these two Ordinances, a total of 25 Ordinances have been promulgated during the term of the 15th Lok Sabha so far. Ordinances are temporary laws which can be issued by the President when Parliament is not in session. Ordinances are issued by the President based on the advice of the Union Cabinet. The purpose of Ordinances is to allow governments to take immediate legislative action if circumstances make it necessary to do so at a time when Parliament is not in session. Often though Ordinances are used by governments to pass legislation which is currently pending in Parliament, as was the case with the Food Security Ordinance last year. Governments also take the Ordinance route to address matters of public concern as was the case with the Criminal Law (Amendment) Ordinance, 2013, which was issued in response to the protests surrounding the Delhi gang rape incident. Since the beginning of the first Lok Sabha in 1952, 637 Ordinances have been promulgated. The graph below gives a breakdown of the number of Bills passed by each Lok Sabha since 1952, as well as the number of Ordinances promulgated during each Lok Sabha. Ordinance Making Power of the President The President has been empowered to promulgate Ordinances based on the advice of the central government under Article 123 of the Constitution. This legislative power is available to the President only when either of the two Houses of Parliament is not in session to enact laws. Additionally, the President cannot promulgate an Ordinance unless he ‘is satisfied’ that there are circumstances that require taking ‘immediate action’. Ordinances must be approved by Parliament within six weeks of reassembling or they shall cease to operate. They also cease to operate in case resolutions disapproving the Ordinance are passed by both Houses. History of Ordinances Ordinances were incorporated into the Constitution from Section 42 and 43 of the Government of India Act, 1935, which authorised the then Governor General to promulgate Ordinances ‘if circumstances exist which render it necessary for him to take immediate action’. Interestingly, most democracies including Britain, the United States of America, Australia and Canada do not have provisions similar to that of Ordinances in the Indian Constitution. The reason for an absence of such a provision is because legislatures in these countries meet year long. Ordinances became part of the Indian Constitution after much debate and discussion. Some Members of the Constituent Assembly emphasised that the Ordinance making power of the President was extraordinary and issuing of Ordinances could be interpreted as against constitutional morality. Some Members felt that Ordinances were a hindrance to personal freedom and a relic of foreign rule. Others argued that Ordinances should be left as a provision to be used only in the case of emergencies, for example, in the breakdown of State machinery. As a safeguard, Members argued that the provision that a session of Parliament must be held within 6 months of passing an Ordinance be added. Repromulgation of Ordinances Ordinances are only temporary laws as they must be approved by Parliament within six weeks of reassembling or they shall cease to operate. However, governments have promulgated some ordinances multiple times. For example, The Securities Laws (Amendment) Ordinance, 2014 was recently repromulgated for the third time during the term of the 15th Lok Sabha. Repromulgation of Ordinances raises questions about the legislative authority of the Parliament as the highest law making body. In the 1986 Supreme Court judgment of D.C. Wadhwa vs. State of Bihar, where the court was examining a case where a state government (under the authority of the Governor) continued to re-promulgate Ordinances, the Constitution Bench headed by Chief Justice P.N. Bhagwati observed: “The power to promulgate an Ordinance is essentially a power to be used to meet an extraordinary situation and it cannot be allowed to be "perverted to serve political ends". It is contrary to all democratic norms that the Executive should have the power to make a law, but in order to meet an emergent situation, this power is conferred on the Governor and an Ordinance issued by the Governor in exercise of this power must, therefore, of necessity be limited in point of time.”