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.
This article was published in the Indian Express on April 8, 2011
Dodging the Drafts
By Kaushiki Sanyal and C.V. Madhukar
Social activist, Anna Hazare’s fast unto death for the enactment of a strong Lok Pal Bill has provided an impetus to examine not only the Bill proposed by civil society activists but suggestions made by various experts.
The idea of establishing an authority where the citizen can seek redress against administrative acts of the government was first mooted in 1963 during a debate on Demands for Grants for the Law Ministry. Under the existing system, a citizen can either move court or seek other remedies such as petitioning his Member of Parliament. However, these remedies are limited because they maybe too cumbersome or specific grievances may not be addressed. Also, the laws that penalise corrupt officials do not have provision to redress specific grievances of citizens. Currently, corrupt public officials can be penalised under the Indian Penal Code, 1860 and the Prevention of Corruption Act, 1988. Both these laws require the investigating agency to get prior sanction of the central or state government before it can initiate the prosecution process in a court.
The office of the Lok Pal or an Ombudsman seeks to provide a forum for citizens to complain against public officials. The Lok Pal would inquire into such complaints and provide some redressal to citizens. The basic idea of the institution of Lok Pal was borrowed from the concept of Ombudsman in countries such as Finland, Norway, Denmark, Sweden, U.K. and New Zealand. Presently, about 140 countries have the office of the Ombudsman. In Sweden, Denmark and Finland, the office of the Ombudsman can redress citizens’ grievances by either directly receiving complaints from the public or suo moto. However, in the UK, the office of the Parliamentary Commissioner can receive complaints only through Members of Parliament (to whom the citizen can complain). Sweden and Finland also have the power to prosecute erring public servants.
The first Lok Pal Bill in India was introduced in 1968, which lapsed with the dissolution of the Lok Sabha. The Bill was introduced seven more times in Parliament, the last time in 2001. Each time it lapsed except in 1985 when it was withdrawn.
Several commissions have examined the need for a Lok Pal and suggested ways to make it effective, without violating Constitutional principles. They include: the First Administrative Reforms Commission (ARC) of 1966, the National Commission to Review the Working of the Constitution of 2002 and the Second Administrative Reforms Commission of 2007. The Lok Pal Bills that were introduced were referred to various Parliamentary committees (the last three Bills were referred to the Standing Committee on Home Affairs).
The First ARC report recommended that two independent authorities be created to redress grievances: first, a Lok Pal, to deal with complaints against the administrative acts of Ministers or secretaries of government at the centre and the state; and second, a Lokayukta in each state and at the centre, to deal with complaints against the administrative acts of other officials. Both these authorities should be independent of the executive, judiciary and legislature and shall be appointed by the President on advice of the Prime Minister, Leader of the Opposition and the Chief Justice of India.
The National Commission to Review the Working of the Constitution urged that the Constitution should provide for the appointment of the Lok Pal and Lokayuktas in the states but suggested that the Prime Minister should be kept out of the purview of the authority.
The Second Administrative Commission, formed in 2005, also recommended that the office of the Lok Pal be established without delay. It was in favour of including Ministers, Chief Ministers and Members of Parliament. However, it wanted to keep the Prime Minister outside the Lok Pal’s ambit. The ARC also recommended that a reasonable time-limit for investigation of different types of cases should be fixed.
The 1996, 1998 and 2001 Bill covered Prime Minister and MPs. The Standing Committee examining the 1998 Bill recommended that the government examine two basic issues before going forward with the Bill: first, MPs are deemed to be public servants under the Prevention of Corruption Act, 1988. If they are also brought under the purview of Lok Pal it may be “tantamount to double jeopardy”; and second, subjecting MPs to an outside disciplinary authority may affect supremacy of Parliament.
The 2001 Bill was also referred to the Standing Committee, which accepted that the Prime Minister and MPs should be included in the Bill. It further recommended that a separate legislation be enacted to ensure accountability of the judiciary. It however stated that the Bill did not address public grievances but focussed on corruption in high places.
The states have been more successful in establishing the Lokayuktas. So far 18 states have enacted legislation to set up the office of Lokayukta. While Karnataka Lokayukta is often hailed as a successful case, several other states have had limited success in combating corruption since all of them are recommendatory bodies with limited powers to enforce their findings.
A Group of Ministers is looking into ways to tackle corruption, including the establishment of a Lok Pal. A public debate on the issues raised by various committees would help iron out the weaknesses of any proposed legislation.
This article was published in the Indian Express on April 8, 2011
