Tuesday, November 10, 2015

Bankruptcy Code on Non-Corporate Insolvency and Bankruptcy

[The following guest post is contributed by Vinod Kothari & Niddhi Parmar of Vinod Kothari & Co]

The Bankruptcy Laws Reforms Committee (“BLRC”) presented its final report (“Final Report”) to the Government of India on November 4, 2015. This Final Report is divided into 2 parts, i.e. Volume I and Volume II comprising the text of the findings and recommendations and the draft Insolvency and Bankruptcy Code, respectively. The Committee has made recommendations regarding a holistic overhaul of the bankruptcy resolution regime in India, irrespective of type of entities. Hence, the suggested bankruptcy framework (“Bankruptcy Code” or “Code”) covers insolvency of companies, limited liability partnerships (“LLPs”), other entities with limited liability (these entities collectively called “Corporate Debtors”) and other entities, including a household.

Presently, the corporate insolvency procedure is contained in three major legislations, viz. the Companies Act, 2013, Sick Industrial Companies (Special Provisions) Act, 1985 (“SICA”), and Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act  Act, 2002 (“SARFAESI Act”). There is no dedicated insolvency law in case of companies – courts apply “insolvency principles” in case of insolvent companies. The insolvency principles have emerged over the years in India and in UK. The law of insolvency of individuals is contained in two separate laws covering individuals, sole proprietorships and partnership firms, viz. Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920. The former legislation covers the erstwhile presidency towns, namely, Calcutta (now Kolkata), Bombay (now Mumbai) and Madras (now Chennai). The rest of the country is covered by the latter legislation, although the contents of the two laws are by and large similar.

The recommendations of the BLRC regarding corporate bankruptcy have been covered in an earlier post on this Blog. The present post covers the recommendations relating to non-corporate bankruptcy.

Elaborate recommendations were made by 26th Law Commission Report on the consolidation of the two insolvency laws into a single law. The said report discusses the evolution of insolvency laws and the principles in India, goes into the need for consolidation, recommendations for the new law in line with UK Bankruptcy Act, etc. For decades, the recommendations of the Law Commission remained on the backburner. In recent times, the N L Mitra Committee made recommendations about comprehensive rewrite of bankruptcy laws. The BLRC’s recommendations about devising a complete new code and providing the draft of the Code is a laudable first attempt of its kind in the available history of Indian legislation.
Scope of the Bill

Part III of the Bill covers insolvency of both business and non-business entities, including individuals, unincorporated bodies or and firms  (collectively referred to as “non corporate debtors”).

The Bill proposes the following scenarios for such non-corporate debtor:

- Fresh start: this is a new and laudable concept indeed, allowing a person to give a fresh start to life. However, the applicability of the option is greatly limited by the very narrow monetary limits laid – annual income of Rs 60000, and assets of Rs 20000. This largely covers the bottom-of-the-pyramid individuals who may not have qualified for any borrowing in any case.

- Insolvency resolution process: This is a regular insolvency resolution process that may be initiated either based on application by the debtor, or by the creditor.

- Bankruptcy process: While liquidation is the ultimate remedy in case of corporate debtors, bankruptcy, that is, declaration of the non-corporate debtor being bankrupt, is the ultimate scenario in case of non-corporate debtors.

Institutional framework

In case of non-corporate debtors, the Debt Recovery Tribunals (“DRTs”) will be the Adjudicating Authority (“AA”). This will require substantial sprucing up of the DRTs, which are currently inadequately staffed. In addition, the insolvency professionals in corporate insolvency will also be involved in non-corporate cases.

Fresh start process

Fresh start is an opportunity granted to the individual, to seek moratorium, phasing out of obligations, etc., so that the individual may start life afresh. Fresh start application may be made by the debtor, provided the income and asset criteria are within the thresholds referred to above, and the “qualifying debt” for which the individual seeks relief is limited to Rs 35000. Secured debt is not included within the definition of “qualifying debt”. Also, student loans are excluded from the purview, as they are defined as “excluded debt”.

We have commented above about the paltry limits of income, assets and the debt fixed under the law. Not only should these limits be enhanced to make the provision practical, the law should not fix the limits – the limits should be left for the Government to notify. It seems highly impractical that an individual seeking relief in respect of debt up to Rs 35000/- will afford the fees and expenses of the resolution process, including those of the insolvency professional, and that the institutional framework should act as Samaritan for such small value cases. The idea of the Committee may be that the fresh start option will lead to financial inclusion, but whether the population segment covered by the provisions will at all be able to reach out to the institutional framework under the Bill will remain doubtful.

A fresh start application may be made in a case of inability to pay the qualifying debt, for which prima facie recommendations will be made by an insolvency professional. The AA may admit the application based on the recommendations. If a fresh start application is admitted, there will be a 6-month moratorium against any legal action for recovery of the qualifying debt. Of course, during this period, there is an injunction on entering into several to-be-notified transactions by debtor. The debtor may travel overseas only with the approval of the AA.

A fresh start process is akin to a one-time waiver of debt, based on the adjudication of the AA.

Insolvency resolution process

While the fresh start process is a debt waiver plan, the insolvency resolution process in Chapter III of Part III is very similar to corporate insolvencies – this involves the appointment of a resolution professional, listing out of all eligible creditors, preparation of a restructuring and repayment plan, and order by the AA in respect of the resolution plan. Unlike the fresh start process, (a) there are no monetary limits in case of the insolvency process; and (b) the application for the resolution may be filed either by the debtor, or by a creditor.

The key element in the resolution process is the preparation of a repayment plan, which is also sanctioned, like in case of corporate debtors, in a creditors’ meeting. Once the AA approves the repayment plan, the resolution professional will also supervise the implementation of the repayment plan. Once the resolution plan has been implemented fully, the AA may pass an order for discharge of the debtor.

The processes in case of repayment plan may be summed up as follows:

- Debtor in consultation with the resolution professional shall prepare a repayment plan containing a proposal to the creditors for restructuring of the debtor’s debts or affairs;

- Resolution professional shall submit the repayment plan to the AA within a period of 21 days from the last day of filling the claims;

- Repayment plan shall be submitted to the AA along with a report of the resolution professional on the repayment plan;

- The meeting of the creditors shall be called on the place, date and time as specified in the report of the resolution professional -- notice shall be served to the creditors at least 14 days prior;

- The meeting of creditors shall not be extended by the resolution professional beyond the period of 5 days at a time;

- Resolution professional shall prepare a report of the meeting of creditors -- copy of the report shall be forwarded to the debtor, creditors and AA;

- AA shall pass an order on the basis of report submitted by the resolution professional -- acceptance or rejection of the repayment plan -- copy of order shall be forwarded to the Board and insolvency professional agency;

- Resolution professional shall supervise the implementation of the repayment plan;

- Resolution professional shall within 14 days of the completion of the repayment plan, send the documents listed out under clause 117 to the persons who are bound by the repayment plan and the Adjudicating Authority -- may apply to AA for extension for a period not exceeding 7 days;

- Resolution professional shall apply to the AA for a discharge order in relation to the debts mentioned in the repayment plan and the Adjudicating Authority may pass an order accordingly;

- Moratorium shall cease to have effect at the end of 6 months from the date of admission;

- Discharge order shall be forwarded to the Board and the insolvency professional agency.

Bankruptcy process

If the non-corporate debtor is not allowed the resolution process, or fresh start process, the AA may order the bankruptcy. Bankruptcy is the ultimate inability to pay – in case of corporate debtors, this may involve the dissolution of the entity. In case of non-corporate debtors, this will involve all assets of the debtor being taken over by the “bankruptcy trustee” (akin to the liquidator in case of corporate insolvency).

Once bankruptcy order is made, it has the effect of vesting the estate of the bankrupt in the bankruptcy trustee, who shall distribute the same to the creditors in the order of priorities laid in the law. Bankruptcy process is like a collective pursuit by the creditors of realisation of their debt. Secured creditors may enforce their security interest in accordance with the applicable law [clause 128 (2)], however, there is a maximum time of 6 months from the date of the bankruptcy order.

The procedure in case of bankruptcy involves the following steps:

- File an application for bankruptcy;

- The applicant may propose a resolution professional as the bankruptcy trustee in the application;

- Moratorium shall commence from the date of making an application (clause 124(1)(a));

- If the resolution professional is nominated as the bankruptcy trustee -- AA shall within 2 days of the date of application make a request to the Board for seeking confirmation -- Board shall communicate in writing about the appointment or rejection and nomination of the resolution professional;

- If bankruptcy trustee is not proposed by the applicant -- AA shall within 2 days of the date of application make a request to the Board to nominate a resolution professional;

- AA shall pass an order within a period of 2 days of receiving nomination of the bankruptcy trustee;

- Moratorium shall cease to have effect on the bankruptcy commencement date (clause 124(1)(a));

- The copy of the order and a copy of the application shall be provided to the bankrupt, creditors  and bankruptcy trustee within 2 days of the passing of the bankruptcy order;

- The order passed by the AA shall continue to have effect till the debtor is discharged;

- If the order is passed on the application form bankruptcy by a creditor then the bankrupt within a period of 5 days from the bankruptcy commencement date shall submit a statement of affairs;

- AA shall issue a public notice inviting claims from all creditors within 2 days from the date of passing an order;

- Creditors shall register claims with the bankruptcy trustee within 7 days of the publication of the public notice;

- bankruptcy trustee shall within 14 days from the bankruptcy commencement date, prepare a list of creditors of the bankrupt;

- As per the list prepared, the bankruptcy trustee shall within 16 days from the bankruptcy commencement date;

- Bankruptcy trustee shall summon a meeting of the committee of creditors - a report of the administration of the estate of the bankrupt in the meeting shall be provided -- the report submitted by the bankruptcy trustee shall be approved by the committee of creditors within 7 days of receipt of the report;

- The AA shall pass a discharging order on the application made by the bankruptcy trustee -- expiry of 1 year from the bankruptcy commencement date or the date of approving the report by the committee of creditors, whichever is earlier -- copy of discharging order shall be forwarded to the Board and the insolvency professional agency.

The provisions pertaining to undue preferences, fraudulent transfers, onerous contracts, extortionate credits etc in case of non corporate debtors are similar to those in case of corporate debtors. Section 178 lists out the priority of claims of different types of creditors – this is also similar to the provisions in case of corporate insolvency.

- Vinod Kothari & Niddhi Parmar

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