The Finance Minister is expected to place the Union Budget in Parliament on February 1, 2025. While critical fiscal law reforms are likely, the government should take this opportunity to initiate deeper reforms to revigorated the Indian stressed assets markets.
The IBC was a radical structural reform when it was introduced in 2016. It has been instrumental in reducing NPA levels and increasing recovery for banks. Over the years, the practical working of the law threw up various challenges. The government as well as the judiciary were extremely proactive in addressing these challenges by continuously streamlining the law and the jurisprudence around it. Two problems, however, persisted.
Read More+
Delays associated with IBC resolutions remain a serious concern. This is particularly evident in the admission process, which has taken over a year in some cases. Even post-admission, CIRPs have been marred by delays.
As per IBBI’s quarterly newsletter (July-September 2024), average time taken for closure of corporate insolvency resolution processes under IBC was 698 days as on September 30, 2024. Another concern is that IBC currently does not incentivise the existing promoter/management to initiate a CIRP at the first sign of financial distress. This is because the promoter/management loses control at the inception of the resolution process. Both these factors are responsible for much of the value destruction of distressed businesses under IBC.
To mitigate these concerns, an expert committee constituted by the IBBI reviewed the restructuring frameworks across UK, USA and Singapore, and proposed a carefully designed creditor-led resolution process (CLRP) specifically customised for the Indian realities. The CLRP framework offers several advantages that are likely to rejuvenate the Indian stressed assets market.
First, the CLRP can be initiated out-of-court by banks. After default, unrelated financial creditors with 51% or more of total financial debt of the corporate debtor may directly appoint a Resolution Professional and notify the Adjudicating Authority and IBBI. The CLRP would formally commence from the date of such notification and no order from the AA would be required. The corporate debtor though would have the right to oppose and challenge such commencement. However, the CLRP cannot be paused or stayed during the pendency of such challenge. These features would help drastically cut down the time taken to initiate a CLRP compared to a normal IBC resolution.
Second, the CLRP introduces a debtor-in-possession regime, in sharp contrast to the present creditor-in-control regime under IBC. There will be no transfer of control to the RP on commencement of CLRP. Instead, the RP would be responsible only for preparing the Information Memorandum and inviting resolution plans from the market. The existing management would continue to carry on the business as a going concern and would likely be better placed to offer the best resolution for the CD. This will incentivize the existing promoter/management to support the resolution plan under CLRP, so long as they are not ineligible under section 29A of IBC. This would improve the chances of a successful and quick resolution.
Third, if the promoter/management turns uncooperative during the CLRP, the Resolution Professional or the Committee of Creditors’ may file an application to the NCLT for initiation of corporate insolvency resolution process, terminating the CLRP. This is a strong incentive for the promoter/management to cooperate with the financial creditors during the CLRP.
Another critical industry concern pertains to the position of statutory first charge holders in the waterfall. The Bankruptcy Law Reforms Committee (BLRC) explicitly recommended a lower priority for government dues as compared to all secured creditors and unsecured financial creditors for ‘promoting the availability of credit and developing a market for unsecured financing (including the development of the bond market)’. This policy underpins the waterfall under section 53 of the IBC.
Other statutes may, however, grant the first charge to dues owed to the government. The Supreme Court in State Tax Officer v Rainbow Papers Ltd. held that such statutory first charge falls within the scope of ‘security interest’, making the government a ‘secured creditor’ under the IBC waterfall.
This judicial position militates against the fundamental policy underlying section 53. It also conflicts with the definition of ‘security interest’ under IBC, which is defined as ‘right, title or interest or a claim to property, created in favour of, or provided for a secured creditor by a transaction which secures payment or performance of an obligation…’. Evidently, ‘security interest’ under IBC cannot be created by operation of law since that is not a transaction. Otherwise, any state government could simply grant statutory first charge status to its own dues to qualify as ‘secured creditor’, bypassing the express legislative intent behind section 53 of IBC.
Although the Supreme Court in Paschimanchal Vidyut Vitran Nigam v. Raman Ispat (2023)expressed doubts about the Rainbow decision, the latter remains an authoritative precedent on. This legal position has detrimentally affected the risks and cost of secured credit, impacting lending transactions. The government must resolve this situation by excluding statutory first charge from the definition of ‘security interest’ under IBC.
Overall, the budget speech could provide a fillip to the stressed assets market by signalling suitable reforms to address the above industry concerns.
This article was originally published in Business Today on 30 January 2025 Co-written by: Anoop Rawat, Partner; Pratik Datta, Associate Director. Click here for original article
Read Less-
Contributed by: Anoop Rawat, Partner; Pratik Datta, Associate Director
Disclaimer
This is intended for general information purposes only. The views and opinions expressed in this article are those of the author/authors and does not necessarily reflect the views of the firm.
The Bar Council of India does not permit solicitation of work and advertising by legal practitioners and advocates. By accessing the Shardul Amarchand Mangaldas & Co. website (our website), the user acknowledges that:
Click here for important public notice from the Firm.