The Evolution And Effectiveness Of The Insolvency And Bankruptcy Code, 2016: An Analytical Perspective

Introduction

The Insolvency and Bankruptcy Code (IBC), 2016, marked a transformative shift in India's insolvency landscape, consolidating fragmented insolvency laws and streamlining the process of insolvency resolution. Since its inception in December 2016, the IBC aimed to enhance the ease of doing business in India, encouraging timely resolution of insolvencies and better recovery for creditors. However, various challenges such as low recovery rates, delays, and high costs have emerged, necessitating an evaluation of the IBC's progress and effectiveness. This comprehensive analysis explores the evolution of the IBC through key Supreme Court judgments, compares it with global best practices, and discusses necessary changes to ensure a more resolution-friendly process.

Contribution of Justice Rohinton Fali Nariman

Study of the jurisprudence under IBC is not complete without recognising the contribution of Justice Rohinton Fali Nariman. Justice Rohinton Fali Nariman has played a pivotal role in stabilizing and shaping the jurisprudence of the Insolvency and Bankruptcy Code during its formative years. His judgments have been foundational in ensuring that the IBC fulfils its intended purpose of providing a clear, fair, and efficient insolvency resolution process. Justice Nariman's contributions are evident in several landmark rulings that have significantly advanced the legal framework of the IBC in India.

His judgment in the Swiss Ribbons case upheld the constitutional validity of the IBC, offering a robust judicial endorsement that has instilled confidence among creditors and investors. He famously described the IBC as "not a mere recovery legislation" but as a "beneficial legislation" aimed at the revival of companies and the maximization of value, a perspective that has been particularly influential in shaping the Code's interpretation.

Furthermore, in the Essar Steel India Ltd. case, Justice Nariman emphasized the primacy of the Committee of Creditors' (CoC) commercial wisdom, asserting that there should be minimal judicial interference in their decision-making process. This judgment reinforced the autonomy of creditors within the insolvency resolution process, which is critical for the effectiveness of the IBC.

Finally, in Pioneer Urban Land and Infrastructure Ltd., Justice Nariman's recognition of homebuyers as financial creditors under the IBC has empowered this group and ensured their interests are protected in insolvency proceedings, addressing a significant gap in the Code.

Justice Rohinton Fali Nariman's landmark rulings have profoundly shaped the trajectory of IBC jurisprudence, establishing a clear and progressive vision for its development. His judgments have been instrumental in ensuring that the Insolvency and Bankruptcy Code functions as a comprehensive and effective tool for insolvency resolution, rather than merely serving as a debt recovery mechanism. Justice Nariman's thoughtful and meticulous approach has addressed and settled complex issues under the IBC, thus fostering a more predictable and stable insolvency regime in India. His contributions during the formative years of the IBC have been crucial in laying a strong legal foundation, and his influence continues to resonate in the ongoing evolution of insolvency law in the country.

Evaluation of the IBC's Effectiveness Based on Recent Data

Though the process under IBC focuses on resolution, the rate of cases under liquidation shows that getting resolution plans for certain types of business are challenging. This is especially true in the case of MSMEs and Start-ups and enterprises which thrive on the expertise of its promoters. IBC has not been very successful in the revival of the service sector because this sector inherently requires drive from its promoters and continued funding from investors till the business achieves a certain scale. Second, it is being used excessively as a recovery tool rather than a resolution mechanism both by industry as well as the banking system.

According to the IBBI Quarterly Review for Jan-March 2024, the IBC has facilitated numerous insolvency cases filed by financial creditors (FCs) and operational creditors (OCs). However, several concerns regarding its effectiveness have emerged:

• Outcomes of Corporate Insolvency Resolution Process (CIRP): Although the IBC focuses on resolution, the high rate of liquidation cases highlights challenges in securing resolution plans for certain businesses. A significant number of cases (48%) have resulted in liquidation, indicating challenges in achieving timely and effective resolutions. While successful resolution plans demonstrate the IBC's potential, the high liquidation rate suggests a deviation from the intended purpose of enterprise revival.
• As of March 2024, the state of cases under liquidation reveals significant inefficiencies and delays within the insolvency framework. Out of 2,476 insolvency cases that have ended in liquidation, 53% have been languishing for more than two years, with only 509 companies (around 20%) having been dissolved. Additionally, a meagre number of cases have seen resolution through alternate means, with only 47 cases sold on a going concern basis and 12 cases resolved through compromises and arrangements.
• The financial recovery through liquidation has been dismal, with INR 8,943 crores recovered against admitted claims amounting to INR 228,702.84 crores, yielding a recovery rate of around 3%. Secured creditors have fared slightly better but still only managed to recover approximately 4% of their claims. Alarmingly, a substantial number of cases (1,516) involving claim amounts totalling INR 1,211,916 crores are still undergoing the liquidation process.
• Pendency and Value Stuck: Significant value remains stuck in unresolved cases, with an average pendency of 340 days. This high pendency rate underscores the need for streamlined processes and increased judicial capacity to ensure timely resolutions. Delays in approving resolution plans contribute to value erosion, undermining the IBC's objectives.
• Approved Resolution Plans: The average time taken for the conclusion of CIRP is 683 days, indicating a minimum of two years for resolution. This duration is a significant concern as prolonged processes can erode the value of the assets and negatively impact stakeholders.
• The success rate of approved resolution plans is 20%, indicating some success in facilitating viable restructuring solutions. However, delays in some cases call for quicker decision-making to prevent value erosion and enhance recovery rates. Approval process continue to be marred by long delays, cross litigations, repeated adjournments. It is a known fact that each day delay in the approval of the resolution plan cost the banking system dearly (besides erosion in value and rising cost) on account of continued involvement of professionals and litigation.
• Recovery Rates: The overall recovery rate stands at around 45%. Despite the IBC's capability in securing recoveries, the disparity between financial and operational creditors highlights the need for a more equitable approach.
• Financial Creditors have an average recovery rate of 32% of their claims, while Operational Creditors recover around 25%.
• Interestingly, Operational Creditors, often considered to be at a disadvantage, have been significant beneficiaries in terms of case filings (3667 cases) compared to Financial Creditors (3440 cases). A notable number of cases initiated by Operational Creditors (756) were settled and withdrawn under Section 12A, compared to 306 cases by Financial Creditors. This shows that OCs are taking benefit of the provisions of the Code for recovery of their dues.
• Addressing the Use of IBC as a Recovery Tool: The IBC is increasingly being used as a recovery tool rather than a resolution mechanism, contrary to its original aim and the recommendations of the Bankruptcy Law Reforms Committee (BLRC). Judicial trends, including those where the NCLAT has directed the admission of cases that do not strictly fall under financial or operational transactions, exacerbate this issue. High number of filings by operational creditors and withdrawal under section 12A indicate the use of the IBC as a recovery mechanism rather than a resolution too.
• Realising Full Potential of IBC: The prescribed timeline under IBC for CIRP is 180 days, with a possible extension up to 330 days. However, the average time taken is 683 days (approximately two years). Assuming timely completion within the prescribed period, there could be increase in recovery rates by 50% due to timely resolution. Possible up in recovery could be as follows:
• Current recovery to FC and OC under IBC (IBBI Quarterly Review March 2024)

• Estimates of the Improved recovery to FCs and OCs due to timely conclusion of process

• Estimate of the Value Erosion Due to Delays

While these are rough estimations of value erosion, however, the fact remains that even if the process could be improved even by 25%, it could substantially improve the value realisation to a substantial extent and help in realising true potential of the process.

• Personal Insolvency

Filing Trends and Recovery: Personal insolvency cases are on the rise, with 2800 applications filed, involving an amount of INR 188155 crores. Out of these, 401 cases were filed by guarantors themselves. The resolution of personal insolvency cases has been poor, with only 4 cases concluding in a resolution plan and an abysmal recovery rate of around 2%.

• Avoidance Transactions

Cases and Recovery: A substantial amount of INR 370942 crores is involved in 1237 cases filed under avoidance transactions. However, only 293 cases have been disposed of, with a meagre recovery of INR 6599 crores.

Notably, INR 5500 crores of the recovered amount pertains to a single case involving Jaypee Infra, where a mortgage of land in favour of the Banks was set aside. This indicates that outside of significant cases, recovery is negligible.

Service Industry Cases Under IBC

Challenges and Limited Success of the IBC in the Service Sector: The Insolvency and Bankruptcy Code (IBC), 2016, was designed to facilitate the resolution of distressed companies, ensuring timely and effective insolvency processes. However, its application in the service sector has revealed several challenges, particularly in the revival of businesses such as airlines and MSMEs. An analysis of recent data from the IBBI Quarterly Review of March 2024 underscores the systemic issues that impede effective resolution.

Key Challenges in the Service Sector

• Dependence on Promoter Expertise: Service sector businesses, especially airlines, MSMEs, and startups, thrive on the expertise and vision of their promoters. For instance, Jet Airways and Go Air, which faced insolvency proceedings, demonstrate how crucial the involvement of promoters is to the survival and revival of such enterprises. The intricate knowledge and operational expertise that promoters bring to the table are difficult to replicate by external administrators or new management teams.
• Continuous Funding Requirements: Service sector businesses often require sustained funding to maintain operations and scale up. Investors are typically more willing to fund these businesses when they have confidence in the promoters' leadership. The absence of promoters during insolvency proceedings can lead to a lack of investor confidence and subsequent withdrawal of financial support. This challenge is evident in the high liquidation rates for service sector companies undergoing Corporate Insolvency Resolution Process (CIRP).

Urgent need to address Delays in India

• While the Government of India in its Union Budget for 2024-25 has proposed strengthening of National Company Law Tribunals (NCLT) mechanism, the issue also need to be addressed at a legislative level. The focus should be on streamlining the process before NCLTs. There is need to establish and adhere to strict timelines for hearings, reducing the frequency of adjournments and ensuring timely progression of cases. Ministry of Corporate Affairs (MCA) need to implement a preliminary screening mechanism to filter out frivolous and non-essential interim applications, preventing unnecessary delays beside introduction of penalties for frivolous or vexatious applications to discourage such practices and streamline the process. There is also need to reassess the scope of inherent powers of NCLT under Rule 11 and Section 60(5) to ensure they are not used to unduly interfere with or delay the insolvency process.
• The NCLT should implement streamlined procedures for approving liquidation applications. Cases that have already exhausted all resolution efforts should be given priority for liquidation approval. This will prevent further value erosion and reduce the backlog of prolonged cases.
• There is urgent need to simplify the procedural requirements under CIRP and PPIRP to reduce complexities and enhance efficiency. It is important to implement standardized templates and processes for common filings and actions to reduce variability and procedural delays. Additionally, it is important to minimize process and regulations and frequency of amendments which adds to complexities rather than resolving issues. There is need to ensure that PPIRP offers clear advantages over CIRP, such as reduced timelines and lower costs, to make it an attractive option for stakeholders.
• Focus on Faster Approval of Resolution Plans: The authorities should encourage the formulation and approval of resolution plans within shorter timeframes to maximize asset value and recoveries. Similarly, application for liquidation should be decided in 30 days' time as there is little scope for judicial scrutiny at this stage.
• Encourage Alternative Dispute Resolution (ADR): It is crucial to integrate mediation and arbitration as part of the insolvency resolution process to resolve disputes quickly and reduce the burden on courts. Alternative Dispute Resolution (ADR) should be made compulsory for IAs by non-stakeholders and it would be prudent to establish a dedicated ADR.
• Enforcement of strict timelines is crucial for each stage of the insolvency process and penalize unnecessary delays. It is also important to regularly monitor and review case progress to ensure adherence to timelines and identify bottlenecks early.
• Revise PPIRP Framework - The IBC's limited success in the service sector underscores the need for tailored approaches that recognize the unique challenges of these businesses. Promoter involvement is crucial for the survival and revival of service sector companies, as their expertise, strategic vision, and industry relationships play a vital role in crafting effective resolution plans. Incorporating best practices from global jurisdictions and ensuring timely and equitable processes can help the IBC fulfill its intended purpose of fostering a robust and resilient insolvency framework.

Case Studies from Public Domain

• Jet Airways: Jet Airways, a major player in the Indian aviation sector, faced insolvency proceedings in June 2019. Despite being one of the largest airlines, it failed to get an effective revival and still languishing.
• Go Air: Similar to Jet Airways, Go Air struggled with financial issues and entered insolvency proceedings. The resolution process faced significant hurdles, and the airline is still undergoing proceedings with no clear resolution in sight.
• Kingfisher Airlines: A high-profile case, Kingfisher Airlines faced insolvency due to financial mismanagement and mounting debts. The company went into liquidation, and efforts to recover dues from the promoter continue to face legal battles.

Global Practices in the Service Industry Insolvency: Illustrations

• United States: Chapter 11 Bankruptcy: The US Bankruptcy Code's Chapter 11 allows companies to reorganize their debts while continuing operations.

For example, tHertz Corporation successfully navigated bankruptcy through Chapter 11, emerging with a new business plan and reduced debt. Success Factors: Flexibility in restructuring, debtor-in-possession financing, and ability to renegotiate contracts.

Lehman Brothers: The financial services firm filed for Chapter 11, and although liquidation ensued, parts of the business were sold off, preserving some value. Lesson: Flexibility and a structured approach allowed for partial preservation and value recovery.

• United Kingdom: The Insolvency Act 1986 provides for administration and Company Voluntary Arrangements (CVAs), focusing on business rescue and restructuring.

Example: Thomas Cook entered administration, with parts of the business being sold off to different buyers. Success Factors: Administration allowed for a structured approach to selling off assets, preserving value, and maintaining employment for parts of the business.

Carillion: The construction and services giant went into liquidation. Efforts were made to preserve public services by transferring contracts to other firms. Lesson: While liquidation was unavoidable, the structured approach to transfer services helped mitigate the impact.

• European Union: The EU Directive on Restructuring and Insolvency promotes preventive restructuring frameworks, allowing businesses to restructure early and avoid insolvency.

Example: Alitalia has undergone multiple restructurings under Italian insolvency laws, with significant state intervention. Success Factors: Early intervention and state support play critical roles in restructuring efforts.

Air Berlin: The airline filed for insolvency and was eventually liquidated, with parts sold to other airlines. Lesson: The lack of early intervention and funding led to liquidation, despite efforts to restructure.

The service sector faces unique challenges under the Insolvency and Bankruptcy Code (IBC), 2016, as evidenced by high liquidation rates and low recovery rates. Global practices, such as Chapter 11 in the US and administration in the UK, offer more flexibility and support for restructuring, leading to better outcomes. For the IBC to be more effective in the service sector, incorporating elements of these global best practices, such as early intervention, flexibility in restructuring, and enhanced support for promoters, is essential. This approach can help preserve enterprise value, protect employment, and improve recovery rates for creditors.

Approach under Major Jurisdictions

The Chapter 11 process under the US Bankruptcy Code prioritizes reorganization over liquidation, allowing businesses to continue operations while restructuring their debts. The UK's Insolvency Act 1986 emphasizes administration and company voluntary arrangements (CVAs), balancing creditor and debtor interests to facilitate effective restructuring and preserve enterprise value. Under the Insolvency, Restructuring, and Dissolution Act 2018, Singapore's regime emphasizes flexibility and restructuring over liquidation, similar to the IBC's focus on creditor-driven processes and debtor-in-possession restructuring, promoting business continuity. The Cayman Islands' Companies Law (2020 Revision) features a dual approach of full powers and light touch provisional liquidations, emphasizing flexibility and creditor involvement. This approach helps preserve and maximize enterprise value, reflecting the IBC's inclusive and comprehensive insolvency processes.

Importance of Business Preservation and Rights Protection

Commercial and financial activities should not be automatically criminalized unless there is strong evidence of fraud or wilful default. Courts have highlighted the importance of protecting rights, even in cases of default. For instance, the Delhi High Court in Balram Garg v. Union of India and Anr[9]. emphasized that mere inability to pay a bank loan should not curtail the fundamental right to travel abroad, guaranteed under Article 21 of the Constitution of India.

There is a need to have a relook at the provisions of section 29A of IBC which debars the promoters from participating in the insolvency process. The Government could evaluate the impact of the provisions especially in cases where there is no element of wilful default or fraud.

Strengthening Recovery Tools and Dispute Resolution Mechanisms

The Government of India has taken significant steps to strengthen the contract enforcement and commercial dispute resolution regime, including alternative dispute resolution mechanisms. The Mediation Act, 2023, and the Arbitration and Conciliation Act, 1996, have been pivotal in this regard. The Mediation Act provides a comprehensive framework for mediation, promoting out-of-court and amicable settlement of disputes, while the Arbitration and Conciliation Act encourages timely resolution of disputes through arbitration. These alternatives need to be properly and effectively utilized.

Compromise and Arrangements under the Companies Act, 2013

The Indian Companies Act, 2013, under Sections 230-232, provides a mechanism for compromise and arrangement schemes, enabling companies to restructure their affairs and liabilities before moving to liquidation. This framework allows companies to propose restructuring plans to their creditors, which can be approved by the National Company Law Tribunal (NCLT). While many jurisdictions, especially the UK and Cayman Islands, continue to utilize such provisions, in the Indian context, lenders do not support such efforts. Therefore, these measures are seldom used, and there is an urgent need to issue guidelines for lenders to consider this route in appropriate cases.

Recommendations for Improvement

• Amendment of Section 29A

Importance of Promoter Involvement: There is no denial of the fact the promoters possess a deep understanding of the business, its market, and strategic vision. In case of start-ups and promoter driver business, investors are more likely to support resolution plans that involve the original promoters, The operational expertise of promoters is vital for maintaining business continuity during the resolution process. Their knowledge of day-to-day operations, customer relationships, and supplier networks can help stabilize the company and prevent further deterioration of value. Additionally, it is observed that major challenges under the IBC come from promoter driven litigation and non-participation of the promoters in the process.

Therefore, there is an urgent need to review the provisions and provide promoters with a fair chance to participate in the Corporate Insolvency Resolution Process (CIRP). Amendments to Section 29A should allow them to participate if they are not willful defaulters or declared fraudulent. This change would enable genuine business revival efforts.

Limiting Interim Moratorium Under Section 96 under Personal Insolvency: It is seen that the provisions of interim moratorium in personal insolvency are primarily being misutilized by debtors as they can effectively stall all recovery actions just by filing an application before the Registry of NCLT and issuing notice to the Creditors about the provisions of Section 96 of the Code. The interim moratorium under Section 96 should be limited to the debtor rather than affecting creditors. This would prevent personal guarantors from misusing the moratorium to stall recovery actions without taking concrete steps for resolution.

• Enhancing the Pre-Pack Insolvency Process

To make the Pre-Pack Insolvency Process (PPIRP) more effective, it is essential to refine the process so that businesses can work on their resolution plans while maintaining control over their operations. This approach mirrors the "light touch" provisional liquidation strategy, allowing companies to manage their affairs with minimal disruption. Although PPIRP was introduced in 2021, the fact that only four cases have been initiated under this system in three years highlights significant challenges within the process that must be urgently addressed.

The PPIRP framework needs simplification by minimizing unnecessary processes and restrictions. It's crucial to ensure that PPIRP offers clear advantages over the regular Corporate Insolvency Resolution Process (CIRP), such as faster resolution timelines and reduced costs. This will not only enhance its appeal but also improve its efficacy as a tool for resolving insolvency efficiently.

• Integrating Mediation and Arbitration

Integrating mediation and arbitration under the IBC for suitable cases, such as startups and service industries, can help preserve value and innovation. The Mediation Act, 2023, and the Arbitration and Conciliation Act, 1996, offer time-bound processes and mechanisms to execute final outcomes, reducing value destruction and ensuring quicker resolutions.

Conclusion

The Supreme Court's judgments have played a crucial role in refining and reinforcing the IBC, ensuring it serves as an effective tool for insolvency resolution. However, continuous improvements, particularly in reducing pendency and enhancing recovery rates, are essential for the IBC to achieve its full potential. By focusing on resolution and value preservation rather than mere recovery, and incorporating best practices from global jurisdictions, the IBC can fulfill its intended purpose and contribute to a robust and resilient insolvency framework. Balancing the interests of both enterprises and lenders, and ensuring fair treatment in cases of financial distress, is crucial for fostering a supportive business environment in India.

Footnotes

1 Civil Appeal No. 8337-8338 OF 2017- Decided on August 31, 2017

2 Civil Appeal No. 9402-9405 OF 2018- Decided on October 04, 2018

3 Civil Appeal No. 99 OF 2018- Decided on January 25, 2019

4 Civil Appeal No. 8766-67 OF 2019- Decided on November 15, 2019

5 Writ Petition (CIVIL) NO. 43 OF 2019- Decided on August 09, 2019

6 Civil Appeals No. 8512-8527 OF 2019- Decided on February 26, 2020

7 Civil Appeal No 4633 of 2021- Decided on July 12, 2022

8 Civil Appeal No. 7667 of 2021- Decided on August 26, 2022

9 W.P.(C) 6739/2024 & CM APPLs. 28113/2024, 32279/2024- Decided on July 12, 2024

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