Impact Of Insolvency And Bankruptcy Code On Financial Stability
Author: LawSphereX
Category: Corporate & Insolvency
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IMPACT OF INSOLVENCY AND BANKRUPTCY CODE ON
FINANCIAL STABILITY
Abhishek Das & Snehashish Roy, Amity University, Kolkata
ABSTRACT
The introduction of IBC has significantly transformed the sector by boosting credit availability and financial stability through a more efficient and timely debt recovery process. Before IBC, the banking sector faced numerous challenges, including an inadequate regulatory framework and inefficient recovery mechanisms that resulted in lengthy and costly procedures. With the advent of IBC, the insolvency resolution process has become more streamlined, lender confidence has grown, and NPAs have decreased. Key reforms, such as the establishment of the National Company Law Tribunal (NCLT) and the Insolvency and Bankruptcy Board of India (IBBI), have ensured a fair and transparent system.
Although challenges remain, the IBC has become a cornerstone of India's financial system, created a healthier banking environment, and contributed to economic growth through improved lending and financial stability. Keywords: Insolvency and Bankruptcy Code, Creditors, Framework, Debts, Investors
Introduction
Financial stability is essential for a thriving economy. It fosters investor confidence, encourages lending, and promotes growth. Effective insolvency frameworks, such as the IBC, are critical in minimizing systemic risks associated with defaults and failures. By facilitating timely resolutions, these frameworks enhance creditor recovery, reduce non-performing assets (NPAs), and ultimately contribute to a more stable financial environment. The Insolvency and Bankruptcy Code (IBC), enacted in 2016, is a landmark legislation in India aimed at overhauling the existing insolvency framework. This Code aimed to make bad debt recovery faster and more time-bound by changing the insolvency resolution This Code aimed to make bad debt recovery faster and more time-bound by changing the insolvency resolution.
1 It seeks to streamline the process of resolving corporate insolvencies and bankruptcies, establishing a time-bound mechanism for the resolution of distressed entities. The IBC consolidates multiple laws related to insolvency and bankruptcy into a single, comprehensive framework. The primary objective of the IBC is to promote entrepreneurship by providing a conducive environment for resolving financial distress. It aims to balance the interests of creditors and debtors, enhancing the efficiency of capital allocation in the economy. By doing so, the IBC plays a crucial role in maintaining the overall health of the financial system, thereby ensuring sustained economic growth. The establishment of Insolvency and Bankruptcy Board of India (IBBI) and along with National Company Law Tribunal were proved to be a major progress under the code.
Both the institutions were established to oversee and govern the insolvency process, by ensuring those be conducted efficiently, smoothly and transparently. By enforcing a streamlined and time-bound process, the code has significantly reduced the time required for recovering of loan. Lenders now have more confidence that their debt will be recovered on time because of this. Banks have recovered a significant amount of written-off loans due to better bad debt recovery rates under IBC. 2 Background A bankruptcy law mainly deals with two agents which are the creditors and the debtors, who 1 Reserve Bank of India, Publications, Insolvency and Bankruptcy Code and Bank Recapitalisation (Dec. 21,
2017) https://m.rbi.org.in//scripts/PublicationsView.aspx?id=18060
2 FE Bureau, IBC reforms may improve NPA recovery, says Ind-Ra, F.E. October 26, 2024
https://www. financialexpress. com/business/banking-finance-ibc-reforms-may-improve-npa-recovery-says-indra-3379275/ are in conflict with each other. A sound bankruptcy law tries to find a perfect balance between the two and thus establishes formal rules to enhance efficiency. 3 The law let the unproductive firms from the market, and thus allowing the available resource be allocated to the more productive firms, and therefore enabling creative destruction. However, over a long time, the bankruptcy law in India have faced a series of challenges which involved complex process, huge number of overlapping laws and authorities, arbitrary practices at different levels, delays and a bias favouring debtors in control.
The absence of ununified and properly framed bankruptcy law led to financial issues such as rising NPAs (Non-Performing Asset) a decreasing credit growth which hampered the potentially high economic growth. Thus, the requirement of a properly framed insolvency and bankruptcy law became essential to run business activity, attract investment and FDI, and support the long-term growth of the economy. Therefore, the Indian government introduced the Insolvency and Bankruptcy Code (IBC) in 2016, aiming to address the NPA crisis in the short term while enhancing ease of doing business and promoting growth in the medium and long term. Issues with Previous Insolvency Frameworks The previous frameworks, including the Companies Act, 1956, and the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, were plagued by inefficiencies.
Key issues included prolonged litigation, lack of clarity on creditor rights, and a lack of a structured process for the resolution of insolvency cases. These challenges created an environment of uncertainty, deterring investment and exacerbating the rise of NPAs. Sick Industrial Companies (Special Provisions) Act, 1985 The Act defined the concept of the sick company and potentially sick company. The Act defined the sick company as those company as any company which existed for at least five years and the accumulated loss exceeded or became equal to the net worth of any financial year. The SICA provided reference to the Board for Industrial and Financial reconstruction under Section
154 of the Act, of those company which had become sick as stated under the provisions of the
Act. The Act failed due to its backward way of dealing with the bankruptcy and insolvency 3 Tanveer Ahmad Khan, Impact of IBC on Credit Networks and Firm Performance: An analysis of Pre and Post IBC Era https://www.ies.gov.in/pdfs/Paper-on-IBC-Final.pdf
4 Section 15 of Sick Industrial Companies (Special Provisions) Act, 1985
problems. The Act provided for a balance sheet approach to detect a sick company rather than potential cash flow method. This approach took a long period to properly address the issue. Sick Industrial Companies (Special Provisions) Repeal Act of 2003 The Act dissolved the Board for Industrial and Financial Reconstruction (BIFR) and the Appellate Authority for Industrial and Financial Reconstruction (AAIFR) established under the Act of 1985. However, the delay in the constitution of NCLT the repeal Act was never notified. The Recovery of Debts and Bankruptcy Act, 1993 The Tiwari committee constituted the Act with objective of solving the problem of the banks and the financial institutes. Under the Act, it proposed establishment of the Debt Recovery Tribunal which would use the public invested money in proper utilization.
Although the provisions of the Act did not apply to those financial institute where the due amount be less than ten lakhs' rupees. The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) The Act was brought for the enforcement of the security interest created in the favour of those of the secured creditor. It dealt with the enforcement of the security interest by giving due notice to the parties for the discharge of their liabilities within sixty days of the date of notice failing which the secured creditor can take against as stated under Section 135 of the Act. The SDR and CDR Mechanism The Corporate Debt Restructuring was introduced in 2001, mainly for the execution by the banks. The scheme was limited to the financial institutions which had an aggregate exposure less than ten crore rupees.
The scheme was non-voluntary in nature and was an agreement between the creditors and debtors for the purpose of restructuring of debts. The Strategic Debt Restructuring (SDR) was introduced by RBI on June, 2015. The scheme aimed to change the management of a company to deal with the stressed assets. Although the 5 Section 13 of The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 number of cases which were solved under the mechanism were very few in number. Post IBC Scenario The enactment of IBC has led to strengthening financial stability through a number of significant steps in India. It has contributed in reduction in NPAs mostly within the banking sector. According to the data from the Reserve Bank of India (RBI) the Gross Nonperforming Assets (GNPA) ratio for the banks of India showed a steep decrease from 3. 2% in September
2023 to 2.8% during the end of March 2024 which was said to be a multi-year low. The Net
NPA ratio also declined from 0. 9% to 0. 6% during the same period. Such reduction has ultimately improved the financial health of the banks, by enhancing their stability as well as their ability to lend. 6 Below are some key areas where the IBC has contributed: Cost of Credit and Bankruptcy Reforms Before the IBC, creditors had limited control over the resolution process and often faced significant delays in recovering their dues. The enforcement of IBC in 2016 led a change in the whole scenario where the control went to the creditors from the debtors, under which the creditors have the power on liquidation and restructuring process of the companies. The creditors led liquidation and reorganizing process have resulted to higher credit supply, debt recovery, along with lower rate of interest.
It was found that such rise in credit condition have resulted in investment, but on the other hand, it was also stated that the liquidation process led a decrease in the cost of banks financing. It was concluded that such reorganization process worsens opportunistic behaviour among new businesses while the change in liquidation process have a disciplinary effect as it reduces credit constraints and improves investment. 7 Moratorium It does not need to be mentioned that the Insolvency the Bankruptcy code unified the laws which were exiting to the enforcement of the statutory rights of the creditors. It has unified all 6 Dayitha T.
K, The Impact of The Insolvency and Bankruptcy Code on The Indian Banking Sector's Financial Stability and Credit Accessibility, 3 JLRJS 480, 483-85 (2024) 7 Tanveer Ahmad Khan, Impact of IBC on Credit Networks and Firm Performance: An analysis of Pre and Post IBC Era (Sep. 17, 2024) https://www. ies. gov. in/pdfs/Paper-on-IBC-Final. pdf the relating to the insolvency process of any corporate entities and the concerned individuals into one governing law. Thus, any lawsuit or claim which were going on or pending under the various pre-existing insolvency laws comes to a pause during the insolvency resolution process. Although there have been decisions by the High Court a well as the Supreme Court have prosecuted on any lawsuit during the moratorium, and which have been kept out of the purview of the moratorium.
Reduction in Non-Performing Assets (NPAs) One of the major impacts of the IBC has been the reduction in NPAs (Non-Performing Assets). The IBC's timebound resolution process has expedited the recovery of bad loans, leading to a decline in the stock of NPAs in the banking system. Combination of IBC reformistic schemes introduced by RBI such as Asset Quality Review (AQR) led the clearance of the balance sheet of the banks. Resolving the problem of NPAs effectively by the banks has also resulted in less exposure to bad loan and increase in capital adequacy ratios. According to data from the Reserve Bank of India (RBI), the gross NPAs of scheduled commercial banks have shown a downward trend since the implementation of the IBC. This reduction in NPAs has improved the overall health of the banking sector and contributed to financial stability.
Promotion of a Resolution Culture Enactment of IBC have led to a start of timely resolution of assets which are sold below their market value due to lack of cash flow or solvency issues (distressed assets). The Conde made it mandatory of maximum period of 270 days (9 months approx. ) for the completion of the insolvency resolution process which shall be including any extension. This step has allowed the stakeholders to expedite the process of resolution any unnecessary delays. These resulted in resolution of any distressed assets in a timely manner, pre-venting erosion and maintaining financial stability. The case of Esar Steel8 illustrated the efficiency and impact of the IBC in resolving large and complex insolvency cases. Essar Steel, one of India's largest steel producers, had accumulated massive debts, leading to insolvency proceedings.
Under the IBC, ArcelorMittal won the bid to acquire Essar Steel for ₹42,000 crores. This resolution not only helped recover a substantial amount for the creditors but also ensured the continuation of 8 Committee of Creditors of Essar Steel India Limited (through authorized signatory) v. Satish Kumar Gupta and Others, (2020) 8 SCC 531. operations, preserving jobs and contributing to the economy. The swift resolution of such a significant case showcased the effectiveness of the IBC in handling large-scale insolvency issues. Transparency and Efficiency On average, there have been 125 resolutions annually since the implementation of the IBC, and during 2023-2024 the number of resolutions stood at around 270 and there will be more in upcoming time. 9 The IBC has brought some significant changes in the aspect of transparency and efficiency in the process of insolvency resolution process.
The Insolvency and Bankruptcy Board of India (IBBI) established under the Code has ensured that such process be conducted in a fair and transparent manner. Moreover, the IBC has introduced a robust framework for information and dissemination, that have enabled the stakeholders to make informed and rational decisions. This transparency has resulted in enhanced credibility and insolvency resolution process and increased confidence in the financial system. Investor Confidence The IBC has had a positive impact on investor confidence in India. By providing a clear and predictable framework for insolvency resolution, the IBC has reduced the uncertainty associated with the recovery of investments. This increased predictability has attracted both domestic and foreign investors, contributing to a more stable and vibrant financial market.
Moreover, the IBC has improved India's ranking in the World Bank's Ease of Doing Business index, further boosting investor confidence. Development of a Stressed Asset Market The IBC has catalysed the development of a vibrant stressed asset market in India. The rise of asset reconstruction companies (ARCs) and distressed asset funds has provided additional avenues for resolution and recovery. This growth not only facilitates better asset management but also enhances financial stability by ensuring that distressed assets are effectively restructured or liquidated. 9 Ensure transparency, faster resolution under IBC for better recovery: IBBI chief, ET, July 12, 2024
Challenges
and Criticisms The IBC was introduced for the main objective of a time-bound resolution process, which actually aimed to protect the companies from getting bankrupted. The code simplifies and accelerates the whole process of insolvency. Along with that the code also allows both the creditors and the debtors to initiate recovery proceedings and seeks to protect the interest of all the stakeholders. The IBC was introduced in 2016, it's been 8 years and within this period the code has gone through total six amendments, and there have been a number of judicial decisions which have interpreted the code in a lot of ways. The lates one was IBC (Amendment) Act,
2023. Despite the many interpretations and amendments of the IBC, it has not been without its
challenges
and criticisms. Here are a few key areas where the IBC has faced issues: Time limit Under the Corporate Insolvency Resolution Process (CIRP), the IBC provide for a time-bound resolution process. The code mandates the process of resolution be completed under 180 days from the date of admission of such application. 10 The period might be extended by the adjudicating authority only when a resolution be passed by the committee of creditors having a vote of 66%. The maximum period of completion of the process must be 330 days. Although extension of 90 days can be provided for any proceedings associated with the resolution process. However, the high number of cases before the adjudicating authority creates an imbalance and the tenure provided for the resolution process i. e. , 330 days becomes very difficult.
11 Also, any such company which have a high number of creditors makes it difficult for smooth functioning of the committee of creditors. In the Esar Steel12 case the court struck down the word “mandatorily” stating that the time which is taken for the legal proceeding must not affect the general interest of the parties concerned. Along with that the Court also stated that the maximum 330 days which is provided under the Code for the resolution process is required to follow, however it might be extended by the NCLT or the NCLAT, given the circumstances of the case.
10 Section 12 of The Insolvency and Bankruptcy Code, 2016.
11 Section 4 of the Insolvency and Bankruptcy (AMENDMENT) ACT, 2019. No. 26 OF 2019.
12 Committee of Creditors of Essar Steel India Limited (through authorized signatory) v. Satish Kumar Gupta and Others, (2020) 8 SCC 531 Role of a Resolution Professional The resolution plan submitted by the applicant, mut be examined in accordance to section 30(2) of the Code by the resolution professional. And then such plan be presented to the committee of creditors for its approval. Once the CoC approve the plan, it is forwarded to the adjudicating authority. The Apex Court in the case of Arcelormittal India Pvt. Ltd. Vs. Satish Kumar Gupta and Ors13 analysed the role of a resolution professional and the stated that the purpose of a resolution professional is to inspect the resolution plans submitted by the applicants and then submitting the same to the CoC.
A resolution professional does not have the authority to decide whether such plan is violative of any law or provisions, nor he has any power to take any decision and opinion regarding contravention of law to be put before the committee. Financial and operational creditors It was contended in the case of Swiss Ribbons Pvt. Ltd. & Another vs. Union of India & Ors. 14 that the difference between financial and operation creditors were in violation of Article 1415 of the Indian Constitution. Along with that the fact that operation creditors were excluded from the Committee of Creditors, was also raised as an issue before the Apex Court.
16 The Supreme Court in reference to the BLRC Report and with the help of Insolvency Law Committee (ILC) held that there is a comprehensible difference between the financial and operational creditors, and most significant difference is in assessing the viability of the corporate debtor. The Court, in the issue of discriminatory treatment of operational creditors, held that the committee of creditors have the main responsibility to evaluate the viability of any resolution plan submitted by the resolution professional. And the financial creditors have the ability to conduct the required study to evaluate the viability of such plan. On the other hand, the main purpose of the operational creditors is to recover the money they paid for goods and services.
And thus, the Court concluded that there was no discrimination against the operational creditors, and nor it was in violation in Article 14.
13 Arcelormittal India Private Limited Vs. Satish Kumar Gupta & Others [(2019) 2 SCC 1]
14 Swiss Ribbons Pvt. Ltd. & Another Vs. Union of India & Others [(2019) 4 SCC 17],
15 INDIA CONST. Art. 14
16 M. S. Bushra Tungekar Challenges of interpretation of Insolvency and Bankruptcy Code, 2016 (Feb. 7, 2021) https://blog. ipleaders. in/challenges-interpretation-insolvency-bankruptcy-code-2016/#Objectives_of_IBC Eligibility of Resolution Applicant A resolution applicant is defined as an individual or a group of individuals, who present a resolution plan to the concerned resolution professional, which is stated under Section 25(2)(h)17 and the provision of Section 29A which reads as, “A person shall not be eligible to submit a resolution plan, if such person, or any other person acting jointly or in concert with such person-” shall be binding upon such resolution applicant. Section 29A provides for several disqualifications of any such individual or group of individuals. 18 The Apex Court in the case of Arcelormittal India Pvt. Ltd. Vs.
Satish Kumar Gupta and Ors19 interpreted the provision which provided for the ineligibility of resolution applicant, and held that, the disqualification of an applicant under Section 29A (c) is enforced after a plan is submitted. Although under the above section the plan can be removed if the person submitting the plan pays all the charges and interest related to the NPAs before submitting the plan. The constitutional validity of Section 29A (j)20 was challenged in the case of Swiss Ribbons Pvt. Ltd. & Another vs. Union of India & Ors. 21. Although the Apex Court in the opinion that under Section 5(24A) provides for the definition of related party, talks about any person acting jointly or in concert must be associated with the business activity of the resolution applicant.
And hence, the term "relative" mentioned must be have any connection to the business activity of the resolution applicant. And if such relation or connection is not present or cannot be proved, then such person cannot be disqualified as mentioned under Section 29A (j) of the Code. Future Trends and Recommendation To strengthen the impact of the Insolvency and Bankruptcy Code (IBC) and address ongoing challenges in the financial sector, several strategic directions and recommendations are suggested.
17 Section 25(2)(h) The Insolvency and Bankruptcy Code, 2016.
18 Sneha Mahawar, Should Section 29A of IBC be struck down as unconstitutional (March 20, 2022)
https://blog.ipleaders.in/should-section-29a-ibc-struck-downunconstitutional/#:~:text=Section%2029%20A%20is%20binding,(2)%20(h).
19 Arcelormittal India Private Limited Vs. Satish Kumar Gupta & Others [(2019) 2 SCC 1]
20 Section 29A(j) of The Insolvency and Bankruptcy Code, 2016.
21 Swiss Ribbons Pvt. Ltd. & Another Vs. Union of India & Others [(2019) 4 SCC 17]
1. Enhancing Stakeholder Communication
Improved communication among banks, creditors, and debtors is essential to minimize misunderstandings and delays. Effective stakeholder communication can be achieved by implementing regular training sessions and guidelines for all parties involved in the insolvency process. These training programs should focus on the roles and responsibilities within the IBC framework, ensuring that all stakeholders are well-informed and equipped to handle their task efficiently. By fostering clear and consistent communication, the resolution process can be expedited, reducing the likelihood of disputes and procedural delays.
2. Streamlining Resolution Processes
Simplifying and making the resolution process more transparent would help reduce case backlogs and increase efficiency in insolvency proceedings. This can be achieved by leveraging advanced technologies, such as blockchain, to track insolvency cases. Blockchain technology can provide a secure and transparent platform for managing and sharing data related to insolvency proceedings, thereby reducing delays and improving the overall efficiency of the process. Additionally, adopting standardized procedures and documentation can further streamline the resolution process, ensuring that cases are handled consistently and effectively.
3. Introducing Pre-default Mediation
The IBC could benefit from incorporating pe-default mediation mechanism to allow lenders and borrows to resolve disputes before a default occurs. Pre-default mediation can serve as a preventive measure, enabling parties to address potential issues early and find mutually agreeable solutions without resorting to formal insolvency proceedings. This approach can reduce the number of cases that escalate to insolvency, thereby alleviating the burden on the insolvency resolution system and preserving business relationships.
4. Strengthening Asset Reconstruction Companies (ARCs)
Asset Reconstruction Companies (ARCs) play a critical role in managing distressed assets. To enhance their effectiveness, it is important to increase the capacity of ARCs and enable them to adopt innovative approaches, such as asset securitization and co-lending. By leveraging these innovative strategies, ARCs can improve asset management and enhance recovery rates.
Strengthening ARCs will ensure that distressed assets are managed more effectively, contributing to the overall stability of the financial system.
5. Empowering the Insolvency and Bankruptcy Board of India (IBBI)
Reinforcing the authority of the Insolvency and Bankruptcy Board of India (IBBI) to oversee compliance is crucial for ensuring that standards are consistently met across insolvency case. An empowered IBBI can enhance regulatory adherence by conducting regular audits, providing clear guidelines, and taking swift action against non-compliance. Strengthening the IBBI's oversight capabilities will ensure that the IBC's procedures are effective and uniform, fostering trust and confidence in the insolvency resolution process.
6. Promoting Financial Inclusion
Expanding credit access, particularly for small and marginalized enterprises, is crucial for fostering economic growth. Strengthening the IBC’s framework to better support Small and Medium Enterprises (SMEs) can help maintain financial stability while encouraging entrepreneurship. This can be achieved by tailoring insolvency procedures to the specific needs of SMEs, providing them with timely and adequate support during financial distress. Promoting financial inclusion will ensure that all segments of the economy benefit from the IBC's provisions, contributing to broader economic resilience.
7. Continuous Monitoring and Evaluation
Regular assessments of the IBC’s implementation can help identify emerging challenges and ensure that the code remains adaptable to the dynamic financial environment. Establishing a robust monitoring and evaluation framework will enable continuous improvement of the IBC. This ongoing review process should involve collecting feedback from stakeholders, analyzing data on insolvency cases, and making necessary adjustments to policies and procedures. By keeping the IBC under regular scrutiny, its positive impact on financial stability can be sustained and enhanced over time. Adopting these recommendations would enhance the IBC’s effectiveness, support economic growth, and solidify its role in promoting financial resilience in India.
By addressing the existing challenges and implementing these strategic directions, the IBC can continue to serve as a robust framework for insolvency resolution and contribute to the overall health and stability of the financial sector. Conclusion The Insolvency and Bankruptcy Code (IBC) has significantly reformed India’s financial landscape by providing a systematic, time-bound framework for resolving insolvencies. By consolidating various insolvency laws, the IBC has streamlined the debt recovery process, reduced non-performing assets (NPAs), and strengthened creditor rights, resulting in a more stable financial environment. High-profile cases like Essar Steel and Bhushan Steel highlight the IBC’s capacity to handle complex insolvency issues, offering substantial recoveries for creditors and preserving economic value, thus reinforcing confidence among investors and stakeholders.
The IBC’s influence extends to improved investor confidence, both domestically and internationally, by establishing a transparent, predictable framework. This clarity has attracted foreign investments, strengthened India’s global financial standing, and enhanced its Ease of Doing Business ranking. The IBC’s robust framework has also contributed to a healthier banking sector, with significant declines in NPAs and improved asset management, ensuring a resilient financial system. However, challenges persist. Delays in resolution due to judicial backlog, high associated costs, and operational inefficiencies, such as a shortage of insolvency professionals, impact the IBC’s full potential. Additionally, procedural complexities sometimes result in prolonged cases, diminishing asset value and hindering smaller entities from fully benefiting from the code.
In conclusion, the IBC has laid a solid foundation for financial stability in India, effectively transforming insolvency resolution. While its impact on reducing NPAs, enhancing transparency, and boosting investor trust is evident, addressing current operational challenges through continuous reforms and institutional capacity building will be crucial. With ongoing improvements, the IBC will continue to play a pivotal role in fostering a resilient, growthoriented financial system in India.