International law and investment: major reform of Indian insolvency law improving environment for foreign investment

By Dr. Benjamin Parameswaran and Johann-Friedrich Fleisch

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India is a colorful place, offering both brighter hues and darker shades. This is also true for India as an investment destination: The subcontinent is an attractive market with promising growth rates, but it doesn’t always make things easy for foreign investors. Indian insolvency law in particular has had a poor reputation among investors: The proceedings take ages, the legal situation is highly complex and the competencies are often unclear. To make matters worse, Indian creditors may be afforded better protection than foreign investors in certain circumstances. On a macroeconomic level, the current inefficiency in insolvency proceedings appears to grow more dangerous within the context of increasing numbers of nonperforming loans.

Yet there are signs of hope. The government under Prime Minister Narendra Modi has recognized that cumbersome insolvency proceedings pose an obstacle to efforts to attract greater investment and has addressed the problem swiftly. With surprising speed, the Indian parliament has passed legislation to reform insolvency law, thus ushering in a new era. The Insolvency and Bankruptcy Code, 2016, introduces uniform insolvency legislation to replace numerous scattered and inconsistent provisions, many of which go back to colonial times. The new law establishes a clear institutional framework, provides for shorter proceedings and levels the playing field for foreign creditors.

Clear competencies

Whereas the competencies of the various courts and three different government authorities frequently overlapped under the old system, the new code defines clear responsibilities: The National Company Law Tribunal, established only a few months ago, is responsible for corporate insolvencies, whereas the Debt Recovery Tribunal handles the insolvencies of partnerships and private individuals. In the interest of uniform administration of the new insolvency law, the Insolvency and Bankruptcy Board of India was established to issue guidelines on the application of the new law and to define the necessary qualifications of insolvency professionals. This aspect in particular needs a great deal of attention as the occupation of insolvency professional, a line of work requiring decision-making capabilities and business skills, previously did not exist.

Quicker proceedings

Another key aspect of the reform includes a reduction in the duration of insolvency proceedings. The old law – particularly in the form of the Sick Industrial Companies Act – provided for protective mechanisms to shield distressed companies from recourse by creditors and the courts. This was originally intended to be a temporary instrument to allow companies to be salvaged, but it was regularly misused by debtors as a means of warding off creditor claims over many years. By the time the debtor’s assets were available for distribution, there was hardly anything left. The new legislation seeks to change that. Corporations are still able to make use of a “Corporate Insolvency Resolution Process” that shields them from suits and the enforcement of claims, but this process is limited to 180 days (and may be extended by a maximum of another 90 days). The resolution process marks the beginning of the insolvency proceedings for all corporations. During the resolution process, the company is placed under the control of an insolvency professional while creditors and the courts have no access to the debtor’s assets. This gives the insolvency professional time to draw up a resolution plan not unlike the “insolvency plan” provided for under German insolvency law. Under Indian law, the resolution plan must define clear steps for restructuring the company’s liabilities and determine whether it is to be restructured or liquidated. The resolution plan must also meet certain conditions if it is to be accepted by the National Company Law Tribunal. In particular, it must give preference to satisfying the claims of suppliers and service providers. A resolution plan that meets all legal requirements takes effect upon approval by three-quarters of the relevant financial creditors, at which point it is binding for all stakeholders in the resolution plan. If no resolution plan is adopted, the company concerned is automatically liquidated.

Improved creditors’ rights

The substantially greater role played by creditors under the new law is reflected in their power to decide on the resolution plan. It is now the creditors who decide whether a company is to be liquidated or not. Under the old law, this decision was made by a court and the outcome was frequently uncertain. Moreover, the new legislation strengthens the position of private-sector creditors over that of public-sector creditors: In the event of ­liquidation, claims held by different groups of creditors are ranked using an approach known as a “waterfall system.” Under this new system, claims held by secured private creditors who have relinquished their security should a liquidation occur now have priority over government dues. In an effort to address social concerns, employees enjoy a particularly high ranking in the waterfall system. Foreign creditors will be pleased to learn that the new legislation expressly includes them as creditors as defined under the new law. Under the old law, foreign creditors could be subject to discrimination under the protective shield process. The new law abolishes this unpleasant situation.

Reform weaknesses

One weakness of the new legislation is that it effectively does not include any provisions on cross-border insolvencies. The intent of the Indian legislator is to have these matters addressed in bilateral agreements with other countries. This, however, entails a very unwieldy process with a completely uncertain outcome.

Another issue requiring further attention concerns “information utilities” – that is, bodies that collect financial information on companies and make it available to creditors. Under the new legislation, these information utilities seek to redress creditors’ information deficits over debtors. The new code does not, however, spell out in any detail the precise nature of these utilities and the role they will play. The same applies to the insolvency professionals who are to execute the resolution, restructuring or liquidation proceedings as administrators. Consequently, decisive parts of the infrastructure foreseen by the new legislation are not yet in place. The new law cannot be fully applied until these unanswered questions have been settled. The Insolvency and Bankruptcy Board of India, which was created only in October 2016, has, however, already issued drafts for regulations that provide answers to a number of open questions. Final versions of the new regulations are intended to be in place by the beginning of December 2016. This means the required infrastructure is quickly taking shape.

In the past, Indian lawyers often joked that their home country had the world’s best laws but the world’s worst implementation. Observers now presume the Insolvency and Bankruptcy Code will not share this fate. During preparation and passage of the act and the establishment of the Insolvency and Bankruptcy Board of India, the Indian government and parliament moved at a speed demonstrating their commitment to improving investment conditions in the country. Some of the more leisurely oriented Indian insolvency practitioners considered the pace “terrifying,” but it has been very welcome news for those looking for a level playing field – for Indian and foreign investors alike.

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