With the enactment of the Insolvency and Bankruptcy Code, 2016[i] (‘The Code’), the creditors are now at ease for realizing their dues. The notion of ‘creditor in control’ instead of ‘debtor in possession’ is truly observed by the code. Moreover, the Code seems to be achieving its objective of maximizing the value of debtor’s assets and restructuring the sinking corporate debtor. The same can be concluded by comparing the recovery rates for the year 2017-2018 under IBC and the erstwhile regime of recovery. According to a report on the trends and progress of banking in India 2017-18, released by the Reserve Bank of India[ii], the recovery rate for the year 2017-2018 was 12.4% under the erstwhile act. Whilst it has improved to 41.3% under the IBC.
The efficacy of any insolvency law is examined on the touchstone of the liquidation process and the mechanism for the distribution of assets laid down under it. The concept of distribution waterfall existed both in the Companies Act, 1956 (“The Act”)[iii] and 2013[iv] and therefore, is not a unique concept introduced by the Code. Upon analysing and comparing the mechanism laid down under the provisions of the Companies Act and The Code, the prevailing flaws in the Code becomes more apparent. The provisions of the Companies Act of 1956 has been relied upon for the purpose of drawing the comparisons as the provision of the 2013 Act pertaining to liquidation were not in force at the time of enactment of the code.
Dilemma for Financial Creditors
For the purpose of liquidation, the Code has bifurcated creditors into three categories, that is, ‘Secured Financial Creditors’, ‘Unsecured Financial Creditors’ and ‘Operational Creditors’. The ‘Secured Financial Creditors’ is further classified as secured creditors who have relinquished their security and secured creditors who have realised their security. Wherein the utmost priority is given to the Secured Financial Creditors.
Interestingly, as per proviso to section 529 of the Companies Act, 1956, secured creditors and workmen’s due were to be kept at the same pedestal, irrespective of whether the secured creditor relinquished his right to recover security or not. It is to be noted that the above mentioned stand of the former Act is inconsistent with the waterfall mechanism provided under the Code. The code provides for a two way path for the administration of the securities. A creditor can either go for liquidation proceeds under section 53 of the Code which makes them pari passu with the claims of workmen’s dues or alternatively, they can realize their security interest on their own by virtue of Section 52 of the Code. There arises a contention between the Act and the Code when the secured creditor opts out of the liquidation proceedings to realize the security interest on its own. If the secured creditor in the liquidation proceedings chooses to realize his security interest without relinquishing his security interest, to the liquidation estate, then any unrealized amount is prioritized below the unsecured creditors. The same is contrary to the erstwhile Act, where they were given uniform priority in the waterfall mechanism. Secured credit for productive purposes drive the economy and create wealth, generates employment and encourages entrepreneurship. It is pertinent to mention that, if other claims are prioritised over the claims of Secured Financial Creditors, it would defeat the purpose of the code. As of now, it is evident that the Secured Creditors are expected to make an arduous choice, which is, whether to relinquish their security and reap the benefits of higher priority or to realize their security and opt to be prioritised below the Unsecured Financial Creditors. This leaves the Financial Creditors discouraged from investing in any business when they are exposed to large haircuts.
Interpretation of ‘Workmen’s Dues’
Workers are the nerve centre of any company and still in the event of insolvency, they suffer adversely. The Act and the Code gives priority to the Workmen’s dues. However, the code nowhere defines the term ‘workmen’s dues’ and instead, the explanation to section 53 of the Code refers and places reliance on section 326 of the Companies Act, 2013 (pari materia to Section 529A of the erstwhile Act) for the definition of ‘workmen’s dues’. Interestingly, the application of section 326 is excluded by the Section 327(7) of the Act in the event of liquidation under the Code. This creates an aperture in so far the interpretation of the word ‘workmen dues’ is concerned. Due to the vacuum so created, the definition has now become open to interpretation, which is usually expounded in a manner detriment to the interest of workmen.
Interests of Operational Creditors
Operational Creditor is defined as any person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred. The liquidation process commences with the presupposition that for some stakeholders, it shall be a dry experience. From their viewpoint, the entire exercise of liquidation is doomed from inception. Neither the Code, nor the Act gives due regard to the interests of the Operational Creditors. The same is evident from the fact that the operational creditors are placed sixth in the hierarchy for the liquidation process in the Code, under the head ‘any remaining debt or dues’.
The implication of the hierarchy explained above is that, the operational creditors are left high and dry since majority of the times, the amount raised by the liquidation process is inadequate to satisfy even the claims financial creditors. This hierarchy is unjust to the operational creditors, especially in Indian context wherein the Operational Creditors are usually small and medium scale enterprises. The consequences of disregarding the interest of the Operational Creditors would be that no creditor will be willing to supply goods and services on credit to any corporate debtor. They will demand upfront payment for supplying goods and services which will have a significant impact on the Indian economy. Therefore, it is imperative to strike a balance between Operational and Financial creditors.
Conclusion:
The
waterfall mechanism provided under the Code and the Act has been enacted after much
deliberations. However, the mechanism still suffers from certain shortcomings
and limitations. The provided waterfall mechanism appears to be inconsistent
with the umbrella objective of the code i.e., balancing the interests of the
stakeholders. The intention of the legislature, to enact a self-reliant code
creating a sustainable and efficacious regime of recovery, seems to be
defeating in the presence of the above analysed inconsistencies and loopholes. Therefore,
a way should be carved out to rectify these anomalies without complicating the
mechanism as provided under the code.
[i] Insolvency and Bankruptcy Code, 2016
[ii] REPORT ON TREND AND PROGRESS OF BANKING IN INDIA 2017-18, Reserve Bank of India.
[iii] Companies Act, 1956 – Access here
[iv] Companies Act, 2013 – Access here
This article is written by Dhiraj Yadav & Barkha Dwivedi of RMLNLU, Lucknow.
Disclaimer: This article is an original submission of the Author. Lex Insight does not hold any liability arising out of this article. Kindly refer to our Terms of use or write to us in case of any concerns.
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