Need for an Insolvency Code tweak for the common man in Budget 2022

On the eve of the budget, the big announcement of last year’s budget of establishing a National Asset Reconstruction Company (NARCL) is yet to be implemented due to procedural logjam. The ask in this budget is to introduce amendments to Insolvency and Bankruptcy Code (IBC Code) that are amenable to implementation and help the common man. Thus, changes vis-à-vis Micro, Small and Medium Enterprises (MSMEs), financial service providers, disclosure to exchanges and tribunals will make the functioning of the Code more meaningful for the common man.

United Nations Legislative Guide on Insolvency Law states that insolvency law must be complementary to, and compatible with, the legal and social values of the society which it sustains. Thus, in the post-Covid world, treatment of MSMEs need to be reassessed. According to recent Reserve Bank of India’s (RBI) Financial Stability Report, MSMEs are showing signs of stress. This, despite a number of schemes targeted towards MSMEs in the past year and a half by RBI and the Union Government. Acknowledging the stress, the Union Budget last year had introduced pre-pack for MSMEs. However, the response has been lacklustre. This clearly calls for alternate steps to obviate MSME stress.

The first step would be to reverse the notification of March 2020 that raised the default amount to INR 1 crore for filing of an insolvency application. The limit was hiked ostensibly to help the MSMEs; however, the higher limit prevented MSMEs to file for insolvency against large corporates despite overdues. Another step would be granting some form of priority to MSMEs. The successful resolution applicant should assign to non-related party MSMEs, a pay-out percentage equivalent to that of the secured financial creditors. Though the Code is not a recovery mechanism, of the 421 cases that have been resolved under the Code by 30th September 2021, the recovery for financial creditors has been 34% whereas the recovery for operational creditors which include MSMEs has been 12%.

While delivering its verdict on Swiss Ribbons, the Supreme Court had data of 80 resolved cases. The dataset at that point in time had indicated that the recovery to operational creditors was similar to that of financial creditors. The court opined that the National Company Law Appellate Tribunal (NCLAT), while evaluating resolution plans, has always verified whether operational creditors are given roughly the same treatment as financial creditors, and if they are not, such plans are either rejected or modified so that the operational creditors’ rights are safeguarded.

The fact that recovery percentages have diverged from the time the Swiss Ribbons judgment was delivered calls for legislative intervention or a re-visit by the judiciary. Moreover, the monetary impact on financial creditors of such a move will not be significant as operational creditor claims are less than 10% of the total claims; the percentage for MSMEs would be lower.

The only case wherein NCLAT had stepped in seems to be that of Videocon, wherein operational creditors were being paid 0.72% of their claims. The NCLAT requested Committee of Creditors (COC) and successful resolution applicant to reconsider distribution, fearing a spate of insolvencies amongst operational creditors including MSMEs. Similarly, in Dewan Housing Finance Corporation Limited (DHFL), National Company Law Tribunal (NCLT) had requested COC to reconsider the distribution method which was skewed against small investors. However, the COC did not adhere to NCLT’s request.

The DHFL case brings out another lacuna that needs to be addressed in the budget i.e., the resolution of FSPs. The current modus operandi for resolving NBFCs is reminiscent of the tail wagging the dog; delegated legislation providing the basis that is not self-evident in the main legislation. Moreover, value maximisation of secured financial creditors may not be the ideal preamble for FSPs wherein numerous non-sophisticated retail investors are involved.

Also, timely and appropriate disclosures to stock exchanges may help the cause of retail investors. Currently, exchanges are notified when a company is admitted for an insolvency resolution process (CIRP). There is a time lag, sometimes substantial, between filing and admission of an insolvency application. Thus, disclosure should be made by companies when an application is filed, and exchanges should device a nomenclature to tag/un-tag such securities. This will act as an early warning signal not only to retail investors but also to operational creditors. In cases where the application is filed by the financial creditor, the burden of financing, in the interim period till admission, is shouldered by the operational creditor, who is oblivious to the developments in the background.

Finally, to obviate delay of admission, some semblance needs to be established at NCLT/NCLAT in terms of the backlog, disposal of cases and the appointment of judges per se. A specialized bankruptcy tribunal conducting virtual hearings with professional case management and emphasis on written submissions should be instituted with proper planning. This will expedite conclusion of cases and will help all players in the ecosystem including the MSMEs.

The author is an Insolvency Professional and Restructuring Consultant.