MANAGING NON PERFORMING ASSETS

PART 2

THIS DOCUMENT IS NOT FOR CIRCULATION

INTRODUCTION
In 2023, Go Air filed for bankruptcy.
Companies like Go Air which are unable to repay their obligations to their creditors can seek
protection from the Court by filing an insolvency petition. If the Court agrees/admits the
petition, it will grant a moratorium of 180 days; during this 180 day period all actions against
the company come to a standstill.
Aggrieved creditors(lenders/suppliers) too can file an insolvency petition against defaulting
companies.

This document explains the process for Corporate Insolvency Resolution Process
under the Insolvency and Bankruptcy Code, along with an interesting case study.

THE INSOLVENCY AND BANKRUPTCY CODE(IBC)

Prior to the IBC there were multiple laws governing defaults/bankruptcies.

The IBC is an act to consolidate and amend the laws relating to reorganisation
insolvency resolution of corporates, partnership firms and individuals in a time
bound manner for maximisation of value of assets of such entities.

The regulator, Insolvency and Bankruptcy Board of India(IBBI, established under

IBC) is a key pillar of the ecosystem responsible for implementation of IBC.

IBBI writes regulations to govern:

• Corporate Insolvency Resolution Process

• Corporate Liquidation

• Individual Insolvency
• Individual Bankruptcy

IBBI enforces the IBC, and rules and regulations made thereunder.

Why IBC

Business plans entail informed risk taking to compete and succeed. Businesses may fail
because they are displaced by new businesses or they fail to carve out a competitive space
for themselves.
Either way, failure of some businesses is integral to a market economy. There can be two
outcomes as a consequence of failure:
✓ RESOLUTION: When a business fails, it needs to be resolved at the earliest and
expeditiously. Any undue delay in commencement or conclusion of resolution may
lead to exodus of key stakeholders and aggravate the failure, sometimes beyond
repair. In resolution, the business survives, typically under a new owner.
✓ LIQUIDATION: If the resolution is not possible, an orderly exit mechanism should
allow stakeholders to recover their dues from liquidation proceeds of the
business and free up resources for reallocation. The company is typically shut
down.

The CORPORATE INSOLVENCY RESOLUTION PROCESS(CIRP)

Corporate insolvency is a state where a corporate entity fails to its pay debt, whether whole
or any part or instalment, when the debt is due and payable.
The resolution process of such a default is described in detail below, in a chronological order.

1)DEFAULT
On a minimum default of Rs 1 crore by a corporate debtor, a stakeholder
– either a financial creditor, an operational creditor or a corporate debtor
may initiate CIRP in respect of such corporate debtor by filing an application with the
Adjudicating Authority, the National Company Law Tribunal(NCLT).

2)KEY TERMS AND TIME LIMITS

✓ Corporate debtor is a corporate entity which owes a debt to a creditor(financial

creditor or operational creditor). Corporate debtor is the defaulting company in this
context.
✓ Financial Creditor: an entity to whom a financial debt is owed by a corporate debtor.
Example of financial creditor: banks which have lent money to the corporate debtor.
✓ Operational Creditor: An entity to whom an operational debt is owed.
o Operational Debt is the claim arising in relation to supply of goods and
services.
Timelines: CIRP shall be completed
✓ within a period of 180 days from the date of admission of the application to initiate
such process
✓ This is extensible by 90 days.
✓ The maximum time within which CIRP has to be mandatorily completed, including any
extension or litigation period, is 330 days, as envisaged under the IBC.
The 330 day timeline is often breached, as explained in the steel company case, further
below.
3)Admission of the application by NCLT
NCLT admits the application within a period of fourteen days of its receipt, if
the application is in order.

4) On admission, NCLT passes an order declaring a moratorium which

continues till completion of CIRP.
✓ The moratorium protects the corporate debtor from new and pending
law suits, and enforcement of security by creditors.
o In the Go Air insolvency petition in 2023, moratorium declaration
has led to contentious legal issues, on the fate of aircraft taken
on lease by Go Air. Typically, airline companies do not buy the
aircraft outright, but lease them from leasing companies(lessors)
to whom they pay lease rent.
o Issue: since the leasing company(lessor) is the owner of the
aircraft, would the moratorium be applicable to them? Would
the lessor have the right to seize the aircraft from a
company/lessee undergoing insolvency, if the lessee defaults on
lease rent payment? The court(NCLT) has not permitted the
foreign lessors(owners) to seize the aircraft. This raises the larger
issue of property rights and the sanctity of contracts in India.

✓ Moratorium also prohibits the corporate debtor(defaulter) from

transferring, encumbering, or disposing of any of its assets.
✓ During the moratorium period, the essential goods and services such as
electricity, water, telecommunication, and information technology
services, cannot be terminated or suspended.

Additional reading:
https://www.livemint.com/companies/news/nclt-admits-go-air-insolvency-plea-moratorium-
kicks-in-11683699511694.html

5)Appointment of Resolution Professional(RP)

✓ On admission of the insolvency application by NCLT, the power of the
Board of Directors is suspended and vested with the RP. Effectively,
the RP is CEO and Managing Director of the corporate
debtor(defaulter) undergoing the insolvency resolution process.
✓ The RP has to manage the operations of the company as a going
concern
✓ The RP conducts the entire resolution process.
The RP is the epi center of the entire corporate insolvency resolution process.

Go Air RP’s first message to employees:

https://www.business-standard.com/companies/news/we-have-to-get-business-back-
running-go-first-s-rp-tells-airline-staff-123051100982_1.html

The RP role is usually taken up by law firms, consulting firms, audit firms etc.:
https://www.livemint.com/news/go-first-insolvency-lenders-consider-big-
four-auditors-for-resolution-professional-job-report-11684894321446.html

Dr MS Sahoo, erstwhile Chairman of the regulator IBBI, provides a well-

articulated view of the role of the RP(also referred to as Insolvency
Professional):
FromChairmansDesk12062018.pdf (ibbi.gov.in)

The RP has to meet the expectations of multiple stakeholders including

employees, customers and suppliers. Here is a good reading on the stress that
the RP can be subjected to, during the insolvency process:

https://economictimes.indiatimes.com/industry/banking/finance/banking/k
idnappers-angry-workers-plague-a-210-billion-debt-
cleanup/articleshow/65157244.cms

The RP often faces skepticism from senior management and hostility from the
promoters(who have been forced to hand over charge of the company to the
RP).

6) Within three days of appointment, the RP makes a public announcement,

inviting all the potential creditors to file claims against the debtor for their
dues. RP will then verify and admit the claims.

7) The RP appoints two valuers to determine the fair value and liquidation
value of the corporate debtor.
✓ Fair value is the estimated realizable value of the assets of the corporate debtor, if
they were to be exchanged on the insolvency commencement date between a willing
buyer and a willing seller in an arm’s length transaction.
✓ Liquidation value is the estimated realizable value of the assets of the corporate
debtor, if the corporate debtor were to be liquidated on the insolvency
commencement date.
8) INTERIM FINANCING
RP needs financing to the run the company on a going concern basis, during
the moratorium period. RP would try to raise interim financing for meeting
various expenses including :
✓ salaries to employees
✓ payment to suppliers of raw material and service providers
✓ maintenance costs of the factory etc.,
✓ fees payable to the RP.

Banks may finance Go First's request for Rs 400 crore interim funding (business-standard.com)

9)Constitution of the Committee of Creditors(CoC)

The RP constitutes the CoC on the basis of claims received against the
corporate debtor. The CoC comprises of all financial creditors of the
corporate. However, a related party to whom the financial creditor owes a
financial debt does not have any right of representation, participation or
voting in CoC.
All important decisions are taken by the CoC. Effectively, the RP reports to
the CoC.

10)The RP prepares an information memorandum (IM) and submits it to

each member of the committee within two weeks of appointment.
Information memorandum contains relevant information of the corporate debtor(defaulter),
required by resolution applicants to formulate a resolution plan.
✓ financial position of the corporate debtor
✓ description of assets and liabilities
✓ information related to disputes by or against the corporate
✓ list of creditors along with their claims
✓ list of shareholders with 1% stake or above
✓ details of all material litigation and ongoing investigation or
proceedings initiated by Government and statutory authorities
✓ the number of workers and employees and liabilities of the corporate
debtor towards them
✓ other relevant information.

11)The RP invites Resolution plans from prospective resolution applicants.

The Information Memorandum is submitted to the resolution applicants.
✓ A resolution applicant prepares the Resolution Plan on the basis of the information
memorandum given by the resolution professional.
Promoters with NPA’s are ineligible to submit a resolution plan.
The resolution plan may include
• restructuring of the corporate debtor, by way of merger
• reduction in amount payable to creditors
• change in interest rate
• extension of maturity date or
• any other change in terms.

12)RP presents the resolution plans to the Committee of Creditors(CoC).

✓ The resolution plan, which receives the highest votes from the CoC, is considered as
approved.
▪ If 66% of creditors approve, the resolution plan is
submitted to NCLT for final approval.

12)The CoC shall, while approving the resolution plan, specify the amounts
payable from the resources under the resolution plan towards insolvency
resolution process cost, to operational creditors, and dissenting financial
creditors. This payment is to be made before any recoveries are made by the
financial creditors who voted in favour of the resolution plan. Creditors in CoC
who abstained from voting and the creditors who voted against the approved
resolution plan are considered as dissenting creditors for this purpose.

The insolvency resolution process cost includes the following:

✓ Amount of interim finance and the cost incurred in raising such finance;
✓ Fees payable to RP and expenses incurred by RP;
✓ Any cost incurred by the RP in running the business of the corporate
debtor as a going concern;
✓ Amounts due to suppliers of essential goods and services;

13)The RP submits the resolution plan, as approved by the CoC, to NCLT for
its approval.

14)If the NCLT is satisfied that the resolution plan meets the requirements
specified in the IBC and the regulations, it approves the resolution plan.

15)On approval of resolution plan by NCLT, CIRP ends and the moratorium
ceases to have effect.
ALTERNATIVE SCENARIO: LIQUIDATION

If no CoC approved resolution plan is submitted to NCLT within the maximum

period(180 days) or extended period permitted for the completion of the
CIRP(an additional 90 days), or the submitted resolution plan is rejected by
NCLT, the liquidation process is triggered for the corporate debtor.

Order of priority for distribution of assets during liquidation

• Insolvency/liquidation related costs
• Secured creditors and workmen dues up to 24 months
• Other employees’ salaries/dues up to 12 months
• Financial debts owed to unsecured creditors
• Government dues* (up to 2 years) and debts owed to secured creditors
for amount unpaid following enforcement of security interest
• Any remaining debts and dues
• Preference shareholders
• Equity shareholders
*Optional reading: https://www.livemint.com/news/india/sc-rules-in-favour-of-government-dues-in-
ibc-resolution-plans-11662529184406.html

APPEAL AGAINST NCLT ORDER

A person aggrieved by an order of the NCLT, be it admission or rejection of
application for initiation of CIRP or the approval or rejection of the resolution
plan, may prefer an appeal to the appellate authority NCLAT: National
Company Law Appellate Tribunal.
✓ A person aggrieved by the order of NCLAT may further prefer an appeal
to the Supreme Court.

THE CASE OF A STEEL COMPANY

While the IBC envisages a total time frame of 330 days for completion of the
Corporate Resolution Process, many high profile cases have dragged on for
years.

The case of a steel company illustrates all that went wrong with the 330 day timeframe for
completing the CIRP.
To start with, at the instruction of RBI, the lender(creditor) filed an insolvency petition against
the defaulting steel company with NCLT.

The first challenge came in the form of the promoters of the defaulting steel company,
wishing to bid for the asset as a Resolution Applicant. This posed a “moral dilemma”.
• Should a promoter who has failed to run the company successfully (resulting in
default and insolvency proceedings), be given another opportunity to turn around the
company.
The bigger issue is that the promoter, responsible for the insolvency, now gets to walk away
with the company, at a cheap price, depending on the extent of the haircut/discount faced
by the creditors/banks.

To address this glaring lacuna, IBC was amended to exclude defaulting promoters (with
NPA’s) from bidding for stressed assets.

To overcome this constraint, the promoter’s bid was submitted through an apparently
unconnected party, though it did not withstand scrutiny. The bid was found to be ineligible.

Apart from the promoter another bid was received from a giant European steel company.

The related party of this European company was a defaulter at yet another Indian company
and hence this bid was determined to be ineligible.
• The related party then paid up the overdues.
• The European company now became eligible to bid(i.e., submit a Resolution Plan).
• The Committee of Creditors accepted its bid, involving a “reasonable” haircut, with
the prospect of realizing an amount higher than what banks were hoping to get as
part of the Insolvency process.

The matter did not end there. The original promoter submitted yet another proposal, which
involved a full pay out for creditors and withdrawal of insolvency proceedings. Banks were
astounded. If the promoter did indeed have the resources to pay off creditors, why wait all
this while, dragging the company through insolvency, almost losing it to a competing tycoon,
and then present a last minute bid to save its “crown jewel”. Where was its financial
wherewithal to follow through on its bid, were some of the questions that arose. This last-
minute bid of the promoter, ultimately did not see the light of the day, after further litigation.

But then it was too early to rejoice for the banks which were hoping to reverse the provisions
made for the non-performing assets. The winning resolution plan cut a much larger share of
the pie for financial creditors and a smaller share for “operational creditors”. The latter cried
foul, and went to the Appellate Tribunal (NCLAT). In an apparent act of judicial overreach,
the Tribunal ordered an equal share for both types of creditors, completely ignoring the
decision of the Committee of Creditors. It did sound fair though, should not everyone get the
same payout? But traditionally financial creditors (suppliers of finance) are secured, while
operational creditors (suppliers of goods and services) are not. Having agreed to supply on
an unsecured basis during a state of the company’s solvency, can operational creditors seek
an equal standing with secured financial creditors, when the company is taken to the
insolvency court?

The government stepped in to address this anomaly, by amending the IBC to give primacy to
the Committee of Creditor’s decision, which comprises of Financial Creditors. Of course, the
operational creditors did not take this well, and challenged this again at the Supreme Court.

The apex court held that operational creditors and dissenting financial creditors are entitled
only to their notional liquidation value and not more. It stressed that the final discretion of
what to pay and how much to pay to each category or sub-category of creditors is vested
with the CoC.

Finally, after a more than two years, and multiple litigation and bidding wars, the steel
company was taken over by the winning Resolution Applicant, the European steel giant. The
erstwhile promoters of the steel company, lost the “crown jewel” of their group.

Note: although the title of the document is NPA Part 2, the IBC applies to any
default, not only to NPA(default of 90 days).

This document provides a perspective on the Corporate Insolvency Resolution Process in a simple to understand manner. It
does not purport to cover all applicable laws and regulations in detail.

THIS DOCUMENT IS NOT FOR CIRCULATION