1 June 2016

Sector: Financials

Expert Speak

The Insolvency and Bankruptcy Code - Finally, a game-changer

Systemic, ambitious and comprehensive financial sector reform

With 12%+ of system loans classified either as non-performing (NPLs) or restructured

(RLs), the Indian banking sector is facing a severe crisis as it reels under the burden of a

burgeoning asset quality problem. Although a lion’s share of the current stress is driven

by corporate delinquencies (a problem that banks revisit every few years), there is no

single law that comprehensively addresses corporate insolvency. Instead, the existing

debt recovery laws are not only fragmented (too many) and woefully inadequate (in

terms of coverage) but also conflicting (in applicability) and overlapping (in jurisdiction).

We hosted a call with Richa Roy, Senior Associate at AZB & Partners, a leading Indian

law firm. Amongst the many hats that she has worn, Richa was most recently on the

drafting panel for the Insolvency and Bankruptcy Code (IBC 2016), which was recently

passed by both Houses of the Parliament. Following are our key takeaways from the

expert call:

Ms Richa Roy

Sr. Associate –

AZB & Partners

Richa Roy is a Senior

Associate at AZB & Partners,

Mumbai. Her key practice

areas are banking and

finance, private equity and

venture capital funds, foreign

direct investment law, anti-

corruption and anti-bribery.

She has been involved in

several public policy and

regulatory reform initiatives.

Most recently, she was on

the drafting team for the

Insolvency and Bankruptcy

Code (IBC). She has advised

the RBI on regulations for

differentiated licenses;

consumer protection and

conduct of business

regulation, and revitalizing

stressed assets. She has been

a consultant and trusted

advisor to various ministries,

regulators and multilateral

institutions.

Unified code replaces archaic, piecemeal laws:

In the context of the ballooning

“stressed assets” problem for the Indian banking sector, the Insolvency and Bankruptcy

Code (IBC) seeks to replace the existing judicial quagmire with a single unified law. The

IBC repeals multiple archaic laws (such as the Presidency Towns Insolvency Act, 1909)

and amends a host of other relatively recent ones (such as The Companies Act, 2013).

Exhibits 1 and 2 capture challenges with the existing plethora of laws and regulations.

current stress in the Indian banking system is driven by corporate delinquencies, IBC

also addresses insolvency and bankruptcy of individuals, sole proprietorships and

partnership firms. The individual / partnership firm insolvency framework has especially

critical implications for India’s sizeable MSME sector (which accounts for nearly 40% of

India’s $2tn GDP and employs over 80m people) and its large funding requirement.

Applicable to companies, individuals and partnerships:

While a lion’s share of the

Comprehensive law for all lenders:

The multitude of existing debt recovery laws has

resulted in lack of clarity and predictability about jurisdiction (overriding), thereby offering arbitrage opportunities.

The IBC, on the other hand, subsumes multiple provisions under a single law and bestows voting rights on all types

of lenders (domestic, overseas, secured and unsecured). The comprehensive lender coverage is especially

significant in the context of (a) rising proportion of ECB funding in the Indian economy; and (b) propping up a

sluggish bond market (unsecured). Exhibit 3 captures provisions (including comprehensive coverage) under the IBC.

infrastructure comprising of (a) specialized insolvency professionals; (b) information utilities; (c) an adjudication

authority; and (d) a regulator. Given the elaborate consultative process followed in drafting the Code, the

government and the market appear to be geared for creation of such proposed infrastructure. For instance,

pockets of expertise (insolvency and liquidation professionals) exist within the ecosystem and will only need to be

upgraded in order to comply with the IBC. Similarly, until a regulator is created, the IBC allows the Central

Government to perform the functions of a regulator. Exhibit 4 carries the proposed institutional infrastructure.

Krishnan ASV

(A.Krishnan@MotilalOswal.com); +91 22 3010 2603

Alpesh Mehta

(Alpesh.Mehta@MotilalOswal.com); +91 22 3982 5415 / Dhaval Gada (dhaval.gada@motilaloswal.com)

Investors are advised to refer through disclosures made at the end of the Research Report.

Motilal Oswal research is available on

www.motilaloswal.com/Institutional-Equities,

Bloomberg, Thomson Reuters, Factset and S&P Capital.

Government and market geared for creation of proposed infrastructure:

The IBC envisages an overarching

Expert Speak

process, which needs to be completed within 180 days. From the time that the insolvency is triggered, a cadre of

insolvency professionals will take over the company and run it as a going concern while reporting to a Committee

of Creditors. In order to minimize frivolous litigation that is often used as a smokescreen by conflicting parties, the

IBC has also narrowed the grounds for appealing the decision of the adjudicating authority. We encapsulate key

highlights of the IRP in Exhibit 5.

the unified law is unlikely to alleviate the banking system’s stress from the current stock of non-performing loans.

Time-bound insolvency resolution process (IRP):

The Code specifies a time-bound insolvency resolution

Code helps address incremental stress:

The IBC is only applicable to prospective cases of default, implying that

Positive implications for insolvency resolution metrics:

India currently fares poorly in the World Bank’s Doing

Business Report (2016), ranked 136 out of 184 countries, in terms of insolvency resolution. The IBC is likely to help

India improve its performance on insolvency resolution metrics including “time to resolution” (from current levels

of 4.3 years) and “recovery rates” (from current levels of 25 cents to a dollar). Exhibit 6 compares India’s

performance on insolvency resolution metrics with the rest of the world (including South Asia).

Super priority for interim finance that is raised during IRP:

In case of liquidation of a company, the Code

prescribes a distribution waterfall, wherein super priority is accorded to the cost of resolution process including

any interim finance that insolvency professionals raise in order to run the company as a going concern. The first-

time concept of super priority assumes immense significance in the context of scarce funding sources that are

usually available once a company is identified for insolvency resolution.

reflects in India’s credit markets, which are dominated by banks and have little or no other alternative sources of

funding. With the IBC and its comprehensive lender coverage (including rights for unsecured creditors) coming into

effect, the hitherto-sluggish bond market in India could get a huge fillip over the medium-term. Exhibit 7 compares

and contrasts the lack of depth in India’s non-bank credit markets compared to developed economies such as

Singapore and the UK.

Implications for the bond market:

The absence of a functional and effective corporate insolvency framework

1 June 2016

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Expert Speak

Story in charts

Exhibit 1: Existing legal and regulatory quagmire - multiplicity of laws throws up arbitrage opportunities

Sick

Industrial

Companies

Act (SICA)

Joint

Lenders'

Forum (JLF)

SARFAESI

Applied only to

industrial

companies

Applied only to

banks and very

few FIs

Applied only to

banks

Triggered after

50% of net worth

is eroded

Reducing

relevance in a

service-oriented

economy

Triggered once an

asset becomes

NPA

Ignores the

interests of

unsecured

creditors

Triggered earlier

than default

event (SMA

0/1/2)

Source: MOSL

Exhibit 2: Backlog of DRT (Debt Recovery Tribunal) cases - value of pending cases at ~20x last 5-yr processing run rate

# of cases disposed off

# of cases pending

Amount disposed (INR b)

3,750

Amount pending (INR b)

4,515

1,462

54,061

2011

1,308

41,205

2012

1,789

47,933

2013

59,645

2014

69,658

2015

Source: Ministry of Finance, Debt Recovery Tribunals, MOSL

Exhibit 3: Key provisions under the Insolvency and Bankruptcy Code (IBC), 2016

Applicable to individuals, sole proprietorships, partnerships and companies

Applicable to all types of creditors including foreign and unsecured lenders

Can be triggered by any creditor or the debtor immediately after default

Prescribes a 180-day timeframe for Insolvency Resolution Process (IRP)

Source: MOSL

1 June 2016

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Expert Speak

Exhibit 4: Proposed infrastructure under the IBC

Insolvency

professionals

Regulator

Institutional

infrastructure

Information

utilities

Adjudicating

tribunals

Source: MOSL

Exhibit 5: Insolvency resolution process (IRP) under the IBC

•Insolvency resolution process (IRP) triggered by any

creditor (financial or operational) or the debtor

Default event

Appointment of

insolvency

professional

Moratorium period /

calm period

Approval by 75% of

creditors

•Licensed insolvency professionals appointed to control

the assets of the debtor during the process

•Insolvency resolution process (IRP) to be completed

within 180 days (extendable to 270 days)

•If approved, the revival plan is implemented; else, the

company goes into liquidation

Source: MOSL

1 June 2016

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Expert Speak

Exhibit 6: Insolvency resolution metrics

Insolvency resolution indicators

Time (years)

Cost (as % of estate)

Recovery rate (cents to the dollar)

Outcome (0 = piecemeal sale; 1 = going concern)

India

4.3

9.0

25.7

0

South Asia

2.6

10.1

36.2

0

OECD

1.7

8.8

71.9

1

Source: World Bank's Doing Business Report 2016, World Development Indicators 2015, MOSL

Exhibit 7: Insolvency resolution metrics and credit metrics

Key indicators

Time (years)

Cost (as % of estate)

Recovery rate (cents to the dollar)

Outcome (0 = piecemeal sale; 1 = going concern)

Bank credit to GDP (%)

Domestic credit by financial sector to GDP (%)

India

4.3

9.0

25.7

0

93.1

74.8

Singapore

0.8

3.0

89.7

1

56.5

126.3

UK

1.0

6.0

88.6

1

85.3

171.5

Source: World Bank's Doing Business Report 2016, BIS Debt Statistics, MOSL

1 June 2016

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