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khaitanlegal · 2 years

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Regulatory framework for insolvency and bankruptcy proceedings for personal guarantors

Background

Personal guarantors have been in the news ever since the provisions of the Insolvency and Bankruptcy Code, 2016 (“Code”) were notified and the first set of 12 insolvency resolution processes were initiated. The jurisprudence on the subject at that time ranged from according a moratorium on personal guarantors during the corporate insolvency resolution process (“CIRP”) of a corporate debtor (“CD”) to personal guarantors being kept out of the CIRP process.

Creating a framework for insolvency and bankruptcy of personal guarantors, the Central Government, on 15th November, 2019, appointed 1st December, 2019 as the date of implementation of provisions of the Code for the insolvency and bankruptcy relating to personal guarantors. Towards that end, following regulations and rules were also made and notified over the next few days, all with effect from 1st December, 2019:

Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 (“Insolvency Rules”).

Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Regulations, 2019 (“Insolvency Regulations”) (the Insolvency Rules and Insolvency Regulations hereinafter collectively be referred to as “Insolvency Rules and Regulations”).

Insolvency and Bankruptcy (Application to Adjudicating Authority for Bankruptcy Process for Personal Guarantors to Corporate Debtors) Rules, 2019 (“Bankruptcy Rules”).

Insolvency and Bankruptcy (Application to Adjudicating Authority for Bankruptcy Process for Personal Guarantors to Corporate Debtors) Regulations, 2019 (“Bankruptcy Regulations”) (the Bankruptcy Rules and Bankruptcy Regulations hereinafter collectively be referred to as “Bankruptcy Rules and Regulations”).

This legal update aims to provide a quick overview of the notified provisions of the Code and the rules and regulations made in connection thereto. These apply to personal guarantors for a corporate entity whose personal guarantee has been invoked and remains unpaid.

Insolvency Resolution of Personal Guarantor

Key Features

Who can file and where: Application for the insolvency resolution of a personal guarantor can be filed by (i) the guarantor, either personally or through a Resolution Professional (“RP”), in Form A; or (ii) by a creditor of such a personal guarantor, either personally or through a RP in Form C. The Adjudicating Authority for insolvency of a personal guarantor is the Debt Recovery Tribunal (“DRT”).

However, if the CIRP of a CD is already pending with the National Company Law Tribunal (“NCLT”), then the insolvency petition for the personal guarantor ought to be filed before the same NCLT. If the petition of insolvency resolution of the personal guarantor predates the CIRP of the CD, then such an application will be transferred to the NCLT.

Demand Notice: Creditor to send a demand notice to the personal guarantor in Form B, demanding payment in 14 days of service of notice.

Withdrawal of Application: The DRT may permit withdrawal of the application either (i) before its admission, on a request made by the applicant or (ii) after its admission, on the request made by the applicant, if 90% of the creditors agree to such withdrawal.

Interim Moratorium: Upon filing of the application, a moratorium commences i.e., during such time any action or proceeding pending in respect of the debt is stayed and no proceedings can be initiated by a creditor against the personal guarantor, for any debt. Interim moratorium ceases upon admission / rejection of the application.

Resolution Professional: If the application lists an RP, then the DRT would either confirm the appointment or reject and nominate a replacement within 14 days of filing the application. If the application does not list an RP, then within 7 days of filing of the application, an RP is nominated to the DRT by the Insolvency and Bankruptcy Board (“Board”), who is then appointed as the RP vide an order of the DRT subject to the eligibility criteria being met.

Admission or Rejection: The appointed RP reviews the application and sends his comments to DRT within 10 days of his appointment recommending rejection or admission of the application. Based on the RP’s report, DRT can either admit or reject the application within 14 days of the RP’s report. If the application is admitted, the DRT can instruct negotiation between the guarantor and the creditor for arriving at the repayment plan. If the application is rejected due to the RP’s recommendation or that the application is to defraud the creditors, DRT would record that the creditor is entitled to file for a bankruptcy of the guarantor.

Moratorium: Once the application is admitted, a moratorium is applicable for 180 days. During this period, all pending legal proceedings for any debt of the personal guarantor are stayed, creditors cannot initiate legal proceedings for any debt and the guarantor cannot transfer, alienate, encumber or dispose of any of the assets or his legal right or beneficial interest.

Publication and Claims: The DRT will issue a public notice of the order of admission and call for submission of claims from the creditors within 21 days of the issuance.

Committee of Creditors: The RP to verify and collate all the claims received and prepare a list of creditors within 30 days of the public notice and establish a committee of creditors (“CoC”).

Repayment: The guarantor along with the RP will prepare a repayment plan with a proposal for restructuring of debts. The proposal should contain a justification and reason why creditors would agree to the proposed plan and also provide for payment of fee to the RP. While Insolvency Rules require the RP to submit the plan and his report within 21 days from the last submitted claim, the Insolvency Regulations require this to be done before completion of 120 days from the resolution process commencement date.

Meeting of the CoC: The plan would either propose a meeting of the creditor or mention that a meeting is not required. A meeting of the creditors, if required, will be held between 14 and 28 days of the RP submitting his report to the DRT, with at least 14 days’ notice. The notice ought to be accompanied by the repayment plan, report of the RP, forms for proxy voting and state of affairs of the guarantor.

The CoC may approve, modify or reject the repayment plan or decide to alter it, with the consent of the guarantor. The approval of the repayment plan requires a majority of more than 3/4 in value of the creditors present in person or by proxy and voting on the resolution in a meeting of the creditors. The voting right of each creditor is in proportion to the debt they are owed.

Report on the meeting by the RP: The RP submits a report on the meeting of creditor, which includes whether the plan was approved or rejected, any modifications that were proposed, the resolutions proposed and decided, creditors who were present or represented at the meeting, and the voting records of each creditor for all meetings of the creditors; and their voting. A copy of the report is to be provided to the guarantor, creditors and the DRT.

Final Order: DRT can either approve or reject the repayment plan on the basis of the report of the RP and provide a decree for implementation. Where a meeting of creditors is not convened, the DRT can direct for it to be convened. If a modification is directed, the DRT can re-convene a meeting of the CoC for reconsidering the modifications in the repayment plan.

Once approved, repayment plan takes effects and binds the guarantor and the creditors. If the plan is rejected, the guarantor and the creditors are entitled to file an application for bankruptcy.

Implementation of the Plan: The implementation of the plan is supervised by the RP. Once implemented, the RP to send the notice of implementation to the creditors, debtors and DRT, report summarising the receipts and payments made pursuant to the repayment plan and the extent of implementing. If the timeline mentioned in the plan passes without the plan being implemented completely, the plan is deemed to have ended prematurely. In such a case, the RP submits a report to DRT and details of receipts and payments under the plan, reasons for the premature end, details of the creditors, not fully satisfied. The premature end is recorded by the order of the DRT and unsatisfied creditors can file for bankruptcy of the guarantor. Basis the plan, a discharge order can be procured recording a discharge either subject to implementation or upon implementation of the plan.

Bankruptcy Process for Personal Guarantors

Key Features:

Who can file and when: The application for initiating bankruptcy can be filed to the DRT by (i) the guarantor himself, in Form A; or (ii) by a creditor either personally or through a RP in Form B where an order has been passed by the DRT due to:

rejection of application for insolvency; or

rejection of repayment plan due to insolvency; or

order that the repayment plan is not completely implemented or has ended prematurely.

In its application, the creditor must either confirm giving up of security for the benefit of all creditors of the personal guarantor once the order of bankruptcy is passed or that the application is only in respect of the unsecured debt.

The Adjudicating Authority for bankruptcy of a personal guarantor is also DRT. However, if the liquidation of a CD is pending with the NCLT, then the bankruptcy petition for the personal guarantor ought to be filed before the same NCLT and if the bankruptcy petition of the personal guarantor is filed and then the liquidation of the CD is ordered, then the bankruptcy petition will be transferred to the relevant NCLT.

Withdrawal: An application, once submitted, can only be withdrawn with the leave of the DRT.

Interim Moratorium: Upon filing of an application for initiating the bankruptcy process, a moratorium commences against the properties of the personal guarantor in respect of this debt. This moratorium ceases upon admission or rejection of the bankruptcy application.

Bankruptcy Trustee: If the application proposes the name of the bankruptcy trustee, then the DRT, would either confirm the appointment or reject the appointment after checking the disciplinary status with the Board. If the application does not propose a bankruptcy trustee, then within 7 days of filing of the application, a bankruptcy trustee is nominated to the DRT by the Board, who is then appointed as the bankruptcy trustee by DRT subject to the eligibility criteria being met.

The bankruptcy order does not affect the right of any secured creditor to realize or otherwise deal with his security interest, subject to the declaration given by the creditor in his application for bankruptcy. Any action for realisation of the security ought to be taken within 30 days of the bankruptcy order.

Effect of the Bankruptcy Order: On and from the date of the bankruptcy order the bankrupt is:

disqualified from acting as a trustee, a public servant, being elected to any public office or as a member of any local authority;

prior to entering into any financial or commercial transaction for INR 1,00,000/- and above, inform the other parties that he is undergoing bankruptcy;

not to act as a director of any company, or take part in the promotion, formation or management of a company, prohibited from creating any charge on his estate or taking any further debt, incompetent to maintain any legal action or proceedings in relation to the bankruptcy debts and not be permitted to travel overseas without the permission of the DRT.

Public Notice: The DRT issues a public notice inviting claims from all creditors of the bankrupt, in Form C within 10 days of the bankruptcy commencement date. A creditor should submit a claim with proof to the bankruptcy trustee within 7 days of the publication of the notice, in Form F.

Committee of creditors: The bankruptcy trustee, within 14 days from the bankruptcy commencement date, prepares a list of creditors of the bankrupt and establish a CoC. Constitution of the CoC is to be informed to the DRT within 3 days from the meeting of creditors.

Meeting of the CoC: Within 21 days from the bankruptcy commencement date, the trustee issues a notice for calling a meeting of the creditors, to every creditor of the bankrupt as mentioned in the list. In the meeting, the voting share of each creditor to be in proportion to the debt owed to such creditor. The creditors/participants of the meeting are entitled to receive minutes of the meeting within 48 hours of the conclusion of the meeting. Any decision of the CoC will require the approval of more than 50% of voting share of the creditors who voted.

Realisation of Security Interest: A secured creditor who seeks to realise his security is required to inform the bankruptcy trustee of the price at which he proposes to realise the secured assets. A creditor cannot obtain interest in the assets of the bankrupt.

Administration and Distribution of Assets: The estate of the bankrupt excluding the excluded assets[ Excluded Assets means a) unencumbered tools, books, vehicles and other equipment as are necessary to the debtor or bankrupt for his personal use or for the purpose of his employment, business or vocation, (b) unencumbered furniture, household equipment and provisions as are necessary for satisfying the basic domestic needs of the bankrupt and his immediate family; © any unencumbered personal ornaments of the debtor or his immediate family which cannot be parted with, in accordance with religious usage shall not exceed INR 1,00,000; (d) any unencumbered life insurance policy or pension plan taken in the name of debtor or his immediate family; and (e) an unencumbered single dwelling unit owned by the debtor (i) in the case of dwelling unit in an urban area shall not exceed, INR 20,00,000 and (ii) in the case of dwelling unit in rural area shall not exceed, INR 10,00,000. ] vests in the bankruptcy trustee immediately from the date of his appointment and will take possession and control of all property, books, papers and other records relating to the estate of the bankrupt. The bankruptcy trustee may, with the approval of the CoC, divide amongst the creditors, properties which from its peculiar nature or other special circumstances cannot be readily or advantageously sold. Where the bankruptcy trustee has realised the entire estate of the bankrupt he will give notice of his intention to declare a final dividend or that no dividend or further dividend to be declared.

A meeting of the creditor is convened on completion of distribution of assets and the bankruptcy trustee provides a report on administration of the estate for the approval of the CoC which is to be approved within 7 days of receipt. Once approved, the bankruptcy trustee is released.

Discharge order: An order of discharge can be applied for 1)on the completion of 1 year from the bankruptcy commencement date; or 2) within 7 days of the CoC approving the report on administration of estate, whichever is earlier. A discharge order releases the personal guarantor from all bankruptcy debt, except for the breach of contract or fraud or excluded debt2.

Conclusion

The notification of the relevant provisions, rules and regulations is a major step towards creating the regulatory regime for insolvency and bankruptcy of personal guarantors. This is likely to be most beneficial for banks and financial institutions as it will be a time-bound process and can take all promoters (who have given personal guarantees) into consideration. Now that the Supreme Court in the matter of Essar Steel has upheld the right of lenders to enforce personal guarantees outside a resolution plan, the timing of these notifications is very interesting. These provisions, rules and regulations formulate the pathway for implementation of the directives of the Supreme Court vis-à-vis actions against the personal guarantors.

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khaitanlegal · 2 years

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Resolving the NPA Conundrum: Bad Bank to the Rescue

The Launch

Indian policymakers have wrestled for more than a few decades to solve the twin balance sheet problem of overleveraged companies and bad-loan-encumbered banks. Indecisiveness, delays in resolution of bad loans and reaching consensus have resulted in unprecedented challenges. Consequently, banks evergreen non-performing assets (“NPAs”) while credit and investment functions take a back seat. Taxpayer’s money is put to risk as public sector banks breach solvency and need to be recapitalized by the Government. Various agencies such as CRISIL and ASSOCHAM have signaled the rise of gross NPAs of banks to 8–9% in the fiscal 2021–22 and stressed assets to 10–11%. The regulator itself has indicated a sharp increase in NPAs of scheduled commercial banks to 9.5% by September 2022.

Currently, the legal framework for resolution of NPAs include the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI”), resolution frameworks released by the Reserve Bank of India (“RBI”) and the Insolvency and Bankruptcy Code, 2016 (“Code”). The Code has to a large extent dealt with the problem of businesses overleveraging assuming there will be no consequence of default. The Code also facilitates businesses functioning as a going concern while the resolution of NPAs is effected.

In this backdrop the Government has now created a new mechanism to deal with the NPA problem — the “Bad Bank”. The idea to have a centralized public sector asset rehabilitation agency was conceived through the Economic Survey in 2016–17. It was proposed that the Bad Bank would take charge of the largest and most difficult NPAs and make politically tough decisions to reduce NPAs. In 2017, Dr. Viral V Acharya, Deputy Governor, RBI, in his speech highlighted potential of a bad bank to resolve NPA induced stress in the economy. Finally, in the Union Budget 2021–22, the Government announced creation of an asset reconstruction company (“ARC”) and an asset management company (“AMC”) to implement such recommendations. The intention is that the ARC consolidates and takes over the existing NPAs of public sector banks and the AMC manages and disposes of such NPAs to entities such as alternative investment funds and other potential investors, unlocking value.

2. Regulation and Function

Pursuant to the budget announcement, the Government has incorporated the National Asset Reconstruction Company Limited (“NARCL”). It is said that NARCL will acquire NPAs worth INR 2 lakh crore from various commercial banks in a phased manner. Additionally, the India Debt Resolution Company Ltd (“IDRCL”) has also been set up with the purpose of selling such NPAs in the market. The twin structure of NARCL-IDRCL is proposed to be the “Bad Bank”. NARCL is registered as an ARC and will be regulated by the RBI under the auspices of SARFAESI.

It is proposed that NARCL will purchase NPAs from public sector banks by paying 15% of the agreed price in cash and for the remaining 85%, NARCL will issue security receipts. It is further proposed that IDRCL will be responsible for resolution and sale of such NPAs. The consequent receipts will be utilized to redeem the security receipts. The Government will provide credit support to the Bad Bank through a guarantee of INR 30,600 crore for 5 years, guaranteeing recovery of such NPAs. Accordingly, the structure ensures the highest credit rating for the security receipts issued by NARCL, while differing the obligation of the Government to recapitalize public sector banks.

3. The Regulatory Roadblock

“Asset Reconstruction” as defined in Section 2 (1) (b) of SARFAESI, provides for the acquisition and resolution function of an ARC under the same legal entity. Accordingly, the RBI has recently opposed the proposed dual structure (i.e., one arm that acquires assets (NARCL) and the other arm that resolves such assets (IDRCL)) of the Bad Bank due to lack of statutory powers to regulate the same under SARFAESI. It is also not clear what will be the valuation/transfer price of NPAs from NARCL to IDRCL.

To overcome this issue, a principal-agent relationship between NARCL and IDRCL is being proposed. Under this agency, it is proposed that NARCL will engage IDRCL and outsource resolutions of NPAs (which would not be binding on NARCL) to IDRCL.

In the first structure elucidated above, there is lack of clarity on the relationship between NARCL and IDRCL and also on statutory sanctity. The second structure provides for a principal-agent relationship between the two. At the outset, the second structure, by virtue of the inherent nature of the “principal-agent” relationship, makes IDRCL accountable to NARCL. Whenever the relation of agency is created, there attaches prima facie to each party a number of duties, liabilities and disabilities-the normal incidents of agency.

In this context, the example of South Korean “bad-bank” structure adopted during the Asian Financial Crisis of 1997 is worth mentioning. At that time, South Korea’s NPAs stood at a glaring 18% of total loans, against present best-in-class 0.5%. The bad bank was called Korea Asset Management Corporation (“KAMCO”) which was state backed with a 5-year sunset window. However, it was not just the KAMCO structure which resolved the NPA stress, South Korea also adopted various other policy measures. These included harmonized information technology system for reporting NPAs by banks, online platform for auctions of NPAs, database of recoveries based on past auction and court-recovery results, which helped provide future basis for pricing NPAs and formula-based pricing to minimize valuation disagreements.

4. Conclusion

While ARC’s have been in existence since early 2000, the proposed “Bad Bank” backed by the guarantee of the Government of India ensures transferring banks will receive the amounts committed by NARCL and perhaps more, thereby resulting in a tradeable security of the highest credit rating and an indirect recapitalization of the transferring bank by the Government. The structure also frees the Bad Bank to deal with purchased NPAs without interference from transferring banks and permits a controlled wind down of such NPAs including through resorting to IBC proceedings or by creating a market for purchase of stressed assets by interested parties, thereby resulting in value maximization. Additionally, the structure will also permit closer interactions with the Government and facilitate policymaking, based on experiences and market demand.

If history is any guidance, there will be gaps between intention and implementation. This is a space to watch. Were the Bad Bank to succeed in cleaning up the NPA mess as intended, the results are for all to see in the South Korean example.

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