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June 07, 2017

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Effect Of Insolvency And Bankruptcy Code, 2016 On SARFAESI Act, DRT Act


- Kunal Tandon, Managing Partner [ Tandon & Co. ]

Kunal Tandon

Section 14(1)(c) of the Insolvency and Bankruptcy Code, 2016 clearly provides that during the insolvency resolution process as defined in the Code, the Code takes precedence over the DRT Act and SARFAESI Act


Centuries-old laws of the Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920 regulated insolvency resolution for individuals and the Sick Industrial Companies Act, 1985 and Companies Act, 1956/2013 regulated insolvency resolution for companies prior to the introduction of Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as the “Code”).

The Code is a welcome step in resolving issues faced in these archaic laws. Moreover, it consolidates laws relating to insolvency and repeals the Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920. Other than that, the Code also amends 11 laws, including the Companies Act, 2013, Recovery of Debts and Bankruptcy Act, 1993 (DRT Act), and Securitization and Reconstruction of the Financial Assets and Enforcement of the Securitization Act, 2002 (SARFAESI Act). From the amendments, it is clear that all these 11 Acts are affected by the enactment of the Code.

Hence, the question that arises for discussion is what happens to proceedings pending before different forums under the DRT Act and SARFAESI Act.

“All pending proceedings are stayed for a period of 180 days from the date of admission of the application to initiate such proceeding in terms of Section 12 of the Code”

The Code devises two separate processes for corporate insolvency matters and individual/ un-incorporated bankruptcy matter. Part II of the Code deals with corporate insolvency mechanism pertaining to companies incorporated under the Companies Act, 1956 and 2013 and limited liability partnership incorporated under the Limited Liability Partnership Act, 2008; matters in this regard will be dealt by the National Company Law Tribunal. Part III deals with the bankruptcy process for individuals and partnership firms (unincorporated entities) and is maintainable before the Debt Recovery Tribunal. Both Parts II and III provide a detailed procedure for declaring a company, LLP, individual, or unincorporated entity.

Section 14 of the Code (falling in Part II) reads as follows: 14. Moratorium

1. Subject to provisions of sub-sections (2) and (3), on the insolvency commencement date, the Adjudicating Authority shall by order declare moratorium for prohibiting all of the following, namely:

(a) The institution of suits or continuation of pending suits or proceedings against the corporate debtor, including execution of any judgment, decree, or order in any court of law, tribunal, arbitration panel, or other authority;

(b) Transferring, encumbering, alienating, or disposing of by the corporate debtor any of its assets or any legal right or beneficial interest therein;

(c) Any action to foreclose, recover, or enforce any security interest created by the corporate debtor in respect of its property including any action under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (54 of 2002);

2. The supply of essential goods or services to the corporate debtor as may be specified shall not be terminated or suspended or interrupted during moratorium period.

3. The provisions of sub-section (1) shall not apply to such transactions as may be notified by the Central Government in consultation with any financial sector regulator.

4. The order of moratorium shall have effect from the date of such order till the completion of the corporate insolvency resolution process: Provided that where at any time during the corporate insolvency resolution process period, if the Adjudicating Authority approves the resolution plan under sub-section (1) of Section 31 or passes an order for liquidation of corporate debtor under Section 33, the moratorium shall cease to have effect from the date of such approval or liquidation order, as the case may be.


From the abovementioned details, it is clear that all pending proceedings are stayed for a period of 180 days from the date of admission of the application to initiate such proceeding in terms of Section 12 of the Code, and the Adjudicating Authority shall by Order declare that no new action is allowed to be initiated if the tribunal makes an order to that effect. During the moratorium period, the debtor will also be prevented from disposing of its assets out of the ordinary course. The idea behind this moratorium is to provide a calm period for the debtor and creditors to discuss the rehabilitation of the company under the Code.

Though the provisions are yet to be examined by the courts of law, Section 14(1)(c) of the Code clearly provides that during the insolvency resolution process as defined in the Code, the Code takes precedence over the DRT Act and SARFAESI Act. In other words, existing actions will be stayed, and no new action can be initiated under the DRT Act and SARFAESI Act.

Similarly, the moratorium period is provided in Section 85 of the Code for individuals and unincorporated entities, which reads as follows:

85. Effect of admission of application

(1) On the date of admission of the application, the moratorium period shall commence in respect of all the debts.

(2) During the moratorium period:

(a) Any pending legal action or legal proceeding in respect of any debt shall be deemed to have been stayed; and

(b) Subject to the provisions of Section 86, the creditors shall not initiate any legal action or proceedings in respect of any debt.

(3) During the moratorium period, the debtor shall:

(a) Not act as a director of any company, or directly or indirectly take part in or be concerned in the promotion, formation, or management of a company;

(b) Not dispose of or alienate any of his assets;

(c) Inform his business partners that he is undergoing a fresh start process;

(d) Be required to inform prior to entering into any financial or commercial transaction of such value as may be notified by the Central Government, either individually jointly, that he is undergoing a fresh start process;

(e) Disclose the name under which he enters into business transactions, if it is different from the name in the application admitted under Section 84;

(f) Not travel outside India except with the permission of the Adjudicating Authority.

(4) The moratorium ceases to have effect at the end of the period of one hundred and eighty days beginning with the date of admission unless the order admitting the application is revoked under sub-section (2) of Section 91.

A similar provision is provided under Section 101 with respect to the insolvency resolution process under the Code.

The period of 180 days starts from the date of admission as provided in Section 84 of the Code, and an option of revoking the moratorium period is provided under Section 91(2) of the Code.

In conclusion, it is thus clear that for a period of 180 days as provided in sections above, from the dates of different mechanisms taken under the Code, the proceedings under the DRT Act and SARFAESI Act remain suspended, without affecting the limitation period for filing the same, though an order to that effect must be passed by the respective Adjudicating Authority.

The second stage that the security held by a creditor may be affected with respect to a corporate debtor is under the liquidation order. In case a liquidation order is passed by the appropriate authority in terms of Section 33 of the Code, a creditor has two options:

(a) A secured creditor can choose to relinquish his/her security interest and be part of the liquidation process in terms of Section 53, in which case, the dues of the secured creditor will rank higher in preference of distribution; or

(b) A secured creditor can choose to stay outside the liquidation process and enforce his/her security interest in accordance with Section 52 of the Code.

The position in respect of individuals and unincorporated entities is different. In the event that a bankruptcy order is passed by the Adjudicating Authority, which is the Debt Recovery Tribunal, the bankruptcy order shall not affect the right of any secured creditor to realize or otherwise deal with his/her security interest in the same manner as he would have been entitled in case the bankruptcy order was not passed.

Though the legislature has made extensive efforts to bring harmony between these laws, it is yet to stand the test of implementation. Some immediate concerns are as follows:

1. Time-bound insolvency resolution requires the establishment of several new entities. Moreover, given the pendency and disposal rate of Debt Recovery Tribunals, their current capacity may be inadequate to take up the additional role (As of December 2014, there were 62,000 cases pending with Debt Recovery Tribunals, and the disposal rate has been about 10,000 cases per year.).

2. Existence of multiple laws (the Code, DRT Act, and SARFAESI Act) and forums (NCLT and Debt Recovery Tribunals) to deal with the debt recovery problems of secured creditors will result in interpretation and harmonization of various laws, leading to delay in insolvency proceedings.

3. Interplay of the Code with debt recovery laws such as the SARFAESI Act and DRT Act has not been fully addressed, and there is an apparent tension between these statutes. However, for an insolvency regime to function effectively, clear harmonization for the interplay of the different laws will have to be done.

4. Additionally, the parties have the liberty to approach a forum dealing with Corporate Debt Restructuring (CDR) and Joint Lenders Forum (JLF). Applicability of the CDR and JLF proceedings on the Code will have to be addressed separately.

We trust and hope that the NCLT and Debt Recovery Tribunal under the Code will function effectively furthering the objective of the Code, and if strict timelines are followed, then the Code may result in improving the prospects of recovery for creditors and provide safeguards to honest insolvents.

Disclaimer – The views expressed in this article are the personal views of the author and are purely informative in nature.

 

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