Legal Challenges in Corporate Bankruptcy and Insolvency Proceedings

Author: Abhishek Nair, Indian Institute of Management, Rohtak.

Taking the qualitative approach would present the real opportunity for insight into the efficiency gap and loopholes of insolvency and bankruptcy legislation in India. Although several amendments took place in this area since the enactment of SICA, 1985 and amendments thereto with regard to provisions related to insolvency, some vital issues including a protracted length of litigation pertaining to liquidation process, inadequate protection to creditors and misuse of the rehabilitation mechanism through debtor companies is yet to be addressed. It has, therefore, been argued in the following paper that to address these issues, the Bankruptcy Law Reform Committee in 2015 took an extreme step by suggesting simplification and harmonization of several insolvency laws. On the other hand, coexistence of the SARFAESI act with the IBC has been feared for making repeated attempts to seek legislation on procedural overlaps. SARFAESI act allows secured creditors to alienation to his security even during the management by the borrower and whereas both secured as well as unsecured creditors are capable of interaction under the IBC.

• Background

The report and draft bill on the Subject-Matter of the Bankruptcy Law Reforms Committee were submitted on 4 November 2015. The Bill attempts to bring in significant changes to India's prevalent laws relating to dealing with the financial woes of debtors and creating robust institutional architecture for dealing with the insolvency or bankruptcy of individuals as well as companies. These recommendations have been undertaken with the purpose of covering certain inadequacies within India's insolvency regime both in theory and in practice as the same was quite a significant impediment to the efficiencies of the nation's credit markets. The World Bank's Ease of Doing Business Index 2015 ranks India at 137th among 189 countries in discharging insolvencies, considering factors like time taken, cost incurred, rate of recovery by creditors, asset management during the whole process, participation of creditors, and strength of insolvency laws. 

Collective insolvency under Indian law is generally approached by separate legislations for rehabilitation and liquidation. The central Act most applicable to the rehabilitation of distressed companies is SICA, which mainly pertains to industrial companies with a 100% net worth erosion assessment criterion. An industrial company facing financial stress is allowed to make an application to the Board for Industrial and Financial Reconstruction (BIFR). The job of the BIFR is to decide the possibility of rehabilitation of the debtor company and approve the scheme of rehabilitation or send it for winding up to the high court.. But, SICA quickly became infamous as an instrument to encourage delays and abuse by debtors who took the BIFR as a "haven" to secrete assets from creditors. The deplorable inadequacies of SICA were so well noted in public that the government passed laws to repeal SICA in 2002.

• Research Problem

The insolvency and debt recovery mechanisms in India were inefficient for ages, accompanied by procedural delay and overlapping jurisdictions. The much-expected move for change has finally been realized by the new insolvency and bankruptcy code 2016 which consolidate all extant insolvency legislation and rationalizes resolution procedures, though, IBC still confronts hurdles mainly with prior enactment, especially while secured creditors maintain parallel procedures of the SARFAESI Act, 2002.

India had a modern and integrated framework for insolvency which had been efficient in reorganizing firms facing financial distress before the advent of the IBC. Even what the Companies Act, 1956, and followed by the Companies Act, 2013, had failed to provide was provisions for the revival of companies. It only provided for their liquidation. SICA-the main legislation for the rescue and rehabilitation of corporate firms-was passed in 1985 and served a narrowly defined, sector-specific purpose. SICA was debtor-in-possession (DIP), but it applied to industrial companies with severely impaired net worth. Still, The procedural delays and inefficiencies of the liquidation and rehabilitation frameworks ensured that recovery was very minimal; thus, it provided no incentives for timely restructuring of debtor companies, which reduced efficiency in general.

The literature on corporate insolvency and debt recovery frameworks points out the criticality of effective systems of insolvency for healthy credit markets and eventual growth. It can be postulated that such inefficiencies that have been perceived in the protracted debate concerning resolution timelines, recovery ratios, or creditor protection arise from studies showing that this existing segmentation of laws and institutions has been at fault. In that case, it can easily be concluded that comparing the conditions with those of countries such as the UK and Singapore will show how consolidated legal frameworks, streamlined adjudication processes, and professionals within insolvency management can achieve a lot in making better systems.

The Insolvency and Bankruptcy Code, 2016, does not specifically deal with the stage of implementing a Resolution Plan by the Successful Resolution Applicant. However, this flexibility has led to SRAs taking liberties that are not warranted and often act negligently by disregarding the terms of the Resolution Plan. SRAs usually approach the Adjudicating Authority (NCLT) or the NCLAT for relaxation of the stringent compliance requirements of the Resolution Plan, including timelines. These tribunals frequently accept such requests by exercising their inherent powers under Rule 11 or their authority to extend time under Rule 15 of the NCLT and NCLAT Rules, 2016.

Judicial discretion must be used sparingly by the NCLT and NCLAT, especially when modification involves changing the terms or timelines already bound within the Resolution Plan. Heavy interference may lead to an eroding effectiveness of IBC that might make the framework redundant. Resolution Plan integrity remains intact and will provide no shortcut to cause an obstacle in its proper and timely implementation. Strict compliance, especially concerning timelines, is necessary for the Resolution Plan to ensure that the IBC's purpose is to achieve an efficient and reliable process of insolvency resolution. 

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002, was enacted by the Government to keep the interference of court to a very minimal level. It is an act that provides procedures for financial institutions to recover bad loans through a legal platform. Concerning the provisions of the SARFAESI Act, the secured creditor may, on failure to make payment, simply repossess and then sell the collateral pledged against the loan. A new Act, called the 'Insolvency and Bankruptcy Code', with speed and efficiency for insolvency and bankruptcy cases has begun in India. IBC is meant to lay down a legislative framework for the collective bankruptcy process to resolve financially distressed companies and protect the interests of the creditors along with the maximization of values if possible to ensure future existence of the company or organization. SARFAESI is more of a rights-based instrument for financial institutions over borrowed amounts, and the IBC covers interests of all classes of creditors from operational to financial and secured to unsecured ones. This complementary interference seems rather benign. It does not disturb any of the parties involved since it is just a nudge in the direction of proceeding towards the cause of recourse mechanisms in instances of bad debt within the conflict of internal interest with the SARFAESI extinguished, yet wherein IBC has barely any angles of grievance. The Supreme Court reiterated this precedent in  Encore Asset Reconstruction Company Pvt Ltd v. Ms. Charu Sandeel Desai. There the Court ruled that the SARFAESI Act is subordinate to the IBC. This ensures a unified and comprehensive approach to insolvency resolution and debt recovery. 

The Recovery and Bankruptcy Act of 1993 was enacted with explicit intentions to make a legal platform for quick resolution and debt recovery of debts owed to banks and other financial institutions. Even though this was a good initiative taken for solving the NPA problem, the general effectiveness remained less than the expectation in enhancing the speed of debt recovery. Therefore, to overcome the above-mentioned difficulties, the government introduced the SARFAESI Act in 2002, focusing on the lapses of the DRT Act.

IBC, as well as the SARFAESI Act, have undergone various amendments since their enactment, looking to increase their effectiveness. The most important reforms were held in 2016 under the Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act. All existing provisions got streamlined, and legal currentization was brought into place through measures taken to expedite the process of recovery of debts. Not only the 1993 and 2002 Acts got amended, but it also modified other related enactments-the Indian Stamp Act and the Depositories Act. Reform was more aligned with ensuring an accelerated, transparent mechanism for settling bad debts, so that consequently, banks and financial institutions may recover their due amount more promptly to strengthen the overall banking sector.

In the case of India, two major laws of the legal world related to liquidation include Insolvency and Bankruptcy Code (IBC) and Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act. The two however can be contradictory to each other. In the case of Encore Asset Reconstruction Company Pvt.. NCLT in Ltd. v. Ms. Charu Sandeep Desai holds that the non-obstante clause in Section 238 IBC makes the law paramount amongst all other existing laws. The court held that pendency of SARFAESI actions cannot be a barrier for fresh applications under IBC and the creditor is entitled to file insolvency proceedings under IBC notwithstanding the pendency of SARFAESI actions in Rakesh Kumar Gupta v. Mahesh Banshal. They are different in terms of approach and scope.

SARFAESI Act is the legislation under which creditors, which are categorised majorly under the banks and other financial institutions, are allowed to recover their dues through the process of auctioning the assets of defaulting borrowers without any kind of litigation. IBC has judicial oversight whereby an insolvent entity has to present its application for the liquidation of its assets before NCLT or DRT, as the case may be. IBC is better structured and integrated with a mechanism addressing both secured and unsecured creditors. SARFAESI acts as a mechanism to secure the interest of the secured creditor. The IBC insolvency resolution process is relatively more efficient; hence, the assets get liquidated or resolved within 180 to 270 days.

Meanwhile, the SARFAESI Act proceedings taken after investigation and proper disposal generally take about 1–2 years. The recoveries under the SARFAESI act tend to be inexpensive, but on large debt sizes, the mechanism of resolution at IBC tends to be quite effective since there is a provision for the possible revival of a distressed entity in IBC, too. Whereas ARCs are approached by SARFAESI for recovery of debt, IBC approaches IPs who set up structured plans for resolution and securitisation, which more frequently help the revival of the company rather than its liquidation. The IBC has shown better efficiency in recovery. In 2018–19,  it was at a recovery rate of 42.4% as compared to SARFAESI at 14.5%, Business Standard reported. Banks prefer IBC for faster and more comprehensive results. Additionally, whereas SARFAESI requires a 90-day notice period before enforcing action, in IBC, creditors can jump directly to proceedings for insolvency on defaulting by ₹1 lakh or above, which puts IBC as a more potent tool for resolving large defaults promptly.

Transition is observed when moratorium or delay periods fall under IBC. SARFAESI action would still be stayed in the moratorium or delay period. It has been held by the Courts in M/S Unigreen Global Private Limited v. Punjab National Bank that the proceedings of SARFAESI can't survive where the moratorium of IBC falls. Then, of course, it would be open to the creditor to go under IBC for a resolution or liquidation process, keeping in place the rights of secured creditors under Section 52 of IBC. Thus, this flexibility makes IBC robust enough to cover issues of insolvency comprehensively.

In the case of S. Ravindranathan, Ex-Director of Corporate Debtor MPL Parts and Services Pvt. Ltd. V. Sundaram BNP Paribas Home Finance Ltd., wherein an appeal was filed from an order initiating CIRP against the corporate debtor by a financial creditor, Sundaram BNP Paribas Home Finance Ltd., under Section 7 of IBC. The corporate debtor had already invoked the SARFAESI Act against it for defaulting on a housing loan, and the financial creditor had taken possession of the secured assets. It had contested those proceedings by saying that there was no financial debt since the value of the assets far exceeded the amount of loan outstanding. However, the NCLT accepted the application, appointed IRP, and slapped a moratorium saying that the IBC under Section 238 overrides the SARFAESI Act. NCLAT dismissed the appeal holding that the CIRP has started in consonance with law since debt and default are proved and that the Section 7 proceeding under IBC may be continued without considering SARFAESI actions, it was further held in Punjab National Bank vs. M/s Vindhya Cereals Pvt.   

Whether the proceedings instituted under SARFAESI Act, 2002 can run in tandem with the proceedings instituted under Insolvency and Bankruptcy Code (IBC), 2016. Here, Punjab National Bank is a financial creditor. Under Section 13(2) of SARFAESI Act, it served the notice. Under Section 7 of the IBC, the said applicant initiated Corporate Insolvency Resolution Process (CIRP) against the corporate debtor. The NCLT dismissed the application on the holding that it was "forum shopping" since both actions had been taken under two statutes. NCLAT reversed that decision holding the financial creditor may be able to file action simultaneously under both the SARFAESI Act and IBC. In particular, the Tribunal relied upon the overriding effect provided under the IBC in its provisions at Section 238 where such a law provides an exception if such an inconsistency prevails.

The NCLAT further clarified that pursuing parallel proceedings does not inherently indicate fraudulent or malicious intent unless specific facts demonstrate otherwise. It directed the NCLT to expedite the pending Section 7 application and set aside its earlier decision, reaffirming the permissibility of dual proceedings by financial creditors under the respective laws.

The inefficiencies in the approach toward insolvency and bankruptcy in India remain in the realms of delay, inadequate protection to the creditors, and inefficient asset management when a firm is in financial distress. While steps in that direction had already been undertaken, through steps like the Sick Industrial Companies Act, 1985, and then further provisions were added under the Companies Act, but the system does not become reliable enough in managing financial distress in a firm. Long periods of liquidation and restructuring processes have also harmed creditor recovery and credit market efficiency.

In 2015, the Bankruptcy Law Reform Committee proposed a single, integrated framework of insolvency to address such issues. Finally, this culminated in the introduction of the IBC, which brought all insolvency laws together into a single comprehensive mechanism. The IBC is concentrated on faster and more transparent procedures both for creditors and debtors to ensure that the recovery rates are maximized and time spent is minimal.

While there are some procedural glitches emanating from the overlap, by virtue of cross-over of sections between the SARFAESI Act and the IBC process, in cases such as PNB v Vindhya Cereals Pvt. Ltd and S Ravindranathan v Sundaram BNP Paribas-learned brethrens have clearly understood, that such can run together too, wherein such IBC would enjoy the 'priority, in spite of contradiction of judgements, and because of delayed deliverables besides institutional lopsidedness critical. Though IBC is an important step, long-term sustenance through further efforts in building capacities, involving all stakeholders and standardizing themselves in global settings are also of immense importance.

This is necessary to ensure a smooth process of insolvency resolution. There should be clarity on the applicability of various legal frameworks, especially the IBC and the SARFAESI Act. There should be clear distinctions so that the circumstances under which each framework applies are defined. This would help the stakeholders understand which law to invoke and eliminate ambiguity and procedural overlaps that may lead to delays in resolving financial distress.

This will be besides the reforming of the SARFAESI Act together with the DRT regime to make it complementary to the overall purposes of the IBC. These two are mutually supportive in aim, but on the one from the legal framework of the SARFAESI Act, the emphasis is on the recovering of the secured assets, while in the IBC the focus is how the wider aspect of insolvency surveillance can be carried out. In this legislative landscape, such synchronization would ensure that such laws coexist and that the measures to deal with economic distress are made more effective and that the rights of creditors are better protected.

There should be cumbersome procedures in terms of conducting IBC or SARFAESI Act in tandem which also invoke the above given principles. Above guidelines should address how best conflicts of interest layers of decision and boundaries of a decision to curb multiple exercises and ensure equity in it. Such clarity will not only limit the potency of litigation but also instill trust for the process in the creditors as well as debtors. With proper alignment of these laws and process by Laws, it is possible to achieve efficient and effective insolvency resolution to the satisfaction of the creditor and the economy at large.

1. Rajeswari Sengupta & Anjali Sharma, Corp. Insolvency Resol.: Lessons from Cross-Country, Apr. 9 2016, 37, 37

2. National Company Law Tribunal Rules, 2016  

3. Encore Asset Reconstruction Company Pvt Ltd v Ms Charu Sandeep Desai [2019] Company Appeal (AT) (Insolvency) No 719 of 2018

4. Rakesh Kumar Gupta v. Mahesh Banshal, & others [Company Appeal (AT) (Insolvency) No. 1408 of 2019

5. Dibaker Banerjee” Comparative Analysis of IBC and SARFAESI Act”(Jan 6, 2025, 6:03 PM), https://www.juscorpus.com/comparative-analysis-of-the-insolvency-code-and-sarfaesi-act/

6. M/S Unigreen Global Private Limited v. Punjab National Bank, Company Appeal (AT) (Insolvency) No. 81 of 2017

7. Insolvency and Bankruptcy Code, 2016