A series of court orders changed bankruptcy rules. Now, the govt is amending the law

The Centre plans to amend the bankruptcy law for greater clarity after recent court rulings altered claims priorities and added procedures, two people familiar with the matter said.

The changes will spell out who qualifies as a secured creditor, one of the two people cited above said on the condition of anonymity. Secured creditors have a lien, or a legal claim, on the assets of a bankrupt company. Claims from a secured creditor get priority over those of other creditors like material suppliers.

"The bill to amend the Insolvency and Bankruptcy Code (IBC) is likely to be submitted in the Parliament's monsoon session. A Cabinet note is now being finalized. One of the areas of amendment is the classification of central and state tax authorities," the person said, adding the idea is to bring clarity on the circumstances when a government authority can be labelled a secured creditor.

While the IBC was enacted to create the most efficient framework in which every factor is aligned towards achieving the primary goal of quick debt resolution, policymakers believe some of the court rulings are not geared to achieve this goal.

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Rainbow case

In 2020, the Supreme Court ruled in the ‘State tax officer vs Rainbow Papers Ltd’ case that tax authorities in Gujarat are secured creditors merely by operation of a statute. The corporate affairs ministry subsequently sought public feedback on a proposal to clarify that state agencies, whether central or state, can be a secured creditor only if they enter into a transaction with the debtor transferring assets, funds etc., and not merely by operation of a law.

The proposed bill is likely to clarify on this matter based on the public feedback and the views received from consultations within government, the person said. The status of state agencies that give land for real estate development projects is also likely to be clarified.

“After a long wait, the much-needed amendments should bring efficiency of operation, clarity, consistency and reliability in the implementation of IBC,” said Anoop Rawat, partner (insolvency and bankruptcy) at law firm Shardul Amarchand Mangaldas & Co.

“The uncertainties over the supremacy of IBC over tax laws should also be removed with clear provisions on the sanctity of Section 53 waterfall with regard to government dues,” said Rawat. Section 53 of IBC outlines the order in which a bankrupt debtor’s asset sale proceeds are distributed, a pattern called the claims waterfall.

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Real estate

The amendments are also likely to include some measures to streamline debt resolution of real estate developers.

“The real estate and construction sector accounts for a third of corporate bankruptcies, the second largest after the manufacturing sector, under the Insolvency and Bankruptcy Code. Comprehensive reforms in debt resolution of the real estate sector with a focus on project completion and allotment of houses, is needed to give relief to home buyers,” said Ashok Haldia, former chairman of the Indian Institute of Insolvency Professionals, who also chaired an expert committee set up by the Institute on improving real estate bankruptcy resolution.

In another ruling last February, the apex court held that the Greater Noida Industrial Development Authority, as a secured operational creditor, has equal rights over the assets of a real estate developer as other secured creditors. That meant government agencies that leased out land for housing projects must be treated as secured creditors. However, in the order of priority of payment of dues outlined in IBC, government dues are ranked below those of secured creditors, along with unsecured creditors.

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CCI in the picture

In the latest instance, the apex court in January ruled by a 2:1 majority that debt resolution plans involving mergers and acquisitions have to be approved by the Competition Commission of India (CCI) before the creditors take them up for clearance.

The court had turned down the debt resolution of Hindustan National Glass and Industries Ltd, a market leader in glass packaging, as CCI clearance had not been obtained when lenders approved the corporate rescue. Policymakers believe mandating prior CCI nod could, in some cases, mean a longer time horizon for lenders to approve the rescue of distressed companies. CCI has now moved the apex court for a review, the first person quoted above said.

Haldia said real estate projects are implemented through multiple closely linked companies, and in the interest of optimum outcomes, a unified approach to dealing with assets and liabilities of the group, is needed, potentially maximizing value and streamlining the resolution process. During corporate insolvency resolution process, execution of the ongoing projects should receive top priority, Haldia said.

Rawat of Shardul Amarchand Mangaldas said that among the key changes, it is expected that a creditor-led resolution framework would be introduced to allow faster and more effective resolution.