This is the first post in our multi-part series that deep dives into the world of NeSL and Information Utilities. Read our introductory post in case you missed it.
In this post, we'll be covering the "Information Problem" that characterizes the conventional insolvency process.
For this we'll need to first zoom out and briefly have a look at the insolvency process itself.
Wait, hang on. Before we do that we need to zoom out even further and briefly look at the concept of debt itself.
A debt broadly involves two types of parties:
In many instances there can be "multiple debtors" or "multiple creditors" for a debt. Then there's the matter of third parties involved like guarantors. But in all these scenarios - the relationship is fundamentally one where "one individual, entity or group" owes "another individual, entity or group" a sum of money.
There are also multiple "types" of debt. But for simplicity's sake we'll be referring to one kind of debt in this series- "financial debt". Financial debt arises out of a transaction where the Creditor gives the Debtor money for the consideration that the debtor will repay the money "along with interest" to account for the "time value" of that money.
That's because the most common form of financial debt is loans.
A significant chunk of economic activity in any economy is driven by loan debt.
Most people wouldn't be able to buy homes if home loans didn't exist. Most people wouldn't be able to buy vehicles if auto loans didn't exist. Most businesses would not exist if it wasn't for business loans. Even consumer goods like refrigerators, TVs, microwaves and phones are purchased with debt these days (what did you think that EMI was?)
Most loans in the formal economy are disbursed by financial institutions like Banks and NBFCs. Both these institutions are super vital for the economy - because they ensure the flow of money available to disburse as financial debt - which in turn gets converted to economic activity.
Banks are even more important. That's because their source of funds largely comes from "deposits" that the public at large - like you and me - make in our bank accounts. Banks also act as the source of funds for NBFCs.
But what happens when a borrower is unable to pay debts back to a Bank or NBFC? What happens when many borrowers are unable to pay back debt?
That's where the Insolvency System kicks in.
As per the IMF, a good insolvency system - helps enhance the flow of credit, creates credit discipline and provides a way for the economy to “preserve value” from defaulting/sick companies.
Basically a good insolvency system is REALLY IMPORTANT for the health of a country’s debt system - and therefore the economy at large.
Before 2016, the Indian insolvency system was, to put it very mildly - NOT GREAT.
It consisted of a jumble of complex and ineffective laws with varying enforcement mechanisms - ranging from Tribunals, District Courts and High Courts.
This complex system had three critical problems:
Naturally this also had a spillover effect to the economy. Instead of kicking of a "virtuous cycle", the sub-par insolvency system kicked of a "vicious cycle of debt"
In 2016, Parliament enacted the Insolvency and Bankruptcy Code, 2016 - or the "IBC" as it is popularly known as.
Parliament decided that - rather than merely tinkering with the laws here and there - it was time for a complete overhaul.
So the IBC did just that. It provided ONE consolidated process for creditors to enforce debt claims. The new process was designed to:
The IBBI, in conjunction with the World Bank have published a detailed handbook on the IBC here.
We won't get into all the details here.
One of the reasons the pre-IBC insolvency system in India was slow - was the manner in which it dealt with evidence and process in insolvency proceedings.
Pre-IBC the system worked something like this:
This system was slow and ineffective because it provided borrowers with a way to frustrate creditors’ claims solely through legal strategy.
The immense frustration often caused creditors to:
Under the IBC, the evidence and process system was greatly streamlined and simplified:
This system was designed to be fast and easy - with very little leeway provided for defaulting borrowers to escape the clutches of insolvency.
Under the simplified, streamlined evidence process under the IBC - the success or failure of any insolvency petition hinges on whether the creditor is able to provide evidence of default of debt.
How is evidence of default of debt proved? Through information about the debt.
Information about debt can be found in two places:
Conventional modes of creating debt documentation and maintaining debt information create problems that cast evidentiary doubt about their veracity.
Physical execution of loan documentation is a multi-step logistics and compliance exercise that takes time and is a pain for both the borrower and the lender.
A typical process would involve - among other things - the following steps:
This process is a multi-step logistics process carried out physically. By nature, it is prone to vulnerabilities like:
At the stage of executing loan documents - both the borrower and creditor have a common goal - disbursal of the loan as fast as possible.
The time consuming, painful nature of the physical execution process directly contradicts this goal.
As a result of this tension, borrowers and creditors often jointly condone shortcuts in the physical execution process like:
These shortcuts often result in the ability to “sow doubt” about the full integrity of debt documentation. As we’ll see later in this article - this has implications for the enforcement of debt.
In the case of loans - especially large corporate loans - borrowers and creditors often revise and revisit the terms of their agreement after disbursal of the loan.
These revisions are often recorded in correspondences - like letters or email. Because of the cumbersome nature of physical execution (mentioned above) - these revisions are sometimes never codified by a freshly executed agreement. And in cases where they are - the revised execution suffers the same vulnerabilities mentioned above.
The conventional process of debt documentation execution and debt information is a process between two parties - the borrower and the lender.
Therefore any debt documentation physically executed is stored with either of the parties - and a copy provided to the other party. The original is usually stored with the lender.
Similarly whenever a borrower makes a repayment to a loan - this information is recorded in a repository controlled by the lender. And when a borrower fails to make a repayment - the information about this default is again in the same repository controlled by the lender.
Both parties are fine with the lack of neutrality during the good times of disbursal - because their common goal is fastest disbursal.
Suppose a borrower defaults on their debt - and the creditor takes them to the NCLT under the IBC.
Now the goals of each party are diametrically opposite (usually):
Under the IBC, a debtor has very limited room to thwart the creditor. The only slim avenue they have is somehow casting doubt on the evidence of default.
The Supreme Court has provided a potent tool to debtors by holding that NCLTs are bound by the principles of natural justice and therefore must afford both parties a right to hearing.
This gives borrowers an opening to:
Therefore, one often hears arguments in the NCLT like:
The list can go on and on.
These arguments are given a veneer of respectability through 500 page objection statements and expensive senior counsels being engaged to appear for the borrowers.
At this point you may laugh and say - “sure, debtors can adopt these arguments. But they get dismissed in almost all cases”
And you would be right.
Except that’s not the point.
By employing these tactics, the borrower doesn’t intend to avoid orders of admission (although this is a welcome outcome) - because this is virtually impossible in insolvency petitions filed by financial creditors.
Instead the end goal of the borrower is to protract and prolong the insolvency petition - and delay admission as much as possible.
In my previous avatar as a lawyer I have personally used these arguments and tactics while representing various corporate debtors in financial creditor petitions before the NCLT.
At this point you may be wondering -"Ok, so some delays happen - what's the big deal. The financial creditors will still get what they want eventually!"
But this fails to take into account one critical fact. In the business of money and debt time is, quite literally, money
Therefore, delays in the process:
A 2021 report by IBBI stated that the insolvency process in India takes an average of 459 days. That’s about 280 days more than the stipulated 180 day time limit in the IBC. 190 - if you count the permitted 90 day extension.
So, while the new IBC system is FASTER than older systems in India - it still isn't meeting its own high benchmarks.
Are these delays ONLY caused by the debt information and documentation process? Obviously not.
But will an improvement in the debt information and documentation process help reduce these delays? Probably.
That’s where Information Utilities step in.
Want to know how exactly Information Utilities solve the Information Problem? Check out our next post.
If you have any questions, comments or feedback - feel free to contact the author at email@example.com
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