Doubtful Receivables in India: The Insolvency Code Solution

The Insolvency and Bankruptcy Code, 2016 (Code) was legislated with the intent to resolve the banking crisis that had engulfed the Indian economy. While the Code provides banks and other financial creditors a theoretically faster mechanism to resolve their bad debts, the infrastructural and procedural aspects surrounding the resolution process are leading to delays. The National Company Law Tribunals (Tribunal) which are the adjudicating authorities under the Code, are understaffed to deal with the vast number of cases being filed. Faster resolution of debts has further been complicated by frequent amendments to the Code. The jury is still out on whether the Code and related enforcement mechanisms have rendered substantial benefits to the banking industry.

However, a welcome beneficiary of the Code has been the domestic and/or foreign vendor supplying goods or rendering services (Suppliers) to businesses in India. Until the introduction of the Code, Suppliers were dependent on the cash flow situation or the discretion of their customers for receiving payments. It is common knowledge that most Indian businesses rarely pay their vendors on time and quite often business losses are passed onto vendors. This severely impacts businesses by causing working capital challenges due to delayed payment cycles.

But, with the commencement of the Code, Suppliers have been empowered significantly as they can utilise the Code to their benefit to recover erstwhile bad debts. This shift of powers, in an Indian context, was demonstrated best by the recent case of Reliance Communications settling Ericsson SA’s outstanding dues of approximately USD 67.42 million. Ericsson SA was a Supplier to Reliance Communications and had initiated the process under the Code as an operational creditor to recover unpaid dues. Under the Code, Suppliers are categorised as operational creditors.

An ‘operational creditor’ can initiate an insolvency process against a defaulting corporate for unpaid dues. “Operational Creditor” means a person (either foreign or domestic) to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred. “Operational Debt” would include a claim from a domestic or foreign vendor for supply of goods or services. Most domestic and foreign Suppliers would be covered within the definition of the term ‘operational creditor’.

Under the Code a defaulting customer (Corporate Debtor) will suffer severe consequences if an operational creditor’s claim is admitted by the Tribunal. Once the operational creditor’s claim is admitted, the controlling persons of the Corporate Debtor lose control of the business! The control of such a defaulting customer is immediately entrusted with a professional called the Interim Resolution Professional / Resolution Professional (Resolution Professional). The Resolution Professional is then required to either remedy the defaulting customer’s business by way of a third party take over or liquidate the business assets. Either of the options are meant to ensure that all creditors of the Corporate Debtor receive their unpaid dues to the extent possible.

Below, we have explained the steps for a Supplier to file a proceeding with the Tribunal and its advantages over conventional civil remedies in India.

When can a Supplier become eligible to proceed under the Code against a defaulting customer?

Before initiating any steps under the Code, the Supplier should check certain important points to avoid the claim from being rejected by the Tribunal.

  • The unpaid amounts should be with respect to supply of services or goods.
  • The unpaid amount should be in excess of INR 1,00,000 (approx. USD 1,400).
  • The unpaid amount should have become due and payable to the Supplier either by way of a contract or express acknowledgement by the defaulting customer for payment on a particular date.
  • The defaulting customer (client or consumer) should not have raised any dispute on the Supplier regarding the invoice, goods or services in question before the formal notice under the Code is sent. Existence of a genuine dispute prior to sending the formal notice will lead to rejection of the claim by the Tribunal.
  • The debt in question should not be older than 3 years.

The validity of a Supplier’s claim will be dependent on the facts and circumstances of each matter. But, a positive confirmation on the above points will ensure a higher degree of success in sustaining the claim.

Can all defaulting customers be made accountable under the Code?

The provisions that are currently operative, can be used only against companies, limited liability partnerships (LLP) and other body corporates. Body corporates would include any other statutory organizations or entity which is different from its stake holders. If a Supplier has unpaid dues against a partnership firm, proprietorship firm or such other unincorporated association of persons, they cannot initiate action against them under the currently operative provisions of the Code.

How long does the recovery process take?

Practically, if the Supplier has a legitimate undisputed debt, the defaulting customer would approach the Supplier to settle the outstanding dues, once an application is filed with the Tribunal. However, many Indian businesses attempt to defend the proceedings before the Tribunal and the matter could proceed for anytime from 2 months to 6 months until the settlement of the claim / admission of insolvency application. Settlement of the claim even within a year, is also a significant advantage compared to the timelines under any other conventional civil action in India. Enforcement in India is notoriously slow and conventional methods rarely offer any advantage to an unpaid Supplier.

What is the process for recovery?

The first step to initiate proceedings under the Code against a Corporate Debtor is to issue a statutory notice to the defaulting Corporate Debtor in a format prescribed under the Code. Within 10 days if the Corporate Debtor does not repay the dues, the Supplier can initiate proceedings by filing an application with the Tribunal for resolution of the debt. A significant advantage of the process under the Code is that any frivolous counter claim or dispute raised by the Corporate Debtor after receipt of the statutory notice is usually disregarded by the Tribunal.

Which Tribunal should a supplier file his claim in?

The Supplier should file the application before the Tribunal which has jurisdiction over the area in which the Corporate Debtor’s registered office is located. The jurisdiction of all the Tribunal benches is listed on the website of the Ministry of Corporate Affairs in India. For e.g. the Tribunal in Mumbai has the jurisdiction to hear proceedings against all companies / LLPs which have their registered office in the states of Maharashtra & Goa.

What are the statutory costs involved?

The Supplier does not have to incur significant statutory costs to initiate an application under the Code. The statutory fee payable for filing the application is INR 2,000 (approx. USD 30). Apart from this, a Supplier will have to incur costs for the professionals it engages to represent itself before the Tribunal and other general expenses for stamp duty, notarisation etc. Miscellaneous expenses other than professional fees could be in the range of INR 10,000 (approx. USD 145)

What supporting documents are required to be filed in support of the Supplier’s claim?

The Supplier in support of its claim must file the documents listed below (among others) to prove the existence of the debt and it being due and payable:

  1. a signed contract with Corporate Debtor for the supply of goods and/or services;
  2. last paid invoice / proof of last payment by Corporate Debtor;
  3. copy of unpaid invoice and/or statutory demand notice delivered to Corporate Debtor; and
  4. certificate from the banker of the Supplier that payment has not been received from the Corporate Debtor.

Is it mandatory for the Supplier to appoint a Resolution Professional?

No, it is not mandatory for a Supplier to appoint a Resolution Professional. The Resolution Professional for all Supplier / operational creditor applications will be appointed by the Tribunal, if not proposed by the applicant Supplier. The fees for such Resolution Professional are to be borne by the Corporate Debtor.

What should be the objective of the unpaid Supplier?

The Supplier should seek to settle the dues if the customer / Corporate Debtor is willing to discuss and offer a settlement. They could at the least seek to recover a negotiated amount that would allow them to offset the expenses incurred for pursuing the claim along with 75-80% (if not 100%) of their written off debt.

Other useful strategic considerations

It may not be a useful strategy to file a proceeding before the Tribunal in every situation, even though, in theory, a Supplier may have a good case to file against the Corporate Debtor. Outlined below are some practical points, among others, to consider before initiating any action:

What is the Corporate Debtor’s turnover, assets and net worth?

If the Corporate Debtor in question is already an insolvent entity, it would be a waste of time to attempt a recovery against such an entity. The chances of compelling a settlement are significant if the defaulter in question is a solvent company and has proportionately material net worth, business assets and turnover.

Have other creditors (banks or other lenders) initiated proceedings against the Corporate Debtor? Has the Corporate Debtor already been categorised as a defaulter by banks?

If other creditors have initiated proceedings against the Corporate Debtor in question, it would be more useful to file one’s claim with the already appointed Resolution Professional as opposed to initiating separate applications against the Corporate Debtor.

Is the Supplier’s debt extremely significant in comparison to the Corporate Debtor’s net worth or turnover?

If the Supplier’s debt is a significant portion of the overall debt of the Corporate Debtor, the chances of recovery get reduced. On the contrary, if the Supplier’s debt is of a proportionately low value compared to other bank and formal debt incurred by the defaulting customer, it would be a good case to pursue.

Conclusion

The Code is an empowering tool in the hands of both domestic and foreign Suppliers and can be used effectively depending on a Supplier’s fact pattern. It is a boon for businesses who were previously frustrated without a practical remedy against a defaulting customer, given the delays and costs involved in litigating before normal civil courts in India.

Most importantly the provisions of the Code will act as a disciplining tool for businesses in India, ensuring that vendor / supplier payments are managed efficiently. This will in turn prevent locking up precious working capital in all stages of the economy and allow better cash flow across businesses.

Lastly, Suppliers must bear in mind that the Code and Tribunal are beneficial only for acknowledged and undisputed debts and are not meant to be a substitute for other contract dispute resolution forums.

Ajay Joseph (Partner, Veyrah Law) and Anshu Bhanot (Of Counsel, Veyrah Law)

Views expressed above are for information purposes only and should not be considered as a formal legal opinion or advice on any subject matter therein.