A system prompting businesses to take steps to mitigate financial distress before it gets out of hand could become a feature of India’s corporate and bankruptcy law if early discussions in the government fructify, according to two persons familiar with the discussions.
The idea is to enable company executives and lenders to closely watch signals of financial distress in a company that precede a payment default and to pre-empt insolvency, the people said on the condition of anonymity. It could take some time before formal proposals are framed, as the matter requires broad-based consultations, they said.
It would add preventive action to the Insolvency and Bankruptcy Code (IBC), which is currently focused on firefighting after bankruptcy proceedings are initiated either by the creditors or the company itself. The discussions follow a suggestion by the Supreme Court while hearing a case.
Such a measure could improve economic efficiency and reduce the load on the National Company Law Tribunal, which adjudicates bankruptcy cases. Since the implementation of the IBC in December 2016, 1,194 companies have gone through resolution, enabling creditors to realize ?3.89 trillion, a third of their total admitted claims. While that is an improvement over the previous regime of debt resolution, several cases exceed the 330-day timeline specified in the law for finalizing the resolution plan.
A ‘Basel-like’ early warning framework could include early stress indicators like financial ratios, continuous disclosure obligations and sector-specific red flags that would trigger alerts well before a default, according to Mohit Adatiya, director at NPV Insolvency Professionals Pvt Ltd.
Director accountability
In terms of mandatory risk reporting, it could require directors and auditors to report signs of distress to regulators and creditors, similar to prudential banking norms, Adatiya said. Pre-insolvency mediation and restructuring would require structured platforms where promoters, creditors, and regulators can explore solutions before default escalates, he said. Also, the regulator, Insolvency and Bankruptcy Board, could consider sector-based triggers and early interventions, he said.
“What is relevant is that such a system would not only prevent defaults from spiralling but also reduce the burden on NCLTs by filtering out cases that could be resolved earlier," said Adatiya.
The apex court had, while delivering its judgment in the Mansi Brar Fernandes vs Shubha Sharma & ANR case regarding a bankrupt developer, suggested that policymakers could consider introducing early warning frameworks such as pre-bankruptcy mediation and preventive restructuring, requiring directors to initiate restructuring before defaults spiral out of control, by looking into global best practices.
The ministry of corporate affairs and the Insolvency and Bankruptcy Board of India (IBBI) are looking into this, said the person quoted above.
Queries emailed to IBBI and to the ministry on Thursday remained unanswered at the time of publishing.
The apex court-suggested early warning system could combine financial triggers like leverage levels, escrow balances, and project cash flows with operational triggers such as construction delays and regulatory bottlenecks, said Amit Maheshwari, tax partner at AKM Global, a tax and consulting firm.
“Developers would be required to file periodic disclosures with RERA/IBBI, which could be integrated into a central database. Breach of these triggers would obligate directors to initiate restructuring discussions with lenders and house allottees, or opt for pre-bankruptcy mediation, ensuring that problems are addressed before insolvency proceedings are triggered," said Maheshwari.
Legal overhaul
To operationalize this, Aditya said, there may be a need to harmonize multiple legal frameworks, including amendments to the Companies Act for director duties in reporting distress, refinements in the IBC to formally recognize pre-insolvency procedures (similar to EU’s preventive restructuring directive). It would also require coordination between the Securities and Exchange Board of India (Sebi) and the Reserve Bank of India (RBI) to align disclosure and financial reporting obligations, he said.
Along with that, according to Maheshwari of AKM Global, “RERA would require stronger disclosure and escrow-monitoring norms, while the Companies Act may need to impose a positive duty on directors to act in the face of impending insolvency, akin to wrongful trading provisions in other jurisdictions."
When the real estate cycle turns for the worse, risks arise for the entire sector, he said, adding that the heavy leverage common in the sector exacerbates the downturn. The early warning approach would shift India’s insolvency system from a reactive, crisis-driven mechanism to a preventive one, safeguarding financial stability while ensuring that homebuyers’ interests remain central, said Maheshwari.
Mukesh Chand, senior counsel at law firm Economic Laws Practice, however, suggested bringing back a legal provision from the pre-IBC era.
A “Basel-like" early warning and pre-insolvency tools suggested by the apex court are in the domain of the RBI/National Housing Bank/Housing and Urban Development Corp. and bank supervision, not the bankruptcy regulator IBBI, he said.
“We should restore a statutory duty–this was specifically built in the Sick Industrial Companies (Special Provisions) Act, 1985 (SICA), under Section 15, but has gone post the repeal of SICA–on directors to initiate restructuring (or file themselves) before defaults snowball and hold them to account when they obstruct IBC."
Since housing is largely a state subject, Chand said states must take the lead in tightening promoter screening norms, ring-fencing project escrows, and real enforcement.
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