Understanding the Insolvency and Bankruptcy Code (IBC) in India and its Impact

Corporate insolvency laws in India have historically been fragmented and sometimes contradictory, due to the application of an amalgamation of insolvency laws. This has caused major delays in insolvency cases, with an average resolution taking four and a half years. In light of these issues, in May 2016, India enacted the Insolvency and Bankruptcy Code ("the Code"), which was aimed at improving India's insolvency laws and adding greater certainty and efficiency to the insolvency process.

The Code has some similarities to the UK's Insolvency Act 1986, for example, the Code empowers any creditor to trigger the corporate insolvency resolution process ("CIRP") by filing an application upon a payment default. The resolution process is time bound and limited to 330 days. Only after this process has been completed can a creditor file for liquidation.

Whilst the resolution process if taking place, the powers of the directors of the debtor are suspended and a resolution professional with statutory duties manages the process. Notably, and in contrast to the UK, the ultimate control over the process is held by a committee of creditors, which comprises of all the financial creditors of the debtor.

On 12 August 2021, the government exacted the Insolvency and Bankruptcy Code (Amendment) Act 2021 to introduce the pre-packaged insolvency resolution process. This functions largely in the same way that pre-packaged administrations work in the UK, however pre-packaged insolvencies in India are available only for certain types of debtors.

According to a report from IBBI, the average time taken for a resolution process is still around 679 days, despite the time limits prescribed in the Act. This is said to be in part due to judicial intervention as the Supreme Court has held the 330-day timeline to be "advisory," as opposed to mandatory.

Furthermore, litigation by multiple stakeholders with competing interests delays resolution and ultimately erodes the value of corporate debtors and in turn, recovery to creditors. However it is not all doom and gloom. According to the same report, "FY23-24 has witnessed an unprecedented surge in the approval of resolution plans under the IBC." 269 resolution plans were approved in 2024, in contrast with 189 in 2023.

To fully understand India's financial landscape, it's important to address the factors that contribute to financial instability in key sectors, such as the power distribution industry.

Financial Distress in the Power Sector: A Case Study of Discoms

For several years now, electricity distribution companies (discoms), which are mostly state-owned, have witnessed steep financial losses. Last week, the Power Finance Corporation reported that state-owned power distribution companies across the country made financial losses amounting to Rs 68,832 crore in 2022-23. This is four times higher than the losses witnessed in 2021-22, and roughly equivalent to the annual budget of a state like Uttarakhand. Between 2017-18 and 2022-23, losses accumulated to over three lakh crore rupees.

In 2021-22, discom witnessed substantial reduction in their losses, primarily because states released 1.54 lakh rupees in subsidies to clear pending dues. State governments provide discoms with subsidies, so that domestic and agricultural consumers receive affordable power. These payments are typically delayed which creates cash flow constraints, and leads to an accumulation of debt. As of 2022-23, losses have increased again to reach Rs 68,832 crore. This increase has been driven by rising costs.

Note: Data from 2020-21 onwards does not include Odisha, and Dadra & Nagar Haveli and Daman and Diu since their distribution function was privatised in 2020-21. Data for Ladakh is available from 2021-22 onwards. Data for Jammu and Kashmir is not available.

In addition, losses reported in the generation sector have also increased. In 2022-23, state-owned gencos reported losses worth Rs 7,175 crore, as compared to the Rs 4,245 crore in 2021-22. Rajasthan accounted for 87% of these, at Rs 6,278 crore.

Key Factors Contributing to Discom Losses

Discoms witness persistent financial losses due to certain structural issues. Their costs are typically high because of old contracts with generation companies (gencos). Power purchase costs in these contracts do not account for production efficiencies over the years, and costs remain unchanged. Tariffs are only revised every few years, to ensure that consumers are protected from supply chain shocks. As a result, costs are carried forward for a few years.

In addition, discoms sell electricity to certain consumers such as agricultural and residential consumers, below cost. This is supposed to primarily be recovered through subsidy grants provided by state governments. However, states often delay subsidy payments leading to cash flow issues, and accumulation of debt. In addition, tariff recovery from the power sold is not optimal.

Purchase of electricity from generation companies (gencos) forms about 70% of a discom’s total costs, and coal is the primary source for generating electricity. In 2022-23, demand for electricity increased by 10% over 2021-22. Between 2008-09 and 2018-19, demand increased at an annual growth rate (CAGR) of 6%. Electricity demand grew as the economy grew (at 7%), and largely came from domestic and agricultural consumers.

Electricity cannot be stored at scale, which means that generation must be scheduled depending on anticipated demand. The Central Electricity Authority anticipates annual demand for each year. It estimated that demand in 2022-23 would be at 1,505 billion units. To meet this demand, electricity generation had to be ramped up.

Coal stocks had already depleted from 29 million tonnes in June 2021 to eight million tonnes in September 2021, on account of high demand in 2021-22. To ensure uninterrupted supply of power, the Ministry of Power directed gencos to import coal. Coal imports rose by about 27 million tonnes in 2022-23. While this constituted only 5% of the overall coal used in the sector, the price at which it was imported significantly impacted the sector.

In 2021-22, India imported coal at an average price of Rs 8,300 per tonne. This rose to Rs 12,500 per tonne in 2022-23, a 51% increase. Coal was primarily imported from Indonesia, and prices shot up due to the Russia-Ukraine war, and demand surge by countries like India and China.

In January 2023, the Ministry of Power advised gencos to import 6% of the required coal, to ensure sufficient stock until September 2023. It noted that due to floods and variable rainfall in various parts of the country, hydro generation capacity reduced by about 14%. This put additional burden on coal based thermal generation in 2023-24. Following this, in October 2023, the Ministry directed all gencos to continue using at least 6% imported coal until March 2024.

Impact on State Finances

Persistent financial losses, high debt and guarantees extended by states continue to pose a risk to state finances. These are contingent liabilities for state governments, i.e., in the event a discom is unable to repay its debt, the state would have to take it over. Several such schemes have been introduced in the past to bail discoms out (See Table 1). As of 2022-23, discoms have an outstanding debt worth Rs 6.61 lakh crore, 2.4% of the national GDP. Debt is significantly high in states such as Tamil Nadu (6% of GSDP), Rajasthan (6% of GSDP), and Uttar Pradesh (3% of GSDP). Previous Finance Commissions have recognised that strengthening discom finances is key in minimising the risk to state finances.

Note that under the Late Payment Surcharge Rules, 2022, discoms are required to make upfront payments to gencos.

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