We seem to have lost sight of the laudable objective of reviving an entity and turned phase I of the insolvency process into a bidding battleground.
The Insolvency and Bankruptcy Code (IBC) of 2016 was meant to signal a break from the past. While there were larger macroeconomic objectives at play, such as solving the “twin balance-sheet problem”, developing a robust corporate bond market, improving the credit environment and, consequently, providing a fillip to India’s competitiveness as a business destination, the new code was designed to introduce a streamlined, two-step corporate insolvency process which, among other things, prevented “value destruction in corporate distress”.
The Banking Law Reforms Committee (BLRC) consciously conceived two phases in the resolution process. Phase I being a “calm period”, which would be for collective negotiation to reassess the viability of the debt in a manner that protects the creditors’ interest without disrupting the functioning of the enterprise. When this fails, phase II is triggered, and the enterprise enters the bankruptcy process, potentially triggering liquidation or change in owners.
The design of the IBC, therefore, sought to usher in what Roy Goode describes as a “rescue culture”, protecting, among other things, the organizational capital, as noted by the BLRC. Stripped of jargon, this basically recognizes that the existing structure of a firm, and the underlying knowledge, experience and culture shall form an integral part of its value, which can best be unlocked in the hands of new owners and management. This is, indeed, the best way to achieve “maximization of value of assets” undergoing insolvency, as laid out in the preamble to the code. Also, while preserving the interests of creditors, the approach looks to “balance the interests of all the stakeholders” which would, arguably, include tangible and intangible assets of an enterprise.
However, we seem to have lost sight of the laudable objective of reviving an entity—a solution which is both economically efficient and morally correct (particularly from the perspective of employees, customers and vendors)—and turned phase I of the insolvency process into a bidding battleground, prompting promoters and disgruntled applicants to approach courts, and clamour to arm the National Company Law Tribunal (NCLT) with powers beyond the statute.
First, we need to remember that the IBC does not contemplate an auction or bidding process. In the present design, the insolvency resolution professional (RP), under Section 29, prepares an information memorandum as a guideline for preparation of a resolution plan. Based on such memorandum, “resolution applicants” (who some have erroneously labelled as “bidders”) come forward with resolution plans. Each resolution plan is cleared by the RP based on a set of parameters enshrined in Section 30(2) of the code. Thereafter, each plan is placed before the committee of creditors (CoC), which is not expected to conduct an auction. This would confuse the CoC process with the auction of a corporate debtor’s assets in liquidation. When the CoC votes to approve a liquidation plan, it must not only consider the monetary value of the fund infusion offered by a resolution applicant, but also keep in mind a multitude of other factors to decide as to which resolution plan is best for the “future prospects” of the enterprise in question. This approach best serves the creation of a “rescue culture” in our legal system.
Second, the adjudicator’s role under IBC is limited. When the resolution plan is approved by the CoC (based on 75% voting share), it goes before the adjudicating authority, i.e. the NCLT, which, based on a conjoint reading of Section 30(2) and 31, merely has to ensure that the list of requirements set out in Section 30(2) is fulfilled, and cannot second-guess the consensus of the CoC. The NCLT cannot and should not weigh competing resolution plans, and attempt to decide disputes between resolution applicants. That would amount to usurping the function of the CoC, and interfering with their consensus and the process followed by the RP. Such interference would, without doubt, destroy the streamlined and time-bound design of the insolvency code, consigning the law to the same fate as SARFAESI (Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act) and the creaking Debt Recovery Tribunal system. Unfortunately, recent events show that the NCLT is already treading down this path, undermining the RP and putting its thumb on the scales of the resolution process by forcing the CoC, in individual cases, to revise its previous consensus.
Finally, to protect the integrity of the process and ensure revival, promoters responsible for driving the enterprise into indebtedness in the first place are kept at arm’s length. An important step in this direction was taken with the insertion of the new Section 29A preceded by an ordinance, which views the promoter of a corporate debtor with suspicion, and bars such promoter from submitting a resolution plan (unless all debts are cleared prior in time, with interest). Apart from preventing promoters from assuming control by offering to pay off creditors, the NCLT should exercise caution to prevent the corporate debtor itself from subverting the IBC process by entering into out-of-court settlements, as this would amount to allowing the corporate debtor to illegally assume management powers that are vested in the RP. One of the fundamental underlying principles of insolvency law the world over is that, on initiation of the insolvency process, the corporate debtor ceases to be the beneficial owner of its own assets and the promoter of management. Out-of-court deals between corporate debtors and third parties would turn the law on its head.
It is now for the regulators, the courts and the stakeholders to preserve our new system, instead of eviscerating the possibility of corporate rescue and revival through long-drawn legal battles during the first phase of the insolvency process.