Almost two years ago, Parliament passed a landmark law called the Insolvency and Bankruptcy Code (IBC). This is one of the most important structural reforms of the past four years. It not only strengthens creditors’ rights, which can go a long way in resolving the current bad loans crisis in banking, but also lends transparency and predictability to the resolution process itself. Some people say that the IBC ranks on a par with industrial delicensing of 1991, the acme of reforms from those tumultuous years.
Capitalism and market economies need free entry and free exit to function efficiently. Delicensing made free entry possible, and IBC now makes exit relatively painless. It is not as if we haven’t tried to legislate how to close down businesses. The ghosts of the Board for Industrial and Financial Reconstruction (BIFR) and the Sick Industrial Companies Act (Sica) still haunt us, reminding us of failed attempts at reviving or closing down sick industries. The IBC provides a mechanism and forum that is quick in resolving or liquidating failing businesses.
Unlike under Sica, where a government board played the key role, under IBC, the key decision whether to restructure or liquidate is taken by the committee of creditors (CoC). It is here that creditors have been empowered. The CoC takes a commercial decision, collectively assessing whether a distressed firm can be revived or should be liquidated. The kingpin of the IBC is the time limit hard-coded in the law itself. From the moment an insolvency case is admitted, it has 270 days for the distressed firm to be restructured or be sold off to a new owner, or else liquidation is automatically triggered on the terminal day. Creditors thus have an inbuilt incentive to hurry if they want to extract value.
Most cases will try and avoid liquidation since it yields value even lower than the harshest hair cut of a creditors’ forum, while in a bankruptcy process, the distressed firm is as if in limbo. So time is the enemy, and any delay just destroys value that may be worth salvaging. Hence the time limit is an extremely crucial part of the new law. It is early days for the functioning of the law, but it has tasted some success, which is evident from the number of cases filed, and resolved.
The IBC empowers a creditor who is owed an amount as little as ₹1 lakh to trigger this process. The IBC also provides for the establishment of a new regulator, the Insolvency and Bankruptcy Board of India (IBBI), which regulates the process as well as the insolvency professionals and institutions, and a new class called information utilities. The IBC also led to the setting up of the National Company Law Tribunal, and its various benches, which admit cases destined for insolvency resolution.
The amendment to IBC currently being considered in Parliament relate to who can or cannot participate in the process. This reform is to prevent promoters or related parties from getting back control of their firm at a distress value. But an important reform to consider relates to something that happens even before the IBC process has begun. This is the point when the case is admitted. In the current framework, an application has to be subject to a judicial review for the case to be admitted to the insolvency process, after which the discipline of the clock starts. If a company has defaulted on its payment due to a creditor, and there is an authentic paper trail of purchase order, invoice, payment reminder notices and so on, surely admitting such a case should be an administrative matter? If you default on your phone bill, EMI on home loan or credit card payment, action follows without it landing up in court. Similarly, if a checklist approach is adopted to verify the claim of a creditor, surely the process of admission would be quicker. However, thanks to a Supreme Court judgement, the admission requires application of a judicial mind. What if the defaulting company has a counter claim against the creditor? What if there is an error in the calculation? What if the service wasn’t fully provided for which the claim is being made? What if it is a frivolous claim?
For all these reasons the apex court opined that a judicial bench should “hear out” the parties. But at this stage it can lead to untold delays by adjournments, minor objections, or simply a traffic jam of cases. Indeed there are already stories of several months of delays in merely getting cases admitted.
Furthermore, surely the kind of situations described above can largely be taken care of by a “templated approach” of filling out forms in a prescribed format. The information utilities too will play a role in minimizing such situations. Or lastly, the hearing at the admission stage can be a written hearing, and not an oral one. Or, at the very least, a short hearing, not a long one. Otherwise, unpredictable and long delays in getting cases admitted will defeat the very purpose of the law.
One is reminded of how applying for and getting a passport used to take months because it needed a lot of “application of mind” and checking for fraud. Thanks to a template approach, process reform and digitization, you get a passport in a couple of days now. The same is the approach in applying for small-ticket retail loans. A template approach reduces time drastically. It is high time we strengthened IBC by templatizing the admission process and made it largely procedural. Only in a small minority of cases will a judicial hearing and scrutiny be needed. This will go a long way in making this landmark law more effective.
Source: July 24, 2018, Livemint