It’s three years since Parliament passed the Insolvency and Bankruptcy Code (IBC) and about 30 months since the first case was filed under the new law. It’s the landmark reform of the past five years and has boosted India’s rankings in the World Bank’s ease of doing business. But the track record in bad loans resolution has been less than satisfactory owing to a variety of factors. Cases are mired in litigation, timelines haven’t been adhered to, the law itself has been amended a couple of times, and the bankruptcy infrastructure hasn’t been ramped up as needed for quicker and effective resolution. Still, the fact remains that IBC was a much-needed, long-awaited reform which, despite warts and all, is an improvement over the previous tools available to creditors to recover their money from defaulter.
The IBC’s promise can be summed up thus: When a defaulting company is taken to bankruptcy court, its management passes on to a resolution professional. If resolution doesn’t take place within 180 days (plus a 90-day grace period), the defaulter is sent to liquidation.
What it does is shift the balance of power from the debtors to creditors. Promoters who held banks to ransom by refusing to pay up their dues could no longer do so simply because they stand to lose their company. The IBC ensured that promoters no longer have any rights over their firms after mismanagement. This naturally helps instill better credit discipline and helps release capital for banks.
As M S Sahoo, chairman of the Insolvency and Bankruptcy Board of India (IBBI) has said, one of the biggest successes of the IBC is the behavioural change it has induced in corporate debtors. The Supreme Court judgement earlier this year which upheld the constitutional validity of the bankruptcy law adds teeth to the IBC.
Moreover, it’s not only banks which can trigger the IBC. Employees, vendors, distributors and other operational creditors can take a firm to court for unpaid dues. When creditor rights are strengthened, it helps deepen the corporate bond market as well. For entrepreneurs, the IBC offers a easy and quick route for winding up their business.
That’s the theory anyway. In practice, the IBC has had teething troubles common for new laws. But the net result is that bad loan resolution is still not taking place as quickly as envisaged in the law.
According to Kotak Institutional Equities’ analysis of IBBI data, a total of 1,858 cases have been registered under the IBC by 31 March 2019. Of this, 378 cases have been closed through liquidation while only 94 cases have been resolved with an average haircut of 52 percent.
What’s more, one in every three of the 1143 cases currently undergoing resolution has exceeded the 270-day outer limit. That includes majority of the big 12 cases – with outstanding dues of Rs 3.45 lakh crore. Some like Essar Steel have crossed 600 days. All this means delayed release of capital for banks.
Almost one in two cases have exceeded 180 days. Even liquidation is taking time. For the 378 cases, that have been admitted to liquidation, the final report (saying that the process has been closed) has been submitted for only 16 cases. In 278 out of the 362 ongoing liquidation cases, the process has been going on for at least six months.
The tardy resolution is hobbling the bankruptcy code. As these pages have pointed out earlier, inadequate institutional infrastructure and two key amendments to the code, have been the key culprits.
Let’s look at the amendments first. In the first one in November 2017, Section 29 A was introduced. It barred defaulting promoters to bid for assets under the IBC unless they cleared their dues. In June 2018, a second amendment allowed withdrawals of cases provided 90 percent of the creditors agreed. It also allowed MSME promoters to bid for their companies, regardless of defaulting status, and said that home buys should be treated on par with financial creditors.
These amendments are no doubt, well-intentioned, but they have not been thought through properly. That’s especially the case with Section 29 A where a wide net of related and connected parties has led to a lot of litigation. The law does not seem to differentiate between defaulters who defaulted in the ordinary course of business and those who are guilty of fraud and siphoning of funds.
The bankruptcy courts have also not made things easier by sometimes entering the realm of commercial decisions and taking it upon themselves to ensure optimal resolution even if it means overstepping their remit. There have been cases when tribunals have allowed last minute bids, permitted withdrawal of cases after the resolution processed ended and so on. This is despite the law clearly stating that an application can be withdrawn only before expressions of interest are submitted.
A more recent example is the National Company Law Appellate Tribunal’s suggestion that the committee of creditors for Essar Steel rethink on how funds should be distributed to operational and financial creditors.
As these pages have said earlier, some of these judgments have set a precedent which provide the basis for escalating litigation and added to the delays.
Inadequate infrastructure has been another factor causing delays. For a long time, the 12 benches of NCLT had only 16 judicial members and nine technical members. Earlier this month, the government okayed the appointment of 32 new members to the NCLT, more than doubling its strength. This is a welcome and long overdue move.
Besides this, “digitisation of the NCLT/NCLAT platform, proactive training/on-boarding of judges, lawyers and other intermediaries will be necessary for effective implementation of the code,” said a report by Crisil and Assocham.
A related area is that of information utilities (IU) which provides access to credible and transparent evidence of default. Currently, only one IU, the National eGovernance Services Ltd (NSeL), is registered.
“Without proper IU infrastructure, the NCLT gets involved in evaluating whether a default has taken place; this can be a time-consuming process and eats into the bandwidth of NCLT,” said the Crisil report. “Further, in the absence of IUs, the formation of committee of creditors may take longer.
There is still a long way to go for a comprehensive bankruptcy law in India. For instance, as MS Sahoo has pointed out in the recent newsletter of IBBI, it is time to focus on individual insolvency. Group insolvency and insolvency related to financial corporations is another area.
Even in the existing corporate insolvency resolution process, innovations should be considered. Last month, the ministry of corporate affairs issued a notice seeking public views on group insolvency and pre-packaged insolvency resolution. In a pre-pack, a defaulter arranges to sell all or some of its assets to a buyer – with the blessings of its lenders – before declaring insolvency. It then files this resolution plan with the National Company Law Tribunal for the court’s approval. Such a mechanism will speed up the resolution process since much of the work is done before approaching the tribunal and relieve the pressure on the NCLT infrastructure.
Of course, such a system can be prone to abuse and needs to be thought through carefully, especially features such as the transparency of the bidding system, treatment of operational creditors, selling it to NCLT and bankers who have been reluctant to take creditors to bankruptcy and so on. But given the delays we have seen and the value destruction that has happened, the time seems right to serious consider taking the next steps to improve the IBC.
Source: MoneyControl, May 10, 2019