Working out the kinks in the bankruptcy code
The human capital that surrounds the architecture of insolvency and bankruptcy code needs both a quantity and quality fix, otherwise the process will get bogged down like our civil legal system
The Insolvency and Bankruptcy Code (IBC) architecture was catapulted into action when the Reserve Bank of India (RBI), in June 2017, referred 12 large cases to the resolution process under the code. This “dirty dozen” represented about 25% of the ₹8 trillion in bad loans at that time. The total size of bad loans is expected to peak in the next few quarters at about ₹12 trillion in India. Subsequently, the RBI referred another 25 cases to the resolution process under the same process. At the same time, financial and operational creditors have together triggered the process for nearly 500 cases. IBC is being subjected to an intense baptism by fire.
IBC is a landmark legislation that consolidates several prior bankruptcy laws into one framework and decisively establishes the institutional infrastructure to administer the complex process. Even though elements of the architecture have been borrowed from committees past, it came together and was adopted as law remarkably quickly on the heels of Bankruptcy Law Reforms Committee (BLRC) in 2015. BLRC expanded the right to initiate bankruptcy from secured to unsecured creditors as well as vendors, employees and other entities (together called operational creditors). It placed the resolution professional (RP) at the centre of a “creditor in control” process. The RP is an institution or entity in turn governed by the Insolvency and Bankruptcy Board of India (IBBI) within an administrative framework. A much-debated part of the IBC code is section 29A—which is an intricate set of rules that disallows defaulting promoters and connected parties from bidding for their asset. The judicial adjunct to the IBC architecture is the National Company Law Tribunal (NCLT) and the appellate tribunal (NCLAT)—designed to adjudicate on the code and which entities get admitted to the IBC process.
The first two large cases that have emerged with a resolution are Bhushan Steel Ltd which has been bought by Tata Steel Ltd for ₹36,000 crore (35% haircut to lenders) and Electrosteel Steels Ltd acquired by Vedanta Ltd for ₹5,300 crore (60% haircut). Two other cases—Monnet Ispat (JSW/AION Capital joint bid) and Amtek Auto (Liberty House)— appear to be heading towards resolution. In all cases, including these ones, huge uncertainties remain.
Several new challenges have been opened in the NCLT and NCLAT and it is not clear how tax authorities will treat pending and evolving obligations. Additionally, there are allegations that former promoters are not allowing smooth transfer of operations.
A holistic evaluation of the entire IBC architecture has not been undertaken by any independent agency—perhaps it is premature since only a few have made it through to resolution or liquidation. Even as the architecture has become operational, some tweaks have been made through amendments and ordinances. Most critique has centered on the large haircuts that are likely to be required for resolution.
My evaluation suggests that the magnitude of the haircuts is not a major issue. These cases predated the IBC and therefore the size of both the debt and the haircuts reflects latency and non-resolution more than any fundamental problem with the code. At a high level, I would judge the IBC to be a dramatic success. It has forced an examination of large cases and has focused a sharp lens on the collusive culture of debt and forbearance between our large corporate firms and our banks. The IBC architecture has a real chance to break that corrosive culture, and early signs are that it is beginning to change the “debt hubris of founders”. It is also offering a voice to constituencies like employees, vendors and others who had no negotiating leverage before.
Where a comprehensive evaluation needs to be undertaken is the administrative complexities, the subtle incentives and the opportunity for gaming arising from inconsistencies in the law. For the record, I strongly support the disallowance of former promoters and connected parties from buying their assets on the cheap—this is a critical element of that same corrosive culture that needs to be culled. However, a sharper and more practical version of “connected parties” needs to be adopted so that 29A does not become a bottleneck. The incentives today, and the experience so far, has been to maximize the value to creditors. The committee of creditors exercises enormous control on the process. There has to be greater balance to both the sanctity of the process and the voice of other stakeholders in the resolution process. The waterfall for liquidation is clear, but the waterfall for resolution is heavily biased towards creditors and may need to be tweaked. We need to find ways (penalties and criminal action) by which the “dirty tricks department” of past promoters interferes less with their firms. And last but not least, the human capital that surrounds the architecture needs both a quantity and quality fix, otherwise the process will get bogged down like our civil legal system.
Overall, the IBC is major new reform and these are quibbles that can be fixed.
P.S. Our corporates seem to be following the ancient Charvaka saying Rinam kritvah Ghritam pibet, translated as “borrow money and eat ghee”. To which Polonius in Shakespeare’s Hamlet would have replied “neither a borrower nor a lender be, for loan oft loses both itself and friend, and borrowing dulls the edge of husbandry”.
Narayan Ramachandran is chairman, InKlude Labs. Read his earlier columns at www.livemint.com/avisiblehand
Comments are welcome at firstname.lastname@example.org
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