The story so far: Speaking at the sixth anniversary of the Insolvency and Bankruptcy Board of India (IBBI) on October 1, Union Finance Minister Nirmala Sitharaman said that the country could not afford to lose the “sheen” of its insolvency law, the Insolvency and Bankruptcy Code (IBC).
“We must be conscious that we can’t afford IBC to lose its sheen, especially when the Prime Minister is looking at the next 25 years of India (to emerge as a developed country by 2047). We must do whatever it takes to keep IBC as sparkling as it was when it was introduced in 2016,” the Minister said, at a time when IBC numbers have shown long delays in cases and banks having taken deep haircuts on their outstanding claims.
Addressing the issue of haircuts— the debt that banks forgo— she said it was unacceptable that banks should take a hefty haircut on loans that go through the resolution process, adding that a 95% haircut could not possibly be the “best resolution” the IBC had to offer, even if some companies came in such a bad state that only ‘junk value’ could be derived.
What is the Insolvency and Bankruptcy Code (IBC)?
In a growing economy like India, a healthy credit flow and generation of new capital are essential, and when a company or business turns insolvent or “sick”, it begins to default on its loans. In order for credit to not get stuck in the system or turn into bad loans, it is important that banks or creditors are able to recover as much as possible from the defaulter and as quickly as they can.
The business can either get a chance, if still viable, to start afresh with new owners, or its assets can be liquidated or sold off in a timely manner. This way fresh credit can be pumped into the system and the value degeneration of assets can be minimised.
In 2016, at a time when India’s Non-Performing Assets and debt defaults were piling up, and older loan recovery mechanisms such as the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI), Lok Adalats, and Debt Recovery Tribunals were seen to be performing badly, the Insolvency and Bankruptcy Code (IBC) code was introduced to overhaul the corporate distress resolution regime in India and consolidate previously available laws to create a time-bound mechanism with a creditor-in-control model as opposed to the debtor-in-possession system.
When insolvency is triggered under the IBC, there can be two outcomes: resolution or liquidation; all attempts are made to resolve the insolvency by either coming up with a restructuring or new ownership plan and if resolution attempts fail, the company’s assets are liquidated.
What is the process followed under the IBC?
When a corporate debtor (CD), or a company which has taken loans to run its business, defaults on its loan repayment, either the creditor (a bank or an entity that has lent money for operational purposes) or the debtor can apply for the initiation of a Corporate Insolvency Resolution Process (CIRP) under Section 6 of the IBC. Earlier, the minimum amount of default after which the creditor or debtor could apply for insolvency was ₹1 lakh, but considering the stress on companies amid the pandemic, the government increase the minimum amount to ₹1 crore.
To apply for insolvency, one has to approach a stipulated adjudicating authority (AA) under the IBC— the various benches of the National Company Law Tribunal (NCLT) across India are the designated AAs.
The Tribunal has 14 days to admit or reject the application or has to provide a reason if the admission is delayed. The CIRP or resolution process begins once an application is admitted by the AA. The amended mandatory deadline for the completion of the resolution process is 330 days.
Once the application is admitted, the AA appoints an interim resolution professional (IRP), registered with an insolvency professional agency (IPA). IRPs could be experienced and registered chartered accountants, company secretaries, lawyers and so on. Once appointed by the Tribunal, the IRP takes control of the defaulter’s assets and operations, collects information about the state of the company from Information Utilities (repositories keeping track of the debtor’s credit history), and finally coordinates the constitution of a Committee of Creditors or a CoC.
A CoC, comprising all (unrelated) financial creditors of a defaulting company, is the most important business decision-making body in every CIRP, as it decides whether the defaulting company is viable enough to be restructured and given a fresh start, or liquidated. It also appoints an insolvency professional (IP), who can either be the same as the IRP or a new professional, who looks after the operations of the company during the CIRP.
The IP invites and examines proposals for a resolution plan for a company, which could include restructuring of debt, merger or demerger of the company. It submits eligible plans to the CoC, which can approve a plan if it receives 66% of the voting share of committee members. If the CoC fails to approve any resolution plan, the company goes for liquidation.
If a plan is approved, the CoC submits it to the Tribunal (before the maximum 330-day deadline), which then approves the plan which the debtor is bound to implement. The AA can also reject a plan.
In July this year, the IBC was amended to introduce pre-packs or pre-pack insolvency resolution process (PIRP) for Micro, Small, and Medium Enterprises (MSMEs).. Under a pre-pack resolution, creditors and owners of a business agree out-of-court to sell the business to an interested buyer. The buyer may be a third party or someone related to the business. The current law limits the pre-pack resolution mechanism to defaults not exceeding Rs. 1 crore
What are the challenges for the IBC?
According to its regulator, the Insolvency and Bankruptcy Board of India (IBBI),the first objective of the IBC is resolution— a way to save a business as a going concern, through restructuring, change in ownership, mergers and other methods. The second objective is to maximize the value of assets of the corporate debtor and the third objective is to promote entrepreneurship, availability of credit, and balancing the interests. The Code says that the order of these objectives is “sacrosanct”.
Keeping this order in mind, when one looks at the IBBI data for the 3,400 cases admitted under the IBC in the last six years, half or more than 50% of the cases ended in liquidation, and only 14% could find a proper resolution, which is the first objective. While the situation was better in 2016 and 2017, since 2018, a majority of the cases ended in liquidation in most of the quarters while cases for which resolution plans were approved ranged between 15% and 25%.
The IBC was touted as a time-bound mechanism in the face of the often laggard states of older mechanisms. Timeliness is key here so that the viability of the business or the value of its assets does not deteriorate further. The IBC initially stipulated a 180-day deadline to complete the resolution process, with a permitted 90-day extension.
The IBC was subsequently amended to further make the total timeline for completion 330 days— almost a year. While in 2018, when the timeline was 180+90 days, most cases (from companies that owed less than ₹50 crore to those which owed more than ₹1000 core) were completed in under 300 days. However, in FY22, it took 772 days to resolve cases involving companies that owed more than ₹1,000 crore. The average number of days it takes to resolve such cases increased rapidly over the past five years, experts said.
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Credit: The Hindu Data Team
Besides, when a resolution happens, it is envisaged that creditors can realise the maximum value of the outstanding claims. On the other hand, when liquidation takes place, it is a piecemeal selling of the company’s assets. This means the value realisable through resolution should be more than through the last resort of liquidation.
But the gap between these two values has been narrowing over the years, and in the last quarter of 2022, the amount realised fell below what the assets would have fetched if they were liquidated.
A haircut is the debt foregone by the lender as a share of the outstanding claim. The Parliamentary Standing Committee on Finance pointed out in 2021, that in the five years of the IBC, creditors on an average had to bear an 80% haircut in more than 70% of the cases. (The chart shows the share of haircuts taken by the lenders)
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Credit: The Hindu Data Team
As per The Hindu Data Team’s analysis, in close to 33 of 85 companies so far that owed more than ₹1,000 crore, lenders had to take above 90% haircuts. In case of the resolution of the Videocon Group for instance, creditors bore a haircut of 95.3%. While it is very possible that companies, by the time they enter the IBC process, are already in a defunct state, Ms. Sitaraman pointed out that creditors cannot be made to forgo 95% of their claims.
There are also other challenges to the IBC, some of which were pointed out by the Standing Committee. These were related to the conduct of the CoCs and the IPs. The Committee stated that the committee of creditors has significant discretion in accepting resolution plans and appointing IPs and called for more transparency and the framing of a professional code of conduct for the CoC.
For insolvency professionals, the Standing Committee noted that Insolvency Professional Agencies (IPAs) and the IBBI took disciplinary action on 61% of the 203 professionals inspected since 2016, adding that considering the important role of IPs, there should be a single regulator for them to ensure best practices and transparency.
What recommendations have been made by experts and judicial authorities?
In order to address the delays, the Parliamentary Standing Committee suggested that the NCLT should not take more than 30 days after filing, to admit the insolvency application and transfer control of the company to a resolution process. Citing the more than 50% vacancy in the Tribunal compared to the sanctioned strength, it suggested recruitment in advance based on the projected number of cases.
It also recommended the setting up of dedicated benches of the NCLT for IBC cases. To reduce case loads,the Committee suggested that the pre-packs option be extended to all corporates after review. This is because, under PIRP, unlike CIRP, the debtor continues to manage company operations during the resolution process.
The IBBI has also called for a new yardstick to measure haircuts. It suggested that haircuts not be looked at as the difference between the creditor’s claims and the actual amount realised but as the difference between what the company brings along when it enters IBC and the value realised. It asserts that a company may have already deteriorated significantly in value by the time it comes under the Code’s process, so the value realised should pertain to the company’s existing assets and not previous assets.