Five Reasons IBC Is Less Effective Than It Could Be

Three years ago, the government passed a consolidated framework for insolvency and bankruptcy. The objectives of the code were clear—resolution of corporate entities, partnership firms and individuals in a time-bound manner for:Maximisation of value of assets.Promoting entrepreneurship, availability of credit.Balancing the interests of all stakeholders.But 30 months and 1,858 cases later, the jury is still out on the success of the IBC in achieving these goals. Yes, some 700 cases stand closed, as per data on the Insolvency and Bankruptcy Board website, but of those 152 were closed on appeal or review or settled, 91 withdrawn, 378 have ended in liquidation and 94 have ended in approval of resolution plans. 1,143 cases are still ongoing.Delays, unending litigation, inconsistent judicial interpretations...the efficacy of the law has suffered for many reasons and new proposals might add to the pain.BloombergQuint compiled a list of key issues that have or could dilute the effectiveness of the IBC. They are:Timelines under the IBC might be sacrosanct, but often only on paper.Insolvency withdrawal mechanism: from non-existent to highly flexible.Court interference in amending an agreed-upon resolution plan.Liquidation hesitation and the effort to give companies a second life.Promoters barred under Section 29A, but only until liquidation..1. Compromised Timelines.Under the IBC, a company has 270 days at the most to resolve its debt. Within such time, if the committee of creditors can't agree to a resolution plan, the company immediately goes into liquidation. This deadline was meant to be sacrosanct given that it’s specified in law and linked to the first objective of “time bound” resolution.But this objective has often remained unmet..IBBI data shows that a third of all pending cases have crossed the 270-day deadline. .Of 12 large accounts referred to insolvency by banks, under directions of the Reserve Bank of India, in June 2017, resolution plans have been approved in only six cases so far. These are high-value cases, adding up to an outstanding claim of Rs 3.45 lakh crore, and yet they have dragged on and on.For instance, Essar Steel Ltd. has now been in insolvency for close to 700 days, Bhushan Power & Steel Ltd. for over 650. Even among the six that have been resolved, many exceeded the 270-day deadline.The main reason for this is unending litigation. Thanks to orders by both the appellate tribunal and the Supreme Court, litigation time is now deducted from the 270-day deadline, thereby sparing these companies from liquidation as long as some case or the other remains pending..A reasonable and balanced construction of this statute would, therefore, lead to the result that, where a resolution plan is upheld by the Appellate Authority, either by way of allowing or dismissing an appeal before it, the period of time taken in litigation ought to be excluded.Supreme Court - Essar Steel Case.When the statutory timeline isn't met or the corporate insolvency resolution process period takes longer than 270 days, lenders lose large quantum of money through interest on loans, which cannot apply while moratorium is in effect, Rajkumar Bansal, managing director and chief executive officer of Edelweiss Asset Reconstruction Company, told Bloomberg Quint. Edelweiss is one of the lenders to Essar Steel.Delays can also result in many uncertainties, specifically in respect of buyers, Bansal said. During the course of the insolvency, the industry itself can undergo a change. The steel industry, for example, isn't as robust as it was one year ago, he said, adding that this may lead to the bidder losing interest or having second thoughts about the value of its investment. “The value of assets also drops significantly over time if the company isn't operational.”Breach of the timelines certainly has an impact on value realisation, L Viswanathan, partner at law firm Cyril Amarchand Mangaldas, told Bloomberg Quint. However, the Indian insolvency code is a new law and it takes time for jurisprudence to develop on various features of the code. The implementation process will become more efficient and fast for future cases, with less time spent on litigation, he added.Viswanathan also said it was necessary that the litigation period be excluded from the resolution process period considering the time taken by the National Company Law Tribunal to resolve cases on account of huge volume of litigation being dealt by it.Bahram Vakil, founding partner of law firm AZB & Partners, and also a member of the Bankruptcy Law Reform Committee which drafted the Code, agreed, saying there is over-criticism on this issue. Partly because some high-profile cases like Essar Steel have overshot the deadline substantially. But that's not true for most cases, he said..The fact of the matter is that until now the average time for resolution under CIRP is 310 days. We have not managed the 270-day period timeline because I think the courts, very judiciously and only if it’s required, stopped the clock.Bahram Vakil, Founding Partner, AZB & Partners.Keep in mind that this is as good as timelines in other OECD countries in the world such as Canada and USA that have had an insolvency framework for much longer, the USA average is 328 days, Vakil pointed out. “So we have gone from six-seven years to 310 days in two years.”The reason for delay in some cases can still be attributed to various legal questions and principles being settled before courts and tribunals. Once these legal issues get clarified, this will end up saving time for the cases to come, he explained..2. Open-Ended Withdrawal.At the time of its legislation the IBC did not have any provision for withdrawal of an insolvency resolution petition once it was admitted by the NCLT. In the absence of this, only the Supreme Court had the power to allow withdrawal.Then, in August last year, the Code was amended to permit withdrawals. Alongside, the IBBI amended appropriate regulations to provide that such a withdrawal may only take place before the resolution professional invites expressions of interest from bidders.But the Supreme Court, in the Brilliant Alloys case, ruled that withdrawal in exceptional cases must be allowed even after issue of invitation for expression of interest. Recently, the BLRC has also recommended withdrawing an insolvency petition anytime in “exceptional cases”.This portion of the IBBI regulation was struck down because the court required this condition to be imbibed in the Code itself, Vakil said. In my view, it must be reintroduced, either as an amendment to the Code or by the Supreme Court laying it down as law, he added..There needs to be a cut-off time to preserve the sanctity of the process and ensure that money, time and efforts aren’t wasted needlessly. If withdrawal is allowed at any time, it may deter serious bidders from evaluating distressed companies under the IBC.Bahram Vakil, Founding Partner, AZB & Partners.Bansal also pointed to loss in bidder interest due to anytime withdrawal..If a bidder has shown serious interest in an asset, he has invested significant time, money and effort. If promoter can settle at any stage then the bidders will not really be vested or interested. Rajkumar Bansal, MD and CEO, Edelweiss Asset Reconstruction Company.While the courts and tribunals may say it's only for exceptional cases, it will be very difficult to define this term, Bansal said. Secondly, in such cases, the promoters unduly benefit from bidders’ hard work to come at the right valuation. The earlier rule of not allowing withdrawal post expression of interest invitation is ideal, he explained.But withdrawal of an insolvency resolution is permitted by law only if 90 percent of the Committee of Creditors vote in favour. That is a good safeguard said Viswanathan.Once pre-packs are permitted, settlements are likely to go through that process rather than a withdrawal simplicitor, he added.Pre-packs are an arrangement under which the restructuring of the company and its debts is negotiated with the creditors before initiating insolvency formally..3. Court’s (Undue) Interference.While the IBC’s mandate is to balance the interest of all stakeholders, the code makes clear the credit hierarchy. The code is a clear ‘creditor in control’ legislature, but only to the extent the creditor is financial. The committee of creditors, responsible for making all key decisions in the insolvency stage, comprises only financial creditors. Operational creditors have no say nor voting rights when the committee decides on matters involving running the asset or approving a resolution plan, not even on the terms on which operational creditors get paid. In liquidation, secured financial creditors have priority in payment while unsecured financial creditors and operational creditors are subservient and in par.In the K Sashidhar case, the Supreme Court said that it's entirely the discretion of committee of creditors to approve or reject a resolution plan. The NCLT has no jurisdiction nor the authority to evaluate commercial decisions of the committee of creditors, the apex court said..Yet, in the Essar Steel case the NCLT and NCLAT have intervened to determine repayment to operational creditors, who’ve petitioned the tribunals saying the committee of creditors has denied them adequate repayment..“.. This Adjudicating Authority can very well advise to the Resolution Professional and the CoC to relook in to its decision(s) and consider for making apportionment/ distribution of amount on pro-rata basis on all admitted claim of all financial creditors including the present applicant and it can work out for a reasonable formula for percentage of payment that may be 85 percent pro-rata basis among all financial creditors and remaining 15 percent may be distributed among the Operational Creditor/ other stakeholders on pro-rata basis of their admitted dues/claims..”.Representing the views of the lenders, Bansal said the courts’ interference in the commercial aspects of the IBC is excessive..The issue of how much and when the courts and tribunals can intervene needs to be decided once and for all. To my mind, CoC is rightly placed to account for the interests of all stakeholders. But no system can be perfect, if you leave it entirely up to creditors to decide without oversight, then creditors with subservient security interest and operational creditors will inevitably want to challenge their decisions. Rajkumar Bansal, MD and CEO, Edelweiss Asset Reconstruction Company.On the other hand, Viswanathan believes the courts are not interfering but rather ensuring that IBC objectives are fulfilled..The judiciary has advanced the objectives of the Code (including value maximisation, balancing interest of stakeholder, revival over liquidation). It has introduced checks and balances when the stakeholders do not perform their functions as per the Code.L Viswanathan, Partner - Finance & Projects Practice, Cyril Amarchand Mangaldas.This is a very vexed but critical issue, Vakil said. The architecture of the law is clear that the CoC has the final decision on commercial decisions including the haircut agreed to for different classes of creditors. The idea was that tribunals and courts should not get into this at all, subject to some equity and fairness, he explained. If a payout proposal has been arrived at through material irregularity or is patently unfair in treating similarly placed creditors, then the courts may intervene. However, if the courts interfere in the commercial judgement of the committee of creditors it would be in violation of the law laid down by the Supreme Court in K Sashidhar case (described above), he said.At least in the Essar Steel case, this litigation by operational creditors and the courts decision to review the resolution plan has added to the delay in insolvency resolution..4. Liquidation Hesitation.While a large number of cases are in liquidation, 378 according to IBBI data, most of them are legacy cases from the erstwhile Board for Industrial and Financial Reconstruction, or defunct.There are several IBC cases where the tribunals have been hesitant to allow liquidation. The law is clear, if insolvency resolution is not achieved in the 270-day period, liquidation is triggered.The NCLT reiterated that in the Gupta Energy case..“Code has nowhere said that the resolution has some primacy over liquidation. It is only said if resolution does not happen within the time prescribed, then it has to go for liquidation.”.But that’s not what happened, say, in the Reid & Taylor case.Even though the committee of creditors approved liquidation, the NCLT didn’t want to give up. On the basis of a plea by some employees that they’d find a suitable investor, the tribunal stalled liquidation, until finally 301 days from the start of insolvency proceedings, it permitted liquidation.In Adhunik Metaliks as well the NCLT granted the resolution professional additional time to allow the committee of creditors to consider revised resolution plan even after the 270-day deadline had been crossed..There is this explicit bias towards reorganisation and resolution and explicit bias against liquidation, Bhargavi Zaveri, senior researcher at the Indira Gandhi Institute of Development Research, told Bloomberg Quint. This is the reason for several issues faced by insolvencies and litigants, including the skewed timelines, which is the symptom of the underlying problem where you don’t want firms to be liquidated, she said..Even when liquidation is permitted, the tribunals are sometimes keen the company is sold as a 'going concern'.For instance, the insolvencies of Gujarat NRE, Reid & Taylor and Bharati Defence, after they failed, were directed to be sold as 'going concerns'..There are different stakeholders that feel that the liquidation process isn’t working as efficiently as it should. It is the majority view that to sell the viable business of an insolvent entity through a slump sale or ‘as a going concern’ will promote one—maximum realisation of value and two—save jobs, assets and business. It is important to draw the distinction—you cannot save the entity, which in liquidation gets dissolved but you can save the business, rather than a distress sale of the assets one by one.Bahram Vakil, Founding Partner, AZB & Partners.“Perhaps I am cynical, but practically I don’t see liquidation as a going concern happening,' Bansal said. “Liquidation as a going concern is nothing but asking for another resolution plan.” If the company and its business were viable, it would have received bidders at the insolvency resolution stage. In fact now, this will lead to more applications under Section 230 (schemes and arrangements) by promoters, he said..5. Promoters’ Backdoor Entry.Bansal is refering to a new route by which promoters of a corporate debtor can get their foot back in the door.The IBC’s section 29A bars promoters of defaulting companies from bidding in the insolvency resolution process. The bar applies to their participation in liquidation, too. Effectively the IBC shuts the door on promoter participation altogether once the corporate debtor is admitted to insolvency. But that door may soon swing wide open.In the SC Sekaran versus Amit Gupta case, the NCLAT allowed the erstwhile management of the insolvent company—which was then under liquidation—to propose a scheme of arrangement under Section 230 of the Companies Act. The NCLAT, in the interest of keeping the company a ‘going concern’, permitted the filing of the scheme, that allows for a compromise or arrangement with the creditors, and gave it 90 days to be completed before the liquidation process picked up again. Again in the Y Shivram Prasad case, the NCLAT noted that promoters can approach the liquidator with a compromise or arrangement under Section 230 of the Companies Act.In its recent report, the BLRC has recommended that promoters be permitted to use the company law provision to restructure the company at liquidation stage.This proposal needs to be evaluated very cautiously, Vakil said, adding that all efforts can be made to restructure the company as a going concern, as mentioned above, even in liquidation. However, the intent and spirit of section 29A of the IBC must be kept in mind, he said.It cannot be said that the effectiveness of section 29A or its intent has been watered down with introduction of withdrawal provision or option to file scheme post liquidation order, Viswanathan said..The overarching objective of the Code is revival of a company, and it’s good if the same is achieved at an early stage through section 12A or even at a stage where liquidation order is passed through a scheme. Applicability of section 29A during liquidation is to be considered. In both cases, approval of the creditors (of the prescribed majority) as well as that of the Tribunal is mandatory. So there are sufficient safeguards.L Viswanathan, Partner - Finance & Projects Practice, Cyril Amarchand Mangaldas.This approach has its own merits over liquidation because it keeps the company running, but lenders may not consent to this because it delays their recovery and has regulatory ambiguities, Bansal said. He added that chances of a scheme succeeding are slim and strip-by-strip asset sale is the most likely outcome for most liquidations.

Five Reasons IBC Is Less Effective Than It Could Be

The key reasons why the Insolvency and Bankruptcy Code is not as effective as it could be.

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