IBC: Unknot The Bankruptcy Law, Don’t Suspend ItBloombergQuintOpinion
In two articles written over a fortnight, we critiqued the union cabinet’s decision to suspend the Insolvency and Bankruptcy Code, 2016. We argued that the bankruptcy framework could be strategically used to help businesses that are facing distress due to the ongoing lockdown. We also made a case for setting up a government-sponsored fund to provide interim finance to businesses that seek to formally restructure their debt under the IBC. We explained why this would be a fiscally feasible, incentive compatible and socially optimal strategy for supporting distressed businesses in India.
Subsequent commentary written across various platforms has similarly supported the case for using the IBC to strategically deal with distressed businesses (example, example and example). However, some concerns have been raised on the potential of the IBC to deal with distressed businesses post the lockdown.
In this article, we attempt to address some of these concerns.
A Vanilla Debt Restructuring Under The IBC
First, a major concern with the IBC appears to be that it does not support a plain, vanilla debt restructuring. A common theme across all commentary underlying the IBC is that once a firm is under the IBC, it must be put up for sale, or that an auction of the firm is inevitable.
The truth is that the IBC neither contemplates sale nor mandates an auction of the debtor firm. A plain debt restructuring that involves an agreement between the promoter and the creditors, is permissible under the IBC. This is reflected in the deliberations of the Bankruptcy Law Reforms Committee.
The operative part of the 2015 report of the BLRC is reproduced below:
“[H]ow the insolvency is to be resolved will not be prescribed in the Code. There will be no restriction in the Code on possible ways in which the business model of the entity, or its financial model, or both, can be changed so as to keep the entity as a going concern. The Code will not state that the entity is to be revived, or the debt is to be restructured, or the entity is to be liquidated. This decision will come from the deliberations of the creditors committee in response to the solutions proposed by the market.”
The IBC envisages that once the firm is under a resolution process under the code, the resolution professional will prepare an information memorandum containing the particulars of the assets and liabilities of the debtor. She will then invite resolution plans for the debtor firm. In fact, the original language of the IBC specifically provided that resolution plans may be invited from “lenders, investors and any other persons”. The law was subsequently amended in 2018 to build in eligibility criteria on who could submit resolution plans.
In any event, the law does not pre-empt the promoter from submitting a resolution plan with a proposal for a plain, vanilla debt restructuring.
The meat of the matter lies in the definition of a resolution plan as contained in the IBC, which explicitly clarifies that a resolution plan “may include provisions for the restructuring of the corporate debtor, including by way of merger, amalgamation and demerger.”
The apprehension that the IBC inevitably leads to a sale of the firm, appears to arise from two sources. First, the infamous section 29A of the IBC, which bars wilful defaulters from submitting a resolution plan under the IBC. This provision does not apply to all promoters. Moreover, as mentioned in our earlier proposals, it would be helpful to suspend section 29A of the IBC, even if temporarily so, to ensure that all options are open for a firm that attempts to resolve distress through the IBC in the wake of the pandemic. Restricting the pool of bidders in a capital starved post Covid world through a litigation-prone section 29A, is not a luxury that India can afford right now.
The second source of this apprehension appears to be the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 which is the procedural framework enacted by the Insolvency and Bankruptcy Board of India governing the resolution process. These regulations envisage a linear process for the sale of the firm, and do not appear to support a vanilla debt restructuring exercise.
For example, these regulations mandate the nationwide publication of an ‘expression of interest’ for inviting resolution plans. This naturally reduces the scope of bilateral negotiations for debt restructuring between the promoters and the creditors. Such a provision may apparently support a fair and open process for the resolution of a distressed firm. However, it has its own disadvantages. For instance, the rigidity of the regulation disincentivises the debtor and creditors from taking the formal route of insolvency, reduces flexibility to the creditors in resolving the firm and potentially increases the costs associated with resolution under the IBC.
This will reduce the costs of resolution and enable options such as pre-packaged insolvencies - where the debtor and the creditors agree to a debt restructuring and then trigger the IBC – without requiring an entirely additional framework as is being currently reportedly contemplated by the government.
Concerns About A Creditor-In-Possession Model
Second, there are apprehensions about using the IBC as it involves suspension of the management, and entrusts the running of the firm to a resolution professional during the resolution process. Commentators have argued that the appointment of a resolution professional adds to the costs of the resolution process under the IBC. Others argue that it is unfair to deprive promoters of the management of their firms due to exogenous shocks such as the nationwide shutdown which was the decision of the government.
These arguments are well-founded.
It is arguable that a debtor-in-possession model might have more efficient outcomes for all the stakeholders involved, under some conditions.
However, as explained above, it is possible to allow a debtor-in-possession model in a pre-packaged insolvency framework.
Once the regulations are amended to allow pre-packaged insolvency negotiations between the debtor and the creditors, the benefits of the debtor-in-possession model can be availed of in India as well.
This is because under such a framework, the debtor continues to remain in possession during the pre-packaged insolvency negotiations between the debtor and the creditors.
Secondly, a critical part of our proposal is a government-sponsored fund for providing interim finance for firms that take up formal debt restructuring under the IBC. We had made a case for allowing debtors under the IBC easy access to the interim finance fund, conditioned on two objective criteria. First, that the firm seeking such interim finance must be under the IBC and second, 66 percent of the creditors must have approved of the debtor accessing this fund.
A key consideration here is that the creditor-in-possession model acts as a natural safeguard against the misuse of this government fund. Since the creditors are in possession of the firm when it applies for interim finance, this naturally filters out debtors who do not wish to lose management powers. Further, the IBC accords priority in payment to the interim financier, i.e. the government, in this case.
Both these factors will act as natural safeguards against the misuse of this fund and the associated moral hazard.
NCLT Capacity Concerns
The other oft-repeated concern is about the capacity of the National Company Law Tribunal to deal with the backlog of IBC cases.
While a permanent solution to this needs long term reform of the judiciary, a short-term solution to this concern involves a multi-pronged approach comprising the following elements:
- first, suspending the provisions of the IBC which are prone to litigation;
- second a conscious strategy of judicial non-intervention except for non-compliance with the due process;
- and third, augmenting the capacity with temporary special insolvency benches, if needed.
Finally, some of these features may well improve the overall functioning of the IBC. Perhaps this time could be used to experiment with the design of the IBC and identify tweaks that give us better outcomes even in happier times.
Bhargavi Zaveri is a senior researcher at the Finance Research Group. Harsh Vardhan is Executive-in-Residence at the Center for Financial Studies of the SP Jain Institute of Management Research.
The views expressed here are those of the authors and do not necessarily represent the views of BloombergQuint or its editorial team.