IBC process needs a re-look – Explained, pointwise

Source: Livemint, The Business Standard

Syllabus: Indian Economy and issues relating to planning, mobilization, of resources, growth

Relevance: The Insolvency and Bankruptcy Code (IBC) is the key instrument aimed to address corporate distress.

Introduction

Many experts are questioning the Insolvency and Bankruptcy Code (IBC) and its effectiveness. Recently, The IBC process for the sale of Videocon to the Vedanta group resulted in a haircut of a whopping 95.85 percent. This means the banks will recover only 4.15 percent of their total admitted claims of Rs 64,838 crore.

The Insolvency and Bankruptcy Code (IBC) 2016, has been the key mechanism for addressing corporate distress and the accumulation of bad loans in the financial sector. It has been five years since the IBC came into force. It has performed well on some parameters but needs amendments to resolve key challenges.

About the Insolvency and Bankruptcy Code, 2016
  • The code replaced all the existing laws and created a uniform procedure to resolve insolvency and bankruptcy disputes.
  • It allows creditors to assess the viability of a debtor as a business decision. Further, the creditors can agree with the plan for its revival or suggest a speedy liquidation.
  • The Code creates a new institutional framework. This framework facilitated a formal and time-bound insolvency resolution process and liquidation. The framework includes:
    1. Insolvency Professionals: They will administer the resolution process. They also manage the assets of the debtor and provide information for creditors to assist them in decision-making.
    2. Insolvency Professional Agencies: The insolvency professionals will be registered with insolvency professional agencies. The agencies would conduct examinations to certify the insolvency professionals and enforce a code of conduct for their performance.
    3. Information utilities: They will keep a record of debts given by creditors along with details of repayments/ dishonour of debt.
    4. Adjudicating authorities: They will give the approval to initiate the resolution process, appoint the insolvency professional, and approve the final decision of creditors.
      1. National Company Law Tribunal(NCLT): It is the adjudicating authority for companies and limited liability entities
      2. Debt Recovery Tribunal: It is the adjudicating authority for individuals and partnership firms.
    5. Insolvency and Bankruptcy Board: The Board will regulate insolvency professionals, insolvency professional agencies and information utilities set up under the Code.
Challenges with the IBC

IBC

  • Weak resolution plan: The IBC came into existence in May 2016. Between then and March 2021, a total of 4,376 companies have been admitted into the corporate insolvency resolution process (CIRP). Of the total, 2,653 CIRPs have been closed. However, only 348 companies have ended up with an approved resolution plan.
  • Poor recoveries: In the past, the lenders have had to take a haircut of 83% in the case of Alok Industries, a little less than 90% in the case of Reliance Infratel and 96% in the recent Videocon Group case.
    (Hair Cut: It refers to the reduction in the value of an asset. For example, if hair cut is 80%, then 80% of credit owed to its creditors will not get recovered).
  • Poor Liquidation: Liquidation means selling the company piece by piece, asset by asset. Liquidation also takes time. As of December 2020, around 69% of the liquidations had been going on for a period of more than one year; 26% of them for a period of more than two years.
    • Further, If a bidder believes there will not be any serious bidder in the fray, he can take his chances by quoting a price close to the liquidation value.
  • The committee of creditors mostly prefers to sell the defaulting company to another entity and recover whatever portion of the defaulted loan that it can. This is due to poor liquidation. For instance,
    • Of the 348 companies which have ended up with resolution plans, the rate of recovery as of March 2021 stood at only 39.3%. Further, of the ₹5.16 trillion owed to financial creditors, only ₹2.03 trillion has been recovered.
    • Only 8 percent of cases have been resolved. Thirty per cent of cases have undergone liquidation.
  • Section 12A under the IBC: This section allows the defaulter and the creditors to close the insolvency case. This is being used as a loophole, with banks going in for a one-time settlement with defaulting promoters.
  • Challenges with Bank-led resolution: It is the Bank-led resolution, not the NCLT, that should be the first resort for banks. They should be able to keep enterprises going through restructuring wherever possible. This doesn’t happen as much as it should. This is because, in the public sector, bankers fear the law enforcement agencies may come after them—even years down the road.
  • Delay in litigation: Resolution under NCLT has been plagued by delays caused by litigation and the sheer volume of cases. Macquarie estimates that cases take more than 400 days (against the stipulated time limit of 270 days). Bidders will also know that acquiring an asset would stretch out in time, and assets will shed value in consequence.
  • Exclusion of promoters: Promoters are excluded from bidding despite they are not wilful defaulters. Banks are also demanding their exclusion. For instance,
    • An NCLT bench had recently suggested that the promoters be given a chance to bid in the DHFL case. Banks were outraged at the suggestion and have taken the case to NCLAT.
      • Banks thinks that allowing promoters to bid for assets after they have defaulted creates a moral hazard. But there are many cases where default occurs for reasons beyond the control of the promoter.
    • Section 92 of the Companies Act, 2013 define a promoter as a person,
      • Who has been named as such in a prospectus or is identified by the company in the annual return referred to in section 92; or
      • Who has control over the affairs of the company, directly or indirectly, whether as a shareholder, director or otherwise; or
      • In accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act:
  • The Impact of Pandemic: The rate of recovery under IBC has fallen in 2020-21 Data from IBBI tells us that in 2020-21, of the total outstanding amount of ₹1.32 trillion, only around ₹25,944 crores was recovered—implying a recovery rate of 19.7%, or only around 20 paise for every rupee of default.
How the situation look if we compare it to other recovery methods?

The other methods are Lok Adalats, Debt Recovery Tribunals (DRTs), Asset Reconstruction Companies (ARCs) and the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI) Act.

  • The rate of recovery in the case of the Lok Adalat stands at a measly 5.1% between 2012-13 and 2019-20.
  • On the other hand, the DRTs and the SARFAESI Act, the rate of recovery stood at 6.1% and 21%, respectively.
  • Asset Reconstruction Companies (ARCs) also offers a very little reconstruction of loans. They were just a means for banks to hand over the liquidation process to a third party. Recoveries were poor as a result.
    • The newly constituted National Asset Reconstruction Company Limited is expected to indulge in serious asset reconstruction.

So, the rate of recovery under IBC is much more than the other methods. According to Macquarie Securities, recovery under NCLT has averaged 24 per cent if we leave out the top nine accounts referred to the NCLT by the Reserve Bank of India (RBI).

Suggestions to improve IBC
  • For a healthy rate of recovery, a defaulting firm must be put through the bankruptcy process as quickly as possible.
  • More transparency in bankruptcy and insolvency data is also needed.
  • The bulk of the gains from the bankruptcy reform come from the modified behaviour of private persons, taking place in the shadow of the law. The threat of the law is expected to induce modified behaviour on the part of borrowers and lenders. But this will take time.
  • Strengthening Bank-led resolution: Public Sector Banks need a mechanism that gives them protection for hair-cuts they take. It is the absence of such a mechanism that has made the NCLT the first resort ever since it came into being.
  • Better Auctioning: The auction of assets will not automatically lead to the discovery and realisation of the best price. The auction has to be efficient. And the conditions for an efficient auction, such as multiplicity of bidders, correct reserve price, etc has to be met.
    • Investment bankers should also be entrusted with a mandate to find suitors on a global basis. Private equity funds must be sought out. Banks are also better equipped to do this.
  • Promoters, who are not wilful defaulters, be allowed to bid at NCLT. Banks might look into the promoter’s track record and if the banks feel that track record does not inspire confidence, they should have the right to reject promoters.

Clearly, corporate loan defaults can cripple the entire financial system, are everybody’s problem. By extension, a well-functioning system that can address those loan defaults effectively is in everybody’s interest.

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