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India’s Insolvency and Bankruptcy Code (IBC), 2016, was designed to focus on addressing stress in chronically sick companies through either resolution or liquidation. The code’s need was felt by mounting non-performing assets (NPAs) in the banking sector that the prevalent system could not adequately fix. The IBC law and practice in India over the past 5 years has matured to focus on entire value chains in addressing enterprise sickness and on the resolution of disputes through means other than litigation. However, it still is surrounded with many challenges like delays, big haircuts etc. which makes it imperative to take some corrective steps.
What is the Insolvency and Bankruptcy Code (IBC)?
The IBC was enacted in 2016 and replaced all the existing laws with a uniform procedure to resolve insolvency and bankruptcy disputes. It allows creditors to assess the viability of a debtor as a business decision, and agree upon a plan for its revival or a speedy liquidation.
The Code created a new institutional framework to facilitate a formal and time bound insolvency resolution process and liquidation. The framework includes
Insolvency Professionals: They administer the resolution process, manage the assets of the debtor, and provide information for creditors to assist them in decision making.
Insolvency Professional Agencies:The insolvency professionals are registered with insolvency professional agencies. The agencies conduct examinations to certify the insolvency professionals and enforce a code of conduct for their performance.
Information utilities: They keep a record of debts given by creditors along with details of repayments/ dishonour of debt.
Adjudicating authorities: They give approval to initiate the resolution process, appoint the insolvency professional, and approve the final decision of creditors. Adjudicating authority for companies is National Company Law Tribunal(NCLT) while individuals have to approach debt recovery tribunal.
Insolvency and Bankruptcy Board: The Board regulates insolvency professionals, insolvency professional agencies and information utilities set up under the Code.
How has the IBC performed till now?
According to the Insolvency and Bankruptcy Board of India (IBBI) newsletter for January-March 2022, 64.7% of all the cases admitted for the corporate insolvency resolution process (CIRP) since 2016 have been closed.
Amongst this, 11% have been withdrawn, about 14 % settled, 30% liquidated and 9% resolved (wherein a resolution plan was approved).
Data released by the IBBI shows that the resolution rate of cases under CIRP is rather low and that the number of cases seeing liquidation are three times more than those being resolved e.g., of the 2,600 cases that were closed by December 2021, 55% ended in liquidation while only 16% were completed with proper resolution plans approved by the lender.
Source: The Hindu. Cases settled are shown in dark grey. In the initial 6 months (January-June 2017) all 100% cases were settled. However, the percentage of cases settled has progressively come down. It was only 5% in Oct-Dec 2021 period. The cases of liquidation has gone up. 57% cases were liquidated in Oct-Dec 2021.
The amounts recovered from the debtors have also been low. Since the IBC came into force, only 32.9% of the claim amounts were recovered. In January-March 2022, this figure stood at only 10.2% of the claim amounts.
What have been the positive outcomes after the passage of the IBC?
First, it has initiated a cultural shift in the dynamics between lender and borrower, promoter and creditor.
Second, Before enactment of the IBC, the recovery mechanisms available to lenders were through Lok Adalat, Debt Recovery Tribunal and SARFAESI Act. While the earlier mechanisms resulted in a low average recovery of 23%, the recoveries have risen to 43% under the IBC regime.
Third, it also helped in improving India’s rank in insolvency resolution indicator of World Bank’s Ease of Doing Business report. The rank improved to 108 in 2019 from 134 in 2014.
What are the challenges associated with the IBC?
Delays in the process: Resolution, and in some cases liquidation, have taken much longer than the mandated time. And the period of resolution has only worsened with time. e.g., of cases involving more than INR 1,000 Crore, the average resolution time was 274 days in FY2018. This has risen to 772 days in FY2022.
Source: The Hindu. The above chart shows the average number of days to resolve a case. Darker the shade, more the number of days taken for resolution. As can be seen, the number of days to resolve have been progressively increasing e.g., cases involving less the INR 50 crore were resolved in 230 days (average) in FY 2018. It is 667 days in FY22. The resolution period of cases of INR 50-100 Crore has increased from 260 days (FY18) to 783 days (FY22). The trend is similar for higher amounts.
The main reason for delay is litigation on the decisions. According to a study undertaken by Indian Institute of Insolvency Professionals, every corporate insolvency resolution process on average takes 3 litigation suits. The National Company Law Tribunal (NCLT) benches are bound to adjudicate on every application filed by any stakeholder, even if later found to be frivolous in nature.
Such an adjudication process, coupled with litigation, counter-litigation and multiple appeals, renders IBC timelines meaningless.
Big Haircuts: Longer delays result in larger haircuts, as the value of sick companies tends to diminish at an increasing pace over time. For instance, 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.
Less Focus on alternatives: Globally, a mechanism like the IBC’s corporate insolvency resolution process (CIRP) has been a last-resort measure. It is used after all other alternatives like mediation, settlement and arbitration have been exhausted. However in India, there are no specific provisions for mediation under the IBC.
Regulatory Fear: Banks, especially those in the public sector, are unable to take pragmatic decisions due to regulatory fear. They feel any risk-taking that could potentially yield a low rate of dues recovery in the short term may subject them to vigilance inquiries and audits.
Resource Deficit: The Government had proposed to set up 25 additional single and division benches of NCLT in July 2019. They were established at various places including Delhi, Jaipur, Kochi, Chandigarh, and Amravati. However most of these remain non-operational or partly operational on account of lack of proper infrastructure or adequate support staff.
Exclusion of promoters: Promoters are excluded from bidding despite them not being wilful defaulters. Banks think 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.
What should be done?
First, there is a need to increase the number of NCLT benches and appoint more competent professionals who have better understanding of the financial system. This will ensure that the IBC platform is not used as a recovery but more as a resolution tool.
Second, there is a need to promote mediation for out-of-court proceedings, with legislative recognition for speedier dispute resolution. The success of mediation has been observed in the U.S where over half the bankruptcy courts explicitly authorizing mediation. It gained momentum in 1998 with the enactment of America’s Alternative Dispute Resolution Act.
The Mediation Bill of 2021 is a step in the right direction. It requires disputants to try and settle civil or commercial disputes through mediation before approaching any court, within a mandated period.
Third, bankers should be protected for bona fide decision-making during the resolution process. A similar provision like the ‘business judgment’ rule that is available for board directors in many countries, should be introduced for them. It protects companies from frivolous lawsuits by assuming that, unless proved otherwise, management is acting in the interests of the corporation and its stakeholders.
Fourth, Promoters, who are not wilful defaulters, should 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.
The Government should take steps to address the loopholes of the IBC in order to make the resolution process more transparent and effective. It will help recover the maximum amount possible from the defaulters. A quick resolution process will also help address the NPA crisis so the banks can issue fresh credit from the freed capital. This will have long-term positive impact on the economy.