Tweaking the insolvency bill
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We had earlier discussed the praiseworthy thrust, and revolutionary elements, of India’s new insolvency bill. We had also outlined practical impediments to its successful application. We now outline the changes the select committee may consider, and that we believe can remove some key deterrents from the final law.
Establishing distinct creditor classes, with impaired classes voting
It is critical to the success of insolvency resolution efforts that impaired and unimpaired creditors be separated in line with their conflicting interests. In the current context, the code should separate secured and unsecured creditors into distinct voting classes.
Only impaired creditors should vote on a proposed resolution plan. A majority vote of each impaired class—the present 75% supermajority, or even a two-thirds majority—should be required for plan approval. As with the acceptance process in Chapter 11 in the US, unimpaired creditors should be deemed to have accepted a plan that meets reasonable legal standards.
Even before a bond market takes root, this may motivate the selling of deficiency claims, i.e., the unsecured portion of originally secured debts, to turnaround investors who can drive restructurings. It may also help segregate the unimpaired, and properly secured, fraction of debt that can be readily refinanced or otherwise settled. It will thus reduce the initial outlay of capital required to acquire debt claims, hopefully promoting larger investments of fresh capital in attempted business turnarounds.
Finally, the mechanism requiring proposed resolution plans to accord priority to organizational creditors can be retained at the initial stage. However, if no such proposals surface or win approval, plans proposing an impairment of organizational claims should also be invited. These will then be put to a vote by each impaired class, now including one representing organizational creditors.
Primacy of insolvency resolutions under new regime
It is also important to ensure that a painstakingly approved resolution plan is not easily laid to waste, whether by dissenting creditors or interference from other laws or forums. In practice, any fear of this occurrence will revive fears of the past, and strongly deter participation.
The most effective solution is to clearly subordinate any related laws that are not being repealed—including the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act of 2002 (SARFAESI)—to the new code. Furthermore, related matters should be subordinated to the new insolvency resolution process, and the jurisdiction of the National Company Law Tribunal (NCLT).
An alternative is to create a form of “adequate protection” for dissenting secured creditors, and similarly cap exposure for any other related claims. The statute should limit such exposure to a threshold agreed upon by the NCLT during the resolution process. This will permit such claims to be determined separately, yet without thwarting the negotiated resolution plan. Upon adjudication at other forums, such claims would be settled through the issuance of new debt of the restructured debtor, carved out as a contingency during the resolution process.
A functioning creditors’ committee
A committee including all creditors as proposed will prove to be a committee for liquidation, whether by design or by default.
Speedy, though careful, deliberation and decision-making is a necessity in a pressured insolvency restructuring. The practical implication is a need for delegation. The larger voting groups required in order to respect natural inter-creditor differences should not be confused with the effective driving force of a restructuring—a committee of creditors that evaluates proposals, and makes choices subject to a vote of all eligible creditors.
The proposed law should be modified to introduce a creditors’ committee comprised of five to seven members, representing the largest unsecured creditors who are willing to serve. The logic of the 80-20 rule means the group will typically represent the vast majority of holdings. The debtor should attend meetings only at the committee’s invitation, and be required to attend when invited.
Other considerations to take into account
Among other matters, the creation of a new approach of “regulated self-regulation” seems fanciful. The undertaking at hand is complex, and fraught with enough risk as it is. This does not appear to be the moment for experimentation with regulatory models. In addition, the inherent shift in control over the insolvency resolution exercise from creditors towards insolvency professionals carries a risk of deterring, rather than reassuring, investors.
It may also be worth ridding the code of new terminology, such as “calm period” when the well-established “standstill” would equally suffice. Conversely, incorporating the treatment of executory contracts and leases from the US code would improve clarity, as would a process for dealing with the tabulation and estimation of claims.
In conclusion, the proposed law contains a well-intended trifecta that may, in practice, scare even the enterprising distressed investor—an insolvency process dominated by regulated insolvency professionals; chaotic creditor deliberations with disparate objectives obviating agreement, or a tendency towards liquidations as secured creditors predominate; and a tight timeline amplifying an impaired creditor’s fear of liquidation.
The prescribed amendments will remove key lacunae that will otherwise hinder successful insolvency resolution. Thereafter, with satisfactory execution of the important next steps in building India’s insolvency infrastructure, this seminal reform may well be the bright line defining a glorious future for Indian credit, and to India’s credit.
Anurag Das is managing partner of Rain Tree Capital, a Singapore-based firm specializing in Asia-Pacific credit, and distressed and special situations.