Resolution code must first resolve balance of rights

Amultitude of hopes and expectations have been hitched to the new Insolvency and Bankruptcy Code (IBC). There is a widespread belief that this is perhaps the best possible instrument so far—in terms of potential and capacity—for resolving the overhang of non-performing assets (NPAs) in the financial system. Conviction in the IBC’s abilities is also blended with large doses of faith: Clearing the backlog of NPAs will allow banks to indulge in fresh lending, thereby stimulating economic growth.

There is merit and rationale for this rising groundswell of belief in the IBC. Compared to previous resolution frameworks—joint lenders’ forum, strategic debt restructuring, scheme for sustainable structuring of stressed assets, to name a few—the IBC seems to have plugged numerous gaps that plagued the earlier systems. It is time-bound, decision-oriented and provides disincentives for promoters trying to shield themselves from creditors. It has been a long and instructive journey when compared with the first attempt at sorting out insolvency through the Board for Industrial and Financial Reconstruction (BIFR).

That said, there is a chance of the resolution process reverting to the BIFR mode owing to bankrupt shareholders finessing the shortcomings in the legal framework. The IBC’s many attributes also hide numerous flaws, including corporate India’s dodgy relationship with capital, providing it with incentives to manipulate the system. Ten out of the first lot of 12 cases—“dirty dozen”—referred to the National Company Law Tribunal (NCLT) by the Reserve Bank of India (RBI) for resolution have collided against their 270-day deadline, with some of them already exceeding the time limit. The resolution processes of these cases provide multiple pointers to the path that lies ahead and the course correction that is now required.

At the core of the corrective mechanism must be a recognition of the balance of rights among various stakeholders—company promoters, other shareholders, members of the workforce, financial creditors, operational creditors, resolution professionals, members on the specialized NCLT and appellate tribunal benches, bidders—and how that squares with the IBC’s legal framework.

Developments so far give rise to two observations. One, the regulatory and legal framework is being liberally interpreted and tweaked by various stakeholders, often at odds with either the code itself or occasionally militating against its very spirit. Two, as things stand, the current process and legal framework accords superior rights to some stakeholders, which may tick all the relevant commercial and legal boxes in a capitalist system but might fail a larger morality (or even ethical) test. Society needs to debate this, especially since the small section of stakeholders which stands to lose the most from the entire process is also a permanent outsider to the political-industrial patronage system, with limited political bargaining power.

The first challenge is countering attempts by company promoters to regain control of companies they rendered insolvent. While the relevant section of the code does declare them ineligible, they have been finding ways to get around the legal hurdles. Debate on this is split down the middle. A school of thought feels securing the highest value for the distressed asset, even if it is offered by a wilful defaulter, should be the end objective of the code. The competing view feels the nation has a moral right to exclude those who used public funds to improve their personal wealth and social stature while bankrupting the operating company.

There is another challenge: how to accommodate the competing rights of various stakeholders. For example, the power sector has demanded a special carve-out from RBI’s new rules on NPA recognition, which has been denied. Acceding to similar demands is like a slippery slope: where to draw the line on special exemptions? There have been arguments that many NPAs are the consequence of misplaced, arbitrary or random government regulations and deserve to be treated differently. The counter-argument is that the high-rollers playing political-economic roulette were well acquainted with the risks. There are no straight answers, as there are no one-size-fits-all solutions; much will depend on the ethical and moral fibre of the resolution professionals, the creditors and the judicial system, and, perhaps, this is a good opportunity to start nurturing it.

This is especially pertinent when debating how much leeway should be granted to resolution professionals or the members of NCLT benches and their appellate tribunals.

The Insolvency and Bankruptcy Board of India is attempting course correction on the fly. For example, a regulatory structure for resolution professionals now seems necessary after it was found that some of them were not immune to external influence. In the case of NCLT members, the issue is whether they can deviate from the code’s script in the name of extracting maximum value from the distressed asset.

Finally, how do you balance the rights of the IBC process with courts of law? Or with the political economy? Some of the high-profile dirty dozen cases have already breached the 270-day time limit and are unlikely to accept the NCLT or National Company Law Appellate Tribunal verdicts without appealing to the Supreme Court. If matters can be prolonged to post-election 2019, it has to be seen whether IBC can be insulated from the political economy exercising its traditionally superior rights.

Rajrishi Singhal is a consultant and former editor of a leading business newspaper. His Twitter handle is @rajrishisinghal.

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