The government has got out of a tricky situation but the solution leaves a lot to be desired. The harsh restrictions on entities eligible to bid for companies under the Insolvency and Bankruptcy Code (IBC) is like cutting one’s nose to spite the face. It could in all likelihood lead to fewer bids and of lower value as it eliminates a potential bidder by default. Lower bids means banks will have to sacrifice more of the money they are owed and take larger losses, and the burden gets shifted ultimately to the taxpayer.
The executive order amending the Insolvency and Bankruptcy Code has placed restrictions on not only wilful defaulters and those involved in fraudulent transactions but also on entities that have defaulted on loan payments for more than a year and those connected to them. That effectively rules out founders of firms that are named in the Reserve Bank’s first list of companies to be fast tracked into the bankruptcy process. Most of them had turned non-performing as on June 2016.
This amendment seems to have been introduced to assuage concerns that fraudulent promoters will get a backdoor entry to control firms at a steep discount. Public anger with the likes of Vijay Mallya who has run away without answering allegations of diverting funds and siphoning money is huge. Keeping out promoters may protect the government from accusations of crony capitalism but it is a body blow to banks seeking to extract the most paise out of every rupee of loans in default.
Barring wilful defaulters is just optics. Which banker would consider approving a plan that is presented by a known wilful defaulter? In any case, Reserve Bank of India rules prevent banks and financial institutions from doing business with such fraudulent promoters. The capital markets regulator too has barred wilful defaulters from raising public funds and taking control of listed entities.
It is the wider restriction that bites. Promoters might get their comeuppance but will it serve the purpose of efficiently resolving the Rs10 trillion worth of stressed assets in the system?
Lenders might not feel the pain now. Currently, the steel cycle is trending up and there is a lot of interest in steel assets, which make up the RBI’s first list. So, barring promoters is unlikely to hurt.
But imagine if most of the big cases undergoing bankruptcy were thermal power assets. These are unlikely to get the same buying interest. Apart from the big cases, there are dozens more mid-tier firms which are entering the resolution process and are unlikely to find as many bidders. In these cases, if the promoter too is barred, they will probably go straight into liquidation. Such promoters have been barred from buying the asset under liquidation too. Prepare for lower liquidation values too.
Simply put, in some cases, it is in the best interest of creditors to take a sacrifice on the loan and give the asset back to the promoter instead of selling it for scrap value.
Indeed, that is the very objective of the code. In a recent judgment, the National Company Law Appellate Tribunal (NCLAT) said that, “It is made clear that Insolvency Resolution Process is not a recovery proceeding to recover the dues of the creditors." Essentially, the code is to ensure that a firm continues as a going concern once it undergoes the resolution process.
Yes, there is the moral hazard issue in allowing promoters to bid. A promoter hoping to win back control at a steeper discount once his firm undergoes the bankruptcy process is less likely to cooperate with bankers in the lender’s forum using other debt restructuring mechanisms. But then, such founders are also taking a risk that rivals and other interested parties won’t outbid them.
The amendment has also asked the creditor committee to “consider feasibility and viability of the resolution plan." That is a vague requirement that can again lead to bankers fretting over whether they can be pulled up years down the line for not doing a good job on this front.
It is not clear whether the Insolvency and Bankruptcy Board of India would specify any regulations on how feasibility and viability has to be evaluated. Resolution plans would vary according to the asset, sector and industry. The evaluation decision is best left to the judgment of the committee of creditors which also has to ensure that a case doesn’t return to bankruptcy process soon after it approves a resolution plan.
Placing unnecessary restrictions on bidders shows a lack of confidence in the process. This is not to say that the Code is flawless. Removing flaws in the IBC—for instance, clarifying that buyers won’t be subject to tax on buying assets at a discount—is welcome. But by barring a section of potential bidders, the government may have undermined the ability of banks to maximize value from the process.