Home / Opinion / New insolvency rules will reduce flexibility

The Insolvency and Bankruptcy Code is one of the biggest reforms of recent times and is expected to be the solution to the country’s highly stressed banking system. In fact, this view is also acknowledged by the World Bank in its “Doing Business" ranking. Since the advent of the code in December 2016, more than 1,000 cases have been filed at various benches of the National Company Law Tribunal (NCLT) and around 400 cases have been admitted for the resolution of insolvency by the tribunal. The code contemplates transfer of control of the insolvent company from the board of directors (representatives of shareholders) to the committee of creditors (CoC), acting through an independent professional called the resolution professional, during the insolvency resolution process.

The code also mandates that the resolution of insolvency should happen within a maximum extendable period of 270 days, and in case the CoC is unable to arrive at a resolution plan with 75% majority within this period, then the company should be liquidated and proceeds distributed as per the liquidation preference. Ten cases have already reached this stage and liquidators have been appointed.

Recently, discussions have taken place in the media and amongst stakeholders as to whether the existing promoters of defaulter companies should be allowed to be resolution applicants or, to put it simply, whether the management should be returned to the defaulters with substantial haircuts in liabilities. The issue of returning control to the existing promoters with reduced liabilities has become all the more contentious because most of the lenders in India are nationalized banks and, hence, public money is involved in all these cases.

The code, before the recent ordinance, did not prescribe any qualification for a resolution applicant, so resolution professionals called for open bids to collect expressions of interest to present revival plans and the CoC then had to select the resolution applicant and the plan best suited to the majority of lenders. Since many of the initial cases of insolvency have reached the stage of determination of resolution applicant, the government has decided to amend the code through an ordinance.

The amendment as it appears is very harsh on the promoters of defaulting companies and weeds out most of them from the resolution process. The major implications of the amendments, as evident from the press note, are (a) clarity about the eligibility criteria of resolution applicants keeping in view the size, scale and complexity of business, (b) listing out the persons who would be ineligible to apply, such as wilful defaulters, or persons who have indulged in fraudulent or preferential transactions as determined by the NCLT, promoters of companies determined as non-performing assets for one year or more, guarantors of defaulting companies and (c) ensuring detailed and robust due diligence of persons applying to be the resolution applicant to determine the credentials, creditworthiness and capability of resolution applicants, for lenders to take an informed decision.

In this direction, on 7 November, the Insolvency and Bankruptcy Board of India had amended the regulations to strengthen due diligence requirements and bring transparency to the credentials of persons applying as resolution applicants.

Discussion about the promoters of insolvent companies taking advantage of their own failure through the code by asking for haircuts from lenders is relevant and intricate. If promoters are allowed to become resolution applicants, who have once failed, it may be viewed as giving undue advantage to the promoters and the issue of crony capitalism will come up.

However, one should not brush aside genuine business failures and the logic of giving an opportunity to existing promoters who may have viable resolution plans since they would understand the reasons for the failures.

Insolvent companies, being stressed assets, outside investors would generally place much lower bids than the reasonable value of the business and there could be situations where there is no viable alternative to the promoters. In such situations, the CoC would only have two alternatives—either allow promoters to run the company or let the company go into liquidation. If the liquidation value is substantially lower than the promoters’ proposal, it would be commercially irrational to reject the proposal and allow the company to die.

It needs to be understood that insolvency resolution is a commercial process and, hence, lenders should be allowed to take informed decisions keeping their best business interest in mind. They should not be compelled to reject resolution plans presented by the promoters merely because the business of a company has failed or it defaulted under their control.

The amendments made through the ordinance appear to be in the right direction as they intend to bring transparency and clarity to the eligibility/ineligibility criteria for persons who can bid for the companies under insolvency. However, they could also totally debar most of the promoters or their group companies and reduce the flexibility in commercial decision making of lenders in the insolvency resolution process.

Manoj Kumar is partner and head, mergers and acquisitions, and transactions, at Corporate Professionals.

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