Needed: bankruptcy-related disclosures
Disclosures must adequately cover the essential information required by investors to make informed investment decisions
The importance of disclosures in combating information asymmetry, enabling informed investor decisions and reducing information costs, is well established. Ongoing disclosures, in particular, ensure that investors are continually aware of the economic stability of a company. These disclosures have added importance in the context of insolvency and bankruptcy. In fact, a recent study showed that bankrupt companies had lower disclosure quality than other companies.
The recent overhaul of bankruptcy and insolvency laws through the Insolvency and Bankruptcy Code, 2016 (IBC) warrants that specific amendments be made to the extant regime of ongoing disclosures for listed companies (the Securities and Exchange Board of India’s, or Sebi’s, listing regulations). The imperfections in the regulations become apparent when the IBC and listing regulations interact. For instance, only recently something as important as loan disclosures was made mandatory by a Sebi circular. That, however, is the just the tip of the iceberg.
As it stands, there are three main reasons to amend the Sebi listing regulations. First, to appropriately reflect the processes introduced by the IBC; second, to ensure timely dissemination of bankruptcy and insolvency relevant information to investors; third, to ensure that these regulations and the IBC are not in conflict with each other.
In the context of global perspectives on bankruptcy disclosures, there are two key questions to be answered. First, do other countries have bankruptcy disclosure requirements? Second, if so, what kind of disclosures do they require?
Bankruptcy-related disclosures do exist. The International Organization of Securities Commissions recognizes three countries as examples of countries that have comprehensive lists of ongoing disclosure items. These are the US, Japan and Brazil. A common feature of these three countries is that they each impose disclosures on bankruptcy. In the US, for instance, bankruptcy-related disclosures are general in nature, requiring “a company’s bankruptcy or receivership” to be disclosed. Whereas in Japan, bankruptcy disclosures are more elaborate. For instance, these include ‘claims to bankruptcy’, ‘significant changes in the company’s financial condition or performance’ and ‘likely defaults of credits’. The World Bank too has specifically acknowledged the need for a legal regime that requires the disclosure of timely, reliable and accurate information on the distressed enterprise. While there is no absolute consensus on what an ideal disclosure regime looks like, it may be safely said that a balanced regime must reflect the need of the hour by evolving with the context in which it operates.
So what needs to change in India? First, disclosures must adequately cover the essential information required by investors to make informed investment decisions. Such information usually remains secret until the company itself discloses it. For instance, the receipt of a demand notice under the IBC is often the first red flag indicating possible bankruptcy proceedings, but is unknown to third parties. Second, general information that could lead to a claim by creditors under the IBC should be considered “material information” requiring compulsory disclosure. For instance, any event that triggers a direct or contingent financial obligation above the IBC threshold of Rs1 lakh must be disclosed. This should also include any default or acceleration of an obligation (whether or not declared as an event of default under a contract) and employee salary defaults. Third, to rectify any inconsistencies between the IBC and the listing regulations. For instance, while an insolvency resolution professional might suspend the board of the company under the IBC, the listing regulations still mandate that all listed companies maintain board committees, without exception.
Before amending the existing regime, however, it is important to recognize the costs involved in making such disclosures. Historically, companies have resisted increased disclosures as they result in increased costs. This is especially relevant for a company already facing insolvency or bankruptcy. While this is an important consideration, it is important to also recognize the cost of not mandating such disclosures to investors. In fact, the importance of this consideration is highlighted in the context of management-level behaviour in a company on the verge of bankruptcy in a scenario where such disclosures are not mandated. A study has shown strategic disclosure behaviour by managers of financially distressed companies (thereby indicating a need to include specific disclosure requirements in relation to bankruptcy).
Bankruptcy-related disclosures are more relevant than ever. This is especially because the risk of bankruptcy has also increased—bankruptcy is now more likely to be invoked in situations where, previously, both creditors and debtor may have resisted taking such drastic measures. While the existing disclosure regime should be amended to include bankruptcy-related disclosures, it must also be borne in mind that these disclosures are to be carefully formulated. They must effectively address changing contexts and investor needs, while also balancing the interests of the companies required to make them.
Diya Uday is a policy consultant at the Finance Research Group, Indira Gandhi Institute of Development Research. These are her personal views.
(The author would like to thank Susan Thomas, Anjali Sharma and Bhargavi Zaveri for valuable discussions.)
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