Road to insolvency resolution4 min read . Updated: 02 Dec 2015, 02:35 AM IST
The outcomes of an Insolvency and Bankruptcy Code are contingent upon building the supporting infrastructure
The current corporate insolvency resolution framework in India fares poorly in terms of timeliness and costs of proceedings. The longer the time taken, the more the erosion in realizable value of assets and the lower the recovery rate—the ultimate parameter for evaluating the strength and efficiency of an insolvency framework. Inordinate delays in resolution arise from a lack of clarity regarding legal provisions, an overburdened judiciary, information asymmetry faced by creditors, absence of well-defined timelines stipulated in the law and an overall weak enforcement mechanism. Institutions that should support the resolution process such as dedicated tribunals, official liquidators and credit bureaus are severely capacity-constrained. All these culminate in a recovery rate of roughly 20% of the value of debt—among the lowest in the world. Bankruptcy reforms in India must therefore focus on minimizing delays.
The Insolvency and Bankruptcy Code (IBC) proposed by the Bankruptcy Law Reforms Committee (BLRC) addresses the timeliness issue by stipulating a strict timeline of 180 days for insolvency resolution and limiting judicial determination at the trigger stage. Triggering the insolvency process in India [under the Sick Industrial Companies (Special Provisions) Act (SICA) or Companies Act] currently involves judicial judgement. Under IBC, the insolvency resolution process (IRP) can be triggered at the first instance of default, requiring the adjudicating authority to merely confirm the existence of default. This will aid early detection and resolution of stress and also avoid clogging judicial bandwidth at the trigger stage. Also a default only triggers a resolution process, and not liquidation. This is unlike the extant situation where winding up proceedings can be triggered on account of a default of ₹ 500, resulting in courts undertaking full hearings at the admission stage and causing delays.
The 180-day timeline is not an implausible one for several reasons. Across the world, firms in distress start conversations about their financial troubles with stakeholders much before initiating formal proceedings. Court-supervised resolution procedures are filed when out-of-court negotiations fail to generate desired outcomes. In the post-IBC regime, if IRP is triggered, it is assumed that the debtor has already undertaken out-of-court negotiations with the stakeholders concerned about possible reorganization avenues to keep the firm as a going concern, and has not arrived at a solution. Triggering IRP is hence considered a last-course effort after sufficient preparation and deliberation.
Once IRP is triggered, it offers a calm period during which a moratorium is imposed on debt recovery actions and existing or new lawsuits against the debtor. During this phase, all creditors come together to collectively assess the viability of the firm and vote on proposed resolution plans, within a well-defined framework of rules enforced by an insolvency professional (IP). The IP takes over management of the firm to prevent potential asset stripping and to continue operations of the firm as a going concern. The likelihood of a moratorium being misused and dilatory tactics applied by promoters is minimal because the debtor loses control. Also there is a credible threat of liquidation should the defined timeframe of 180 days lapse without 75% of the creditors’ committee consenting on a resolution plan.
In view of the above, completing the final round of conversation between the debtor and creditors within 180 days to resolve temporary insolvency as against structural breakdown is not infeasible.
Once the creditors’ committee approves a resolution plan, the adjudicating authority reviews the plan not from a commercial perspective but against touchstones of conformity with applicable laws and repayment of interim finance (on priority) and operational creditors. This will free up judicial bandwidth to focus on critical issues of justice, such as compliance with procedural requirements, overseeing the IP and adjudicating on voidable transactions and potential penalties against management and promoters.
Delays in the resolution process also result from opacity of creditors’ claims and related information. The system of information utilities (IUs) proposed by the IBC and the BLRC report will store all financial transactions between a firm and its financial creditors. This should significantly assist the IP in assessing veracity of claims, thereby saving valuable time.
It is important to underscore here the centrality of the institutional pillars upon which the entire edifice of IBC stands. While the draft bill contains provisions to reduce delays and improve efficiency of resolution, the de facto outcomes in terms of effective and timely functioning of the process are contingent upon building the supporting infrastructure. This includes developing a new class of IPs to conduct the resolution process in a time-bound and disciplined manner, an extensive network of IUs vital for reducing information asymmetry and speeding up the process of initiating IRP and collecting claims, a well-functioning regulator to govern the operations of IPs and IUs as also issuing delegated legislation and finally, an effective adjudicating infrastructure replete with a well-laid-out appeals mechanism.
For the IBC to deliver the desired economic outcome of high recovery rate, a robust implementation plan for building the aforesaid institutions and creating state capacity is essential to complement the enactment of the draft bill. None of these will happen overnight.
It will take time for firms and all stakeholders to get familiar with the new system and to understand the new rules of the game.
This column is the last of a two-part series.
Richa Roy and Rajeswari Sengupta are, respectively, banking and finance lawyer at AZB & Partners and assistant professor of economics at IGIDR, Mumbai.
Comments are welcome at firstname.lastname@example.org