India’s insolvency regime needs to address chinks in its armour

Even though there was cynicism that the IBC too would head down the underwhelming route of other laws like SICA and SARFAESI, it has been a resounding success. The gross bad loans of banks have trended down to a 10-year low of 3.9%. The capital adequacy ratio is at a healthy 16.1%. Most importantly, IBC has changed promoter behaviour, underscored the importance of credit appraisal, thereby reducing the probability of default, and increased recoveries on enforcement, reducing losses arising from defaults. Further, it has shrunk timelines for insolvency resolution and deepened the market for distressed debt. In seven years, the IBC has helped resolve nearly 700 cases, leading to recoveries of about ₹2.8 trillion. It has been a rare law to have seen unanimity of policy goals across government agencies. A series of amendments have strengthened the law.

However, in the recent past, several chinks have appeared. There are delays in the admission of cases and approval of resolution plans. A series of judgements have compromised the rights of secured creditors and eroded the primacy of security interest. Contrary to legislative intent, the Supreme Court suggested that government dues deserve priority over bank dues. It also held that the admission of an IBC case even if a payment default to a bank is clearly established is at the discretion of the National Company Law Tribunal (NCLT). There have been complications in the resolution of real estate projects. Further, an inflexible definition of a ‘resolution plan’ has meant that discrete assets of an insolvent company are not being sold even if they are deteriorating in value or could separately fetch more.

The ministry of corporate affairs (MCA) released a public consultation paper in January, seeking comments on a slew of proposed amendments. Extensive debate ensued among banks, insolvency professionals and regulators as well as bidders, and detailed submissions have been made to the MCA by industry bodies on some important reforms. As per the consultation paper, real estate insolvencies could be conducted on a project-wise basis rather than imperilling the entire corporate entity, which could also be operating healthy projects. Further, universally recognized principles of the sanctity of secured debt must be restored. A push is being made for the introduction of technology in establishing a payment defaults via information utilities to overcome the need of lengthy court hearings to determine factual issues. There is also a proposal to extend the ‘pre-pack’ insolvency regime (currently applicable only to small and medium businesses) to large corporates. It offers a mechanism to resolve financial distress at an early stage by encouraging promoters to approach banks for a debtor-in-possession restructuring. It also gives banks overall supervisory control over the process by installing their own choice of insolvency professional to oversee the insolvency process and ensuring that operational-creditor and government dues are paid to the maximum extent possible. Lastly, such a resolution plan receives the imprimatur of the NCLT, thereby insulating lenders from any allegation of wrongdoing.

Unlike 2016, the banking sector today is in prime shape. The first-quarter profits of major banks have surpassed analyst estimates. At the same time, after covid, India has emerged as one of the world’s fastest-growing large economies. The Reserve Bank of India (RBI) governor in his foreword to RBI’s latest Financial Stability Report remarked that both banking and corporate sector balance sheets have been strengthened, engendering a “twin balance sheet advantage" for growth. However, there is a fear that India’s success at solving its twin balance sheet crisis may have led to policy complacency that could stop IBC reforms from getting traction. Legislative myopia at this stage will not only endanger the resolution of stressed assets, but will also be deleterious to the credit growth of banks and new crop of alternate credit providers, such as alternate investment funds, distress-focused funds and other foreign investors. A predictable insolvency regime complemented with an efficient security enforcement mechanism will help channel much-needed debt capital to fuel economic growth and contribute to a reduction in the cost of capital.

The IBC was born in a credit crisis, a war-like situation, but it needs to be nourished during peace-time so that when the global credit cycle turns and we are faced with mounting debts, we have the institutional and legal capacity to deal with the onslaught. The groundwork for the next generation of IBC reforms has already been done by the government. It is vital that these reforms are placed in Parliament during its ongoing monsoon session.