The SC’s ruling on personal debt guarantees will help unlock dead capital

  • India's insolvency law cleared a significant hurdle last week and is a stronger tool for bankruptcy resolution as a result. Vast sums of unproductive capital need to be unlocked.

Ajit Ranade
Published14 Nov 2023, 08:00 AM IST
In the first five years of its operation, the value of capital realized from all cases admitted under IBC was only 20%, implying a rather dismal haircut rate of 80% for creditors.
In the first five years of its operation, the value of capital realized from all cases admitted under IBC was only 20%, implying a rather dismal haircut rate of 80% for creditors.

The adoption of the Insolvency and Bankruptcy Code (IBC) in 2016 was one of the most important economic reforms of the past 10 years. The passage of this landmark law paved the way for a systematic and time-bound resolution of bank-ruptcies and the transfer of assets to new owners. Failed businesses with bad debts represent locked capital that is dead. Either the business needs to be revived by new owners or operators, or its assets need to be liquidated and some capital value has to be salvaged. Otherwise, the landscape would be littered with dead capital in limbo—neither revived nor liquidated.

Various earlier attempts, such as the very old Sick Industrial Companies Act (SICA), the SARFAESI law of 2003 and various debt recovery tribunals, had yielded unsatisfactory results. Matters could be stuck for years or decades. One adage making the rounds was that there could be sick industries, but never a sick industrialist. Hence, the IBC was a fresh approach from scratch. The lynchpin of the new IBC law was the time limit set for debt restructuring or resolution. If a debtor and its consortium of creditors were unable to come to a satisfactory resolution within that time frame, then the asset would automatically go into liquidation. The resolution rules were also designed to prevent any hold-up by a minority of (or small) creditors.

There have been two major amendments to the IBC since 2016. Despite much preparation prior to its passage, and much brainpower being invested in the writing of the Code, several tweaks have been necessary to tighten loose ends and plug loopholes. For instance, the possibility had to be closed of owners of failed enterprises re-appearing as bidders for their own distressed assets during the liquidation process. What if the bankruptcy process were to simply get used as a ruse to write-down the value of a firm’s bad debt completely, and then re-possess the same asset at far lower cost, free from all prior debt obligations? This possibility was plugged with some tweaks. Whether they have been adequate or not is yet to be seen, since prior owners could re-appear ‘in disguise’ or as a newly formed corporate.

But the fact that this issue and several others got attention from lawmakers and rule makers is significant. The law is only as good as the rules framed under it and how well these rules are enforced. In that sense, the IBC is still a work in progress. In the first five years of its operation, the value of capital realized from all cases admitted under IBC was only 20%, implying a rather dismal haircut rate of 80% for creditors. And nearly 30% of all cases were landing up in liquidation, which was not the main aim of the law. Indeed, the law as it stands is not meant to be a debt recovery tool, but rather an instrument to restructure valuable capital and assets.

And one more failure has been the frequent breaching of the Code’s time limit, which was its lynchpin. In its latest quarterly report, the Insolvency and Bankruptcy Board of India (IBBI) reports that more than 65% of the cases under resolution have exceeded 270 days, defeating the very purpose of the law. While these delays have the legitimacy of judicial considerations, they are harmful nevertheless.

The IBBI also noted that till June 2023, creditors have realized 2.92 trillion of value under various resolution plans of the initial total claims of 9.23 trillion. Thus, the realization ratio had improved marginally since 2021, from 20% to 32%.

The big benefit of the IBC, however, is invisible. Like the dog that did not bark. Thanks to the threat of being pushed into an insolvency resolution process (IRP), many debtors might be hastily settling their debts before their cases land up at the National Company Law Tribunal (NCLT), which is the first step of the IBC process.

Such unobserved data can be corroborated only through survey-based questionnaires and anecdotal evidence. It needs independent verification and triangulation both from lenders and debtors. But it is certain that credit discipline has improved and efforts to avert IBC provisions are significant. The ill-fated attempt of the Reserve Bank of India to send all bad debt resolution after a deadline to the IBC failed in the Supreme Court. But that move had a positive effect on the country’s credit culture and discipline in general.

More recently, the Supreme Court’s decision to uphold the constitutionality of IBC provisions related to personal guarantors is a big shot in the arm for the insolvency resolution process. As of September, 2,289 insolvency applications have been filed against personal guarantors involving corporate debt of more than 1.64 trillion. Some of these cases involve high-profile names. Guarantors had been seeking legal protection against the automatic application of insolvency proceedings against them, claiming that it amounted to a violation of natural justice, and that resolution professionals could not play an adjudicatory role.

The apex court asserted that the process was not arbitrary at all, dismissing more than 200 petitions of various personal guarantors. Thus, a failure to recover dues from a debtor will mean recourse can be taken to personal or corporate guarantors within the same NCLT process. The IBC, therefore, is being continuously strengthened, whether through legislative amendments, a tweaking of rules, or a strengthening by means of case law. The medium- to long-term impact of this ruling on unlocking unproductive or dead capital will be immense.

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First Published:14 Nov 2023, 08:00 AM IST
Business NewsOpinionViewsThe SC’s ruling on personal debt guarantees will help unlock dead capital

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