Five years of IBC: A glass half full?

During the subsequent discussion on the proposed Insolvency and Bankruptcy Code (IBC), Sinha told Lok Sabha that this legislation was “one of those transformational building blocks that will actually be able to transform" India’s economic landscape.

The IBC, which was cleared by both houses of Parliament in June that year, sought a “time-bound resolution" in the event of bankruptcy. Five years later, Sinha, now the chairperson of the standing committee on finance, informed the Parliament on 3 August that the steep haircuts taken by lenders (as high as 95% in some cases) and the fact that more than 71% of the cases remain pending for more than 180 days point to a deviation from the original objectives of the Code.

Sinha’s panel was particularly worried about the “disproportionately high and unsustainable haircuts" taken by financial creditors and wanted a review on the extent to which the IBC has fulfilled its stated goals.

This biting critique of the IBC, especially from someone who was an early proponent, reflects the high expectations of policy makers when it comes to the bankruptcy code’s ability to resolve the mounting level of industrial sickness in the country.

According to official data, nearly half of the 2,653 companies that have gone through the IBC process got death warrants— received orders for liquidation—instead of the creative destruction, which policy makers had originally hoped for. Of the overall firms that sought resolution under the IBC, only 13% got a fresh lease of life.

Great expectations

Industrial sickness has been a major headache for the Indian government for many decades. In 1985, the government introduced the Sick Industrial Companies Act and subsequently debt recovery tribunals were set up in the early 1990s to deal with the problem. In 2002, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act was brought in to help lenders recover dues without having to go to a court. However, early diagnosis of a company’s financial troubles and its quick resolution in a time-bound manner could not be achieved through these instruments.

The poor corporate governance standards in many firms, stress building up to historical levels, aggressive lending practices of the post-2008-09 financial crisis era, wilful defaults and in some cases corruption steadily worsened the situation. In 2015, an expert panel led by T.K. Viswanathan suggested the contours of a new bankruptcy code, which became a reality a year later, making it one of the most important reforms during the previous term of the National Democratic Alliance (NDA) government—next only to the goods and services tax or GST. In 2017, the Reserve Bank of India (RBI) instructed banks to initiate bankruptcy proceedings under IBC against 12 large accounts—referred by some as the ‘dirty dozen’—even as bad loans of scheduled commercial banks inched up to ₹10 trillion.

Bankruptcy reform led to two major changes—a shift in the credit culture and an immediate empowerment of operational creditors such as material suppliers and workers. For the first time, the prospect of a major shareholder—under whose watch a firm defaulted on repayment obligations—losing control of the business became a real possibility.

This proved to be a big jolt to many in the industry—a factor that has made it necessary for the management and shareholders to seek an early resolution to stress in the balance sheet before the company is pushed into bankruptcy.

IBC has instilled discipline and fear in the minds of borrowers, said Nirmal Gangwal, managing partner at investment banking firm Brescon & Allied Partners LLP, which specializes in handling businesses in distress, especially at the pre-bankruptcy stage. “It has sent the message that corporate borrowers cannot get away with defaults and take the system for granted. But one of the factors that has affected the IBC’s outcomes is the delays caused by litigation. In business, the time value of money is huge, and delays caused by litigation and (onerous) procedures could cost the lenders dearly," Gangwal said.

Under the earlier regimes, operational creditors, who are in the nature of unsecured creditors, could not initiate bankruptcy proceedings. Now, vendors whose payments are not paid and even workers whose dues have not been cleared can take a defaulting business to a bankruptcy tribunal. This prompted many micro, small and medium enterprises (MSMEs) to use the threat of bankruptcy to pressure a debtor to clear the outstanding dues.

As per data available with the Insolvency and Bankruptcy Board of India (IBBI), more than half of all the 4,376 bankruptcy cases that have been initiated so far were triggered by operational creditors. The Code has given them an effective platform to pursue the recovery of their dues.

Hits and misses

Experts argue that the IBC’s outcome cannot be put in black and white, and requires a more nuanced reading. In some areas—such as the steep haircut on outstanding loans—the outcome may seem unpleasant, but the IBC era is a significant improvement over all previous regimes.

The average resolution time has come down from 4.3 years in the earlier regime to 1.6 years under IBC, as per the World Bank’s 2020 ease of doing business report. There is still some distance to go, however. In the US, for instance, the average time taken to resolve a bankruptcy case is only 1 year. The recovery rate in India (as a share of the claims made by creditors) stood at 71.6%, compared to 81% in the US. The recovery rate in Norway, the best performer in this parameter, is as high as 92.9%. If one looks at the outcome of the bankruptcy proceedings initiated against the 12 large accounts that were originally flagged by the RBI, the picture is a little bit more encouraging. Of these 12, resolution plans have been approved for nine firms, including Electrosteel Steels Ltd, Bhushan Steel Ltd and Essar Steel India Ltd. Two others were ordered to be liquidated and proceedings are underway in one case. Creditors of Essar Steel, which was bought by Arcelor Mittal India Pvt. Ltd, recovered ₹41,018 crore or about 83% of the claims admitted under the IBC process.

However, not all businesses are asset-heavy like Essar Steel. Many small businesses derive value only if the business is profitable as they have very little physical or intangible assets. That is one reason why small businesses have very fewer takers. If a small business without physical assets is defunct for years, it is almost certain that it will end up in liquidation. Data available with IBBI shows that the 348 businesses that got their resolution plans approved till March 2021 had assets worth ₹1.11 trillion, while the 1,277 businesses that ended up with liquidation orders had assets worth ₹0.46 trillion by the time they reached the tribunal. Thus, in value terms, around 70% of the distressed assets were rescued and only 30% went into liquidation.

Experts say that, in general, large businesses with more physical assets are expected to get more bids since in the event of a business failure, at least some money can be recovered through the sale of physical assets. “In the case of small businesses, the risk is higher since the buyer is entirely dependent on the resurrection of the business and there’s no backup (in terms of physical assets)," said Divakar Vijayasarathy, founder and managing partner at DVS Advisors LLP, a consultancy. Experts also say that investor interest in specific industries would keep fluctuating depending on the fortunes of the sector.

Earlier, there were few takers for the metals sector, but now, interest in the sector has skyrocketed due to the ongoing commodity supercycle. Investors’ interest in the pharma sector has also gone up significantly as compared to three years ago. The size of the business also matters. For instance, a one million plus tonne capacity steel plant is more likely to get a buyer than a 200,000-tonne plant. Apart from the nature of the business, there are also procedural hurdles. One such procedural hurdle is the share of vacant positions in the various benches of the National Company Law Tribunal (NCLT). According to official data, about half of the 63 NCLT positions are vacant. But experts say that despite these teething problems, many of the pending concerns regarding the implementation and constitutional validity of IBC has been sorted out by the Supreme Court and the framework is now finally in a fairly good position to substantially increase the pace of resolution.

The way forward

Bankruptcy professionals say that NCLT needs to be strengthened further. Despite being a powerful entity, the vacancies are creating hurdles to meeting the strict timelines mandated under the bankruptcy resolution process. IBBI chairperson M.S. Sahoo said that the government has taken cognizance of the matter. “The government is alive to the infrastructural needs of the bankruptcy regime and is taking appropriate measures to address them," Sahoo told Mint in an interview.

Contrary to expectations, what might help set things in order is that there has been no sudden surge in new bankruptcy applications once the one-year suspension on filings ended in March this year. The higher threshold on default ( ₹1 crore now instead of the earlier ₹1 lakh in order to give some protection to firms from creditor action), coupled with support and forbearance from the RBI, has limited the inflow of new applications, Sahoo said. He added that the pre-pack process, an alternative insolvency resolution scheme that is informal up to a point and takes relatively less time, has also become a reality in recent months.

A key pending suggestion is the automatic admission of IBC cases in tribunals, according to Anoop Rawat, partner, Shardul Amarchand Mangaldas & Co., a law firm. Since a record of default is available when an insolvency case comes for admission, it could become an automatic process, he said, adding that it takes roughly 2-3 months to get a case admitted currently. Delays in the admission of a case works to the disadvantage of lenders. Policy makers are also aware of another key suggestion from businesses and experts—the dilution of section 29A of the Code, which currently disallows a promoter under whose watch the firm defaulted on repayment from bidding for the assets. On this, government officials insist that a cautious approach is required. Going forward, if the failure of a well-governed insolvent firm can solely be attributed to economic conditions, in such cases the section 29A ineligibility may be reviewed and relaxed, said Rawat. “This relaxation, however, should not be available to firms where the promoters’ conduct has not been above board," he added.

Gangwal of Brescon & Allied Partners said that course correction is clearly required to improve the IBC’s outcomes. The measures needed, he said, include the ability to initiate pre-pack schemes not only for mid-sized but also for large businesses. Whether these changes will see the light of day, and how soon, remains to be seen. Until then, sick firms that have ceased to do business will continue to erect problems for the whole economy long after their doors have shut.