Context: The Insolvency and Bankruptcy Code (IBC), which was touted as a panacea to the debilitating problem of bad loans that had crippled the Indian financial system, has been attacked as being ineffective at best and counterproductive at worst.
- The Insolvency and Bankruptcy Code, 2016 (Code) sets out a time-bound insolvency resolution process for defaulting corporate debtors.
- It introduces a creditor-in-possession model whereby a committee of creditors (CoC) is constituted to take decisions regarding the operations of the corporate debtor, including evaluating prospective resolution plans for resolving the corporate debtor's account.
The mandate of the IBC
- To nip souring debt in the bud by divesting promoters of control and resolving it as soon as possible, while also realising the best possible value.
- This would pave the way for fresh credit and investments.
Salient Features of IBC
- It applies to both individuals and companies.
- Earlier it provided for a 180-270 days period to resolve insolvency but now the deadline of 330 days has been set for completion of corporate insolvency resolution process (CIRP), including litigation and other judicial processes.
- It provides immunity to the debtors from claims of resolution by creditors during this period of resolution.
- It provides for a common platform of debtors and creditors of all classes to resolve insolvency.
- The Code gives the highest priority to those who have brought interim finance to meet the costs of resolution or liquidation, followed by dues to workers for the past two years and dues to secured creditors in equal priority.
- Employees other than workmen, and unsecured creditors and operational creditors are further down the line in the priority of receiving resolution or liquidation proceeds.
Advantages of IBC
- When the Insolvency and Bankruptcy Code (IBC) came into force five years ago, it was rightly hailed as a landmark reform move to speedily transfer capital locked in unproductive assets to productive uses.
- The extant systems — SARFAESI, Lok Adalats and Debt Recovery Tribunals — had proved ineffective.
- What marks out the IBC is its creditor-in-control model as opposed to the debtor-in-possession system.
- Under this, the promoter loses control over the management of the company as the debt is auctioned to interested parties other than the promoter.
- Ejecting the promoter was expected to rule out lengthy litigation.
- Counter restructuring of loans: The IBC was also conceived in a context where large defaulters had their way with banks and got their loans restructured multiple times till they turned irrevocably bad.
- While the Asset Quality Review process brought these NPAs into the open, it required an IBC to weed these out of the banks’ books.
- The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, more commonly known by its shorter name SARFAESI Act, is a legislation that allows banks and other financial organizations to recover bad loans effectively.
- The act can be utilized to tackle the problem of Non-Performing Assets (NPAs) through different procedures. However, this is possible only for secured loans. For unsecured loans, banks should move the court to file a civil case of defaulting.
- This act makes the court's intervention unnecessary in case of secured loans. The first asset reconstruction company (ARC) of India, ARCIL, was set up under this act.
- The primary criticism against IBC has been on account of its paltry recoveries, which according to many critics makes IBC a legal mantelpiece instead of a powerful tool for economic value creation.
- The recent Parliamentary Standing Committee report on insolvency observes that “low recovery rates with haircuts as much as 95 per cent and the delay in resolution process with more than 71 per cent cases pending for more than 180 days clearly point towards a deviation from the original objectives of the Code.
- Less number of resolutions: Of the nearly 4,500 cases admitted by the National Company Law Tribunal over time, only 8 per cent have seen resolution, while 30 per cent have gone into liquidation and 40 per cent are pending resolution.
- Pending cases: The NCLT has received over 32,000 insolvency applications, out of which a decision (to admit or not) is pending in over 13,000.
- The astonishing projected haircuts in ongoing cases such as Siva Industries and Videocon point to the need for accountability in the conduct of the committee of creditors and the resolution professional.
- These relate to subjects such as cross-border insolvency, group insolvency and the tricky issue of resolution process for financial services companies as the DHFL experience shows.
- Also, as the RCom experience shows, what happens to assets (such as spectrum) leased out to companies when they hit the insolvency court?
- The Department of Telecommunications (DoT) has raised objections to the debt resolution plans proposed for Reliance Communications (RCom) and its subsidiary Reliance Telecom Ltd (RTL) under the Insolvency and Bankruptcy Code.
- At the centre of the entire issue is the question about who owns the spectrum allocated to RCom. DoT is of the opinion that spectrum being a public resource, the ownership is with the Government and therefore it cannot be sold by the banks under the insolvency process.
- Unlike the western nations, where banks are well informed and corporate bonds are subject to the discipline of free markets, most loans in India are issued by uninformed and poorly incentivized ‘sarkari’ bankers and the issuance of such loans is often due to political influence and corruption.
- Many loans are secured on the ‘personal guarantees’ of promoters and are therefore unsecured for all practical purposes.
- Therefore many loans in India lose value at the time of disbursal and not due to the IBC at the time of recovery.
- Despite the value loss on issuance, on average, IBC recovery rates are comparable to those in the US bankruptcy process, long seen as the gold standard for this.
Comparison with previous schemes
- According to Reserve Bank of India (RBI) data, for the three years that IBC was used, recoveries averaged around 45%. Many have criticized the IBC by arbitrarily declaring this number as low.
- As RBI data shows, average recoveries for asset reconstruction companies (ARCs) under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act surpassed those under IBC just once in the 17-year period ended 2020, and have largely languished under 30% during this period.
- Similarly, Debt Recovery Tribunals surpassed the 45% recovery mark only thrice in this 17-year period and have been languishing with single digit recovery rates for the past few years.
- In any bankruptcy process, recoveries are impacted by a host of macroeconomic and firm-specific factors.
- This is because asset values are not constant and change according to the larger economic environment and competitive dynamics of the industry within which the firm operates.
The IBC has certainly proved to be a superior process compared to the earlier systems but clearly, it will have to evolve with experience in order to be effective. While vocal, rhetorical and political arguments have been made against the IBC on the basis of anecdotal evidence, a reform as radical and complex as this deserves a more objective and data-intensive evaluation.
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