One of the best bits of news earlier this month was that the government seems serious about overhauling the bankruptcy Act in Budget 2023. Just six years after it began on a high note, the Insolvency and Bankruptcy Code (IBC) needs serious fixing and not a mere patchwork. Ideally, a draft law, accompanied by a status report, should have been put in the public domain so that experts have an opportunity to point out potential loopholes, unworkable clauses and interpretation issues, before these get passed into law. Instead, media reports suggest that the ministry of corporate affairs (MCA) has adopted the usual formula of ‘widespread’ consultation, while the actual drafting will, perhaps, be outsourced to a legal NGO (non-government organisation) or a consulting firm, instead of going through the fine toothcomb of law ministry mandarins.
While the good news is that the government agrees that a fairly new legislation needs urgent fixing, the bad news is that, just when a few contentious issues have been settled through judicial pronouncements, we may have a new litigation emerging from the amended law that will have pass through three layers of an overburdened judiciary before being settled. A public discussion, often, triggers hectic lobbying by vested interests to dilute stringent legal provisions; but unworkable provisions that wind up in court and deliberate loopholes does greater damage since our slow and expensive judicial process gives an advantage to those with deep pockets. So let us first look at where the IBC stands today and some fixes that are urgently needed or worth trying out.
IBC Status
The IBC process started with a bang in 2016 by taking on some of the biggest defaulters, such as Essar Steel, Bhushan Power and Steel, Electrosteel Steels, Monnet Ispat & Energy, etc. These cases were monitored by the prime minister’s office (PMO) and, although there were delays due to legal challenges, there was no political interference. This was the high point. The average recovery, which was around 35% in the early days has plummeted to 20% and is embarrassingly lower in some quarters. Financial Express (FE) reported in May 2022 that the recovery rate was a pathetic 10.2% of admitted claims in January-March 2022.
The IBC mechanism is beset by long delays, lack of manpower and, above all, corruption and collusion between erstwhile management, resolution professionals and secured creditors who have the final say. There is also the problem with pushing non-banking finance companies (NBFCs) under the IBC. But more about that later.
Data released by the Insolvency and Bankruptcy Board of India (IBBI) reveals that 47% of companies, admitted to the insolvency process between December 2016 and March 2022, went into liquidation and only 14% were resolved under the Act. In terms of numbers, of the 5,258 corporate bankruptcy proceedings initiated in this period, 3,406 were closed; but, of these, only 480 were resolved and as many as 1,609 were liquidated.
We are now at a stage where even large conglomerates, with some valuable assets, are attracting bids far below the liquidation value and, in a growing number of cases, creditors are happy to accept a haircut of 80%-99% leaving nothing for other stakeholders.
This is best told by an observation by the NCLT (national company law tribunal) in June 2021, while approving the sale of Videocon Industries to Vedanta group’s Twin Star Technologies at a 99.29% haircut. Against total claims of Rs71,433 crore and admitted claims of Rs64,838 crore, Twin Star made a bid Rs2,962 crore!
NCLT observed that Twin Star was paying ‘almost nothing’ for the purchase and operational creditors were being forced to accept was a ‘tonsure, or total shave’ rather than a haircut. Investors and financial creditors would get nothing. This case continues to be litigated and is not finally settled. But Videocon is not the only one. There is Jet Airways, Siva Industries and several small and unknown companies that pass through NCLT without making headlines.
Just as shocking as Videocon is the case of Anil Ambani’s Reliance Capital (RCap), which has attracted bids that are 50%-60% of its liquidation value of around Rs13,000 crore, despite eight valuable subsidiaries in its fold (Read: How SEBI, RBI and IRDAI Turned a Blind Eye for Years as Reliance Capital Crumbled). In September 2021, RCap’s consolidated debt was Rs40,000 crore; in November 2021, the Reserve Bank of India (RBI) superseded the board, appointed an administrator and referred it to the IBC. While the issue of whether to liquidate the company or accept a low-ball offer remains contentious, the fact is that bidders have only offered between Rs4,000 crore-Rs5,200 crore for the entire assets.
The SREI group, which was allowed to run amok under RBI’s watchful eye, is another huge mess. Although the resolution of its two main NBFCs—Srei Infrastructure Finance Limited and Srei Equipment Finance Limited—began in October 2021, a top banker tells me that there is lack of clarity on the true state of the group. In this case, the admitted claims are Rs32,750 crore and transactions worth over Rs5,000 crore have been classified as fraudulent. There are 17 bidders in the fray but they have bid Rs15,000 crore or significantly less.
Clearly, the IBC process is not really working for NBFCs. Financial service-providers (FSPs) were deliberately kept out of the legislation in 2016 in line with policy decisions around the world, after the 2008 global financial crisis. At that time, the plan was to have a separate process for banks, insurers and systemically important NBFCs under a newly minted Resolution Authority as recommended by the Financial Sector Legislative Reforms Commission. In line with this plan, was the controversial Financial Resolution and Deposit Insurance Bill, 2017 (FRDI Bill) which proposed that depositors would bail out failed entities. It would not have worked in the Indian financial system, dominated by public sector entities and poor regulatory accountability. Also, since this was proposed against the backdrop of major defaults failures, it became a political hot potato that was quietly junked, after being introduced in parliament.
That was when we had large financial failures such as the giant Infrastructure Leasing & Financial Services (IL&FS), Yes Bank, Punjab-Maharashtra Cooperative Bank (PMC Bank), Dewan Holding and Finance Ltd (DHFL) and the SREI group. Almost all were all the result of RBI studiously looking the other way and failing to act in time. A second attempt to reintroduce FRDI as the Financial Sector Development and Regulation (Resolution) Bill, 2019 (FSDR) also had to be junked and other solutions were pursued (Read: Moneylife Exclusive - FRDI Bill To Come Back as FSDR: Many Questions Unanswered).
The NBFC Solution
In September 2018, with general elections around the corner, Ireported how IL&FS, a massive, shadowy conglomerate of over 347 companies and outstanding debt of Rs1 lakh crore had defaulted on its repayment obligation to SIDBI (Read: IL&FS defaults on Rs1,000 Crore Short-term Loan from SIDBI?). Since NBFCs were kept out of the resolution process, IL&FS had to be handled differently. In order to avoid a systemic shock and domino effect, the government appointed a public interest board comprising many retired bureaucrats and led by well-known banker Uday Kotak.
When IL&FS was followed by the two large defaults engineered by branches of the same business family of Wadhavans—DHFL and PMC Bank—the government had to find a solution to the NBFC issue. A quick notification was issued amending the rules governing financial service-providers on 18 November 2019, (https://ibbi.gov.in/uploads/legalframwork/ 7bcd2585a9f75b9074febe216de5a3c1.pdf) to pave the way for NBFC resolution with the condition that such a resolution would be initiated by the regulator. DHFL was the first NBFC to be resolved under the IBC followed by the SREI group and Reliance Capital. But the response to RCap suggests the need for a better alternative.
The Kotak Proposal
In an interview to The Economic Times on 5th December, Mr Kotak suggested that, for companies with an outstanding debt of over Rs25,000 crore, we need to appoint a public interest board rather than a resolution professional. In a quick comparison between the IL&FS resolution that he led and the pathetic bids for Videocon and RCap, it certainly seems a better alternative, provided the government is serious about finding the best people with integrity and experience to deal with such cases. After all, defaults of Rs25,000 crore usually happen because previous managements are powerful, crooked and politically-connected enough to get regulators to look away and bankers to collude in fresh borrowing and ever-greening operations.
In terms of optimising value for stakeholders, IL&FS is certainly a success story. The board successfully disentangled a complex mass of 347 companies, sold or shut down many to reduce them to 100 operational entities, paid out over Rs16,000 crore to creditors and estimates total recovery at 60% or around Rs60,000 crore (out of over Rs94,000 crore). But this is not the ideal solution. Decisions of the public interest board (PIB) have to be cleared by a retired judge and then ratified by NCLT. The whole process remains slow, complicated and is mired in litigation which will have to wind its way past the appellate tribunal and the Supreme Court. Finding people for multiple PIBs, who are trustworthy as well as competent, is a challenge, but the failure to do so will trigger more controversy.
While Mr Kotak, in his interview, is upbeat about the IBC process putting creditors first, he agrees that it could do with some tweaking and suggests a solution could be found under Section 241 and 242 of the Companies Act 2013 which empowers the government and the resolution professional to act in the interest of the company. The government has already filed action in the Videocon case [Union of India v. Videocon Industries Limited and Others (2021)].
There will be many such ideas to fix the IBC law to maximise stakeholder value through resolution. There is a need for open discussion on issues such as introducing the concept of voluntary bankruptcy filings, whether to permit asset reconstruction companies (ARC) to participate in the resolution process, conflict of interest when creditors are also bidders and rectifying the impact of a Supreme Court order which, contrary to the thinking behind the IBC, put the operational creditor on a better footing than the financial creditor and allowed NCLT the discretion to admit or reject initiation of the insolvency proceedings even after a default (Read: SC Order on Vidarbha Industries Gives a 440 Volt Shock to Bankruptcy Code-IBC!). All this will happen when the government is confident enough to open the process to public discussion rather than rush through a hurried amendment full of new loopholes and problems.
Unless Tribunals are free from MCA's puppet game, unless IBBI concentrates more on the working of Tribunals and MCA and take remedial measures by roping in PMO, this law is just failing.
One thing need to understand in this situation is no one is hearing minority shareholder nor value them ... Need to improve this as minority shareholder are not aware of this type of unethical activity done by any of the involved person/parties/member whatever it may be... Hope someone listen and care my point of view. Also requesting SEBI through your platform to address this earliest as SEBI is prime body who preserve minority shareholder interest.
Other than this I strongly believe that if this situation persist longer than no one will trust our Indian economy & people starts assuming all are fraud like that....
Apart from the long list of mishaps in the resolution process pointed out in the article, the Act requires that the firm that would like to register as Insolvency Professional Entity should have five Resolution Professionals as Directors on the Board. This would mean that the actors and the directors should be the same and this brings in conflict of interest in the functioning of the IPE. Instead, the IPE should have been allowed to work with RPs as consultants and the IPE should have the experience of handling the resolution of stressed entities outstanding creditors with speed and equitable treatment to the creditors.
A nice article by the author that gives a clear picture of how tax payers' money is compromised by the defective system which experiments with IBC law that defies solution at last. More brains, more mess ???
Full of loop holes, contradictions and fallacious assumptions born in a lack of experience and intelligence substituted by Bollywood and the like is true of all post 1947 laws of India commencing with the deeply flawed Constitution of 1949.
yes it is right any improvements need to look at it from all angles and should not be brought in a hurried way and then everyone will be pointing out the mistakes in it
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Other than this I strongly believe that if this situation persist longer than no one will trust our Indian economy & people starts assuming all are fraud like that....