Bankruptcy code reforms must be handled with special caution
Let market forces determine value while we focus on speedy case clearance and professional training
A parliamentary standing committee has called for an overhaul of the Insolvency and Bankruptcy Code (IBC), 2016. The major concern has been over large haircuts and a high rate of liquidation. While the suggestion to overhaul the law is welcome, it is important to understand the root cause of the problem and address the same.
Somehow, while assessing the effectiveness of the Code, too much emphasis has been laid on haircuts, which is often seen as the only determinant of its success. The IBC is not responsible for large haircuts. This is the result of losses in enterprise value. Why should the market pay ₹1,000 for an asset that is worth only ₹100 by the time it comes under IBC? Fixing a limit on a haircut is like asking the market to pay a minimum of, say, ₹1,000 for an asset which is worth merely ₹100 just because creditors had given the business a loan of, say, ₹1 lakh.
Nothing except market forces should determine the haircut that creditors must take on their dues. Fixing any benchmark for it will result in a double whammy. Firstly, it will incentivize banks to extend riskier loans, for now they would be assured of getting a minimum proportion of their dues back. Secondly, it will discourage prospective bids for assets, as their market value may not be worth the minimum proposed. This will push companies further towards liquidation. This, in turn, will be terrible for economy, which is already grappling with high non-performing assets and high unemployment. Insolvency laws impinge on various other variables, from employment and banking-sector health to the environment, etc. The corporate rescue ethos was about the revival of companies on the brink of collapse and salvaging those units that could be viably saved for the restoration of production and safeguarding of jobs in the larger interest of the economy. The question then is whether there is any chance for the turnaround of a company after a big haircut of, say, 95%: if the answer is yes, the law has achieved its purpose.
The primary objective of the IBC is maximization of value, among others. The Banking Law Reform Committee had noted that value should be determined by net present value calculations. Measuring the amount recovered by secured creditors against the debt owed to them is misleading. Debt recovery was never the objective of this law. In any case, recovery should be measured only against the value that’s left in the company on the day it becomes an IBC case.
We need to celebrate what the IBC has achieved in 5 years. Out of the 363 companies yielding resolutions under it, till 31 March 2021, 123 of them were defunct or Board for Industrial and Financial Reconstruction (BIFR) cases. The total realizable amount by financial creditors was 34% of their admitted claims even in these 123 defunct companies. Financial creditors realized 160% of the liquidation value in these companies.
If Parliament is seriously looking to overhaul India’s insolvency law, it must revamp the judicial infrastructure. The law must provide a strict timeline for the National Company Law Tribunal (NCLT) to look into insolvency matters. The court should also be given legislative guidance on how its powers are to be used, so that there are no judicial delays. The focus should be on creating a fresh cadre of insolvency and restructuring professionals. Currently, the work of insolvency professionals is overregulated and most of their energy is wasted on compliance fulfilment. They should be given training on the operational turnaround of stressed companies. The regulatory regime governing insolvency professionals should encourage pragmatism and business risk-taking. It should incentivize ethical conduct. For this, the entry barrier for these professionals should be raised, with focused training imparted at a younger age.
Also, there is a dire need to develop a market for stressed assets so that sales are not a challenge. India’s stressed asset market, which is estimated at $115 billion, presents a large opportunity for investors through the IBC process as well as out-of-court alternatives. The regulatory regime should allow the entry of global capital to this space and strengthen the process based on best practices observed in better developed stressed-asset markets. The participation of asset reconstruction companies in insolvency resolutions should be encouraged and not prohibited.
The success of any business regulation rests on the effectiveness of the court system. There must be a policy call made on the extent of involvement of commercial courts. The role of courts should be limited, while their effectiveness and capacity are enhanced. A lot has been said about the commercial wisdom of committees of creditors. Perhaps it is time to talk about the commercial wisdom of courts and provide legislative guidelines on how this wisdom is to be exercised in insolvency cases.
One needs to be very cautious about the nature of changes being proposed in India’s insolvency law. Such a law must enshrine business failure as a normal and legitimate part of the working of a market economy. If we undermine market forces from determining insolvency-resolution outcomes, vestiges of our poor BIFR experience will continue to haunt India for years.
Abizer Diwanji & Neeti Shikha are, respectively, head, financial services, Ernst & Young, and incoming associate dean, Indian School of Public Policy. These are the authors’ personal views.
