Parliament is reviewing a fix for India’s bankruptcy law that promises faster resolutions, but the proposed plan has some fundamental flaws.
The Insolvency and Bankruptcy Code (IBC) 2016 is up for a reset under an amendment bill currently being considered by the Lok Sabha. A key proposal is the introduction of an alternative insolvency resolution process alongside the one the IBC currently provides. This parallel process is intended to be largely out-of-court.
Unlike the existing model, it does not require creditors to obtain the approval of the National Company Law Tribunal (NCLT) to trigger insolvency. And unlike the current system, which puts a resolution professional in charge of running the company during the insolvency resolution process, the proposed alternative retains the debtor in possession of the company.
The stated intent is for this new model to save about a year by cutting down the time now consumed in securing NCLT admission of an insolvency case, while also providing more flexibility and minimising court interventions in the process.
However, in this article, I argue that this out-of-court, debtor-in-possession model is unlikely to reduce court interventions or shorten timelines.
On the contrary, it may well increase the time for resolving insolvencies by at least a year. It is problematic because it undermines some of the core principles that shaped the original law, which the expert committee responsible for these proposed amendments has itself applauded. The amendment is likely to make the law more unpredictable than it currently is.
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Why the new model is less equitable
The proposed model undermines the core philosophy of empowering all creditors, irrespective of their size or nature, to invoke bankruptcy against a defaulting company.
Under the IBC as it currently stands, any creditor who has been defaulted upon to the tune of Rs 1 crore may trigger insolvency against a defaulting company. Whether the company has defaulted on a vendor, an employee, a bank, or bondholders, once the threshold of Rs 1 crore is met, the law empowers them to take the defaulting debtor to insolvency.
The proposed model weakens this equitable principle in two ways.
First, it empowers only financial creditors to initiate the out-of-court insolvency process, depriving smaller and otherwise less powerful creditors of the right to avail of this option.
Second, only financial creditors notified by the government may use this framework. It does not lay out the principles on which such creditors will be notified. For example, the government may choose to notify only public sector or Indian banks, disadvantaging other lenders. Or, as was done under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act—a law empowering financial firms to enforce their security without going to court—the government may empower only banks to use this route, leaving out non-banking financial companies and bondholders, both of which are non-trivial lenders in the Indian economy.
In a system where regular courts are not an efficacious forum for enforcing debt contracts, the ability of small creditors such as employees and suppliers of a defaulting company to trigger insolvency and dispossess management allowed them some leverage. Excluding them from this option deprives them of this advantage.
New layers of unpredictability
In its nine-year life, the Insolvency and Bankruptcy Code has seen six sets of amendments. And 122 sets of amendments to the regulations issued under it. Constant changes make it hard for borrowing businesses and lenders to plan their affairs, invariably adding a “legal uncertainty” premium to the cost of borrowing.
The proposed model adds new layers of unpredictability to creditors’ decision-making when they advance loans to companies. Three sources of unpredictability stand out.
First, only debtors notified by the government will be subject to the proposed model. When a creditor advances money to a borrowing company, ex ante, it is unpredictable whether the proposed model will apply to that borrower, as its applicability depends on government notification. Government notifications can be easily issued and just as easily revoked.
Second, availing of the proposed model requires the approval of 51 per cent of the eligible financial creditors. At the time of lending, the creditor may not even know who these will eventually be, as the creditor composition will likely change during the duration of the loan. The current model, in contrast, does not make a creditor dependent on other creditors to initiate insolvency.
Third, the current model provides for a moratorium on all parallel recovery proceedings on the commencement of the resolution process, ensuring a “calm period” for the creditors to negotiate in peace. Under the proposed model, there is no automatic moratorium, and the resolution professional must apply to the NCLT for one. To apply for such a moratorium, the resolution professional must first obtain the approval of the committee of creditors constituted upon commencement of the process.
Does it really save time?
The proposed model is unlikely to reduce the timeline for the resolution of a defaulted company, and may well increase it.
First, as mentioned earlier, an eligible creditor must obtain the approval of 51 per cent of other eligible financial creditors to avail of this option. Depending on the number and kinds of financial creditors of the debtor company, this negotiation may consume time even after the default has occurred.
Second, the creditor desirous of availing this option must give the defaulting debtor an opportunity of being heard, adding 30 more days to the timeline.
Third, it allows the debtor to object to the commencement of the insolvency resolution process before the NCLT. While the NCLT is expected to decide such objections within 30 days, similar timelines provided in the original law have not been complied with, and there is no way to enforce them on the NCLT. These pre-trigger negotiations and approvals will add an estimated 90 days after default for commencing the insolvency process.
Finally, the proposed model lays down a 150-day timeline, extendable by 45 days, for the debtor company’s resolution. If, at the end of this period, no resolution plan is received or accepted by the creditors’ committee, the NCLT must convert this into a regular 330-day-long corporate insolvency resolution process, which the IBC currently contemplates. The IBC currently provides for automatic liquidation for companies that undergo this 330-day process where a resolution plan is not accepted by the creditors’ committee at the end of this period. The threat of automatic liquidation was intended to persuade creditors to accept reasonable resolution plans. Conversion of a 195-day process into a further 330-day process not only increases the timelines, but also disincentivises accepting reasonable resolution proposals.
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Need for a rethink
The proposed model’s intent is to provide for a pre-packaged mechanism that involves minimal interaction with the court, will reduce timelines, and make insolvency resolution less adversarial than it currently is. However, the alternative route is unlikely to solve these problems.
Perhaps, re-examining, in greater depth, why the current provisions of the IBC governing pre-packaged insolvency for Micro, Small and Medium Enterprises (MSMEs) did not work out and easing the current bottlenecks, is a more viable route to achieve this intent.
Bhargavi Zaveri-Shah is the Co-founder and CEO of The Professeer. She tweets at @bhargavizaveri. Views are personal.
(Edited by Asavari Singh)