Editorial Notes

[Editorial Notes] Insolvency and Bankruptcy Code: Not the last resort

Insolvency and Bankruptcy Code should be the preferred option for resolution of bad loans, not the last resort.
By IASToppers
November 21, 2019

Contents

  • Introduction
  • Recent Indications of recalibrated approach of bank
  • Which factors are behind the shift in approach of stakeholders?
  • How does the Essar Steel Case is a ray of hope amid concerns?
  • What needs to be done to ensure smoother functioning of the IBC code?
  • Conclusion

Insolvency and Bankruptcy Code: Not the last resort

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Introduction

The Introduction of the Insolvency and Bankruptcy Code (IBC) marked a structural change in the resolution architecture in India. But despite its strength of time bound resolution of bad loans, various stakeholders are modifying their approach to deal with the problem of bad loans through the IBC process.

Insolvency-and-Bankruptcy-Code

Recent Indications of recalibrated approach of bank

RBI-panel-proposes-stricter-rules-for-core-investment-companies

  • Under Urjit Patel (former governor of RBI), the Reserve Bank of India took a forceful approach to resolving bad loans through the IBC process.
  • There is an institutional rethink on the approach to resolving bad loans under the new leadership and the June 7 circular on the resolution of stressed assets signals this change in stance of the RBI.
  • A few weeks ago, the minister of state for finance, said there should be an attempt to resolve stressed assets outside the IBC as it would help banks and the business community.
  • Banks now appear to be in favour of resolving the bigger cases outside the IBC process rather than taking companies to the NCLT.

Which factors are behind the shift in approach of stakeholders?

Several factors have prompted this shift:

  1. Delays in the resolution of cases: An endless litigation have lowered the enthusiasm for the IBC process. Out of the 1,497 cases which are currently going through the resolution process, 36 per cent have crossed 270 days, while another 22 per cent have crossed 180 days. The time bound resolution was the most attractive feature of the IBC process but these delays have definitely leaves little chance for the stakeholders to opt for this resolution process.
  2. The recovery rates have not been along expected lines: The recovery rate under IBC currently stands at 41 per cent but that also needs to be qualified. It is pro-cyclical as during high growth phases, the businesses tend to be more inclined to bid for assets as higher returns are expected. The higher recovery rates are partly driven by the resolution of steel companies during a period that coincided with high global steel prices.

A slowing economy coupled with an over-leveraged corporate sector has reduced the demand of assets which are stuck in the NCLT. In such a scenario there is little incentive to resolve bad loans through IBC.

  1. Lack of clear precedents has complicated the matters: It was hardly possible to calculate expected returns on their investment with any degree of certainty for investors.
  2. The enforcement directorate attaching property, as happened in the case of Bhushan Power and Steel, have further disincentivised buyers.

How does the Essar Steel Case is a ray of hope amid concerns?

Essar Steel Case

  • The judgment in the Essar steel case addresses one of these concerns.
  • The Court has done away with the uncertainty surrounding the distribution of claims. This is a positive step for creditors who otherwise have faced uncertainty.

What needs to be done to ensure smoother functioning of the IBC code?

  1. The provisioning norms for bad loans should be made more stringent to ensure banks have strong incentives to take companies through this process and not postpone the decision for hoping to restructure the loan outside IBC.
  2. The decision to relaxing the 330-day deadline must be reviewed as it will further dampen enthusiasm. The idea of having a time-bound process was to put pressure on the committee of creditors (CoC) to ensure speedy resolution. Delays in either taking the company to NCLT or in the resolution process destroys enterprise value.
  3. The government should establish the supremacy of IBC to ensure that assets are not allowed to be attached once they have been admitted. Under Section 53 of the law, amounts due to the central government rank below those of secured and unsecured creditors. This hierarchy needs to be respected.
  4. There is the need for clarity on the role of promoters. Allowing promoters to participate in liquidation but not in the resolution process would be inconsistent. Unless there has been a considered view that promoters, barring willful defaulters, should be allowed to come back which is now possible only through the backdoor.

Conclusion

Addressing these issues would go a long way in ensuring that IBC is the preferred option for dealing with bad loans rather than being the last resort.

 

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