Insights into Editorial: Changed priorities
The President of India gave his assent to an amendment in the Insolvency and Bankruptcy Code that barred a majority of defaulting promoters from buying back their assets.
The changes via an ordinance made at least nine categories of persons ineligible for submitting a resolution plan for the indebted companies facing insolvency action at the National Company Law Tribunal.
Amendments to the code said that those whose accounts have been non-performing for a year will not be allowed to participate in the resolution plan.
The move came at a time when about 50 of the India’s biggest defaulting companies face insolvency proceedings.
What is bankruptcy? What is the IBC’s intent?
A company is bankrupt if it is unable to repay debts to its creditors (banks, suppliers etc). The inability to repay debts by some Indian firms has resulted in a huge pile of NPAs for the banking system.
The Indian government had introduced the IBC as a method to tackle the issue. Under the Code, a resolution has to be found for the indebted company within 270 days. Otherwise, a liquidator is appointed. The company can also opt for voluntary liquidation by a special resolution in a general meeting.
The Insolvency and Bankruptcy Board of India (IBBI) is the regulator set up on October 1, 2016 under the Insolvency and Bankruptcy Code. The resolution professionals entrusted with the responsibility of sorting out the insolvent companies. The IBBI is assisted by the disciplinary, advisory and technical committees.
How has IBC progressed? Why was the amendment needed?
The resolution to stressed assets picked up steam under IBC and investors started warming up to the huge opportunity. The question was whether existing sponsors / promoters of corporate debtors (i.e. the company with debt and under the insolvency proceedings) can directly or indirectly acquire stake in these firms post acceptance of a resolution plan which would have entailed substantial discount to outstanding loans of lenders.
The key questions were —
- Can promoters seek a huge cut from lenders and be back in the business?
- Does this provide a level playing field to other prospective bidders?
- Does this send the right political and economic signals?
The government took note of all these concerns expressed by investors, and that’s what led to the recent (amendment) ordinance.
What are the key elements of the amendment?
The amendment has inserted two new sections in the insolvency code —
- Section 29A, which provides for persons ineligible to be a Resolution Applicant;
Those ineligible to be a Resolution Applicant include:
- Wilful defaulters
- Persons convicted for any offence punishable with imprisonment for two or more years
- Undischarged insolvent
- Persons disqualified as directors
- Persons barred by SEBI from the securities markets
- Those whose accounts are classified as Non-Performing Assets (NPAs) for one year or more and are unable to settle overdue amounts including interest and charges relating to the account before submission of the Resolution Plan.
- Persons who have given a guarantee to a creditor in respect to a corporate debtor in IBC
- Persons from foreign jurisdictions
- Section 235A, which provides for punishment for contravention of the provisions where no specific penalty or punishment is provided. The punishment is fine which shall not be less than one lakh rupees but which may extend to two crore rupees.
What the amendment means in terms of NPA resolution? What are the key challenges?
The government has taken the high moral ground to deal with the menace of non-performing assets or NPAs that have brought many public sector banks on the verge of bankruptcy.
Many are of the view that if the errant promoter is disqualified from the bidding process it will lead to further losses for banks.
- Deciding who will be eligible to bid:
The key challenge would be to invite expression of interests and resolution plans from applicants who are not related to the Corporate Debtor after conducting due diligence about the creditworthiness of such buyers.
It is now up to the resolution professional to decide who will be eligible to bid for the defaulter companies or their assets.
- Advisory committees chaired by several top corporates
The advisory committees on corporate insolvency and liquidation are chaired by several top corporates.
The appointment of corporates as heads of important corporate insolvency advisory committees under IBBI may not inspire confidence in the credibility of the resolution process.
The recent ordinance may end up being used selectively to defeat the very objective of penalising the errant promoter.
The banks will only lose if resolution is side-tracked by the ensuing power struggle among corporate India to purchase distressed assets at rock-bottom prices.
- The Ordinance gives incentives to the banks to delay NPA recognition for as long as possible
By disqualifying a large number of persons, the Ordinance will lower the amount that the banks as the main financial creditors in most of the IBC cases expect to recover. This may result in the banks not recognising accounts as NPA so that the promoters can submit their bids in the IBC resolution process.
- Affect the incentives of the government
The Ordinance may also affect the incentives of the government as the majority shareholder in these banks. The government maybe incentivised to encourage public sector firms (PSUs) to bid in the IBC resolution process so that the deals go through at relatively higher prices and the PSU banks do not face large haircuts.
What is the likely impact of this Ordinance on IBC?
- Procedural impact:
The Ordinance introduces substantial procedural uncertainty in the resolution process and opens it up to disputes and litigation. These insolvency professionals now have the task of determining the eligibility of applicants as per this Ordinance.
- Economic impact on resolution
The Ordinance effectively disqualifies vast sections of the corporate world, both in India and abroad, from participating in the IBC bidding process.
In doing so, it significantly reduces the number of likely resolution plans that maybe submitted in any IBC case in an already gloomy landscape. The lack of competition among the narrow pool of eligible bidders will depress the financial value of any resolution plan
- Impact on IBC principles:
By substantially shrinking the universe of eligible resolution applicants as well as potential buyers in liquidation, the Ordinance violates the core principles of the IBC.
The IBC is based on the premise that all business failure is not fraud. The Ordinance by its very design goes against this principle. A person may have faced adverse economic shocks such as a business cycle downturn or a commodity price shock. This is different from a fraudulent or an unscrupulous promoter who may have been siphoning off assets from her own firm.
But, The Ordinance treats both these categories on par.
An ultimate test of the success of IBC is the recovery rate. As the preamble to IBC clearly states, the primary objective of the law is maximisation of value of assets of the debtor firm undergoing the insolvency and bankruptcy proceedings. Fulfilling this objective requires a competitive bidding process such that there is a fair price discovery mechanism.
One way to resolve this conundrum maybe to bar promoters from participating in the IBC bidding process in their full capacity while permitting them to make deals with third parties such as private equity funds, who would be the primary bidders.
Even though there have been concerns about the amendment, it should ensure that errant promoters don’t end up getting the business back with all sacrifices being made by the lenders.