Banks Are Losing Out. India’s Insolvency & Bankruptcy Code Needs Repairs
The Videocon case calls for a relook into the Code given the deep haircuts taken by creditors.
The Insolvency and Bankruptcy Code (IBC) was supposed to solve the great Indian banking crisis. But over four years after it started, its efficacy is being questioned.
The recent case of the thirteen companies of the Videocon group, which owed the banking system and its operational creditors around ₹64,839 crore, being sold for a song for ₹2,962 crore to Twin Star Technologies, hasn’t helped the IBC’s cause.
When a company is put through the Corporate Insolvency Resolution Process (CIRP) under the IBC, it can end up with a resolution plan, which includes everything from a change in management or product portfolio to the restructuring of the organisation or its business model, and even an alteration in the repayment schedule of the defaulted loan.
What’s the Point of Tiny Recoveries?
But the history of IBC over the last few years tells us that a resolution plan usually entails the company which has defaulted on loans being sold to another company, like the Videocon group companies were sold to Twin Star Technologies.
The money thus recovered is shared amongst banks and operational creditors to whom the defaulting company owed money to. When a company ends up in a financial mess, it doesn’t default on just its bank loans, but also on what it owes to its employees, suppliers, contractors, and so on. Such creditors are referred to as operational creditors.
Thus, the rate of recovery in the case of the Videocon Group of companies was 4.6 per cent (₹2,962 crore as a percentage of ₹64,839 crore) of the amount owed to financial and operational creditors. Given this, the haircut for the creditors amounted to over 95 per cent.
Not surprisingly, this led to a lot of hue and cry. If only ₹5 of the ₹100 defaulted on is recovered, what is the point?
Big Haircuts, Mounting Defaults
The National Company Law Appellate Tribunal (NCLAT) has put the potential transaction on hold. The Videocon Group isn’t the only case where the lenders have decided to take such a big haircut. In the past, Alok Industries was sold for ₹5,052 crore, against the ₹29,523 crore it owed to its financial creditors. This meant a haircut of 83 per cent. In the case of Reliance Infratel, the haircut was around 90 per cent, with a recovery of ₹4,236 crore against the ₹41,055 crore that was owed.
So, the question is, why are banks ready to take such huge haircuts? The short answer is that they are incentivised to do so — it is important to understand that.
A defaulting company can be sold to another company. The money thus earned can be used to pay off the creditors. The trouble is this doesn’t happen all the time. Between early 2017 and March 2021, as many as 2,653 CIRPs have been closed. Of this, only 348 companies, or a little over 13 per cent, have ended up with a resolution plan.
The point is that the chances of a company put through the NCLT process ending up with a resolution plan are low.
If a company doesn’t end up with a resolution plan, the chances that it will end up being liquidated and sold asset by asset, are very high. No financial creditor wants this to happen, simply because the recovery that happens through this route is next to nothing.
The major reason for this is the fact that India doesn’t have a system that can help carry out the liquidation process.
Data from the Insolvency and Bankruptcy Board of India tells us that as of March 2021, liquidation had been carried out for 1,277 companies. Of this, data for 1,271 companies are available, and it doesn’t paint a pretty picture. The total amount outstanding in these cases was ₹6.47 lakh crore. But the assets on the ground stood at only around ₹46,000 crore. Also, selling these assets isn’t easy either, and it takes a lot of time.
As of December 2020, around 69 per cent of the liquidations had been going on for a period of more than a year; 26 per cent of them for a period of more than two years. This explains why no financial creditor (read banks) wants to get into this mess. Or, as mentioned earlier, the banks are incentivised to take huge haircuts, which is to say, recover whatever is possible, and move on.
IBC Isn’t Entirely Fruitless
Further, it is worth pointing out here that the rate of recovery under IBC for defaulting companies that end up with resolution plans stood at over 39 per cent, as of March 2021. The total amount owed to the financial creditors, in this case, stood at ₹5.16 lakh crore. Of this, around ₹2.03 lakh crore has been recovered. A bulk of this recovery happened through the sale of two defaulting steel companies — Bhushan Steel and Essar Steel. If we leave these companies out, the rate of recovery falls to a little under 31 per cent. But even a 31 per cent recovery rate is higher than the recovery through other methods like Lok Adalats, Debt Recovery Tribunals and the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI) Act.
Also, the rate of recovery under IBC had stood at 46 per cent as of March 2020. The year 2020-21 has been bad for recoveries, as it has been for pretty much everything else connected to the economy. As mentioned earlier, as of March 2021, the rate of recovery has fallen to around 39 per cent. Further, the data do not capture the fact that the IBC has forced many defaulting promoters to come to the negotiating table with banks and settle before the defaulting company is put through CIRP.
So, there are problems with the IBC. Nevertheless, it has had a lot going for it as well. The rate of recovery for companies that end up with a resolution plan clearly shows that. Also, the promoters now fear losing control over their company if they default. While this is difficult to quantify, it is one of the gains from the IBC.
Having said that, there is tremendous scope for improvement, as is the case with any new system that is put in place. The Lok Sabha Standing Committee on Finance points out in a recent report that there are 13,170 IBC cases pending with total defaults amounting to ₹9.2 lakh crore. Of this, ₹6.77 lakh crore is owed to financial creditors (primarily banks).
The Code Needs New Ideas
The faster the defaulting companies are put through the CIRP, the greater is the chance of better recoveries. But that doesn’t seem to be happening.
The longer it takes to bring a defaulting company into the CIRP, the longer the defaulting promoter remains in control, enabling him or her to transfer assets and divert funds, leaving very little on the books of the company.
Many defaulting companies get unsolicited bids after the bidding process has been completed. This further delays the process. The IBC needs to be amended and such bids shouldn’t be allowed, given that they create procedural uncertainty.
The resolution plans also keep getting appealed in courts given the poor quality of judgment in many cases. All this delays the resolution process, and meanwhile, the defaulting company keeps losing value.
To conclude, the IBC is one of the few genuine reforms that have happened over the last few years. Of course, there are problems with this system, but that doesn’t mean junking the system, given that the earlier systems were much worse. We need to improve the current system. Any new law that has as many repercussions for the economy as the IBC does needs to be a work in progress, with the loopholes being plugged in constantly and new ideas being thought of.
(Vivek Kaul is the author of Bad Money. He can be reached @kaul_vivek . This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for them.)
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