“Delve into the complexities of the Insolvency and Bankruptcy Code, 2016, exploring its objectives, mechanisms, and the principle of allocative efficiency. Assess the success and failures of IBC & CIRP, analyzing their impact on debt recovery, credit availability, stakeholder interests, and entrepreneurship. Uncover the real-world numbers, revealing challenges and opportunities in the quest for efficient corporate insolvency resolution in India.”
This article explores the objectives of the Insolvency and Bankruptcy Code, 2016. It discusses the procedures and structures adopted by the IBC to deal with insolvency related matters, with a focus on the principle of allocative efficiency, on which the Code operates. Lastly, this paper analyses the success or failure of the IBC and analyzes its shortcomings.
Page Contents
SCOPE AND OBJECTIVES OF THE PAPER
1. To understand the procedures and mechanisms proposed under the IBC to deal with insolvency related matters.
2. To determine, through an assessment of numbers, whether the introduction of IBC and CIRP have been successful. If yes, to what extent.
3. To analyze the objectives with which the IBC was established and whether it has achieved those objectives or not.
INTRODUCTION
“Non-viable businesses need to be allowed to fail so that the larger economic ecosystem can reallocate resources from non-viable projects to viable initiatives. This is, in a sense, a sine qua none of an efficient, effective, efficacious economic system.”[1]
The enactment of the Insolvency and Bankruptcy Code, 2016 (IBC) brought about major structural changes as it aimed to consolidate and amend the laws on insolvency, revival and liquidation of corporates, LLPs, Partnerships and individuals. IBC seeks to provide for a mechanism of reorganization and resolution of insolvency of debtors in a time bound manner.
One of the fundamental changes that the introduction of IBC brought about was moving away from the ‘debtor-in-possession’ regime to a ‘creditor-in-control’ (CIC) regime where in creditors are given tremendous powers to decide matters of the corporate debtor along with the assistance of Insolvency Professionals (IPs). This regime promotes greater availability of credit as lenders by virtue of having control over the process of insolvency resolution would be willing to lend. At the same time, CIC regime also promotes entrepreneurship while maximizing value of assets.[2]
Prior to 2016, India did not have any formal experience of an insolvency regime that is proactive, market-led and time-bound. For IBC to be formally put into place, the law had to be laid down, infrastructures had to be created, professionals had to be developed and prepared, markets and market practices had to be evolved and adapted and above all the stakeholders had to be made aware of the Code, accept, change and learn how to use it.
Implementation of a law of such tremendous significance throws up innumerable challenges. The Code and its regulatory framework underwent several amendments in sync with emerging market realities.
PROCEDURE AND MECHANISMS UNDER THE IBC
The IBC provides for the resolution of insolvency matters while ensuring or at least attempting to manage the business of the corporate debtor as a going concern. The Code seeks to provide for the reorganization of a distressed company if its business is viable. In case the company is capable of being revived, the claims of the creditors are restructured and are either paid to them immediately or over time. In case of winding up of a distressed company, the assets of the company are sold and the proceeds from the sale of such assets is distributed among the stakeholders, in a manner prescribed by the code, in a waterfall mechanism.
The IBC entrusts the responsibility of revival and reorganization of a stressed company to financial creditors, not only because they have the capability to take crucial business decisions but also because their interests are aligned with the interests of the company having going concern, making it a positive sum game[3].
The resolution strategy under the Code, broadly has 3 elements[4]:
1. Prevention: the code seeks to resolve financial stress where it could not be prevented. It has various provisions to prevent such stress. There is a believable threat that if a company defaults, and consequently gets into CIRP, in all probability, it would move away from the hands of current promoters / management. This is because, firstly, promoters/ management may not be eligible to submit a resolution plan. Secondly, even if they are eligible, they might not submit the most competitive plan and this deters the management and the promoters from operating below the optimum efficiency level and encourages them to make best efforts to avoid default in the first place. It encourages them to settle debt with the creditors voluntarily or immediately on filing of an application for CIRP before the admission of such application by the adjudicating authority.
The Code has thus brought in significant behavioral changes and thereby re-defined the debtor-creditor relationship. With the Code in place, the defaulter’s paradise is lost. Repayment of loan is no more an option; it is an obligation.
2. Start Early and Close Timely: IBC allows the stakeholders to initiate CIRP as soon as there is threshold amount of default in order to prevent the stress from ballooning to unresolvable proportions. In early days of default, the value of the enterprise is typically higher than the liquidation value, hence, the stakeholders would be motivated to resolve insolvency of the company rather than to liquidate it.
The Code requires resolution in a time bound manner as undue delay is likely to reduce the organizational capital of the company. When the company is not in pink of its health, prolonged uncertainty about its ownership and control may make the possibility of resolution remote, impinging on economic growth.[5] The Code requires that a CIRP shall mandatorily be completed within 330 days, including any extension of time as well as any exclusion of time on account of legal proceedings. In fact, timeline is the USP of the Code.
3. Closure of Non-Viable Companies: IBC provides for a mechanism for a company, where a solution is neither possible nor desirable, to exit with the least amount of disruption and cost and release unutilized resources in an orderly manner for their fresh allocation to efficient uses.
The code, therefore-
- Endeavors to prevent insolvency,
- Provides for a market determined and time-bound mechanism for resolution of insolvency related matters,
- Provides for ease of exit,
- Endures optimum utilization of resources- either by ensuring efficient use of such resources in the distressed business or by releasing unutilized/ under-utilized resources for efficient uses through closure of the distressed enterprise.
THE SUCCESS OF IBC AND CIRP
The first order objective of the Code is ‘resolution’. The second order objective is asset value maximization of the distressed business and lastly, to promote entrepreneurship, availability of credit and balancing interests of the stakeholders. An effective legal framework for timely disposal and resolution of insolvency related matters supports development of credit markets and encourages entrepreneurship.
The success of the Code can be evaluated in terms of the following[6]:
1. Value Maximization: The Code enables maximization of the value of assets of the corporate debtor by putting the responsibility on the creditors to endeavor to revive the failing business of the debtor by improving utilization of resources. If revival fails or is not possible, the value of assets of the corporate debtor improves. It prevents depletion of value by ensuring early initiation of proceedings for revival and its expeditious conclusion.
The Code envisages limitless possibilities of resolution- turn-around, buy-out, merger, acquisition, takeover, etc. It also mandates the Resolution Professional (RP) and the Liquidator to determine, if the corporate debtor has been subjected to vulnerable transactions (such as preferential transactions, fraudulent transactions, undervalued transactions etc.) in the past, and if so, then one is obliged to file an application with the Adjudicating Authority for claw back of the lost value.
2. Enhancing Credit Availability: The Code through its provisions for resolution and liquidation, enables creditors to recover their dues from either future earning, post-resolution or sale of assets in case of liquidation. This incentivizes creditors, both secured and unsecured, financial and operations, foreign and domestic- to extend credit at lower costs especially when they have rights under the Code to initiate CIRP in case of any default.
3. Balancing Interests of Stakeholders: Stakeholders have varied interests in a company. The Code has set the priority of stakeholders in the form of a waterfall mechanism in case of liquidation. It prescribes a minimum protection for certain stakeholders at the stage of CIRP. It requires the resolution of insolvency within a framework of fairness and equity in a manner that maintains the incentives of all stakeholders.
4. Promoting Entrepreneurship: Unused or under-used resources hinder the growth of a country and its people. By rescuing viable businesses through successful Corporate Insolvency Resolution Process (CIRP) and shutting down the non-viable ones through liquidation, it releases the resources which can be put to better use. A company may fail to deliver as planned owing to competition and innovation and consequently, may default in payment of its obligations. IBC attempts to reduce the incidence of failure by incentivizing its prevention, rescuing failing businesses, wherever possible, and releasing resources from failed/ non-viable businesses, wherever required.
It enables an honest entrepreneur to make an orderly exit if the enterprise fails despite the best of intentions and efforts. Thus, the possibility of failure does not hold up an entrepreneur from commencing a business, implementing a new idea and/or running the enterprise.[7]
Beyond its explicit statutory objectives, the Code seeks to rescue and revive corporate debtors thereby, rescuing employment of several employees and their livelihood. In the absence of CIRP, there is a possibility that the business of the corporate debtor suffers a natural death. The code operates on the principle of ‘Allocative Efficiency’, which requires the resources in an economy be put to their most efficient use. The economic goal of allocative efficiency is maximization of social welfare. A vigorous corporate insolvency regime, like the IBC can help foster growth by enabling efficient allocation of resources- from failing/ failed enterprises to efficient companies.
ARE IBC AND CIRP REALLY A SUCCESS- WHAT DO THE NUMBERS SAY
More than five years down the line IBC has ended up with a loss of 80% admitted debt claims, and has led to liquidation (closure of business) in 29.7% of cases, according to the latest data provided by the Insolvency and Bankruptcy Board of India (IBBI).[8]
Fig. 1.1 Source: IBBI Newsletter, 2021
From 2016 to 2021 (up to June 2021 for which IBBI data is available), a total of 4,541 cases of Corporate Insolvency Resolution Process (CIRP) were admitted in which corporate debts amounted to ₹13.94 lakh crore.
Until June 2021, only ₹1.82 lakh crore of it, or just 20% of the admitted debt claims, is realizable or realized — a net loss or haircut of 80% debt. The earlier debt resolution process under the Sick Industrial Companies (Special Provisions) Act of 1985 (under which Industrial and Financial Reconstruction (BIFR) functioned) had a recovery rate of 25% – a far better performance in comparison.
Apart from this, a very large number of CIRP cases are ending in liquidation, where settlement leads to closure of businesses, causing job losses, and debtors getting a pittance. Of the 4,541 CIRP cases, 29.7% have already gone into liquidation. While there is no data on the resultant job losses, debtors have lost (haircut) 95% of their loans.[9]
The two together – loss of credit and loss of business and jobs – mean the economy is getting hurt, something which the IBC seeks to prevent.
Fig.1.2 Source: IBBI Newsletter, 2021
The IBC’s another key objective of timely disposal of matter has gone for a toss too. Instead of settling the cases in 180 days, as its mandate, the IBBI data shows 80% of cases have crossed the limit, with 75% of cases taking more than 270 days.[10]
The Parliamentary Committee on Finance examined the IBC’s performance and submitted its report in August 2021. It expressed serious concerns about low recovery and long delays. It stressed that the “fundamental aim of this statute (IBC) is to secure creditor rights”, and “greater clarity of purpose” is needed for this “particularly considering the disproportionately large and unsustainable “haircuts” taken by financial creditors over the years”. It also asked to fix a benchmark for the quantum of haircuts in line with global standards.[11]
CONCLUSION AND ANALYSIS
Having stated the above, the IBC has certainly matched up to the challenge of reinvigorating the insolvency regime in India. Not only has it been able to tackle the menace of non-performing assets, but it also has been effective in contributing to the economy in various indirect ways such as improving credit discipline in the market owing to the fear instilled in the minds of promoters of losing their control in the companies, creating foreign investment opportunities in light of increased confidence on account of the structured and time bound approach and saving jobs by preventing companies from going into liquidation.[12]
However, for the IBC and the mechanisms proposed under it to work, its implementation needs to be strengthened. There is a need of robust framework to deal with such a big inexperienced and unexpected lockdown and its impact over the economy. Though there is clear shift in the approach of the government towards rescue culture however such a blanket suspension is against the spirit of IBC as well as in the economic interest of the nation. In all over the world the steps have been taken to mitigate the effect of pandemic by bringing the necessary procedural changes however no other country has come with the blanket suspension of Insolvency and Bankruptcy Code like India.[13]
[1] Guru, A. & Shekar, M., Iov -Registered Valuers Foundation – Insolvency and Bankruptcy Board of … Insolvency and Bankruptcy Board Of India (IBBI). Available at: https://ibbi.gov.in/uploads/resources/S&FA.pdf [Accessed August 19, 2022].
[2] Sriram, B., Driving Successful Resolutions through IBC. Insolvency & Bankruptcy Board Of India (IBBI). Available at: https://ibbi.gov.in/ [Accessed August 21, 2022].
[3] Report of the Working Group on Tracking Outcomes under the Insolvency and Bankruptcy Code, 2016
[4] O Anon, Insolvency and Bankruptcy Board of India. Available at: https://ibbi.gov.in/ [Accessed August 21, 2022].
[5] Report of the Working Group on Tracking Outcomes under the Insolvency and Bankruptcy Code, 2016, Insolvency and Bankruptcy Board of India. Available at: https://ibbi.gov.in/ [Accessed August 21, 2022].
[6] Report of the Working Group on Tracking Outcomes under the Insolvency and Bankruptcy Code, 2016, Insolvency and Bankruptcy Board of India. Available at: https://ibbi.gov.in/ [Accessed August 21, 2022].
[7] Report of the Working Group on Tracking Outcomes under the Insolvency and Bankruptcy Code, 2016, Insolvency and Bankruptcy Board of India. Available at: https://ibbi.gov.in/ [Accessed August 21, 2022].
[8] Mohanty, P., 2021. The Feats & Failures of IBC: Why it must change. Fortune India: Business News, Strategy, Finance and Corporate Insight. Available at: https://www.fortuneindia.com/opinion/the-feats-failures-of-ibc-why-it-must-change/106119 [Accessed August 21, 2022].
[9] Mohanty, P., 2021. The Feats & Failures of IBC: Why it must change. Fortune India: Business News, Strategy, Finance and Corporate Insight. Available at: https://www.fortuneindia.com/opinion/the-feats-failures-of-ibc-why-it-must-change/106119 [Accessed August 21, 2022].
[10]Anon, Insolvency and Bankruptcy Board of India. Available at: https://ibbi.gov.in/uploads/resources/f841a45902d901ef311fe6d76127d094.pdf [Accessed August 21, 2022].
[11] Report of the Working Group on Tracking Outcomes under the Insolvency and Bankruptcy Code, 2016, Insolvency and Bankruptcy Board of India. Available at: https://ibbi.gov.in/ [Accessed August 21, 2022].
[12] Sriram, B., Driving Successful Resolutions through IBC. Insolvency & Bankruptcy Board Of India (IBBI). Available at: https://ibbi.gov.in/ [Accessed August 21, 2022].
[13] Jangir, M., Insolvency and bankruptcy code (1) – researchgate.net. Available at: https://www.researchgate.net/profile/Mukta-Jangir/publication/355584285_Critical_Analysis_of_Insolvency_and_Bankruptcy_Code_Amendment_Act_2020_Shift_in_Approach_from_a_Liquidation_Culture_to_Corporate_Rescue_Culture_Critical_Analysis_of_Insolvency_and_Bankruptcy_Code_Amen/links/617790523c987366c3e9bc9d/Critical-Analysis-of-Insolvency-and-Bankruptcy-Code-Amendment-Act-2020-Shift-in-Approach-from-a-Liquidation-Culture-to-Corporate-Rescue-Culture-Critical-Analysis-of-Insolvency-and-Bankruptcy-Code-Amen.pdf [Accessed August 21, 2022].
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