From UPSC perspective, the following things are important :
Prelims level : IBC 2016
Mains level : Paper 3- Right timing in the use of IBC matters
Understanding the role of IBC 2016
- For reasons sometimes a company may experience stress, that is, is unable to repay the debt in time — implying that it has assets less than claims against it.
- So, when a company has inadequate assets, the claim of an individual creditor may be consistent with its assets while claims of all creditors put together may not.
- In such a situation, creditors may rush to recover their claims before others do, triggering a run on the company’s assets.
- The IBC provides for reorganisation that prevents a value-reducing run on the company.
- It aims to rescue the company if its business is viable or close it if its business is unviable, through a market process.
- Restructuring: The claims of creditors are restructured, which may be paid to them immediately or over time.
- In case of closure, the assets of the company are sold, and proceeds are distributed to creditors immediately as per the priority rule.
- Reorganisation by financial creditor: The IBC entrusts the responsibility of reorganisation to financial creditors as they have the capability and the willingness to restructure their claims.
Why so much variation in haircut?
- Where the company does not have adequate assets, realisation for financial creditors, through a rescue, may fall short of their claims known as haircut.
- The IBC process yields a zero haircut (100% recovery of claimed amount) in one case and 100 per cent haircut (i.e. 0% recovery) in another.
- Factors: It depends on several factors, including the nature of business, business cycles, market sentiments, and marketing effort.
- It critically depends on at what stage of stress, the company enters the IBC process.
- If the company has been sick for years, and its assets have depleted significantly, the IBC process may yield a huge haircut or even liquidation.
- A haircut is typically the total claims minus the amount of realisation/amount of the claims.
- But this formulation may not tell the complete story.
- The realisation often does not include the amount that would be realised from equity holding post-resolution, and through the reversal of avoidance transactions and the insolvency resolution of guarantors — personal and corporate.
- It also does not include realisations made in other accounts.
- The amount of claim often includes NPA, which may be completely written off, and the interest on such NPA.
- These understate the numerator and overstate the denominator, projecting a higher haircut.
Significance of IBC
- A haircut should be seen in relation to the assets available and not in relation to the claims of creditors.
- The market offers a value in relation to what a company brings on the table, not what it owes to creditors.
- Value maximisation: So, the IBC maximises the value of existing assets, not of assets that probably existed earlier.
- Market determined value: The IBC enables and facilitates market forces to resolve stress as a going concern.
- Resolution applicants, who have many options for investment, including in stressed companies, compete to offer the best value.
- If the best value offered by the market is not acceptable to creditors, the company is liquidated.
- Maximum realisation: In addition to rescuing the company, the IBC realises, of the available options for creditors, the highest in percentage terms.
It is a tool in the hands of stakeholders to be used at the right time, in the right case, in the right manner.
Back2Basics: Avoidable Transactions in IBC 2016
- The UNCITRAL Legislative Guide on Law of Insolvency defines avoidance proceedings as “provisions of the insolvency law that permit transactions for the transfer of assets or the undertaking of obligations prior to insolvency proceedings to be cancelled or otherwise rendered ineffective and any assets transferred, or their value, to be recovered in the collective interest of creditors.”
- It is very important for the Resolution Professional (RP) or the liquidator to identify such transaction and file applications to avoid it so that creditors can collect their claims.
- The Insolvency and Bankruptcy Code, 2016 (IBC) contains four types of avoidable transactions- preferential, undervalued, defrauding creditors and extortionate transactions.
- Usually, the avoidable transactions should be made within the prescribed relevant time or look back period.
- Look back period is the relevant time up to which an RP or a liquidator can go back to scrutinize an expected avoidable transaction.