Insolvency and Bankruptcy Code

How IBC is moving away from promotor averse approach

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Pre-pack in IBC

Mains level : Paper 3- Pre-packs for MSME in IBC

The Insolvency and Bankruptcy Code was amended recently taking into account its creditor centric approach.

Introducing pre-packs for MSMEs

  • IBC was amended last week, through an ordinance.
  • The amendment sought to address a structural weakness in India’s resolution architecture by introducing the concept of pre-packs for micro, small and medium enterprises (MSMEs).
  • The pre-packaged framework involves a privately negotiated contract between the promoters of a financially distressed firm and its financial creditors to restructure the company’s obligations.
  •  This contract is negotiated within the IBC architecture but before the commencement of insolvency proceedings.
  • Once accepted by creditors, the plan must be presented to the National Company Law Tribunal (NCLT) for approval.

How this framework is different from the existing framework

  • A firm’s promoters could have submitted a resolution plan even after it enters the insolvency proceedings, subject to restrictions imposed under Section 29A which clarifies all those who are ineligible for submitting the resolution plan.
  • So, the difference in the new framework essentially boils down to the following.

1) Control of the firm

  • Under the IBC, upon the initiation of insolvency proceedings, control of a firm is taken away from promoters, and a resolution professional is appointed.
  • Now, during the restructuring, the promoter, through the pre-pack, retains control over the firm.
  • So effectively, we have transitioned from a “creditor-in-control” model of resolution to a “debtor-in-control” model of restructuring.
  • This amendment, which creates a framework for restructuring, without the promoter losing control over the firm, addresses a lacuna in the IBC.

2) Issue of price discovery

  • In this arrangement, the is an absence of an open bidding process, such as during the resolution phase.
  • This might raise questions over price discovery, especially if value maximisation for creditors is the yardstick to measure the efficacy of IBC.
  • This marks a fundamental change in the IBC framework.

Why the changes were needed

  • The IBC, while it has strengthened the position of the creditors, had swung to an extreme.
  • The resolution architecture as it stood prior to this amendment was perceived as being too creditor-centric.
  • Wresting control from the “errant” promoter, comes with its own set of consequences.
  • The notion that all business failure is due to the connivance of promoters needs to be reconsidered.
  • Firms may be unable to pay their obligations simply because the economic cycle has turned.
  • Or projects have not materialised as expected.
  • Of the 2,422 cases closed since IBC came into being, 46.5 per cent of the firms have gone into liquidation, while a resolution plan has been accepted in only 13.1 per cent of the cases.
  • This indicates liquidation bias.
  • At a time when there aren’t enough buyers in the economy, the IBC process would lead to significant value destruction.

How it will benefit both creditor and promotors

  • Promoters get to hold on to their firms, and exit the process with more manageable obligations, making this an attractive proposition.
  • For creditors, considering the liquidation bias in IBC, as long as the value of the restructured obligation is greater than the liquidation value it makes sense to choose this option.
  • Moreover, this entire process remains outside the restructuring framework of the central bank.
  • And, considering that the pre-packs encompass all financial creditors, as opposed to RBI’s restructuring schemes which deal only with banks.
  • This takes into account the concerns of other financial creditors as well.

Consider the question “How far IBC has succeeded in improving the insolvency regime in India? How the concepts of pre-packs is different from the previous system?

Conclusion

This approach will help clarify issues, bring about greater certainty to the process. And, once the creases are ironed out, it will create a permanent mechanism for restructuring debts.

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