From UPSC perspective, the following things are important :
Prelims level : IBC 2016 provisions.
Mains level : Paper 3- IBC provisions and need for novel approach to deal with the economic fallout of the pandemic.
In this article the author suggests a new approach to deal with multiple bankruptcies and stressed assets that would come up post COVID. So, what is the new approach and how it is different from the existing IBC? Read further.
Why is speed of resolution important?
- First, because it is the only way to revive the economy.
- As revenues have dried up cash flow problems have cascaded down the supply chain.
- Firms will consequently be unable to restart production unless they first get credit to pay their suppliers and workers.
- But impaired firms cannot get credit and impaired banks cannot provide it.
- So, the entire economy will be stuck unless the balance sheet problem is sorted out.
- Second, speed will also minimise the losses from the COVID crisis.
- The value of bankrupt firms decays rapidly over time, and the bill for this loss will have to be borne ultimately by the government.
- So, speed is necessary to contain the damage to the government’s financial position, which has been badly eroded by the COVID crisis.
- But moving quickly will be difficult.
- The only real mechanism that currently exists to handle stress and bankruptcy is the Insolvency and Bankruptcy Code (IBC) system, which has been suspended for six months.
Why the IBC cannot help much?
- Many have therefore argued for bringing the IBC back into operation as soon as possible.
- Why such a strategy would not be very effective? The system is slow, with many cases taking two years or more; it could easily become overwhelmed completely if it is forced to absorb a large new set of bankrupt firms.
- In addition, the IBC envisages that banks maximise their recoveries by auctioning off the bankrupt firms to the highest bidder.
- But in a nation and indeed a world, where all balance sheets are damaged, it is not obvious who would be able to buy these firms, or at what prices.
- So recovery rates from sales could be low, undermining the objective of the exercise.
- Even if strong bidders could be found, there is a fundamental political, even philosophical, question of whether it is really right to take these firms away from their promoters.
- After all, many of these firms did nothing wrong; they got into financial difficulties because of the corona crisis.
So, what is the solution?
- What is needed is a new set of procedures that can utilise much of the existing IBC framework, but are simple, straightforward, and prompt, with a built-in expiry clause.
- Let’s Call them Special Non-Adversarial Procedures (SNAP).
- As soon as the lockdown is largely over, the IBC creditor committees (CoCs) could meet to assess the new wave of NPAs.
- The largest, most complex cases — say, those with debts exceeding Rs 10,000 crore — would be sent to the IBC for regular treatment.
- But all other cases would be eligible under SNAP
- After all, the wider the set of companies that are put back on their feet quickly, the stronger the recovery will be.
How would the SNAP work?
- Under SNAP, CoCs would, over the next three months, examine delinquent firms’ financial records, checking to see whether they are actually viable.
- If so, these firms would be designated as Lockdown Affected Enterprises (LAEs), eligible under SNAP.
- Since the basis of the designation would be that the firm is fundamentally sound but because of COVID impact, an Insolvency Professional (IP) appointed by the CoC would work with existing management (who would continue to run the firm) to arrange for interim finance.
- Then, the IP would assess how much of a debt reduction the firm needs, and within three months would present a specific proposal to the CoC.
- If the CoC can reach a two-third majority in favour of the proposal, the promoter would keep the firm, while the firm would be granted immediately released from bankruptcy.
- Since the National Company Law Tribunal (NCLT) is already overloaded, it would not be involved at all in SNAP.
- If the CoC cannot reach agreement within the three-month deadline, or if at any subsequent point the firm defaults on its newly reduced debt, it would be sent to the IBC for resolution.
- SNAP would be disbanded by end-December 2020.
Checks and balances under SNAP
- Such a system would have a series of checks and balances, to prevent firms from securing undeserved debt reductions.
- Banks would need to certify that defaulters are truly LAEs.
- IPs would need to certify the size of the debt reduction.
- A large majority of creditor banks would need to agree to the IP’s proposal.
What should be the role of the government in SNAP?
- With these checks and balances in place, the government should then commit to two things.
- First, it should provide some legal cover, ensuring that bankers would not be subject to investigations by the anti-corruption agencies, as long as they followed the LAE rules.
- Second, the public sector banks would be compensated for the costs of the reduction in the value of the asset, automatically and fully.
Major advantage of SNAP
- Besides speed, SNAP would have one further major advantage.
- It would reduce the adversarial nature of the IBC process, arising because promoters are forced to cede their firms.
- Under the proposed system, promoters would not only have incentives to cooperate; they would actually want to take the initiative, applying for LAE designation themselves, in the hopes that they could get back to business as soon as possible.
- Such a system might seem difficult to envisage, but it is certainly feasible: It is a design feature under Chapter 11 of the American bankruptcy act.
- If SNAP succeeds, some of the special procedures could be introduced permanently into the IBC framework, adding a new dimension: Not just liquidation and rehabilitation under new promoters but rehabilitation under existing management.
- After SNAP, repair of the financial system would have to go back to addressing the long-standing problems, which will have been aggravated by the crisis.
- Firms that were unviable even before the COVID crisis would be sent directly to the IBC, but with the IBC reformed.
- The government should issue guidelines focusing on the following three-
- 1. Focusing the COCs on the goal of maximising value, disregarding non-commercial objectives.
- 2. Directing the NCLT courts to focus on the CoCs’ adherence to the procedure rather than on the merits of their decisions.
- 3. Increasing competition in the auction by allowing promoters to bid for their assets, as long as they have not been declared wilful defaulters.
- For the power and real estate sectors, a sui generis approach via the creation of a bad bank is still the best way forward.
- Real estate resolutions need to take into account the interests of home-owners, something that is almost impossible to do under the IBC.
Consider the question, “Economic revival after the pandemic would require some tweaks in the IBC as it was not designed to handle such situations. Suggest the ways to handle the bankruptcies more effectively and changes that are desired in the IBC.”
Introducing three-pronged strategy quickly would set the stage for the economic recovery of India: 1) Special, expedited, non-adversarial and time-bound bankruptcy procedures (SNAP) for COVID-affected firms 2) A reformed IBC focused squarely on loss-minimisation 3)Bad banks for stressed assets in the power and real estate sectors.
Back2Baciscs: What is Insolvency and Bankruptcy Code-2016?
- The Code creates time-bound processes for insolvency resolution of companies and individuals. These processes will be completed within 180 days. If insolvency cannot be resolved, the assets of the borrowers may be sold to repay creditors.
- The resolution processes will be conducted by licensed insolvency professionals (IPs). These IPs will be members of insolvency professional agencies (IPAs). IPAs will also furnish performance bonds equal to the assets of a company under insolvency resolution.
- Information utilities (IUs) will be established to collect, collate and disseminate financial information to facilitate insolvency resolution.
- The National Company Law Tribunal (NCLT) will adjudicate insolvency resolution for companies. The Debt Recovery Tribunal (DRT) will adjudicate insolvency resolution for individuals.
- The Insolvency and Bankruptcy Board of India will be set up to regulate functioning of IPs, IPAs and IUs.