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Anuj Lakhotiya

 

ASSESSING THE EFFECTIVENESS OF THE INSOLVENCY CODE: ADDRESSING THE DECLINE IN INSOLVENCY ACTIVITY AND POTENTIAL STRATEGIES TO MINIMISE HAIRCUTS FOR CREDITORS

INTRODUCTION

The Reserve Bank of India (“RBI”) recently released a handbook of statistics on the Indian Economy 2023-241, which revealed a noteworthy decline in Gross Non-Performing Assets (“NPAs”) to 2.8%, a 12-year low feat with Net NPAs at 0.6%2. The significant decline in NPAs is attributable to the Insolvency and Bankruptcy Code, 2016 (“IBC” or “Code”) and the evolving credit-culture in India. The valiant efforts of the government, Insolvency and Bankruptcy Board of India (“IBBI”), judiciary, Insolvency Professionals (“IPs”), and the surrounding ecosystem has played a pivotal role in resolving stressed assets and restoring the confidence in the financial sector.

The Code has certain objectives at its core i.e., reorganisation and insolvency resolution in a time-bound manner, maximisation of value of assets, promotion of entrepreneurship, availability of credit and balancing the interests of the stakeholders. As observed by the Apex Court, this order of objective is sacrosanct in nature.3 In light of the same, the author explores effectiveness of the Code while addressing the impact, and explores strategies to maximise value of stressed assets. Since the provisions w.r.t. individual insolvency are yet to come into force, this article limits to corporate insolvency.

1 Reserve Bank of India, “Handbook of Statistics on Indian Economy” 95 (2024).

2 Insolvency and Bankruptcy Board of India, “Insolvency and Bankruptcy Board of India Celebrates its Eighth Annual Day” 1 (2024).

3 Binani Industries Limited v. Bank of Baroda, 2018 SCC OnLine NCLAT 565.

QUICK STATISTICS

As per IBBI’s quarterly report for the quarter ending June 30, 2024, a total of 7,813 companies/ LLPs have been admitted into the Corporate Insolvency Resolution Process (“CIRP”) and around 30% of these matters were withdrawn under Section 12A of the Code or were settled/ closed on appeals or reviews. While 1,005 Resolution Plans were approved by the Adjudicating Authorities (“AA”), order of liquidation was passed in 2,547 matters. A total of 1,973 cases were ongoing4. The sector having the most matters were (i) Manufacturing and (ii) Real Estate & allied business activities with a whopping 59% share.

In CIRPs yielding resolution plans, the creditors were able to fetch 161% of the realization as percentage of the liquidation value i.e., value during distress sale. However the recovery stood at around 32% of the claim amounts. The average time taken for closure of a CIRP was 685 days. On the other hand, in CIRPs yielding liquidations, average time taken for closure of process was 499 days and the creditors realised 6.3% of their claim amount. The total amount realised by the creditors was around Rs. 3.39 Lakh Crores as against the admitted claim amount of around Rs. 10 Lakh Crores.

4 Insolvency and Bankruptcy Board of India, “The Quarterly Newsletter of the Insolvency and Bankruptcy Board of India, April – June, 2024” 11 (2024). 

EFFECTIVENESS OF THE CODE: 

The above numbers illustrate that the Code has been way more efficient than its predecessors in terms of realization. However, the Code has made a far reaching impact than just realization, few of the aspects are as below:

  1. Effective Resolution:

    2. The first and foremost is the focus on resolution as against recovery. The courts, along with the regulator, have been resolute to their objective of resolving the corporate debtor as a going concern so that the interest of the stakeholders and the business is protected. To put this under perspective, the resolved Corporate Debtors (“CD”) have shown a remarkable increase of 76% sales in the three-years since resolution, employment in the resolved firms have been on a substantial increase and the trends have indicated an increase of around 50% in the average assets owned by the resolved firms, aligned with a 130% increase in capex. The aggregate market valuation of all the resolved CDs has seen a threefold increase from around Rs. 2 Lakh Crores to Rs. 6 Lakh Crores.5 The resolved firms appears to have reverted to being efficient and productive. The data published by the IBBI suggests that there has been an increase in the number of CIRPs resulting in resolution as a percentage of liquidation orders going up from 21% during FY 2017-18 to 45% during FY 2022-23.6 The Code has resulted in a significant reduction in cost of debt, improvement in debt structure and indicates an improved overall performance of the distressed firms’ vis-à-vis non-distressed firms.7

  2. NPAs on a downward trajectory:

    3. The gross reduction in NPAs have reduced the burden on the balance sheets of the financial institutions and have decreased the losses. The banks have started being profitable and the twin-balance sheet conundrum is a thing of past, at least for now.

    5  Indian Institute of Management Ahmedabad, “Report of Study on Effectiveness of the Resolution of Process: Firm Outcomes in the Post-Ibc Period” 3 (2023).

    6  Insolvency and Bankruptcy Board of India, “The Quarterly Newsletter of the Insolvency and Bankruptcy Board of India, July – September, 2023” (2023).

    7 Tanveer Ahmad Khan, “Impact of IBC on Credit Networks and Firm Performance: An Analysis of Pre and Post IBC Era” 1.

  3. Shift in Credit Culture:

    4. By introducing a transparent and time-bound resolution, the Code has helped in improving the credit discipline by incentivizing corporate borrowers to repay the dues on time as the consequence of default now are severe. Further, the shift in credit culture has enhanced accountability of borrowers by strengthening the negotiating powers of the creditors. Moreover, the code has incentivized companies to adopt better corporate governance practices so as to avoid insolvency.

  4. Successful Deterring Effect:

    5. The code successfully serves as a deterrent to the borrowers in default, this is substantiated by the fact that a total of 23,608 matters were settled before admission by the AA, involving an amount of Rs. 7.21 Lakh Crores. The rate of settlement of CIRP at the pre-admission stage comprises more than 68.74% of the NCLT’s total disposal.8

  5. Easy exit:

    6. The Code is now an operative tool for facilitating exit of distressed CDs, in turn allocating the resources towards more productive uses and cleaning off balance sheets of the creditors. The Code has provided an effective way to resolve the companies which have been in the debt spiral for long. To illustrate further, a detailed analysis of the data indicates that 77% of the cases that concluded in liquidation were either inherited from the Board for Industrial and Financial Reconstruction (“BIFR”) regime or were already defunct units with significant value erosion prior to their admission under the IBC9. The Code has offered a structured exit mechanism for these legacy cases. Notably, 38% of the successful resolution outcomes involved companies that were previously under BIFR jurisdiction or were defunct. Without the 2016 law, the fate of these companies may have remained uncertain.

    8 Expert Committee Constituted by the Insolvency and Bankruptcy Board of India, “Report on Framework for Use of Mediation under the Insolvency and Bankruptcy Code, 2016” 58 (2024).

    9 R.K. Bansal, “Ibc: The Journey So Far, Challenges Ahead and Way Forward” 68 (2022).

  6. Investment perspective:

    7. The code has instilled faith in investors for quicker resolutions of the distressed CDs. This is backed by the fact that India has jumped 79 ranks from 142nd in 2014 to 63rd in 202010 in ‘Ease of doing business rankings’. Investors have seen the resolution process as a great business opportunity to buy stressed businesses with quality assets at attractive prices. Foreign investors too are utilizing this opportunity to enter the Indian debt market. The Resolution applicants’ takeover the management and control of the CD as a going concern without the past liability, as aided by Section 32A of the Code. Even if the business of the CD cannot run effectively, quality assets such as land & building, or specific machineries present themselves as a lucrative opportunity. The significant increase in the number of Asset Reconstruction Companies (“ARCs”) and the fact that foreign institutional investors have taken up a substantial stakes in a few ARCs, such as holding of 69.73% by Avenue capital group in Asset Reconstruction Company (India) Ltd11, and Blackstone holding 51% stake in International Asset Reconstruction Company12, depicts the strength of Indian stressed asset market. Aggressive participation in resolution process by huge conglomerates like Adani group reaffirms the above point.

10 World Bank, “Ease of Doing Business Rankings” 1 (2020).

11 ARCIL shareholding, available at: 80Arcil Shareholding_April_2024.pdf (last visited on October 09, 2024).

12 IARC shareholding, available at: 20230822 Notice of AGM FY23.pdf (iarc.co.in) 4 (last visited on October 09, 2024).

DECLINE IN INSOLVENCY ACTIVITIES

As per IBBI’s data13, 1,003 cases were admitted during 2023-24 which is only 49.5% of 2019- 20 when the number of cases admitted were at its zenith. This suggests that there are no alarming signs of stress in India Inc. There has been a significant decline from the year 2019- 20 owing to multiple reasons as discussed hereinbelow:

  1. Preventive Measures

    2. Owing to the deterrent created by the Code, it has become imperative for the promoters to put in place effective measures to curb default instances. The defaulters have resorted to restructuring and refinancing deals with the creditors, generally banks in this case. The fact that bankers have now started to understand that pushing a company into insolvency shall be the last resort to recover their dues is a cherry on top. Improved corporate governance, efforts to maintain positive net cash-flow so as to meet short- term liabilities, efficient use of resources, focus on operational efficiency, mergers- demergers, etc., are examples of the preventive measures taken up by the companies. These measures crafted with innovative approaches have prevented companies from going into insolvency. One of the best examples comes from the ‘Strategic debt- restructuring’ arrangement of GTL Infrastructure Limited.14 The National Company

    13 Supra note 4 at 12.

    14 Joe McDonough, “A TOWERING CHALLENGE How GTL Infra Made a Miraculous Turnaround” CEO Magazine 8.

    Law Tribunal Mumbai had rejected an application to initiate CIRP against the company citing its financial health and the Vidarbha Judgment15.

  2. Early Detection:

    3. The management of companies have started paying heed to early warning signs such as inadequate cash flow or high use of cash, poor strategic management of the business, inefficient financial control, falling sales, high and delayed trade receivables, bank overdraft facilities being pushed to limit periodically, delay of wages, legal issues, etc.

  3. Regulatory changes:

    4. Regulatory changes in a positive direction coupled with technological and innovative approaches have also played a huge role in decrease of insolvency activities. To highlight, a few changes:

    1. Mandatory pre-institution mediation as per Section 12A of the Commercial Courts Act, 2015.16
    2. MahaRERA’s new rule w.e.f. July 01, 2024 for developers to maintain three separate accounts is set to bring in positive outcomes for the homebuyers.17
    3. Use of ‘MSME Samadhaan – Delayed payment monitoring system’ has helped Medium and Small Enterprises to file cases against debtors for a speedy resolution. As on October 1st, 2024, a total of 2,08,487 applications have been registered as filed, involving an amount of Rs. 46,459.93 Crores.18

      4. 15 Vidarbha Industries Power Limited v. Axis Bank Limited, (2022) 8 SCC 352.

      16 The Commercial Courts Act, 2015 (4 of 2016), s. 12A.

      17 Maharashtra Real Estate Regulatory Authority, Order No. 56 of 2024, Maintainance and Operation of Bank Accounts of Registered Projectes, 3 (June 27, 2024).

      18 Ministry of Micro, Small & Medium Enterprises, “MSME SAMADHAAN – Delayed Payment Monitoring Portal – Respondent Category Report” (2024).

    4. Direct tax Vivad-Se-Vishwas Scheme19 (‘DTVSV’) as presented in the Union Budget 2024-25, use of arbitration as a first measure by the corporates, special amendments and provisions for specific sectors such as the notification dated October 3rd, 2023 w.r.t. the non-applicability of provisions of Section 14(1) of the Code to transactions, arrangements or agreements relating to aircraft, aircraft engines, airframes and helicopters20 and notification dated June 15th, 2023 w.r.t. contracts under Oilfields (Regulation and Development) Act, 194821 are a few steps in a positive direction.

  4. Use of Other available remedies

    5. Financial institutions such as banks and ARCs often resort to proceedings under the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 so as to avoid insolvency resolution process cost and the haircuts. Upon comparison, the said trend is observed in the retail segment more than the SME & corporate sectors. Other recovery means, such as the proceedings under Section 138 of the Negotiable Instruments Act, 1881; proceedings under the Recovery of Debts due to Banks and Financial Institutions Act, 1993 (“RDDBFI Act”); Arbitration Act, 1996; and invocation of guarantees, are a few such measures.

  5. Concerns over Haircuts

    6. One of the major reasons for decline in insolvency activities may be attributed to the fact that the creditors have to go through huge haircuts. A ‘haircut’ refers to the amount of money that creditors need to sacrifice as part of the resolution process. Of late, creditors, and majorly operational creditors, have been facing this issue. For instance, creditors were to take 95.85% haircut in the Videocon industries’ resolution plan22 or the 97.59% haircut in the resolution process of Era Infra Engineering Limited23.

    19 “CBDT Notifies Rules and Forms for Direct Tax Vivad Se Vishwas (DTVSV) Scheme, 2024”, Press India Bureau, Sept. 21, 2024, available at: https://pib.gov.in/PressReleasePage.aspx?PRID=2057271 (last visited on Oct. 9, 2024).

    20 Ministry of Corporate Affairs, S.O. 4321(E), 2 (October 03, 2023).

    21 Ministry of Corporate Affairs, S.O. 2660(E), 2 (June 14, 2023).

    22 Abhijit Guhathakurta v. Twin Star Technologies Limited, 2021 SCC OnLine NCLT 12427.

    23 Union Bank of India v. Era Infra Engineering Limited, 2024 SCC OnLine NCLT 2811.

    Images

    Applications for initiation of CIRP under Section 9 of the Code i.e., by Operational Creditors, has decreased significantly as can be observed from the below illustration:

    Images

    Based on IBBI’s data24, 77 applications were filed by Operational Creditors in Q1 of 2024-25, which echoes the declining trend.

  6. Other changes:

    1. Public sector banks have established specialized units to aggressively recover distressed assets. They’ve also separated pre and post-approval monitoring roles for better oversight, and hired specialized agencies to monitor large-value accounts.
    2. Setting up of National Asset Reconstruction Company Limited (“NARCL”) for resolving stressed assets above Rs. 500 Crores and the one-of-its-kind guarantee of around Rs. 30,000 Crores backing the Security Receipts.25
    3. Aggressive acquisition by ARCs and permitting ARCs to be resolution applicants26 has further reduced insolvency litigations as ARCs look to settle the dues mutually as a first resort.

24 Supra note 4 at 12.

25 Lok Sabha Debates on July 24, 2023 available at: AS56.pdf (sansad.in).

26 Reserve Bank of India, RBI/2022-23/128, Review of Regulatory Framework for Asset Reconstruction Companies (ARCs), 9 (October 11, 2022).

POTENTIAL STRATEGIES TO MINIMISE HAIRCUTS FOR CREDITORS

As is evident from the available data, haircuts are one of the major roadblocks in the insolvency resolution process. Minimising haircuts is one of the key drives for effective resolutions and achieving the objective of the Code.

In view of the same, let us explore a few potential strategies for minimising haircuts:

  1. Timelines:

    2. The due compliance with the timelines provided under the Code, Regulation 40A of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 and Regulation 47 of the IBBI (Liquidation Process) Regulations, 2016 is very pertinent. The IRP/RP/Liquidator, as the case maybe, shall make every effort to achieve the resolution or realization within the prescribed timelines. Very often, the delays are caused by the lack of permissions available with the representatives of the financial institutions for taking key decisions. This leads to unreasonable delays in making decisions, irrational extension in voting period, declining value of assets, etc.

    Adherence to the time limits is a duty of all the stakeholders involved in the resolution/ liquidation process as the scheme of the Code largely depends on multiple stages and milestones, these stakeholder includes, but are not limited to, the Adjudicating Authorities (time-taken during deciding various applications at different stages); claimants (filing of claims within the stipulated timeframe); government departments (such as Electricity & Water boards, EPFO, ESIC, etc.); and Ex-management of the CD (Cooperation & assistance).

  2. Early Action:

    3. Early detection and efforts to resolve the stressed assets in a reasonable timeframe would go a long way in protecting the value of assets. The time taken in the procedure before the Debt Recovery Tribunals in matters of RDDBFI Act and SARFAESI Act needs to be reduced. Changes are to be set on an institutional level, especially for the financial institutions. Effective asset tracing by the creditors is paramount during the

    twilight period27 for preserving the value alongwith regular review of the asset quality and proactive steps with respect to the specific needs.

  3. Effective Valuation:

    4. Valuation of stressed assets is not merely a numerical concept but a complex process to be followed by the registered values of all the three classes which requires a delicate balance of legal understanding, ethics, and financial acumen. Conducting a proper valuation with international standards would assist in valuing the assets as per their distressed value, which may result in increasing the reserve price.

  4. Easing the bidding process:

    5. The stakeholders shall also focus on easing the bidding process for the prospective resolution applicants so as to increase the likeliness of the stressed entity being resolved. For e.g., the Resolution Professional shall strive to cover all the details of the CD, as available, in the Information Memorandum as per Regulation 36 of the CIRP Regulations, 2016 so as to enable the prospective investors to assess the financial of the CD. Information symmetry is pertinent in insolvency cases, use of technology such as creation of Virtual data rooms (“VDRs”), and transparent eAuctions shall also be incorporated. NeSL, India’s first and only Information Utility, has recently developed its own VDR. Further, use of Swiss challenge method, wherein a resolution plan is set as a base plan and the bidders compete keeping the same as an initial benchmark, has turned out to be effective in maximising value as the bidders compete against each other so as to secure the assets of the CD.

  5. Avoidance Applications

    6. As per IBBI’s data28, a total of 1,245 avoidance applications for Preferential, Undervalued, Extortionate and Fraudulent (“PUFE”) transactions have been filed under the Sections 43, 45, 47, 48, 49, 50, and 66 of the Code involving huge amount of

    27 Mayank Mehta and Nikita, “Walking a Legal Tightrope: An International Perspective on “creditor Duty” During “twilight Zone”” Insolvency and Bankruptcy Board of India 99 (2024).

    28 Supra note 4 at 18.

    Rs. 3.71 Lakh Crores. Out of which 313 applications have been disposed of involving Rs. 6,667.61 Crores which is merely around 1.8 % of the total amount. There is no data available w.r.t. the actual recovered amount as the notorious promoters often use various methods to escape the liability including appeals, filing Section 94 application, disposing off assets, etc. The jurisprudence revolving Avoidance applications is currently evolving through judicial mechanisms and one can only hope that the result is coherent with the Code’s objective. If the instant issue is resolved soon, creditors are bound to be benefit as the provisions would substantially increase the amount receivable, in turn, decreasing the haircuts.

  6. Easing Regulatory hurdles

    1. Effective measures by the government such as public outreach programs for creating awareness about the Code in government departments such as EPFO, ESIC, Electricity boards, Industrial Development Corporations, etc.

    2. Steps to de-freeze the assets of the CD undergoing CIRPs/ Liquidation so as to maximise pool of assets. The Enforcement Directorate’s (‘ED’) recent restitution of assets worth more than Rs. 16,000 Crore is a welcome step.29

    3. Easing the compliance burdens from the Insolvency Professional who are overly regulated due to which the majority of time goes into the procedural work. The IPs have become ‘Glorified clerks’ and are not able to streamline efforts towards the resolution and bidding process. Further, in matters involving claims more than Rs. 1,000 Crores, IPs with expertise in the specific sector(s) may be granted the assignments.

    4. Introduction of Pre-pack insolvency resolution process for Non-MSMEs.

29 Directorate of Enforcement, Department of Revenue, Ministry of Finance, Government of India, available at: Restitution of properties/assets | Directorate of Enforcement (enforcementdirectorate.gov.in) (last visited on October 09, 2024).

CONCLUSION

The Insolvency and Bankruptcy Code has been a significant step forward in India’s insolvency resolution regime. It has successfully reduced non-performing assets, improved credit culture, and promoted better corporate governance. While there has been a decline in insolvency activities due to preventive measures and other factors, the code remains an effective tool for resolving distressed companies.

To further enhance code’s effectiveness, it is essential to address challenges such as haircuts and ensure consistent enforcement of its provisions. By continuing to refine and implement the 2016 law, India Inc. can potentially further strengthen its financial system and promote a more resilient business environment.