Bankruptcy Code being gamed from the start? IRRATIONAL CHOICE

Almost everybody believes that the problems of bad debt-laden public sector banks can be fixed with the new Insolvency and Bankruptcy Code (IBC). Well, they might like to know that the IBC is already off to a rocky start. The Act, stylishly called the Code, allows for the creation of a massive bureaucracy and multiple levels of professionals who will all need certification (more bureaucracy and costs in an already high-cost economy). This bureaucratic superstructure is all very wonderful in an ideal world. When the Act was formulated, a friend of mine pointed out to me, cynically, that Indians have a natural tendency and skill to game any system. How can we ensure that the justice system and insolvency resolution professionals work fairly, he asked. I had dismissed that comment since it would take time for the rot to set in and it would only be fair to give the Act a chance.

However, it didn’t take too long for my friend’s cynicism to come true. Charges of malpractice are being levelled from the very first case up for resolution. About 10 days ago, Edelweiss Asset Reconstruction filed a complaint with the National Company Law Appellate Tribunal (NCLAT) that the first case of resolution under the IBC involving Synergies Dooray Automotive Ltd was a fraud and a sham. Later Edelweiss complained against resolution professional (RP) Mamta Binani, involved in the Synergies Dooray case, to the Insolvency and Bankruptcy Board of India (IBBI), alleging she conducted herself in a partisan manner and acted without taking approval from the committee of creditors. Binani has refuted these allegations. Edelweiss has complained that Binani refused to investigate allegations of fraud perpetrated at Synergy Dooray. She also did not seek expert legal advice and obtain clarity on her role as the insolvency resolution professional, alleged Edelweiss.

The resolution of Synergies Dooray under the bankruptcy resolution system indeed seems to be a sham. Synergies Dooray made an application to the National Company Law Tribunal, Hyderabad, for resolution. Resolution plans were submitted by the three resolution applicants (RAs): SMB Ashes Industries, Synergies Castings Ltd (SCL), and Suiyas Industries P Ltd. Of these, no details are available for the first. Synergies Castings is a group company of the borrower with significant bank loans of their own. Suiyas has a paid-up capital of just ~25 lakh, too small to make this bid. A committee of creditors (CoC) was formed and it included Edelweiss ARC, Alchemist ARC Ltd, Millennium Finance Ltd, and Synergies Castings Ltd (SCL). Among these, Edelweiss had a voting strength of 9.84 per cent, Alchemist of 13.83 per cent, Millennium Finance of 76.33 per cent, and Synergies Castings no share of vote since it was a related party.

The CoC rejected the plan of two RAs and accepted that of SCL, a promoter group company. This involved paying only 4.84 per cent of the debt outstanding. Quite clearly, Millennium Finance, with its brute voting power, backed the promoters’ plan, allowing them to come back and throw some crumbs to the debt holders in the process. Is this the kind of insolvency “resolution” we will get from now on? SCL and Millennium have certainly offered a template for Indian promoters who cannot pay the bank but want to hold on to their companies. Here is the template: SCL had held 75 per cent of debt of the defaulter. It had transferred a significant chunk of loans to Millennium Finance Ltd. This enabled Synergies Castings to put in place a proxy (Millennium) in the committee of creditors. Interestingly, an expert has publicly welcomed the “resolution” of Synergies Dooray as an example of lenders’ openness to take a large hair cut! Edelweiss has filed an appeal in the NCLAT on September 8 against the resolution plan.

If the IBC has to work, it would be critical to do some course correction. Under Section 29, the RP is required to prepare an information memorandum and invite RAs to bid. The best of these bidders has to take over the distressed company. In other words, an ideal resolution process must have enough competitive bids, efficient price discovery, and, eventually, maximum credit recovery. If this core process is compromised, it’s a sham. In the worst case, it would mean ticking the boxes to benefit the promoter coming back. In the case of Synergies Dooray, two non-descript parties bid for a large corporate. Rajendra Ganatra, an RP who was also an IDBI director in Synergies Dooray in 2003, says “by not stipulating proper financial and technical qualification criteria, such non-descript parties were allowed, with three so-called resolution applicants, the process was undermined, just to allow the promoter group to walk away with the assets. It was a stunted and inefficient process”. The Synergies case is just the tip of the iceberg. There would be many loopholes. As I have mentioned twice already, the IBC is a flawed architecture.