Knee-jerk reactions to structural deformities
A couple of recent amendments in the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, seem to be knee-jerk reactions towards the various issues surfaced in the implementation of the Insolvency and Bankruptcy Code (IBC).
On August 16, the Insolvency and Bankruptcy Board of India (IBBI) introduced a concept of “other creditors” in the rules, without providing any corresponding protection or right to such class of creditors in the norms. In a similar vein, the IBBI amended the regulations on October 5 to mandate that a resolution plan shall include a statement as to how it has dealt with the interest of all stakeholders. Certain news reports suggest that both the amendments were introduced to address the concerns of stakeholders such as homebuyers. But, these amendments are unlikely to provide any meaningful relief to such stakeholders as they fail to grant any corresponding protection or right to such stakeholders.
However, it would not be right to blame the IBBI for these knee-jerk reactions. The IBBI is bound by the provisions of the IBC. It has little or no room to address these structural issues. The IBC is structured in such a manner that it gives preference to financial creditors over any other class of creditors, be it retail/individual creditors or SMEs or operational creditors employing a large number of workers. A financial creditor is primarily preferred on two counts. Firstly, financial creditors enjoy preference over operational and other classes of creditors in liquidation waterfall. Secondly, only financial creditors have voting rights in the Committee of Creditors which approves the resolution plan.
There is no apparent justification for preferring financial creditors over other classes of creditors in the liquidation waterfall. It is equally important to ensure that the interest of retail/individual creditors or SMEs or operational creditors, employing a large number of workers, are also adequately protected in liquidation. A historic legislation like the IBC should not be hijacked by the immediate concerns of non-performing assets of banks. Other jurisdictions such as the US, the UK, Canada or Australia do not provide any preference to financial creditors. In India, while the Sarfaesi and the DRT Acts provided certain preferential treatments to financial creditors as far as procedural aspects of recovery of loans were concerned, no legislation prior to the IBC provided a superior right to financial creditors in the liquidation waterfall.
The reason cited by a joint parliamentary committee for non-inclusion of operational creditors in the Committee of Creditors was that operational creditors are not willing to take the risk of restructuring their debt in order to make the corporate debtor a going concern. This does not seem to be a strong logic for noninclusion of other classes of creditors in the Committee of Creditors considering that all classes of creditors are exposed to the risk of a haircut in the insolvency resolution process. The fact that only financial creditors would have voting rights in the Committee of Creditors seems to be a hangover of the corporate debt restructuring scheme (CDR) and joint lenders forum (JLF).
It does not take into account that the decisions of CDR scheme and JLF were binding only on creditors who were part of relevant committees. No No major jurisdiction grants any preferential treatment to financial creditors in the context of right to participation or voting right in Committee of Creditors major jurisdiction grants any preferential treatment to financial creditors in the context of right to participation or voting right in Committee of Creditors.
The government should consider amending the IBC to sort out these structural deformities. Such an amendment should provide that all classes of creditors would have participation and voting right in Committee of Creditors. In cases where retail customers or home buyers are creditors, such creditors can nominate their representative. Alternatively, the National Company Law Tribunal or the IBBI could be granted a right to nominate a representative of retail customers. If the government does not act promptly, the provisions of the IBC creating substantive preferential rights in favour of financial creditors may have to be tested by the courts on the parameters of Article 14 of the Constitution which grants equality before law to all people.