Insolvency: More tinkering to plug loopholes IRRATIONAL CHOICE

On November 7, the Insolvency and Bankruptcy Board of India (IBBI) came out with a notification that is a classic example of motherhood statements from a “responsive” regulator when faced with practical issues that escaped the legal pundits and experts while making a new law. The notification reminds us, in case we did not know, that the resolution plan “should come from any person who can really rescue the insolvent business and the committee of creditors is expected to approve the best of them”. The regulator then goes on to instruct how the committee of creditors must conduct itself. The committee “is expected to carry out due diligence of every resolution plan to satisfy itself that (a) the plan is viable, and (b) the persons who have submitted the plan and who would implement the plan are credible, to avoid the plans which may lead to liquidation, post resolution, and to select the most suitable plan”.

Anyone reading this would be flummoxed by the sermonising. The committee of creditors has its own money at stake. They are not like governmentor court-appointed receivers, which need to be reminded of their obligations. Often these days, the creditors are from asset reconstruction firms, whose only objective is to maximise their returns. The creditors could also be private sector bankers who want the most out of a bad situation. The only people who probably need to be told to act in their own interests are bankers from public sector banks (PSBs) who have no skin in the game and have been hand-in-glove with defaulters. If so, the IBBI instructions to them should have come from the ministry of finance.

But what is the trigger for such homilies by the IBBI anyway? It appears that the Indian promoters, having badly mismanaged their businesses, don’t want to give up control over their assets. Hence, in one case after another, it is the promoters who are in the forefront of acquiring control over the same assets through the new bankruptcy mechanism. This has caused a lot of outrage, even among businessmen. Sajjan Jindal, founder of the JSW group, tweeted “[d]ubious promoters should not be allowed to submit the rehabilitation plan to prevent misuse of the IBC (Insolvency and Bankruptcy Code). Also the bidding criteria should be spelt out explicitly prior to inviting the bids. This will avoid likely litigation.” It is of course another matter that much before JSW Steel became a successful company, its earlier avatar, Jindal Vijayanagar, was sick for about a decade and Mr Jindal retained control due to banks’ largesse before he could turn around his group’s fortunes.

The issue of whether the promoters of companies that are under the resolution process can be denied the right to bid is a complex one. The first is a practical issue. These promoters will have an unfair advantage because they have more information about the company than other bidders. The second issue is a moral one: These promoters have grounded the company — how can they be allowed to be back at the helm, especially in the case of repeated defaults and proven malfeasance? While such outrage is a fine talking point in the media, to stand up in the court of law the definitions of who can be excluded and why need to be very clear under the IBC. One of the many flaws of the badly drafted IBC and the whole new bankruptcy architecture is that it did not take into account the very Indian possibility that promoters (and others) will try to game the system in many obvious ways. To avoid such situations, the bankruptcy resolution could have been handled through tradable securities (at least for large companies) because the market price of securitised debt can establish the value of an underlying asset far better rather than closed-room negotiations. But that cleaner path would be too radical for India.

What India prefers are nanny regulators that will issue endless circulars, each in reaction to specific practical problems that legal pundits missed while drafting the law. For instance, in the November 7 instructions, the IBBI says the resolution plan should disclose details so that the committee of creditors can assess the “credibility” of applicants to take a “prudent decision”. The disclosure should also cover the details of the resolution applicant such as their holding companies, subsidiary companies, associate companies and related parties, and also details of convictions, pending criminal proceedings, disqualifications under the Companies Act, 2013, orders or directions issued by the Securities and Exchange Board of India, categorisation as a wilful defaulter, etc. The plan must have details of preferential transactions, undervalued transactions, extortionate credit transactions, and fraudulent transactions as defined in the IBC. It is not clear though whether all these details would mean another round of mindless disclosures, or would be used to turn down any applicant. If it is the latter, it would be promptly challenged in courts. Interestingly, even as the IBC is busy telling creditors to be “prudent” and look for applicants with “credibility”, there is no term like “fit and proper” under the IBC. We should expect many legal skirmishes and endless tinkering of the IBC rules in future.