IRRATIONAL CHOICE Bankruptcy ordinance: Motivated criticisms?
Ihave never been a fan of the new bankruptcy law, stylishly called the Insolvency and Bankruptcy Code (IBC). The reason is that it does not incorporate the most simple and elegant solution to a bankruptcy process, that is, a vibrant market for tradable, distressed securities, which I personally saw functioning very well two decades ago in New York. Such a market could have established the value of distressed assets much better, on a continuous basis, attracted larger global players with deep pockets, created a new merit-driven ecosystem, and set in motion a much faster distressed assets clearing cycle, at least for the larger companies. Instead, we now have closed-door negotiations, reliance on a small batch of individuals called insolvency professionals of extremely uneven quality, and a massive cumbersome regulatory superstructure; and, we have financial sector regulators with very little accountability.
What happens when a few wise men — researchers, lawyers, bankers, and judges — forge their own creation and impose it on the market, ignoring the benefits of an efficient and well-regulated marketplace that brings in buyers and sellers and sets prices transparently? Since it is impossible, even for the wisest men, to anticipate all the possible ways in which a new law can create unintended consequences, and how to handle them, major hiccups arise in implementation. Over a period of time, the hiccups lead to a bigger and bigger mess and the well-intentioned law turns completely useless. It is then time for a new law. This has happened to at least three previous bankruptcy regulations and the IBC is slowly headed that way.
Of course, this government is made of sterner stuff. It refuses to accept such slow deterioration. It prides itself on listening to sensible feedback and responding quickly, as we have seen during demonetisation. Hence, it has come out with an ordinance to fix one of the many problems of the IBC — promoters legally getting control back over the companies they have mismanaged. I had exposed this trend first, in my September 18 piece in this paper (“Bankruptcy code being gamed from the start?”). That was about a small company called Synergies Dooray. But it showed the way to larger companies like Essar and Bhushan Steel, whose promoters have been aggressively vocal in the media about reclaiming control of their companies. This was obviously a red rag to a government which was further goaded into action by potential bidders such as Sajjan Jindal, who used social media to aggressively to ask the government to stop “dubious promoters” from bidding for their companies. Hence it has come out with an amended Section 29A of the IBC to keep out wilful defaulters; persons associated with non-performing assets (accounts classified as non-performing assets for a year or more) and are unable to settle their amounts; and those who have executed an enforceable guarantee in favour of a creditor in respect of a corporate debtor undergoing a corporate insolvency resolution process. Persons connected to all of the above are also disqualified. While there can be debates on whether this is legally tenable, the intention behind the move will resonate widely.
Quite amazingly, a chorus of voices among lawyers, media commentators, business leaders, consultants, and financial analysts have criticised this move as regressive and almost foolish. I have summarised their arguments below, and they to me sound flimsy and motivated
Negative for banks, given the probability of higher hair-cuts and delay in the resolution process; ·
Resolutions may happen at a lower-than-anticipated valuation because promoters, in a bid to retain control of existing assets, may have potentially bid higher, thereby setting a higher benchmark for other bidders;
Likelihood of delay in resolution process as fresh bids will have to be called;
Due diligence will have to be conducted more rigorously to ensure non-participation of wilful defaulters or related entities;
No other restructuring law in the world has such restrictive thresholds;
The lack of strong promoter bids may dilute the competitive process between the remaining resolution applicants and so, lower the recovery for lenders.
If there are 100 bankruptcy cases to be resolved, in how many cases can the promoters reclaim their assets? If it’s impossible to do this calculation, why jump to conclusions? Assuming that in 10 per cent of cases the defaulting promoters are successful, why cry about an amendment that will not apply to 90 per cent of the cases anyway? And if there was no amendment and in 50 per cent of the cases the defaulting promoters emerged as successful bidders, wouldn’t you say that the bankruptcy process has failed again? About ~10 lakh crore of bad assets have arisen mainly because of deep corruption and the nexus between bankers, businessmen and politicians. And our solution is to let the same bankers hand over the businesses to the same businessmen? What are we missing here? This is one decision of the government that is correct if it also dramatically increases the supply of bidders and removes the frictions in the resolution process. But that is a subject of another piece.