Another IBC fix?

Regulator’s proposal for code of conduct for creditors deserves scrutiny

The Insolvency and Bankruptcy Board of India (IBBI), which is the regulator established under the 2016 insolvency code, has issued a discussion paper on the corporate insolvency resolution process and invited comment on its suggestions. The IBBI’S concern is that, while it regulates other segments of the insolvency and bankruptcy chain and ecosystem, the committee of creditors (COC) — the group of financial creditors of a company going through the IBC (Insolvency and Bankruptcy Code) process — “functions in an unregulated environment”. The discussion paper argues that appellate authorities have questioned the “capacity and conduct” of the COC, and that the responsibility that accrues to the COC when it comes to choosing the proper market-based resolution implies it should also be accountable. It further argues that there are international precedents for regulation of the COC. To that end, the IBBI paper proposes a code of conduct for the COC that it claims will create this accountability, through broad ethical principles. The paper further points out the frequent revisions of the resolution plans have caused “delay and uncertainty” and argues that new bidding processes such as the Swiss Challenge should be used. Also in the recent past, the question of a code of conduct for the COC was raised by the Parliamentary Standing Committee on finance.

There are good arguments on both sides of the question when it comes to a code of conduct for the COC. It could be pointed out, for example, that the question of accountability is a red herring. After all, every member of the COC is individually accountable to her or his own shareholders. Further, it is a stretch to argue that the COC is unregulated, since the members of the COC are typically from highly regulated sectors such as banks. It is also far from certain whether a code of conduct would speed up the insolvency process or lead to further delays, as the COC might be challenged at any time for failing to follow some aspect of the code. While principle-based regulation is better in theory, in practice there might be some concern that it would lead to regulatory creep, with more and more specific cases leading to precedents that bound the hands of successive Cocs.

It is, however, also true that while the members of the COC are responsible to their individual shareholders, there is also the overall insolvency process to consider. Some actions by Cocs in the past, including the acceptance of lastminute resolution plans and of one-time settlements by former promoters under Section 12A of the IBC, show how their accountability to their investors might clash with the overall interests of the IBC. It is in that context that the demand for a code of conduct begins to be understandable. However, in the end, a code of conduct for Cocs that are often dominated by public sector banks runs afoul of a more basic problem of accountability — namely that the banks themselves are only insufficiently accountable because of state control. If the IBC has been undermined because of misuse of clauses such as Section 12A, it is a reflection of the poor governance within the banks that led to the growth of bad loans in the first place. A code of conduct might be one step towards improving the IBC, but until bank governance is addressed it will not fix the real problem.