Tarun Bhatia Featured in Economic Times’ BFSI Edition

On 17th May 2020, the finance minister (FM) announced the fifth and last set of stimulus package to tackle the impact of COVID-19 on the Indian economy. Many were anticipating relaxations in the Insolvency and Bankruptcy Code (IBC) as the economy is in disarray and companies both small and big are unable to carry out their business. There is permanent erosion of revenue and with leveraged balance sheets, many companies are staring at defaults in the coming months. The moratorium, while offering temporary respite is only postponing the inevitable.

In this context, it is important to look at the rear view mirror and remember that since it came into its existence in 2016, IBC has been considered a landmark reform and one of the most critical (and positive) initiatives of the ruling government. Incidentally it was exactly four years ago that the Code received the assent of the President of India on 28 May 2016. In these four years, while the overall number of resolutions may not be very high, the code has brought about a cultural change in the way corporate India operates and created a level playing field between the companies and banks. For the first time, banks had the power to, through IBC, seize control of a defaulting company, remove the promoters and the management and identify a suitable investor (or liquidate) to recover its dues. For the first time, errant promoters were actually losing control of their companies without any financial benefit. It is important to have this context as we look into the IBC related measures announced as part of the stimulus.

The FM announced four specific relaxations to IBC:

• Minimum threshold to initiate insolvency proceedings raised to Rs. 1 crore
• Special insolvency resolution framework for MSMEs
• Suspension of fresh initiation of insolvency proceedings up to one year
• Excluding COVID 19 related debt from the definition of “default” for the purpose of triggering insolvency proceedings

The measures announced appear to have two key triggers. One to protect the interest of MSMEs and ensure they are not dragged to the bankruptcy courts in the aftermath of the pandemic. Two, to maintain confidence in the corporate sector and ensure that the entrepreneurship spirit stays alive.

The trigger with respect to the MSME sector is very relevant and it is comforting that the government has taken its economic importance into consideration. It is estimated that MSMEs provide employment to over 125 mn people and contribute to almost 30% of India’s GDP. These are not small numbers. COVID-19 has materially affected the MSME community through supply chain disruptions and displacement of labour. With the pandemic continuing to worsen in India, it is difficult to predict the impact of this disruption and also how long it will take before MSMEs can start on the path of normalcy. While a lot more stimulus is needed for this segment of the industry, increasing the minimum threshold and the special insolvency resolution framework will aid their revival process. It also goes hand in hand with the INR 3 lac crore (USD 40 bn) Emergency Credit Line Guarantee Scheme announced for by the government for MSMEs. While we are awaiting the insolvency resolution framework for MSMEs, however I expect the code to factor in the learnings from the resolution process for small companies over the last four years and thus be more accommodating towards MSMEs, especially in light of the impact of the pandemic.

On the other hand, the suspension of fresh insolvency proceedings for one year and relaxations for COVID-19 related debt can have some serious implications and devalue IBCs relevance. While the intention of the government was to provide breather to companies, it can have some meaningful unintended consequences. There are a few concerns:

• Firstly, the IBC as a concept had taken shape and both companies and banks had gotten used to its existence. Creating a year’s gap in the process will provide companies with a window to find options to give IBC a complete miss. Similarly, investors will see this as intervention and their confidence in investing in and funding turnarounds could be dented.
• As is internationally proven, bankruptcy process can also help the companies, especially if the road to recovery is extremely difficult. It can help in protecting shareholder value and also jobs. Not having a bankruptcy option could lead to prolonged pain without any near-term benefits.
• Banks will suddenly feel clueless about what to do with a defaulting company and the options it has to recover. It is very likely that they will seek support from the regulator and we may see a round of special restructuring packages. It had taken us years to dismantle the evils of BIFR, CDR, etc. and we might be dragged back into the dark ages.
• Distress events lead to increase in frauds including companies resorting to financial misreporting, diversion of funds and creation of personal assets by the promoters. Companies may seek relief and loans under the COVID-19 schemes, in disguise, and take benefit of exclusion offered under the stimulus package

The government could have instead offered more authority and accountability to IBC and introduced levers to fasten the bankruptcy and resolution process. While still in its infancy, the resolution track record of IBC can be challenged. As per the data available in public domain, till December 2019, 3,254 companies had been admitted for resolution under IBC. Of this, however resolution plans had been approved for only 190 cases and 780 companies had been liquidated. An efficient insolvency process can add more value to the economy and ensures appropriate allocation of capital and resources.

While the companies and banks grapple with the recommendations of the government, the recent National Company Law Appellate Tribunal (NCLAT) order which disallows former bank officials from being appointed as resolution professional (RP) in a company facing bankruptcy has caused chaos in the ongoing cases. Many of the RPs, as approved by IBBI, are ex-bankers and currently associated with multiple resolution process including that for prominent companies. The order in its current form can cause significant delay to the resolution process. While the argument of perceived bias has its merits, the same needs to be viewed in light of the existing process and the lack of experienced restructuring and turnaround specialists available in the country.

The coming months are going to be very critical in defining the success of IBC. While addressing the broader economic concerns, we need to realize that bankruptcies and insolvencies are business realities. While the ecosystem should help companies become successful, Darwin’s theory of ‘survival of the fittest’ should also apply at all times.

Article Credit: ETBFSI.com

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