Can IBC turn around the investment cycle?

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New Delhi | Published: August 3, 2018 2:11:59 AM

Two years since its introduction, the IBC has been a modest success … the beginning of 2018 saw more resolution processes ending compared to the entire year of 2017, and the resolution processes resulted in higher recovery value compared to their liquidation value.

India has improved its ranking in both the World Bank’s Ease of Doing Business and the World Economic Forum’s Competitiveness Index by more than 30 places between 2015 and 2017.

India has improved its ranking in both the World Bank’s Ease of Doing Business and the World Economic Forum’s Competitiveness Index by more than 30 places between 2015 and 2017. However, the growth of capital formation in India—which is crucial for both overall growth and jobs—is one of the lowest since the global financial crisis during the post-reforms period. In fact, the investment ratio declined from a high of 35.6% to 26.4% of GDP, between 2007 to 2017. The major fall is in the area of private investment—5 percentage points out of the 6.3 percentage point overall fall in investment, between 2007 and 2016, mainly due to sour accounts in the corporate sector affecting balance sheet of banks, and thereby affecting both the demand for and the supply of credit. Debt burden and stalled projects in the private sector negatively affected both private investment and the banks’ capability to lend.

The Insolvency and Bankruptcy Code (IBC) was introduced replacing multiple archaic laws in May 2016—to look at stalled projects and cleaning balance sheet problems of corporates and the banking sector. The IBC aimed to offer an efficient way to resolve the risk of outstanding debts and address the problem of bankruptcy and insolvency cases. Provisions like time-bound resolution process, 180 days with 90 days extension, and management control with insolvency resolution professionals (IRPs) make the IBC an effective framework for cleaning up the balance sheet problems and turn around investment cycles. And the results, so far, are encouraging.

Before the functioning of the IBC, the average time taken to resolve insolvency cases was around 4.3 years, with the recovery rate of only around one quarter. Prior to the introduction of the IBC, insolvency was defined as the inability to pay debt and was based on balance sheet basis, whereas the insolvency procedure now is based on payment basis and can be started with a default of just Rs 1 lakh. Further, earlier the realisation and liquidation were dealt under separate laws. There was no guarantee of recovery under the various laws and the liquidation action was not successful under the Companies Act, 1956. Therefore, the IBC, which provides time-bound, single and transparent framework for insolvency resolution process, is meant to resolve insolvency quickly and address the non-performing asset (NPA) situation head on. The initial outcomes since the IBC’s inception are encouraging.

According to the National Company Law Tribunal (NCLT) data, as many as 525 corporates are undergoing the Corporate Insolvency Resolution Process (CIRP) as of end-March 2018. As compared to initial days, the number of cases being admitted has been increasing quickly. According to the NCLT bulletin, a total of 2,050 applications were filled till June 2017. In the first quarter of 2018, there were 167 cases to this process. Also, 701 corporates were admitted to the resolution process, and of which 67 cases have been closed on appeal or review, 22 cases resulted in approval of resolution plans, and 87 cases underwent liquidation. Initially, operational creditors initiated more resolution processes vis-a-vis financial creditors and corporate debtors, but of late more number of cases have been initiated by financial creditors and corporate debtors. Overall, there has been an increasing trend of the number of cases admitted, those undergoing resolution process, those whose resolution was approved, etc.

There are a few positives if we look at the performance of the IBC in terms of the number of resolutions and the recovery rate. During the January-March quarter of 2018, 12 cases ended in resolution as compared to 10 resolutions until December 31, 2017. The beginning of 2018 saw more resolution processes ending compared to the entire year of 2017, and the resolution processes resulted in higher recovery value compared to their liquidation value. According to the quarterly newsletter of the Insolvency and Bankruptcy Board of India (IBBI), the realisation of financial creditors in the 12 cases stands at 215%, in comparison with the liquidation value, while the average rate of recovery is 69.7% of their claims. The grand total of these 12 cases was around Rs 4,405 crore, of which Rs 3,070 crore was recovered. However, the degrees of recovery realised by financial creditors varies across cases. According to the IBBI bulletin, the realisation value is more than 50% in 10 out of 15 cases, whereas in the other five cases the realisation value is 100% of the total claims made by financial creditors. Realisations by financial creditors as compared to their liquidation value are crossing 100% in most of the cases.

It has only been two years since the introduction the IBC, and the number of cases has been increasing every quarter at a fast rate. Even though the resolution process is time-bound, the IBC is experiencing delay in the processes. The average time taken for cases yielding realisations is 245 days, which although is more than 180 days, but is well under the 270 days’ extended time limit. The time varies across cases and the minimum time taken was 119 days for Nandan Hotels Ltd case, whereas the maximum time of 323 days was taken in the case of Sharon Bio-Medicine Ltd. There are 10 cases which took more than 270 days. Even the liquidation process takes an average time of 227 days. The reason for this delay is mostly in cases where (1) a company that has been through several procedures and has almost exhausted all of its resources; (2) incomplete records and uncooperative officials; and (3) infrastructural and logistical challenges for IRPs.

The IBC is at an initial stage and is evolving into providing an efficient exit option to the insolvent and bankrupt companies. The rise of applications and the increasing success of the IBC has created a sense of responsibility among reckless borrowers and founders to pay back their outstanding debt in the fear of being dragged to the IBC. It has been reported that companies facing bankruptcy petitions have paid their debt to the tune of $12 billion. With the government’s plans to introduce cross-border insolvency to go after foreign assets of defaulting companies and to make individuals accountable who stood guarantee for loans to a firm, the IBC would be much more stringent and create a fear among borrowers to be more responsible. In fact, proper functioning of the IBC would help revive stalled projects, release resources for investment, and force a discipline amongst borrowers and company founders, which will turn around investment cycle in India. However, the IBC needs improvement and refinement, with proper infrastructure facilities, to move to a more mature stage and change the insolvency landscape of the country.

The author is Professor, Institute of Economic Growth (IEG), Delhi 

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