The Reserve Bank of India (RBI) believes the Insolvency and Bankruptcy Code (IBC) is probably the best mechanism for creditors to recover their dues. In response to criticism over the massive haircuts—in some cases, as much as 95%—borne by creditors, RBI’s robust defence is that the right way to look at the effectiveness of the law would be to compare the resolution value to the liquidation value and not the total loans.
In the latest report on Trends and Progress of Banking released on Tuesday, RBI said, in cases where corporate insolvency resolution processes were initiated by financial creditors, the realisation value through the IBC as of end-September was close to 201% of the liquidation value. The central bank’s optimism is touching, but it probably downplays the concerns expressed by many about huge delays and massive haircuts.
RBI, of course, has suggested improving the efficacy of the IBC through various measures, one of which includes extending the ‘pre-packaged’ (pre-pack) insolvency resolution process, now allowed for micro, small and medium enterprises (MSMEs), to large borrowers as well. It said the pre-pack resolution process combines the best of the out-of-court resolution efforts and the judicial finality of a resolution plan. This mechanism, RBI hopes, may effectively complement the prudential framework if extended to all borrowers. On paper, this is a sensible suggestion.
A pre-pack envisages the resolution of the debt of a distressed company through a direct agreement between secured creditors and the existing owners or outside investors, instead of a public bidding process. One of the key criticisms of the corporate insolvency resolution process (CIRP) has been the time it takes for resolution. The pre-pack, in contrast, is limited to a maximum of 120 days, with only 90 days available to stakeholders to bring a resolution plan for approval before the National Company Law Tribunal (NCLT).
But let’s look at the reality. Despite the hype over the pre-pack process after it was launched in April 2021, it has only two cases admitted under it so far. Among other things, the poor response has been attributed to the hesitancy on the part of creditors on the voluntary haircut provision. There is a fear that such a decision might be scrutinised later, leading to potential harassment by investigative agencies.
Experts also say that the ‘debtor-in-possession’ model, under which the borrower retains charge of the company, may militate against the Swiss challenge option, as the existing management may create hurdles for an outside investor seeking information to potentially invest in the company. The timeline for the pre-pack process is also difficult to meet for lenders and distressed firms, as forensic audits are particularly important in cases where the control of the firm remains with the same management.
The pre-pack process is also complicated—for example, creditors will have to go through a three-fold approval, which includes permission of at least 66% of financial creditors that are unrelated to the corporate debtor before a resolution plan is submitted to the NCLT. The IBC regime was introduced to overhaul the corporate distress resolution regime and consolidate previously available laws to create a time-bound mechanism with a creditor-in-control model as opposed to the debtor-in-possession system. The process needs to be finetuned, but any decision such as extending the pre-pack process to other borrowers must be taken only after a proper appraisal of its journey so far.