Preparing for the Insolvency and Bankruptcy Code storm

March 27, 2021 6:00 AM

With the suspension lifted, there is the likelihood of a surge in filing of IBC cases. To avoid overwhelming the tribunals, the govt must look at encouraging ‘out of court’ mechanisms to resolve these

Pre-packaged insolvency resolution, MSME, IBCThe biggest issue that pre-pack schemes will face initially is that CD may not raise additional capital or debt from investors or banks.

By Neeti Shikha

With the lifting of the suspension on filing of fresh Insolvency and Bankruptcy Code (IBC) cases, a question worth examining is whether it will result in a surge of fresh cases. The challenge that lies before India is how it handles this storm. In the past, most crises have been followed by surges in restructuring and bankruptcy filings. For instance, in the aftermath of the 2001 Argentine crisis, there were 243 bankruptcy and creditor contests. Debts declared by companies and individuals in the bankruptcy proceedings reached $183.58 million. The Netherlands experienced a 50% increase in the number of enterprise filings in 2009 during the global financial crisis. Evidence from the United States too indicates that insolvency proceedings are on the rise. A report published by the World Bank notes that the filings by foreign companies that can use Chapter 15 of the Bankruptcy Code of the USA have risen almost 3 times. Chapter 11 filings, a route which is more often used by larger firms for restructuring the debt, have risen by almost 45% from 2019 to 2020. Similar cases have started to rise in Canada too.

While considering the case of India, it is worth noting that the above countries did not have fresh insolvency filing suspended. Given that India has announced that all defaults post 25 March 2020 shall be excluded from the ambit of defaults attracting IBC, it is doubtful whether creditors will ever be able to bring in fresh cases with ease against the defaults that have occurred in the past one year. But, there is certainly stress in companies and the creditors would be waiting to opt for recovery through IBC, now that the suspension is lifted.

According to official data, 63% of more than 21,000 cases that are pending with NCLT benches as of end-January have been filed under the IBC. Given that there are limited NCLT benches, and adding more benches requires a lot of work over a long time, there is an urgent need to simply allow debt restructuring through different schemes and to look for alternative dispute mechanisms for settling disputes related to IBC.

Two things can be done by the government. First, it can announce a simpler option, a scheme under Section 230 of the code, wherein most of the restructuring can be done outside the court if the 75% creditors agree. The scheme should also be simplified to constitute only those classes of creditors whose rights are affected under the scheme. The settlement should be taken to courts only for final approval. An executive decision of the government—say, through the ordinance route—can allow for time till this settlement scheme is given final shape. This will take off the pressure from NCLT.

Second, and more important, the government must push creditors to mediate the dispute before bringing it under IBC. Outcome of the ADR mechanism may create a win-win situation for all the stakeholders, including the creditors. The Netherlands did a pilot study in 2012 on the prevention and resolution of bankruptcies using mediation wherein insolvency courts deployed “under the radar” mediation-like strategies to prevent actual and potential conflicts involving insolvency practitioner. The study showed that it enhanced the speed and cost-effectiveness of the winding-up of cases, as perceived by the stakeholders.

It is expected that the mediation procedure will limit the costs of creditors incurred on account of the insolvency proceedings. However, one will have to be careful, since the outcomes may raise some unprecedented legal consequences. For instance, a request for mediation could lengthen the bankruptcy proceeding if it fails. Furthermore, the hourly fee and other costs of the mediator and mediations will most likely become a preferential claim in the final distribution of assets. All these issues will need to be addressed through the regulation to avoid any such future conundrums.

Given the want of empirical evidence of efficiency of ADR in insolvency, a policy response to include mediation in insolvency cases needs to be done with great care and clarity. There is indeed an urgent need to give impetus to ‘out of court’ settlements in the case of insolvency disputes. This will provide more flexibility to both companies and creditors. After all, default does not always mark the death of a company.

The author is Head, Centre for Insolvency and Bankruptcy, Indian Institute of Corporate Affairs
Views are personal

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