Why exclude promoters from insolvency process; implications can be serious

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Published: November 15, 2017 5:43:58 AM

Of late, there has been considerable speculation on allowing promoters to participate in the resolution of companies facing insolvency resolution process under the Insolvency and Bankruptcy Code 2016.

promoters from insolvency process, exclude promoters, insolvency process, insolvency resolution, insolvency resolution processOf late, there has been considerable speculation on allowing promoters to participate in the resolution of companies facing insolvency resolution process under the Insolvency and Bankruptcy Code 2016.

Of late, there has been considerable speculation on allowing promoters to participate in the resolution of companies facing insolvency resolution process under the Insolvency and Bankruptcy Code 2016. There are some that favour barring defaulting promoters from submitting resolution plan. Many are of the view that new investors should be preferred over promoters, while promoters argue that they should be given the first right of refusal to revive the company. The code does not prohibit promoters from submitting a resolution plan or create any preference in their favour. Nor was it the intent of Parliament to disqualify promoters from participating in the resolution of insolvent companies. On the contrary, the Bankruptcy Law Reforms Committee (BLRC) clearly stated in its report that “the promoters can make a proposal that involves buying back the company for a certain price, alongside a certain debt restructuring” and there should be no “constraints on the proposals that the resolution professional can present to the creditors committee.” This approach is reiterated in the notes to clauses of the code presented to Parliament as a Bill. Promoters can present a plan and resolution professionals are duty-bound to examine it and present it to the committee of creditors if their plan qualifies the parameters laid down in the code and regulations.

To debar promoters, the code will have to be amended. Any such amendment would be contrary to the basic tenets of insolvency law and contrary to global best practices. It is also likely to face a legal challenge on grounds of discrimination under Article 14 of the Constitution of India. The government would be ill-advised to go that route and expose the code to a legal scrutiny or criticism at this stage when the code has been mainly responsible for scaling up India’s Ease of Doing Business ranking. A promoter is the most natural candidate to present a plan. Then, where does the debate to disqualify the promoter stem from? Bankrupts are generally viewed with suspicion and the assumption that, in most cases, criminal behaviour could have been the reason behind the failure to repay debts remained a very popular idea.

This is precipitated by cases like Synergies Dooray where defaulting promoters succeed in thrusting over 90% haircuts on lenders by abusing the process of law. In many cases filed under the code, there are no resolution plans received other than from promoters, and lenders may be constrained to handover the companies back to promoters at heavy discounts. While the big cases in insolvency do not face this limitation, in others the level of interest by investors is low, as India does not have a developed market for distress asset investors. The concern is that, in such cases, the promoter will have the last laugh by bagging the company back at a very high discount. As long as there in no trust deficit between lenders and promoters, and insolvency is not caused by fraud or mismanagement by the promoter, it should not be a problem to provide the promoter a second chance. At the same time, lenders should not hesitate in liquidating the company if promoters or new investors have doubtful credentials and no other investor comes forward with a credible plan.

Recognising this, the Insolvency and Bankruptcy Board of India amended the regulations recently to make it obligatory on resolution professionals and lenders to take into account the credentials of investors and promoters while considering their resolution plans. In a way, the amendment only states the obvious. Lenders are, in any case, obliged to stay diligent while considering the resolution plan and take into account the antecedents of sponsor of the plan. The amendment does not take away the prerogative of the committee of creditors to take a commercial call in favour of the promoter if there is no trust deficit. It is critical that honest promoters do not become victims of this narrative. Disqualifying promoters as a class, even by perception, can have deep implications for the economy and society. It is crucial to recognise that where there is credit, there is also default. The use of credit unquestionably makes companies vulnerable to the shifting currents of the overall economy. As people try their luck at business, many learn about success, as well as failure, in the pursuit. People take risks, and the bankruptcy system facilitates this risk by design. Modern insolvency laws are built on the principle of granting a fresh start to the honest but unfortunate debtor. This culture of tolerance towards non-payment is necessary to encourage people to continue entrepreneurial pursuits.

Therefore, the BLRC clearly stated in its report that “in a growing economy, firms make risky plans, of which some plans will fail, and will induce default. If default is equated to malfeasance, then this can hamper risk-taking by firms. This is an undesirable outcome, as risk-taking by firms is the wellspring of economic growth. Bankruptcy law must enshrine business failure as a normal and legitimate part of the working of the market economy.” As it is, bona fide defaulters are feeling short-changed at being dispossessed from management and assets on default in payment of even one interest instalment under the code. Treating them unfairly in consideration of resolution plan would be unduly harsh. There are many honest promoters who are unfortunate defaulters and deserve to be given a second chance. It would be unfair to exclude them from consideration by bracketing them with dishonest promoters. After all, every person with the name Prem Chopra is not a villain!

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