Flexibility on bankruptcy

Govt deserves credit for insolvency code changes

Parliament on Tuesday gave its assent to the amendments that the government had proposed to the Insolvency and Bankruptcy Code, or IBC. These are meant to address some hurdles afflicting the implementation of bankruptcy proceedings. The new flexibility introduced by the changes is an important indication that the government is serious about getting distressed assets up and running or, failing that, freeing up capital for other uses. The problem is that the government has to deal with multiple objectives and constraints, making the exercise a tightrope walk.

It needs to, first of all, try to maximise the probability that these assets will be revived rather than liquidated or abandoned. It then has to ensure that the system it designs to revive or sell off assets is structured to ensure that creditors receive the highest possible bids in auctions. The structure should also maximise the probability that all the creditors agree on a rescue plan, and reduce the likelihood of holdouts in the committee of creditors. Finally, it needs to ensure that moral hazard is not created by the bidding process — that those who ran those assets into the ground and failed to pay their dues do not benefit from the process of bankruptcy by regaining these assets at knocked-down, bargain basement prices.

To deal with these multiple objectives, the government has been forced to be nimble. The earliest version of the IBC led to fears that tacit agreements between banks — desperate to ensure that there were some bidders for distressed assets — and the promoters of those companies — who ideally would like to be the only bidders for those assets, and at a very low price — were undermining the insolvency resolution process. The government addressed this through an ordinance to exclude such promoters from the bidding process. This recently passed Bill gives parliamentary sanction to that ordinance. But, after the ordinance, fears grew that the exclusion of bidders was too stringent and that it would, for example, keep out innocent corporate guarantors and completely decimate the ranks of small and medium enterprises (SMEs) applying for bankruptcy. The government thus altered the provisions significantly in the final version of the IBC amendment, to try and protect the interests of SMEs as well as ensuring that corporate guarantors were only excluded from the bidding of assets that they had guaranteed. It also seeks to ensure that asset reconstruction firms and asset investment funds are not excluded in error by a provision meant to target errant promoters.

Meanwhile, the relevant regulator, the Insolvency and Bankruptcy Board of India, has also been active — removing a provision that made mandatory the disclosure of the value of a distressed asset if it were to be liquidated. There were concerns that this low value would have incentivised bidders to game the system and send in similarly low bids. But creditors will be made aware of this value, and since it will likely be low, they have more incentive to agree with any resolution plan and increase the chances that the asset will be salvaged. While the effect of all these changes is yet to be seen, it inspires confidence that the government has moved swiftly to make them. The insolvency process will be closely watched going forward.