Undermining auctions

Legal loopholes in bankruptcy process exposed

The Supreme Court (SC) on Monday allowed UltraTech Cement’s purchase of bankrupt Binani Cement to go through, backing an order by the National Company Law Appellate Tribunal (NCLAT). This is a victory for UltraTech and for the committee of creditors of Binani Cement but a severe blow to the integrity of the process embedded in the Insolvency and Bankruptcy Code, or IBC. It is unfortunate for the sanctity of the auctions in the IBC that the apex court has chosen to uphold a decision by the NCLAT that will set the quality of the bankruptcy process back and is not in keeping with the natural justice of the auction process — a process that in other judgments the SC has done so much to support.

The genesis of the problem is simple: In the course of the bidding involved in the IBC resolution of Binani Cement’s debts, Rajputana Properties had bid Rs 69.30 billion. However, the committee of creditors then received a revised bid from UltraTech cement of Rs 79 billion. Upon a legal challenge, the NCLAT had declared — after referral by the SC — that operational creditors also needed to be taken into account although they were not part of the resolution process, and that the new offer was better for them. Operational creditors are not specifically “discriminated” against in the IBC process — there is, in all economic transactions, a hierarchy of creditors. Financial creditors such as bond-holders are usually at the top of this list, and the IBC recognises this basic fact.
 

Acceptance of offers outside the IBC-sanctioned bidding process undermines the whole basis of the auction mechanism. For the sealed-bid auctions to be efficient in garnering the maximum revenue, no participant or potential participant can be allowed to use information gleaned from the auctions after opening the bid to make another offer. If this is allowed, all future auctions will see lower bids as other parties begin to hold back their offers to examine what others would bid. This is a well-understood consequence and has been studied by the economics profession theoretically and practically for decades. The Indian legal process cannot imagine that it can ignore the results of economic theory in this manner. 

In any case, there is now an incentive for companies to short-circuit or manipulate the bidding process. This has been seen elsewhere in which some companies have bid too high so as to win the auction and then renegotiated subsequently; it is now possible to bid too low and then win the asset being auctioned through issuing an offer slightly higher than the highest bid in the auction. This cannot be allowed to stand. Clearly, this gap needs to be addressed by the government. The NCLAT judgment needs to be carefully studied by the appropriate ministries, including the corporate affairs ministry, the finance ministry and the law ministry, and suitable amendments proposed to the IBC’s governing legislation that closes any legal loopholes that have been taken advantage of in this case. If not, the entire IBC process stands in danger of being turned into a mockery of itself.