Problems range from voluntary bankruptcy that does not work as it should, to irresponsible and unethical resolution professionals (PRs) and the lack of a sufficiently deep and broad market for corporate debt. These all need to be addressed.
Turn a new chapter
It’s common for commentators to yearn for something like America’s Chapter 11 bankruptcy. In this, the management in place retains control and runs the business, under the control of the court, for a limited period during which the business is exempt from paying interest or repaying debt.
The equivalent provision in the Indian code should be that a company in financial difficulty voluntarily files for bankruptcy. But it didn’t take. Under Article 10 of the IBC, a debtor business can file for bankruptcy after defaulting on debt service and must indicate a PR to run the business. These provisions should be amended. Voluntary bankruptcy should be a preventive measure, seeking relief from debt service while relief is in place. The stipulation of filing for bankruptcy only after default should be removed. The current management should be allowed to implement the turnaround, with the approval of the turnaround plan, with monthly milestones, the failure of which should be sufficient reason for the voluntary bankruptcy to expire.
PR is another source of anxiety. It would be unfair to tar the whole flock on the basis of a few black sheep that prepare unforeseen sacks of wool, one for the master, one for the lady and one for their own little sheep who live down the alley. However, the institutional framework to maintain their good conduct is lacking.
PRs are governed by codes of conduct, one from the Insolvency and Bankruptcy Board of India (IBBI) and another from their affiliate institute. The only code Indians instinctively follow is that of caste honor, which leads to the murder of young couples who love each other according to biology rather than sociology. There must be a rigorous simultaneous audit of the conduct of PRs. IBBI needs to be strengthened to monitor this activity.
The employees of a bankrupt company are as much victims of default / mismanagement as the creditors. Their help could be relied on in determining the value of a company’s assets. In the original scheme of things, information custodians were supposed to appear that would contain all the relevant data about the companies. It did not materialize.
The value of a company’s assets is often vague, and there is little to stop company management or PRs from siphoning off value from a company. It may be wise to put in place an institutional framework to draw up an inventory of the assets of a company involving employees. Whistleblowers need to be protected and rewarded.
Liquidation value No secret
In recent insolvency proceedings, a chamber of the National Company Law Tribunal (NCLT) questioned whether there had been collusion between the RP and the bidder who had made a bid just above value. liquidation of the company. It could have been unfair. If the company’s books were reasonably accurate, due diligence would reveal the liquidation value to anyone.
In any case, why would the liquidation value be a secret? This must be a piece of information accessible to all bidders. If there is sufficient competition between potential buyers, transparency on the liquidation value would not bias the offers so that they converge towards this figure. This brings us to the central flaw in IBC’s operation: insufficient competition between potential buyers of resolved assets, either as operating businesses or as liquidated parties.
Even without collusion among potential buyers, there could be a shortage of very many viable bidders for a business under the hammer – during the 180-day window in which resolution is supposed to take place. The way out of this time constraint is to sell the asset to patient capital who can, one, pay a competitive price for the asset, two, keep the business until a decent buyer comes along , and, third, manage it competently in the meantime, if necessary.
Asset Reconstruction Companies (ARCs) created under the Securitization and Reconstruction of Financial Assets and Enforcement of Collateral Act 2002 (Sarfaesi) fall short. They have no capital, they are supposed to pay banks only 15% of the transaction price in cash, the rest is in the form of security receipts, essentially IOUs which can, in theory, be traded on the market but are not. And, CRAs don’t have the managerial bandwidth to run the businesses they buy until they find buyers for those businesses. Only private equity does this sort of thing.
Recently, the CRAs have sought government assistance in obtaining bank credit. CRAs should issue bonds to raise the funds they need – but for that we need a market for risky bonds. And they should be able to raise enough from the sale of risk bonds to repay the full value of what they’re willing to pay for the resolved assets. This is the only way ARCs would stop being vehicles for banks to perpetuate bad loans – instead of bad debts, banks hold IOUs from ARCs.
CRAs need to be overhauled, entirely, like businesses, without being tied to the chains of the RBI apron.
The opinions expressed are those of the author