We need to rethink the insolvency ecosystem before it loses its appeal

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As the Narendra Modi government celebrates “Azadi ka Amrit Mahotsav”, an initiative to commemorate 75 years of independence, one should assess the success of India’s bankruptcy code, which is arguably one of the most more progressive laws that have come into effect in recent times across the country, offering businesses the “freedom to exit”.

This groundbreaking law made its debut in 2016, in the form of India’s Insolvency and Bankruptcy Code (IBC), which allowed companies to exit easily and within a specified period. The IBC made a radical change in the way loans were perceived. At the beginning of its implementation, a defect as small as 1 lakh could lead to the opening of insolvency proceedings by the affected creditor. This reassured creditors that borrowers, especially developers, would take their obligations seriously.

However, the law was found to be insufficient. Consistent delays were observed. In 2020, the delays and the contribution of each stage to them were mapped, and it was found that 64% of the average total delay was due to the delay in obtaining the approval of a resolution plan by the creditors’ committee (CoC) and the adjudicating authority, the bankruptcy courts.

In its early years, the IBC faced some teething problems and it was expected that over time these would be resolved and its operation would improve. However, according to the Insolvency and Bankruptcy Board of India (IBBI) Newsletter from January to March 2022, 64.7% of all cases admitted for Corporate Insolvency Resolution Process (CIRP) since 2016 that have been closed, 11% have been withdrawn, approximately 14% settled, 30% liquidated and 9% resolved (in which a resolution plan has been approved). Data published by the IBBI shows that the resolution rate of CIRP cases is rather low and that the number of cases in liquidation is three times higher than in the process of being resolved.

Thus, it is clear that the CoC and the courts have been bottlenecks to the success of the IBC. Banks, especially those in the public sector, are unable to make pragmatic decisions because any risk taking that could lead to a low rate of collection of contributions in the short term may be subject to due diligence and audits. It discourages decisions. So we need to allow banks to make bold decisions and not create an environment in which they limit their decisions to choosing the “L1” or the lowest possible haircut rating for fear of future problems. More importantly, banks must be freed from this regulatory burden so that they can take bold steps to restructure. To achieve this, bankers should be protected for good faith decision-making during the resolution process, based on a premise such as the “business judgment” rule available to board directors in many Many countries.

Also, since most of the delay occurs at the admission stage of the file, it is worth making the applications for admission under Articles 7, 9 and 10 of the CIB available on a written plea rather than on pleadings. Furthermore, one could identify provisions of the IPC where the courts are mandated not to adjudicate but only to administer. But concerns will remain about the expertise of commercial court judges to rule on such issues. Commercial courts need new talent with business understanding for proper decision-making.

The insolvency litigation procedure should aim to reduce the length of the process as well as the volumes of business, so as to reduce the resulting uncertainties. This can be done by shortening the time within which a party must bring a claim, whether an initial challenge or an appeal, which elsewhere is often shorter than in other civil or criminal disputes. In France, it is generally 10 days; in 2021, through insolvency and restructuring law reforms, it further extended it by providing for full judicial settlement of certain disputes before a court confirms a restructuring plan. In the same spirit of limiting insolvency litigation, the reform also limits the parties who can initiate certain legal actions. These are court-appointed insolvency practitioners or parties involved in the restructuring process. Another feature worth considering is either giving some decision-making power to the insolvency practitioner assigned to the case or appointing a supervising judge for each case. In France, these judges have exclusive power to authorize material settlements with the insolvent company, some of which also require ratification by the insolvency court. They are often the first to decide an issue, and although their decisions can be challenged in the insolvency court and the latter’s decision can be challenged in a court of appeal, insolvency courts tend to confirm the orders of the judge-commissioners. Most litigants expect to have to take their case to an appeal court to effectively challenge the decision of a supervisory judge, which is not easy.

In conclusion, we need to seriously rethink how to design an India-friendly insolvency ecosystem amid our current challenges of limited court capacity and high regulatory cholesterol. Whatever the government’s decision, it is important to act in time before BAC loses its luster and stakeholders who saw this law as a savior give up hope and the search for a new regime.

Neeti Shikha is Associate Dean of the Indian School of Public Policy.

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