Dec 06, 2022

The IBC & the Sea-Link

As I drive across Mumbai this morning for a meeting, I cross the Sea Link. This sea bridge offers an alternative route to traverse the city’s midsection. Its detractors say it doesn’t really reduce traffic, that its infrastructure could have been better, that its entry and exit points can be improved, that it is not being used enough and that changes are needed for it to remain relevant. It occurred to me that the IBC’s detractors voice similar complaints!

Changes are certainly needed. Before that, a word of encouragement. The IBC was introduced to help change credit culture, to enable the restructuring of companies (in a short timeline) and to free up the flow of credit, productive assets and jobs.

And on each count, in my view, the report card is glowing.

First, by 30 September 2022, more than 23000 IBC applications were resolved before admission. That means tens of thousands of creditors (largely operational) of these 23000 companies have been resolved to their satisfaction. The amount involved is approximately 7.3 lakh crores.

Second, approximately 6000 companies were admitted to insolvency resolution under the IBC by September 2022. Four-times as many cases were withdrawn than admitted. Pre-IBC, there was no effective law to enable restructuring of distressed companies. And the IBC has brought down timelines to a third of what it used to be and plummeted NPA ratios of banks.

This is empirical evidence of the fact that companies will be persuaded to pay up for fear of being admitted into IBC. A clear change in our credit culture.

Third, add to the 7.3 lakh crore amount above, approximately Rs 2.4 lakh crores recovered under resolution plans, you have Rs 10 lakh crore of credit freed or satisfactorily restructured.

A new financial sub-industry has developed under the wing of the IBC – special situations financing. Pre-IBC, special situations capital barely touched Indian shores – for want of a mechanism to force a hard exit if borrower vitals worsened. With the IBC, we have seen numerous distressed financing trades as these players took comfort that the IBC would get them paid – either with its threat or via insolvency resolution. This is important given that even at our current GDP we need USD 30-40 billion of private credit. This inspite of the fact that our credit/GDP ratio is a conservative 56% (largely supplied by our banks).

Now to the changes needed. They are serious and much needed.

Three judgements from the Hon’ble Supreme Court have hobbled the IBC. Vidharba, Rainbow and Resurgence – what I call the dreaded VRR. ‘Vidharba’ has already led to denial of admission of defaulting companies. ‘Rainbow’ (along with NCLAT’s decision in Aircel), has reordered the priority of payment of Government dues and could be the deathknell for resolution of companies with large government dues, especially infrastructure companies. ‘Resurgence’ and related judgements, have left secured minority creditors to the whims of the larger creditors; so new secured lending where the lender does not have a majority in the company’s debt stack, is now perilous.

The positions created by these judgements can only be remedied by statutory amendments, which are needed soonest.

Now on entry into and exit from IBC. Remedying the position in Vidharba will improve entry – as will more judges with dedicated IBC benches and judicial colloquiums to improve consistency. Many court approvals are delayed because of intercreditor fights on distribution. Separating plan approval and distribution of resolution proceeds with an escrow is key to avoid this. This is happening in practice in many cases but should be the rule.

Lastly, how to increase the use of IBC. Most promoters are not keen for their company to enter insolvency resolution. Even if a moratorium, cross-class creditor cramdown and whitewash are needed to save the company, which are only available under the IBC. It may be because the IBC takes on average eighteen months, follows a creditor-in-possession model and restricts many promoters to bid in IBC. So, we find ourselves with a missing piece. Promoters are unable to restructure distressed companies outside the IBC and are too scared of the IBC. Much like the missing piece on the Sea Link between Worli and Marine Drive.

If promoters can be incentivized to use the IBC, the company will be resolved much earlier post-sighting of distress. And this will lead to higher recovery. Is there a way to do this? It’s under our noses. The prepack. Extend it to all corporates. This has debtor in possession. The time period is expected to be 90 days or less (as opposed to 330 days). While S29A IBC still applies, if the company goes into the process early, key S29A restrictions will not start to apply and so the promoter may be able to bid for her company. Key benefits of the IBC will also be available. We may find for the first time in our history, promoters opting for early resolution of distress.

With these changes, I am confident that the IBC which has already achieved much, will become more dynamic and successful. A little like the Sea-Link, I think, as I scoot across to Bandra in minutes and contemplate its extension to Marine Drive!





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