What is the IBC suffering from? A quick fix problem
Since the publication of the January-March 2022 issue of the Insolvency and Bankruptcy Board of India (IBBI) newsletter, the media has been inundated with gloomy observations – “Delay, your name is IBC”, “Recovery of the IBC falls to a new low of 10%”, “Realization fell below the liquidation value of the assets for the first time”, etc. the Insolvency and Bankruptcy Code (IBC) has serious consequences. Value recedes over time, and it cannot be saved or realized unless timely and prompt action is taken.
The newsletter reports that 29 corporate insolvency resolution processes (CIRPs) concluded with resolution plans between January and March 2022. They achieved only 98% of the liquidation value (LV) for creditors financial (CF). Full realization, however, includes realization for CIRP costs, realization for operational creditors (OC), including laborers who are paid at par with guaranteed CFs, and realization as equity for CFs . If these are taken into account, for which data is not currently available, we would have a better picture of the achievement compared to LV. Nonetheless, the achievement of CF, as a percentage of LV, tells its own story.
LV is the estimated value of a company’s assets at the start of the CIRP. The longer the business remains under CIRP, the greater the loss in value resulting from the uncertainty surrounding the fate of the business and, in some cases, continued operating losses and, therefore, the lower the realization. . To limit the loss, the IBC caps the CIRP period at 180 days under normal circumstances. Against 180 days, the 29 CIRPs took an average of 734 days, or more than two years, achieving 98% LV for CF. Compare that with CIRPs that took an average of 236 days to complete in 2017-18, achieving 193% LV for the CF. Several factors, including the pandemic, explain the drop in achievement from 193% to 98%; the increase in the CIRP period from 236 days to 734 days is probably the most significant of these, which is a major cause for concern.
Unlike the pre-pack, where the contracting authority (AA) and the market have separate deadlines for completing their tasks, the CIRP provides a combined deadline of 180 days for both. Basically, a CIRP has two phases: the first is from the start of the CIRP until the resolution plan is approved by the CoC, and the second is from the resolution plan approved by the CoC until it is approved. by the AA. The second phase of the 29 CIRPs lasted an average of 325 days. For at least four of them, it took more than two years.
On the one hand, LV is receding over time. On the other hand, an inordinate and indefinite delay in closing the CIRP depresses value realization. A resolution plan approved by the CoC may become unviable the moment it is approved by the AA. It is a huge risk for a resolution seeker to implement an unviable resolution plan. A potential applicant may refrain from submitting a resolution plan to avoid such delay-induced risk, as it does not have the option of withdrawing once its plan has been approved by the CoC. If he is willing to take the risk, he would offer value that he expects to acquire upon approval of the resolution plan.
Based on his worst estimate of approval time, say X years, he would offer the value available with the company after X years, discounted to the current date. If resolution plans are approved within a firm time frame of, say, 30 days, there would be relatively more competing resolution plans, increasing achievement for the CF.
A CIRP technically closes upon approval of the resolution plan by the AA. But this is not the end of the journey. Litigation continues in the Court of Appeals and the Supreme Court, sometimes resulting in the restarting of the CIRP. CIRP in Jaypee Infratech Ltd. has been ongoing for five years.
The successful resolution candidate faces harassment as stakeholders submit new claims and fight all the way to the Supreme Court level. Most of the avoidance transactions claims have yet to be decided. All of this uncertainty and confusion is holding back the market for distressed assets.
Several factors and actors contribute to the delay in launching and closing CIRPs. For example, we highlighted the delays attributed to the CoC in a previous post in this article (bit.ly/3NC8U2Q). This exhibit highlights the delays attributed to the AA. That’s not to say that AA isn’t performing at its best, but it just doesn’t have the capacity to match the workload, which needs to be prioritized.
Admission to a CIRP should only take 14 days according to the IBC. In contrast, as IBBI reported in a recent working paper, the admission of applications filed by CBs took, on average, 650 days in 2021-22. No less than 82 of them were admitted after a lapse of two years.
The value declines very quickly between the filing of an application and its admission for obvious reasons. If the admission of an application takes two years and the first and second phases of a CIRP take two years each, especially when a company reaches AA after 3 to 5 years of stress, it is difficult to achieve a reasonable value for the creditors or to save the company in distress.
When many applications take so long to be admitted and many resolution plans take so long to be approved, the market believes that any admission or approval will take so long in all cases. It takes these delays into account in its decisions and thus offers a value that may even be lower than the NAV. Unless this belief is overturned by a demonstrable opportunity in admissions and endorsements, the realization of value could decline further in the days ahead, rendering the IBC irrelevant.
The distressed asset market has an underlying “lemon problem”. A disproportionate and indefinite delay in the CIRP, in addition to the rapid depletion of the LV of the stressed assets, converts the under-equipped institutional structure also into “lemons”, which should be avoided.
(The authors are respectively Director of the National Institute of Securities Markets and Professor Emeritus of the National Law University of Delhi.)