Understanding IBC: Insolvency and Bankruptcy Code

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Amidst the megaton explosions of Demonitization and GST roll-out, crackle of Insolvency and Bankruptcy Code (will be addressed as IBC henceforth) has taken a back seat. Had it been passed in reform-less UPA-II, it would have been on headlines for as long as one can remember. Recently, According to World Bank’s ease of doing business rankings, India has advanced significantly and IBC was one of the main reason behind that. For any country to be successful, private participation in investment and developmental activities is vital. And to have efficient private participation, ‘easy entry and easy exit from business’ will be on top of anybody’s priority list. For our discussion, let us skip the ease of starting a business as IBC exclusively deals with ease of exit half of business.

To appreciate the need and importance of IBC, we must travel back, at least, to 2002. It was the year when Asean and European countries started dumping their money in USA (reasons of which are beyond the scope of this article) and that cheap money coupled with historical lower interest rates have fueled housing bubble in USA which was subsequently busted in 2008. In a globalized financial network, no crisis goes unnoticed, not at least the crisis of this magnitude. It sent shock waves all across the world and we thought India was one of least affected nation of subprime crisis. In fact, we have celebrated our resilience and world institutions praised our established structures. Yes, we were resilient than most of the nations, but, we were not immune to that crisis. So, what has changed over a period for us to realize? Due to the easy money that was flowing to every developing country including India, we have grown at spectacular rates. As the aphorism goes, ‘a rising tide lifts all boats’. Not surprisingly, along with our economy, almost all the major corporate entities flourished. Suddenly, future of Indian companies seemed brighter than it has ever been. With buoyancy of easy money, Indian industrialists started taking huge risks and started expanding to every possible territory all over the world. After all, raising equity was easier than snapping fingers, so does the loans from banks. Interest rates were at historical lows and it was easier than ever to get a loan from banks. In fact, banks started running after corporates to provide them loans at ‘competitive’ rates. Because, money seemed secure as the prospects of the companies were bright.

As Isaac Newton Famously said, ‘All that goes up must come down’. Corporates were no exception, buoyancy settled and subprime crisis subsequently created cash crunch. Financial institutions in western countries have lost faith in each other and they have almost stopped lending. When that easy money from banks stopped coming, western investors stopped pumping money into emerging markets. And, it eventually lead to cash crunch in developing markets. Companies in India have undertaken long term projects based on short term prospects, which is never a good thing. As if companies are not suffering enough, inflation started to rise in India, so did the interest rates. Companies that were able to get loans from banks at cheaper interest rates, now had to repay at higher rates while the income from the already undertaken projects had drastically come down or even halted. Well, that’s where NPAs started to rise in the balance sheets of banks. Currently, about 56% of bad debts in public sector banks are from corporates. And, Indian banks have no way to recover their money from the defaulted entities as corporate entities can always resort to courts for delaying or even to stop the proceedings against them by banks.

As I have already mentioned, it is always best to have an exit strategy before starting anything. Indian legal system used to lack any effective exit mechanism. IBC is intended to provide the same to Indian corporates and to lenders as well.

Why an easy exit is so important? Assume, you have lent 1 lakh to Mr. A to buy a particular machine and you asked him to hypothecate the purchased machine in your name as along the loan remains. Also assume, the borrower fails to repay your money. What can you do in that scenario? You can sell the machine which was registered in your name to recover money. But, what if the money you get from selling the machine falls short of the money you have lent to Mr. A? You have to go to the court for further recovery of money. As you know, it takes very long time to get a resolution via courts. It takes on an average of 4 years to wind up a company in India. That is exactly where IBC comes to rescue. IBC is not the first act aimed to address bad debts malaise, there were few acts in the past like SIC Act, 1985, SARFAESI Act, 2002, but they failed to deliver to the expectations and most importantly, they failed to update with the changing needs of the economy. The aim of IBC is to bring all the existing insolvency laws under one roof and to provide easy and time-bound closure of the business. In the majority of developed countries, insolvency proceedings are professionally driven rather than by a court, and India has tried to bring insolvency laws in line with international standards by introducing IBC.

Without taking much of your time, I will try to brief you about how insolvency proceedings under IBC works.

On default of a loan, any creditor can apply for insolvency proceedings against the default of the credit facilities. On application, regulatory authorities will appoint Insolvent professional (IP) to look over the proceedings of the company’s day to day operations. Board of directors will be suspended for the insolvent company and IP will assume the duties of board of directors. A period of 180 days (which can be extended by another 90 days) will be given to company to come up with a resolution plan for the revival of the company. All the creditors to the subject company will form a credit committee to which the company has to present the resolution of revival. If the committee agrees with the revival plan with over 75% majority, company can go ahead with the implementation of the resolution plan. If credit committee still thinks revival plan is not achievable, they can recommend and go ahead with the liquidation proceedings. Yes, on paper, it’s as simple as it sounds.

Apart from the significantly lesser time it takes to arrive at closure/resolution, IBC is simple and intuitive as well. Apart from the direct benefits it offers in timely resolution of a troubled entity, it indirectly injects confidence amongst the lenders for fresh lending as they are vested with more powerful tools for recovery of bad loans from troubled entities. Executed rightly, it can be very powerful tool in shaping the future of this country and economy.