Escalating Haircuts: Turning the Clock Backwards for IBC ?

Introduction

A competent insolvency procedure assists creditors and corporate debtors in recognizing whether the firm is approaching financial collapse and subsequently reaching an amicable solution for the identified issues. It is critical to include provisions requiring prompt, efficient, and impartial resolution of insolvency as the primary purpose of any insolvency law. In the Indian setting, the Insolvency and Bankruptcy Code, 2016 (“IBC”) is still attempting to achieve harmony between the aforementioned features, especially securing good recovery rates. Owing to this endeavor, huge haircuts have been observed in few insolvency cases in recent times.

The Committee of Creditors (“CoC”), Resolution Professionals (“RPs”), and the Adjudicating Authority (“AA”) play a pivotal role in the prevailing issue. More precisely, the CoC have entire control over the operation of the corporate debtor, and may make critical decisions and formulate resolution options. However, their main focus is to initiate the settlement process; the RP’s principal function is to secure corporate debtor regeneration; AA’s principal function is to resolve bankruptcy or liquidation cases initiated by corporate debtors. Predominantly, their segregated autonomies have played a prejudicial role at various instances of haircuts, be it the approval of resolution plan or negotiating for One Time Settlement (“OTS”) through withdrawal of Insolvency Process under Section 12 of the Code. Furthermore, the unregulated autonomy of the CoC has created greater levels of uncertainty in achieving the objective of the Code. The primary object of the Code comprises the restructuring/resolution of the corporate debtor and not liquidation.

This blog is juxtaposing the position of IBC across the constantly declining recovery rates for creditors. A special emphasis has been given to the causes and effects of increasing haircuts vis-a-vis the shortfalls in achieving the objectives of the Code. Finally, the blog focuses upon the various approaches that can be used to achieve the Code’s goal.

The trigger points of increasing haircuts

There exists significant contrast in the objectives and current happenings because of increasing haircuts, owing to the following reasons:

  1. Section 12A of the Code kindles an interesting controversy. It provides for the withdrawal of an application after the admission of a settlement plan, if 90 percent of the CoC agrees. A little tweak by the promoter to negotiate for OTS at a huge haircut (even after the resolution plan is approved by CoC) is diluting one of the most important objectives of the Code i.e., time-bound resolution process. Additionally, the AA must not be obligated to approve the withdrawal of application, since Section 12A uses “may” and not “shall”. Providing a glimmer of optimism, recently the NCLT (Chennai Bench) rejected the Siva Industries’ settlement offer citing it as a “business restructuring plan”. Furthermore, the bench clarified that a withdrawal application under Section 12A cannot be made in case of ambiguous terms of settlement on the part of CoC, hence, hinting towards the lack of conscience and responsibility on the part of CoC.
  2. The Supreme Court in various cases has affirmed that the commercial wisdom of CoC cannot be questioned. But the question which remains unanswered is whether the CoC is competent enough to understand the nitty-gritty of the resolution process. In the case of Videocon Industries Limited, the successful resolution applicant decided to pay at a haircut of 99.28%. The NCLT Mumbai was distressed by the above situation as the applicant was paying not even close to the liquidation value. Therefore, whenever there is high slippage in debt recovery rate, yielding huge haircuts, the court is not sufficiently empowered to draw a red line between judicial wisdom and the commercial wisdom of the CoC, so as to judge whether the revival has taken place or not.
  3. Since the inception of the Code, the court has often granted stay orders which delay the timeline for time-bound resolution process. As a result, the Corporate Debtor’s value also decreases with an increase in time, emanating huge haircuts. Subsequently, this demands a more proactive approach as the debts of the Corporate Debtor are already riddled with ambiguity. Therefore, ensuring effectiveness of the already delayed resolution process with huge, entangled debts is not an easy task for RPs who are new to the game.

Consequences of increasing haircut

The absolute independence given by courts to the commercial wisdom of creditors has created an “overwhelming effect” on other objectives, including value maximization of assets and time-bound resolution process. The commercial wisdom of creditors entailed in the code aims to formulate efficient means of recovery, promote greater interest in the development of debtors, benefit stakeholders, promote entrepreneurship, and generate better economic conditions in the market. However, the prevailing circumstances have proved to be reducing the probabilities of revival of the stressed company. It is pertinent to consider that the role of the committee of creditors is very crucial in the entire insolvency process. In recent times, the creditors have lost reasonableness in handling their responsibilities.

While considering the OTS, the creditors are often seen voting for the withdrawal applications in the greed of upfront cash without considering the objective of revival of the company. Moreover, the law is not equipped to allow liquidation after the withdrawal. Also, such conduct is unjustified because a lot of time is employed in the resolution process when the creditors concur for OTS under the aegis of Section 12A at huge haircuts.

Similarly, the unfair valuation of the assets of the corporate debtor by the resolution applicant is leading to the erosion of value of the corporate debtor, in terms of time and preservation of assets. This effect can be attributed to the negligence and lack of knowledge on the part of RP. Consequently, huge haircuts and fraudulent promoters are encouraged, defeating the value maximization aspect.

The haircuts have led AA to just serve as a welcoming forum susceptible to every decision of the CoC, since they are unable to exercise their power to evaluate the compatibility of settlement plan with the Code. However, NCLT’s outlook in the case of Siva Industries has proved that every cloud has a silver lining. In this case, AA interrupted the autonomy of CoC in order to promote the overall objective of IBC.

In the entire dilemma of haircuts, the hard-earned money of the common man is being compromised. This is because the banks generate funds from the common man and certain creditors borrow funds from banks. While settling for very low recovery rates, the proportion of Bad Loans is increasing and no mark of resolution/restructuring or even recovery is being observed.

Potential considerations

Having stated all the above issues that arise with increasing haircuts, the recent trends suggest that huge haircuts are dampening the interests of all stakeholders. In that regard, few recommendations would include:

  1. Invocation of Section 12A would be justified only in the case where CoC is able to secure a better deal than the CD undergoing insolvency. When huge haircuts are observed in OTS, the relevance of 12A gets questioned. In Swiss Ribbons Pvt. Ltd. v UOI, the apex court clarified that regulation 30(A) read with section 12A is directory and not regulatory. Hence, only in exceptional circumstances, the application should be allowed to be withdrawn. This subjectivity of exceptional circumstances has often motivated the CD to delay the insolvency proceedings by invoking section 12A (for OTS) of the Code, hence, disturbing the entire motive of time bound resolution and defeating all the time/effort invested by CoC. In such a situation, AA must be empowered to comprehensively consider the relevance of time-bound resolution as well as exceptional circumstances, and identify the minimum criteria which are compulsory for withdrawal application so as to foster timely and fair disposal of the matter.
  2. At the outset of the Code, it has been iterated that the commercial wisdom of CoC brooks no interference. However, the code of conduct of CoC is a major challenge. Hence, two steps should be taken care of i.e., firstly, scrutinization of collective educational qualification of CoC. The code was created to protect CoC’s commercial wisdom vastly.  However, the evident inaccuracies in the recovery rate shows that tougher rules are required. Therefore, ensuring qualification of CoC is critical to safeguard other stakeholders’ and the public’s interests. In the end, financial creditors like banks take massive losses on the hard-earned money of ordinary people. And secondly, check their (CoC’s) understanding of the fundamental principles of the Code to ensure transparency in the resolution process. A three–pronged approach adopted by IL & FS that laid emphasis on resolution, restructuring, and recovery clearly justifies what all a Corporate Debtor undergoing CIRP could achieve when credible people are in charge.
  3. The CIRP comes up with many riders and understanding all the technicalities that go behind conducting a CIRP may not be feasible for early starters. The Insolvency Professional Agencies governing the RPs are identical in nature, in terms of the eligibility criteria and ensuring code of conduct of the RPs. A distinctive self-regulatory body for RPs is needed to go beyond the existing legal framework to independently vouch for RP’s actions, foster competition and create stricter norms for non-compliance.
  4. Section 238 of the Code gives an over-riding effect to the provisions of the Code (over other laws). Had the Securities and Exchange Board of India (“SEBI”) Act been applicable, then it would have delisted the already indebted companies and prevented the CoC from massive lending. Abstracting from a larger picture, a balance must be stricken between both the laws to protect the interest of all the stakeholders.

Conclusion

The IBC came into being as a result of the aftermath of the financial crisis of sick companies, but the huge haircuts have shown that the efficacy of the Code is falling. It is crystal clear that Section 12A, the ‘infallible’ wisdom of the CoC and the conduct of RP’s, etc. all have contributed to undermining the real intent behind the Code. The SICA did not live up to its mark because it could not resolve the sick companies with speedy recoveries. The IBC’s fate is also looming over along the same lines. The day is not far off when the Code of 2016 will also fail, if the long-overdue steps are not taken. A mechanism that can vouch for the actions of all the stakeholders to conduct the resolution process transparently and without any delays is the need of the hour. In a nutshell, it should be ensured firstly, that the resolution of a sick company should always be the paramount objective. Therefore, the CoC as well as all the other stakeholders should channelize their individual goals towards the resolution of the company. Secondly, the resolution process should always be time-bound, because “delayed revival is denied revival”.

(This post has been authored by Priyanshi Jain and Simran Lunagariya, IV Year B.Com LL.B (Hons.) students at Institute of Law, Nirma University.)

Cite As:Priyanshi Jain and Simran Lunagariya, ‘Escalating Haircuts: Turning the Clock Backwards for IBC?’ (The Contemporary Law Forum, 12 January 2021) <https://tclf.in/2022/01/12/escalating-haircuts-turning-the-clock-backwards-for-ibc/> date of access. 

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