Rising Haircuts: A Death Knell for IBC

Priyanshi Jain & Simran Lunagariya*

Introduction 

A competent insolvency procedure assists creditors and Corporate Debtors (“CD”) in recognizing whether the stressed company is approaching financial collapse and finding an amicable solution for the same. To this end, it is important that the insolvency procedure is prompt, efficient, and impartial. 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. 

Huge haircuts have been observed in a few insolvency cases in recent times. In the overall conundrum of haircuts, the hard-earned money of the ordinary bloke is being jeopardized. This is attributable to the fact that banks get their funds from the general public, whilst CDs obtain their funds from banks. While settling for very low recovery rates, the percentage of bad loans continues to grow without evidence of resolution/restructuring or even recovery. One of the major contributors to escalating haircuts is the provision of One Time Settlement (“OTS”) through withdrawal of Insolvency Process under section 12A IBC. 

In this post, we will examine if growing haircuts contribute to the Code’s failure to achieve its goals. To begin, we will explore the factors that have significantly contributed to increasing haircuts in relation to section 12A. Second, we want to emphasize the negative repercussions of growing haircuts. Lastly, we will discuss possible solutions to the problem.

Unwrapping the Conundrum Around Increasing Haircut

Despite the fact that IBC aims to achieve through prompt, efficient and impartial restructuring/resolution, there exists significant contrast between the objectives and current happenings because of increasing haircuts. This is due to following reasons:

• Has Section 12A Failed to Walk the Talk?

Section 12A of the Code states that; if 90% of the Committee of Creditors (“CoC”) collectively agree to withdraw  Resolution Plan for an OTS, then such application is approved. This section is often abused by the CoCs to bargain for OTS at a significant haircut in order to get earnest money even after the CoCs have given their assent for the resolution plan. 

The CoCs often vote for the withdrawal applications in the greed of earnest money without considering the objective of the revival of the company.  Additionally, the law is not equipped to allow liquidation after the withdrawal. Since a lot of time is employed in the resolution process. 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. 

Furthermore, 12A authorizes Adjudicating Authority (“AA”) to allow for withdrawal applications after 90% of Creditors have given their assent. In the majority of the cases, the AA “may” allow for withdrawal application have been outcasted because the CoCs approval has been given paramount importance. 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. Furthermore, the bench clarified that withdrawal application under section 12A cannot be made in case of ambiguous terms of settlement on the part of CoC. Hence, this alludes to the need of conducting an evaluation of the CoC’s judgment and responsibility in deciding on OTS by AA.

• The ‘Infallible’ Commercial Wisdom of CoC – An Irony

The Supreme Court in various cases has affirmed that the commercial wisdom of CoC cannot be questioned. 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 as the applicant was paying almost not even close to the liquidation value. The creditors often vote for the withdrawal applications in the greed of earnest money without considering the objective of the revival of the company. A question that remains unvoiced is whether the CoC is competent enough to understand the nitty-gritty of the resolution process. 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 commercial wisdom of CoC to judge whether the revival has taken place or not. 

Moreover, absolute independence has been given by courts to the commercial wisdom of creditors. This has created an “overwhelming effect” on other objectives including value maximization of assets and time-bound resolution process. The prevailing circumstances have proved to be reducing the probabilities of the revival of the stressed company. It is pertinent to consider that the role of the CoCs is very crucial in the entire insolvency process. In recent times, the creditors have lost reasonableness in handling their responsibilities when ordinary people are trying it difficult to make ends meet.

• Lack of Competence of New RPs vis-à-vis Valuation of Assets

The court has often granted stay orders which delay the timeline for the time-bound resolution process. As a result, the CD’s value also decreases with an increase in time, emanating huge haircuts. Additionally, the unfair valuation of the assets of CD by the resolution applicant in the resolution process is leading to the erosion of the value of a CD in terms of time and preservation of assets. This effect can be attributed to the negligence and lack of knowledge on the part of new Resolution Professionals (“RP”). When graduates are hired as RPs, their competency remains questioned when the stressed company, involving complex processes undergoes the CIRP and it is also seen that as per a report, disciplinary action has been taken against 123 RPs out of 203 inspections so far. When the old RPs are stumbling hard to serve best then in such a case it becomes trickier for new RPs.

As a result, huge haircuts and fraudulent promoters are encouraged, defeating the value maximization aspect. Therefore, ensuring the effectiveness of the already delayed resolution process with huge, entangled debts is not an easy task for RPs who are new to the game. 

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. The terminology used in section 12A clearly iterates that the application is subject to approval by AA but since the CoC’s commercial wisdom cannot be second-guessed, the AA gets compelled to approve the application if the said criteria of 90% approval have been fulfilled. This creates a dichotomy in the functioning of AA.  Therefore, the AA must be diligent enough to exercise their discretionary power whenever the autonomy of CoC is overpowering the interests of the revival of CD’s company and reject the withdrawal application accordingly. Moreover, such an exercise of power under section 12A shall not be construed as against the commercial wisdom of CoC but interpreted harmoniously in order to achieve the greater motive of enacting IBC i.e., maximization of value and time-bound resolution process.

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, scrutinizing the intention, objective, and transparency of decision making of CoC. The code was created to protect CoC’s commercial wisdom vastly.  However, the evident inaccuracies in the recovery rate show that tougher rules are required. Thus, assuring the relevance of CoCs’ activities is crucial for safeguarding the interests of other stakeholders and the general public. Secondly, present ethical standards are insufficient to serve as a guiding light for the CoC, a standard guideline for ethics must be constructed for the CoC for reference while performing their duties. A three-pronged approach adopted by IL & FS that laid emphasis on resolution, restructuring, and recovery clearly justifies what all a CD undergoing CIRP could achieve when credible people are in charge. 

3. The CIRP comes up with many riders and knowing all the technicalities that go behind conducting 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.

   
   

Conclusion

The IBC came into being as a result of the aftermath of the financial crisis of sick companies, but the abysmal huge haircuts have shown that the efficacy of the Code is failing. It is crystal clear that Section 12A, the ‘infallible’ wisdom of CoC’s 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 has always been the paramount objective. Therefore, the CoC as well as all the other stakeholders should channel their individual goals towards the resolution of the company. Secondly, since time has always been the essence of the resolution process, it should always be time-bound because “delayed revival is denied revival”.  

*The authors are students at Institute of Law, Nirma University pursuing B.Com LL.B (Hons.)