Shun rhetoric, appreciate IBC problem

The IBC ordinance is another example of attempting to write a law to solve a problem that is not properly defined at the threshold

The debate over the presidential ordinance amending the Insolvency and Bankruptcy Code, 2016, (IBC) to insert disqualifications of potential participants in the resolution process of an insolvent has become bipolar and divisive. Television channels are going breathless airing alternative views on alternate days. Columns (including in this paper) have attributed motives and sought to call out “canards” — a classic “Hinduho-ke-Musalmaan” type of zeal seen only in “holy wars” claiming righteousness.

 

The very nature of this fight makes it evident that the ordinance is good politics. However, in the process, the sweep of the real problem posed by the ordinance, runs the risk of remaining unaddressed, thereby risking the very effectiveness of the IBC.

 

The disqualifications introduced should first be noticed. The ordinance lists various categories of persons who would stand disqualified from participating in any resolution plan for any insolvent under the IBC.  Any promoter of such disqualified person, and indeed any “connected person” with such disqualified person also stands disqualified. The term “connected person” includes all “related parties” and “associates” of the disqualified person. In other words, once any person is disqualified, the scope and sweep of the disqualification is wide and expansive.

 

Now, three categories of disqualifications in the list, clearly are amenable to the charge of not having been thought through, and will truly have mindless and unintended consequences.

 

First: the disqualification of any borrower that has been classified as a “non-performing asset” and has stayed in that status for over a year. At first blush, this would appear logical — obviously an entity that is unable pay its own debts cannot be involved in resolving the problems for any other insolvent. However, every “connected person” i.e. every “related party” of such entity and every associate too would automatically stand disqualified.

 

The term “related party” under the IBC is wide — for example, any company with common shareholding of just 2 per cent would be a related party. The term “associate” would be even more problematic — but the minute detail is not necessary to make this point in this column. Therefore, if a business goes bust for any reason whatsoever, every promoter of that business, and every related party and associate can never participate in any resolution plan for any other insolvent under the IBC. It is not even the case that only the participation of such related persons in the resolution of that disqualified person would be barred. Every resolution of every other insolvent under the IBC would also be barred.  This is extreme, an unreasonable restriction, and can substantially wipe out the supply of authors of resolution plans.

 

Second: the disqualification of any guarantor of any debt owed by any insolvent under the IBC. This is an inexplicable disqualification. A guarantor of a company’s debt is someone who believed in that debtor and agreed to guarantee that debtor’s promise. When a resolution plan is sought to be made, the guarantor would have skin in the game because it is his neck on the line.  While keeping out such a person from the resolution of the debtor is itself questionable, keeping out such a person and every person connected with him from every other resolution plan for every other insolvent under the IBC is not even intelligible.

 

Third: the disqualification of any person (and indeed, of every connected person, related party and associate of such person) to whom the capital market regulator may have issued directions not to deal in securities or access the securities market. No time frame of the period of prohibition on dealing in securities is set out. The capital market regulator is known to have been trigger-happy in the past, issuing such directions even on an “ex parte” basis (without a hearing). There is no settled science or rationale for the choice of the length of the directions in the law.  Courts disturb or uphold such directions on the basis of the human judgement of nature of the facts in the cases before them. This disqualification would remove from the resolution market for all insolvents, a wide range of persons for no plausible, objective or intelligible rationale.
Worse, the same principles of exclusion from the market, would apply to any affiliate outside India.  This would wipe out from the resolution market almost every single multinational company that has an interest in India.  If any person anywhere in the world has ever become insolvent, or has become a non-performing asset or has been issued any direction not to deal in securities. all affiliates of that person all over the world would be ineligible to participate in a resolution plan in India under the IBC.

 

One can go on to other disqualifications too — for example: the disqualification upon conviction with an imprisonment term for a period of two years, without regard to what the conviction was for. So, if one family member has had an unfortunate tragic criminal conviction, every relative and every “connected person” would be banned from participating in any resolution plan for any insolvent. However, the three examples above would suffice to show how the public debate is wrongly focussed on “good vs. evil” terms — without nuance, and with deployment of blunt weapons rather than sharp instruments.

 

The IBC ordinance is another example of attempting to write a law to solve a problem that is not properly defined at the threshold. If the problem sought to be solved was to keep out those responsible for the cause of an insolvency from the resolution of that insolvent, the ordinance as promulgated is not the solution.
The very concept of identifying persons responsible for causing insolvency is very difficult to define in a one-size-fits-all manner.  The ordinance has demonized the occurrence of insolvency instead of recognizing that business failure is a part of life.  Every star investor and global business would have insolvents among their related parties.
This is why the IBC clearly envisages a role for professional resolution professionals and bankruptcy professionals.  It is for these professionals to oversee a resolution plan for insolvent companies. A committee of financial creditors has to approve the resolution plan. It is open to the resolution professional and the financial creditors to weed out misfits from participation. If a resolution professional does not perform well, she is subject to regulatory intervention from the Insolvency and Bankruptcy Board of India, the regulator of these professionals. Instead of studying if this profession performs properly, the ordinance has put the very efficacy of IBC at risk, with an air of misplaced righteousness. It is time to cut out the noise and focus on the gravity of the problem.

 

A substantial part of this piece was published as the Without Contempt column in the Business Standard editions dated November 29, 2017

2 thoughts on “Shun rhetoric, appreciate IBC problem”

  1. Dear Sir,

    My question is in relation to defining the problem at the threshold. You correctly the mentioned that the problem remains unresolved if the threshold is – keeping the concerned debtor out of his own resolution process.

    But it seems to me that this threshold would leave open the possibility of debtors acquiring assets of other insolvents at cheap prices. The nature of the assets change but the problem of acquiring assets at cheap prices (even if they had been participating in their own resolution) would remain intact. (which is what the government seems to want to tackle)

    But, admittedly, this approach leaves out a huge number of potential solution- providers out of the process. So is there a possibility of treading a middle path? One approach could be identifying the debtors who went insolvent because of reasons having nothing to with the business cycle or other economic factors and excluding them from participation while including the others. The problem of associates and RPs indirectly working for the insolvent debtor would still remain (which is also one of the problem that government seems to want to address) but then this would be easier to sell for the government, from the point of view of political optics. What do you think?

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