India’s new insolvency and bankruptcy regime has been functioning for a year without any disclosure norms or mandatory transparency regulations. In the first year of its application, the regime is already dealing with more than 450 cases that add up to thousands of crores of rupees of unsettled debts. Neither the details of the cases being dealt with nor the deliberations over the case by creditors behind closed doors nor the final decision of either resolution or liquidation are being put out in public.

This has led to rumours and controversies about the decisions being taken by the tribunals set up under the regime, as well as the deep discounts banks and other financial lenders have had to take to settle their debts.

The new insolvency regime was set in place in May 2016 with the passing of the Insolvency and Banking Code by Parliament. The law set in place a time-bound mechanism supervised and adjudicated by the National Company Law Tribunal and the National Company Law Appellate Tribunal to resolve cases of unpaid debts by companies. It set up the Insolvency and Bankruptcy Board to set the ground rules for the resolution of bad debts.

Companies with unpaid debts have three options once a creditor triggers a case against them under the insolvency process. They can mutually settle the debt with the applicant within 14 days of an application being filed. But once the application is admitted, the company has to face all its creditors who mutually agree to a resolution plan that can keep the company running and repay its debts. This is called the resolution process for which other entities can make bids to buy stakes in the company under scrutiny. If in 270 days a resolution plan cannot be mutually drawn up, the indebted company is liquidated, and whatever money that is recovered from selling it is then distributed to its creditors. In either of the cases the creditors have to take a hit (called a haircut in the financial world’s parlance) and recover only part of their dues.

But researchers and experts monitoring the tribunals and the insolvency process have found it to be working under a shroud of opaqueness – information regarding most of the steps of the process is not put out, even after the process has been completed.

“At the moment we do not come to know how one resolution plan has been chosen over the other, or how creditors decided to go for liquidation instead of other alternatives,” said Bhargavi Zaveri, senior research associate at the Indira Gandhi Institute of Development Research. “We do not know who has proposed resolution alternatives, what is the recovery rate or how is it computed. We have to rely on media articles, or glean through the fineprint of orders of the tribunals and dig whatever information we can from them. Those too are not standardised and often do not reveal the relevant information.”

No transparency, no trust?

The lack of transparency is disquieting for three key reasons. The decisions on how to handle insolvency or bankruptcy of an indebted company are taken by only financial creditors – banks and other financial institutions who have given loans to the company. The other creditors – known as operational creditors – can trigger the insolvency process but are not seated at the negotiations with the debtors when it is decided how the companies shall repay their debts in the future or be sold as bankrupt to recover their leftover value.

Second, shareholders of listed companies, employees of the debtors and other stakeholders under the insolvency process also do not come to know of how creditors have taken decisions that impact their investments and future relations with the company.

Zaveri pointed to another important need for transparency. “We need to see data on how a law is performing at an aggregate level,” Zaveri said. “We cannot be making changes to law on a one-off case that maybe an outlier. We need to see trends. For that transparency from the courts and from the resolution process is absolutely essential. We can debate the level of transparency depending on the commercial considerations but if we all agree on the principle then those debates get easier.”

One recent reaction from the government on a one-off case was when the government passed an ordinance barring a certain category of promoters, such as wilful defaulters of bank loans, from bidding for their own companies under the resolution process. This happened as news emerged that the Essar Group had put a bid to buy out Essar Steel through the resolution process.

This, some experts warned, would cause a moral hazard with promoters able to buy back their companies cleansed of the debt. But others, such as Zaveri, warn that barring certain category of promoters from bidding would bring down the bid values for the indebted company. Promoters have the best sense of their company’s working, some experts point out.

At the moment, all the changes the government makes or contemplates, or what the media reacts to, is based on hearsay as no information on the insolvency process exists in the public domain officially. Citizens at large have no way to know or corroborate the claims made by either the media, the government or other experts who have privileged access to the resolution process and corridors of the tribunals.

For the public at large, transparency leads to trust in the new regime that is going to decide upon large sums of public money – money that companies owe to public sector banks but have failed to pay back. These are called Non-Performing Assets of the banks.

Just the first 12 defaulting companies that the Reserve Bank of India forced banks to take to the insolvency process add up to 25% of the total bad loans of public sector banks. Some experts peg the amount at Rs 1.9 lakh crore. This is just the tip of the iceberg. The RBI has finalised another list of 26 companies that could likely go through the insolvency process.

(Photo credit: AFP).

RBI opaque too

What adds to the opaqueness around the bad loans of public sector banks is that the RBI too does not share information on how it selects accounts to go under insolvency proceedings. After selecting the second set of companies for debt resolution, it recently gave them more time to first deal directly with their lending banks. But it did not give this option to the first 12 big defaulting companies, leading to charges of arbitrary decision-making and discretion.

When asked about the need for transparency, a senior official of the Insolvency and Bankruptcy Board of India said: “Nobody can have a different view on transparency. [This is the] first time we are doing this. When we began we did not even know on what parameters transparency would be required. We are working on it. It will take time.”

When asked if the board was working against a deadline to enforce transparency through the insolvency process, he said, “I can only say that I do not want to make the ‘best’ the enemy of the ‘good’. There is an approach in that direction. I cannot say that there is a timeline but I can tell you it shall happen sooner rather than later, like it has happened with the entire process.”

The bankruptcy proceedings in other countries are easy to analyse with public databases available on each case.

What we know so far

In the meanwhile, the research team that Zaveri is part of at the Indira Gandhi Institute of Development Research has tried to dig out whatever information it could from the orders of the tribunals so far to find trends. It studied 515 final orders from 10 benches of the tribunals between December 2016 and August 31. The results were presented at the Law and Economics Policy Conference organised in Delhi recently by the National Institute of Public Finance and Policy. They show that in some cases the tribunals have gone beyond the powers the law provides to dismiss petitions for insolvency instead of admitting them. In one such case the tribunal inspected the accounts of a company to suggest that the company was in good health and could easily repay the creditor later – a role the tribunal is not empowered to undertake. The law says that if the petition is complete and there is an undisputed default in repayment of the debt, the petition must be admitted.

The study brought out other insightful information on trends. Out of the 515 cases studied, the researchers found 267 had been filed by operational creditors such as vendors and employees, and only 123 by banks and other financial creditors . One possible reason for this may be the availability of other options with banks and financial institutions to recover money against secured assets from companies that have defaulted.

Out of the 267 cases filed by operational creditors, 133 were by vendors of the defaulting companies who had not been paid. Fifteen employees who had not been paid their salaries too had approached the tribunals for insolvency. Applicants with dues close to the lower limit of Rs 1 lakh had also dragged companies to the proceedings to recover their money.

Out of the 515 applications filed before the tribunal, 223 had been admitted for resolution or bankruptcy proceedings while the rest had been dismissed on different grounds including some for reasons not permitted by law.

The research also found that in some cases the tribunal had allowed applicants (creditors) and debtors to withdraw the case midway between proceedings even though the law does not permit this to protect the rights of all other creditors. The tribunals cited two Supreme Court orders while doing so even though the apex court had used its extraordinary powers under the Constitution to allow the withdrawal of cases, and had stated that their orders were not to be used as a precedent in other cases.

The lack of transparency around the cases denied researchers the opportunity to understand how the settlements or decisions were being reached within the insolvency process and how decisions were being taken by the committee of creditors that decides these resolution plans by a 75% vote.

Risking complications

“The corporate insolvency regime is one of the three parts of the unfolding Indian exit framework,” said Ajay Shah, professor at the National Institute of Public Finance and Policy. “It is the first time that the divine privilege of the promoter has been done away with. It reaffirms that the ownership of equity has a responsibility. Equity ownership is not ownership of the company: it is a contract with debt. When equity fails to perform on its contract with debt, equity holders are pushed aside.”

He was referring to how in India, traditionally, promoters who set up companies with initial equity tend to control the companies even if they default on their obligations to banks and others who lend money for the entity. The insolvency code, by setting a time-bound threat of removing defaulting promoters, increases the chances of them either repaying their debts or being ejected even as the company continues to operate.

But he warned that the new system was going to be tested with the RBI bringing the 12 biggest cases of corporate bad loans to the insolvency process when the code is still picking pace and had not reached, what he called, “a steady state”.

“Ideally, we should learn to walk before we run,” said Shah. “The outcomes of these cases will be messy as the big companies will bring in their high-powered lawyers and could go to the court against the procedural weaknesses that are yet to be set in place.”

The absence of regulations for the mandatory disclosure of the proceedings of the insolvency process would not perhaps bother the 12 major defaulting companies, but it will prevent citizens from knowing how decisions are taken to recover the public money that public sector banks lent to the defaulting companies in these and other cases that are going to pile up in the insolvency pipeline in the future.

The 14-member Insolvency Law Committee set up by the government, chaired by the corporate affairs secretary, has been formed to bring changes to the insolvency code. It has invited inputs from all stakeholders. But, as of now, officials in the insolvency board, admit that baking transparency and disclosure norms into the process is not high on the government’s priorities.