The Insolvency and Banking Code was brought in as a law in May 2016 to resolve cases of unpaid debts by companies. It allows creditors to initiate insolvency proceedings against defaulting companies so as to recover their money. The code was thought necessary because existing systems of dealing with insolvent companies had failed to deliver, with cases dragging on for years without result.

The code sets up an Insolvency and Bankruptcy Board of India to lay down the rules and regulations for two tribunals to oversee the proceedings. These tribunals – the National Company Law Tribunal and the National Company Law Appellate Tribunal – oversee the resolution of cases between creditors and debtors by insolvency professionals.

But a year after the board and the tribunals started functioning, some experts have grown wary. The resolution process is being carried out in secret even though, at times, it involves recovering vast sums of public money that banks have lent to private companies.

The Finance Research Group at the Indira Gandhi Institute of Development Research, Mumbai, has been trying to monitor insolvency proceedings for a year. Its research shows the tribunals sometimes work outside the remit of the law and that there is no regulation for mandatory disclosure or transparency norms to govern the tribunals or the resolution process.

Bhargavi Zaveri, senior research associate at the Indira Gandhi Institute of Development Research, explains to the rationale behind the code, and talks about his institute’s research and the importance of transparency.

Excerpts from the interview:

When you say you need data to monitor how the tribunals are living up to the original idea they were formed with, what you are really saying is we need transparency in how insolvency proceedings are being carried out?
Yes. We need transparency right from when a petition is filed before the National Company Law Tribunal to trigger the bankruptcy case up to the stage of resolution, so that one is able to figure out the recovery rates. If the company is liquidated, then we should be able to find out the liquidation value. This information is good for everyone in the economy. Basically, you need transparency of filing in courts and what is going on in the creditors’ committee meetings. In India, we have seen repeatedly that some class of creditor is preferred over others. The Amtek Auto bond default case was one such case that came out in the media. When the bond default happened, some bond holders were paid preferentially over other bond holders.

The idea is that there should be no back-door dealings. The debtor, the person who proposes the resolution plan, the people supposed to vote on it, the people who are affected by it but have not been given a voting right, all of them should know what is happening.

The last set of people is too disaggregated to be on the committee to decide a resolution and they generally do not have the wherewithal to decide how to restructure the company’s debt. For example, employees, vendors and contractors who are owed money by a company. It is important what is happening in the creditors’ committee is known to them. It is important especially in the case of a listed company that it is known to shareholders as well.

That transparency does not exist as of now?
Right now the creditors’ committee meetings are a bit of a black box.

You mean we do not know what is happening in these meetings and how companies’ debts are being restructured under these resolution plans?
We do not know. We do not have the minutes of these creditors’ committee meetings.

Are these meetings not being recorded or are the records not being made public?
They are not being made public. It is only when the National Company Law Tribunal asks for the minutes, then the public might get to see them. There is no statutory obligation in the law for these resolution plans to be made public or even to disclose the date of the meetings.

Bhargavi Zaveri.

But would that not militate against the need to maintain privacy regarding a company’s records?
There is a case to be made that the minutes would have information that is commercially sensitive and we should be able to balance the need to keep that bit confidential. Definitely. We can think of a solution that after the resolution process is over and a plan for restructuring the debt has been approved, the details are brought out. I cannot see a reason why a lot of it should not be made public.

What was the thought process of a creditors’ committee in choosing one resolution plan over three others? You can choose to redact the name of the parties, depending on what the commercially sensitive information is, and the insolvency professional can be tasked to make the call. There are ways to do so.

But the point is, every creditor should know what is happening. The operational creditors do not have a seat on the committee. How will they know what is happening to their money? Similarly, shareholders of listed companies must know what is happening to their value.

How important is transparency for the new regime to work well for everyone?
We need to see data about how a law is performing on an aggregate level. We cannot be making changes to laws on the basis of a one-off case. 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.

Insolvency databases are regularly maintained in the United States and the United Kingdom. They are easily searchable and you can find out what happened at the beginning of the case and what happened through the process or at the end – you will get all that data. It is amenable to research.

Transparency is essential for citizens to trust and understand what is happening. Research and analysis of the raw data, if made available, would help the public trust and understand the insolvency regime.

Your research shows there are more operational creditors such as vendors and employees and fewer financial creditors such as banks and other financial institutions taking companies to insolvency proceedings to recover their money, right?
If I am an operational creditor and someone defaults on my debt, what are my options? I can file for winding up of the company. For which, then, a High Court will serve a notice on the debtor and on all stakeholders and creditors to come and object – it is a long process. Research done by Aparna Ravi in 2015 showed that in 45 cases of companies being wound up, about 40% took five years to 10 years to wind up. So, operational creditors had no chance. The second option is arbitration, which can be expensive. The third option is to file a civil suit but slow court processes do not make this a good proposition. That is why the bankruptcy code, which threatens promoters with immediate dispossession of their company, is possibly becoming a recovery tool for operational creditors.

The big debate is that the code was not supposed to be a recovery tool. It was meant to allow companies to restructure their liabilities so that they come out as going concerns if the stress was temporary.

In time, we will hopefully see that before the application is made to the National Company Law Tribunal to trigger the bankruptcy code, companies will start settling their debts. In the first five months of this year, we saw two to three companies out of 110 settling their debts.

After insolvency proceedings began?
No, right after the petition was filed. There are 14 days for the National Company Law Tribunal to accept the petition. It is during this period that they negotiate and the guy pays up and they settle outside. By August-end, 25% of the cases were being settled in this manner in the 14-day window by debtors paying up and the petitions being withdrawn. Another 27% of the cases were also withdrawn, but I cannot tell you why because the court orders do not reflect the reasons for the withdrawal of the petition. Right now, there is a steady increase in operational creditors getting paid when they trigger bankruptcy proceedings.

Is it also that financial creditors such as banks are more compromised than operational creditors?
I think one reason could be that banks are typically secured creditors. If you are sitting on a security against the loan, you are more relaxed. It is easier for a bank to enforce the security under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act instead of getting every other creditor to the table and negotiating a restructuring.

Another reason is that until the ordinance amending the Banking Act was introduced in May, banks were hesitant to trigger the code. The bank management that decides on taking the defaulting debtor through the process would be held responsible for the haircut [the percentage of dues the bank forgives to recover a loan] should the outcome be challenged.

Could you explain how the ordinance made a difference?
The ordinance basically says that the Reserve Bank of India may direct banks to refer some defaulted loans to insolvency proceedings. These powers were there with the Reserve Bank but the ordinance spelt it out explicitly. The Reserve Bank has general powers to issue all kinds of directions to banks. This could arguably have been done under its existing powers. But the ordinance explicitly states that the powers include the power to trigger the bankruptcy code.

But isn’t that odd? The Reserve Bank, with its auditing and regulatory powers over banks, was to make sure banks do not see such large bad debts. In a sense, the regulator first failed to do its duty. Then the regulator took over the role of the executive to tell banks to clean up some accounts. In a way, it absolves the entire banking sector in cases where bad debts happened because debtors connived with the banks to flout due processes? There is no chance now that the banks and the Reserve Bank would be held accountable for their failure and malfeasance in cases that get referred for insolvency proceedings?
It is like the referee at a football match telling the players how to play.

The question is, how does the Reserve Bank settle on a criterion to take some debtors to bankruptcy proceedings and not others? This is the Reserve Bank taking a call after it has failed in exercising its auditing powers over the banks that have brought us to this place. The bankruptcy process lays no blame nor detects possible malfeasance, it ideally just wants to keep a company as a going concern, right?
I am not sure of the thought process underlying the directive.

Right, but there will be a certain number of cases where loans were given in violation of rules and regulations.
Yes, but I think that is a slightly separate point. We start touching upon wilful defaulters, where the banks decide which of the loan defaulters are wilful and which are not. That is a bit like being the judge of your own cause. It also creates opportunities for rent-seeking. But we do not want to go there. I think the Reserve Bank ordinance was just done so that the decisions are not left to the risk-averseness of bank managements. There is a lot of dilemma around this.

Your research shows the National Company Law Tribunal is taking decisions that go beyond its powers, like by dismissing cases at the application stage for reasons not permitted by the law.
The law allows the insolvency petition to be admitted the moment the creditor is able to show undisputed default and if the petition is complete. The law allows a petition to be dismissed only if it is not an operational creditor or a financial creditor, or the petition is incomplete or the default is genuinely disputed. But what we see is that the National Company Law Tribunal has some inherent powers as a quasi-judicial tribunal. We see that sometimes the National Company Law Tribunal has gone into the debtor’s balance sheet to evaluate whether the company can or cannot repay.

We saw a very odd ruling where the National Company Law Tribunal told a petitioner that the debtor has other receivables that it can recover money from and easily repay you, so why do you want to file a petition? We have orders of this kind. We have decisions where petitions have been allowed to be withdrawn even after the proceedings have been triggered.

Which is not allowed under the law? There were two cases where the Supreme Court said we are allowing the petition to be withdrawn, but these are exceptional cases and this cannot be used as a precedent.
Yes, that is right.

Yet, in some cases the National Company Law Tribunal has referenced these judgements of the Supreme Court to allow withdrawal of petitions after the proceedings have started?
Yes. But I must say in the first case, the National Company Law Tribunal got it right. When the petitioner asked for withdrawing the case after triggering insolvency proceedings, the National Company Law Tribunal said it had no power to allow it. Then the petitioner went to the appellate tribunal and it said the same thing. The petitioner went to the Supreme Court, which used its extraordinary powers under Article 142 of the Constitution to allow withdrawal of the case. The court said well, the debtor and the creditor are here before us and they want to settle, why should anyone have a problem with that?

What volume of debt has come in to the National Company Law Tribunal so far? And is there a pattern to the size of creditors coming to bankruptcy proceedings?
The threshold to file a petition is Rs 1 lakh and we have seen people with debt amounting to Rs 1.04 lakh also triggering it. So it is not skewed against small or big sized debt. With time, as we figure out the costs associated with resolution and the recovery rates, we may be able to quantify the size of debt for which it makes sense to take the pain to trigger insolvency proceedings instead of taking recourse to other recovery mechanisms. People have tried to trigger insolvency proceedings even with a Rs 35,000 debt being owed and have been rejected.

There have been reports about how some creditors had to take more than 90% haircuts on the money they were owed. Is the lack of transparency creating more scare about how the system is operating and also creating a chance of arbitrage and malfeasance within the bankruptcy processes?
I completely agree. How do you know that the bank has taken the haircut? For example, the Synergy Dooray case. It was before the Hyderabad bench of the National Company Law Tribunal. The case was pending before the Board for Industrial & Financial Reconstruction since 2005. In 2012, the board said the creditors will recover about 27% of their dues. Exim Bank, which was one of the creditors, said they were not happy with that. We are in 2017 today and the creditors have recovered 6% from it. The allegation is that the promoter indulged in wrongdoing to influence the decision and that the haircut was 94% and that is the best this process can do.

I think it is important to highlight how old the debt is. It is possible that the large proportion of the claims coming in the initial days of the Insolvency and Bankruptcy Code are actually debts that have been unpaid for a long time – or non-performing assets for a long time – so the recovery rates cannot be expected to be any better. What is the option? You go into liquidation and you find the recovery rate is even lower. Whenever I see this 6%, I ask myself how we know it is 6%.

The resolution plan deciding this is not public. No resolution plans are made public. It is just a claim.

Does the National Company Law Tribunal order not provide details of the resolution plans?
No. It can just pass an order saying the resolution plan has been accepted.

Is this a systematic weakness that there is no clear format for giving decisions, there are no mandatory disclosures along all the steps that are undertaken?
Yes. There are two ways of fixing it. I would like such things to be in the primary law but the other way is that the National Company Law Tribunal gets proactive and understands the importance of aggregate level data and the authorities dictate to the benches that when you pass orders, at least include these minimum details. In my opinion, a sanctioned resolution plan should be public. I am not sure what the big anxiety is about not making the resolution plans public.

Was it also contemplated that a high level of transparency should be maintained, it should be open and records should be put out through the proceedings?
Yes. Very implicitly but it was. For example, how will someone challenge the actions of an insolvency professional? One would have to file minutes of the meetings to show what went wrong. Otherwise, how will you prove one way or the other that a resolution plan went through due process? The minutes of the meetings will tell if 75% of the creditors – as required by law – voted in favour of a plan or not. Ideally, I would want details of the discussions that happened at the meeting.