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April 30, 2017

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New Insolvency Code Can Boost Transparency & Investigation


- Michael Harrington, Director [ Mintz Group ]
- Saranya Kapur, investigator [ Mintz Group ]

The recent push towards demonetization by the current administration, in conjunction with the code, could reduce cash transactions and help create a paper trail of cash flows, which could further help identify bad debtors


On January 19, 2017, after nearly four years of legal maneuvering, a Bengaluru tribunal finally allowed a consortium of lenders to start the process of recovering more than $910 million from embattled airlines and liquor baron Vijay Mallya. Mallya, a flamboyant millionaire from whom India’s largest financial institutions have been attempting to recover nearly $1.3 billion in debts, has had recovery proceedings pending against him in tribunals in Goa and Pune since 2013, and more than 500 hearings have been held in his case since then. India’s arcane and fragmented insolvency resolution system, along with a lack of transparency, have been to blame.

In May 2016, however, the country took a significant step toward fixing its bankruptcy laws. The introduction of India’s new insolvency code, passed into law by both houses of parliament last year, was cheered by investors and the business community. The code has the potential to increase transparency and confidence in India’s capital markets. It could also create opportunities to reduce information asymmetry in debt markets, potentially allowing creditors to conduct extensive due diligence into debtors prior to debt being issued as well as in-depth investigations into potential fraud after insolvency has been declared. But while the code is a step in the right direction, its full impact will not be known until details on its implementation are fully understood.

“While the code is a big step in the right direction, its impact will be measured by how it is implemented”

Inefficiencies in India’s Insolvency Resolution Systems


While the past 30 years have seen rapid growth in India’s GDP as it has liberalized and modernized its economy, its insolvency resolution process leaves much to be desired. World Bank statistics rank India 136th on its resolving insolvency ranking, much lower than its fellow BRICS countries, including Brazil, China, Russia and South Africa, which rank 67th, 53rd, 51st and 50th, respectively. It currently takes a whopping 4.3 years, on average, to resolve insolvency in India, and recoveries from insolvency proceedings are a meager 26 cents on the dollar. In comparison, China’s insolvencies are resolved in 1.7 years, and recoveries are higher than India’s, at 36.9 cents on the dollar.

Prior to the 2016 code, India did not have a single bankruptcy law, operating instead on a patchwork of different laws, including the Companies Act of 2013, the Companies Act of 1956, and Sick Industrial Companies Act of 1956 that governed insolvency, restructuring, liquidation and asset recovery. This fragmentation of laws, combined with multiple adjudication forums, created backlogs and long delays in resolution. As of October 2015, nearly 1,500 companies had been pending liquidation for more than 20 years, according to a report by the Joint Committee on the Insolvency and Bankruptcy Code.

Further, gross non-performing assets on commercial banks’ balance sheets have been steadily climbing over the past years. As of September 2016, commercial banks’ gross nonperforming assets climbed to 9.1 percent of total advances, according to the Reserve Bank of India’s December 2016 Financial Stability Report. This increase in NPAs has had implications on the country’s credit markets, impacting banks’ cash flows and their willingness to lend.

This lack of institutional support for creditors, as well as the rise in non-performing debt, has lessened India Inc.’s image in the eyes of foreign investors, increasing India’s risk perception in the eyes of the world and hurting Indian companies’ ability to raise capital internationally.

The Insolvency and Bankruptcy Code, 2016


Perhaps most importantly, the Insolvency and Bankruptcy Code of 2016 creates time-bound processes for insolvency resolution, requiring these processes to be completed within 180 days, with the option of extending this period to 270 days in certain circumstances. If a plan cannot be agreed upon during this period, the assets of the debtor will be sold to repay all outstanding debts.

The code establishes a regulatory body, the Insolvency and Bankruptcy Board of India (IBBI), tasked with regulating a newly created group of licensed insolvency professionals, who will administer insolvency cases. These insolvency professionals will be licensed by insolvency professional agencies, which will conduct examinations for their licenses and enforce a code of conduct. Insolvency resolution for companies will come under the ambit of a National Company Law Tribunal, while individual insolvency will come under the jurisdiction of a Debt Recovery Tribunal. Information utilities will be established to collect, collate and disseminate financial information to facilitate insolvency resolution.

In cases where an insolvent debtor has assets abroad, the code empowers the Central government to enter into agreements with other countries to enforce provisions of the code.

Greater Scope for Due Diligence and Investigations


Currently, there is a lack of information on borrowers’ track records, causing difficulty when assessing their creditworthiness at the time of a loan being given. While certain regulatory checks are available, such as the Reserve Bank of India’s defaulters’ list, information provided by the Ministry of Corporate Affairs and CIBIL credit reports, these are often not enough.

The new code could change this. The code provides for the establishment of “information utilities,” whose primary function is to “provide high-quality, authenticated information about debts and defaults,” and resolve “information asymmetry” in India’s debt markets, according to a January 2017 report by the Working Group on Information Utilities, commissioned by the IBBI. According to this report, these information utilities were envisaged as entities that would “capture a comprehensive picture of the financial liabilities of all entities.” Some of this data, particularly for publicly listed companies, would be made available in the public domain, while data on unlisted entities could be made available in more limited circumstances, with the entity’s consent. The bankruptcy code, however, has not specified these disclosure norms, and their implementation has been left to the regulator.

Over time, the information collected by these information utilities could prove to be a valuable data source while conducting due diligence. Investors could have a way to verify borrowers’ financial standing through an independent third party source prior to making investments. During insolvency or bankruptcy proceedings, creditors could have a clear picture of the insolvent entity’s liabilities and the scope of possible asset recoveries. This information could also be a valuable source of information for civil or criminal litigation, and it could help provide an understanding of a litigant’s assets and financial predicament.

In general, the code could also create opportunities for fraud investigations surrounding insolvencies. The renewed focus on transparency would facilitate investigations conducted in conjunction with creditors or bankruptcy trustees to identify cases of fraud or embezzlement, or help trace assets that may be hidden domestically or in foreign jurisdictions. Insolvency professionals would have access to a company’s books and records, which could provide powerful investigative leads to trace hidden assets.

The recent push towards demonetization by the current administration, in conjunction with the code, could reduce cash transactions and help create a paper trail of cash flows that which could further help identify bad debtors.

Challenges


While the code is a big step in the right direction, its impact will be measured by how it is implemented. According to some estimates, there were approximately 62,000 cases pending with debt recovery tribunals as of 2014. A massive increase in infrastructure will be required to adequately dispose the currently pending cases while also handling new cases. Similarly, while the creation of a new industry of licensed insolvency professionals, as well as the creation of information utilities, will have a positive impact, it may take time before the rules governing these entities are clarified and implemented. Nonetheless, the new insolvency code should pave a clearer path for investors, lawyers and investigators’ fact-gathering in India.

Disclaimer – The views expressed in this article are the personal views of the author and are purely informative in nature.

 

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