The conflict between the Insolvency and Bankruptcy Code 2016’s twin objectives of timely resolution and value maximisation of corporate persons has been subject to much debate. The sweeping conclusion from judicial decisions indicates that actions in pursuit of maximising value of the corporate debtor are defensible even when they transgress the boundaries of the code.
The battle continues with the Ministry of Corporate Affairs’ (MCA) notification, dated 18 January 2023, which proposes certain changes to the code. The MCA has inter alia proposed reinstatement of corporate insolvency resolution process (CIRP) in cases of rejection or non-implementation of a resolution plan, or even after commencement of liquidation process where the liquidator continues to carry on the corporate debtor’s business.
The notification further mentions that the possibility to revive the company shall be determined by the committee of creditors (CoC) and proposes discretionary power to the adjudicating authority to either allow such reinstatement or liquidate the corporate debtor.
The MCA’s proposal deviates from the legal design and intent of the code and is problematic for a multitude of reasons. Firstly, it is aimed at entity preservation, which was a significant shortcoming of the erstwhile insolvency regime where policy principles were steered towards preservation of industries and concerns of employee welfare.
As noted by the Interim Report on Bankruptcy Law Reforms Committee (BLRC), the judicial practice under the previous regime was incommensurately inclined towards rescue even for commercially unviable businesses.
Further, courts often permitted companies to explore rehabilitation options even after issuance of liquidation opinion by the Board for Industrial and Financial Reconstruction. This led to process delays, increased costs for creditors, and erosions in the company’s asset value. Such procedural innovations led to the failure of the Sick Industrial Companies (Special Provisions) Act, 1985.
Given this, the code was enacted as a market-led time-bound mechanism, which results in either reorganisation or liquidation, the latter occurring when market forces have been unable to resolve the corporate debtor’s financial distress.
The BLRC, in its report of 2015, specifically noted that the code should be outcome neutral, and liquidation should be an irreversible process. This enables an orderly exit for unviable companies, unlocking human and natural resources for productive enterprises.
A timely exit mechanism, as prescribed by the code, preserves the corporate debtor’s value and is critical for entrepreneurial growth. Further, judicial precedents indicate that commercial decisions by the CoC (comprised of financial creditors) are often self-serving and do not adequately balance the interests of other stakeholders. Allowing the CoC to reinstate the CIRP and endlessly extend the process of value maximisation would not only be inconsistent with the objects of the code, but would also lower recoveries for other stakeholders negatively impacting their financial health.
Secondly, in exceptional cases, a second round of bidding may provide better value than liquidation (with adequate safeguards), however, the possibility of stakeholders abusing the sanctity of the process cannot be excluded. A second round of the CIRP will incentivise under-bidding by resolution applicants at the first instance. Further, it will leave scope for foul strategic play, as potential resolution applicants would be deterred from rescuing the company at a fair price if the company has not generated economic interest in the market on the first occasion. Reinstating the CIRP will not only encourage exploitative practices but will also compromise the certainty, predictability and timeliness of the process.
The code and its subordinate legislation allow a distressed company to be rescued in various ways. Corporate debtors can honour their debt obligations at possibly every stage of the CIRP, and even after commencement of liquidation, which may result in withdrawal of a CIRP application.
The CIRP also allows market participants to rescue the corporate debtor by following a transparent bidding process. Further, although paradoxical and in conflict with the fundamental idea of liquidation, the liquidation regulations outlined under the code permit the sale of the corporate debtor as a going concern even during liquidation.
With sufficient rehabilitation mechanisms established, the MCA’s proposal to reinstate the CIRP is a dangerous tool, which may prevent timely liquidation for struggling companies, keeping them in the process until most value has depleted. Attempting futile resolution endlessly at the cost of value destruction of the corporate debtor is not the objective of the code. Resolution should be aimed at value maximisation, which can only be a reality if such resolution takes place in a time-bound manner.
Misha is a partner, and Aishwarya Satija and Kritika Poddar are research fellows at Shardul Amarchand Mangaldas in New Delhi
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. Further, the views in this article are the personal views of the author.
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