The Working Group on Tracking Outcomes under the Insolvency and Bankruptcy Code, 2016 has submitted its Report on November 10, 2021 to the IBBI.
We are summarizing the important points covered in the said report below:
The Insolvency and Bankruptcy Code, 2016 ('IBC' or 'the Code') provides for resolution of stress of a company, a limited liability partnership, a proprietorship, or partnership firm, or an individual. The Resolution Strategy envisaged in the Code has three broad elements:
- Prevention: The Code resolves financial stress where it could not be prevented. It has several provisions to prevent such stress. There is a credible threat that if a company defaults, and consequently gets into CIRP, in all probability, it would move away from the hands of current promoters / management, most probably, for ever. Firstly, because the promoters may not be eligible to submit a resolution plan. Second, even if eligible, they may not submit the most competitive plan. This deters the management and promoters of the company from operating below the optimum level of efficiency and motivates them to make the best efforts to avoid default.
- Start Early and Close Timely: The IBC entitles the stakeholders to initiate CIRP as soon as there is threshold amount of default to prevent the stress from ballooning to unresolvable proportions. In early days of default, enterprise value is typically higher than the liquidation value and hence the stakeholders would be motivated to resolve insolvency of the company rather than to liquidate it.
- Closure of unviable company: For a market economy to function efficiently, the process of creative destruction should drive out failing, unviable companies continuously. It was not happening hitherto in the absence of an effective mechanism.
OBJECTIVE OF THE CODE:
- The first order objective of the Code is Resolution
The sole object of the Code is reorganisation, as stated in its long title. Reorganisation has several benefits, namely, it promotes entrepreneurship, improves credit availability, maximises the value of assets of the company, etc.
- The second order objective is Maximisation of Value of Assets of the Firm
The Code enables maximisation of the value of the assets of the CD by requiring the creditors to make a collective endeavour to revive the failing CD and improve utilisation of the resources at its disposal. If revival is not possible, the Code releases resources for other efficient uses. In either case, the value of the assets of the CD improves.
- The third order objectives are Promoting Entrepreneurship, Availability of Credit and Balancing the Interests of Stakeholders
Promoting Entrepreneurship: Unused or under-used productive resources is anathema for the growth of a country and people. By rescuing viable businesses through the insolvency process and closing non-viable ones through liquidation, it is releasing resources, including entrepreneurs. The reallocation of resources to more efficient uses is essential to optimise the economic cycle.
Availability of Credit: Through provisions for resolution and liquidation, the Code enables creditors to recover their dues from either future earnings, post- resolution, or sale of liquidation assets. It incentivises creditors - secured and unsecured, bank and non-bank, financial and operational, foreign, and domestic - to extend credit at lower costs, particularly when they have rights under the Code to initiate CIRP in case the CD defaults.
Balancing interests of all stakeholders: The stakeholders have different rights on the assets of the CD under contracts or special enactments. The Code has set the priority of stakeholders in the shape of a waterfall in case of liquidation. It prescribes certain minimum protection for certain stakeholders at the stage of the CIRP. It requires the resolution of insolvency within a framework of fairness and equity in a way that maintains the incentives of all stakeholders in the project. Beyond the explicit statutory objectives, the Code rescues failing CDs and thereby rescues the employment of several employees and their livelihood.
NEED FOR A FRAMEWORK TO TRACK THE OUTCOMES OF THE CODE
There is presently no standard framework to track the outcomes of insolvency and bankruptcy regime in various jurisdictions, other than the DBR indicators. In the absence of a standardised framework and centralised data bank, it is important to design a framework for the assessment of the performance of the insolvency regime in the country in terms of its effectiveness, efficiency, and efficacy. Such a framework would inform various stakeholders, in a structured manner, of the outcomes of the new regime, and enable organisation and availability of information required for the framework. The WG is of the view that it is essential to capture both quantifiable and non-quantifiable outcomes of the Code. Analysis of both qualitative and quantitative parameters can be undertaken at different points in time- ex-ante, interim and ex-post efficiency.
CURRENT DATA SOURCES: Currently, most of the data to processes
under the Code, namely, CIRP, liquidation, voluntary liquidation,
individual insolvency, and financial service providers is
maintained and disseminated by the Insolvency and Bankruptcy Board
of India (IBBI). The IBBI tracks and publishes data on outcomes of
the following corporate processes under the Code on a quarterly
basis in its newsletters and on an annual basis in its annual
report.
- Insolvency Resolution
- Liquidation
- Voluntary Liquidation
- Status of Twelve Large Accounts
- Individual Process
- Financial Service Providers
Working Process of The Working Group:
The IBBI constituted the WG in May, 2019 with the mandate to suggest a framework for tracking the outcomes of the Code vis-a`-vis its objectives, including:
(a) identification of quantitative and qualitative parameters;
(b) institutional arrangement (s) for capturing the parameters;
(c) manner of using the identified parameters.
WG has identified the following six layers of outcomes of an insolvency and bankruptcy regime:
(a) The growth, strength and efficiency of the insolvency ecosystem consisting of IPs, IPAs, IPEs, RVs, RVOs, IUs, AA, Appellate Tribunal, IBBI, Government, Courts, etc.;
(b) The strength, efficiency, and efficacy of the processes, namely, corporate insolvency resolution, corporate liquidation, voluntary liquidation, pre-packaged insolvency resolution, fresh start process, resolution of personal guarantors to corporate debtors, resolution of proprietorship and partnership firms, individual insolvency resolution, bankruptcy, etc.;
(c) The growth and efficiency of markets such as markets for
interim finance, resolution plans, liquidation assets, insolvency
services, along with cost efficiency, information efficiency,
etc.;
(d) The impact on businesses in terms of cost of
capital, capital structure, availability of credit,
entrepreneurship, capacity utilisation, creative destruction,
competition ? innovation, etc.;
(e) Behavioural changes amongst the debtors and creditors, trust of the creditors in debtors, meritocratic lending, non-observable impact, humanitarian considerations, proactive/ preventive impact of the Code, etc. and
(f) The overall impact on employment, income, and economic growth of the nation.
SUGGESTED FRAMWORK
The framework for measuring the outcomes with respect to CIRP is proposed by the WG considering the six identified layers of outcomes of the Code. The WG suggested juxtaposing the objectives of the Code against three E's:
- Effectiveness: This is the measure of the extent to which an insolvency system achieves its intended objectives.
- Efficiency: This is the measure of the extent to which the insolvency system achieves those objectives with the minimum use of resources.
- Efficacy: This is the measure of the extent to which there exists a connection or contribution of the insolvency system (sub-system) with the higher-level systems like the legal, economic, and financial systems.
- EFFECTIVENESS
Objective: Maximisation of the value of assets of CD undergoing a resolution process:
Parameters proposed:
(a) Undertaking a time series analysis of the assets of the CD, pre- and post-CIRP.
(b) Market capitalisation of the CD viz., the value of the CD traded on the stock market, can be assessed pre and post-CIRP of the CD.
(c) Enterprise value of the CD, which is the market capitalisation of the company plus debt, both long term and short term, minus cash, and cash equivalents. The enterprise value of the CD, pre and post-CIRP can be compared to assess the value of the assets of the CD.
(d) Changes in debt-equity ratios (leverage) of the CD, pre- and post-CIRP process.
(e) Changes in the asset turnover ratio of the CD, pre- and post-CIRP to assess continuity of operations during CIRP.
(f) The capital structure of the resolved entity
Indicative Methodology:
The indicators may include the following:
(a) Net fixed assets and its break-up in terms of plant and machinery, land and buildings, transport equipment, furniture, fixtures, intangible assets, etc.
(b) Net worth, net of revaluation reserves
(c) Market capitalisation and enterprise value
Objective: Reduction in financial stress of the CD
To be effective in reducing financial stress of the CD, IBC must ensure that
(a) There is growth in investment;
(b) There is rise in debt-equity ratios, in the aggregate; (c)
Credit rationing decreases;
(d) Cost of debt/capital reduces.
Indicative Methodology- The indicators mentioned above will need to be observed and measured in a macro sense. This data can be acquired from RBI, CMIE, Ministry of Statistics and Programme Implementation.
Objective: Enhancing the availability of credit- The effectiveness parameters proposed to measure the objective are as follows:(a) The effectiveness of the Code in increasing the overall availability of credit in the economy can be measured by tracking the varied parameters that banks employ to assess improvement in recoveries and the subsequent increase in the availability of funds. One such indicator is the measure of gross NPAs of banks and provisions maintained for NPAs. A decline in both figures would indicate an increase in the capacity of banks to lend. (b) Tracking the number of upgradations in accounts maintained by banks and the value of recoveries made by them.(c) Interest rates, or the terms and conditions for providing credit by creditors in general.(d) Outcome of the Code in terms of its effect on the cost of capital: The decline in the cost of capital because of effective and time-bound recoveries under the Code is imperative to increase credit offtake in the economy.
Indicative Methodology - The indicators identified above to measure credit availability in the economy can be assessed through data published by banks and the RBI.
Objective: Balancing interest of all the stakeholders
The effectiveness parameters proposed to measure the objective are as follows:
(a) Priority ranking of claims between classes of creditors and within a given class can be studied to evaluate fairness in the treatment of different types of creditors in the proposed resolution plan approved by the CoC.
(b) A study of the distribution of proceeds of liquidation of the CD among creditors and the weighted distribution of the total original claims can be a proxy to measure equity.
Indicative Methodology/Sources - Detailed information with respect to admitted claims of creditors and the amount realised by all creditors from resolution or liquidation of the CD can be gathered from IPs handling various CIRP assignments.
- EFFICIENCY
Objective: Maximization of the value of assets.
The efficiency parameters proposed to measure the objective are categorised as follows:
(a) the proportion of outstanding loans that are restructured before the CD defaults on any obligatory payment. Since informational asymmetry is a given, and different claimants have different, and non-verifiable, subjective probabilities of future outcomes, the procedural cost of IBC cannot ever be fully avoided. However, a more efficient institution will have more entities finding it in their interest to avoid the IBC.
(b) Realization - One of the primary considerations for any stakeholder to initiate CIRP is the amount of realization that can accrue to it upon completion of the process. One measure of realization is calculating realization by FCs and OCs as a percentage of their claims in a particular CIRP that has yielded resolution and comparing it with realization as a percentage of liquidation value in respect of the CD. Further, the realization by FCs and OCs can be compared with the realization rates under the erstwhile insolvency and bankruptcy regime in the country and in other jurisdictions.
(c) Time - Time is the essence of the Code and speedy resolution of the insolvent CD is essential to preserve asset value. To measure the efficiency of the Code with respect to the time-bound resolution of the CD, the total time taken from the date of admission of application for initiation of CIRP to the date of approval of resolution plan or liquidation of the CD by the AA, can be calculated. Another dimension of time-efficiency is the efficiency of the AA in terms of time taken to admit and dispose of an application. One important aspect of the time- bound resolution is the relationship between timely initiation of CIRP and the amount of haircut taken by the creditors upon completion of CIRP.
(d) Cost - The total cost involved in the CIRP of a CD can either encourage or discourage stakeholders from initiating the process. An efficient insolvency and bankruptcy regime entails minimum cost and is thus the preferred mode of seeking redressal. Quantitative data on cost indicators (in line with international best practices) such as court/bankruptcy authority fees; fees of the resolution professional; and asset storage and preservation costs etc. can be ascertained to calculate the total cost involved in the completion of CIRP.
Indicative Methodology/Sources - Data with respect to recovery rates and time is maintained by IBBI. Detailed information related to the cost involved in CIRP is available with IBBI as reported by IPs.
- EFFICACY
Objective: Trends in CDs in stress- To bring resolution of stress in Corporate Debtors.
This parameter of reduction in CD's stress can be measured in the following ways:
(a) Number of CDs, with the amount of assets involved, entering bankruptcy proceedings per month.
(b) Proportion of disputed amount recovered.
(c) Time taken for final resolution.
Indicative Methodology - IBBI maintains detailed CD wise data as well as aggregate data which can be used to measure the above parameters.
Objective: Promoting Entrepreneurship
The WG has the following suggestions in this regard: (a) A monitoring mechanism may be set up that tracks the actions of entrepreneurs whose companies had to go through an insolvency resolution process. It would be very useful to trace the business future of such entrepreneurs. Did they set about creating new enterprises or did they decide to retire or were they perpetually mired in endless litigation? Did they switch industries or jurisdictions? Over time, it could be possible to study if they became more successful entrepreneurs or did they fail again or repeatedly. (b) Tracking the new business endeavours of these entrepreneurs is one way of measuring the promotion of entrepreneurship. Another, and more direct way would be to conduct periodic direct surveys of these entrepreneurs. This could give different insights into the mental makeup and thinking of these entrepreneurs. (c) A third dimension would be the perspective of the creditors. Do creditors demand a premium on the credit extended to entrepreneurs who had gone through an insolvency resolution process. It is also possible to examine this aspect by studying the behaviour of creditors towards group companies of such entrepreneurs.
Indicative Methodology/Sources - There are two sets of indicators to measure growth in entrepreneurship. The first set of indicators are directly correlated with the outcomes under the Code and the second set of indicators are partly correlated because of the consequence of the processes under the Code or affected by the Code. Mapping the growth in the number of 'second-time' entrepreneurs, viz., entrepreneurs or promoters whose businesses have completed CIRP under the Code and have successfully started new ventures post CIRP belongs to the first set of indicators. An upward trend in this indicator reflects the freedom to exit and ease of doing business envisaged under the Code. Mapping the growth trend in 'start-up' activity in the country, especially growth in MSMEs belongs to the second category of indicators. To measure the above identified indicators, researchers can source secondary data from the Ministry of Commerce and Industry or employ a survey-based method for the collection of primary data regarding entrepreneurs' decision to retire or being involved in litigation or switching industries or jurisdictions. Further, over the short and medium-term a study can be undertaken to assess whether these 'second-time' entrepreneurs became successful entrepreneurs or not.
Objective: Expanding channels of credit
The efficacy parameters proposed to measure the objective are as follows:
(a) Development of the market for interim finance.(b) Credit supply to and investment ratios in stressed sectors like real estate, construction, metals, etc. (c) Change in cost of capital, particularly for stressed sectors.
Indicative Methodology/Sources - Information from IPs may be sought for earlier and ongoing cases with respect to interim finance. Data can be sourced from CMIE and RBI databases to ascertain credit supply and investment ratios in stressed sectors and changes in the cost of capital.
Objective: Impact on the Financial and Economic Ecosystem- The efficacy parameters proposed to measure the objective are as follows:
(a) Changes in the size of the corporate bond market in the country.
(b)Change in Credit to GDP ratio
(c)Change in unemployment rates.
(d) Trends in private investment to GDP ratio.
Indicative Methodology/Sources - The above indicator on the size of the corporate bond market can be tracked by gathering corporate bond market data from stock exchanges and RBI. Data published by the RBI and government statistics are also useful sources to track changes in macro-economic indicators.
Objective: Rescuing Employment and Income
To measure this, it is possible to track the well-being of all employees of affected companies beyond the conclusion of the CIRP by studying the following indicators:
(a)Employment saved by the rescue of viable CD through the insolvency resolution process. (b)Track the well-being of all employees of affected companies beyond the conclusion of CIRP. Well-being implies whether employees retained their pre-CIRP commencement pay structures, post-retirement benefits, health insurance cover, etc.
(c)Delays (number of days) in the release of dues to employees or workmen of the CD, pre and post-resolution. (d)There were detailed discussions on whether IBC had raised the risk-premium, and whether IBC had adequately empowered the small and medium sector enterprises to trigger CIRP, whose sources of debt are from money lenders and informal sources. This would be an important outcome to track.
Indicative Methodology/Sources - Data with respect to employment and income of workmen and employees of the CD can be obtained from IPs and IBBI. Further, questionnaire- based surveys of the affected employees can be undertaken to ascertain inconvenience, if any, caused by the initiation of CIRP against the CD and its effect on the financial and mental well- being of the employees.
Objective: Behavioural changes in stakeholders
The following were suggested as questions, answers to which will help in identifying the behavioural changes amongst the stakeholders:
(a) Do creditors demand a premium on the credit extended to entrepreneurs who had gone through an insolvency resolution process?
(b) Do creditors trust the debtors?
(c) Do creditors indulge in meritocratic lending?
(d) Does the incentive structure of law proactively prevent insolvencies and bankruptcies?
(e) Do debtors avoid invocation of CIRP under IBC due to fear of losing control on business?
(f) Does IBC provide freedom to exit and voluntary liquidation?
Indicative Methodology/Sources-
(a) Survey based collection of information on the above parameters.
(b) Available data on withdrawal of CIRP under section 12A.
(c) Available data on voluntary liquidation.
(d) Generation of awareness about the provisions of the Code, to be determined by the number of workshops and awareness programmes conducted by the regulator and the number of participants in such workshops/programmes.
(e) Analysis of the landmark judgments of the AA and Supreme Court under the Code may be conducted. The cases may be categorised based on the issues already addressed by the said judgments. The analysis of the judgments will be helpful in measuring the intended and unintended objectives of the Code.
Conclusion
The parameters suggested in the report of the Working Group seem to be helpful in understanding and measuring the effectiveness, efficiency and efficacy of the insolvency and bankruptcy regime. This would require an in-depth study to understand the real impact on the financial ecosystem. The entire IBC regime is yet to be fully operative. While it has been five years since the IBC, especially the corporate insolvency resolution has been introduced, the pre-packaged insolvency resolution process has been introduced only in the current year and not many applications have been filed under the said process. Individual bankruptcy (except Personal Guarantors to Corporate Debtors) and Cross-border Insolvency mechanism are yet to see the light of the day. Issues such as insolvency of a Group of Companies whether should be dealt under a single umbrella has been raised on many occasions and there have been judicial verdicts by the NCLTs on some occasions. The statute, however, does not allow a different treatment to such cases, as on date. We should keenly await the entire IBC regime to come into operation and then apply the parameters suggested in the report of the Working Group to track its real outcomes.
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