IBC plot twist may let defaulters keep the reins

The ministry of corporate affairs’ insolvency law committee, comprising officials and independent experts, will examine this proposal in detail, said a person familiar with discussions in the government.

If accepted, this will be a major shift from the current practice of shareholders of defaulting companies ceding management control to an administrator appointed by a committee of creditors. The proposal to let the existing management retain control contrasts the original IBC structure of creditors taking control after the admission of the bankruptcy petition. The fear of losing control of their companies has encouraged many defaulters to resolve their disputes with creditors and avoid insolvency proceedings. However, some experts contend that the tribunal-led process was not flexible enough for lenders and shareholders to effectively craft a rescue plan and save the company before its operations failed and regulatory permits were lost.

Earlier, the government had experimented with the debtor-in-control feature under IBC in the ‘pre-pack’ scheme, a bankruptcy resolution template tailormade for small firms. Still, it did not take off in a big way as small businesses explored loan restructuring under other schemes. The idea now is to offer this format to larger firms as experts have said this is suitable for them.

“The Insolvency Law Committee has already met three times and will hold another two meetings. These suggestions are being looked into,” the person said on condition of anonymity.

An email sent to the spokesperson for the ministry of corporate affairs on Sunday seeking comments for the story remained unanswered at the time of publishing.

Under the pre-pack scheme, much of the work in finding new investors and restructuring the business to become viable is done informally, and once a workable plan is ready, lenders and shareholders approach the National Company Law Tribunal (NCLT) to get its seal of approval, a scheme that offers a significant amount of flexibility to the parties.

While rolling out the pre-pack scheme, the government was cautious in limiting its scope to MSMEs. The minimum payment default threshold of ₹10 lakh was set for initiating the pre-pack insolvency resolution process. That is, a small business which has not met its payment obligation of ₹10 lakh could either on its own accord initiate a bankruptcy resolution scheme with approval from lenders, or lenders could initiate the process. The advantage is that the existing management, which is well versed in the operational aspects of the business, remains in control rather than a professional, who may not have the sectoral knowledge of the industry.

Experts said the proposed change in IBC could make it more responsive and effective. Extending the features of the pre-pack resolution scheme meant for small businesses to larger entities as well is a good idea because, under this, one could start with a resolution plan that is at an advanced stage, said Anoop Rawat, partner (insolvency and bankruptcy) at law firm Shardul Amarchand Mangaldas and Co. “Large corporations will be able to handle the process and the costs involved. The debtor-in-possession framework will work well in cases where the defaults have happened due to economic reasons and not because of any wrongdoing by the management.”

In cases where the distress is due to voidable transactions by the existing management, control would anyway be ceded to lenders as it is not desirable that such people continue to run the business.

The move to have a debtor-in-possession feature as a general IBC provision also indicates that the government wants an overhaul of the code to improve its outcomes rather than patchwork specific areas. It also recognizes one key element in rescuing a firm—the expertise and networking that shareholders and management have in a specific sector, which may be unmatched by an independent professional. India rolled out IBC in 2016, banking on resolution professionals to run distressed firms, but last year allowed entities to sign up as resolution professionals and run these businesses as it requires multi-disciplinary skills.