IBC: Huge haircuts, low recovery spoil the code’s report card

Despite resolving a record number of cases, India's IBC grapples with rising haircuts for creditors, raising concerns about its effectiveness.

India’s Insolvency and Bankruptcy Code appears to be a success on the surface, with a record 269 plans currently underway and awaiting resolution in FY24. IBC resolution plans with the National Company Law Tribunal have surpassed the previous high of 189 cases in FY2023, according to an analysis by ICRA. Consequently, Rs 1.7 lakh crore worth of creditor claims were resolved in FY24, compared with Rs 1.5 lakh crore in FY2023. However, a worrying trend underlies these numbers, requiring urgent attention. While the number of cases is rising, so are the haircuts. Creditors have been settling for haircuts as high as 73%, up from 64% in the preceding fiscal year.

Among the changes needed to make the IBC more effective, increasing final claim amounts is the most prominent. The persistently high haircuts mean creditors are recovering only a fraction of what they are owed, one of the biggest impediments to the success of the flagship mechanism. ICRA expects recoveries to remain modest in the coming year, ranging from 30-35%, while recovery from the liquidation process would be closer to 5%.

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Fixing IBC’s loose ends

Established in 2016, IBC has helped reset credit relations by strengthening the position of both financial and operational creditors. The prospect of relinquishing control over their enterprises serves as a significant motivation for promoters to fulfil their financial responsibilities. However, the IBC is not without faults.

A perceived unique selling point of the IBC is the time-bound resolution process. While it used to take 4.3 years to resolve insolvency in India before the IBC’s entry, the code has significantly reduced resolution time. Nevertheless, more efforts are required to close the gap between the admission of a case and its resolution. Incidentally, the average duration for closing CIRP (corporate insolvency resolution process) yielding a resolution plan increased to 843 days in FY2024, up from 831 days in FY23. This period has been rising compared to the previous average of around 653 days.

This continues to exceed the expected timelines. In cases of liquidation, 55% of cases exceed two years. Despite several steps taken to tighten the code and improve its functioning over the years, more needs to be done. The delay erodes asset value and discourages potential buyers. Closing CIRPs within the intended time frame remains a challenge due to multiple factors. Overburdened NCLT benches struggle to manage a heavy caseload, and legal disputes, such as restructuring debt, selling assets, or a change in management between promoters and dissenting creditors, also stall proceedings.

Recently, an action taken report on the working of the Insolvency and Bankruptcy Code made several suggestions to improve the code’s efficacy. The report acknowledges that while the IBC has been amended multiple times, its effectiveness is hampered by issues with implementation, not the code itself. The focus should be on fixing the governance aspect of the agencies involved, particularly the National Company Law Tribunal.

The present bench strength at the NCLT is insufficient to handle the growing number of cases. The government must address vacancies at the NCLT immediately. Perpetual vacancies due to retirement and completion of members’ terms necessitate raising the sanctioned strength from the current 62 members. There is a huge backlog of more than 20,000 cases in NCLT at the end of every year.

However, strength alone is not the only issue in governance. The NCLT’s style of working also needs improvement. Its members, both judicial and technical, require an urgent upgrade in their knowledge and would benefit from more domain expertise in bankruptcy matters in an evolving business landscape. For this, the NCLT needs young professionals with technical and legal expertise in bankruptcy, which could help modernise the tribunal.

The Standing Committee report also identifies the competence of resolution professionals as a major hurdle in the IBC process. These professionals are entrusted with crucial tasks like managing troubled companies, creating reports on their health, and finding buyers. However, their skills are often lacking. The Insolvency and Bankruptcy Board of India recently took action against malpractices by RPs, but that may not be enough. The report proposes establishing a dedicated body to continuously evaluate and improve the capabilities of RPs. Capable RPs could significantly reduce resolution times while ensuring higher chances of improved valuations and the revival of companies instead of liquidation.