Impact Of Delays In Insolvency Resolution On The Economy

“Speed is the essence”

Bankruptcy Law Reforms Committee (“BLRC”) was very clear while setting out the objectives of the new insolvency law for the country and speedy resolution/decision making in an insolvency situation was stated to be one of such foremost objectives. Fragmented laws governing an insolvency and lack of a cohesive framework governing the rights of various stakeholders during insolvency was identified as a primary reason for inefficiency of the pre-existing legal framework. 

A robust legal system needs to create an eco-system which enables quick decision-making to make most efficient economic choices. Expeditious decision making is particularly significant in an insolvency context for several commercial reasons.

First, in an insolvency situation the underlying business and business relationships can deteriorate very quickly. Therefore, to salvage intrinsic value of the business its crucial to bring into effect a formal framework which can pause the negative consequences of a distress situation. It is with this in mind that the Insolvency and Bankruptcy Code, 2016 (the “Code”) provides for a trigger for corporate insolvency resolution process (“CIRP”) to be mere “default in repayment of debt” as against earlier winding up test of “inability to pay debts”. Additionally, the admission into CIRP brings into effect moratorium inter alia on all legal proceedings and enforcement of security interest. 

Second, even during moratorium and ongoing CIRP, economic realities can change very quickly. To begin with, on account of moratorium the financial creditors have to forsake on interest during entirety of the CIRP. If this period was limited to 180/270 or even 330 days, one could justifiably give up on it for the sake of efficient decision making leading to early resolution or liquidation. The longer it takes to conclude CIRP, the greater the distress on account of delay to such financial creditors. 

The above apart, the cost of insolvency is also significant on the corporate debtor itself. The entire cost of the formal insolvency resolution process along with legal and professional costs for running the CIRP as well as operational costs, are quite high. In circumstances where the corporate is cash trapped, although there is a provision for raising interim finance, in practical reality it is difficult to raise interim finance and run the business of the corporate during CIRP. Furthermore, the overhang of insolvency irrespective of the moratorium brings in business uncertainty putting a strain on the business and business relations of the corporate debtor.

Furthermore, one corporate’s insolvency has an impact not only on its creditors and shareholders but equally on its trade partners. Trade partners situation in fact is pretty precarious as they may not have means to assess the seriousness of the situation and need to make business decisions to substitute their own trade supply chains/customers based on expected outcomes of a corporate’s insolvency. The sooner the clarity, the better it is for such trade partners to make appropriate business decisions.

Therefore, each days’ delay costs the stakeholders – once again emphasising the need for quick resolution/decision making. Notably, the BLRC while outlining the new law, was also very clear that the aim of the law is to allow a framework for quick decision making and arrive at an optimal solution for each case. It also noted that in some cases, liquidation may as well be the best outcome of an insolvency situation. The rationale being that the CIRP needs to facilitate best economic outcome and in case where the business of a corporate is unviable and can still retrieve value through liquidation, then that’s the best outcome and one doesn’t need to artificially push for resolution in each case. 

Third, preventing delays facilitates CIRP conclusion in a timely and predictable manner. Timeliness and predictability has been long recognised as a cornerstone of an efficient insolvency resolution process. This attracts competition and serious bidders to come forward and participate in the process. The design of CIRP is a public process which needs to maintain its sanctity and due process by adhering to the prescribed process and timelines. Any detraction from the process disincentives serious bidders from coming forward and spending their time and resources to participate in CIRP.

The processes under the Code have witnessed two significant factors which have contributed to delays in conclusion of CIRP. One – the resolution professional and the committee of creditors’ running the process in a manner so as to allow last minute changes in the prescribed process often on the name of “maximisation of value of assets”. Permitting toppling bids and last minute tweak in process to sneak in backdoor competition, seriously undermines the sanctity of the process. In the long term, it would in fact, act as a dis-service to the object of “maximisation of value of assets” as serious bidders would be dis-incentivised to participate in the process and/or as a matter of routine participating bidders would not quote the true value in its bid and await an opportunity to outbid others by improving the bid on a small margin by revising its original bid subsequently.

Two, the litigation delays have contributed significantly to overall delay in conclusion of CIRP. The delay in admission of CIRP and approval of resolution plans is often stated as a primary cause of delays. That it is – equally, delay in decision on interim issues raised with respect to the process; inter-se rights of the stakeholders such as distribution of plans proceeds etc., also cause immense uncertainty in the processes. Such interim issues also need resolution in a timely manner, so as to avoid delays and overcomplicating resolution plan approval subsequently. 

Lastly, delays in the process cost significantly to the participating bidders as well. By participating in CIRP, the bidders have to keep blocked their own/borrowed funds till the successful completion of the process. This blocks significant capital in the economy, struck only because of delays in the conclusion of the CIRP and decisions taken thereto being subject to long-drawn litigation battles. It is in that sense a complete economic wastage. 

It is thus, but obvious that delays in insolvency resolution is detrimental not only to the corporate in distress but to all of its stakeholders as well as potential bidders and their financiers. The effort has to be made to restore the key theme of a successful resolution process –“ speed” and ensure that the process is implemented in its true spirit in a timely manner.