Resolution Of The NPA Problem Through IBC

The Insolvency and Bankruptcy, 2016 (IBC) was passed to combat the burgeoning effect of non-performing assets (NPAs) on the banks and the Indian economy, at large. From the perspective of economic growth, the IBC was enacted with the overarching objective of ensuring the essential freedom to exit the economic system so that there could be a seamless reallocation of resources in the economy, from the failing enterprise to an efficient one.

Behavioural Change

The enactment of IBC is best defined and understood by an intersection of law and economics, specifically the change in incentives underlying the decision-making of the stakeholders. While law seeks enforcement of a certain kind of behaviour in a society, economics can provide incentives/disincentives to rational individuals to ensure that they make optimal choices so as to maximize the overall utility from a limited pool of resources. This interplay of law and economics allows lawmakers to understand the economic behaviour of different stakeholders under different circumstances and design legislation appropriately such that its enforcement results in the most efficient outcome.

The shift of regime from debtor-in-possession to creditor-in-control along with the bar on re-entry of promoters in the defaulting entity under Section 29A of IBC effectively employs the famous ‘nudge theory’ from behavioural economics to bring about a cultural shift in the dynamics between the lenders and the borrowers. Taking note of this policy shift in law, the Hon’ble Supreme Court in Swiss Ribbons Private Limited v. Union of India remarked that with the enactment of the IBC, the defaulter's paradise was lost.

In this way, the IBC has changed incentives for the promoters to enhance decision-making process, act with reasonable financial discipline, and take all steps to prevent default so as to preserve their own interests, which in turn maximizes both the value for the creditors and welfare of the society at large. If the promoters fail to fulfil their duties towards the firm, they risk being replaced entirely once the insolvency proceedings are initiated against the firm – accordingly, the first signs of distress now serve as early warnings for promoters and management to take corrective actions to avoid defaults. This is further evident from the large number of cases where the corporate debtor has entered into a settlement with the creditors after initiation of insolvency.

One complication caused by the re-alignment of incentives could have been that the promoters, upon gaining knowledge of the imminent insolvency, start engaging in wrongful/fraudulent trading to alienate and ring-fence the assets of the corporate debtor from the creditor pool. However, the IBC effectively takes that into account while providing the claw-back mechanism for preferential, undervalued, fraudulent, and extortionate credit transactions and damning the officers in default to criminal penalties.

Substantive Change

The IBC envisages the resolution of the insolvent entity as a going concern, which is continued to be run by the resolution professional during the insolvency period, with necessary supervision from the committee of creditors. Through a non-adversarial mechanism, the IBC has established a framework for creditors to resolve/revive a company within a fixed timeframe (in a calm period ensured by the moratorium) and proceed towards liquidation, if such revival efforts failed. The time bound nature effectively protects the interests of all the stakeholders by: (i) putting an end to the right of promoters to have a continuous say in the running of their company; (ii) ensuring the maximization of value of the assets of the borrowers by minimizing the time for turnaround of the debtor.

Since its enactment, the IBC has become the most preferred tool for the resolution of stressed assets, with the average recovery rate for the lenders being the highest, as compared to the past regimes. The successful impact of IBC has been evident with the jump in India’s rankings in World Bank’s Index on Ease of doing business, where India now stands at 63, a massive improvement from 130 in 2016.

The Way Forward

Despite being a landmark step in India’s fight against NPAs, the IBC continues to be a nascent economic legislation, with miles to go and leaps to take. The government and the insolvency regulator have so far been proactive in their approach towards monitoring the pitfalls and proposing solutions to the problems being faced by the stakeholders. While the insolvency process has become smoother, consistent, and more uniform with the passage of time in light of several amendments and judgments clarifying the jurisprudence surrounding the implementation of its provisions, there have also been radical critiques of the IBC surrounding the high haircuts recently. In this light, one must not lose sight of the Supreme Court’s observation that a nascent economic legislation should be allowed a certain play in the joints to ensure its success and accordingly, a knee-jerk reaction to one-off problems might do more harm than good.