Don’t Junk CDR Learnings, Can Strengthen IBC
When the Insolvency and Bankruptcy Code (IBC) was enacted in 2016 in India, which replaced all other previous schemes including the widely used corporate debt restructuring (CDR) scheme, there were heightened expectations that India’s infamously long and unwieldy corporate dispute resolution processes will undergo a significant transformation.
While CDR emphasised restructuring and negotiation, the IBC emphasises resolution through mechanisms such as insolvency resolution processes and liquidation, with a focus on protecting the interests of all stakeholders, including creditors, shareholders, and employees. It was expected to ensure reorganisation for commercial entities as an alternative to liquidation or other mechanisms of debt enforcement, reshaping the way insolvent firms could restore their financial well-being or close down.
Nearly eight years later, the reality is somewhere in between harsh reality and the narrative of the aggregate recoveries. While there is no gain in saying that there have been some good resolutions, mainly of large operating assets and high-profile crises, the recovery rate has been significantly below expectations. In 2023, the average recovery process under IBC was 36 per cent, implying that about only three of every 10 cases brought under the IBC have recovered following resolution. This is a very low recovery rate of a law that sets a cap of resolving with an outer limit of 270 days or nine months. This often results in a worsening in the value of the assets leading to an even lower recovery for non-operating assets under IBC.
CDR has been used as a crucial mechanism for addressing financial distress faced by companies. It involved the renegotiation of terms related to debt obligations between a distressed company and its creditors, aiming to provide relief and facilitate the revival of the company's operations. When a bank takes a 'haircut', it means it accepts less than what was due in a particular loan account. If the promoters have shown commitment in the past and there is no diversion after due forensic audit, lenders have managed to recover almost the full amount. In CDR, since they convert their part of debt into equity and take their stake to 51 per cent, it helps them in navigating the company and also ensures the protection of their financial exposures.
Despite these criticisms, it is important to acknowledge that CDR has been instrumental in resolving financial crises and preserving value for creditors and shareholders in many cases. The structured framework provided by CDR allowed for orderly debt resolution and prevented the chaotic liquidation of assets that can occur in the absence of a formal restructuring process. Furthermore, CDR helped stop contagion effects and systemic risks by containing the fallout from a distressed company’s failure.
For example, if Indian steel companies of the early 2000s had been put into IBC, instead of the then CDR, some of the large Indian steel majors would not have existed today. The RBI’s annual report of 2002-03 shows that 8 steel accounts with outstanding loans of Rs 28,000 crore were admitted to the CDR cell that year. At the time, a combination of low international prices, sluggish domestic demand and overcapacity had forced bankers to restructure and offer a lifeline to these companies.
Jaiprakash Power Venture Limited is another case in point. Under IBC when they explored the bidding process, the potential suitors indicated to give an 80 per cent haircut to lenders in 2019. Lenders eventually declined to take such a sharp haircut and opted for CDR, which virtually protected the lender's principal as well as interest at the company’s then-share price. Lenders took over the majority stake of 51 per cent within four years, and the company’s net worth increased substantially in this period. Rajnish Kumar, former State Bank of India (SBI) Chairman in his book `The Custodian of Trust: A Banker's Memoir’ pointed out that “this problem of inexorable control by promoters has plagued many failing businesses though there have been exceptions like that of Manoj Gaur of the JP Group, who willingly sold one business after another to curtail his debts.”
The success of CDR in India can be attributed to several factors. Firstly, it provided a structured framework for negotiations between borrowers and lenders, allowing for a coordinated approach to debt restructuring. Secondly, it allowed for the customisation of restructuring terms based on the specific circumstances of each case, thereby increasing the likelihood of a successful resolution. Thirdly, CDR often involves the participation of multiple creditors, enabling a collective decision-making process that takes into account the interests of all stakeholders.
We need to pick good elements of CDR for strengthening IBC. A timely resolution needs continued emphasis in any recovery process, for only then can it ensure retrieval of the businesses that may have defaulted to creditors for a variety of reasons. For those stressed entities facing deep-rooted operational or governance issues, IBC is an easier solution.
A fundamental gap within the Insolvency and Bankruptcy Code (IBC) is the presumption that promoters of a failing enterprise inherently harbour malicious intent. This presumption overlooks the possibility of genuine business failures and may lead to moral hazard, where the intent of promoters is unfairly questioned. Recognising and understanding genuine business failures is essential to foster a fair and just environment conducive to economic growth.
A fundamental question that needs to be raised is whether IBC’s sole objective is to hammer out resolutions or is recovery the ultimate goal. In its quest for resolutions, the IBC framework, the evidence suggests, seems to have lost the purpose of ensuring recovery in entities that it is mandated to resolve. Timely recovery needs continued emphasis in any resolution process, for only then can it ensure retrieval of the businesses that may have defaulted to creditors for a variety of reasons. The IBC process remains a work in progress. It needs the benefits of the CDR, to embolden creditors, and hastening both resolution and recovery.
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