[Arth is a student at National Law School of India University.]
This article seeks to evaluate the role of the creditor-in-control (CiC) model in achieving the objectives of the Insolvency and Bankruptcy Code 2016 (IBC). The IBC is based on the underlying rationale that if the management of the company defaults on its loans, equity owners can no longer run the business and should transfer the control to the creditors. The CiC model has been considered to be a welcome change in the insolvency framework in India. This is due to the reason how the debtor-in-possession (DiP) model used to work in India – from sanctioning infeasible schemes against the interest of the creditors to information asymmetries to strategic threats of delay; the DiP model was heavily biased in favour of the management of the corporate debtor. The CiC model works on the premise that the control of the company should not be with the party that is the reason behind the firm’s failure. The CiC model was also needed because of the pro-debtor bias exhibited by various judicial bodies who wanted to save companies from being liquidated. The CiC model gives confidence to the creditors that debtors will not work in a manner that erodes the value of the company and the introduction of the resolution professional solves the information asymmetry too. The resolution professional has the duty to preserve and protect the property of the corporate debtor but he needs permission from the creditor’s committee for major decisions.
Maximisation of value of assets
It is contended that giving the control of the corporate debtor to the creditors that has defaulted will prevent the management from acting irrationally or maliciously and diminishing the value of the corporate debtor.
However, the problem with IBC, that is argued to be a result of CiC model, is that creditors have to take haircuts on their loans for up to 95%. This is because the companies by the time they enter into the insolvency framework are in such a bad state that only junk value can be realised from them. This may be due to the fact that the management does not want to lose control of the corporate debtor, something they are both financially and emotionally invested in. This may be even truer in India wherein the companies are run by promoter groups that are essentially families. The directors are reluctant to lose control of their firm. The Parliamentary Standing Committee in Finance has pointed out that in more than 70% of the cases, creditors have had to bear an average of 80% of haircuts. This is clearly indicative that the CiC model by taking full control from the corporate debtor forces them to not get into the insolvency framework until a time which is too late. This results in a failure of the IBC in achieving the goal of maximization of value of assets.
It is presumed that because the management of the company will be under risk of losing control over the company, it will act cautiously and avoid unnecessary risks or loans and will be responsible while paying off its debts. This would be in turn provide for establishing and promoting responsible entrepreneurship.
However, the CiC model fails to distinguish between the reasons that might have led to the corporate debtor being insolvent. This could be due to either financial failures or business failures. Moreover, an amendment to the IBC had banned promoters from regaining the control of the company. While promoters are able to propose resolution plans after paying all outstanding amounts within one year, one year is too short of a time period to clear out all outstanding debts. This presumes that the erstwhile management of the corporate debtor were engaged in mismanagement or fraudulent management, this is against the recommendations of the Bankruptcy Law Reforms Committee (BLRC) Report. Moreover, one year may not be enough to decide whether there was mismanagement or malfeasance on part of the management of the corporate debtors. This shuts down the possibility of honest promoters retaining control and does not seem to promote entrepreneurship and discouraging risk-taking aptitude of entrepreneurs. The lack of a distinguishing factor between business failures or malfeasance is also against the goals set up by the BLRC.
Availability of credit
To ensure credit availability, it is crucial that banks or creditors are able to recover their dues from the corporate debtor to the maximum extent possible in the earliest possible time. Credit is effectively maintained in the system when viable businesses are able to start afresh or new owners or when its assets are liquidated and the value of assets is then pumped back into the credit system. In the DiP model which worked against the creditors, the creditors realising that they have weaker rights to claim the credit loaned by them and low recovery rates, they would be averse to lending. This used to result in less credit in the system shooting up the interest rates as well. Post the introduction of the CiC model in the IBC, it has been empirically found that credit availability has expanded and the cost of debt financing has decreased. Moreover, data indicate that the CiC model has helped expand the credit availability without restricting the credit demand.
Balancing interests of all stakeholders
The CiC model attempts to balance the interests of all stakeholders as it is believed that giving control to the creditors will incentivise them to take greater interest in the performance and development of the corporate debtor during the insolvency proceedings. In the event of a debtor's default, the CiC model significantly rebalances the power between debtors and creditors. This approach makes economic sense since the borrower generates economic surplus that is dispersed to the equity owners forever until a default takes place, and the creditor only receives the contractual portion of that surplus. Equity shareholders are now shielded by limited liability, but creditors are no longer at risk from bankrupt debtors.
However, it seems that instead of balancing interests of all stakeholders, the current IBC with its CiC model has basically ended up being the polar opposite of the previous insolvency framework, being heavily inclined in favour of creditors as the committee of creditors is considered to be the key decision making body in the restructuring of the corporate debtor. The IBC is also marked by a generalised distrust towards the corporate debtors. The CiC model purported to balance the rights of all the stakeholders. But the working of the current IBC has pressed the claims of the creditors to such an extent that the claims of other stakeholders such as minority stakeholders have been overshadowed by the former. Instead of creating a balance that the current IBC sought to do, the CiC model has worked just to create a polar opposite of a debtor-friendly framework that the new insolvency framework sought to prevent.
According to IBBI, the objectives of the IBC are in a hierarchical order which is sacrosanct. The first and foremost objective being resolution, which is trying to save a business as a going concern by restructuring including mergers and change of management. The second objective is to maximize value of the assets of the corporate debtor, and the last objective is to promote entrepreneurship, ensure availability of credit and balance the interests of all stakeholders. The same also been upheld by the National Company Law Appellate Tribunal in the case of Binani Cements v Bank of Baroda.
In light of the above analysis and hierarchy of objectives, it seems that the CiC model might not be the panacea to achieve the objectives of the IBC. The CiC model has been remarkably efficient in ensuring and promoting credit availability but it must be tweaked a little bit to address and fill the lacunas that still exist. There needs to be a cultural shift in business owner perception such that the management feels comfortable in coming into the realm of the insolvency framework. Moreover, the resolution professional could be given the added responsibility of balancing the rights of the debtor and creditors without being influenced by any of the stakeholders.