Videocon Saga: Does Commercial Wisdom Justify Huge Haircuts?
[Vedaant and Pratham are students at National Law University, Jodhpur.]
The inception of the Insolvency and Bankruptcy Code 2016 (Code) was aimed at time-bound resolutions of debt-ridden entities and avoiding devaluation of its assets. However, in recent years, the Code has fallen short of its objective and failed to maximize the value of the corporate debtor’s assets. The recent insolvency proceeding of Videocon Industries is a testament to such failure, where creditors have taken huge haircuts, as high as 96% on the outstanding amount.
During the insolvency proceedings, Videocon Industries and its 12 group companies were looking at an aggregate debt of INR 64,838.63 crores, with the resolution plan being submitted for only INR 2,962.02 crores. Although the National Company Law Tribunal (NCLT) approved the resolution plan, it remarked the offer to be a ‘tonsure or total shave’ for the operational creditors as they were looking at a haircut of 99.28%. They warned of the potential insolvency proceedings these operational creditors would themselves face and asked the creditors to increase the payout.
However, through multiple decisions, the Supreme Court (SC) has clarified that the committee of creditors (CoC) is not questionable for its commercial decisions, and the Adjudicating Authority's powers are limited to certain enquiries under Section 31 of the Code. As observed by the Apex Court in Essar Steel, the commercial wisdom of the CoC cannot violate the very objective of the Code.
Thus, the Videocon case raises questions on why CoC's often agree to take such huge haircuts on their debt and disputes the “commercial wisdom” of the committee and its scope. While haircuts are not new to insolvency proceedings, taking such huge haircuts, where creditors lose almost all their due money, is questionable. Thus, through this short piece, the authors intend to answer these fundamental questions and check if these haircuts truly cater to the objective of the Code.
Commercial Wisdom of CoC
While asserting the supremacy of the commercial wisdom, the SC in K Sashidhar v. Indian Overseas Bank and Others, held that the Code gives paramount importance to the CoC for ensuring completion of CIRP within the prescribed timeline, without any judicial intervention. The court observed that the legislature has intentionally not endowed the power to challenge/ question the approval or rejection of a resolution plan to the NCLT. Its power is limited to checks and enquiries under Section 31 and Section 61(3) of the Code, without the application of equity or fairness.
The position has been reiterated in the recent case of Kalpraj Dharamshi and Another v. Kotak Investment Advisors Limited and Another, where the SC also noted that business decisions on the disposition of the defaulting company are solely made by the CoC, by a majority vote. Such decisions should not and cannot be judicially intervened or questioned.
These judgments have given unabated powers to the CoC to exercise the hollow and subjective tool of commercial wisdom. Although it is mainly restricted by the objectives of the Code, this tool has no visible boundaries, checks or objective criterion to determine its limit.
Logical Flaw with Haircuts: Unabated Use of Commercial Wisdom
The recent rise in haircuts taken by the CoCs of various stressed corporate entities is directly an exercise of their commercial wisdom. While the CoC must speed up the resolution process and ensure completion of the CIRP, using their wisdom to such an extent that the stakeholders get only 99.28% of their claimed credit is problematic. Some of the flaws with such haircuts in the name of commercial wisdom can be listed as follows:
NPA and insolvency
Indian banks have long been burdened with an overwhelming number of non-performing assets (NPAs). Earlier, Indian banks were reluctant to take haircuts on their due credits, and bad loans usually sat idle for years, with no recovery whatsoever. However, the Code served as a new path through which the banking institutions could clean their credit books. Keeping up with the trend in other countries, Indian banks took haircuts on their bad loans and accepted whatever the entity was worth. This was aimed at lowering the NPAs at the cost of some loss on the revenue.
Since the CoC is led by financial creditors which primarily include banking institutions, their decisions are often motivated to clear bad loans from their books. Although it becomes beneficial for the banks to reduce their NPAs, such commercial decisions based solely on the benefit of some stakeholders while harming the others are neither equitable nor in consonance with the Code's objectives.
Pushing operational creditors into insolvency
While such haircuts are beneficial or less harmful for the bank, they often adversely harm the operational creditors. These haircuts are forced on the operational creditors who are not even part of the CoC, eventually pushing them into bankruptcy.
For instance, most of the operational creditors in the Videocon case are MSMEs. As noted by the NCLT, taking haircuts as much as 99.28% on the debts of operational creditors will eventually push these small businesses into insolvency. The authors believe such decisions can start a chain reaction of insolvency proceedings, which might put out the business of many operational creditors.
Usually, banking and credit institutions advance loans based on risk propensity. Many times, loans are based on the entity's reputation and future operational benefit without any physical assets. For instance, service or technology-based entities usually do not have any physical assets to mortgage. However, loans for entities are secured by their business operation and future growth. Financial institutions take these calculated risks, and even if such business goes into bankruptcy, taking haircuts on such bad loans will not majorly harm these institutions. In contrast, operational creditors have a lower risk propensity and often advance credit without calculating or evaluating an entity's assets or business models.
Thus cautioned by the NCLAT in the case of Binani Industries Limited and Others v Bank of Baroda and Others, forcing such huge haircuts on the credits of small businesses or operational creditors will force them into bankruptcy or lower the general credit belief in the market, where no operational creditors may supply goods or services to any corporate debtor, without any advance payment.
In the Videocon case, the CIRP of the corporate debtor and its 13 group companies were initiated vide a consolidation order, dated 8 August 2019, by the NCLT. This type of consolidation is aimed at administrating the resolution proceedings of multiple entities of a solitary group that underwent insolvency. Presently, the Code neglects and fails to deal with group insolvency in India. In the absence of a compressive framework, the 'consolidated proceeding' devised by the NCLT is essentially a band-aid solution intended to fill the legislative void. As a result, there are stark downsides of this scheme whereby creditors and lenders have taken huge haircuts on their claims.
This is because creditors extend debts to the companies as individual entities rather than a single group. They have an independent claim and remedy against each entity. However, such consolidation of debt proportionately reduces the debt owed to the creditor, thereby reducing voting shares in the CoC and impacting the decision-making during the CIRP. Even the operational creditors lose their right to attend the CoC meeting due to a reduction of shares below 10% in the consolidated debt (see consolidation order, paragraphs 33 and 71). As a result, it negatively impacts the creditors by reducing the recoveries and forcing them to take huge haircuts in the resolution plan from the common pool of assets and liabilities. Herein, such discriminatory and inequitable treatment impinges the ability of the creditor to exercise its prudence and commercial wisdom towards economically sound decisions.
During the CIRP of Videocon Industries, the NCLT questioned the confidentiality of the liquidation value and fair market value. This is because the resolution plan submitted by Twin Star Technologies valued all the assets and liabilities similar to the liquidation value of the corporate debtor.
Generally, under the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations 2016, the liquidation value and the fair market value are kept confidential and disclosed to the CoC only when finalizing the resolution plan. However, if the confidentiality is breached and the resolution applicant is made aware of the valuations before the resolution plan's approval, it would inevitably lead to a decreased valuation of the assets resulting in large haircuts for the creditors.
Accordingly, such breach of confidentiality poses a significant dilemma for the creditors wherein they have to decide whether to prolong the value depreciation of the assets by extending the proceedings to call in fresh resolution plans or whether to accept the resolution plan with a value that they would eventually get if the debtor is thrown into liquidation. Whatever be the outcome, a breach of confidentiality manifests the lack of commercial wisdom employed by the creditors during decision making.
The Way Forward
The Videocon saga has brought the issue of huge financial haircuts to the limelight. Although financial haircuts have not been confined by the judiciary, owing to the supremacy given to the commercial wisdom of the creditors, critical analysis shows that such haircuts do more harm than good. While it expedites the CIRP and keeps the proceeding within the prescribed timeline, it risks plunging the operational creditors into financial distress. These haircuts might clear the NPA, benefiting the financial creditors in the CoC, but it essentially fails to balance out the overall equilibrium of claimed debt for all the stakeholders.
In the instant case, the exercise of commercial wisdom evinces unabated discretion with the financial creditors, which is not only logically flawed but also risks harming other stakeholders. While the authors acknowledge the expertise of CoC to exercise commercial wisdom, it is also imperative to establish an objective criterion to limit the subjectivity attached to the tool. Each case must be objectively analysed on parameters that can examine the feasibility and plausibility of the commercial decision. Additionally, the commercial wisdom should not only account for the objectives of the financial creditors but also accommodate the interest of the operational creditors in each case. Therefore, it is time that CoC is held accountable for its decisions taken behind the veil of commercial wisdom.