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<div class=WordSection1>
<h1 style='text-align:justify'><span style='font-size:18.0pt;line-height:150%'>IBC:
Killed by market indifference or simply bad luck?</span></h1>
<div class="box">
<div style='border:solid black 1.0pt;padding:4.0pt 4.0pt 4.0pt 4.0pt;
margin-left:7.5pt;margin-top:7.5pt;style="background-color:#66ccff";margin-right:7.5pt;margin-bottom:7.5pt'>
<h3 style='text-align:justify'><span style='font-size:18.0pt;line-height:150%'>TL;DR</span></h3>
<ul style="list-style-type:disc">
<li>76 per cent of
the 1969 CIRPs “resolved by liquidation” (liquidation cases) between Dec 01,
2016 and Dec 31, 2022 did not receive a single resolution plan;</li>
<li>Defunct companies
made up 76.60 per cent of the liquidation cases</span></p>
<li>Operational
creditors (OC) triggered as many CIRPs--that ended in liquidation—as financial
creditors</li>
</li>
</ul>
<p class=MsoNormal style='margin-top:7.5pt;margin-right:70.0pt;margin-bottom:
7.5pt;margin-left:0cm;text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>A hypothesis: The IBC framework is increasingly being
marginalised as a direct outcome of the sub-optimal outcomes delivered in the
seven years since inception.</span></p>
</div>
</div>
<div>
<p class=MsoNormal><span style='font-size:18.0pt;line-height:150%'>In an </span><a
href="https://pradeepraje.github.io/IBC/"><span style='font-size:18.0pt;
line-height:150%'>earlier post</span></a><span style='font-size:18.0pt;
line-height:150%'>, we had analysed data for the full sample of 2707 CIRPs—closed
between Dec 01, 2016 (inception of IBC) to June 30, 2023. This sample included
</span><span style='font-size:18.0pt;line-height:150%;font-family:"Times",serif;
color:black'>i677 resolution and 2030 liquidation cases.</span></p>
<p class=MsoNoSpacing style='text-align:justify;line-height:150%'><span
style='font-size:18.0pt;line-height:150%'>The Insolvency and Bankruptcy Board
of India (IBBI) had reported in Table 2 of its quarterly newsletter for the
quarter ended March 2023 while 677 CIRP plans were closed upon approval of
resolution plan, three times the number (2030) were closed by liquidation. We had
noted in passing that CIRP plans closed by resolution had a better average
realisation of 31.8% as against 7.0% in the case of liquidation cases.</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>In this post, we map the dynamics of CIRPs that ended in
liquidation. Data is available up to December 2022, for 1969 entries; after
removing entries with NA values in critical columns, we are left with 1901
entries.</span></p>
<h2 style='text-align:justify'><span style='font-size:18.0pt;line-height:150%'>1.
Indifference or market failure?</span></h2>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>The first items that stands out in the data set is that 76
per cent of the 1969 CIRPs ending in liquidation did not receive a single
resolution plan. Data is summarised in Chart 1. The key observation here is
that an amount of ₹4.20 lakh crore over 1449 cases was valued in the
competitive market for such assets at a lower price point than the liquidation
value set by the valuer appointed under Regulation 27 of <a
href="https://ibbi.gov.in/webadmin/pdf/legalframwork/2018/Apr/word%20copy%20updated%20upto%2001.04.2018%20CIRP%20Regulations%202018_2018-04-11%2016:12:10.pdf" >CIRP Regulations.</a> Hence, not a single resolution plan.</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'><img border=0 width=480 height=480 id="Picture 1"
src="IBC_2_1.png"></span></p>
<p class="caption" >Chart 1: Distribution of liquidation
cases, by resolution plans received. Labels on top indicate amount of admitted
claims in ₹‘000 crore.</p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>A hypothesis here is that the size of the stressed
businesses--proxied by the amount of debt in default and hence of admitted
claims—is so small that competitive firms do not consider it worthwhile to
acquire such assets/businesses.</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>Chart 2 presents another facet of the data. It plots number
of CIRPs on the y-axis against bins of admitted claims. The main chart is an overall
view of the entire range of admitted claims (max: ₹53,451 cr. for Lanco
Infratech Ltd.); an expanded view of admitted claims less than ₹500 cr is
presented in the inset.</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'><img border=0 width=480 height=480 id="Picture 2"
src="IBC_2_2.png"></span></p>
<p class="caption" >Chart 2: Heavy positive skew in
distribution of admitted claims in CIRPs that ended in liquidation.</p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>An alternative hypothesis is that the small and medium
enterprises (see inset chart) have neither been able to create a market for
themselves nor are operating at optimal efficiency in hyper-competitive and
fragmented markets.</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>Or, it could be just the reverse. Perhaps, these small
businesses have done very well in their markets and have hit a growth stall due
to lack of management bandwidth/skills in combination with lack of adequate
equity or funding support.</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>This is a very interesting facet to the local dynamics of
small firms, which needs to be investigated.</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'> </span></p>
<h2 style='text-align:justify'><span style='font-size:18.0pt;line-height:150%'>2.
Defunct companies at the Pearly Gates</span></h2>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>Of the 1897 valid entries in the liquidation sample, a good
1452 companies (76.54 per cent) were defunct on the date of commencement of
Insolvency.</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>One can forcefully argue that inefficient or defunct firms
exiting the economy in an orderly fashion actually increases the overall
efficiency of capital employed. The </span><a
href="https://www.indiabudget.gov.in/budget2016-2017/es2015-16/echapvol1-02.pdf"><span
style='font-size:18.0pt;line-height:150%;color:windowtext;text-decoration:none'>Economic
Survey 2015-16</span></a><span style='font-size:18.0pt;line-height:150%'>
(Chapter 2: The <i>Chakravyuha</i> Challenge of the Indian Economy) drew a parallel
between the <i>chakravyuha</i> in the epic Mahabharta and the lack of exit options in
the Indian economy. It documented the opportunity cost of not allowing
‘creative destruction’ in an otherwise dynamic economy.</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>Equally strong is the counter argument that the large number
of defunct firms at the IBC gates, with an aggregate debt of ₹5.11 lakh
crore, speaks very poorly of the oversight mechanisms in banks and financial
institutions. No firm shuts down overnight, unless there is fraud or criminal
intent involved. The incipient signs of stress show up early in the life of the
firm. Perhaps, financial institutions have their oversight targeted at large
accounts, with the net result that no one is mind the small credits.</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'><img border=0 width=480 height=480 id="Picture 3"
src="IBC_2_3.png"></span></p>
<p class="caption" >Chart 3: Status of firms on date of
initiation of CIRP, grouped by category of initiator</p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>There is voluminous academic literature on why firms die
young. Key findings from across the world include:</span></p>
<ul style="list-style-type:disc;font-size:18.0pt;line-height:150%">
<li>Lack of management skills, specifically in financial management;</li>
<li >Inability to create moats around the business;</li>
<li>Lack of effort at building reputation capital and,</li>
<li>Finally, excessive reliance on debt to fund the growing business, without adequate equity support.</li>
</ul>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>I am rather ambivalent on the ex-post efficiency of the
Insolvency and Bankruptcy Code (2016). In the chapter ‘</span><a
href="https://www.mca.gov.in/content/mca/global/en/data-and-reports/reports/other-reports/report-company-law.html"><span
style='font-size:18.0pt;line-height:150%'>Restructuring and Liquidation’</span></a><span
style='font-size:18.0pt;line-height:150%'>, the Expert Committee on Company
Law, 2022 (released April 13, 2022) noted:</span></p>
<p class=MsoNormal style='margin-left:108.0pt;text-align:justify'><span
style='font-size:18.0pt;line-height:150%'> </span></p>
<p class=MsoNormal style='margin-left:108.0pt;text-align:justify'><span
style='font-size:18.0pt;line-height:150%'>“The Insolvency law should strike a
balance between rehabilitation and liquidation. It should provide an
opportunity for genuine effort to explore restructuring/ rehabilitation of
potentially viable businesses with consensus of stake holders reasonably
arrived at. <b><i>Where revival/ rehabilitation is demonstrated as not being
feasible, winding up should be resorted to</i></b>. Where circumstances
justify, the process should allow for easy conversion of proceedings from one
procedure to another.” (Emphasis added)</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'> </span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>This is a reasonable and equitable framework for argument.
After all the intent of the Insolvency and Bankruptcy Code (2016) is captured
in the preamble:</span></p>
<p class=MsoNormal style='margin-left:108.0pt;text-align:justify;text-autospace:
none'><span style='font-size:18.0pt;line-height:150%'> </span></p>
<p class=MsoNormal style='margin-left:108.0pt;text-align:justify;text-autospace:
none'><span style='font-size:18.0pt;line-height:150%'>“An Act to consolidate
and amend the laws relating to reorganisation and insolvency resolution of
corporate persons, partnership firms and individuals in a time bound manner for
maximisation of value of assets of such persons.”</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'> </span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>One can make an argument that “maximisation of value of
assets” includes revival/ rehabilitation of assets where feasible and orderly
disposal of the assets at maximum realisable value. But where the firm has
already ceased operations on the date of initiation of CIRP
proceedings—technically ‘defunct’—it would be erroneous, if not outright
foolhardy—to assume that maximisation efforts can lead anywhere but to liquidation.</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>A simple conceptual map of the situation suggests that if the
equity owners of the distressed firm have written down the value of their
equity to zero, no resolution plan would rationally put a real price on the
assets. There may be circumstances where the firm’s fixed assets in plant and
machinery have already been written down in the books but still command a
replacement value in the competitive markets.</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>The bulk of evidence suggests the IBC platform is being used
largely for an orderly, judicially-mediated distribution of assets of defunct
companies. It follows, therefore, that overall efficiency gains can be obtained
through a fast track exit tribunal, where liquidation is the first—but not the
only--option. Only if the CIRP attracts significant resolution plans, should
rehabilitation be considered a viable option.</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>The short point is that the CIRP process of subjecting all
cases through the same workflow for “maximisation of value,” is a waste of the
IBC platform and of judicial time. The time so saved could perhaps be used for
expeditious disposal of CIRP cases yielding resolution, bringing back the
disposal time within the prescribed 180 day limit.</span></p>
<h2 style='text-align:justify'><span style='font-size:18.0pt;line-height:150%;
font-weight:normal'>3.</span><span style='font-size:18.0pt;line-height:150%'>
Operational creditors are quick on the draw</span></h2>
<p class=MsoNormal style='margin-top:7.5pt;margin-right:62.5pt;margin-bottom:
7.5pt;margin-left:0cm;text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>Operational creditors (OC) triggered as many CIRPs--that
ended in liquidation—as financial creditors, see chart 3 above. OCs initiated
CIRP proceedings in 848 cases, compared with 849 cases filed by financial
creditors (FC).</span></p>
<p class=MsoNormal style='margin-top:7.5pt;margin-right:62.5pt;margin-bottom:
7.5pt;margin-left:0cm;text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>Without entering the realm of speculation, one can
hypothesise that OCs, being small and vulnerable to defaults in the principal
firm, pin their hopes on the promise of time-bound resolution under the IBC.</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>A corollary here is that the urgency of stressed loans on FCs
is no longer as pressing as it was in the first half of the 2010’s. The Reserve
Bank of India’s last </span><a
href="https://rbi.org.in/Scripts/PublicationsView.aspx?id=21578"><span
style='font-size:18.0pt;line-height:150%'>Report on Trends and Progress of
Banking in India</span></a><span style='font-size:18.0pt;line-height:150%'>,
2022 </span><span style='font-size:18.0pt;line-height:150%'>Chapter IV,
(‘Operations and Performance of Commercial Banks’), which</span><span
style='font-size:18.0pt;line-height:150%'> notes:</span></p>
</div>
<p class=MsoNormal style='margin-left:108.0pt;text-align:justify'><span
style='font-size:18.0pt;line-height:150%'> </span></p>
<p class=MsoNormal style='margin-left:108.0pt;text-align:justify'><span
style='font-size:18.0pt;line-height:150%'> IV.1: “The legacy challenge of
non-performing assets (NPAs) is easing, and profitability has been improving
sequentially to levels last observed in 2014-15. This has been accompanied by
lower slippages and the bolstering of capital buffers.”</span></p>
<p class=MsoNormal style='margin-left:108.0pt;text-align:justify'><span
style='font-size:18.0pt;line-height:150%'>IV.12: “From its peak in 2017-18, the
GNPA ratio of SCBs has been declining sequentially to reach 5 per cent at end-
September 2022. This decrease was led by lower slippages as well as reduction
in outstanding GNPAs through recoveries, upgradations and write-offs. And</span></p>
<p class=MsoNormal style='margin-left:108.0pt;text-align:justify'><span
style='font-size:18.0pt;line-height:150%'>IV.33: “<span style='background:white'>In
2021-22, the reduction in NPAs was mainly contributed by written-off loans in
the case of PSBs, while upgradation of loans was the primary driver for asset
quality improvement for private sector banks.”</span></span></p>
<p class=MsoNormal style='margin-left:108.0pt;text-align:justify'><span
style='font-size:18.0pt;line-height:150%'> </span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>In response to a Right to Information (RTI) query, the RBI
replied that <span style='background:white'>Banks in India wrote off bad loans
totaling more than ₹2.09 lakh crore during the FY23.</span></span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%;background:white'>Newspaper </span><a
href="https://www.livemint.com/industry/banking/banks-write-off-over-rs-2-09-lakh-crore-bad-loans-in-fy23-rs-10-57-lakh-crore-written-off-in-the-last-five-years-11690172407086.html"><span
style='font-size:18.0pt;line-height:150%;background:white'>Mint reports</span></a><span
style='font-size:18.0pt;line-height:150%;background:white'> that l</span><span
style='font-size:18.0pt;line-height:150%;background:white'>oan write-offs by
banks increased to ₹209,144 crore during FY23, compared to ₹174,966
crore in FY22 and ₹202,781 crore in FY21, as per the RTI data. <i>Banks
have been utilising loan write-offs as a strategy to reduce the burden of
non-performing assets on their books (Emphasis added).</i></span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>Indian banks are utilising the opportunity thrown up by a
combination of lower NPA build-up, higher provisioning coming out of higher net
profits to either write off stressed loans or sell off the loans to the. Asset
reconstruction companies (ARCs). Boosted by the brighter long term economic
outlook, ARCs have been aggressively scouting for opportunities in the
distressed asset space.</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>The </span><a
href="https://m.timesofindia.com/business/india-business/bad-loans-sold-by-lenders-to-asset-reconstruction-companies-rise-31-to-nearly-rs-1-8-lakh-crore-despite-ibc-option/articleshow/100911641.cms"><span
style='font-size:18.0pt;line-height:150%'>Times of India reports</span></a><span
style='font-size:18.0pt;line-height:150%'> from </span><a
href="http://www.arcindia.co.in/assets/img/ARCPerformanceMar23R.pdf"><span
style='font-size:18.0pt;line-height:150%'>ARC Association data</span></a><span
style='font-size:18.0pt;line-height:150%'> that the book value of bad loans
acquired by ARCs has risen 31 per cent to ₹756,090 crore in FY23, compared
to ₹577,807 crore in FY22. “Bankers assert that ARCs remain a viable option for
recovery due to their ability to consolidate bad loans, save management time,
and free up capital,” the news report asserts.</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>The RBI’s Report on </span><a
href="https://rbi.org.in/Scripts/PublicationsView.aspx?id=21578#CH14"><span
style='font-size:18.0pt;line-height:150%'>Trends and Progress of Banking in
India, 2022</span></a><span style='font-size:18.0pt;line-height:150%'> (<i>ibid.</i>)
reports that recoveries under the Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) and
Debt Recovery Tribunals (DRTs) yielded recovery rates comparable to the IBC mechanism.
The pre-pack insolvency resolution process, introduced for MSMEs in April 2021,
is yet to gain traction and only two cases have been admitted under the channel
so far (up to September 2022) (Para IV.40).</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'>Perhaps the promise of IBC has already outlived its
expiration date. Unless the Ministries of Law & Corporate Affairs,of Law
and of Finance put their heads together, the BC platform will deteriorate into
another legacy institution, requiring rehabilitation itself.</span></p>
<div>
<div>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'><img border=0 width=1306 height=1 id="Horizontal Line 8"
src="IBC-2.fld/image004.png"></span></p>
<p style='text-align:justify'><span style='font-size:18.0pt;line-height:150%'>Raw
IBBI data is available for download from my </span><a
href="https://github.com/pradeepraje/IBBI"><span style='font-size:18.0pt;
line-height:150%'>git repo</span></a><span style='font-size:18.0pt;line-height:
150%'>. Request attribution.</span></p>
<p class=MsoNormal style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'><img border=0 width=1306 height=1 id="Horizontal Line 7"
src="IBC-2.fld/image004.png"></span></p>
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<p class=footnotetext style='text-align:justify'><span style='font-size:18.0pt;
line-height:150%'> </span></p>
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