Diminishing fear of takeovers

The fear of losing control and ownership as a defaulter is no longer a major driver of settlement of financial overdues, as the possibility of substitution by another robust, financially sound entrepreneur has diminished. Section 29A of the code prevents incumbent promoters and persons in management who caused the insolvency to bid for their own companies. Such promoters are ineligible for the benefit of scaled-down dues of banks, financial creditors and trade creditors if they remain in management. If no suitable resolution applicant can be found in a time-bound CIRP, the scheme of the code requires that liquidation be mandatorily initiated, after the time limit of a CIRP expires.

As such, this measure ensures that businesses do not have to undergo a CIRP when it would not be value maximizing to do so. Businesses that are only temporarily facing distress on account of covid-19 and related lockdown disruptions will be protected from CIRPs. Combined with the Reserve Bank of India’s (RBI) steps to allow banks to place moratoria on the repayment of loans, this measure will help alleviate distress that is linked to temporary disruptions.

The suspension of CIRPs does not adequately address cases where covid-19 has caused deeper distress, and requires a more holistic rescue/reorganization that cannot be resolved by simply deferring repayment or deferring insolvency proceedings. By completely suspending the CIRP, the government has taken away the only tool that has proved successful in ensuring time-bound going-concern resolutions that are binding on all/heterogeneous creditors of the business, while providing a moratorium to businesses from piecemeal enforcement of bankers’ security.

Prior cases, filed or admitted before 25 March 2020, continue before the NCLT and will suffer a lack of demand from opportunist entrepreneurs wanting to take over, except in the case of distressed businesses that have rare or controlled raw materials that are valuable, or where a takeover results in enhanced control of a sector.

A question of survival

This suspension makes it harder for businesses to resolve distress early and access new finance to kick-start their businesses. On the other hand, it pushes creditors to attempt initiation of a CIRP after the suspension ends. Therefore, suspending CIRPs without an effective alternative for resolution of such defaults at best kicks the can down the road.

The RBI’s 7 June 2018 circular for informal restructuring mechanisms has its shortcomings, and very rarely does a negotiated resolution emerge. Many creditors do not come to the table, and several of them hold out by not signing inter-creditor agreements or master restructuring agreements that would bind them to decisions taken by a majority of financial creditors. Schemes of arrangement under section 230 of the Companies Act, 2013, are inadequate in the absence of a cross-class cram-down, lack of a moratorium, and delays.

Financial creditors and trade creditors cannot be rendered without remedy for a period of one year or more, as it affects their ability to operate and survive. If the government has suspended recourse to the code on the rationale it is not best suited to resolve business distress in these macroeconomic conditions, it should also address how such distress should be resolved if conditions were to persist for a longer period. Merely having a limited time suspension will not be helpful to cases where permanent long-term measures are required for resolving entrenched business distress.

As such, there is a need to provide a credible mechanism for resolution of covid-19-related distress, both until the time the suspension of the CIRP is in place, and after, when it could emerge as a preferred option for commercial players. Such a mechanism should ideally combine those features of the CIRP that are suitable for insolvency resolution in such a changed macroeconomic scenario (particularly, the moratorium, priority to interim finance and binding nature), with more flexible and less costly options for resolution (including through allowing going-concern sales of assets in a CIRP, and amendments to section 29A).

While there are reports that the RBI is contemplating the introduction of a one-time settlement scheme, it is critical to know that this scheme will not be able to do away with the need for a mechanism that can apply to those creditors that are not regulated by the RBI as well.

How this alternative mechanism is developed will be key to containing covid-19’s impact on India’s economy in the long run, and will determine how fast the economy swims to recovery.

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