How has the bankruptcy code played out for India Inc?

India has seen three landmark economic reforms over the last decade which—despite their flaws and need for amendments—have gone a long way in creating a better environment and producing a set of opportunities for businesses to flourish over a longer period.

These three—Goods and Services Tax (GST), on-tap licensing for universal banks, and the Insolvency and Bankruptcy Code (IBC)—have sought to improve fiscal leakages while forming a more efficient taxation framework, expand the spread of banking services, allow time-bound resolution for bad loans for lenders and provide a valve to flush out virtually dead companies.

To be sure, all of them are work in progress despite having been in operation for about five years, and the country is yet to leverage the full potential of these reforms, partly because of the way they have been implemented.

IBC as an exhaust fan

If we sit down to get a status report on the IBC, its primary objective was to harmonise the separate norms governing the insolvency of companies, individuals, partnership firms and other type of borrowers. In the past, different rules tended to act as a circuit breaker for a smooth process. They were all brought together under the IBC. The new law set an initial time-frame of 180 days within which to resolve insolvency, with an extension of 90 days if required.

Later, the overall limit or deadline for full resolution was kept at 330 days, and only to be extended beyond in exceptional cases. In a nutshell, once a corporate insolvency resolution procedure (CIRP) is initiated, it needs to show a result within a year.

So how has it fared?

If we look at the first five years, since the IBC came into force on December 1, 2016, close to 5,000 cases have been filed. Of these, around one-third are still in process and the remaining have seen a closure, either resulting in liquidation or resolution or simply withdrawn.

Data shows the CIRP filings have moderated since the Covid-19 pandemic hit businesses two years ago. While counterintuitive, this is partly explained by the interim moratorium put in place by the Reserve Bank of India (RBI) on loan repayments and accordingly what can be classified as a bad loan.

At the same time, the debtors as well as lenders also saw how the IBC was progressing and may have put an extra effort to resolve it before an impending CIRP filing.

If we look at what happened to cases that have seen a closure to date, 1,514 firms—or nearly half (46.63%)—have resulted in orders for liquidation. This entails the assets of the company being sold off to pay off the lenders.

However, around two-thirds of these were pre-existing cases already admitted under previous bankruptcy laws or were defunct with value of assets under 8% of the actual outstanding amount.

Of the rest, 714 (21.99%) have been settled on appeal or review, 562 (17.31%) have been withdrawn, and 457 (14.07%) have ended up in approval of a resolution plan.

Thus, while 1,733 cases have been settled as a going concern, 1,514 have gone for liquidation.

Entities engaged in the manufacturing sector top the chart of cases going for liquidation. This is not surprising as manufacturers also lead the chart for the creation of CIRP cases.

But there is a gap. While manufacturing entities comprise 40% of all CIRP cases, they constitute 43% of the liquidation orders. Some other sectors that exhibit similar trait of liquidation orders exceeding admission proportion include retail trade and transport.

On the flip side, real estate and construction related admissions were more than those headed for liquidation.

Who dunnit

As per the rules, three set of creditors and debtors can initiate a CIRP case: an operational creditor, a financial creditor or a corporate debtor itself can do so voluntarily. Interestingly, while it is perceived that financial creditors such as banks or non-banking finance companies (NBFCs) would be the prime driver of insolvency cases, operational creditors are the real drivers of CIRP filings.

Operational creditors are entities or persons to whom an operational debt is owed. In other words, these are creditors where liabilities arise from transactions on operations. As many as 2,527 CIRP cases, or just over half of the total cases, have been triggered by operational creditors.

Notably, who has initiated the CIRP case seems to have a bearing on what happens.

For instance, if we look at CIRPs initiated by corporate debtors themselves that have met a closure, three-fourths have ended up in the junkyard sale or liquidation. Of the cases started by financial creditors, just over half have ended up in liquidation. For cases filed by operational creditors, around 39% ended up dead.

Around a fifth of the cases by both corporate debtors and financial creditors resulted in an approval of the resolution but this proportion was far less (8%) for cases initiated by operational creditors.

If we look at the closed cases, CIRPs initiated by operational creditors topped the charts when it came to settlement on appeal or review (30%). This proportion was just half for cases started by financial creditors and almost negligible for voluntary cases filed by corporate debtors.

The operational creditors were also more flexible in withdrawing the applications compared to financial lenders.

All good? Maybe!

If we look at cases that were withdrawn, 562 in total, a bulk of these (three-fourths) were for small claims of under Rs 10 crore. Half of these were withdrawn on full repayment.

On the other hand, if we consider cases that were resolved under CIRP, they did turn out to be a better deal for the financial creditors.

The value realised by the financial lenders compared to the liquidation value of the assets as of December 31, 2021, is pegged at 165.7%. This means the lenders got around 66% more than what they could have received if they pushed for liquidation.

But it was not all hunky dory for them either. They eventually had to settle with one-third of what they were owed.