Ex-RBI gov Raghuram Rajan bats for allowing promoters to participate in IBC proceedings

Former Reserve Bank of India (RBI) governor Raghuram Rajan and former deputy governor Viral Acharya have said in a jointly written paper that the India’s Insolvency and Bankruptcy Code (IBC) needs an overhaul to improve its performance, which they say remain underwhelming so far.

The paper suggests two big changes in the way the National Company Law Tribunal (NCLT) oversees the resolution of loan defaults cases currently – first, the insolvency law should now allow the original borrower to also bid in the NCLT-run auction, and second, there should be greater use of out-of-court restructuring and the NCLT should be used to stamp the out-of-court restructuring with legal finality.

Two big changes in dealing with insolvencies

Allowing promoters to participate in insolvency proceeding: The two former RBI bankers are of the opinion that the requirement of change in management was necessary in the past because otherwise there is a strong incentive for the failed incumbent promoter to scare away other bidders and buy back his company on the cheap, thus defrauding creditors. However, this requirement makes the NCLT a poor mechanism to deal with borrowers whose firms are stressed through no fault of theirs – which is more likely to be true in case of stressed loans arising from the pandemic.

They argues that in either case, it should be up to a super-majority of creditors to approve such exceptions (from the norm that original promoters are not allowed to bid), and they would do so only if the borrower is likely to be co-operative.

Out-of-court restructuring: The two also stressed on the need to look for more out-of-court settlement of insolvency cases. “Out-of-court restructuring frameworks can be designed for time-bound negotiations between creditors of a stressed firm, failing which National Company Law Tribunal (NCLT) filing should apply.

They say that the two systems – IBC and out-of-court restructuring — need to work in tandem as the Insolvency and Bankruptcy Code’s (IBC) procedural threat serves as the fall-back, facilitating meaningful negotiation out of court.

IBC’s underwhelming performance

The two also raised concern on the underwhelming performance of IBC so far. They noted that recoveries from defaulted loans are meager, and even though recoveries have improved somewhat in recent resolutions under the Insolvency and Bankruptcy Code (IBC) to 40-45% against the low 25-30% historically, they are way short of global average.

They also raised concern over the NCLT’s limited capacity. “It already has a large backlog of cases, some of which have dragged on for much longer than the targeted duration for bankruptcy. It cannot possibly handle the volume of distress that will have to be dealt with post-pandemic without a significant expansion of the number of its judges and benches. Unfortunately, the quantum of trained personnel that is needed may simply not exist,” they noted.