“Don’t shy away from liquidating ineffective companies”
An effective insolvency legislation should not shy away from liquidating ventures, M Rajeshwar Rao, deputy governor of Reserve Bank of India (RBI) recently said.
While addressing the International Research Conference on Insolvency and Bankruptcy held at IIM Ahmedabad, Rao said that when ventures are perceived to be costlier to the society, it is better to be liquidating the company to unlock the value for redeployment.
He said that while any resolution framework should prioritise preserving the value of the firm, going concern over liquidation cannot be an absolute preference.
“In case of borrowers deploying unproductive or outdated factors of production, liquidating a company can help unlock the value stuck in such ventures and then be recycled to aid more efficient and productive ventures. In the absence of ease of exit, overall production capacity in an economy will be held hostage to inefficient business ventures and prevent the economy from reaching to its potential,” the deputy governor said in his speech which touched upon several aspects of the insolvency and resolution process.
Concern about large haircuts
Addressing the concern about the high levels of haircuts that creditors have had to take in resolutions under the Insolvency and Bankruptcy Code (IBC), Rao says that such discussions miss the fact that in a public auction-based resolution model, the extent of haircut represents the discount the market demands in continuing to invest in an insolvent borrower.
“Since significant value deterioration may have happened to the assets of the insolvent borrower, comparison with the outstanding amount may not be a reasonable indicator to evaluate the effectiveness of resolution. Rather, the resolution values must be compared with the next best alternative for the creditors, which in this case is liquidation,” he reiterated.
Of the CIRP cases that have yielded resolution, financial creditors have been able to realise 166% in comparison to the liquidation value of the debtors indicating that creditors have been better-off than the next logical outcome.
He also pointed out that people often ignore the impact of the ‘threat of insolvency’ in debtor behaviour. “A key metric for assessing this impact is the number of CIRP applications that are withdrawn before admission. Till December 2021, 19,803 applications for initiation of CIRPs having total underlying default of Rs 6.1 lakh crore were resolved before admission. In the absence of the Code, it is most likely that these defaults would have lingered on for much longer, resulting in value destruction,” he said.
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