Big businesses get buyers but medium and small businesses generally go through liquidation, which is why the government brought in a new alternative informal resolution scheme for small businesses, which is called pre-pack scheme.
The Parliament amended the Insolvency and Bankruptcy Code in August 2021, providing for a pre-packaged insolvency resolution mechanism for micro, small and medium enterprises (MSMEs). Though the government says there will be a better way for business rescue, the IBC 2021 has ironically exacerbated the fear among corporate borrowers across the board.
The core philosophy of bankruptcy codes the world over is to facilitate liquidation of financially unviable companies, and to protect the rights of creditors and other stakeholders, which includes borrowers too. IBC has indeed sent the message that corporate borrowers cannot get away with defaults and take the system for granted. At the same time, it has failed in instilling positive bias among borrowers, which is essential for business revival. In the current form, the IBC is tilted towards liquidation rather than revival.
One of the factors that defeated IBC’s purpose is the delay caused by litigation. In business, the time value of money is huge and delays caused by litigation and procedures could dearly cost the lenders. The average time taken to resolve the cases is 459 days, which is higher than the stipulated 180 days.
This has raised concerns that the high percentage of liquidation, after companies failed to get viable plans, will be on the rise. As many as 1,277 of the total 4,376 companies undergoing insolvency proceedings have been liquidated so far. That is 30 percent of all cases, instilling fear among promoters of companies facing financial distress.
The scale of many businesses is very small. Unless and until the government permits entrepreneurs to bid for their businesses, the recovery is going to be very poor. If handled well, a lot more businesses can be revived under IBC.
If corrections like offering pre-pack schemes, not only for mid-sized but also for large businesses, and allowing existing management to bid for business unless they are directly implicated in fraud or siphoning of money, are made, it will help improve the outcome. Debtor in possession is a good choice for India. Creditor in possession is not working as proved by past instances. Also, companies should recognise that the risk of financial stress will always be there and the stigma of debt resolution and restructuring which makes people delay decisions has to go.
Big businesses get buyers but medium and small businesses generally go through liquidation, which is why the government brought in a new alternative informal resolution scheme for small businesses, which is called pre-pack scheme. The fortunes of individual sectors keep changing.
Earlier there were few takers for the metal sector but now interest in this sector has gone up due to the commodity supercycle. Three years ago, there was not much interest in the pharma sector, but now there is a lot of investor interest in this industry. The size of the business also matters. A one million plus tonne capacity steel plant is more likely to get a buyer than a 200,000 tonne plant. It depends on the viability of the business.
In nutshell, the high liquidation rates and huge haircuts have undermined IBC’s possible success. Unless there is a complete overhaul of the present mechanism, business recovery will be retarded in the face of the ongoing economic slowdown caused by the pandemic.
Source: Business World
