[Pratik Datta is a researcher at the National Institute of Public Finance and Policy (NIPFP)]
India experienced a major structural change with the enactment of the Insolvency and Bankruptcy Code, 2016 (“IBC”). Since then, India’s ranking under the Insolvency head in the World Bank Group’s Doing Business report has sharply risen from 136 to 103. India was also awarded the Global Restructuring Review (GRR) Award for the Most Improved Jurisdiction in restructuring and insolvency regime. Yet, the IBC has also raised various concerns, many of which could be conceptually classified under two broad categories – the value destruction problem and wealth transfer problem.
My working paper titled “Value destruction and wealth transfer under the Insolvency and Bankruptcy Code, 2016” applies theoretical concepts from the law and economics literature on insolvency to identify the sources of these two problems in insolvency law. It then applies these theoretical concepts to the IBC to identify the potential sources of the value destruction and wealth transfer problems in the law.
The paper identifies two potential sources of value destruction under the IBC. First, the law entrusts the decision about the future of a financially distressed corporate debtor with a supermajority of financial creditors, whose payoffs may not necessarily be affected by the outcome of that decision. Therefore, they may not have the right incentive to preserve the value of the business of the corporate debtor. Second, by limiting the benefits of the cramdown provision only to post-insolvency restructuring, the law delays restructuring and enhances the risk of value destruction of the corporate debtor.
The paper identifies four potential sources of wealth transfer under the IBC. First, the law does not expressly provide for judicial supervision to ensure fairness in a resolution plan adopted by cramming down the minority financial creditors. Consequently, until 5 October 2018, a resolution plan that paid only the break-up ‘liquidation value’ to such dissenting minority financial creditors would have been perfectly legal under the regulations and had to be approved by National Company Law Tribunal (NCLT). This created potential risks of wealth transfers from dissenting minority financial creditors through resolution plans. After 5 October 2018, in the absence of a specific valuation benchmark for dissenting financial creditors in the law or regulations, it remains to be seen what valuation benchmark could be successfully used in this regard. Second, the regulations before 5 October 2018 used the break-up ‘liquidation value’ instead of going concern ‘liquidation value’ as the benchmark for restructuring of a financially distressed company, reducing the valuation of the claims of the dissenting minority financial creditors in the restructured company. After 5 October 2018, in the absence of a specific valuation benchmark for dissenting financial creditors in restructuring cases, it remains to be seen what valuation benchmark could be successfully used in this regard. Third, the law incorrectly applies the ‘liquidation value’ benchmark used in restructuring to going concern sales for cash to third parties, creating opportunities for wealth transfer from operational creditors to junior claimants in such sales transactions. Fourth, the appointment process of registered valuers could create scope for strategic valuation favouring wealth transfer to majority financial creditors.
The Indian policymakers need to revisit some of the fundamental legislative design choices embedded within the IBC to successfully address these very sources of the value destruction and wealth transfer problems.
– Pratik Datta