The central issue is: How can efficient and equitable price discovery be enabled for a stressed asset?
A high-level panel set up to review the functioning of the new Insolvency and Bankruptcy Code (IBC) has submitted a report that is now in the public domain. The panel is part of the government’s continuing and welcome efforts to fine-tune the operation of the IBC. Restoring stressed assets to health in a manner that balances the varied needs and rights of creditors — owners, stakeholders such as workers, and the broader economy — is an overdue task, and so the government deserves credit for constantly seeking to improve on the performance of the IBC. The central issue is: How can efficient and equitable price discovery be enabled for a stressed asset?
Under what considerations, also, can the best incentive structure be created for the current owners of the asset or company?
What is necessary is to ensure that owners put in as much effort as possible to revive a company before it reaches the IBC stage — that, in other words, bankruptcy is not be seen as an easy method of evading the requirement of repaying loans?
Efficient price discovery, meanwhile, requires a large and liquid pool of bidders for the asset. The need is to balance the requirement of a large pool of bidders with restrictions on them to ensure that promoters do not use the IBC to seek to re-acquire control of assets cheaply.
These requirements must also be balanced, in turn, with the needs of the broader economy and other stakeholders. In other words, a higher price is not always better.
The committee’s attempt to optimise within these multiple constraints has much to recommend itself. For one, the panel has recommended that the list of entities prohibited from participating in the auctions for a stressed asset be significantly reduced. It has suggested that only those bidders guilty of committing any one of a particular list of offences be barred. The list itself is to be determined later. This will restore some clarity to rules barring “offenders” from the bidding process, but much depends on the exact nature of the offences eventually put on the list.
Default will presumably be one such offence, but the list should not extend too far beyond it if price discovery is to remain effective. Other recommendations include the exemption of financial companies, which have different methods of operation, from the relevant disqualifications under the IBC.
The panel has, importantly, suggested that small and medium enterprises have the least onerous restrictions on bidding.
However, the government should resist putting in place one particular recommendation that risks undoing the committee’s other good work.
In particular, the suggestion that out-of-court settlements as to the disposal of a stressed asset are acceptable must be ignored. Allowing those who have not participated in the bidding to walk away with an asset, even if at a better price, undermines the entire IBC process as designed.
It is also just not right for bidders to enter private settlements with sellers after the end of the formal process.
Few will take the auction process seriously if they can swoop in afterwards with a better price than revealed by the bidding.
What is needed is a reform of the bidding process within a rules-based framework, for example, by allowing time-bound counter-bids. This will ensure that the maximum possible purchasers for the asset are found without subverting the price discovery mechanism.