In the overall IBC scheme of insolvency resolution, the CoC has a pivotal role. The robustness of the resolution plan hinges upon the integrity and competence of the CoC. But are CoCs are up to the job? There have been, in the recent past, cases that have cast aspersions on CoCs’ conduct.
Former chairman, SEBI
One of the significant attributes of the Insolvency and Bankruptcy Code (IBC) that differentiates it from earlier insolvency resolution regimes include the resolution professional taking over the running of the corporate during the resolution process under the supervision of a committee of creditors (CoC), which takes a call on the commercial aspects while approving the resolution plan.
In the overall IBC scheme of insolvency resolution, the CoC has a pivotal role. The robustness of the resolution plan hinges upon the integrity and competence of the CoC. But are CoCs are up to the job? There have been, in the recent past, cases that have cast aspersions on CoCs’ conduct. Regulation 38 (IA) of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 states that a resolution plan shall include a statement as to how it has dealt with the interests of all stakeholders, including financial creditors and operational creditors, of the corporate debtor. As of now, a CoC comprises financial creditors of the corporate debtor. Operational creditors (or their representatives) with dues not less than 10% of debt also form a part of the CoC.
However, voting is limited to only financial creditors, with operational creditors left out. Some have argued that secured financial creditors may prefer to liquidate a distressed business if, as per their assumptions, the present value of the expected returns from continuing the business is likely to be less than their payoff in immediate liquidation. This is despite the possibility that sustaining the business may have fetched a better overall outcome, and the operational creditors, employees and minority shareholders may have had a differing perspective. This short-termism could be a potential source of value destruction under IBC.
First Among Equals
It is globally accepted that secured creditors have priority over unsecured creditors, equity shareholders and other stakeholders. This rule of absolute priority is also provided by IBC under the waterfall mechanism, where the sale proceeds or liquidation value are distributed to creditors in the order of their seniority, junior creditors and shareholders often getting wiped out.
However, in the recent past, the case of bankruptcy of car rental company Hertz under Chapter 11 of the US Bankruptcy Code has raised some fundamental concerns regarding the concept of absolute priority. It is argued that absolute priority distorts the incentives of those in control of the bankruptcy process, as it may lead them to push for ‘fire sales’, thereby shifting ownership of that bet to one class of creditors. Few are of the view that a coherent bankruptcy system could exist with ‘relative priority’ in which junior investors (equity holders) are allowed to recover their option value even if senior creditors are not paid in full, by a stake in the reorganised firm, or a warrant exercisable at future date.
Clearly, there is a need to bring about necessary balance in the CoC’s composition. It should comprise all the creditors – both financial and operational – having voting rights in proportion to their due amounts. Addressing the concerns of minority shareholders is tricky. Perhaps, minority shareholders could be given an opportunity of being heard by the CoC while finalising the resolution plan – one authorised representative each of retail and institutional shareholders may be permitted to participate (without voting right) in the CoC meetings.
Pick and Choose
The method of selecting an authorised representative of retail and institutional shareholders may be prescribed by the Insolvency and Bankruptcy Board of India (IBBI). If the CoC overrules any objection raised by the shareholders to the resolution plan, these may be recorded in the minutes, along with the reasons for not considering them, which may be placed before the National Company Law Tribunal (NCLT). While NCLT may not have jurisdiction over CoC’s decision, such public disclosure may impede the CoC’s discretion by CoC while taking a view on such matters.
Wherever the resolution plan of a listed company involves its delisting, or all the equity value is getting extinguished, the resolution plan may provide for an opportunity to the minority shareholders to participate in fund-raising after resolution within the near future in a manner does not impose any cost on the entity.
The need for having a code of conduct for creditors in the CoC has been under discussion for quite some time now, including in an August 2021 IBBI discussion paper (bit.ly/3wUpnca). The code should be finalised at the earliest and come out in the form of a regulation from IBBI, or even by suitably amending the IBC. The IBBI should be the enforcing authority for such a code, no matter that the creditors may be licensed and registered with other regulators. In serious cases of creditors’ misdemeanour, IBBI could even refer the matter to the concerned principal regulator to consider cancelling licence or registration.
Criteria for IBBI intervention may include cases where the approved resolution plan involves haircut to creditors beyond a certain threshold, or where the concerns of other stakeholders have been ignored by the CoC with no valid reasons. In such cases, IBBI may get the resolution plan evaluated by an independent valuer, or even commission concurrent audit. Once a credible code of conduct for CoCs is put in place, such intervention by IBBI should become rare.