Another IBC fix? (On a Code of Conduct for CoC)

Synopsis: Regulator’s proposal for code of conduct for the Committee of Creditors (CoC) deserves scrutiny.

Introduction

The Insolvency and Bankruptcy Board of India (IBBI) has issued a discussion paper on the corporate insolvency resolution process and invited comments on its suggestions.

What is the issue?

CoC is unregulated, since the members of the CoC are typically from highly regulated sectors such as banks. However, lack of regulation has led to lack of accountability. For instance,

Recently, Appellate authorities have raised questions about “capacity and conduct” of the CoC, and its responsibility when it comes to choosing the proper market-based resolution.

Even, the more recent IBBI’s discussion paper has stated that the committee of creditors (CoC) looking after the IBC process “functions in an unregulated environment”.

What are the IBBI’s recommendations in its discussion paper?

Code of conduct for the CoC: The IBBI paper proposes a code of conduct for the CoC that it claims will create accountability, through broad ethical principles. It is in line with the suggestion made by the Parliamentary Standing Committee on finance that suggested a code of conduct for the CoC recently.

Effective bidding process: The paper further points out the frequent revisions of the resolution plans that have caused “delay and uncertainty” and argues that new bidding processes such as the Swiss Challenge should be used. (Under the Swiss challenge mechanism, any third party would be permitted to submit a resolution plan for the distressed company. Then, the original applicant would have to either match the improved resolution plan or forgo the investment.)

Why a code of conduct is needed?

Some actions by CoCs in the past show how their accountability to their investors might clash with the overall interests of the IBC. Such actions include the acceptance of last-minute resolution plans and of one-time settlements by former promoters under Section 12A of the IBC etc.

Why a code of conduct might not be the solution?

It is far from certain whether a code of conduct would speed up the insolvency process or lead to further delays, as the CoC might be challenged at any time for failing to follow some aspect of the code.

While principle-based regulation is better in theory, in practice there might be some concern that it would lead to regulatory creep (Regulatory creep arises when the rules are unclear – when there is confusion about the standards, guidance and regulation. People are left not knowing what is expected of them, what constitutes compliance with the law).

Further, a code of conduct for CoCs that is often dominated by public sector banks runs in conflict with a more basic problem of accountability –  Banks themselves are only insufficiently accountable because of state control.

What is the way forward?

IBC has been undermined because of misuse of clauses such as Section 12A. It is a reflection of the poor governance within the banks that led to the growth of bad loans in the first place. A code of conduct might be one step towards improving the IBC, but until bank governance is addressed it will not fix the real problem.

Source: This post is based on the article “Another IBC fix? “ published in Business Standard on 6th September 2021.

Terms to know:

• IBBI