Editorial: The gaps that a haircut exposed

The personal insolvency case against a media baron has exposed the structural vulnerabilities in the country’s Insolvency and Bankruptcy Code.

The specialised tribunal that adjudicates insolvency cases found itself in the eye of a major legal storm with its controversial ruling ordering an unprecedented 99.97% haircut for the lenders in the personal insolvency case of Essel or Zee group’s Subhash Chandra. The ruling sent shockwaves across the legal and financial system, and triggered a major public and social media backlash. The National Company Law Tribunal (NCLT) went on a damage control mode and constituted a five-member bench, which stayed the operation of the earlier verdict and decided to conduct hearings all over again. It also restrained the promoter from alienating assets.

The controversial ruling, which eventually could not be finalised due to differences of opinion among members of the bench, had proposed the repayment of a paltry Rs 6.25 crore against admitted claims exceeding Rs 22,000 crore. It threatened to rock the foundation of the Insolvency and Bankruptcy Code 2016, and revealed the alarming gaps and loopholes in the IBC framework and its adjudication process.

Firstly, even though most of the lenders opposed the repayment plan, the promoter and business entities related to him were able to get push for the questionable repayment plan by using the disproportionately large block of 60% voting share held by them against the dissenting institutional lenders, such as HDFC Bank, Canara Bank, Axis Bank and LIC Housing Finance, which together accounted for less than 20%.  

Secondly, the larger problem relates to the system of due diligence on the part of lenders, as they allowed the promoter to give personal guarantees for loans running into thousands of crores across several financial institutions. The legally binding guarantee became worthless when the promoter showed to the tribunal that his personal wealth was miniscule compared to the total personal guarantees given by him.

Thirdly, the insolvency code, and the proceedings under it, are vulnerable to manipulation as they lack a robust and credible system to nail the actual net worth of high-profile promoters who often use an intricate web of shell companies to park their personal wealth. The system fails in the face of the glaring difference between on paper personal wealth of a promoter and the wealth perceived to be under his control.

The framing of the issue and its sensationalist reporting by sections of media lacked nuance but it did help in creating a public furore and backlash resulting in stalling the disputed ruling. The ramifications of the case go far beyond the individual in question; they point to the serious lacunae in the code and the urgent need for reforms. The issues to be fixed include prevention of collusion by borrowers acting as a group and their abuse of the flawed voting system, the creation of a fool-proof method for verification of claims, a system for proper inquiry into the personal guarantor’s real financial position and a better method for disclosure and treatment of their personal assets.

The banking system, too, should get its act together. The fact that it has written off nearly 10 lakh crore rupees given as loans to large corporates and services in the last 12 years is indicative of the magnitude of the problem.