How conflicts of interests among stakeholders challenge IBC's effectiveness

Six blind men are in a room with an elephant. Each touches the animal and tries to discern its shape, size, age, and other aspects of its nature. But, being handicapped, they can only observe what is in reach which is why there is a need for an independent evaluation of the beast. 

At the heart of the Insolvency and Bankruptcy Code (IBC) of 2016 is the institution of the Resolution Professional (RP). The RP acts as the “eyes and ears” for the six blind men, providing them with an independent “right” perspective.

Experts told Business Standard that there are several fundamental challenges for RPs. These include selection of legal and financial advisers, cooperation from the existing management (of the corporate debtor), cooperation from staff and employees, coordination and consensus between lenders, claims evaluation and settlement, and what seems to be the hardest task: sourcing interim finance to keep the corporate as a ‘going concern’.

A source working on a large insolvency case said that the Committee of Creditors (CoC) should help the RP and “help empower them under the IBC process.”
 

The first major issue in the IBC process relates to how RPs are selected and appointed. Theoretically, the lead bank or the top lenders in the CoC conduct a tender process to select the RPs as well as the legal/financial advisers, based on their financial and technical know-how.

The source cited above informed Business Standard, “The CoC should understand ‘potential conflict’ between the advisers to the RP and the CoC, which may have existing or past business relations with the corporate debtor. Some of the large reputed consultancies and legal firms may have a history with the corporate debtor and yet, are still selected to advise the RP and CoC under the IBC. This may pose a conflict.” 

Moreover, the source added, “the CoC may select the lowest bidder to be the advisers to the RP and CoC, overlooking the potential conflict”. 

Experts say that the question of a 'past business relationship' is not an immediate indication of a problematic conflict, it depends on the material nature of that conflict, which is something that only the Insolvency and Bankruptcy Board of India (IBBI) can decide. Under the current IBC regulations there is a test for the "materiality" of conflict, however there may be a need to revisit the threshold. 

“The process may not have matured as all involved are still learning. However, one sees a significant improvement in the manner in which the National Company Law Tribunal has emerged in dealing with the cases and the entire IBC process. Discipline and transparency have emerged as strong pillars in the IBC resolution process,” said Khushroo Panthaky, director at Grant Thornton Advisory.

There are two over-arching roles for any RP. One is to run the company, whether it is a textile firm, steel manufacturer, chemical industrials or even a services oriented company, and the second is to conduct the Corporate Insolvency Resolution Process and hold CoC meetings.

“When you have a competent and helpful management, then managing the operations are easier for the RP. Overall, RPs have a tremendous obligation to fulfill within a tight time-frame so it is by no means an easy job. It is entirely fact-specific,” said Bahram Vakil, founder and senior partner, AZB & Partners.
 

Vakil added: “There could be thousands of companies coming into the IBC henceforth, and given that the RP has a wider range of powers in small and medium-sized enterprise insolvency cases, we need to ensure that their conduct continues to be effective.”

Ashwini Mehra, senior advisor at Duff and Phelps, differentiated between two aspects of the work: “Conducting the CoC meetings and the procedural aspects related to that is the easy part for RPs, while due diligence is difficult given that the information flow is not very good.” 
 

This was seconded by Ankur Srivastava, managing partner at EZY Laws who said:  “RPs have been given little power but all the responsibility. The biggest challenge for RPs is to manage the CoC as every decision needs to be approved by them and sometimes the representatives of the banks that are part of the CoC do not have the power to take decisions.”

This, coupled with inherent conflicts of interest among the advisers, the RP, the lenders and the promoters or management of the corporate debtor, has an effect on valuations.

“Barring a few cases, most of the bids for the defaulting companies have been under-stated either because the information is not complete or because bidders are wary of being embroiled in further litigation. Therefore, they mark down the valuation they are willing to pay,” said Mehra. 

Over the past two years the IBBI has acted swiftly against any discrepancy or process violation by the RPs. The regulator has consistently enforced fines against RPs and in some instances even stripped some of them off their licence to operate.

However, experts say more can and should be done.

Sanjeev Krishnan, private equity and deals leader at PWC, believes that since everyone is in a learning phase and since there could be genuine errors or mistakes, “It’s good that the regulator is calling out RPs for particular digressions. The sum of the fine is not as important, as the fact that they are being called out publicly which will affect their credibility and reputation and which, in my mind, is a far more effective mechanism.”

Conflict management should be the main focus going forward as systems need to be improved, he added.

“Although the regulator has done a great job so far, there is a need for a greater monitoring mechanism. We have to be very cognisant of conflict of interest and if the regulator continues to act sternly, it will be a good deterrent,” said Vakil.

The issues of conflict, which plague the efficacy of the IBC process, if not addressed by the IBBI, will continue to arise in future, especially since the code is being used by creditors, of all types, to enforce credit discipline.

Ultimately, the CoC and lead bankers need to look at the expertise of the ‘process’ advisors, the reputation of the RP and their independent thinking, in order to get better offers, in relation to their credit exposure, from prospective bidders.