Thursday, September 21, 2017

Gaming the rules - the case of India's Bankruptcy Code

I had blogged earlier about the challenges associated with the effective implementation of the Insolvency and Bankruptcy Code (IBC). In particular, I had alluded to the likelihood of capture of the valuation agency, Insolvency Resolution Personnel (IRP), Insolvency Professional Agency (IPA), and the Insolvency and Bankruptcy Board of India (IBBI) and the round-tripping of assets back to promoters. 

Well, on the face of it, both concerns appear to have materialised in the very first case settled through the process! 

The resolution of Synergy Doorays is nicely described by Debashis Basu here. The modus operandi is simple. Get proxies (of the promoter) to submit Resolution Applications (RAs). Get another proxy as the majority debt holder in the Committee of Creditors (CoC), by either cutting a deal with the majority creditor or transferring the major share of loans to that creditor. Then force down massive haircuts. And if you can capture the IRP, an easy picking on most occasions, then everything becomes all the more easy. There will be small sub-plots that vary with cases, but the script would more or less remain the same. Welcome to the real world of implementing IBC!

I am not one bit surprised and and will not be surprised if such subversion becomes the norm. In fact, I would surprised if it does not become so, especially if we stretch the system with too many cases to start with. After the first blush of cases occupy the handful of good IRPs and resolution agents and the limited market size in stressed assets buyers starts to bind, gaming will become easier still. 

Why shouldn't it be the case? Consider the ingredients. Very high stakes. Resolution institutions populated by existing market participants, many of whose reputations were never covered in any glory. Weak institutional capacity. Government agents prone to being captured. Promoters desperate to retain control.   

In this milieu, it is very difficult to expect institutional integrity, of both private and public participants, to remain unscathed. 

Though I have not examined the procedures in detail, it does appear that there were no clear technical and financial qualification norms for the RAs or norms that govern creditors and transfers among them. Let's face it, these playbooks are pretty well known and at least some of these egregious violations could have been avoided.

But a more effective approach to ensuring effective implementation of such regulations is to have the approach explained here and here. Get the best possible version of regulations out, and then keep  resources and personnel ready to respond swiftly and credibly to emergent problems. A few iterations and with good luck, you could potentially have settled on a good and practical set of regulations. Easy to do? Yes, in theory. But requires leadership and professional competence of a very high order. Unfortunately, both very scarce resources.

This is also a teachable moment in making regulations. There is no point in having state-of-art regulation if the real world in which it has to function cannot be expected to bear them. What is the use of grafting an elaborate insolvency architecture if its implementors are most certain to be seriously compromised? Wouldn't second-best options have been better? Or maybe, we should just graft state-of-art regulations and then hope that things mature and fall into place in a couple of decades? Or, and I really hope so, I am being very pessimistic!

Update 1 (14/09/2017)

Bloomberg Quint and Andy Mukherjee have more on the details of the transaction.


Dipen said...

This is all too complicated and hence open to subversion. Why not just recover overdue money by seizing promoter assets? After all they mostly provide personal guarantees for loans...

Pratik Datta said...

You are right when you say that "these playbooks are pretty well known". However, these rules can't just be lifted from a foreign jurisdiction and fitted into the Indian context. It requires tons of hard work to figure out how to connect these new rules with the rest of the Indian legal system so that they have the intended effect. If you look at US, there is an army of legal academics and researchers who work on drafting restatements and model laws. The skill sets required to do this job is very different from the contract drafting skills of private law firms and practicing lawyers. The Indian government and regulators need to realise this and invest in developing these skill-sets within Indian legal academic/research institutions. Outsourcing regulation drafting to private firms is not a long term solution!