IBC Tweak To Resolve MSME Bad Loans Is A Necessary Evil, But Caveats Are In Order 

If at all further evidence is needed, the amendment to the Insolvency and Bankruptcy Code announced yesterday (5 April) through an ordinance shows how core principles always fray at the edges when they crash against the hard rocks of Indian reality.

The key element of the changes, which will apply only to stressed loans in the micro, small and medium enterprises (MSME) sector, is that the defaulting promoter (partner or board or owner) can propose a resolution by finding a buyer of his choice without first handing over control to a resolution professional (RP).

While the creditors are not obliged to accept the resolution proposal put forward by the management or board (they can terminate this pre-IBC “pre-packaged” resolution plan with a 66 percent vote), the chances are many banks will opt for a resolution when the terms are reasonably good.

It does not suit banks to endlessly pursue a resolution process by using the normal route of the National Company Law Tribunal (NCLT) over small loans which they may have already provided for in their books or have the capacity to write off.

This “pre-packaged” resolution process essentially cocks a snook at a core principle underlying the IBC process, where defaulters are excluded from retaining control of their companies once a company files for bankruptcy.

After the changes, the scope for abuse of the system may be huge, for crooked promoters can then default wilfully and then ask banks to write off a substantial chunk of the loan. Or they can use related parties to buy them out, thus reducing their loan burden.

In other words, this so-called resolution may – in practice – become another form of evergreening of unrepayable loans, something the regulator has frowned upon in recent years. It may look good on bank books to have a regular loan, but the rot stays hidden.

The one safeguard is that even this bypass route for resolving MSME bad debts will need the imprimatur of the NCLT, but given the sheer number of such cases involved, it is unlikely the NCLTs will throw a spanner in the works when the creditors are okay with it.

Clearly, a core principle of the IBC is being violated or stretched by not allowing fairer and open bids for the assets in question.

But we have to ask ourselves a more basic question before we reject the just-about-tolerable workaround in favour of the unattainable IBC ideal: do we want a solution to the problem of thousands of small, stressed loans, where the economic costs of retrieval through the IBC process may well outweigh the moral hazard involved in allowing some unscrupulous promoters to get away with murder, or do we stick to principle and let the process drift towards meaninglessness?

It is best to swallow the poison of occasional crookery and let the honest multitudes revive their companies without being subjected to the time and cost delays of the IBC process.

The MSME sector has been the most negatively impacted sector in India due to the Modi regime’s drive against crony loans, tax evasion and the cash economy.

Formalisation and compliance have been the theme songs and small companies have borne the brunt of demonetisation, the goods and services tax and the Covid economic collapse. So, standing on high principle when almost the entire sector is under some degree of stress hardly makes sense.

When taxes go uncollected, governments adopt voluntary disclosure schemes which obviously are unfair to those who played by the rules. But we sacrifice the principle in favour of the practical. We are doing the same here with the pre-packaged resolution process for MSMEs.

The IBC tweak can be defended on grounds of practicality, but there is a caveat: we should not allow the core principle to be hijacked entirely by slowly extending the process to all kinds of companies, big or small. That would be a travesty – and a defeat for what is one of the Modi government’s most important pieces of legislation. If defaulters are seen to pay no costs for their mistakes, it would only encourage more crookery not less.

It is okay to work around some principle when they are impossible to implement, but we cannot end up like Groucho Marx either. He famously quipped: “Those are my principles….and if you don’t like them, well I have others.”

The IBC is okay for tweaking, but not a formal cremation where the core principle is sacrificed bit by bit.