## Thursday, April 11, 2019

### The Indian bankruptcy reform: old defaults vs. recent ones

The Insolvency and Bankruptcy Code (IBC) was enacted in 2016. At the time, there were a large number of zombie firms in the Indian landscape, where the first default had taken place a while ago. This motivates a question: Does the IBC perform differently when confronted with a recent default, compared with the outcomes obtained when dealing with legacy problems? In what form does the difference manifest itself?

Our prior is that old cases would fare worse, for two reasons. First, there is a selection bias. The defaulting firms who were relatively stronger, are more likely to have found a solution through successful private negotiations. The survivors are likely to be the zombie firms who would be in bad shape. Second, a firm that defaults is a melting ice cube. Every day, value is destroyed. The very fact that the default in these old cases took place a while ago suggests that substantial value destruction may have taken place. In a sound bankruptcy process, the firm is brought to the insolvency resolution process rapidly, which increases the chances of rescuing a viable business under a new ownership and balance sheet. These old cases did not have access to a sound bankruptcy process, until now.

If such a phenomenon is at work, the unconditional performance of the IBC (example, example, example) will tend to be understated. The correct measure of how well the IBC works should then be seen by restricting the analysis to recent defaults only.

In this article, we show some early small sample evidence, where IBC outcomes of old and new defaults are compared. We look at two metrics: the final outcome (liquidation or resolution), and in the class of firms that did go through a resolution, the time taken and the recovery rate. We find that a larger proportion of the old, legacy cases were liquidated. Median recovery rates were lower for the old cases that did go through a resolution compared to the more recent cases. However, there was no difference in time taken to complete the IRP process.

### Institutional setting

We do not have access to the date of default. This information is not disclosed by either the National Company Law Tribunal (NCLT) or the Insolvency and Bankruptcy Board of India (IBBI). We identify old cases as those where resolution began under the Sick Industrial Companies Act, 1985 (SICA) and have remained pending at the Board for Industrial and Financial Reconstruction (BIFR).

With the repeal of SICA, the Eighth Schedule of IBC explicitly provides for the abatement of the existing SICA cases pending at BIFR and Appellate Authority for Industrial and Financial Reconstruction (AAIFR), with an option to re-initiate them as new cases under IBC.

### Data

We use two sources of data. The first comes from the IGIDR Finance Research Group's (FRG) database on bankruptcy. The dataset contains all unique debtor firms from January 1, 2017 till December 31, 2018. This provides us a macro picture on the number of liquidations and resolutions of BIFR and non-BIFR firms.

The data on resolutions is sourced from the IBBI which has obtained the information from resolution professionals. In this databse we see 82 firms where resolution plans have been approved by the NCLT as of December 31, 2018. This is the most recent data available as of now. We remove the outliers from our sample, where the realisation amount exceeds the total amount of claims filed. This gives us a dataset with 72 cases. An interesting feature of this data is that the BIFR cases are smaller, with a mean liquidation value of Rs.1.75 billion, as compared with the mean liquidation value of Rs.6.25 billion for the non-BIFR firms.

### Q1: Do we see more liquidations of BIFR firms?

According to the FRG database, there were 1000 ongoing cases of bankruptcy. 304 firms had been liquidated while 79 had undergone resolution. Table 1 provides a break-up of BIFR and non-BIFR firms depending on their resolution status.

 Legacy (BIFR) cases Fresh (non-BIFR) cases Liquidation 220 84 Resolution 28 51

This suggests that most of the firms that had been in BIFR and that came to IBC, went into liquidation. This is not surprising as substantial value destruction would have taken place just by being in the process for many years, and it is highly unlikely that these firms had any value as a going concern.

### Q2: Do we see a difference in time and recovery rate of the approved resolutions?

Using the information from the IBBI dataset, we calculate the average recovery rates and the average time taken for the legacy (BIFR) and recent (non-BIFR) cases, as shown in Table 2. The recovery rate is estimated as the ratio of the realisable amount and admitted claims of the respective classes of creditors (FCs and OCs). This is not calculated on a net present value (NPV) basis and hence needs to be interpreted accordingly. We do not have access to information on realisable amount on an NPV basis.

Table 2: Comparison of BIFR & non-BIFR cases: Time and Recovery

Legacy (BIFR) cases Fresh (non-BIFR) cases
Number 24 48
Mean time to resolve (days) 311 311
Median time to resolve (days) 282 282

Mean recovery rate (%) 46.23 47.63
Median recovery rate (%) 32.69 42.77

Mean recovery rate of FCs (%) 45.57 49.01
Median recovery rate of FCs (%) 35.70 42.75
Mean recovery rate of OCs (%) 36.04 35.44
Median recovery rate of OCs (%) 11.92 19.84

The main feature of these results is that the sample means and the medians of the two groups are rather alike on a number of parameters. The average and median time taken to resolution is the same for the two groups. The mean recovery rate is around 47% for both groups. There is, however, almost a 10 percentage point difference in the median recovery rate - once again not surprising given that BIFR firms are likely to have seen significant value destruction before they came to the IBC. The same pattern is repeated when one looks at recovery rates of financial and operational creditors between the two groups of firms.

### Conclusion

Our prior was that the legacy cases have been festering for long and hence have experienced prolonged value depreciation, and would therefore see different outcomes than fresh defaults. We find the difference in the form of more liquidations of the legacy firms, and significant differences in liquidation value, and median recovery rates. We, however, do not find any difference in the time taken to complete the insolvency resolution process. This could be because the legacy cases which were in worse shape went into liquidation and those that remained in IRP were not very different in nature compared to the recent defaults.

This also motivates thoughts for further research. Will this result hold up with stronger datasets that maybe visible in a year or two? This kind of analysis, conducted on a bigger dataset spanning a few years post IBC, is likely to give a more realistic picture of the performance of IBC as opposed to analyses which view the legacy and recent cases from the same perspective.

The authors are researchers at NIPFP and IGIDR respectively.

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