Insolvency code is one of India’s success stories. But it now needs a new life

Insolvency and Bankruptcy Code is not immune to the shortcomings of India's justice system like delays despite being one of the key reform initiatives of the government.

20 July, 2022
The Print

The Insolvency and Bankruptcy Code (Amendment) Bill has been listed for introduction in the Monsoon session of Parliament. The IBC is one of India’s success stories. Since 2016, the IBC has managed to deal with insolvencies of 2,089 firms either through resolution or liquidation.

However, judicial discretion and delays may lead the IBC to become less effective than what was envisaged. While the Bill is a chance to breathe life into a potentially moribund legislation, the fundamental problem can only be solved through judicial reform, led by the judiciary.

IBC recognised time value of money

IBC was not the first attempt at dealing with insolvency of firms. However, it was different from previous efforts in that it recognised the damage from delays. If a firm has defaulted, then value can only be salvaged if it is taken into the insolvency process quickly. With each passing day, the amount creditors can recover becomes smaller, and capital and labour remain locked in.

The IBC recognised the time value of money and addressed it through two ways. First, it put in place strict timelines related to when a petition needs to be admitted, when a resolution plan needs to be approved, and at what point should the decision to liquidate the firm be made. Second, it reduced the scope for judicial discretion. This was done so that time would not get wasted in litigation, and courts would not get involved in commercial decisions. It was not for the courts to judge whether an outcome was valid, or fair, or optimal, as long as it was accepted by the committee of creditors. The court’s mandate was only to ensure that the correct procedure was followed.

The problem of judicial delays and discretion

According to the IBBI quarterly newsletter of January-March 2022, the average time taken from the start of the proceedings to approval of resolution plans by the judiciary is 408 days. This is a far cry from the 180 and 270-day timeline set by the law. How did we end up here?

Judicial delays are endemic to the justice system in India, and the IBC is not immune to the shortcomings of the justice system despite being one of the key reform initiatives of the government. The capacity at the National Company Law Tribunal (NCLT) turned out to be no exception with 34 vacancies on a sanctioned strength of 63 members as of September 2021. Even though the IBC was suspended in the pandemic, the NCLT was disposing of only half the cases relative to the pre-pandemic period.

The deeper problem is that of judicial discretion. On various occasions, the Supreme Court held that timelines prescribed by the legislation were only directory and not mandatory in nature, and provided for extension of the processes. The latest judgment has now reopened the question of whether an insolvency application should even be admitted — even if there is debt and existence of default. In another case, the NCLT exercised discretion at the stage of admission of insolvency cases, in contravention to the IBC. This was upheld by the NCLAT (appellate tribunal).

Courts have also allowed new applicants to put in resolution plans or older applicants to revise their plans after the due date. They have passed orders that dilute the rights of secured creditors. This has undermined the procedural sanctity of the process, and added to the delays. These are just a few examples of judgments that have opened the floodgates to exactly what the drafters of the IBC wanted to prevent.

What needs to change?

The administrative problems of vacancies and workflow are easier to resolve. Numerous articles and reports have discussed reforms that will separate court administration from judicial decision making. India has experience with process engineering in other sectors that can be deployed at courts to solve for assignment of cases, and anticipate future case-loads. Investments can be made in improving the physical infrastructure, as well as providing resources in the form of researchers and training programmes. It is unclear what the roadblocks for these reforms are, but one can hope that they will get addressed in the near future.

The Report of the Insolvency Law Committee, 2022 has made suggestions to improve timely resolution of the insolvency process. These include greater reliance on the information utility for establishing default, as well as curbing judicial interventions on issues such as acceptance of unsolicited resolution plans, or revision of resolution plans, and strict adherence to timelines for approval or rejection of resolution plans. The question to ask is if the recommendations of the Law Committee, even if they made their way to the amended Bill, will be upheld any more than the original legislation.

The judiciary perhaps finds it appropriate to intervene if it believes such intervention is in the interest of natural justice. Court judgments often end up going against the letter and spirit of the legislation. To be fair, the written law will always be incomplete, and there is a case to be made for judicial discretion. But there needs to be more engagement on the rationale and substantive content of such interventions, the incentives they lay out for various stakeholders, and the downstream effects on markets and the economy. The attempts by the legislature to find solutions to problems of the Indian judiciary are unlikely to succeed. Only the judiciary can solve this. However, it has to be first convinced that there may be a problem.

Giving up on NPS a tragedy for state govts. DB pensions are ad hoc, delay fiscal stress

Several of the problems of the National Pensions Scheme can be easily remedied. The solution to fiscal stress isn't going back two decades ago.

06 July, 2022
The Print

Several state governments in India have made the decision to exit the National Pension Scheme for their employees and go back to the Old Pension Scheme. They hail this as a move to protect the old-age income security of their employees. However, the reality is that they are postponing the current fiscal stress on finances to the future, thereby increasing the employees’ pension risk.

The two pension schemes

Till 2004, government employees enjoyed a ‘defined benefit (DB) pension’, which meant that upon retirement, they would get a pension roughly equal to 50 per cent of their last salary for the rest of their lives. And who paid for this? Ultimately, the taxpayer.

By the early 2000s, the fiscal deficit of the Union and state governments began to balloon. Policymakers began to worry that this kind of pension was not sustainable and states would run out of money. The Atal Bihari Vajpayee government at that time came up with a ‘defined contribution (DC) scheme’ — the NPS. Under this scheme, contributions by the Union government and the employee are taken, and at retirement, the employee can take one part of the accumulation as a lump sum, and another as an annuity (pension). By contributing upfront, the government would reduce its unfunded pension liability in the future.

The Union government implemented the NPS only for those joining service from January 2004. State governments adopted the same system for their employees. But this year, many state governments want to revert to the old DB scheme.

The double payment problem

A contributory system such as the NPS is a check against future liabilities of governments. However, at present, the state government(s) is paying for both sets of employees — it has a pension bill for retirees and a contribution bill for employees. The benefits of the NPS from a fiscal perspective will only be seen once current employees begin to retire. That is still two decades away.

As the fiscal position of states weakens, reversing the NPS appears attractive. States assume they can save money by discarding the NPS and deal with the pension problem when it happens. Indian states are not unique in getting cold feet as the transition from DB to DC gets underway. Several countries in Eastern Europe have also undergone reform reversals precisely because they could not escape the ‘double payment problem’. But by postponing the problem to the future, state governments are increasing the risks of DB pensions for their employees.

The risks of DB pensions

A DB scheme that guarantees a pension equal to 50 per cent of the last salary and is indexed to inflation is an attractive proposition. But there are two chinks in the armour that government employees need to think more carefully about.

A DB scheme makes promises for 50 years later. A lot can happen in this time — people may live longer than expected or macroeconomic conditions can change, such that those payouts become no longer viable. Across the world, DB plans are struggling to hold their promises and require additional funding. As employees advance into old age, state fiscal finances may deteriorate and governments may find it difficult to keep promises. Delayed pension payments are not unusual in India. And while the Supreme Court has ruled that interest should be paid in case of delay, fighting for one’s rights during old age may become difficult.

Second, governments can and do renege on their promises in invidious ways. Croatia and Belgium stopped uprating the past earnings that entered the benefit formula in line with average wage growth. Austria and Greece reduced the accrual rate, thereby lowering the initial pension. Italy, Sweden, Latvia, Poland and Norway have shifted their public employment-related schemes to an actuarial method of benefit calculation and eliminating all internal redistribution.

There has been a steady increase in the retirement age in almost all OECD (Organisation for Economic and Co-operation Development) countries. In fact, future life expectancy has gotten incorporated into the benefit formula of pension in all Nordic countries. Other such adjustments to the benefit formula, or pay increases, are a core element of pension policy across the world. In India, the increase in the DB pensions for armed forces, owing to the One Rank One Pension (OROP) policy, has been an important driver of the Agnipath scheme. It would be short-sighted to expect that Indian civil servants will somehow be insulated from the pressures that come with continuing with DB pensions.

Govt guarantee isn’t permanent

Most employees seem to think in binaries — that which is market-linked is risky, and that which is government-guaranteed is safe. There is a strong conviction that the government will never run out of money, and even if it does go through a period of fiscal stress, it will cut down expenditure on other things but continue to pay pensions on time. Past experience shows us that the guarantee is not as certain as it seems. There are risks with DB pensions as well, and these are more opaque than the risks the market poses.

The NPS does pose market risks. But as we have argued, several of the problems of the NPS can be easily remedied. It is possible that the NPS annuity will be less than 50 per cent of the last pay that the DB scheme promises. But there is no risk that the benefit formula will change, or a fiscally stressed government will not disburse pensions on time.

Giving up on the NPS would be a tragedy. States have already come halfway to reducing pension liabilities. In another 20 years, the NPS cohorts will start retiring and the benefits of the reform will begin to show.

Why Rajasthan government’s decision to return to old pension scheme is a fiscal disaster

 by Rajiv Mehrishi and Renuka Sane

We wrote in the Indian Express about the Rajasthan government decision to revert back to the Old Pension Scheme for its government employees.

(Published on 3 March 2022)