Critical Analysis of the Benefits and Drawbacks of CLRA: Exploring Opportunities for Enhancement
Seigunhao Haokip and Ravi Pratap Sikarwar
5th batch, PGIP, Indian Institute of Corporate Affairs
The Creditor-led resolution approach is a mechanism that combines both out-of-court and in-court interaction. It stems from the recommendations of the Expert Committee constituted by the Insolvency and Bankruptcy Board of India on February 1st, 2023. The Committee was tasked with examining the feasibility and recommending a regulatory framework for a creditor-led resolution approach for the fast-track corporate insolvency resolution process under the Insolvency and Bankruptcy Code, 2016.[1]
Introduction
The main objective of Insolvency and Bankruptcy Code is to provide a time-bound and efficient process for resolving insolvency and bankruptcy in a transparent manner. So naturally, every effort must be made by relevant authorities and all stakeholders to achieve this objective. To address distressed assets, consideration was given for introducing a progressive insolvency resolution system within the Code. This is because out-of-court proceedings take lesser time as they do not involve many formalities and litigation proceedings. The Creditor-led resolution approach empowers financial Creditors to lead the insolvency resolution process of the Corporate Debtor outside the formal judicial process, allowing for a resolution plan formulation while maximizing asset value. The proposed approach involves Financial creditors driving the process out-of-court as a committee of Creditors. Simultaneously, the defaulting company is expected to continue operating as a ‘going concern’ under its existing management.
The main aim of this initiative is to provide direct statutory legitimacy to the ‘out-of-court’ process and judicial enforceability to resolution plans approved by the creditors. This preserves the efficiency and flexibility inherent in party-driven ‘out-of-court’ initiated resolution mechanisms. What sets apart CLRA from Corporate Insolvency Resolution process, is the element of cooperation by the corporate debtor during the resolution process.
Recognizing the importance of offering alternative options for stress resolution and firm restructuring, this model seeks to enhance the financial system’s efficiency in managing insolvencies. The secret formula here is to combine an out-of-court initiated workout procedure with a robust formal insolvency process, which aims to fortify the overall insolvency system. In comparison to the recently introduced pre-pack framework, which is perceived as more closely resembling a formal insolvency procedure due to substantial Adjudicating Authority involvement, the Creditor-Led resolution approach (CLRA) has a longer span for the out-of-court process.
The proposed Framework draws inspiration from the RBI Prudential Framework for Resolution of Stressed Assets 2019. However, the resolution plan approved under the RBI Framework lacked legal sanctity as it was not binding on all the stakeholders. Therefore, the CLRA is proposed to overcome this limitation. The Expert Committee advocates for an efficient creditor-led out-of-court insolvency procedure by suggesting amendments to the fast-track insolvency process under the Code to complement Pre-packs and regular CIRP.
Stages of CLRA
Understanding the process of this framework becomes critical to analyse whether it will be beneficial for the insolvency ecosystem in India. The CLRA involves two stages, where the first stage comprises ‘out-of-court initiated’ discussions during which unrelated financial creditors of the corporate debtor explore a variety of resolution plans and may approve one such plan. In the second stage, this plan is taken for the final approval of the Adjudicating Authority which will call for objections to the proposed plan, if any.
Stage 1: Out of Court Process
Stage 1 is further divided into two steps. CLRA begins with the initiation of the financial creditors. Although no specific form or procedure is mandated, a 30-day notice period is given to the corporate debtor after the occurrence of a default. If no response is received from the debtor, the FCs may choose to initiate the process, provided they hold either individually or collectively, voting shares of not less than 51% of the financial debt of the CD. Optionally, unrelated FCs may form committees for organizational efficiency. Thereafter, the creditors can appoint an insolvency professional to oversee the process.
In the second step, the insolvency professional can approach the AA for a declaration of moratorium. Until the application for moratorium is approved by the AA, an automatic temporary moratorium is set in place. After this, the RP invites claims through public announcement, forms the Committee of Creditors, and prepares an Information Memorandum in collaboration with the Corporate Debtor. Resolution plans are invited and assessed, and through a challenge mechanism, the best plan is selected. The best plan must be approved by at least 66% of the financial creditors before it can be sent to the AA for its consideration. This entire exercise is expected to be completed in 120 days.[2]
Stage 2: Court Process
This stage is the transition of the process from out-of-court to within-court. The resolution professional files an application before the Adjudicating Authority seeking approval of the resolution plan. The application includes the CoC-approved resolution plan, the Insolvency Professional’s report, and certification of compliance with the Code and its related regulations. The AA’s scope is limited to ensuring compliance and procedural sanctity. Following this, the AA invites objections to the plan issues a final determination either approving or rejecting the resolution plan. If the plan is not approved by the AA, it shall pass an order directing the conversion of CLRA into CIRP. [3]
Advantages of CLRA
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The advantages of CLRA are manifold. Firstly, it aims to establish a unique dynamic where debtors operate with a sense of control, as this approach combines debtor-in-possession with creditor-in-control model. It helps in achieving balance, benefiting both debtors and creditors. It also preserves operations, leveraging debtor expertise for faster decision-making and cost savings. Creditor oversight fosters transparency and collaboration, leading to favourable resolutions. Furthermore, flexibility allows tailored solutions, maximizing value for all stakeholders. The structure encourages creditors to collaborate, fosters cooperation in the process, leading to swift resolutions, ultimately contributing to greater time and cost efficiency.
In the CLRA, since the role of the AA is minimal, there is a greater scope for financial creditors and corporate debtors to enter a compromise and mould the process according to their preferences. The adaptability inherent in CLRA fosters innovation and flexibility by integrating international best practices and drawing insights from experiences in other jurisdictions. This approach offers significant versatility, thereby maximizing the likelihood of satisfying both parties involved. This, in turn, helps accelerate the timelines by avoiding the tedious litigation and court processes typically involved in other mechanisms.[4]
Drawbacks of CLRA
It is indeed true that the proper implementation of CLRA holds the potential for remarkable achievements. However, there are certain drawbacks that merit discussion. Specifically, the process allows only notified unrelated financial creditors to initiate proceedings, completely excluding operational creditors and corporate debtors. This limitation implies that only a select few stakeholders can derive benefits from this process. However, this limitation is expected to be only temporary and would be relaxed over time.
The non-admission of resolution plans by the Adjudicating Authority and the subsequent failure of the CLRA process compel the AA for converting the process into CIRP. This necessitates starting the process from scratch, resulting in a significant time consumption and value-erosion.
The CLRA also lacks transparency and protection for corporate debtors and creditors, potentially raising concerns about fairness, accountability, and value maximization. This is because the process may not undergo the same level of disclosure, scrutiny, and oversight as the formal insolvency process. Individual actions such as recovery suits, enforcement of security interests, or initiation of insolvency proceedings, may disrupt the resolution process and result in value erosion, as corporate debtors and creditors are not afforded the same protections as in the formal process, in the event the AA refuses to grant moratorium.
Furthermore, concerns arise over the lack of clarity regarding the prerequisites for a valid appointment of the resolution professional as the RP himself/herself has to inform the AA about his/her appointment. The absence of a formal appointment of the RP by the AA raises questions about their status as court-appointed officers. Additionally, ambiguity surrounds the intermittent withdrawal of applications under CLRA, contributing to uncertainties in the resolution framework.
Conclusion
It is important to note that CLRA is still in its ideation stage, and it is too early to comment on how beneficial or disadvantageous it could be. However, its greatest advantage lies in its ideation stage, as it can be moulded according to the current situation of the insolvency ecosystem. The mistakes and drawbacks of existing frameworks can serve as lessons, allowing us to incorporate what we have learned from them. For instance, we can leverage the advantages of CIRP, PPIRP, and fast-track insolvency resolution process and incorporate them into the proposed framework. This was also one of the suggestions of the Expert Committee in the “Framework Report on the Creditor-Led Resolution Approach in the Fast-track Corporate Insolvency Resolution Process under the Insolvency and Bankruptcy Code, 2016”.
With regard to the pre-packaged insolvency resolution process, banks are hesitant to initiate PPIRP due to voluntary haircuts. Unlike PPIRP, haircut is the last resort in the Corporate Insolvency Resolution Process (CIRP), the (CLRA) provides creditors with the option to either opt for a voluntary haircut or resort to a haircut as the last option. In PPIRP, concerns arise regarding potential scrutiny of such decisions in the future, leading to the possibility of capital being trapped in failed units, thereby thwarting the objectives of the Insolvency and Bankruptcy Code (IBC). Voluntary haircuts result in reduced resources from the winding-up process, amplifying the potential for corrupt practices to thrive. Therefore, CLRA must also consider haircut as the last resort, as its success can be observed in the CIRP. The Expert Committee of the Framework Report on CLRA suggested learning from the implementational experience of CIRP and PPIRP under the IB Code, for which this is a perfect example.[5]
It is crucial that the best mechanisms are incorporated into CLRA if it aims to be successful in addressing many problems in the Indian economy and helping us prosper. For instance, the absence of proper regulation by the IBBI is also a significant issue. As an out-of-court mechanism, it is acceptable that the court’s oversight and intervention will be minimal. However, processes such as the appointment of a Resolution Professional must be strictly regulated by the IBBI, as there can be a scope for significant fraud and illegal activities to occur under the radar. While minimal court intervention might facilitate acceleration and offer more flexibility to the process, if not regulated well, it could wreak havoc on the insolvency ecosystem.
References:
[1] Report of the Expert Committee, ‘CREDITOR LED RESOLUTION APPROACH’ (Framework Report, IBBI May 2023) < https://ibbi.gov.in/uploads/resources/ede9252b24c28166ea95602ca3c214b1.pdf > accessed 20 february 2024
[2] Ibid, 25ff, paras 4.25-4.31
[3] Ibid, 35ff, paras 4.65-4.73
[4] Ibid, 37ff, paras 4.74-4.81
[5] https://www.livemint.com/politics/policy/why-pre-pack-insolvency-failed-to-find-takers-11663531286274.html
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