The modus operendi to achieve an optimum insolvency regime is to critically analyse the performance of the legislation on the basis of the effects it has on the overall business and credit market. Thus critiquing its efficiency is an important element of any codified law in a country. This need is even more imperative not only because of the number of applications under the Insolvency and Bankruptcy Code, 2016 (“Code”) but because of the increasing use of this new mechanism to achieve the enforcement of debt obligations and reorganization outside the formal process under the Code, as an arm twisting means, making it more onerous to investigate its effectiveness and efficiency.
[Sakshi Goyal is a student of LL.M (Business Laws) from the National Law School of Indian University, Bangalore and has completed her integrated LL.B from the Indian Law Society (ILS) Law College, Pune. She has also completed the course of Company Secretary from the ICSI and can be reached at email@example.com]
1. The Need and Importance of Information Symmetry
Information with the inside and outside elements[i] of any business can be considered as the lifeblood of the economy which facilitates its credit circulatory system. Information symmetry of credit information plays the same role for an insolvency regime as evidenced by UNITRAL’s Legislative Guide on Insolvency Law which establishes the key objectives for an efficient insolvency regime. It provides that an effective insolvency regime should ensure a transparent and predictable legal framework that contains an incentive for gathering and dispensing information.[ii] This will promote stability in commercial relations and foster lending and investment at lower risk premiums. The World Bank Report on the Principles for Effective Insolvency and Creditors/Debtor Regimes[iii] which provides that insolvency law should be transparent, accountable and predictable which forms the fundamental of sound credit relationships.
The Report of Bankruptcy Legislative Reforms Commission (“BLRC”), headed by Dr T. K. Viswanathan[iv] (“Vishwanathan Committee”) which formed the basis for the enactment of the Code, clearly acknowledged that the Code will enable symmetry of information between creditors, debtors and other participants. Further, it provided that the law should strive to ensure that information that is indispensable to the insolvency process is available when required, that access to this information is made available directly or through the regulated professional and access to the third parties who are to take part in the resolution process through the regulatory authority.
2. Basis for Evaluating Information Symmetry
Having observed the importance of information symmetry in insolvency and bankruptcy it is important to see the contribution of the Code to facilitating this symmetry. The efficiency of information dissemination can be evaluated at three stages in the bankruptcy process- ex-ante, interim, and ex-post depending upon the information available at the time.
i. The Ex-ante Stage (prior to the onset of financial distress, for example, when the debt contract is signed)
The underlying measures towards reducing information asymmetry have fundamentally been linked to the imperative of increasing information-sharing among creditors and especially financial creditors in order to reduce adverse selection and moral hazard between lenders and borrowers. There has been a considerable amount of theoretical studies supporting the position that information symmetry hereafter between lenders and borrowers affects financial development and helps in increasing the efficient allocation of capital. In essence, lenders are most often confronted with issues of adverse selection owing to their lack of information on the characteristics of borrowers, especially when it comes to risks associated with the investment for which borrowers want to mobilise financial resources. For example, a borrower could decide to conceal the proceeds of the underlying investment in order to reduce responsibility in the event of default or prevent repayment of the underlying debt. Such tendencies are not exclusively present in insolvent borrowers since solvent borrowers could also face the temptation of manoeuvring to avoid complying with reimbursing financial obligations associated with the loan. Ultimately, in order for lenders to caution against such risks, credits are often characterised with rationing activity and high-interest rates which have substantial adverse consequences for financial development, growth and poverty alleviation. These downsides can be limited by the sharing of information on borrowers’ solvency characteristics. In essence, the fundamental objective of increasing information sharing is to improve financial inter-mediation, efficiency and the sharing of information to boost competition and reduce information rents which could lead to more lending or financial activity.
ii. The Interim Stage (when the firm’s distress is privately known but not shared)
The interim stage thus is crucial as the distressed position becomes common knowledge, necessitating restructuring, and if this fails, formal insolvency or bankruptcy process is initiated. Referring to this stage, the creditors, managers and owners have different information regarding the firm’s liquidation and going-concern values. For example, a creditor whose claim is secured by a particular asset may have monitored its value throughout the life of the loan and have better information about its value than other creditors, or indeed the firm itself. Moreover, insiders are likely to have different information than outsiders about the going-concern value of individual divisions or the firm as a whole. Thus the interim stage of insolvency is blocked with intensive information asymmetry for which the optimum information generation is to be incentivised by the legislation or regulatory authority which enables attainment of the very thin balance between dissolving the viable business at the same time liquidating the unviable one.
iii. The Ex-post Stage (when all the information is in public domain)
Ex post efficiency would be achieved if all this private information could be without cost communicated to all creditors, managers, and other interested parties and therefore, efficient decision making could be done on the basis of complete information. An important question is whether such ex-post efficiency would also guarantee ex-ante efficiency so that optimal investment and financing decisions would be achieved both before and after the firm is in financial distress? One view is that if ex-post efficient investment decisions can be achieved without deadweight costs, then ex-ante efficiency should also be achieved. The basis of this view is that any financial reconstructing which is made in order to achieve ex-post efficiency will be anticipated at the inception of the debt contract. For example, creditors who expect to be adversely affected by such reconstructing (referred to as negative deviations from absolute priority) will demand a higher interest rate than they otherwise would. The implication is that any reconstructing or bankruptcy should not affect ex-ante optimal investment. Given this irrelevancy proposition, the role of the Code must be to promote low-cost information production.
3. Information Utilities: An Avenue for Information Symmetry
3.1. Information Utilities
An Information Utility (“IU”) is an information network which would store financial data like borrowings, default and security interests among others of firms. the Framework of IUs has originated from the Code. The utility would specialise in procuring, maintaining and providing/supplying financial information to businesses, financial institutions, adjudicating authority, insolvency professionals and other relevant stakeholders of the insolvency resolution process. The objective behind IUs is to provide high-quality, authenticated information about debts and defaults, as per the report of the Working Group on Information Utility published by the Ministry of Corporate Affairs, Information utilities are expected to play a key role in the insolvency and bankruptcy process and the system of credit as they allow storage of financial information of registered users and expeditiously process and verify information received. Moreover, the database and records maintained by them would help lenders in making informed decisions about credit transactions. It would also make debtors cautiously, as credit information is available with the IU. More importantly, information available with the IU can be used as evidence in insolvency and bankruptcy cases before the National Company Law Tribunal.
Information utilities are governed by the Insolvency and Bankruptcy code 2016[vi] and IBBI (Information Utilities) Regulations 2017[vii]. The Insolvency and Bankruptcy Board of India (IBBI) overseas aspects such as registration and cancellation of these entities, their shareholding and governance, among others.[viii]
3.2. Information to be submitted
One of the most important aspects in this is to identify what kind of information is of critical importance and should be available to ensure resolution in a time-bound manner. For example, if the creditor needs to trigger a case, they must demonstrate proof of (a) having liability against the entity, and (b) The entity having failed on a promised payment. Without this evidence, the adjudicator will refuse to register the insolvency case or defer the matter until the insolvency can be proved.
The financial information to be filed as provided under the IBC[ix] in various instances namely on default of the credit, records of the corporate debtor for the purposes of facilitating the Insolvency Professional to examine the various claims, prepare the resolution plans, examine the validity of the priority transactions and various other reason.
3.3. Positive role in facilitating information symmetry
The role of the Information Utilities is seen as information repositories for the corporate debtor which is to be submitted pre, during and even post-insolvency process which clearly establishes the area of operation as beyond the Code. The information that is mandatory from the side of corporate debtor and financial creditor regarding the debt to be forwarded as well as the various other information of the debtor clearly establishes intention of the policymaker to establish information symmetry in the market which comprehensively covers the complete life cycle of the entity as a going concerns instead of restricting it to situation of financial distress. So, if the regulators are successful in establishing this comprehensive database, it will lead to effective symmetry of ex-ante information.
With regards to the interim stage and information symmetry at that stage, the role of Information Utilities are in consonance with the information filed prior to the distressed condition and will lead to information dissemination to be properly extended.
The ex-post information symmetry is where the provisions of the IBC are silent, as it does not mandate disclosure with regards to the decisions of the creditor’s committee taken and the various instances on which such decisions are taken.
3.4. Shortcomings in the framework of Information Utilities
On analysing the various provisions of the framework that is created under IBC with regard to the Information Utilities, the same is not free from shortcomings that will hinder effective implementation of the framework.
i. The first and foremost issue that will be faced by the IUs is the overlapping jurisdiction of various regulators of the financial market which will lead to the proposed information not being filed by the incumbents. As was seen by the instance of January 2018 which witnessed the collective objection by the Banks (which are the principal financial creditors in the market) to file information with regard to their assets without the permission granted by the RBI. Though RBI has subsequently issued a directive to comply with the provisions of the IBC, the RBI is still one of the many regulators which the mandate of the IUs will be subjected to.
ii. The second issue that is faced by the IUs in their functioning will be in terms of the authentication of the information being filed by the corporate debtors. The core principle for establishing of IUs under IBC is to provide a fast-track framework of information which will have conclusive evidentiary value. But this value can be achieved only if there is a uniform mechanism adopted by the IUs to examine and authenticate the information filed with it. Currently, neither the Code nor the Regulations thereunder provide for the same.
iii. The third and the most glaring issue is seen in terms of the functioning of the Information Utilities, is the absence of provisions which makes it incumbent on the Insolvency Professionals to file the information with the IUs once the claims are established and the ex-post stage commences. This will create an imbalance between the ex-ante and ex-post information symmetry making the ex-ante information assimilation redundant as there will be no sync between the information filed and the actual market standing of the firm at the time of the insolvency process.
iv. The last issue that is to be seen as a hindrance in the functioning of the IUs in the future is the privacy concerns that will be raised by the corporate debtors and creditors due to the sensitivity of the information that is liable to be filed. The provisions on the working of the IUs and the IBC itself are silent as to how the privacy concerns will be tackled by the IUs as for the protection of the sensitive corporate data.
The Insolvency and Bankruptcy Code, 2016 has been enacted, iner alia, in the illumination of the mandate to have information symmetry in the system for effective actualization of the objectives. Thus the IBC is a novel law for insolvency in India which has paved the way for a completely new eco-system which has the traditional aspects of the insolvency with an interface with new institutions like the Insolvency Professionals (IPs), the Insolvency Professional Agencies (IPAs) and the Information Utilities (IUs) to ensure efficient and speedy resolution of distress, along with a statutory bankruptcy regulator Insolvency and Bankruptcy Board of India (IBBI) to regulate the industries as well as the resolution processes. The law is thus framed in such a way so as to achieve information symmetry but the same has yet to be achieved holistically, partially due to implementation issues and partially due to the time required to build the system effectively. Therefore, it is critical to keep track of the various avenues for information symmetry, with reference to the role envisaged under the Code at the same time analysing if the same are able to remove information asymmetry, as is the need.
[i]Inside elements being the management, employees, shareholders, etc and outside elements refer to customer, general public, government, etc.
[ii]Legislative Guide on Insolvency Law,UNITRAL, Available at: https://www.uncitral.org/pdf/english/texts/insolven/05-80722_Ebook.pdf
[iii]Report of the Working Group of World Bank, Principles for effective insolvency and creditors/debtor regimes, Available at: http://www.worldbank.org/en/topic/financialsector/brief/the-world-bank-principles-for-effective-insolvency-and-creditor-rights
[iv]Bankruptcy Legislative Reforms Commission (BLRC) report, headed by T. K. Viswanathan, Available at: https://ibbi.gov.in/BLRCReportVol1_04112015.pdf
[v]Julian R. Franks, Kjell G. Nyborg, and Walter N. Torous, A Comparison of US, UK, and German Insolvency Codes, JSTOR, Available at : https://www.jstor.org/stable/3665810?seq=1#metadata_info_tab_contents
[vi]Insolvency and Bankruptcy code 2016, Available at: http://www.mca.gov.in/Ministry/pdf/TheInsolvencyandBankruptcyofIndia.pdf
[vii]IBBI (Information Utilities) Regulations 2017, Available at : https://ibbi.gov.in//webadmin/pdf/legalframwork/2018/Oct/PDF%20upto%2011.10.2018%20IU%20Regulations_2018-10-21%2015:31:34.pdf
[viii]Sanjay Vijaykumar, Information utility under the IBC, https://www.thehindu.com/business/Industry/information-utility-under-the-ibc/article19866301.ece.
[ix]Section 3, 7, 15 and 37, Insolvency and Bankruptcy Code, 2016, Supra note 6