Does continuation bias exist under the Indian insolvency law?

By Gausia Shaikh (REDD Intelligence) 

India’s Insolvency and Bankruptcy Code (IBC) is no stranger to allegations of what is termed “continuation bias”, with the law being critiqued for relatively high liquidations since its introduction. Continuation bias is the phenomenon of perceiving liquidation as an adverse outcome of insolvency proceedings, and consequently attempting to reach some form of restructuring for a financially distressed company to ensure that it continues to operate. This article answers the question of whether such bias in fact exists in the IBC ecosystem.

Be it the World Bank’s Principles for Effective Insolvency and Creditor/Debtor Regimes, the UNCITRAL Legislative Guide on Insolvency Law, or the Report of the Bankruptcy Law Reforms Committee (BLRC) which designed the principles underlying the IBC, it is globally recognised that there are some firms — i.e. unviable firms — which must be closed down.

When continuation bias creeps in, companies continue to survive in a state of financial distress, when they should have ideally been liquidated. Each such day of continued distress in the misplaced hope of revival, not just adds to the insolvency process costs, but more importantly, leads to value destruction of the company and its assets.

Additionally, industry experts note that liquidation serves the same economic purpose as a reorganisation — being the optimal use of resources. Liquidation of an unviable firm makes its assets and resources available for reallocation in the market. Continuation bias prevents such reallocation.

If you look at the IBC to assess its outlook towards liquidation, the text of the law checks all the boxes on paper. However, a few examples of a continuation bias have been observed in practice.

Instances of continuation bias

Under the IBC, the completion of the corporate insolvency resolution process (CIRP) without a feasible resolution plan being approved by the insolvency tribunal is a trigger for starting liquidation proceedings. However, according to data released by the Insolvency and Bankruptcy Board of India (IBBI) — the Indian insolvency law regulator — CIRPs were restarted in 23 cases as on 31 March 2024.

A restart of the CIRP was neither contemplated by policy makers in the BLRC Report nor in the text of the law itself. There is a cost to restarting CIRP, not only in terms of running the process again, but also in the form of additional value lost by the company during a second round of CIRP. 

One of the first cases where CIRP was restarted was in respect of the insolvency of a real estate developer. The CIRP was restarted in this case because of a change of classification and rights of a key set of creditors — home buyers. Importantly, it took the Supreme Court of India to use its special powers to restart the company’s CIRP. It is not known whether the restart of the other CIRPs was driven by similar special circumstances.

Additionally, it has also been seen that after passing an order to liquidate a company, such liquidation has been stopped by the appellate tribunal, to permit a look at revised bids since “it is well settled that the objective of the IBC is to revive the corporate debtor and liquidation is the last resort”. The decision of the committee of creditors is paramount and once the liquidation procedure has commenced following its decision, going back to assessing bids adds to the uncertainty and unpredictability of outcomes under the IBC processes.

The above sentiment of revival being the objective of the IBC and liquidation being the last resort has been echoed in various judicial orders, thereby prompting some level of bias. However, the devil is in the details in some of these judicial orders. For instance, when speaking of liquidation as a last resort, the judiciary is seen re-emphasising that first an attempt must be made to revive the company through the bidding process, with the last resort for resolving the company’s distress being to put it into liquidation. That said, the IBC does permit the creditor committee to initiate liquidation any time after the constitution of the committee, even before the process of seeking resolution plans.

The public interest conundrum

An argument which usually trails close behind continuation bias is that of ‘public interest’ affected by a liquidation decision. This interest is usually centred around employees losing jobs and the impact of a liquidation on businesses connected with the liquidated company. Even the ‘Cork Report’ on the English insolvency law recognises a community interest in insolvency law.

Research notes that there are economic and social issues emanating from insolvencies, such as, workers losing their jobs, traders losing customers, communities losing employers, creditors losing money, and the consequent community disruption.

While this view may hold true, the continuation of an unviable company also creates a burden on the economy and society at large. In its state of financial distress, the company is unable to pay its employees and suppliers; creditors continue to lose money; and consequently, the community sees a disruption in this case as well. Additionally, value destruction from continued distress further aggravates each of these issues. In such a situation, it is in public interest to let the company exit the market, let the erstwhile promoters explore other business opportunities, let workers seek gainful employment elsewhere, let suppliers and creditors mitigate their losses, and consequently limit community disruption in the long run.

Evidently, the conversation around public interest and insolvency laws is not straight-forward, and requires a balancing of interests affected by insolvency decisions.

Does continuation bias exist in the IBC regime?

While the above instances of continuation bias have been observed in practice in the IBC ecosystem, the data tells a different story. Data shows that liquidations far exceed restructurings under the IBC. As on 31 March 2024, 2476 liquidation orders have been passed by insolvency tribunals, while 947 resolution plans have been approved. 44% CIRPs have resulted in liquidation proceedings, while 56% have been a mix of company revivals, appeals, reviews, and withdrawals.

Further, around 77% of the CIRPs ending in liquidation as on 31 March 2024 were either defunct or placed with the Board for Industrial and Financial Reconstruction (BIFR) — the erstwhile institution established with the objective of reviving sick companies. This effectively denotes that these companies had been under prolonged financial distress, and had become unviable even before the IBC entered the picture. In fact, the IBBI notes that the economic value in most of these companies had almost completely eroded even before they had been admitted into CIRP — with the companies’ assets being valued at an average of 6% of the outstanding debt amount.

The above data leads to the inference that IBC stakeholders, as well as the judiciary, are choosing liquidation when a company is deemed unviable.

In view of the above, it can be said that continuation bias does exist in the IBC regime, but is not systemic. Instances of bias are most likely a hand-me-down of the erstwhile company law winding-up era, where a liquidation and dissolution of the company was viewed as the “death” of a company.

Conclusion and Recommendations

To ensure that instances of continuation bias are limited, substantial reasoning to justify procedural deviations such as restarting CIRP or bid-approval processes is essential. It is also advisable that the loss of value of the company and the cost associated with such deviations is estimated to be able to conduct a cost-benefit analysis of taking a divergent step.

In respect of public perception, it is essential that court orders are read, interpreted and presented in their entirety without a focus on buzz words and phrases. Advocacy focused on promoting the importance of liquidations also is required.

Additionally, there is also scope for further research to gain more clarity on the extent and causes driving continuation bias. For instance, it is possible that the absence of a developed market for assets of a company in liquidation makes the public/market prefer that a company is reorganised and changes hands retaining its low valued assets, than be liquidated. The long duration of most CIRPs makes assets unattractive to potential buyers — especially fixed assets such as machinery which depreciates daily, and assets such as land, which are surrounded by complexities when considered for sale. Consequently, it is important that a study be conducted to analyse the true status of the development of a market for such assets. After all, the argument in favour of reallocation of assets emanating from liquidations succeeds only if there is a market to absorb such assets.

Dealing with public perception on the impact of liquidations on the labour market is especially essential. An analysis of the employment of workmen and employees from liquidated companies, and their wages and income before and after liquidation might bring some level of clarity on this widely discussed issue of public interest associated with liquidations.

Lastly, as with any transformative reform like the IBC, it is essential to provide training to stakeholders and the judiciary to routinely refresh and re-emphasise key principles underlying IBC procedures and timelines. Revisiting first principles in such a manner will act as a catalyst in ensuring reduced continuation bias, such that it eventually becomes non-existent in the IBC regime.

* This article is based on the INSOL India-REDD Intelligence research paper titled ‘An analysis of continuation bias under the IBC regime’.