Conflict of interest in resolution plans may erode IBC credibility

In February, a resolution plan for Sharon Bio Medicine was approved by a bankruptcy court wherein lenders would receive Rs 230 crore against dues of Rs 702 crore. Ideally, secured lenders should have rejoiced, considering if it had gone into liquidation, they would have received just about Rs 175 crore.

A closer look at the resolution plan shows that of Rs 230 crore, only Rs 10 crore would be paid up front, but over 6-8 weeks after all regulatory approvals. The remaining was to be paid over 10 years. That’s not all. There would be moratorium of 12 months on interest payment and 24 months on principal payment. Lenders would have to swap Rs 300 crore into equity and write off the balance loan.

For unsecured creditors with exposure of Rs 188 crore, the settlement amount was Rs 184 crore, although all of it was swap of debt into equity. The haircut was minimum and they had equity upside. Yet, 93% creditors approved the plan — an even bigger surprise. The plan so skewed in favour of unsecured creditors is mainly because one of them, FCCB holder Peters Beck & Partner, had submitted a resolution plan that was approved. FCCB holders contributed 28% to the vote and themselves voted in favour of the plan submitted by them.

Requirement for a proposal to be supported back in February was 75% of votes in favour of a plan. Thus no other plan would have sailed through without them endorsing it. Also, they were not solo bidders. There were seven non bidding bids and four shortlisted. This clearly shows conflict of interest where bidders have the veto power to approve or reject a plan by virtue of being a member of the committee of creditors.

Experts say that if many such cases keep coming up, the credibility of the Insolvency and Bankruptcy Code will be questioned and many cases could face litigation, delaying resolution. “The resolution professional (RP) or RP’s counsel should have discretion to determine conflict of interest. But where there are instances of allegation against the RP itself, these should be decided by the committee or creditors or appellate authority,” said Eshwar Karra, CEO of Phoenix ARC.

Conflict of interest occurs when an entity is in a position to exploit its official or personal capacity in some way for personal or corporate benefit. The regulator, Insolvency and Bankruptcy Board of India (IBBI), has so far not issued any guidelines or a code of ethics on this matter yet. The most recent case of conflict of interest was the Adani-Wilmar-Ruchi Soya deal where Cyril Amarchand Mangaldas (CAM) was the legal counsel for both the resolution professional and bidder Adani Wilmar, which was eyeing the bankrupt edible oil company.

As a midway solution, CAM resigned as advisor of Adani Wilmar and lenders appointed their own counsel Luthra & Luthra to ring fence against any allegations of being imprudent. “We don’t have a say on whom the RP wants to appoint as their legal counsel, but we can have our own counsel to advise us,” said a bank official.

Similarly, there have been instances where four bidders were advised by the same legal counsel in a recent case that is mired in litigations. There are other cases where lenders have provided interim finance to one of the bidders and there is yet another case where a subsidiary of a lender is advisor to a bidder.

“Ideally, in the first meeting, all the participants- the committee of creditors, the resolution professional, the counsel for the RP and the lenders- should make upfront disclosures about their links with the company if any in the past and their interests. Similar disclosures by the bidders should be made in the later stage as well,” said M R Umarji, former executive director of the Reserve Bank of India and architect of the Insolvency and Bankruptcy Code.

“This way everyone is aware about the interest of the other party in rejecting or accepting a plea. This is followed in some jurisdictions overseas and it could be a good start here as well,” he added. Inadequate disclosure can be a strong dent on the reputation of the company involved. In the recent days, ICICI Bank CEO Chanda Kochhar had to proceed on forced leave on grounds that adequate disclosures about her husband, Deepak Kochhar, dealing with loan defaulter Videocon were not made.

Lenders said that for resolutions under IBC, there will be many more instances of conflicts of interest, particularly at the RP level. For large accounts, most banks prefer an RP who is backed by large firms since they have to adhere to strict timelines. Since there are a handful of large consultancy firms such as EY, Delloite, BDO, KPMG and RBS who have been auditors and advisors for very long time are now dabbling as administrators for the bankrupt companies, there will be conflicts as some who acted as auditors are now acting as administrators investigating if there were diversions of funds or related party transactions.

Veteran banker K M Jayarao, who is executive chairman of Ambit Flowers ARC and was senior general manager of ICICI Bank, said: “The buck stops at the committee of creditors. They should be taking a final call on how to sort out conflicts among parties without prejudice.”