In the Insolvency and Bankruptcy Code, 2016 (IBC) haircuts in the resolution plan is the difference between the amount creditors claim and what they receive. It essentially signifies the amount the lender has to “cut off” from their claim due to the company’s inability to fully repay their debts. Critics argue that high haircuts can discourage lending and hinder the effectiveness of the IBC process, as lenders may be less willing to extend if they anticipate significant losses in insolvency situations.
Understanding haircuts in the resolution plan of IBC
What is a Haircut in Insolvency Proceedings?
“Haircut” refers to the significant loss creditors experience when a distressed company is being resolved when the approved resolution plan offers a lower repayment than the total debt owed. For instance, if a company defaults on a ₹1,000 crore loan and the approved resolution plan offers only ₹250 crore, the haircut is 75%, as creditors recover just 25% of their dues. haircuts in the resolution plan are often necessary in insolvency proceedings because the company’s assets may not be sufficient to fully repay all creditors, forcing them to share the losses proportionally.
Key Statistics on Haircuts in IBC Cases
According to recent reports in 2024, creditors experienced a significant “haircut” of around 73% in the financial year 2024. This marks a significant increase from the 64% haircuts in the resolution plan seen in the previous fiscal year. This indicates that creditors had to accept a substantial reduction in the amount they were owed during the corporate insolvency resolution process (CIRP). Some high-profile cases have seen haircuts as high as 96% which raises concerns over the effectiveness of IBC in debt resolution.
Why Are Haircuts Rising in IBC Resolutions?
Delays in the Resolution Process:
The IBC mandates a 330-day deadline for CIRP, but many cases stretch beyond 2-3 years, leading to asset deterioration and lower recoveries. The average time taken to resolve an IBC case has been increasing significantly, allowing for further deterioration of a company’s assets and reducing the potential recovery for creditors.
Lack of Competitive Bidding:
Where there are few or no bidders competing to purchase assets of a company undergoing proceedings under the IBc, this results in potentially lower sale prices and less optimal returns for creditors due to a lack of market competition for the assets benign sold. Stressed assets attract only 1-2 bidders, leading to lower offers and poor price discovery.
Asset Value Erosion During CIRP:
In some cases, the valuation of a company’s assets may be inaccurate or not reflect their true market value, resulting in lower recovery for creditors. Further, prolonged litigation leads to falling business valuations, forcing creditors to accept deep discounts.
High Debt Levels & Weak Business Models:
Many insolvent companies have over-leveraged balance sheets and business models that are not viable, making full recovery nearly impossible.
Suggested Reading : Handling Disputed Claims During CIRP
Promoters’ Role & Legal Hurdles:
Promoters have a crucial role in attracting potential investors to revive the corporate debtor. Legal challenges by promoters often delay the process, reducing asset attractiveness for bidders. The fear of large haircuts in the resolution plan could discourage lenders from providing credit to companies with higher risk profiles.
Impact of Rising Haircuts on Creditors & the Economy
Financial Stress on Banks & NBFCs:
High haircuts in the resolution plan on bad debts can significantly impact the profitability of banks, potentially leading to reduced lending capacity and impacting the overall banking sector. Banks face heavy losses due to poor debt recovery which can affect their ability to offer fresh credit.
Suggested reading : Role of Special Economic Zones in the Insolvency Process
Weakening Investor Confidence in IBC:
Frequent large haircuts can erode investor confidence in the insolvency resolution process, discouraging potential lenders from participating in future CIRP. Both global and domestic investors become hesitant to participate in distressed asset acquisitions.
Preference for Out-of-Court Settlements:
Encouraging proactive debt restructuring before companies become severely distressed can lead to better outcomes for creditors. Creditors are increasingly favoring private debt settlements to avoid massive losses under CIRP.
Judicial Trends on Haircuts in IBC Cases
The Essar Steel case was a landmark Supreme Court ruling in 2019 that upheld the Committee of Creditors (CoC) authority to decide how to distribute funds to creditors in insolvency resolution processes The ruling also clarified that creditors cannot be treated equally if they are not in the same class. This case highlighted the CoC’s right to approve resolution plans, even with high haircuts.
Policy Recommendations to Reduce Haircuts Under IBC
- It is recommended that the IBBI enforce strict adherence to the 330-day time limit to complete the insolvency process to prevent asset depreciation.
- To strengthen the bidding mechanisms under the IBC, it is advised to mandate Swiss Challenge Bidding to ensure higher competition among buyers.
- It is recommended to encourage pre-packaged insolvency to enable quick restructuring and avoid prolonged litigation.
- To improve credit monitoring, it is important to strengthen RBI oversight on stressed assets, thereby reducing large corporate failures.
Conclusion
Growing haircuts contribute to the IBC’s failure to achieve its goals, such as completing the resolution process in a time-bound manner and maximizing the value of assets. Even though the IBC seeks to achieve its aims through prompt, efficient, and impartial restructuring or resolution, there exists a significant contrast between the objectives and current occurrences due to increasing haircuts. The haircuts in the resolution plan result in financial risks for banks, investors, and creditors. Further, this may result in delaying the overall resolution process. To address this issue, policymakers need to reform CIRP and bidding processes for better recovery rates.