The source of the biggest flaw in the IBC framework, the wrinkle in the table cloth, can be traced to two short paragraphs in the Report of the body which gave us the Code, the Bankruptcy Law Reforms Committee:

The creditors committee will have the power to decide the final solution by majority vote in the negotiations…

The Committee deliberated on who should be on the creditors committee, given the power of the creditors committee to ultimately keep the entity as a going concern or liquidate it. The Committee reasoned that members of the creditors committee have to be creditors both with the capability to assess viability, as well as to be willing to modify terms of existing liabilities in negotiations. Typically, operational creditors are neither able to decide on matters regarding the insolvency of the entity, nor willing to take the risk of postponing payments for better future prospects for the entity. The Committee concluded that, for the process to be rapid and efficient, the Code will provide that the creditors committee should be restricted to only the financial creditors.

Ignore, if you will, the gratuitous use of the loaded term “final solution”. What was decided in this part of the Report was that the entire affairs of a bankrupt company, including the crucial question of which bidder gets to take over the company, would be decided upon by a “committee of creditors”, and this committee would have only financial creditors and not operational creditors.

How are creditors in a position to take a decision on anything other than their own loans? Why would financial creditors be any more qualified than operational creditors to decide issues concerning the future of an insolvent company? The answer, my friend, is blowing in the wind. The real consequences of the IBC’s facile assumption that a committee of financial creditors will look out for the whole company rather than the individual debts owed to them came to the fore in the fresh round of litigation in the Essar Steel story.

Two facts in Essar Steel serve to prove that all involved were quite aware of the fact that creditors only care about the repayment of their debt and nothing else:

One: ArcelorMittal bid Rs. 42,000 crore for the company, almost exactly as much as the total admitted claims of the secured financial creditors of the company (Rs. 41,958 crores) – to pay off only the debts of these creditors. It knew that it could get away with not providing for any payment to operational creditors, since they don’t have a vote. Also, this bid was hardly an attempt at showing the Committee how Arcelor would be good for the “future prospects” of the company ­- the payment was offered upfront. Arcelor knew it had to offer to pay off the secured creditors superquick to win the bid, and that’s what it did.

Two: What the creditors then did is positively Machiavellian, but understandable: They got Arcelor to submit a fresh bid, this time leaving to the Committee of Creditors the right to decide how the amount paid would be distributed among the secured creditors. The result, the judgment says, was that the other creditors on the Committee got together and froze out one creditor, Standard Chartered, and appropriated the money that was to be paid to Stan Chart as per the original plan (about Rs. 2,500 crores), to themselves. The rest would therefore get 100% principal (as originally envisaged) and 40% interest on their debts.

None of this is surprising. Can anyone blame a creditor from seeking its own interest above all else? Why should the creditor be bothered with the lofty intentions behind the formation of the Committee of Creditors?

To this absurd turn of events, roundly protested by Standard Chartered, the remedy prescribed by NCLAT made it even more obvious how truly unworkable the Code can be. The NCLAT decided that the plan was discriminatory to StanChart and the operational creditors (who were to get nothing), and decided to itself amend the bid. Working with Arcelor’s bid amount of Rs. 42,000 crore, it decided that all creditors, operational and financial, over Rs. 1 crore, would get 60.7% of their debts back – a seemingly reasonable solution.

Except for one thing. Since when did the NCLAT get the right to put its fingerprints on a resolution plan by changing its terms? The Code only grants Tribunals the authority to approve or reject a plan. Also, the Code makes it mandatory for the CoC to accept a resolution plan, yet the CoC wasn’t granted the right to vote upon the changes inserted by NCLAT. There are limits to ad hocism, and what the NCLAT did could never be done under the current provisions of the Code. The proposed new amendment to the IBC crosses out this part of the judgment, and rightly so.

So here we are then, and here we will remain, till somebody realises that the “Committee of Creditors” is a supremely bad idea. In retrospect, the use of the term “final solution” doesn’t seem so out of place.