Enhancing Bankruptcy Outcomes in India: A Legal and Financial Analysis of Viability Assessment Frameworks for Distressed Firms

The Insolvency and Bankruptcy Code, 2016 (IBC) introduced a creditor-in-control focus to India’s chequered insolvency resolution laws, which prioritises the resolution of distressed firms as going concerns. The IBC aims to maximise asset value while preserving viable firms that can continue contributing to economic growth. However, despite its transformative intent, a critical gap persists in its implementation—the absence of a standardised framework for assessing a firm’s going concern viability during insolvency proceedings. In our paper published in the Asian Journal on Law and Economics, we hypothesise that this gap in measuring the viability of distressed firms has led to inefficiencies in the allocation of interim financing. Upon examining the performance of 21 distressed firms undergoing insolvency, we find that the absence of a clear viability assessment has led to suboptimal outcomes: viable firms may be underfinanced, and unviable firms may be overfinanced. 

IBC and the Viability of Insolvent Firms

The IBC provides a robust legal structure aimed at preserving value during insolvency proceedings. Section 20 mandates that resolution professionals (RPs) manage the debtor firm as a going concern, thereby ensuring operational continuity and safeguarding asset value. The moratorium imposed under section 14 prevents creditor claims during the corporate insolvency resolution process (CIRP), enabling the debtor firm to stabilise operations. The committee of creditors (CoC), comprising financial creditors, holds decision-making authority over critical aspects such as interim financing and resolution plans.

Despite these provisions, the assumption that the CoC will act in the best interest of preserving going concern value may be flawed. The incentive structure for financial creditors can result in prioritisation of short-term recoveries over long-term value creation. As a result, the CoC may not be inclined to continue the debtor firm as a going concern when the upfront recovery through liquidation or a lower value resolution plan would provide immediate recovery. Due to information asymmetry, viable firms may be forced into liquidation due to insufficient funding, while unviable firms may receive resources that could have been better allocated elsewhere.

The Crucial Role of Interim Financing

Interim financing is crucial for maintaining operational continuity during insolvency proceedings, providing liquidity for essential expenses such as employee salaries, supplier payments, and asset maintenance. However, our study highlights systemic inefficiencies in its allocation under the IBC framework. 

We analyse 21 firms undergoing CIRP and identify two key issues: underinvestment in viable firms and overinvestment in unviable ones. Taking the example of a particular case, a steel manufacturer with operational plants and steady cash flow was denied interim financing due to the purported preference of its CoC for upfront repayment. This decision led to liquidation of the debtor company at a value significantly below its potential going concern valuation. Conversely, in another example, a defunct textile company with obsolete machinery received INR 50 crore (i.e., INR 500 million) in interim finance but failed to attract bidders, resulting in substantial losses for existing creditors as well as the interim finance lenders.

These cases underscore the need for a standardised approach to assessing firm viability during insolvency proceedings. Without clear metrics, stakeholders (especially investors interested in taking over the distressed debtor firm) lack the information necessary to differentiate between viable and unviable firms, leading to suboptimal outcomes.

Proposed Framework for Viability Assessment

To address these challenges, we propose a periodic viability assessment framework that would serve as a cornerstone for more effective insolvency proceedings under the IBC. First, standardised metrics should be developed to evaluate firm viability during CIRP. These metrics could include common operational indicators such as functioning assets, supplier payments, and employee retention rates, and industry-specific operational parameters, alongside financial metrics like EBITDA trends, liquidity ratios, and cash flow projections validated by independent auditors. By establishing common parameters for viability assessment, stakeholders can make more informed decisions regarding interim financing.

Second, transparency mechanisms should be enhanced by creating a public database of viability scores and interim financing decisions. This would not only improve decision-making within the CIRP but also foster a market for distressed debt by attracting investors interested in viable but financially distressed firms. Third, we advocate incorporating pre-insolvency triggers into law which would enable lenders to identify financial distress early and increase the likelihood of successful resolutions before the effect of balance sheet insolvency deepens. For example, consecutive quarters of negative cash flow could serve as an early warning sign for intervention.

Finally, legal amendments should be made to incentivise resolution over liquidation. Extensions of CIRP beyond 330 days must be allowed only for such firms demonstrating viability, which could enable competitive bidding processes for their resolution and provide more time for restructuring efforts. The US Chapter 11 model offers valuable lessons for India’s insolvency framework. Under Chapter 11, debtor-in-possession (DIP) financing allows viable firms to secure funding during bankruptcy proceedings by granting lenders senior claims on assets. This mechanism not only sustains operations but also serves as a market signal of viability. Indian courts have emphasised similar principles in landmark judgments such as Swiss Ribbons Pvt. Ltd. v Union of India (Supreme Court of India, 2019), which affirmed that the IBC is not merely a recovery legislation but aims at resolution through market-driven processes. However, unlike Chapter 11’s judicial discretion in assessing viability based on metrics like ‘reasonable likelihood of rehabilitation,’ India’s IBC lacks standardised measures for evaluating going concern value—a gap that our framework seeks to fill.

Towards a Market-Driven Insolvency Ecosystem

We find our ideas echoed by Professors Mark J. Roe and Michael Simkovic in their seminal essay ‘Bankruptcy’s Turn to Market Value’ published in the University of Chicago Law Review, where they argue that Chapter 11 of the US Bankruptcy Code was a failure in the US in the 1980s until bankruptcy courts and stakeholders factored in market value considerations. The duration of bankruptcies shortened once protection of market value of the debtor firm became a focal point for the courts to adjudicate upon. This resulted in preventing value destruction, and also drawing in investors for viable yet distressed debtor firms, leading to increase in the market value for the debtor firm through competitive bidding. For Asian jurisdictions, and especially India, it is vital to develop institutions – both courts and regulators – to facilitate value preserving transactions for resolution of distressed firms. 

By adopting standardised metrics for viability assessment, enhancing transparency mechanisms, introducing pre-insolvency triggers, and incentivising resolution over liquidation through legal amendments, India can transform its bankruptcy system into a market-driven ecosystem that prioritises long-term value creation through resolution over short-term recoveries. 

Jayanth R. Varma is a Former Professor of Finance and Accounting at the Indian Institute of Management, Ahmedabad and a Former Member of the Monetary Policy Committee of the Reserve Bank of India. 

Anant Agarwal is an Associate at Shardul Amarchand Mangaldas. 

The authors’ paper can be found here.