"IBC's Achilles' Heel: Navigating Insolvency in the Service Sector"

"Using the IBC as an immediate response to every default is akin to wielding a hammer for every problem, regardless of its nature."

Introduction

On January 20, 2025 another aviation company, Go Airlines (India) Limited, in India is ordered to be liquidated under the provisions of the Insolvency and Bankruptcy Code (IBC), 2016.

The insolvency of Go Airlines (India) Limited ("Go Air") represents a critical reflection point for the Insolvency and Bankruptcy Code (IBC), 2016, particularly concerning its effectiveness in resolving distress in the service sector. As the second aviation company after Jet Airways to enter insolvency under the IBC framework, Go Air's liquidation decision highlights systemic challenges within the ecosystem that impede successful resolution for service-driven businesses. Beyond aviation, several other service-sector entities, including hospitals, IT companies, and hospitality firms, have faced similar fates, exposing the IBC's limitations in addressing sector-specific complexities.

Service industries, unlike manufacturing or asset-heavy businesses, rely heavily on intangible assets such as goodwill, intellectual property, contracts, and licenses. These intangible and operational assets often lose value rapidly once operations cease, leaving limited scope for revival. Additionally, service sector insolvencies frequently involve intricate stakeholder relationships, dynamic market dependencies, and regulatory hurdles, further complicating the resolution process.

Track Record of IBC in the Service Sector

Data from IBBI reports and insolvency records reveal a concerning trend: a significant proportion of service-sector cases end in liquidation rather than resolution. For instance, in the aviation sector, Jet Airways underwent protracted proceedings, and its resolution faced repeated delays due to regulatory complexities, high liabilities, and operational dependencies. Go Air followed a similar trajectory, where the lack of commercially viable resolution plans and the inability to revive operations compelled the Committee of Creditors (CoC) to opt for liquidation. Beyond aviation, other service-sector examples, such as educational institutions, healthcare facilities, and IT firms, demonstrate a low success rate for revival under IBC.

IBBI’s latest report (as of 2023) highlights that out of the total cases admitted under IBC, nearly 75% of resolutions have occurred in asset-heavy sectors like manufacturing, real estate, and steel. In contrast, service-sector cases often stagnate or fail due to the absence of suitable frameworks tailored to address the unique needs of these businesses. Additionally, recovery rates for creditors in service-sector liquidations are often significantly lower than the IBC average.

A Premature Strike: The Risks of Using IBC as a Default Response to First Default

There is another challenge which might create havoc for banking as well as business. Now many policy makers are recommending use of IBC as the first instance of default. IBC was envisioned as a mechanism to address corporate insolvency and promote the resolution of distressed entities. However, advocacy by policymakers and especially IBBI urging banks to file insolvency applications immediately upon the first instance of default is a deeply concerning proposition. This approach, while seemingly proactive, risks destabilizing not only the IBC ecosystem but also the broader banking and business environment.

Overloading the IBC Ecosystem

The IBC framework is already grappling with capacity constraints. The system is burdened by a large volume of unresolved cases, many of which drag on far beyond the prescribed 330-day timeline. If banks begin filing cases at the first instance of default, hundreds of new cases will be added every quarter, further overwhelming an already strained ecosystem. The National Company Law Tribunals (NCLTs) lack the requisite manpower and technical expertise to process such an influx effectively. This deluge could lead to a slowdown in the adjudication process, frustrating the very purpose of the IBC — timely resolution and lead to pre-mature death of many enterprises.

Temporary Defaults Are Not Insolvency

Not all defaults signify insolvency. Many defaults occur due to operational or business-related challenges, such as delays in receivables or supply chain disruptions. These are often temporary phenomena that can be resolved during the next working capital cycle. Treating such instances as insolvency events requiring IBC intervention is an overreach. Forcing businesses into insolvency proceedings for short-term cash flow mismatches risks destroying otherwise viable enterprises and discourages entrepreneurship.

Existing Banking Mechanisms Address Defaults

India's banking sector already has well-established mechanisms to handle defaults. The Reserve Bank of India (RBI) provides a structured framework for restructuring stressed assets, including schemes like the Prudential Framework for Resolution of Stressed Assets and the Strategic Debt Restructuring mechanism. These frameworks have been successfully used by banks to address defaults while keeping businesses operational. Furthermore, mechanisms such as one-time settlements, debt refinancing, and consensual restructuring provide sufficient tools to address financial distress without invoking the IBC. Additionally, filing of cases even before the account turning NPA will force the Banks to make provisioning as per Prudential Norms of RBI thereby eroding their profitability and capital which is not at all desirable. Therefore, IBBI should leave the matter to banks as they understand the Banking better and also know how to handle situations which arise on account of defaults.

IBC is Not a Cure-All

Additionally, IBC is not, and should not be, a catch-all solution for every default. It is a specialized mechanism meant for resolving deep financial distress or corporate insolvency where revival through conventional means is no longer viable. Its use should be limited to cases of severe financial stress that cannot be resolved through the regular banking and restructuring processes. Applying the IBC indiscriminately as the first response to default undermines its intended purpose and dilutes its effectiveness.

The Cost of Overuse

Triggering insolvency proceedings on the first default will not only overburden the IBC framework but also erode trust between borrowers and lenders. Businesses facing operational challenges may find themselves unnecessarily dragged into insolvency, leading to loss of jobs, destruction of value, and disruption in the economy. From a lender’s perspective, pursuing every default through the IBC increases litigation costs and reduces recovery efficiency.

Repercussions for the Banking System

Banks need to assess defaults on a case-by-case basis, considering the underlying causes and the borrower’s potential to recover. Filing insolvency applications for every default will disrupt the normal operations of the banking system. It could discourage lending to businesses perceived as high-risk, stifle innovation, and lead to credit contraction in key sectors of the economy.

Policymakers need to recognize that not all financial distress requires insolvency intervention. A calibrated approach is essential, focusing on the following:

1. Strengthening Early Warning Systems: Banks should focus on identifying signs of financial stress early and engaging with borrowers to resolve issues before they escalate.
2. Promoting Restructuring Mechanisms: Expanding and improving restructuring tools can provide a sustainable path for businesses to overcome financial difficulties without invoking insolvency.
3. Selective Use of IBC: The IBC should remain a mechanism of last resort, used only when all other avenues have been exhausted and the business is no longer viable.

Using the IBC as an immediate response to every default is akin to wielding a hammer for every problem, regardless of its nature. Such an approach will not only harm businesses and the banking sector but also undermine the IBC itself. Policymakers must adopt a nuanced perspective, ensuring that the IBC remains a tool for addressing genuine insolvency while promoting the growth and resilience of the broader economy. Default is not always a sign of failure, and not every default demands the intervention of an insolvency framework. Instead, a balanced strategy that leverages existing tools and preserves the sanctity of the IBC is the need of the hour.

Critical Questions and Challenges - In the Light of failure of IBC to address insolvency of service sector

The Go Air case, like others in the service sector, raises thought-provoking questions about the adequacy of the IBC in its current form to address sector-specific insolvency challenges:

1. Are Generic Frameworks Enough? The IBC’s existing provisions are designed for asset-based recoveries. Should there be a specialized framework for sectors like aviation, IT, healthcare, and hospitality that focuses on preserving intangible value and operational continuity?
2. Can Intangible Assets Be Better Leveraged? Service industries often rely on customer contracts, regulatory licenses, and intellectual property. Should there be a legal mechanism to protect and monetize such assets more effectively?
3. Role of Sectoral Expertise: The lack of sector-specific expertise among resolution professionals and CoCs often leads to suboptimal outcomes. Can the system institutionalize the involvement of industry experts to guide the resolution process?
4. Third-Party Funding: Go Air’s reliance on litigation funding for arbitration with Pratt & Whitney highlights the need for innovative financial solutions during insolvency. How can third-party funding and similar mechanisms be institutionalized to maximize recoveries in service-sector cases?

Way Forward

The liquidation of Go Air underscores the urgent need for reforms in the IBC framework to address sector-specific insolvency challenges. Lessons from global practices, such as Chapter 11 of the U.S. Bankruptcy Code, suggest that allowing debtor-in-possession financing, prioritizing operational continuity, and enabling industry-focused resolution mechanisms could significantly enhance outcomes for service-sector cases. Furthermore, the inclusion of industry-specific guidelines, expedited timelines for operational businesses, and mechanisms to preserve intangible assets could better align the IBC with the unique needs of the service sector.

Policymakers must rethink the IBC's approach to ensure its efficacy across all sectors, especially those that are service-oriented. Without such reforms, the IBC risks alienating a significant portion of the economy, leaving service-sector businesses to face inevitable liquidation rather than meaningful revival.

Disclaimer

The views expressed in this write-up are the personal opinions of the author and do not reflect the thoughts, opinions, or policies of the firm or organization with which the author is associated. These are intended for academic and intellectual discourse only.

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