Good Governance - A sine qua non in any Corporate Setup (especially under bankruptcy)
CA. Dhinal Shah
The author is a member of the Institute of Chartered Accountants of India. He can be reached at eboard@icai.in
“By its very nature, the purpose of a Company is to survive, generate business, and distribute the value for its stakeholders. An important aspect of survival in the corporate ecosystem is ‘governance’. Simply put – governance means the way in which a person/group of person does things. Naturally, what follows is the meaning of good governance, i.e., a manner in which a person/group does things and which is beneficial for all. Corporate governance is the system of rules, practices and processes by which a company is directed and controlled. Read on…”
Foundational Architecture: Power, Accountability and Stakeholder Trust
Corporate Governance fundamentally defines the architecture through which companies are directed, managed, and controlled, and to what ultimate purpose. It establishes an unequivocal delineation of who wields institutional power, who bears accountability, and who executes critical commercial decisions. Commercial enterprises governed by robust corporate governance principles cultivate and sustain enduring trust and satisfaction across the entire spectrum of stakeholders—including customers, vendors, trade suppliers, operational and financial creditors, and equity investors.
A comprehensive corporate governance framework is anchored on four non-negotiable pillars: competent leadership, rigorous internal financial controls, an ingrained risk management culture, and transparent accountability to external stakeholders. The Board and executive leadership play an indispensable role in articulating ethical standards, ensuring an appropriate balance of power, avoiding concentration of authority, and maintaining independent decision-making across all group operations. In the modern digital era, effective risk management has grown even more critical as issues surrounding corporate data protection, cloud sovereignty, and cybersecurity threats take center stage.
Why Governance Becomes Decisive Under Bankruptcy
Within a bankruptcy environment, corporate governance becomes extraordinarily decisive. More often than not, a corporate default in the run-up to insolvency is directly attributable to defective business practices, internal financial mismanagement, and a collapsed governance framework. While occasional genuine business failures arise from exogenous shocks, establishing a disciplined governance framework has never harmed a corporation. While a solvent entity is managed by its Board of Directors under general powers conferred by shareholders and constitutional charters, insolvency abruptly triggers a structural shift in legal control.
The Paradigm Shift: From Debtor-in-Possession to Creditor-in-Possession
As corporate affairs deteriorate and an enterprise enters payment default, the locus of corporate control undergoes an automatic legal metamorphosis under the Insolvency and Bankruptcy Code (IBC), 2016. Unlike jurisdictions practicing the *“debtor-in-possession”* model (such as Chapter 11 in the United States), Indian insolvency jurisprudence is intentionally designed around the “creditor-in-possession” doctrine.
The Bankruptcy Law Reforms Committee (BLRC) Observation:
“The limited liability company is a contract between equity and debt. As long as debt obligations are met, equity owners have complete control, and creditors have no say in how the business is run. When default takes place, control is supposed to transfer to the creditors; equity owners have no say.”
While baseline compliance stems from mandatory statutory regulations, the proactive governance practices that an enterprise institutes beyond statutory thresholds represent the true boundary separating ordinary firms from exceptional ones.
The Art of Balance: Separating the Doer from the Beneficiary
The simplest, most elementary axiom of sound governance is separating the doer from the beneficiary of the doer’s actions. In practical corporate administration, this structural separation is institutionalized through six vital operational safeguards:
Codified financial and administrative delegation thresholds ensuring no single officer exercises unvetted transactional discretion.
Collective executive wisdom is inherently superior to individual bias for commercial procurement and financial outlays.
Segregation of duties across operational functions where data originators cannot authorize their own transactions.
Unannounced operational audits to identify control lapses, inventory leakage, and cash handling irregularities in real-time.
Iterative updates to standard operating procedures (SOPs) matching evolving market dynamics and regulatory circulars.
Embedding ethical behavior and governance discipline deeply into corporate culture so compliance becomes second nature.
Life in Default: Mitigating Pre-Bankruptcy Value Dissipation
A financial default by a corporation marks the perilous tipping point of a falling house of cards. In the desperate struggle to stave off corporate demise, established internal controls and regulatory compliances are frequently abandoned in favor of crude survival maneuvers. It is precisely during this twilight period of distress that the risk of illicit asset stripping, preferential debt settlements, and fraudulent transactions by errant promoters reaches its apex.
Upon admission into the Corporate Insolvency Resolution Process (CIRP), the powers of the Board of Directors are suspended by operation of law. All executive powers, corporate responsibilities, and committee mandates vest immediately in the Resolution Professional (RP). Crucially, the RP must not degenerate into a passive “Compliance Manager”; rather, the RP must actively structure an internal committee architecture mirroring a well-governed Board, maintaining strict checks and balances across operational, financial, and risk dimensions.
Statutory Governance Provisions Under the Insolvency and Bankruptcy Code
Financial institutions maintaining accounts of the corporate debtor must act exclusively on the instructions of the Interim Resolution Professional (IRP) and furnish all available financial intelligence. With vast control comes solemn fiduciary accountability: the RP must manage corporate cash flows with extraordinary prudence, safeguarding creditor wealth from leakage.
While the IRP/RP is vested with the entire management of the Corporate Debtor, their authority is subject to statutory boundaries and regulatory restrictions imposed by the Insolvency and Bankruptcy Board of India (IBBI), preventing administrative overreach.
The RP bears explicit statutory responsibility for complying with all laws of the land on behalf of the corporate debtor (labor laws, tax filings, environmental consents, factory registrations). Crucially, the law establishes that financial penalties and procedural costs arising from compliance defaults attach personally to the account of the Resolution Professional.
To insulate the CoC from conflicts of interest and perverse self-dealing, related-party financial creditors are categorically stripped of all rights of representation, participation, and voting. This statutory firewall guarantees that commercial decisions are made strictly at arm’s length.
As William Pitt observed: “Unlimited power corrupts the possessor.” Section 28 curtails the RP’s executive discretion by mandating prior approval of the CoC for major capital actions. Concurrently, Sections 43 (Preferential), 45 (Undervalued), 50 (Extortionate Credit), and 66 (Fraudulent Trading) empower the RP to conduct transaction audits and file avoidance applications before the Hon’ble NCLT to claw back diverted assets.
CIRP Governance, Valuation Bidding and Going Concern Protection
The maintenance of contemporaneous, verifiable operational records during the CIRP is legally indispensable, enabling reasonable observers to review the commercial rationale of the RP’s decisions. Furthermore, corporate governance during distress directly determines corporate valuation during competitive bidding:
Scenario A: Governance Deficits & Bid Discounting
When prospective Resolution Applicants encounter systemic compliance defaults, unhedged operational exposures, and regulatory gaps, they aggressively discount their financial bids—calculating substantial future cash outflows to remediate past legacy liabilities.
Scenario B: Robust Governance & Value Maximisation
Conversely, when a company under CIRP is administered under pristine governance protocols, risk mitigation safeguards, and audit-ready records, incoming bidders compete aggressively, preserving going-concern value and delivering maximum financial recovery to the CoC.
Prudent governance is exceptionally paramount for institutions under heightened regulatory supervision, such as Financial Service Providers (FSPs), where operating licenses and statutory charters hinge directly upon real-time regulatory compliance. For enterprises managing public capital, rigorous insolvency governance rebuilds market credibility and public trust—ensuring that the enterprise, once rescued, thrives within the very marketplace where it had earlier defaulted.
Conclusion: Inculcating Good Governance Culture
In conclusion, the Insolvency and Bankruptcy Code empowers the Resolution Professional to steer the governance framework of the corporate debtor throughout the turbulent distress cycle. It demands the specialized technical and fiduciary skill of the RP to execute CIRP administration in a transparent, independent, and value-accretive manner.
“A tad more compliance never affected anyone – infact, it only creates an ecosystem where culturally the stakeholders get habituated to follow the principles of good governance.”