Govt should not have extended suspension of bankruptcy work
The Insolvency and Bankruptcy Code (IBC) is one of the major reforms of the National Democratic Alliance government. Its purpose is to make the market for capital considerably more flexible and address what former chief economic advisor Arvind Subramanian called “the problem of exit”. A modern bankruptcy law prevents capital being tied up endlessly in litigation and frees it to more productive purposes. This is the context in which observers should evaluate Monday’s announcement by Union Finance Minister Nirmala Sitharaman that the IBC’s normal operation would remain suspended for another three months. The IBC was suspended for new defaults shortly at the time of the national lockdown in end March, and this suspension was extended subsequently up till December 24. The law permitted one last three-month extension, and the government has utilised that window. The initial suspension made sense because the purpose of the IBC is to deal with those businesses that are insolvent, and not the ones facing a temporary crisis of liquidity. In a market-wide liquidity shock such as presented by the initial weeks of the pandemic, there was no question that suspending the IBC was one of the few options available.
The issue is whether this logic continues to hold nine months on. It has been argued that most cases are heading towards liquidation rather than restructuring. In the September quarter, more than 60 per cent of the processes that were closed had ended in liquidation. These are generally legacy cases.
Three-fourths of them were previously under the earlier regime, the Board for Industrial and Financial Reconstruction. Thus, it is worth noting that this is not necessarily a sign of the failure of the IBC, but a reflection of the fact that there was considerable pent-up demand for a mechanism that is a lot like it. The government should also consider during this period whether the IBC is being overused by operational creditors, who have filed more than half of the over 4,000 applications to date. The IBC is to allow an orderly shutdown of businesses that no longer have an operating justification, not a mechanism to solve contractual disputes. Many of these cases were settled before the stage of formal admission into the IBC. Had the IBC not been misused as a small claims court, the government might have been more confident about the resumption of normal activity at the tribunal.
The IBC is a crucial mechanism for triggering the recovery of the Indian economy. The reinjection of capital into viable but struggling enterprises that it promises is of course important. It is also essential to recognise that the availability of the option is itself important to provide confidence to capital. The government should not have suspended the normal operation of one of its most reformist pieces of legislation for longer than necessary, particularly since it is also itself claiming that the economy is on pace to recover and that green shoots of growth are visible. Also, a large number of businesses are not approaching the banking system for loan restructuring, which suggests that the need for regulatory forbearance is declining. Many have complained that there is no great demand for distressed assets at the moment. However, the fact is that this demand will revive when there are more attractive assets that go on the market — which will happen only when the IBC resumes normal operation.