All is not well with India’s bankruptcy law. Here’s how it can be fixed – The Economic Times

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The problems range from voluntary bankruptcy not working as it should to unaccountable and unethical resolution professionals (RPs) and the absence of a deep and broad enough market for corporate debt. These must all be addressed.

T K Arun

T K Arun

ET Consulting EditorAll is not well with the Insolvency and Bankruptcy Code (IBC), on that there is agreement, across Parliament’s Standing Committee, promoters and sundry commentators. How can it be fixed?

The problems range from voluntary bankruptcy not working as it should to unaccountable and unethical resolution professionals (RPs) and the absence of a deep and broad enough market for corporate debt. These must all be addressed.

Turn a New Chapter
It is commonplace for commentators to yearn for something like America’s Chapter 11 bankruptcy. In this, the incumbent management stays in control and runs the company, monitored by the court, for a limited period during which the company is given reprieve from paying interest or repaying debt.

The equivalent provision in the Indian code should be a financially stressed company voluntarily filing for bankruptcy. But this has not caught on. Under Section 10 of IBC, a corporate debtor can file for bankruptcy after committing debt-servicing default, and has to indicate an RP to run the company. These provisions should be changed. Voluntary filing of bankruptcy should be a pre-emptive move, seeking respite from debt servicing while a turnaround is put in place. The stipulation of filing for bankruptcy only after default should be removed. The incumbent management should be allowed to implement the turnaround, with the approval of the turnaround scheme, complete with monthly milestones, failure to achieve which should be reason enough for voluntary bankruptcy to lapse.

RPs are another source of angst. It would be unfair to tar the entire flock based on some black sheep who prepare unscheduled bags of wool, one for the master, one for the dame, and one for their own little ewes who live down the lane. However, the institutional framework to keep their conduct proper is missing.

RPs are governed by codes of conduct, one of the Insolvency and Bankruptcy Board of India (IBBI), and another of their affiliating institute. The only code Indians instinctively follow is that of caste honour, which leads on to the killing of young couples who love according to biology rather than sociology. There must be rigorous concurrent audit of the conduct of RPs. The IBBI must be beefed up to monitor this activity.

Employees of a company going bankrupt are as much victims of management failure/misconduct as creditors. Their help could be invoked to determine the value of the assets of a company. In the original scheme of things, information depositories were supposed to come up that would contain all the relevant data on companies. This has not materialised.

How much the assets of a company are worth is often vague, and there is little to prevent company managements or RPs from siphoning value out of a company. It might be a good idea to put in place an institutional framework for creating an inventory of a company’s assets involving employees. Whistleblowers must be protected and rewarded.

Liquidation Value No Secret
In a recent insolvency proceeding, a bench of the National Company Law Tribunal (NCLT) wondered if there had been collusion between the RP and the bidder who put in a bid just above the liquidation value of the company. This might have been unfair. If the company’s books were reasonably accurate, due diligence would reveal the liquidation value to anyone.

In any case, why should the liquidation value be a secret? It should be a piece of information available to all bidders. If there is sufficient competition among would-be buyers, transparency on liquidation value would not bias bids to converge towards that figure. That brings us to the central defect in the working of IBC: insufficient competition among would-be buyers of resolved assets, either as going concerns or as liquidated parts.

Even without collusion among would-be buyers, there might be a paucity of very many viable bidders for a company going under the hammer — during the 180-day interval in which resolution is supposed to take place. The way out of this time constraint is to sell the asset to patient capital that can, one, pay a competitive price for the asset, two, hold on to the company till a decent buyer comes along, and, three, run it competently in the meantime, if necessary.

The asset reconstruction companies (ARCs) created under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfaesi) Act of 2002 are not up to the task. They do not have capital, they are supposed to pay banks only 15% of the deal price in cash, the rest is in the form of Security Receipts, essentially IOUs that can, in theory, be traded on the market but are not. And, ARCs do not have the managerial bandwidth to run the companies they buy until they find a buyers for those companies. Only private equity does this kind of a thing.

Recently, ARCs sought the government’s help to obtain bank credit. ARCs should be issuing bonds to raise the money they need — but, for that, we need a market for subprime bonds. And they should be able to raise enough from sale of subprime bonds to pay off the full value of what they are willing to pay for the resolved assets. That is the only way ARCs would cease to be vehicles for banks to evergreen their bad loans — instead of bad loans, banks hold IOUs from ARCs.

The ARCs must be recast, entirely, as companies, without being attached to the RBI’s apron strings.

Views expressed are author’s own

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3 Comments on this Story

Mukundagiri Sadagopan 36 minutes agoVery ambitious law with modern concepts and provisions. Wonderful when and if this works consistently for our people and economy. Like in many other areas the economy is severely behind in the legal, judicial, financial and even technical infrastructure. If someone or a party X decides to break the provisions there is – in practice – no legal recourse! A… law suit can take 20 years, which is same as no legal infrastructure in existence. In this case the law is in advance of its ecosystem. In other case the law is behind Times. Good attempt by the Law Ministry. Jai Hind.Read More
Ashok 5 hours agoResolution Professionals … One doubts this concept can ever work in India or what are called the high context societies. Where people knowing one another, not always in honourable ways, is imperative for a business to succeed. Visualise a real estate or liquor business being run by an RP. 2. If there is dissatisfaction with how the IBC mechanism has… worked so far, it is necessary to set two simple benchmarks : 1) Percentage of recovery, or severity of haircut; and 2) Time frame in which the recoverable amount will come back to the banks.Read More
Raj Dev Singh Adv 6 hours agoThe first provision which the Legislature should think of is to penalize the guys, who given or taken Loan,if found guilty for misappropriation. The Debtors, promoters and Bankers are guilty here who do not monitor their wealth, capacity and skillset. They should be behind the bars so that it cant be planned either in the form of Section 10 or maybe via Section 7 & 9. The rest parties only suffer, victims and scapegoats. Unfortunate law of IBC.

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