Dealing With Failure

The new bankruptcy code can stimulate credit availability for entrepreneurs.

Written by Susan Thomas | Published: November 13, 2015 12:07 am
Bankruptcy law, Bankruptcy law India, Industrial and Financial Reconstruction, BIFR, Sick Industrial Companies Act, express column The proposed bankruptcy code sets down a ‘calm period’ of 180 days. During this time, the claims of all creditors will be suspended. (Illustration by: C R Sasikumar)

On November 4, the Union ministry of finance released the report of the Bankruptcy Law Reform Committee (BLRC) along with a draft bill called the “Insolvency and Bankruptcy Code” (IBC). The IBC is a proposed legal framework for facilitating the transparent and rapid exit of failed enterprises. At present, India’s laws do not allow for easy exits.

All mature market economies have an institutional infrastructure called “the bankruptcy process”, which kicks in when a firm defaults on payments. A swift and predictable process comes into play after default, which yields an economically sensible outcome. The BLRC proposals aim to create such an infrastructure in India. This will help address the crisis of non-performing assets in the banking sector, improve the climate for entrepreneurship and enable the corporate and infrastructure bond market.

The legal framework for bankruptcy involves lenders and owners agreeing on two key issues: How to objectively define failure, and whether such a failed firm can be salvaged. Firms have financial dues (loans, bonds, credit card payments, etc) as well as operational dues (wages to employees, trade credit bills, etc). Failure takes place when these payments are delayed. In India, the facts about default are often contested, which can result in litigation. Similarly, there can be disputes about the pledging of assets.

The IBC envisages a regulated industry of “information utilities”, which store information and help reduce, and ultimately eliminate, such disputes.

When a firm defaults, the most important question is: Should something be salvaged from the business? Some firms have useful organisational capital, and can survive after a restructuring of their debt and a new management takes over. Others are better off with liquidation of assets.

Unlike India, in other countries, the bankruptcy process involves creditors and the debtor sitting down and calmly discussing this problem. The proposed IBC sets down a “calm period” (called the “insolvency resolution process” or IRP) of 180 days. During this time, the claims of all creditors will be suspended. The debtor will have the comfort that all pledged assets remain with the firm, and that no creditor can disrupt the smooth working of the enterprise. In return for this protection, the debtor will agree to the firm being managed by a regulated “insolvency professional”. Doing so will assure the creditors that managers will not resort to asset stripping.

Then a committee of creditors will be formed. Various people — promoters, private equity funds, competitors — will be able to propose revival plans to the creditors’ committee in an open and competitive environment. These plans will include all possibilities such as debt restructuring, infusion of new equity capital, bringing in new shareholders, etc. The final decision will be entirely up to the creditors’ committee. If a plan were approved by 75 per cent of the creditors, then it would be accepted. The role of the judiciary will be to verify that the calm period was operated properly, that the creditors’ committee was correctly constituted, and that the accepted plan received over 75 per cent of the votes. If no revival plan achieves the 75 per cent mark, then the firm will go into liquidation.

The IBC thus seeks to ensure that neither the executive nor the judiciary take economic decisions about the firm’s future.

A sound bankruptcy legislation is a complex piece of procedural law. The drafting has to be ironclad so that there are no loopholes, which may lead to delays. The proposed law rests on four pillars of enabling infrastructure: A regulator, insolvency professionals, information utilities and the tribunals. For the bankruptcy process to work properly, each of these pillars has to be of world-class quality. If they are not, we run the risk of having a law that only looks good on paper.

Under a well drafted and implemented IBC, the time taken to resolve a firm’s failure will come down to three to four years — a big gain from the present norm of 10-15 years. Creditors presently recover only about 20 per cent of their loan value; this may go up to 80 per cent. This will make lenders more willing to provide unsecured loans.

The writer, assistant professor, Indira Gandhi Institute of Development Research, Mumbai, was a member of the Bankruptcy Law Reform Committee.

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