On July 13, 1993, then Finance Minister Manmohan Singh was presented a 104-page document. Somewhat boringly titled, “Report of the Committee on Industrial Sickness and Corporate Restructuring”, it began with three brutally honest sentences. To quote: “There are sick companies, sick banks, ailing financial institutions and unpaid workers. But there hardly any sick promoters. There lies the heart of the matter.” Called the Goswami committee report, I know this document intimately for, as its chairman, I had personally drafted it.
While the report was positively received by the press, economists and the civil service, nothing came of it. Despite reforms in the first 24 months, by July 1993, the coalition government of Prime Minister P.V. Narasimha Rao was beset by several political crises. The Harshad Mehta security scam blew up with a parliamentary committee subjecting the finance minister to a political grilling that he had never had. Then came the demolition of the Babri Masjid in December 1992. And in July 1993, when the Goswami committee report was publicly released, the government faced a no-confidence motion from the opposition. Amidst this, it was alleged that Narasimha Rao offered crores of rupees in a suitcase to Shibu Soren and others of the Jharkhand Mukti Morcha to vote in favour of the government. It was hardly a time to ruffle vested interests with a radical revamping of bankruptcy laws. The report, therefore, found its place in one of the many dusty cupboards in North Block that have held such documents since Independence.
Thereafter, for almost 22 years, while India saw four prime ministers, the same number of finance ministers and the author of the report gaining many kilos around his midriff and a shock of white hair, nothing whatsoever was done to reform our bankruptcy laws and the mind-numbing, time-consuming procedures of the Board for Industrial and Financial Reconstruction (BIFR), which operates under the legal rubric of a thoughtless act called the Sick Industrial Companies (Special Provisions) Act, 1985 (Sica). The first sign of possible reform came late last year when Raghuram Rajan, governor of the RBI, began to sharply criticise a system where promoters were profiting from corporate “sickness” and poor bankruptcy processes at the expense of India’s banks, term-lending institutions and non-banking financial companies (NBFCs). He wanted a drastic overhaul of bankruptcy processes that gave greater powers to creditors held in thrall by many corporate debtors.
The first real change has come with the budget speech of Finance Minister Arun Jaitley. Paragraph 36 says, “Bankruptcy law reform, that brings about legal certainty and speed, has been identified as a key priority for improving the ease of doing business. Sica… and [the] BIFR… have failed in achieving these objectives. We will bring a comprehensive bankruptcy code in fiscal 2015-16, that will meet global standards and provide necessary judicial capacity.” In what follows, let me state some key elements of substantive bankruptcy reform.
The first point to remember is that barriers to prompt and efficient exit are nothing other than barriers to entry. No country with tedious, neverending bankruptcy processes can expect to get significant direct investments, be these from local entrepreneurs or foreign shores. Where I can’t exit, I shan’t enter. Jaitley is dead right: good bankruptcy laws and procedures improve the business climate of any country. India is no exception.
Second, we must recognise that in corporate bankruptcy, where a company is unable pay dues to its banks and secured creditors, there is a simple decision tree that is known to all who matter. Decision One: Is the promoter honest or dishonest? The former requires help and consideration; the latter not. Decision Two: Is the project causing bad debt essentially viable but suffering from difficult external circumstances, or is it not? Again, the former may require restructuring of the loan terms and giving some breathing space; the latter necessitates rapid bankruptcy and potential takeover.
Third, the best people to make such decisions are those whose money is at stake — secured creditors such as banks, term-lending institutions and NBFCs, which have thousands of crores locked up in bad debts that earn no cash interest, increase the stock of non-performing loans and create constraints in funding other projects. Since it is their loan covenants and contracts that are broken by circumstance or design, it is they who should be in the driving seat regarding bankruptcy.
Fourth, we must not create a second Sica or another BIFR avatar by trying to adopt the procedures of Chapter 11 of the US Bankruptcy Code. The US has efficient fast-track bankruptcy liquidation under Chapter 7. In that context, Chapter 11 was designed to give companies a chance at restructuring. The less said of our winding up processes the better. Why then should we create a law that forces restructuring and pushes the inevitable back by several years? Besides, there is now enough research to show that Chapter 11 processes are inefficient and often allow companies to take creditors for a ride. It is hardly a model worth emulating. The German and British models of “administration” and liquidation make more sense.
Fifth, and this follows, fast-track bankruptcy restructuring is meaningless in the context of snail-track liquidation. If we want to reform bankruptcy restructuring, we must simultaneously radically improve our winding up processes whose score, at present, is close to minus infinity.
Finally, bankruptcy courts — be these for restructuring or liquidation — must be manned by people who understand company law and basic accounts. I remember a worthy who sat on the bench of the BIFR’s appellate authority wondering why share capital was a liability, and what was the reason for discounting 10-year cash flows to net present value.
I could go on. Jaitley’s initiative is welcome. It now depends on dotting the Is, crossing the Ts and thinking in terms of basic first principles to make a law that works for the 21st century. We need to win on this one.
Goswami, founder and chairperson of CERG Advisory Private Limited, is author of ‘Corporate bankruptcy in India: a comparative perspective’.