Dealing with failures - A synopsis that runs through the bankruptcy code

CA Hitesh Sachdev , Last updated: 05 December 2015  

Dealing with failures and their aftermath.
A synopsis that runs through the Bankruptcy code.

The finance minister in his budget speech mentioned about a law that would enhance ease of doing business with regards to fill the void that the Sick Industrial Companies Act (SICA) could not fill with the Board of Industrial and Financial Reconstruction (the BIFR). He stressed on a comprehensive law about speedy revival or closure of failed enterprises that would match the global standards and even then be an "entrepreneur friendly legal framework".

But “why do we need such a law?” would be the first question.

Bankruptcy” the origin of the word can be traced back to ancient Latin with ‘bancus meaning a table or bench and ‘ruptus meaning broken. In short means inability to pay debts.

Insolvencyis a word used often in the business or corporate sector for any business or company that has failed and is in debt. When the cash inflow of the company freezes and is not able to meet its required financial commitments to continue its proper functioning, the company is called to be suffering from insolvency.

Insolvency could be through Economical distress or Financial distress. Economic distress being inability to produce and sell goods while the later refers to capacity to service debts. As long as the company if suffering from financial distress alone, it could be a viable company and eligible for re-organization. When an enterprise defaults the first and foremost question should be whether to close or reorganize it. Failing which the management drags it on and the situations worsens with time adding to the woes of the stakeholders.

In India there is no single comprehensive & integrated policy on corporate bankruptcy in India. As a result, four different agencies have overlapping jurisdiction leading to chaos and unnecessary delay.

  1. The High courts,
  2. The Company law board,
  3. The Board for Industrial & Financial Reconstruction (BIFR) and
  4. The Debt recovery tribunals (DRTs)

So when an enterprise caught in the eye of storm, and its future is not bright it is the lenders who will be left with sleepless nights. Apart from this it impacts employees, shareholders and at macro levels the economy. Particularly in a country like India, because of delayed decision making on viability of business, tactics are employed by promoters to delay reorganization attempts, sell off assets or handover management to professionals. This goes on to block creation of new jobs, income and economic growth is restricted.

Some mechanisms like BIFR and Corporate debt restructuring have failed to serve this purpose.

So how can the proposed modern law help?

Like in the west, a modern law with focus on identification and appraisal of enterprises on the brink of default and speedy closure or reorganization leading to either recovery or revival, respectively is aimed. It basically deals with questions like,

  • How to objectively define failure? (This in order to separate viable companies from unviable ones.)
  • Whether such a failure can be salvaged?
  • Resorting to measures that would speedily force in reorganization or closure, as appropriate.

Let's look at how the new bankruptcy code will change the life for lenders especially banks, corporate borrowers, and the banking system as a whole and also for the economy.

Protect rights and interest of lenders.

The new code would protect the rights and interest of lenders, especially banks. In India, banks are the big source of funding the corporate sector as debt markets are not well developed. Under the current legal framework, the bankers are at the mercy of promoters or corporate borrowers who try every trick to delay the process of restructuring or recovery sometimes creating huge burdens of NPAs on banks.

Preservation of assets:

At times, the asset loses its value because of the delay in the process of restructuring. Timelyaction will minimize losses and help the asset regain its value or productivity.

Release of resources for banking system:

Today, the stressed assets in the system are over 10 per cent of the total loan books of the banks. Many of these assets are not paying interest or the principal amount. Some are locked in legal battles in various courts. This will help in releasing such locked resources for other productive lending, which in turn will help in loan growth, profitability and employment.

Helps the economy:

When a company fails, it has implications for creditors, shareholders, suppliers, employees, etc. The corporate failure also has implications for the economy as there are hundreds of suppliers connected with the company or employees. The ease of resolving insolvencies is also a very critical factor affecting the ease of doing business in a country. In India, this can be a big stumbling block for foreign investors willing to set up factories in India (India ranks 137th worldwide and it takes on an average 4.3 years).

The current law is creditor unfriendly and the new law prima facie aims at balancing it as a crucial aspect of the code is to protect unsecured creditors. India’s contemporary bankruptcy procedures are not so brutal, but they are not so efficient, either. The system operates at a painfully slow pace as courts try to interpret a variety of conflicting laws that cover insolvency. In the meantime, owners of sick companies retain day to day management control and often prolong court proceedings as nervy creditors watch the value of their assets dwindle. It is also common for defaulters to start siphoning off business from the old one. Ailing companies have to wait until their net worth is reduced by half before they qualify as “sick”.

As it appears Investor patience is running out, the government needs to push through at least one big banner reform. The bankruptcy code will help reorganize a stressed business in a short span of time without endless litigation which erodes the viability of an enterprise.

Failure is inevitable in a free enterprise system like India. This helps us conclude that the modern law aims at reducing the ill aftermath effects of failure. The new law would also add impetus to the ambitious “Make in India” regime by boosting investor’s confidence. The efficacy of the code would depict the Government’s commitment towards increasing ease of doing business.

Hitesh T. Sachdev
(WRO 0405754)

Published by

CA Hitesh Sachdev
(Associate Consultant)
Category Others   Report



Related Articles