Banking

India’s New Bankruptcy Law is Welcome, but Falls Short of a Home Run

While the speed with which the government has brought about the new legislation deserves to be applauded, the absence of many significant provisions takes the sheen off an otherwise much-needed piece of reform.

The Bombay Stock Exchange. Source: BSE

The Bombay Stock Exchange. Source: BSE

The passing of the Insolvency and Bankruptcy Code by parliament has finally paved the way for a much-needed modern framework to deal with the insolvency and bankruptcy of corporate entities and natural persons in India. While many financial sector laws have undergone a massive transformation after the liberalisation of the economy, the insolvency law, which is an essential part of any country’s financial architecture, remained outdated and unreformed, with the rehabilitation or winding up of companies comprising a long-drawn and time consuming process.

An efficient insolvency system is necessary to encourage enterprise, underpin investment and economic growth and create wealth. It helps create a sound climate for investment, and enable market participants to more accurately price, manage and control default risks and corporate failure. An effective exit law promotes responsible corporate behaviour to avoid the consequences of insolvency and preserves employment through an effective system for rehabilitating financially distressed but viable enterprises, while ensuring maximum play in a fair reallocation of assets to more efficient market users.

While the speed with which the government has acted deserves to be applauded, many significant provisions or absences take the sheen off an otherwise shining piece of legislation. There are a number of concerns.

Cross-border insolvency

Firstly, the legislation fails to provide a framework to deal with issues involving cross-border insolvency. Many global companies have investments in India. In recent years, Indian companies have grown multinational in character and have made high profile and high stake acquisitions abroad. A number of foreign companies have subsidiaries or branches in India. Similarly, Indian companies have set up business entities overseas. Foreign banks and creditors have financed Indian assets and Indians banks have branches overseas.

However, there is no effective mechanism for cooperation between the courts of India and those of other countries, or for administration of cross-border insolvencies and treatment of stakeholders, in the event that insolvency proceedings start in any foreign jurisdiction while involving assets or creditors in India. Many previous committees on insolvency law reform have recommended the adoption of the UNCITRAL Model Law on Cross Border Insolvency, to provide an effective mechanism to deal with cases of cross-border insolvency. The position of the government is that cross border cooperation will be achieved by signing bilateral agreements with sovereign countries. This will not only be time consuming, but will also run the risk of different, and at times conflicting, rules being framed for different jurisdictions. The absence of a cross border framework is likely to be of considerable concern to the global entities seeking to do business with India.  This does not align well with the Make-in-India pitch.

Attracting quality professionals

Secondly, the new code fails to provide a suitable framework to attract quality professionals to join the discipline of insolvency professionals. A key component of an effective and efficient insolvency system is the role undertaken by the insolvency professional. In cases where a jurisdiction has a well-developed cadre of insolvency professionals who ascribe to the highest standards of conduct, together with the appropriate oversight, the insolvency system should function effectively and efficiently. The stature of insolvency professionals, their ability to draw trust and their level of skill, enable them to bridge the differences between various stakeholders and to help ensure that business assets are deployed to maximise value.  

The code, however, provides for intrusive involvement by the government in the conduct of the insolvency process and unnecessary involvement in the appointment, removal and oversight of conduct of insolvency professionals. It requires the establishment of a Board of Insolvency and Bankruptcy, comprising senior government functionaries and others appointed by the government. Amongst other powers, the board will be able to appoint, license and de-licence insolvency professionals, and hold disciplinary proceedings against them. Professionals are appropriately self-regulated through statutory frameworks.

The role reserved by the government for itself is likely to hinder experienced professionals joining the insolvency profession. Besides, the government is invariably a party in insolvency proceedings or has direct or indirect interest in proceedings due to dues owed to it or its instrumentalities. There is a direct conflict of interest that the board, as a government instrumentality, will face by being involved in the process. The role of the government should be only to act as an overall watchdog of the insolvency industry, and undertake regular stock-taking and oversight to ensure that the best practices are being observed.

Flawed approach

Thirdly, the code tilts heavily in favour of creditors, depriving debtors of fair participation and a level playing field. The Committee of Creditors has been made the sole, all-powerful authority that can either accept or reject the revival plan of the debtor company. All other creditors and stakeholders have been kept out of the decision-making processes. The participation of all stakeholders is necessary for the ultimate revival of a company. The code does not even require the corporate debtor to be heard before ordering the commencement of proceedings and the takeover of the management and debtors’ powers by the insolvency professional. There are many other provisions that are contrary to principles of natural justice. This approach may not be conducive to the business environment of the Indian economy.   

Fourth, though the government deserves a pat on the back for taking up the reform of the archaic statutes dealing with the insolvency of natural persons, proprietorships and partnerships (Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920), its approach in preparing and passing this complex legislation is somewhat flawed. Personal insolvency is not only an economic phenomenon but has deep social and cultural connotations. It is perceived differently and has various implications for individuals, communities and the social fabric of which they are a part. The law for bankruptcy of natural persons and partnership firms will apply to over 1.2 billion people living across the country with diverse cultures, traditions, customs and ways of life. Filing bankruptcy is considered a stigma in many societies within India, as it impacts the social standing of individuals as well as their family members. The stakeholders, principles, approaches and outcomes of personal insolvency are different from those of corporations. A one-size-fits-all approach to the entire population may not be suitable. The government should have avoided such a bottom-down approach and instead prepared draft state legislation, in consultation with experts and stakeholders, and persuaded state governments to legislate by convincing them of the merits of a vibrant personal insolvency law.

Vesting debt recovery tribunals (DRTs) with jurisdiction to deal with personal insolvency resolutions is likely to adversely impact an equitable access to resolutions and speed thereof. Most DRTs are located in state headquarters. Suicide by farmers reeling under debt has been of great concern of late. Farmers find it difficult to access the law, as traveling long distances from a village or small town to file or participate in an insolvency proceeding involving small amounts is time-consuming and costly. DRTs are already overburdened with work and suffering from a backlog of cases. To add this massive jurisdiction to their existing load will impact the quality of their work in another key area – the recovery of debt and unlocking key assets trapped in litigation to be reallocated back into economy.

Unfortunately, the code will be able to do little to resolve the current non-performing asset (NPA) crisis faced by the Indian banking sector, as it will take more than a year for the new law to be implemented. Creating an insolvency practitioners’ framework, making appointments to the board, framing rules and building capacity in the system is going to take time. The resolution of NPAs cannot wait that long. To facilitate the quick, cost-effective and efficient resolution of NPAs, we require an immediate solution.  

The author is Chairman, Kesar Dass B. & Associates & Past President, INSOL International. He can be contacted at sumant.batra@kesardass.org.

  • Shivanand Kanavi

    Yes for example the disaster called Dabhol Power Company set up by Enron which owed thousands of crores to IDBI and ICICI. What happened to it when Enron declared bankruptcy in US ? This can happen again.

  • K SHESHU BABU

    Since the law is yet to take off, many bankrupt persons or corporations can have a sigh of relief and try the escape route via ‘ panama’. Meanwhile the PSBs grappling with NPAs have to push themselves into the ‘ red’ ..!