Will insolvency code bring certainity?

India does not have a good insolvency legal system, and corporate failures can have rippling impact on the economy, affecting the solvency of many other businesses. The existing framework is outdated, inadequate, and ineffective and results in undue delays in resolution of distress assets.  Therefore, it is necessary that there is a highly efficient corporate insolvency regime that ensures minimise losses to all stake holders.

 However, recently the Insolvency and Bankruptcy Code, 2015 (IBC) was passed by the Parliament and soon hopefully, India will have a modern insolvency law. The objective of IBC is to consolidate various laws relating to insolvency and bankruptcy of corporate, partnerships, and individual in a time bound manner. If within stipulated time, the issue cannot be resolved, then assets of the borrowers can be sold to repay creditors. The IBC will help promote entrepreneurship, availability of credit, and balancing of interest of various stake holders. It would also enable timely resolution of distress assets, support credit market, improve ease of doing business and consequently facilitate more investments and higher economic growth.

Need for ecosystem

The complete eco-system will have to be created to make the IBC operational. The resolution process will be conducted by licensed Insolvency Professionals (IPs), who will be members of Insolvency Professional Agency (IPA). The information utilities (IUs) will be established to collect, collate and dissemination financial information to facilitate insolvency resolution. The Insolvency and Bankruptcy Board of India will be established to regulate functions of IPs, IPAs and IUs. The national company law tribunal  will adjudicate insolvency resolutions for companies and debt recovery tribunal will adjudicate insolvency resolutions for individuals.

 In the current period, pre-IBC era, there is no single law in India that deals with insolvency and bankruptcy. There are number of different laws that are applicable to different industries.  Illustratively, for companies there are laws like the Sick Industrial Companies (Special provisions) Act, 1985 (SICA); Recovery of Debts Due to Banks and Financial Institutions Act 1993(RDDBI); the Securitisation and Reconstruct of Finance Assets and Enforcement of Security Interest Act 2002 (SARFAESI) and the Company’s Act, 2013.

SARFAESI and Debt Recovery Tribunals (DRT) work under the RDDBI to cover issues relating to debt recovery of solvent debtor companies. Interestingly liquidation of companies is handled by the high courts.  Individual bankruptcy and insolvency is dealt under the Presidency Town Insolvency, Act 1909 and the Provisional Insolvency Act, 1920. Though these are central laws both of them have number of states specific amendments.

 Historically, the need for a comprehensive bankruptcy code was flagged by Mitra Committee in 2001, and by 2013 Financial Sector Legislative Reforms Commission (FSLRC) had drafted a financial code for India for resolving distress financial firms.  In 2009, a committee chaired by present governor, Raghuram Rajan had observed that if India is to have a flourishing debt market, then a well-functioning bankrupt code is necessary when a company becomes distressed, especially large infrastructure companies which have many claim-holders.  Rajan Committee had, then, also observed that the closing of business in India, on average takes 10 years, while in China it takes less than 2 years.

 In terms of cross-country experience despite the importance of insolvency and bankruptcy laws, track record even in advanced market economies is not very strong.  Even in advanced countries, procedures are extremely time consuming, costly and inefficient.  In many cases, costs are so high that outcomes are wrong and global average of loss is nearly 48%. In case of developing countries, the situation is still worst.
The IBC empowers the bankers, and therefore is a positive development for the financial sector.  The IBC will help building enabling circumstances for initiating legal action against willful defaulters and parties with malafide intentions. However, legal system needs to be supportive and have judicial capacity for successful implementation of IBC. Anecdotally, in India, there are number of practitioners who will help in postponing of court hearings at DRT. Similarly, pricing of assets put up on sale is a consideration and therein role of valuers, chartered accountants, auditors and legal experts becomes important.

 The psychology of buyers would also need to change.  Illustratively, as in India, residential buyers are shy of shifting into a new house which has been vacated by declared bankrupts, as a bad omen.  Similarly, bankers report that bankrupt owners don’t vacate the house and in most cases it is responsibility of the new home buyer to get the house vacated. In case of sale of industrial premises, buyers would generally know the bankrupt seller and therefore there is reluctant to bid for the property. Further, only people who are in similar business and would require similarly designed premises, would be eager to bid for the property at an appropriate price.

‘Perfection-less’

No bankruptcy law can be perfect and process of review need to be undertaken every few years to examine its success in practice.  Therefore, regularly the data base should be created as to the companies that needed rehabilitation, administrative cost of bankruptcy, number of successfully rehabilitation companies, extent of credit recovery, and time taken to resolve the insolvency.

 The setting up of institutions and required ecosystem under IBC can take some time but implementation of the IBC will change the current climate, where corporates raise debt from banks but treat it as equity. Thereafter when business is flourishing it is profits for the entrepreneurs but when a crisis hits, then it is the bank that bears the loss.

The contract of debt, between the banker and the corporate, needs to be respected. And this will be possible once the IBC is operational giving more powers to banks to enforce their contracts. Hopefully, IBC, in line with global standards, will bring legal certainty and speed, and help in raising the global ranking in ease of doing business.

New Bankruptcy Code

Creates time-bound processes for insolvency resolution of companies and individuals. These processes will be completed within 180 days. If insolvency cannot be resolved, the assets of the borrowers may be sold to repay creditors.

Resolution processes will be conducted by licensed insolvency professionals (IPs). These IPs will be members of insolvency professional agencies (IPAs).  IPAs will also furnish performance bonds equal to the assets of a company under insolvency resolution.

Information utilities (IUs) will be established to collect, collate and disseminate financial information to facilitate insolvency resolution.

National Company Law Tribunal (NCLT) will adjudicate insolvency resolution for companies.

Debt Recovery Tribunal (DRT) will adjudicate insolvency resolution for individuals. Insolvency and Bankruptcy Board of India will be set up to regulate functioning of IPs, IPAs and IUs.

 (The author is the RBI Chair Professor of Economics at IIM Bangalore)