Published Editorial

Bankruptcy Code 2016: Just what the doctor ordered

May 2016

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The Economic Times


Abizer Diwanji
Partner, Financial Services, EY India

The Insolvency and Bankruptcy Code 2016 is one of the most forward-looking and contemporary legislations in recent times. It will establish some very basic principles of doing business in India. Having said that, the proposed law is currently, at best, an innovative plan awaiting correct execution.

The code makes a clear distinction between insolvency and bankruptcy. The former is a short-term inability to meet liabilities during the normal course of business. The latter is a longer-term view on the business. As all businesses cannot succeed, it is perfectly normal for some businesses to fail, making it important to emphasise on corrective action.


No Life Sentence for Assets

The code carries a clear focus on quick decision-making, be it turnaround or liquidation. It emphasises the speedy release of scarce capital assets locked in a closed unit for productive use, apart from the early settlement of all stakeholder issues.

Until now, Indian promoters were presumed to have a divine right over their businesses. They were protected by multiple laws, each carrying its own bankruptcy rules. Indian courts have time and again granted stays liberally to avoid winding down, thereby delaying recovery, under the age-old premise that it destroyed assets and resulted in job losses.

A lack of timely action has caused more harm than solutions. The code amply clarifies that insolvency or bankruptcy is a commercial issue, backed by law to enforce transparency and objectivity. It is not another law behind which the inevitable can be delayed. This now stands to replace all other bankruptcy proceedings in any other law, making it effective.

However, the other laws, including Recovery of Debts Due to Banks & Financial Institutions Act, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfaesi) Act, and the Companies Act 2013, which impact bankruptcy directly or indirectly need to be amended or repealed to ensure that all existing laws are perfectly aligned with the code.

One of the code’s most significant provisions is the waterfall mechanism — liquidation proceeds will be paid in the following sequential manner: secured creditors, workmen’s dues for 12 months, employees other than workmen, unsecured creditors. The biggest commitment of the government has been with regards to government dues that have been made junior to most others.

Appropriate information-flow, establishment of a tribunal process and the provision to bring in responsible professionals to manage the process are some other benefits.

The present laws tend to protect only financial creditors, especially banking creditors. The new code also seeks to protect the interests of operational creditors. It provides for orderly and timely resolution of default and insolvency of companies, firms and individuals.

It, however, does not cover financial institutions and banks. The government is working through a task force for setting up a resolution corporation for financial institutions.

The full benefits of the code will be realised only when all stakeholders contribute to creating an ecosystem conducive to an effective, fair and expedient implementation of the code.

Banks and other creditors will have to recognise that insolvency and liquidation will need innovative solutions towards the structural and financial aspects of a business.

From Test Match to T20

This also mandates the requirement of sufficient insolvency professionals, capable of objectively assessing businesses and able to turn them around or liquidate them, within a governance framework as defined by the code and other existing laws, with minimum court intervention. More importantly, these professionals will need to be held accountable for the fiduciary duties they are performing with penal provisions for negligence. India must adapt to global standards and set up an independent board for oversight at the earliest.

Information utilities — a system to verify defaults — is another important element to ensure that bankruptcies are correctly enforced. While this could operate like a credit bureau, the data therein needs to be collated and filed appropriately. The Reserve Bank of India could set this up as has been done for bad loans.

India has in excess of 5,000 pending insolvencies in its various courts. The legacy can’t be burdened on the new National Company Law Tribunals (NCLTs). Debts Recovery Tribunals (DRTs) need to be formed. The code envisages 10 NCLTs and one DRT.

The code mentions using discretion in enacting the machinery, yet the system could be clogged with cases that may take time and, hence, beat its very purpose. Most regulations were all well-meaning and eager to find a resolution in a systematic manner as much as the current law does.

However, there has been misuse in the form of prescribing the processes in the regulation as a mere formality to achieve the desired objective. If the same is done with the Insolvency and Bankruptcy Code 2016, it will become just another piece of comprehensive legislation.

Satyam was revived under special rules and by a group of competent professionals. The same rules have simply been generalised rules in a law now. Also, a systematic winding down or revival through change is possible in India — whether promoter-driven or for conglomerates — when the right rules are in place and implemented in earnest.