Are they effective enough to combat Corporate Insolvency? Better bankruptcy laws and reduction of red-tapism in corporate liquidation is a need of the hour, discerns Witness
Bankruptcy is nothing but a market sanction. When a market fails to impose the change, the systematic market exit becomes necessary. A uniform bankruptcy law throughout the world is impossible. Also, all bankruptcy laws cannot be identical. A law, which performs reasonably well in one environment, cannot be expected to deliver the same performance elsewhere. The bankruptcy laws should be framed to address the core problems of the industry. Different institutional arrangements should emerge on the basis of the inter-creditor equity to well-delineated economic problem of the company.
In the ancient times, the bankruptcy used to be considered as a criminal act and bankrupts used to be subjected to the severe punishment, sometimes used like slaves. As the time passed gradually, bankruptcy codes were evolved as per the trend of the merchants. In America too, till recently, the bankruptcy was used as last resort of the firm in the corporate world. The chief executives, who were in-charge of the affairs when the firm became bankrupt, considered their careers ended. However, the scenario has changed now. The bankruptcy has become a strategic tool in many industries and the failure has become a badge of honour for the executives.
“A law that performs reasonably well in one environment cannot be expected to deliver the same performance elsewhere. The bankruptcy laws should be framed to address the core problems of the industry.”
Today, the fundamental idea of the bankruptcy code in the US is to give the unfortunate debtor a fresh life and opportunity by relieving him from the personal liability and protect him from the creditors to jump on him suddenly. However, what about the laws in India?
Indian archaic laws in the bankruptcy field continue. Bankruptcy laws outside India focuses on reorganising the business with various mechanisms of restructuring, whereas the archaic laws of India provide various avenues to roll over the debts to keep the company in the suspended animation, like in the case of the Kingfisher Airlines.
The legal frame work of the bankruptcy laws in India is fragmented, complex and filled with controversial corporate insolvency procedure. Till now, there is only one legal frame work with two “formal” procedures:
Under the existing system, the Board for Industrial and Financial Reconstruction (BIFR), established under SICA, can only oversee rehabilitation of companies with licences to run factories. Those companies, which have operated for a minimum of five years and holding a factory licence, are eligible to approach the BIFR, if accumulated losses equal or exceed their net worth.
Even though the UK Act of bankruptcy was overhauled in 1986, India is yet to change the laws that suit the realities as per the prevailing financial markets.
“In the present scenario, bankruptcy has become a strategic tool in many industries and the failure has become a badge of honour for the executives.”
Inefficient insolvency regime along with poor enforcement process are the major setbacks for not able to evolve good bankruptcy laws. Insolvency laws are from colonial era. Apart from Kolkata, Chennai and Mumbai where the presidency Town Insolvency Act of 1909 exists, the Provincial Insolvency Act, 1920 is prevailing in rest of India.
Prime Minister Narendra Modi, having a strong belief that archaic laws only hamper governance by creating unnecessary confusion, appointed R. Ramanujam Committee to examine Acts and rules, which may have become obsolete in the last 10 to 15 years. Let us hope that the insolvency laws may be one of them and new Acts will come into force as per the suitable market forces. The new Insolvency Act shall deal with corporate insolvency unlike the old Acts, which cover only the individual and partnerships.
Debt restructuring under BIFR offered very little help for distressed companies because of the lengthy procedures. The idea of redeploying the resources and put idle assets for better use by referring the sick companies to BIFR was never achieved. Forthe investors from outside India, the apprehension that once the unit is sick, it is inevitably doomed, is prevailing.
The present RBI Governor, Raghuram Rajan, submitted a report in 2008 as the then Chief Economic Advisor, mainly based on the reality that India’s business uses both capital and debt for their financial needs. The report stressed mainly to improve the bankruptcy and liquidation procedure in India and to keep the insolvency and bankruptcy laws at pace with heightened cross-border transactions with requisite provisions to deal with international insolvency. Inevitable offshore demand for easy liquidation, consolidation activity and sell outs gathered momentum to introduce the Companies Act, 2013.
The Companies Act, 2013 gave life to the stagnated provisions for bankruptcy and insolvency under the old Act. Chapter XIX of the 2013 Act lays down the provisions for the revival and rehabilitation of sick companies. It has embedded the new bankruptcy code and integrated theprovisions of SICA with the Companies Act. Unlike SICA, it is not restricted only to industries, but all the companies irrespective their sectors. Therefore, it has modernised the laws on bankruptcy, liquidation and the revival of sick units.
The existing two procedure system, that is the revival of sick units by BIFR and their liquidation by high courts, has been modified and brought the entire system based on the balance sheet threshold, before the National Company Law Tribunal(NCLT), which will consist of judicial and technical members and is vested with the both the existing dual procedure. Hope this will simplify the legal formalities and will have in place time bound procedure to expedite the company liquidation and will show the way to a sick company as to how to use the existing resource for better use. While NCLT got legislative sanction in 2002, its setting up was delayed due to litigation.
Given that asset values and their re-usagecan faster change the Companies Act 2013 proposes to sinking companies to come out of red within a specific time period.
It took barely 72 hours for Lehman Brothers in the USA to takeover after it declared bankruptcy. There are two different laws governing bankruptcy in the US – one is Chapter 7 to deal with liquidation stopping all the operations of the company and a trustee is appointed to liquidate the company’s assets and the second is chapter 11 to give protection to consolidate the company’s financial affairs.
The chapter 11 gives breathing time to the debtor to reorganise its business and to become profitable again. On the other hand, in India, which is third biggest economy in Asia, has no legal frame work to show the bankrupt company Kingfisher Airlines Limited (KAIR), which is struggling to resume its services. It could not see the similar fate what the US airlines had seen under chapter 11of bankruptcy of the US laws, because India’s bankruptcy laws are not helping it.
Under the Companies Act, 2013, the sickness definition changed from the existing concept of erosion of 50 percent net worth to an inability of paying debts amounting to 50 percent of the secured creditors. It is also not restricted to onesecured creditor, but all creditors having 50 per cent of the defaulted amount of the debtor. The debtor, if fails to pay within 30 days of demand, can approach the NCLT for declaring the debtor company as sick unit. In other words, the burden of showing the debtor company as a sick company has been shifted to the banks and financial institutions rather determining on the basis of net worth erosion of the company.
Again, the new companies act talks of the bankruptcy laws for the secured creditor only. Having said that earlier too secured creditors alone have been privileged to have the Acts like Recovery of Debts Due to Banks and Financial Institutions Act(RDDBFI) and Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) to secure their interests.
By looking at the provision of issuing 30 days demand notice for repayment of debt, before preferring to NCLT under the new Companies Act, 2013, there is a need for the amendment in the SARFAESI Act that allows a lender to take procession of a defaulter’s assets, if he does not fulfil his financial obligations after 60 days of receiving a notice. So, while the new company law is proposing a sophisticated bankruptcy and restructure proceedings, experts say that it would not be sufficient to ensure that companies in trouble get access to a fair restructure and liquidation process.
“Inefficient insolvency regime along with poor enforcement process are the major setbacks for not able to evolve good bankruptcy laws.”
Under the new Act also, the fate of the unsecured creditor is left to the fate of the company’s revival and rehabilitisation, which will be again depending on the vote of the secured creditor representing the three-fourth of the outstanding debt. The Act does not involve all the stake holders in revival and rehabilitisation of the sick company. Under the new bankruptcy code, revival plan will be formed by the administrator appointed for the job, who is an experienced person in the field. Once the tribunal forms an opinion that the rehabilitisation of the company is not possible, it orders for liquidation of the company under a liquidator to be appointed from a panel of liquidators.
Bankers are hoping that under NCLT, misuse of BIFR by certain promoters and companies for getting the stay against the recovery proceedings, which goes for period of uncertainty, will be stopped. The new Companies Act provides that such a stay is possible only if the NCLT orders it and also, this provision will apply only for 120 days.
If the NCLT thinks that the company will be able to pay its debts within a reasonable time, it will give that much time through an order. In addition to the powers to the NCLT, the new Act proposes a body to be established by the central government’s Serious Fraud Investigation Office (SFIO)for investigation of frauds relating to a company. SFIO identifies the fraud and makes any person representing the company liable for punishment for fraudulently obtaining credit facilities from any bank or financial institutions for making any false, deceptive or misleading statement.
The enactments, which are the relics from the colonial era Acts, should be stopped. Speedy and borrower friendly bankruptcy regime should be adopted and a settlement based bankruptcy regime should come into force. The philosophy behind bringing the new bankruptcy code to continuously rechannelise economic and human resources into more efficient use by restructuring viable businesses and helping to close unviable ones and start new ones should be strictly followed.
“Under the Companies Act, 2013, the sickness definition changed from the existing concept of erosion of 50 per cent net worth to an inability of paying debts amounting to 50 per cent of the secured creditors.”
Closure of any unit should always be the last option when so many stakeholders’ interests are at stake. Every sick company has made some initial investments in setting up basic infrastructure. Thus, it owns some assets and has employees working for it.
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