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Bankruptcy Law In India – An Overview By SK Srivastava

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In India, even the pursuit of bankruptcy can be agonizing. It takes more than four years to wind up an ailing Company here, almost twice as it does in China. Recovery of debt is stuck at 25.7% among the worst emerging economies. The Kingfisher, once the second biggest airlines, provides an illuminating example. The Company was grounded in 2012 with debts of over $1.5 billion.But it was not until February 2014 that its long-suffering creditor banks got their hands over former headquarter in Mumbai. Nearly 60,000 cases languished in India’s overburden courts.

I ndia does not have a single bankruptcy code but an assortment of laws that govern insolvency. The system operates at a painfully slow pace as courts try to interpret a variety of conflicting laws that cover insolvency. For instance, some laws forbid creditors from taking any legal action against the defaulters until a restructuring plan is in place; that can take several years. In the meantime owners of the sick companies retain day-to-day management control and often prolong court proceedings as the nervy creditors watch the value of their assets dwindle – if they have not already been stolen. It is also common for the defaulters to start a business under their relative’s name by siphoning of funds from their old business.

Insolvency protection for debtors, too, is similarly flawed. Ailing companies have to wait until their net worth is eroded to half or nil before they qualify as ‘sick’. Some creditor-friendly laws are too keen to liquidate such firms rather than to restructure them. A few others conflict with regulations on land and labor which prevent the selling of property or laying off workers at factories.

The failure of businesses impacts employees, shareholders, lenders, and the broader economy. In a country like India particularly — because of delays in making decisions on the viability of businesses, tactics employed by company promoters to delay reorganisation or attempts to sell off assets, change of managements or litigation that goes on and on — the drag on new business units, jobs, income generation and economic growth can be significant.

India does have some laws — including one on Securitisation and Enforcement of Security — and other mechanisms, like Corporate Debt Restructuring or CDR, to address the problem of the insolvency of firms. But the fact is some of these laws, such as the Sick Industrial Companies Act or SICA, have not worked because of inefficient enforcement and court delays.From April 1, 2014, all the restructured loans necessarily need to be classified as NPAs and the relative provisioning at banks would be 15% of the loan outstanding. This provisioning is an increase by 10% from the existing 5% on `restructured standard asset’ as applicable earlier.

However, banks may not feel the pressure immediately as they may slow down doing a restructuring of loans since the incremental stress on asset quality may not be much due to improvement in the economy. A number of restructuring proposals had also come down over a period. “No immediate impact,” said State Bank of India chairman Arundhati Bhattacharya in a texted message. “Since only future restructuring will be classified as NPA.

” The total stock of restructured loans would be about 6% of gross advances or Rs 820000 crore by March 2015 as per India Rating estimates. This includes those under corporate debt restructuring cell and the loans under Discom financial restructuring plan. The gross NPA ratio is likely to be 4.5% or Rs 3,50,000 crore which would put the estimate of impaired loans as 10.5% or Rs 76,00,000 crore.

If one includes ARC receipts and Discom bonds which reflect in the bank’s investment book the total estimate of stressed assets would be 12.5% by March 2015.

So how can a modern law help?

Like in the West, a modern law with a focus on speedy closure will help firms on the brink to be either restructured or sold off with limited pain for all involved. In some cases, if this is done swiftly, assets can be put to good use and the firm can be revived. Delaying a decision on whether to shutter a firm or to try to revive it causes the destruction of value for all involved. Indian policymakers have recognized this. For banks or lenders, the money recovered can be lent again, promoting the efficient allocation of resources, besides development of financial markets such as a bond market with clarity on repayment for debtors. An efficient and swift insolvency regime ensures greater availability of credit or funds for businesses by freeing up capital and is thought to boost innovation and productivity.

What is the international experience?

The US has a Bankruptcy Code that provides for fairly quick liquidation or reorganization of business with what is popularly known as Chapter 7, with cases being filed in bankruptcy courts; Chapter 11, which deals with reorganization of businesses; and Chapter 15, on cross-border insolvencies. Individual bankruptcies are dealt with separately. In the UK, once cases are filed for bankruptcies, after 12 months, there is either discharge with part of the assets being used to pay off debts, or, in situations where companies can be turned around, court-appointed administrators handle cases. The German insolvency law is applicable to both individuals and firms, with independent court-appointed insolvency practitioners helping in realizing assets or reorganizing the business.

What is India planning?

A committee headed by former law secretary T K Viswanathan has suggested a timeline of 180 days — extendable by 90 days — to deal with applications for resolving cases of insolvency or bankruptcy. During this period, the management of the distressed firm or debtor could be placed in the hands of a resolution professional — a new class of professionals equipped to deal with such cases, which would be supervised by a proposed new regulator. The proposal also envisages them getting into talks to revive firms, and work out a repayment plan. A Debt Recovery Tribunal will be the adjudicating authority over both individuals and unlimited liability partnership firms. The National Company Law Tribunal will be the adjudicating authority with jurisdiction over companies with limited liability. The law will have to be approved by Parliament. What about financial sector insolvencies? The Financial Sector Legislative Reforms Commission (FSLRC) has recommended the creation of a resolution corporation to monitor financial firms, and intervene before they go bust. The aim is to either close firms that can’t be revived or change their management to protect investors or depositors. This is important because the failure of large banks or institutions imposes costs on taxpayers in the form of bailouts or capital infusion. The proposal is to promote the Deposit Insurance and Credit Guarantee Corporation (DICGC) as Resolution Corporation.

Currently, there is no law that specifically deals with insolvency and bankruptcy. Liquidation of Companies is handled by the High Courts. Individual cases are dealt with under the Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920. The other laws dealing with issue include SICA, 1985; Recovery of Debt Due to Banks and Financial Institution Acts, 2002 and Companies Act, 2013. The Objective of the Code according to statement of Finance Minister Mr Arun Jaitley “is to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximization of value of assets of such persons, to promote entrepreneurship, availability of credit…”

It also aims to balance the interest of all the stakeholders including alteration in the priority of payment of government dues.

An effective legal framework for the timely resolution of insolvency and bankruptcy, would support the development of credit markets, encourage entrepreneurship. It would also improve ease of doing business and facilitate more investments leading to higher economic growth and development. Blog is written by -Shailendra Srivastava Corporate Finance Advisor- Bilcare Ltd

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