Can the latest legislative attempt to improve India’s abysmal debt recovery rates succeed where others have failed? Rebecca Abraham reports
Winding up an ailing company in India is not for the faint-hearted. It can take more than four years, and lenders currently expect to recover only around 20% of what they are owed once a default takes place.
Emblematic of the problem is the situation with the now defunct Kingfisher Airlines, which owes ₹70 billion (US$1 billion) to lenders. Creditors are set to auction the airline’s Mumbai office building in April, nearly three years after its planes were grounded and employees stopped receiving their salaries.
A thicket of laws
Blame for situations such as this is typically assigned to the complexity of the legal framework for insolvency and bankruptcy. Multiple laws provide for debt recovery – including the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, and the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) – and the forum for debt recovery is sometimes a debt recovery tribunal and at other times a court.
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Meanwhile, the insolvency of an industrial company is governed by the Sick Industrial Companies (Special Provisions) Act, 1985 (SICA), which was repealed in 2003 but continues to apply as it has not been replaced.
However, a report by a high-level committee that recently looked into bankruptcy reform said one of the key problems with the current regime is that creditors have had little clout when faced with default as promoters remain in control.
Underdogs no more
The Insolvency and Bankruptcy Code, 2015, introduced in parliament on 21 December 2015, seeks to change the balance of power between creditors and debtors of all types: companies, partnerships, limited liability partnerships, individuals and any other body specified by the central government.
It does not however apply to entities in the financial sector such as banks and insurance companies. Presenting the annual budget for 2016-17 on 29 February, India’s finance minister remarked that there is a there is a “systemic vacuum” with regard to bankruptcies in such firms. The minister said that the government would be introducing a Code on Resolution of Financial Firms in parliament in the course of the year. The two codes taken together are expected to provide “a comprehensive resolution mechanism” for the economy as a whole.
Be that as it may, the Insolvency and Bankruptcy Code would repeal multiple current laws and provisions and provide a swift process for the resolution of insolvencies in non-financial firms. The process for companies and limited liability entities would take only 180 to 270 days from when an application is filed to initiate the corporate insolvency resolution process. A fast-track insolvency resolution process could be initiated for smaller companies, i.e. with assets or income below a prescribed level, or those with a prescribed class of creditors or prescribed amount of debt.
A key change and one that will not be taken lightly by companies across India is that the company’s promoters would lose control over management of its assets during the insolvency resolution process. Instead, an insolvency professional – licensed by an insolvency regulatory body that is to be set up under the new regime, the Insolvency and Bankruptcy Board of India – will take control.
A stitch in time?
The draft code provides for the quick resolution of an insolvency situation
Under the Insolvency and Bankruptcy Code, 2015, which is currently being considered by a joint parliamentary committee, resolving an insolvency for companies and other limited liability entities should take only 180 days from the filing of an application to initiate the corporate insolvency resolution process. This period can be extended by 90 days, if creditors accounting for 75% of the debt agree.
During the 180 or 270 days an insolvency resolution plan for the company has to be put together by the creditors, working with an insolvency professional. Debtors would have few or no rights in the process.
If there is no agreement on a resolution plan, the company will go into liquidation at the end of the period – either 180 or 270 days as the case may be. During this period no suits can be initiated against the company and all creditors’ claims remain frozen.
A fast-track insolvency resolution process can be initiated for smaller companies, i.e. those with assets or income below a prescribed level or with a prescribed class of creditors or prescribed amount of debt. The fast-track process allows only 90 days – extendable by 45 days – in which a resolution plan has to be negotiated and agreed.
The resolution plan, once agreed, needs to be sanctioned by an adjudicating authority, which for companies and other limited liability entities is the National Company Law Tribunal. This quasi-judicial body is to be established under the Companies Act, 2013, and would replace the Company Law Board and the Board for Industrial and Financial Reconstruction in adjudicating on insolvency matters.
A changed reality?
Commenting on how the proposed changes would affect corporate India, the general counsel of a pharmaceutical company says: “cash management will be more under internal as well as external scanners”.
But can the proposed Insolvency and Bankruptcy Code be expected to improve debt recovery rates?
“This is a new attempt to make creditors happy … If specialized insolvency courts are not set up then this is merely an administrative change that will go the same way as SICA, etc.,” says Rajinder Sharma, general counsel of Filipkart.
Having experienced the expectation and euphoria of earlier attempts, Sharma now is sceptical. “When SICA came into play people were gung-ho but nothing came of it. Then the debt recovery tribunals were constituted but this has now become a den of corrupt inefficiency. Next came SARFAESI but this too has been a big failure.”
Achilles heel
Under the code, the corporate insolvency process could be set off by a financial creditor (who is owed a financial debt) or an operational creditor (such as a person who is owed money by the company) or by the debtor itself. While it is expected that this will bring the law in line with international practice, which permits unsecured creditors to initiate the insolvency process, this may also prove to be its Achilles heel.
“As it stands, the proposed bankruptcy code does not distinguish between secured and unsecured creditors,” says B Gopalakrishnan, legal and secretarial adviser at Neterwala Group. Gopalakrishnan, formerly head of legal at Axis Bank, says this will not benefit banks that will be looking to recover loans.
“The sanctity of priority of creditors that was there earlier has been taken away,” remarks Sharma at Flipkart, who believes that the proposed legislation may be just as problematic for debtors as it will take away the ability of a debtor to prioritize its creditors. “The creditor definition is too wide … all creditors fall into the same basket.”
H Jayesh, founder partner at Juris Corp, refers to the clubbing together of all creditors as a “fundamental flaw” of the proposed bankruptcy code. “The secured creditors can ride rough over the unsecured creditors as often the secured creditors are the more active,” says Jayesh.
There is little love lost between secured creditors and unsecured creditors (dominated by international lenders and debt instrument holders) in India. A case in point is Wockhardt, an Indian pharmaceutical company that was at the brink of defaulting on loans in 2009. The company worked out a corporate debt restructuring scheme with its secured lenders, but unsecured lenders – led by a group of foreign currency convertible bond (FCCB) holders – refused to go along.
Wockhardt was involved in a complex legal battle with its lenders before Bombay High Court before eventually being forced by the court to pay the FCCB holders their dues, or face liquidation.
Jayesh says it was thanks to the unsecured creditors that all lenders eventually benefited. Juris Corp represented several of the FCCB holders in this dispute, including DBS Bank.
The proposed bankruptcy code defines a creditor as any person to whom a debt is owed and includes a financial creditor, an operational creditor, a secured creditor, an unsecured creditor and a decree holder. Any of these persons can trigger the insolvency resolution process following a default by the debtor, even if they are not directly affected by the default.
Speed is of the essence
The code sets strict timelines for both the insolvency and bankruptcy process (for details see A stitch in time?).
Gopalakrishnan says this will mean that “as a creditor you can immediately call for putting the company to an end”. He sees this as a key benefit for foreign investors as they will be allowed an easy exit route.
The big question now is will parliament adhere to any timeline as it considers the bill?
The Insolvency and Bankruptcy Code, 2015, was introduced in the lower house of parliament, the Lok Sabha, as a financial bill with the recommendation of the president. Media reports had said that it was introduced as a money bill and as such, it would only need to be passed by the Lok Sabha in order to become law.
The Bharatiya Janata Party, which is currently in government in India, has a majority in the Lok Sabha, but not in the upper house of parliament, the Rajya Sabha. However, as a financial bill it requires the approval of the Rajya Sabha as well. This could take time.
In the meanwhile India’s banking system is struggling to cope with ballooning non-performing assets (NPAs). There are currently 10 banks – all in the public sector – with gross NPAs at over 8%. This is expected to increase as the March 2017 deadline set by India’s central bank approaches for banks to clean up their balance sheets.
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