Our Policymakers No Longer Trust Holders Of Capital, And It’s Showing

Two things are clear about the ordinance brought in to amend the Insolvency and Bankruptcy Code (IBC). It is ruthless. To cut out the weeds that stifle the growth of healthy corporates, it has served up poison as fertiliser for many companies. The other is, it will sail through Parliament without any difficulty, to become a law.

As distinguished commentators – like Andy Mukherjee here and Rajeshwari Sengupta and Anjali Sharma here – have pointed out, the ordinance disturbs the core principles of settling bankruptcy. The premise that they lay clear on the basis of first principles are (and I quote):

a) Businesses can and will fail, and all failure is not fraud. The IBC provides a forum for creditors to collectively resolve such failures.

b) Insolvency resolution is a commercial decision best left to the collective wisdom of the creditors, who are better placed than the state or judiciary to decide whether to resolve or liquidate a firm in distress.

c) Predictability in the resolution process and the resolution outcomes improve the overall credit ecosystem.

The three commentators have argued that the ordinance cleared by the Corporate Affairs Ministry has instead put to sword the head of almost anyone who could be interested in the revival of a company which has landed in a bankruptcy court. To weed them out, the legislation prescribes eight types of disqualification. Among these are descriptors like any “connected person”, “related party”, wilful defaulter or anyone with a pending non-performing asset (NPA) account of more than one year, all of whom are all barred from bidding for a company facing liquidation.

Why such a drastic law has come up can be seen in what I would call the delegitimisation of the role of capital in Indian polity. In this context, I would refer to the recent debate on the Financial Resolution and Deposit Insurance Bill (FRDI), 2017 too, a bit later.

The delegitimisation of capital has not happened suddenly. But once it was set in motion, it has become pervasive enough to make it impossible for a lawmaker to write any piece of legislation now, which seeks to reward the owner of capital for any economic risk she undertakes. This is why the ordinance is likely to get a standing ovation from both sides of the House even as it makes bankruptcy the equivalent of a crematorium for a company instead of a reorganisation of capital, as it should be.

It is difficult to be precise about the dates, but the unease among citizens about the slipping standards of Indian business, has bubbled for quite some time near the surface. It possibly burst out with the series of scams that hit India from 2011 onwards, among them 2G, coal and even one concerning Indian Space Research Organisation. What happened with them subsequently is well-known, but they were not products of isolation. The pervasive image of corruption at the municipal level gave the accusations a personal feel. Since then, as the scare against black money and demonetisation has demonstrated, holders of capital are left with few public friends in India.

The problem stretches across small and large enterprises. One can argue that the smaller ones have taken their cue from the larger fellows. As T N Ninan points out in one of his editorials, with reference to the goods and services tax, “The bad news concerns mostly the small and unorganised businesses, especially those that supply to downstream businesses. Many of them have been functioning by evading or avoiding tax”. About large businesses, as economist Ajay Shah points out, “There are some unique features of most firms in India… Most firms in India do not have a clean structure of legal contracts. There are a large number of unwritten arrangements which keep the firm aloft.” Large or small, either way the picture both present for the public is not pleasing at all.

This enters dangerous territory. How does an insolvency professional know that the bid for a company’s revival is not rigged? In this milieu, expecting the worst, there is a natural tendency to fear the “unwritten agreements” among promoters.

To get a sense among the public that they are left with the cost of the clean-up, one has only to look at another piece of legislation that is up for discussion now. The FRDI Bill is a simple piece of legislation. It too has been in the works for some time. It seeks to set up a ‘Resolution Corporation’ which will monitor the risk faced by financial institutions such as banks and insurance companies, and resolve them in case of failure.

The problem surrounding the bill is a term bail-in. There is a succinct explainer for the bill put out by PRS Legislative Research. It says that Clause 52 of the Bill creates an option to allow a bank or an insurance company that is at the risk of failure to be revived by internally restructuring its debt. The method is the opposite of a bail-out, that for instance has recently been cleared by the Finance Ministry for state-owned banks. This has created a scare that the money of the depositors could be commandeered to provide liquidity to the bank.

The Bill has been around for quite some time with all the clauses — in fact, it is a product of the Financial Sector Legislative Reforms Commission that was set up under then finance minister Pranab Mukherjee. The framers of the bill imported the concept of a bail-in from the Financial Stability Board set up by the G-20 after the global financial meltdown of 2008, to which they added in the protection, lifting the provisions of the relevant Deposit Insurance and Credit Guarantee Corporation. As of now, the government is debating the extent to which the deposit insurance should be raised. In any case, the Reserve Bank of India as the country’s banking regulator, has always made it clear that it will not allow any retail depositor to suffer even if a bank has to shut shop. The high-profile cash support operation it mounted in the case of ICICI Bank when there was a run on the bank, makes this amply clear.

It will however be churlish to blame the public for their sense of annoyance. The response to the FRDI Bill is a demonstration of their sense that large swathes of the holders of capital, i.e., industry leaders, are not doing their fiduciary duty of holding up its value. There is a long history to this grievance and the juxtaposition of the ordinance and this Bill demonstrates how it has now come to boil. How such widespread anger would dissipate is difficult to gauge. It is clear however that it is this sense of delegitimisation that prompts the executive to write such a draconian piece of legislation that actually harms rather than helps the cause of revival of firms.