Bankruptcy Code Needs Two Cheers; But Don’t Expect Miracles Too Soon

Many metaphors can be employed to describe the passing of the Insolvency and Bankruptcy Code, 2016 (IBC 2016), which was passed by the Rajya Sabha yesterday (11 May). We could say it is about shutting the stable door after the horse has bolted, and we aren’t just talking Vijay Mallya here. Or we could say it’s about putting the cart before the horse, for we neither have the insolvency professionals we need, nor the regulatory infrastructure to oversee quick completion of insolvency proceedings. What we have is an ecstatic tweet straight from the horse’s mouth after the bill was passed: “History is written today as Rajya Sabha passes Bankruptcy Bill!” The horse in question is Jayant Sinha, the Minister of State for Finance who piloted the bill.

Horse sense should have told us that you need to prepare the ground before you unleash something as historic like the IBC 2016, which supersedes several existing laws – the Companies Act, the Sick Industrial Companies (Special Provisions) Act (SICA) and the Recovery of Debts Due to Banks and Financial Institutions (RDDB) Act, among others – when it comes to individuals and companies filing for insolvency. But then, in India we like to shoot first and then ask questions. We are like that only.

None of the above comments, however, should be taken as criticism of the bill itself, which could be one of the best legacies the Narendra Modi government will leave to the country even if it were to depart in 2019. But we have to reserve judgment on its working for later, when it is shown to be working reasonably well.

We have a history of making “historic” laws that look good on paper and end up yielding a mouse. Two previous laws made with a similar intent as IBC 2016 have fallen flat on their faces after 30 years of trial and error – more error than trial. We enacted SICA in 1985, out of a misguided sense that “sick” companies have to be revived, never mind the cost. Eight years later, when the government discovered that SICA was not helping revive sick units, many of which had gone into rigor mortis by then, it tried the RDDB Act in 1993.

What SICA actually achieved was a furtherance of crony capitalism, for promoters could borrow money from banks and then head to the Board for Financial and Industrial Reconstruction (BIFR) to seek a “revival package” – frustrating the recovery process. BIFR usually ends up giving more money to failed businessmen, or, by endlessly delaying a resolution, ensuring that the borrowed money is never repaid by the promoter. The number of companies revived under the BIFR process can be written on the back of a postage stamp. On the other hand, what the RDDB achieved was a slow process of minuscule debt recovery. The process was so long-winded that banks would have been better off just writing off many of the smaller bad loans on their portfolios. But in Indian public sector banking, that would have meant a vigilance enquiry. So no one writes off anything.

The Supreme Court hammered the final nails in these two coffins when, 18 months ago, it decided that SICA will supersede RDDB, thus ensuring that banks trying to use debt recovery tribunals (DRTs) to get back some of their money could be stymied by promoters deciding to call in the BIFR instead. In a case involving Arihant Threads, an export-oriented spinning unit financed by the IDBI in the early 1990s, the promoter evaded debt recovery by trying to move the BIFR. Though IDBI won the case some 20 years after letting the loan go bad, it won on a technicality: apparently the promoter moved BIFR only after seeing the debt tribunal proceedings going against it. In short, if he had moved the BIFR earlier, he would have blocked the bank altogether.

This is one reason why the Insolvency and Bankruptcy Code is sorely needed, but even here it may be sorely tested in courts at some point. The courts have been wayward in helping lenders recovery money, and if IBC faces repeated court challenges, it will again stymie the intention behind the act.

But it is pointless to try and write the epitaph of a law still in its birth pangs. The IBC is, at least theoretically, just what we need right now, and the intentions behind it are surely honourable.

The main highlights of the code are these:

One, any company that is about to default on loans, can seek temporary protection of up to 180 days (six months) from creditors by filing for insolvency. If bankers and the company cannot resolve the issues (reschedule loans, write off some of it, etc) the lenders can start selling the assets. If 75 percent of creditors agree on a revival plan, the 180-day limit can extend by another 90 days. In other words, most insolvency cases can expect to be settled in nine months’ time max.

Two, according to PRS Legislative Research, the entire process will have to be conducted by “insolvency professionals (IPs)”, a breed that does not exist right now. The big accounting firms, CAs, and other finance professionals, will have to create this new breed, if necessary through crash courses, and also the professional agencies (IPAs) that will house these IPs. Since any IPA will have to offer bonds equivalent to the “assets” of a company under insolvency proceedings, this will be one uphill task. There is going to be no rush to do the job till the fine print of the bill is understood.

Three, complementing the IPs and IPAs will be information utilities IUs), which presumably will come from credit rating agencies, bankers themselves, and others with information needed to resolve insolvency issues.

Four, while the National Company Law Tribunal will finalise insolvency cases, the existing debt recovery tribunals will decide cases of individual insolvencies. These DRTs are already creaking under their existing workloads, so one wonders how they will cope with the avalanche of individual bankruptcies that may explode over their heads once the law is promulgated and put into effect.

Five, the new IBC gives primacy to workers’ dues, with PF, pension and gratuity dues being separated from the corpus of assets available for insolvency proceedings. Even in the balance, workers will get priority over lenders for salary dues upto 24 months. Lenders will get the assets only after this. This could create opportunities for litigation where courts love to play saviours to workers.

Six, none of this will work if bankers themselves are not proactive in recognising debts before they go really bad and become unsalvageable. Through various kinds of regulatory forbearances, now being removed slowly by the Reserve Bank under Raghuram Rajan, banks have ever-greened bad loan accounts just in order to avoid having to face up to the reality of having to write them off or take a “hair-cut”. This is particularly true of public sector banks, where the top management has limited tenure and thus a vested interest in kicking the can down the road. This enables them to retire before the stuff hits the fan.

What the Insolvency and Bankruptcy Code 2016 does is create a framework for things to get better, but it does not guarantee this will happen. Both SICA and RDDB generated a lot of enthusiasm, before filling lenders’ hearts with ashes. There is a whole lot of work that needs to be done to fill the huge gaps in infrastructure, information and regulatory frameworks that are needed for a successful IBC. It will take a minimum of 18 months to two years for the infrastructure to be created.

IBC is a necessary condition for India to move forward on the ease of doing business ranking, but it is not a sufficient condition. The Modi government deserves two cheers for getting the law enacted, but we should reserve the last cheer for later, when the rest of the work gets done.

Many other things need to change before IBC can start working. Passing the bill is only the first hurdle crossed. Many more remain.