In 2016, India embarked on a landmark reform of providing a robust platform for resolution of troubled corporate entities. In principle, insolvency and bankruptcy are covered in the Seventh Schedule under the Concurrent List in the Constitution, allowing both states and the Centre to develop the legislative framework. However, in India, there is no state legislative history regarding either insolvency or bankruptcy in the post-Independence period, an important departure from the US. All such Indian post-Independence laws have their origins in UK laws.
Till the year 1985, the legal framework for dealing with corporate insolvency and bankruptcy in India consisted of only one law — the Companies Act, 1956. In 1985, the Sick Industrial Companies Act, 1985 (SICA), followed by the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (RDDBFI) under which debt recovery tribunals (DRTs) were established and finally, the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act (SARFAESI) was enacted in 2002. Around the same time when the SARFAESI Act was introduced, the Reserve Bank of India introduced a corporate debt restructuring scheme that provided broad guidelines for banks. It was thus clear by the year 2010 that a single, comprehensive framework was needed to effectively tackle delay in insolvency and bankruptcy proceedings.
This 60 years of Indian experience in insolvency resolution (till the IBC came into existence) suggests a similar story as in the US, where the first bankruptcy law was passed on April 4, 1800. Over time, however, almost all the efforts prior to the IBC failed to meet expectations. The success rate of companies under several regulations pre-2016 was abysmally low and varied from 16 per cent to a maximum of 25 per cent. In contrast, the success rate of companies under the IBC in terms of a closure is already at 41 per cent and increasing. The recovery rate is 43 per cent, up from 12 per cent in FY15 through other mechanisms with defaulting promoters losing control of the company. The Essar judgement, assuming a provision of 80 per cent, could potentially result in a provision writeback of more than Rs 30,000 crore for the banking system.
There are, however, a few trends that merit attention. Firstly, the number of cases admitted through Lok Adalats and DRTs has declined significantly post introduction of the IBC. As an example, the IBC platform is now being used by operational creditors (48 per cent of the cases admitted). Given the very small threshold limit of Rs 1 lakh, operational creditors seem to be more aggressive in dragging the corporate debtor into the NCLT, eating up the bandwidth of the court and thereby delaying resolution of the bigger cases and defying the main objective of the IBC. It is high time that the government seriously rethinks increasing the threshold value substantially from Rs 1 lakh and increasing the number of NCLT benches with a preponderance of more erudite professionals who understand the financial system better. This will ensure that the IBC platform is not used as a recovery but more as a resolution tool.
Secondly, it is observed that more than 23 per cent of the admitted companies ended with liquidation. One way of viewing it is that at the time of low demand and economic downturn there are not enough buyers of the stressed assets. Regulations must be made allowing foreign portfolio investors (FPIs) to acquire stressed rupee loans directly instead of going through an asset reconstruction company (ARC) and allowing eligible external commercial borrowing investors to fund the acquisition of stressed companies both under the IBC and outside it.
In fact, as companies are admitted into liquidation, the employees on the rolls of the company are only cumulatively compensated till the resolution process is completed, while the contractual employees are downsized. This could also act as a constraining factor on consumption growth and thus it is essential that we find a quick resolution (average resolution time is of 324 days as on March 2019).
Thirdly, it is also observed that sectors such as construction, EPC, electricity, where there are no hard assets, are also being dragged to the NCLT and such companies are mostly liquidated. Efforts should be made to find a resolution of such companies outside the NCLT as these could save resources and time for hard-pressed NCLT benches.
Fourthly, will the IBC facilitate the development of the corporate bond markets in India? After the IBC came into force, the SEBI chairman in a summit organised by CII in August 2017, said: “From an investors’ standpoint, an effective and robust bankruptcy regime is important for developing the corporate bonds market. Investors have been shying away from low-rated corporate bonds and even if the rating is of investment grade, given the high rate of defaults”.
The recent empirical work on links between corporate bond markets and the bankruptcy system predicts that safe firms will issue bonds but higher risk firms, for whom insolvency is more likely, issue bonds as long as bankruptcy is efficient. Clearly, this might require more analysis in the Indian context but there is evidence already.
Finally, where the IBC has been largely successful, in countries like China and Japan, culture has played a crucial role. As an example, Japan makes bankruptcy a personal, not business, failure. This characterisation of bankruptcy in Japan often leads to tragedy for the individual, be it isolation from family or otherwise. Culture also plays a substantial role in Chinese laws. In Chinese society, the notion of bankruptcy has long been condemned as “bad luck”. If a father owes a debt, his sons or grandsons would be responsible for it; bankruptcy implies living with a burden for generations to come.
Is Indian culture any different? Interestingly, in India, ordinary households take it upon themselves to repay their debt (household debt to GDP is lowest across all countries at 11 per cent of GDP). Thus, culture is indeed important. But in the larger context, two things are imperative to making the IBC successful in India.
First, learn from outcomes and strengthen the code so that the law is robust over time. This is currently being done. And, the ultimate test for culture is when promoters themselves approach the IBC for resolution for the benefit of all stakeholders.
The writer is group chief economic advisor, State Bank of India. Saket Hishikar, economist, SBI, contributed to this article. Views are personal
— This article first appeared in the November 29, 2019 print edition under the title 'A code for resolution'