Finance Minister Arun Jaitley said in his Budget speech that, “Bankruptcy law reform, that brings about legal certainty and speed, has been identified as a key priority for improving the ease of doing business, SICA and BIFR have failed in achieving these objectives.” He added: “We will bring a comprehensive bankruptcy code in the fiscal 2015-16, that will meet global standards and provide necessary judicial capacity.”

Reforms in bankruptcy laws can play an extremely crucial role in economic growth and financial stability. An effective insolvency framework — both in court and out of court (such as corporate debt restructuring) — can offer huge economic benefits such as ensuring maximisation of value of creditor’s claim by rehabilitating the ailing debtor company and maximisation of creditor’s claim through an effective liquidation framework in case rehabilitation is not achievable.

Optimisation of creditor’s claim encourages financial institutions and other lenders to extend credit facilities, which, in turn, develop and strengthen the financial markets leading to increased availability of credit for business.

Reform insolvency system In order to achieve an effective insolvency framework, there is a dire need to reform the insolvency system in India — whether it is liquidation of companies through the Companies Act (Act) or revival of sick companies through the Sick Industrial Companies Special Provision Act (SICA).

The experience of liquidation under the Act or revival under SICA is abysmally discouraging. It is a long and cumbersome process to liquidate or revive a company in India defeating the very objective of liquidation or revival.

Often, SICA is misused by the debtor company as reference with BIFR is deliberately filed to seek an automatic stay on creditor enforcement against the company. SICA shields the debtor company from creditor enforcement, instead of providing genuine rehabilitation and restructuring.

Alternative insolvency mechanisms such as the enforcement of security interests under the Sarfaesi Act without the intervention of the court, and CDR, have gained popularity. But they too suffer from limitations.

For instance, the Sarfaesi Act does not give protection to unsecured creditors; the CDR is limited to only banks and financial institutions, and to companies with a debt exposure of ₹10 crore or more from more than one bank.

The problem Therefore, there is an immediate need to overhaul the insolvency framework by enforcing the provisions of the Act pertaining to revival and rehabilitation of companies.

The problem for such enforcement is that the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT), the tribunals which will undertake revival and rehabilitation, are still not in operation. They are embroiled in a legal battle in the Supreme Court where their constitutional validity has been challenged.

To put an end to the legal battle and make way for setting up these tribunals, the government should itself offer to alter the composition of these tribunals to be sync with an earlier Supreme Court order on this issue.

The Companies Act provides a good starting point for insolvency reforms as it incorporates many international best practices, including determination of sickness on the grounds of a company’s inability to pay its creditors, rather than erosion of its net worth; greater control to creditors over the company during insolvency proceedings; appointment of professional administrators; and vesting the process with sophisticated and advanced tribunals.

In spite of these positives, many provisions are defective as also pointed out in detail in the interim report of Bankruptcy Law Reform Committee of the ministry of finance, headed by TK Vishwanathan.

Some recommendations To overcome these defects, the committee has made recommendations, including giving a secured creditor the right to initiate rescue proceedings when a company fails to pay debts exceeding a prescribed value.

This is against rescue proceedings being brought by at least 50 per cent or more of the outstanding debt of secured creditors, as currently provided in the Act.

Other recommendations include also giving the right to unsecured creditors to initiate rescue proceedings; reducing time-lines to determine whether to rescue or liquidate a company; appointment of a company administrator directly by secured creditors; takeover of management or assets of the company by the administrator; developing appropriate criteria for determining when a company is ‘unable to pay debt’ for the purposes of winding up; priority of payments to secured creditors over government tax dues in winding up; strengthening managerial accountability in insolvency proceedings. The out-of-court framework as well requires reforms to make it applicable to all creditors and not just banks and financial institutions.

Lastly, to provide a binding effect to the out-of-court framework, the court should also approve the debt restructuring agreement reached out of court by the majority of creditors.

India’s ranking in ease of resolving insolvencies in the latest World Bank report on doing business is dismal. The Vishwanathan Committee pointed out that “in spite of being structurally similar to some efficiently functioning insolvency regimes of the world (especially for winding up or liquidation), the Indian regime has not proved to be very effective in practice”.

It’s time to walk the talk on the Budget promise.

The writer is a partner with J Sagar Associates. The views are personal

Related Topics
comment COMMENT NOW