Virtues of a strong bankruptcy law

In the Bank’s latest report, Doing Business 2016, India has has moved only one place in terms of ranking for resolving insolvencies — from 137 to 136. This encapsulates the challenges the country is facing with managing insolvencies. The average time taken for insolvency proceedings in India (according to the report) is about 4.3 years, while it is only 1.7 years in the high-income OECD member countries.

Having a robust insolvency resolution mechanism can help creditors recover a larger part of their investment faster allowing them to re-invest in other businesses, facilitating the efficient flow of capital across the economy.

A strong bankruptcy law, therefore, becomes a critical requirement that provides a debtor with various mechanisms to restructure and revive its business, be it acquiring finance on favourable terms or providing a stay on litigation.

For banks and lending institutions, a more comprehensive bankruptcy law would help protect their rights, promote predictability, clarify the risks associated with lending, and make the collection of debt through bankruptcy proceedings more attractive, thereby facilitating credit and a higher flow of capital in the economy.

Most of the bankruptcy regulations in developed countries tend to focus on the revival of a business. A case in point would be the bankruptcy regulations in the US which are outlined in the US Bankruptcy Code. Under Chapter 11 of the Code, a debtor firm can propose a reorganisation plan much before it turns sick to keep the business afloat and pay creditors over time.

While there is no comprehensive and integrated policy on corporate bankruptcy in India, like in the US, along with the Companies Act, 2013, there are three major legislative Acts and several special provisions which provide procedural guidance on liquidation or reorganisation.

As a result, four different agencies (High Courts, Company Law Board, the Board for Industrial and Financial Reconstruction, and the Debt Recovery Tribunals) have overlapping jurisdiction, which can create systemic delays and complexities in the process. This further causes the entire bankruptcy process to become lengthy.

Along with other benefits that a strong bankruptcy law will entail, it would also help to give banks teeth to tackle the problem of stressed assets. So the draft report submitted by the Bankruptcy Law Reform Committee (BLRC) to the Finance Minister on November 4, 2015), is a positive step towards suggesting immediate reforms to the existing legal regimes governing bankruptcy in the country.

Whilst the BLRC recommendations seem to address most of the aspects relating to bankruptcy in India, there are a couple of areas where the recommendations could have been strengthened.

One view is that the viability of an enterprise should not just be examined by a committee of creditors but by a team which would have a wider participation of all stakeholders — creditors, shareholders, promoters, etc.

Additionally, given that in developing countries such as India, the litigation process may be used to cause delays, it is advisable to include a provision which will empower the regulator to levy fines in case frivolous adjournments are sought.

While the recommendations by the BLRC intend to speed up the process of rescue or liquidation for companies under financial distress, the proposed changes, if accepted, shall help in reviving the economy as creditors along with the debtor company shall be assured of a speedy rehabilitation/ liquidation procedure.

The new rules may encourage Indian promoters to approach lenders with their revival plans at a much earlier stage of stress and discourage abusing the system.

It is also believed that the recommendations would ease the investment opportunity in the country for Special Situation funds which are involved in acquiring distressed assets and thus are an important part of the bankruptcy eco-system.

This will help banks/ financial institutions recover dues with a fair degree of certainty as well as within a select time frame.

This in turn will help banks avoid the perils of a time-consuming litigation process which tend to work to the benefit of a corporate house/ promoter since it delays a bank from taking control of assets post default.

While the bankruptcy law is a much needed regulation, the devil may be in its implementation.

The writers are with Deloitte in India. The views are personal