The Indian government’s attempts to ease doing business currently seem one-sided. Facilitating market entry and tearing down barriers to production and trade are just one side of the coin. The other involves allowing defunct, unhealthy firms to seamlessly exit the market, where they can easily liquidate their assets.
The current financial scenario in India makes this all the more important. Most companies and major banks’ balance sheets are riddled with NPAs (Non-Performing Assets). Bad lending practices, natural disasters, and poor credit policies also contribute to the rising number of NPAs. Due to these NPAs, mostly comprising of faulty loans and overdue debt obligations, banks become starved of incoming cash flows and therefore have to compensate by charging extremely high interest rates on some products. Bank shareholders are also adversely affected. NPAs have a profound effect on the financial scenario in an economy and are often responsible for causing liquidity crunches for major financial institutions. This in turn has a destabilizing effect on the economy.
The Insolvency and Bankruptcy Code takes this recent phenomenon amongst other harmful mechanisms into account, seeking to create a database of all the serial defaulters, and enhancing the debt resolution process. The efficient and timely liquidation of assets is of special importance to international creditors and investors when a company or entity is on the verge of bankruptcy. The main aim of the Bankruptcy and Insolvency bill is to minimize the amount of procedural time and effort that is devoted to clearing non-performing assets or debt.
India’s current trajectory seems similar to that of the U.S. economy right before the 2008 recession. Customers in both economies do not have an optimal level of credit-worthiness. Banks continue to lend to such customers despite it being risky. Similar economic circumstances precipitated the recession in the US, where several companies plummeted into bankruptcy due to such risky borrowing. India will head down a similar path if lending is not checked and the necessary framework created to address the concern of bankruptcy and insolvency. India aims to create a safety net to mitigate such risks and the Insolvency and Bankruptcy Code is viewed as the primary driver to create the safety net. The following section in the article explores the key takeaways from the proposed Code.
- The bill deals with insolvent, bankrupt companies in the following manner: The bankruptcy code will consolidate the existing framework of laws that deal with insolvency and create a new institutional structure. The code outlines insolvency resolution processes for individuals, companies and partnership firms. Either the debtor or the creditors may initiate the process. It will be known as the Insolvency Resolution Process (IRP). When the IRP is on, creditors’ claims are frozen for 180 days, during which they will hear proposals for revival and decide on their future course of action. Within those 180 days, 75 percent of the creditors must agree to a revival plan. If this minimum threshold is not met, the firm automatically goes into liquidation. If three-fourths of the creditors decide that the case is complex and cannot be addressed within 180 days, the adjudicator can grant a one-time extension of up to 90 days on the process.
- Licensed Insolvency Professionals (IPs) will conduct the resolution processes. These IPs will be members of insolvency professional agencies (IPAs). IPAs will also furnish performance bonds equal to the assets of a company under insolvency resolution. Asset Reconstruction Companies (ARCs) will also be given encouragement. Such companies function in a similar manner, and perform many of the same operations. These professionals will be allowed to levy criminal charges on those who advocate asset stripping.
- Information Utilities (IUs) are to be set up to collect, collate and disseminate financial information to facilitate insolvency resolution. They will store the credit information of corporates.
- Two institutions are to be set up: The National Company Law Tribunal (NCLT) will adjudicate insolvency resolution for companies and limited liability partnerships. The Debt Recovery Tribunal (DRT) will adjudicate insolvency resolution for individuals and partnership firms.
- The Insolvency and Bankruptcy Board of India will be set up to regulate functioning of IPs, IPAs and IUs.
- The code also proposes to protect the workers in case of insolvency, paying their salaries for up to 24 months. They will get first priority during liquidation off assets.
The Insolvency and Bankruptcy Code aims to improve the Ease of Doing Business in India. Currently, for instance, China deals with an insolvent company in a fraction of the time that India takes. China taking about 1.7 years versus India’s four. The creation of the bill will boost India’s ranking on the World Bank’s ‘Ease of doing Business’ Index.
The bill also aims to reduce crony-capitalism, where the regulations only seem to benefit a select few. This bill is a step forward in allowing market forces to freely decide economic outcomes. The right amount of government and agency intervention is allowed to prevent stagnating firms from imposing negative externalities on other portions of national economy. It can also be looked at as a step towards combatting corruption, private sector complacent risk-taking, and overall efficiency losses. Analysts do have some reservations about the bill. For instance, the bill has proposed to establish an Insolvency and Bankruptcy Fund; however, the role of the Fund has not been specified. The code also provides for the creation of multiple IUs. However, it does not specify that full information about a company will be accessible through a single query from any IU. This will lead to the scattering of financial data. If the bill addresses these reservations, it can be a landmark economic legislation. The code has the potential to set India on a path to sustainable economic development and financial stability.
This article was first published July 2016.
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