Will Insolvency Code Resolve Liquidation Crisis?

India’s banking industry is in the throes of a crisis. Bad debts are piling up at banks. Earlier, the multiplicity of laws dealing with the insolvency of a company has been a problem in the way of banks failing to recover their loans.

The new insolvency and bankruptcy code brought by the incumbent National Democratic Alliance (NDA) government has given the headroom to companies indebted massively and performing miserably to declare themselves as bankrupt and it has also facilitated the lenders to expedite recovery and resolution of stressed assets. Thereby, many are heading towards National Law Company Law Tribunal. This is a crucial step towards taking India out non-performing assets crisis.

Sunil Kant Munjal, Chairman Hero Enterprise told BW Businessworld, “The new insolvency code is a big step forward for India, the Indian economy, Indian Industry and for the banking system. While we can expect that it will take some time to fully implement and get full benefit but it is clear that this is the best and the most practical way of bringing blocked assets back into productive use. This implementation of this act will have multiple benefits with the biggest benefit coming to banks to help them resolve many of their non-performing assets. This will also help in releasing entrepreneurial energy that can be reapplied to create more enterprises and therefore create more jobs and economic opportunities that are crying need of the nation.”

According to a report by Bankruptcy Law Reform Committee (BLRC) released before the law was enacted, “The current state of the bankruptcy process for firms is a highly fragmented framework. Powers of the creditor and the debtor under insolvency are provided for under different Acts. It is problematic that these different laws are implemented in different judicial fora. Cases that are decided at the tribunal/BIFR often come for a review to the High Courts.”

The reform has taken care of this aspect by removing the webs of multiple and ‘ancient’ laws. Uday Bhansali, President - Financial Advisory, Deloitte Touche Tohmatsu India LLP told BW Businessworld, “The new code is the most important piece of legislation that has been passed. This legislation is modeled on advanced countries, with suitable adjustments to make it conducive for India. The law will help in putting forward a pragmatic plan for resolving the debt and turnaround of the company, coupled with the possibility of the company going into stronger hands. If this does not work, then liquidation would be the ultimate outcome.”

However, the new code on bankruptcy and insolvency (which is said to be inspired from Singapore judicial system) isn’t seen as an ideal one just like GST by many economists. The law provides for appointing an insolvency professional (IP) to conduct the process in a legal and smooth way. According to the new law, the plans chalked out by the IP are further voted by a committee of creditors (CoC). These stages lead to higher bankruptcy costs. According to Doing Business 2016 report, India ranks 136 out of 189 countries when it comes to resolving insolvency. Further, considering Indian scenario, it gives too much discretion power to the IP as he/she is likely to have little or almost no practical experience of this domain.”

On being asked about IP and CoC, Bhansali said, “There are qualification standards prescribed for the IRP, minimum experience, and an online exam for someone to be registered as an IP. So, you are going to engage professionals with a reasonable degree of maturity. Ultimately, their job will be to analyse the insolvency plan with a certain amount of logic and rationale, fact, and figures. Now, the CoC consists of seasoned bankers who are representing the leading lenders. As long as you follow transparency in the decision making, and there is sound rationale, CoC will arrive at the right decision.”

Adding to the misery is a large number of cases which is sure to make it extremely challenging for National Company Law Tribunal, the adjudicating body associated with corporate default cases, to rapidly clear cases. According to an estimate by consulting firm Alvarez & Marsal, “The tribunal will be burdened with as many as 25,000 insolvency cases and it may take at least seven years to clear them all.”

“The new code is quite promising. There is a decent chance of cases finishing within the envisaged timeline. Obviously, clearing resolution cases within the envisaged time frame is subject to external factors including the courts and actions of creditors, but at least matters are progressing well at present. These are very early days,” added Bhansali.

The BLRC also noted this in the report saying, “An aspect that exacerbates the issue is problems of multiple judicial fora. The fora entrusted with adjudicating on matters relating to insolvency and bankruptcy may not have the business or financial expertise, information or bandwidth to decide on such matters. This leads to delays and extensions in arriving at an outcome, and increases the vulnerability to appeals of the outcome.”

Another glaring fact is the extent of losses that banks will have to suffer to resolve the bad asset case. Also, if an insolvent company has assets to offload, the availability of buyers may also become an issue. “The NPAs happen due to a large number of factors including the overall functioning of the company, the business model, economic environment, international and domestic competitive factors, and the government policies. The NPA situation in each individual case hasn’t happened overnight but over a period of time. The new code won’t fix the NPA issue overnight. This is the fundamental issue that the banks have to tackle based on their lending decisions, project viability, review of capex plans and cash flow, etc. Bankruptcy code is not a magic wand which can immediately crack the NPA crisis,” said Bhansali.

The code also provides for 180-270 days deadline for completion of corporate insolvency case failing which, the code mandates the “Adjudicating Authority” to order liquidation. It is good that the lawmakers took notice of time but this might push otherwise salvageable companies into liquidation, disrupting markets and affecting jobs and thereby, livelihoods.

According to an EY report, “The code, at best, is a plan currently awaiting execution. While the execution has started, its effectiveness is yet to be seen. “The successful implementation of this act will depend on multiple players including government and the judiciary but the biggest advantage would be in the cultural change of accepting failure as a natural outcome of life and allow people who have encountered failure for any reason whatsoever become productive contributors to the economy and society,” added Munjal.