In the march of motivated policy reforms that are afoot in India, a new insolvency code was tabled in Parliament last month. A hat tip is due to the Bankruptcy Law Reform Committee (BLRC) for the dramatic qualitative upshift from its interim report.
The broad direction of the proposed corporate insolvency law is excellent, and it addresses the three most important failings of the past. First, it recognises the right of creditors to determine the future of an insolvent borrower.
Second, it sets a time frame of 180 days for insolvency resolution, with a 90-day extension if judged necessary, to be followed by liquidation.
Finally, it almost succeeds in introducing one comprehensive law for corporate insolvency, and charges the still nascent National Company Law Tribunal (NCLT)—which will need to carefully build and nurture its own reputation—as the exclusive court.
Bankruptcy reform is key to enabling sustained and higher growth in India. If successful, it could transform the Indian financial landscape—ensuring a consistent supply of credit; attracting new capital and expertise into business revival; improving creditor recoveries and lowering the cost of credit; and finally, enabling a real corporate bond market.
Sometime soon, the clock will begin to tick on a multi-year test of the new regime as reorganisations play out in this revised context. The abatement of most pending insolvency proceedings can create a fertile ground for this test.
The Armageddon risk to bear in mind, for all the good intent and effort: continuing India’s tradition of capital- and expertise-free insolvency reorganisations, and failing to deliver better restructurings and speedy liquidations. Then we will only have drawn an artificial line in today’s process, procedurally terminating “insolvency” after 180 or 270 days, and initiating a theoretical “liquidation”.
Zombie companies will still undergo gradual decay, this time in “liquidation trusts” under the paid supervision of regulated “liquidators” checking off procedural minima, with equally disappointing recoveries. In summary, nothing substantive will have changed.
It is important to understand that this risk is not de minimis under the currently proposed law.
Practical experience from a large number of insolvencies across several jurisdictions points to three critical impediments. These will be more easily evident over a multi-year period of application, and pose a tremendous risk of failure. They are consequently worthy of review by the parliamentary panel before the law is enacted.
The first significant impediment comes from clubbing together disparate financial creditors into a single voting class. A practical reality of insolvency is a natural conflict of interest between creditors—unimpaired creditors prefer to liquidate to promptly recover their dues, while those impaired seek a revival to reduce their loss. The concept of a pivotal security or creditor class is thus germane to a restructuring. Absent effective separation, decisions will tend towards liquidations.
Furthermore, empirical data suggests that more successful insolvency resolutions tend to involve an infusion of fresh funds. The psychology and core skills of banks inhibit such investment. Perhaps even more importantly, prospective bond investors will need evidence of a clear mechanism to resolve inter-creditor conflicts under the new regime. The proposed over-simplification rejects the opportunity to establish a precedent.
The second deterrent is the potential for an approved resolution plan to be derailed by interference from other extant laws that are neither being repealed nor clearly subordinated.
Let us consider a single factory comprised of several units, one mortgaged to a dissenting creditor. Under the proposed law, it appears that this single secured creditor can foreclose under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act of 2002 even after a resolution plan has been painstakingly approved over a 6 to 9-month effort. Similar issues could arise if other laws interfere with the planned resolution. In practice, investors in risk-prone and statute-driven insolvency reorganisations are paranoid about legal uncertainty and the potential for such disruption. Many will steer away.
The third shortfall is more procedural, though equally damaging—the inclusion of all financial creditors on the Creditors Committee. In practice, involving every creditor in routine tasks and decisions will lead to chaos. Furthermore, given the tight resolution time frame, the resulting failure to reach agreement will lead to frequent liquidations.
One could argue that regulated insolvency professionals will guide the insolvency process in practice. Experienced investors, however, will not be content to allow insolvency administrators to define the restructuring agenda, and to rubber-stamp proposals. This is especially so since liquidation is most damaging to impaired investors, and its prospect will loom large.
A need for specific modifications
There are other elements of the proposed law—the priority of organisational creditors, the 14-day limit to tabulating claims, a failure to address executory contracts and leases, and the inclusion of the debtor in all creditor committee meetings—that could prove burdensome in practice.
Insolvency reorganisation is a delicate exercise at the best of times, and leaves little room for unforced errors. It will thus be unfortunate if the key lacunae above were baked into law, straitjacketing the new regime at its very inception.
In part II, we will outline some prescriptions for improved practical operation of the code. Then a real test of the new regime can begin as the remaining insolvency infrastructure is built, and as businesses are restructured under its aegis.
Anurag Das is managing partner of Rain Tree Capital, a Singapore-based firm specializing in Asia-Pacific credit, and distressed and special situations.