Bankruptcy code: Will the govt be able to achieve its objective?

The government now needs to create state capacity for the four pillars of institutional infrastructure required for the Code to work


The ministry of finance has designed a ‘task force’ process for creating new institutions, an innovation compared with the traditional government approach of hiring a few wise men to do the job. Photo: Pradeep Gaur/Mint
The ministry of finance has designed a ‘task force’ process for creating new institutions, an innovation compared with the traditional government approach of hiring a few wise men to do the job. Photo: Pradeep Gaur/Mint

The Lok Sabha adopted the Insolvency and Bankruptcy Code (IBC) by voice vote on 5 May, and it is likely to be passed by the upper house soon. But this is only the beginning.

As one member of Parliament said: “Will the government be able to put life into the vision of this Code?”

The government now needs to create state capacity for the four pillars of institutional infrastructure required for the Code to work. And it needs to plan a transition from existing provisions of laws, pending cases and financial regulations.

The IBC is a complex procedural law which prescribes what must happen after default. The prescribed procedure assumes that the four pillars of institutional infrastructure exist: new regulated industries of “information utilities and insolvency professionals”, with oversight by “insolvency professional agencies” like stock exchanges to brokers; information repositories like stock depositories; a new regulator, without the failings of existing regulators; and a high quality adjudication infrastructure, without which the IBC caseload will collapse under the inefficiencies of courts and tribunals.

Unless these four pillars are in place, the Code will fail.

The new regulator is the Insolvency and Bankruptcy Board (IBB), the focal point of the IBC. Many elements of the insolvency process are specified in regulations that the IBB will issue. The IBB will need to establish a feedback loop of identifying gaps in the bankruptcy process, and use a sound regulation-making process to revise the regulations. IBB will also be the regulator for the two new regulated industries—information utilities and insolvency professionals. On day one, these industries do not exist.

The ministry of finance has designed a ‘task force’ process for creating new institutions, an innovation compared with the traditional government approach of hiring a few wise men to do the job. Such a process is required to rapidly build the four pillars of institutional infrastructure.

The Code provides for a National Company Law Tribunal (NCLT) for corporate insolvency resolution and Debt Recovery Tribunals (DRT) for individual insolvencies. The NCLT and NCLAT (the appeals body) are yet to become operational. Even when they do, they are going to be a common forum for two major laws, the Companies Act and the IBC. This means that the NCLT will have the case load of the Company Law Board (CLB), the high courts and the Board for Industrial and Financial Reconstruction.

The CLB had 5,862 cases pending as of March 2014. The high courts had 4,814 winding up cases and 231 cases of amalgamations under Section 394, pending as of March 2014. The BIFR had 871 pending cases in March 2013. Further, many of the banks’ existing non-performing asset (NPA) accounts might find themselves as new cases under the IBC. DRTs currently deal with cases under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 and appeals under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, with around 60,000 cases pending.

Conventional government techniques of setting up a tribunal will collapse under this load. This calls for utilising the business process re-engineering that has been devised by Justice N.K. Sodhi and his team in the Task Force for the Financial Sector Appellate Tribunal.

Multiple cases dealing with recovery actions by lenders, resolution and winding up are pending at present. A transition plan must be created ahead of time, put up for public inputs and finalised. New institutions, arrangements and funds must be put into place before the new law comes into force. Without this, the transition process will be chaotic.

The IBC interacts with numerous laws. For example, the Code visualises rapid closure of firms in liquidation. However, earlier attempts to do the same have run into conflict with labour laws and the Industrial Disputes Act, 1947. These conflicts must be examined, analysed and steps must be taken to ensure that this conflict does not reappear as case law to bedevil the implementation of liquidation under the IBC.

Sector regulators such as the Reserve Bank of India (RBI), Securities and Exchange Board of India (Sebi) and for Insurance Regulatory Development Authority (Irda) will need to review and revise their regulations to ensure rapid resolution of default under the IBC. An example is the asset classification and provisioning norms specified by the RBI for banks. This should now switch to the global standards about how banks treat a firm where the bankruptcy process has begun. Similarly, Sebi’s norms for mergers and acquisitions, closure of listed firms, and debt to equity conversions will need review, as will similar provisions under the Companies Act, 2013.

In summary, enacting the IBC will be a great step forward for Indian economic reforms. But the gains for the economy will come only after an exercise in complex project management covering eight areas:

1. Creation of the regulator

2. Creation of an adequate National Company Law Tribunal

3. Creation of an adequate Debt Recovery Tribunal

4. Creation of Information Utilities

5. Creation of Insolvency Professionals

6. Drafting a transition process for existing cases

7. Ensuring interoperability with existing laws

8. Modifying financial sector regulations

Failure on any of these could mean failure to achieve the objective of the Code—a sound bankruptcy process.

The writers are with the IGIDR.

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