The Union government’s intervention apropos of Satyam has been sensible, sober and measured. A company has multiple constituencies—customers, employees, suppliers, lenders and, of course, shareholders. It is not my case that all companies should be propped up at the expense of the public. Far from it. But I think it is appropriate to ensure that companies faced with special circumstances—either when they go through a life-threatening illness or when they exit from the corporate firmament—should be able to exit in an orderly way. This would minimize the distress incurred by different constituents and protect the legal rights of all concerned.
Illustration: Jayachandran / Mint
To this end, we need a proper bankruptcy law for the country. This will ensure that sensible government intervention as has happened with Satyam becomes part of a predictable systemic process and does not have to rely on the government of the day to take the right response. Many persons think that bankruptcy laws encourage people to go bankrupt. Contrary to this, well-defined bankruptcy procedures more often than not ensure that corporate entities survive, albeit with radical restructuring.
When companies appear to be heading for implosion due to fraud, mismanagement or even plain bad luck, every creditor moves in, not wanting to be the last one, customers get worried and look for other suppliers and in any event are tempted to delay payments, employees start looking for jobs, suppliers start cutting off supplies and focus their attention on getting all old bills settled, and everybody goes into panic mode. This can easily lead to a self-fulfilling downward spiral. Even a viable company can head towards oblivion as it becomes a victim of such circumstances. In many cases, the operations of companies may be in reasonably good shape. Bad financing decisions, speculation by the company’s centralized treasury (that takes part in bets and derivative or hedging contracts—which, if defaulted on, can create trouble) and outsized problems that are otherwise confined to one division should be kept separate. These problems can and should be distinguished from the operating base, which may be healthy or in need of only manageable tweaking.
The first things that troubled companies need are time and breathing space. Creditors who demand an early liquidation to get their dues need to be stopped. The cash needs of the ongoing operations should not be unduly restricted. The financial snapshot needs to be separated and restructured, giving due weight to the priorities of different claimants. Sometimes even fresh cash injections may be required. Then again, no one is likely to make such injections unless they get a preferential or sweetened deal; hence, such deals will have to be concluded. In rare cases, it is possible that even after taking into account new plans for operating and financial restructuring, the viability of the firm remains doubtful. Only in such cases is there a need to look to an outright and immediate liquidation.
Faced with the prospect of losing large chunks of loans, lenders are likely to make compromises—forgoing some interest, for instance. The same holds true for suppliers who may be willing to accommodate a discount, and employees might settle for lower salaries rather than losing jobs outright. As a consequence, often, operations that looked dismal suddenly end up becoming viable.
A transparent and widely understood bankruptcy process is, therefore, usually referred to as a “reorganization”. No doubt, this expression captures the spirit of what is happening with the underlying assets and resources of the company. It is the best prescription to ensure that we do not have implosions and liquidations on account of inaction. The dire consequences of company breakdowns that can have great ripple effects can be contained and managed in a constructive fashion.
As the Indian corporate sector grows, there is urgent need for this kind of well-crafted bankruptcy code. The current laws on the books, such as the 1985 Sick Industrial Companies Act (Sica), are not designed to address reorganization questions. The Board for Industrial and Financial Reconstruction (BIFR) is expected to revive companies that have gotten into operating trouble or those which are headed for liquidation. But we need a completely different approach for companies where operations may be wholly, or even partially, quite sound. In these companies, the issues on the table deal with capital structure or fraud—not complete failure of the kind BIFR or Sica deal with. In this regard, we need to learn from the best practices elsewhere, such as the laws governing Chapter 11 bankruptcy in the US. We are here not looking for a BIFR-induced bailout or for a summary liquidation, but rather for a step-by-step reorganization that tries to protect and salvage ongoing operations as far as possible.
The Satyam episode is a warning bell. While we should all fervently hope and pray that there are no more Satyams lurking around, we must accept the fact that sooner or later we will have a situation where an orderly transition-reorganization-exit mechanism will be required. Let us be prepared with a law and a well-defined process—this will ensure that fair, sober, measured and timely decisions will be the rule and not the exception.
Jaithirth Rao is an entrepreneur and writer based in Mumbai.
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