Govt working on a simpler insolvency and bankruptcy code for SMEs

New Delhi: After dealing firmly with large corporate loan defaulters, the government has started drawing up a simpler version of the insolvency and bankruptcy code for partnership and proprietorship firms, the legal form that most small and medium enterprises (SMEs) take.

Though the loans are smaller in value, SME borrowers far outnumber companies, resulting in their borrowings exerting a significant influence in the financial sector’s stability. The insolvency and bankruptcy code that is currently in place deals only with companies, not other forms of organized economic activity.

One reason the government is keen to evolve an efficient and low-cost insolvency code for the SME sector is its ability to create jobs with low capital and the need for quick redeployment of capital in the event of an enterprise’s failure.

According to data compiled by the ministry of micro, small and medium enterprises, the sector accounts for 33% of India’s manufacturing output. There are as many as 36 million such enterprises in the country, half of them in rural areas, employing more than 80 million people, the data showed.

The Insolvency and Bankruptcy Board of India (IBBI) has started working on a blueprint for the SME bankruptcy code, the framework of which is expected to be drawn up by the end of this month, a person privy to the development said on condition of anonymity.

SMEs are mostly organized as partnerships and proprietorships, whose promoters have unlimited liability, unlike companies, in which the promoters’ liability is limited to the extent of their share capital.

This calls for a special regime for the small entrepreneurs who take the risk of doing business and create jobs without any protection for their personal assets—just a house, in many cases. The proposed simpler code will also cover personal bankruptcy of individuals with business interests.

“SMEs’ need for restructuring is different from that of big companies. The issues they face are less concerning business restructuring and are more about operational challenges and access to credit. Most of them need counselling. The bankruptcy regime for them ought to be simple, low cost and based on a humanitarian approach,” said Sumant Batra, insolvency expert and managing partner of law firm Kesar Dass B. and Associates.

Sapan Gupta, national practice head, banking and finance, at law firm Shardul Amarchand Mangaldas, said that the process of bankruptcy resolution of sole proprietorship needs to be simple and costs should not be prohibitive.

“And at the same time, in the name of simplification, it shall not compromise the right of the creditors. It may be worth thinking about an obligatory process with the participation of creditors before going to the court,” said Gupta.

Bankruptcy resolution is high on the agenda of the central government, which is keen to improve the ease of doing business in India and attract more private investments from domestic and overseas sources. An efficient exit route from failed projects is an essential factor that lenders consider before participating in projects.

The government on 5 May amended the Banking Regulation Act, 1949, through an ordinance to give more powers to the Reserve Bank of India to deal with non-performing assets.

A few lenders, including State Bank of India, Standard Chartered Bank and Corporation Bank, have since approached the National Company Law Tribunal, initiating bankruptcy proceedings against some large defaulters.

This, in turn, has prompted the promoters of some of these firms to move high courts seeking a stay on the bankruptcy proceedings to buy time for the restructuring they were planning to do.

Once a company goes into bankruptcy, its valuation declines and a stake sale may fetch much less than what the promoter would have realized when a stake is sold in the company as a going concern.

“The insolvency and bankruptcy code will go a long way in resolving the banking sector’s problem of bad debts, despite the initial teething troubles in implementation,” said Dinkar V., partner, restructuring, at consulting firm EY.