OPEN APP
Home / Opinion / Financial rebirth for firms

The ideas of janma (birth), samsara (continuous cycle, reincarnation), karma (balance of deeds) and moksha (liberation) are key to Hindu philosophy.

Paradoxically, contemporary Indian legal philosophy, while permitting rebirth from insolvency for mortals, confers limited possibility on perpetual entities such as companies. Like many laws, insolvency regulation is a patchwork of rules, largely inherited from British times and needs a radical makeover for a fast growing India.

First, the background. In India, there are two laws that govern individual insolvency: the Presidency-Towns Insolvency Act, 1909 (PTIA), and Provincial Insolvency Act, 1920 (PIA). The PTIA is applicable in Mumbai, Chennai and Kolkata, while the rest of the country comes under PIA. The laws are so antiquated and their awareness in a modern context so poor that there are only a handful of cases that make it through the system each year.

Corporate insolvency regulation was born in the idea of winding up of sick companies in the Companies Act of 1956, with the authority vested in the high courts. In a partial modernization, the Sick Industrial Companies Act, 1985 (SICA) was passed. This created a revival mechanism for companies using specialized tribunals—the Board for Industrial and Financial Reconstruction (BIFR) and the Appellate Authorities for Industrial and Financial Reconstruction (AAIFR). BIFR and AAIFR were charged with speedy and specific revival and resolution of specialized insolvency cases. Over the years, companies entering such a process have been stigmatized and resolutions have slowed to a crawl.

In a further attempt to improve the process and on the back of several committee reports—such as Narasimhan II (1998), Eradi (1999), Andhyarujina (2000) and Mitra (2001)—the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, popularly known as SARFAESI, came into being. The Narasimhan and Andhyarujina committees taken together with the Reserve Bank of India’s corporate debt restructuring (CDR) mechanism produced a solution that resulted in banks preceding other stakeholders in a corporate insolvency. In contrast, the Eradi and Mitra committees were mandated to discuss the implications for companies. The Eradi committee’s recommendation to set up a consolidated tribunal—the National Company Law Tribunal (NCLT) and its appellate authority, the National Company Law Appellate Tribunal (NCLAT)—to take over the function of BIFR, AAIFR and the high courts was accepted by government but was challenged on technical grounds and hence did not become law.

The World Bank’s Doing Business report ranks India 121st among all countries, with Japan (surprise) on top. Approaches to a bankruptcy framework vary between foreclosure, reorganization and liquidation. The US uses a structured-bargaining method (Chapter 11) in a court-supervised process. Chapter 11 of the US Bankruptcy Code confers significant discretion on the trustee of the business to be reorganized. Effective use of Chapter 11 requires deep and timely institutional capacity both with trustees and the judicial system. While India desperately needs a bankruptcy regime, Chapter 11 should not be considered as the de-facto standard.

India has functioned as a soft state with respect to corporate bankruptcy. We have a plethora of regulation for other subjects but a weak, time-consuming and ultimately unsuccessful legal framework for bankruptcy. This situation has arisen for a variety of reasons: 1) it is a complex topic, 2) India’s regulatory forbearance with respect to debt default is extra-ordinarily high and 3) the institutional capacity to provide speedy, specialized resolution is limited.

Putting in a place a balanced and effective framework for bankruptcy regulation is non-trivial. A good insolvency regime balances the interest of the entrepreneur, the financial institution and other stakeholders such as employees, customers and suppliers. Keeping a viable business operational is important because the credibility of the insolvency regime subliminally affects the risk taking behaviour of all parties.

Evidence from countries that use reorganization as a major plank of bankruptcy reform suggests that it is more effective than other alternatives. India’s new bankruptcy system must allow for reorganization and should make a distinction between large and small companies because of resource intensity. Large companies may be allowed to restructure in a process similar to Chapter 11 with a National (NCLT) and several regional tribunals. This will require careful reconsideration of SARFAESI and the primacy of financial institutions in a supervised reorganization. Many businesses in India have less than five employees and the nature of their insolvency is inevitably related to the individual. Personal and small business bankruptcy law must therefore be integrated in one simple framework. A supervised, structured bargaining process will be overkill for small firms. We owe them a simple, direct option to be born again.

P.S. “At the end of seven years, you must cancel your debt, because the Lord’s time for cancelling debts has been proclaimed," says the Old Testament in Deuteronomy 15:1

Narayan Ramachandran is chairman, InKlude Labs.

Comments are welcome at narayan@livemint.com. To read Narayan Ramachandran’s previous columns, go to www.livemint.com/avisiblehand

Follow Mint Opinion on Twitter at https://twitter.com/Mint_Opinion

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less
Subscribe to Mint Newsletters
* Enter a valid email
* Thank you for subscribing to our newsletter.
Close

Recommended For You

×
Edit Profile
Get alerts on WhatsApp
Set Preferences My ReadsWatchlistFeedbackRedeem a Gift CardLogout