Small firms using bankruptcy code to make large customers pay back dues: Economic Survey

Small businesses that do not get their dues cleared on time from large business clients are making use of India’s new bankruptcy system as a recovery tool, according to the Economic Survey 2019 tabled in Parliament on Thursday by finance minister Nirmala Sitharaman.

The Survey, which made a strong case for policymakers to use insights from behavioural economics to make impactful public policies, has highlighted the effect India’s new bankruptcy system has had on lender-borrower relations. The new system came into operation in 2016.

The insolvency and bankruptcy code (IBC) has, until February, resulted in 6,079 cases involving ₹2.8 trillion being withdrawn before admission in tribunals under the provisions of the code, the Survey pointed out, indicating the reliance banks as well as operational creditors—vendors, material suppliers and service providers of corporate borrowers—place on the bankruptcy code to recover their dues.

India’s bankruptcy reforms have effectively reset the balance between the rights of shareholders of defaulting companies and those of their creditors.

The IBC makes it a real possibility for owners of a defaulting firm to lose control of his or her enterprise once a creditor invokes bankruptcy proceedings. Besides, major shareholders of defaulting companies are barred under the code from bidding for their company before paying back their dues to lenders.

“The IBC has paved the way for operational creditors, mostly SMEs and small vendors to use the IBC as a recovery tool. The threat of promoters losing control of the company or protracted legal proceedings is forcing many corporate defaulters to pay off their debt even before the insolvency can be started,” said the Survey authored by chief economic adviser in the finance ministry Krishnamurthy Subramanian.

The IBC has made a significant impact on the way default on debt repayment is viewed and treated by promoters and managements. It has initiated a cultural shift in the dynamics between lenders and borrowers, said the Survey.

Lenders are recovering about 43% of their dues under IBC, nearly double of what they used to under the previous system of debt recovery tribunals and other mechanisms, the Survey said.

The Survey, citing RBI reports, pointed out that ₹50,000 crore has been received by banks from previously non-performing accounts . The Survey also said an additional ₹50,000 crore has been “upgraded” from non-standard to standard assets, pointing to a behavioural change in the lending ecosystem.