New Delhi: The government is set to curb lenders’ penchant to drag companies to bankruptcy courts at the slightest delay in loan repayments through a change in the insolvency code, amid rising strain on balance sheets because of a slowing economy.

The idea is to prevent the aggressive use of the insolvency and bankruptcy code (IBC) as a recovery tool by lenders by rebalancing the rights of lenders and loan defaulters, a government official said on condition of anonymity.

“Bankruptcy code should not be the first resort for a lender for handling a default, especially in the case of micro, small and medium enterprises (MSMEs). Some changes will be built into the code to ensure that. The government is cognizant of the abuse of the IBC," the official said.

The move implies that the government, which has been taking steps to improve liquidity in the market, does not want lenders to take an unrelenting position on debt recovery by invoking the IBC.

In recent weeks, the ministry of corporate affairs, which is looking into the possible amendments to the Code, has been signalling its disapproval about the aggressive use of the IBC. Minister of state for finance Anurag Thakur cautioned bankers in September that lenders should refer cases to the National Company Law Tribunal (NCLT) only if a satisfactory resolution was not available outside the courts. This will also help in reducing litigation. Experts said that the government’s effort is possibly to give a breather to businesses, especially MSMEs, in a slowing economy by preventing them from coming under the pressure of bankruptcy proceedings.

(Graphic: Ahmed Raza Khan/Mint)
(Graphic: Ahmed Raza Khan/Mint)

“In the MSME sector, there are not many bidders. Invoking bankruptcy code against them poses a risk of their liquidation rather than a revival, which is not good for our economy in which MSMEs are big employment generators," said Sumant Batra, managing partner and head of insolvency practice at law firm Kesar Dass B & Associates.

The move also comes after the recent amendment to the Code in August, which gave an upper hand to banks in the proceeds of bankruptcy resolution, over operational creditors, which are mostly small enterprises that supply materials and services. “The government’s effort may be to correct the signal that has gone to small enterprises and balance stakeholders’ interest," said Batra.

Some said that there is a case for calibrating the IBC. “The intent of the Bankruptcy Code, which opens up the possibility of change in ownership, is to create a deterrent against defaults. It should not be resorted to very frequently. Several real estate and power companies risk going into bankruptcy proceedings if IBC is treated as the first option to deal with a default," said Manoj Kumar, partner, Corporate Professionals, a consultancy. Kumar said banks seem to be unable to decide on a resolution plan within six months that the Reserve Bank of India (RBI) has allowed them before referring defaults to NCLT. According to a 7 June RBI circular, lenders have to review defaulting accounts for a month and decide the strategy, and have six months to take them to the bankruptcy court.

The government has been constantly fine-tuning the Code to correct anomalies and to address problems arising from experience.

The financial troubles of Infrastructure Leasing and Financial Services Ltd have shown that resolution of a large number of companies under a holding group may need a new framework.

An expert panel led by U.K. Sinha, former chairman of the Securities and Exchange Board of India, recently recommended a framework for group insolvency to be implemented in phases. Bankruptcy of group companies, personal insolvency and cross-border insolvency are the new areas that may be added to the Code in due course. Out of the total 2,162 cases of bankruptcy cases admitted as on 30 June, 120 have been closed by resolution and 475 by liquidation, while the resolution process is going on in the case of 1,292. Some cases were closed after the debtor and its lenders reached a settlement.

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