Let’s reform India’s bankruptcy code but without getting in the way of commerce

To reform the IBC, the government should create a separate and new cadre of policy experts who can evaluate fault-lines based on what the evidence shows.
To reform the IBC, the government should create a separate and new cadre of policy experts who can evaluate fault-lines based on what the evidence shows.

Summary

  • There’s a case to tweak the IBC. But India should take care to oil the wheels of business and not throw in a spanner.

The Standing Committee on Finance recently made some crucial observations on the workings of the Insolvency and Bankruptcy Code (IBC). The overarching concern is that the very purpose behind its enactment has been stifled by problems which have cropped up in recent years. While most of the panel’s observations ring true, some seem rhetorical and without reason or evidence. It may be true that young insolvency professionals (IPs) may not be capable of handling big cases, but there is demand for both young and experienced IPs, especially in a country where small and medium-sized businesses abound. As for whether they have added value to the insolvency ecosystem, the proof is in the pudding. During my tenure at the Indian Institute of Corporate Affairs where I spearheaded the graduate insolvency programme, its graduates obtained 100% placement with leading firms. Some of them let go of job offers to start their own enterprises and their journey so far affirms the idea of having a young cadre of IPs.

The committee’s concern over court capacity seems to have been addressed. The ministry of corporate affairs has filled most of the vacancies at the National Company Law Tribunal (NCLT), bringing its total strength to 57 out of the sanctioned 63 members, which is close to 90%.

The Indian government has also agreed to expand the NCLT by adding 100 members. The challenge from here onwards will be to find members with the relevant expertise. Most NCLT members have little experience in dealing with commercial matters and commercial laws have their own raison d’etre that requires knowledge of economics and a deep understanding of how markets work.

Further, cases such as Bank of Maharashtra vs Newtech Promoters and Developers Pvt Ltd show an emerging form of court jurisprudence under which the financial health of a corporate debtor seems to be a criterion for the rejection of an insolvency application under Section 7 of the IBC. This approach was not envisaged in the Code’s design. If lawmakers wanted a business’s financial health as a criterion for denying the admission of an insolvency petition, they would have kept a balance-sheet test within the Act’s legislative design.

Also, every insolvency case has an impact on the rights of third parties, and the concept of equity works differently in matters of commerce. Importantly, the law’s framework has scope for the withdrawal of an insolvency petition under Section 12A of the Code. This makes space for a corporate debtor to come to the compromise table under judicial oversight. As much as we may disagree with the decisions of creditors, their wisdom should not be questioned. What could be done, however, is to nudge them to consider the interests of other stakeholders while they evaluate a revival plan, although this is something that should be enabled by the legislature through law and not be done by courts.

Courts should remind themselves of the case of Salomon vs Salomon & Co Ltd, where although Salomon used the company to defraud creditors, a rigid construct of company law was adopted to establish a century-old principle that a corporation is a separate juristic personality, a distinction that gave rise to the legal structure of modern businesses. In these early years of the IBC in India, courts should give effect to the letter of the law so that the Code gets firmed up.

Now, turning to a crucial question, what should the government do when it considers how to reform the IBC? Foremost, it should create a separate and new cadre of policy experts who can evaluate fault-lines based on what the evidence shows. Second, this time, the government should adopt an evidence-based approach before making any amendments to the Code.

For disciplining errant IPs, we need stricter gatekeeping, which can be achieved by toughening the insolvency exam. Once candidates become IPs, there should be checks and balances within the system to monitor any suspicious activity by these professionals.

The regulator can evolve a two-stage process. It can examine cases internally to see if there is prima facie merit in the allegations before initiating disciplinary proceedings as the second stage. In the event that misconduct is established, the punishment should be harsh, as with serious white-collar crimes, so that such conduct could be deterred.

While making any amendments to the IBC, both regulators and the legislature should be cautious not to create any regulatory cholesterol. It is always useful to remind ourselves that in financial regulation, less may be more. It is worth noting what an outstanding judge of an English commercial court had said: “We are here to help businessmen, not to hinder them; we are there to give effect to their transactions, not to frustrate them; we are there to oil the wheels of commerce, not to put a spanner in the works, or even grit in the oil." Thus, the aim of both the law and the courts should be to oil the wheels of commerce and not throw a spanner in it. New India needs businesses to drive its economy, and businesses, in turn, need legal certainty.

These are the author’s personal views.

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

MINT SPECIALS