Bankruptcy’s Birth Pangs
Frivolous cases under bankruptcy code have raised fears that yet another well meaning law could be abused by unscrupulous elements. But the chances of despair turning into hope are high, writes MINTSTREETMasala
When a little-known company Shiv Sneha Associates advertised that it would file bankruptcy proceedings against the NYSE-listed MakeMyTrip, valued at $3 billion, to recover its dues, it showed how a new law can become a tool to intimidate businesses.
A number of frivolous petitions at the National Company Law Tribunal (NCLT), which administers the Insolvency and Bankruptcy Code (IBC), is a cause for anxiety among bankers and promoters over whether the tool, supposed to be a lubricant for the economy, is becoming an obstacle.
As judicial officers at NCLTs and insolvency professionals (IPs) grapple to understand the code, where resolution has to be timebound, industrialists and bankers, who knew the judiciary as a stalling mechanism, are beginning to see a different world.
It is not just the shallow threat to MakeMyTrip that has raised fears of abuse of the IBC, but strange things like a promoter threatening to sue an IP for loss of a contract, an IP shutting off funds to suppliers, physical threats to IP from promoters, and resolution professionals overreaching their mandate by interfering in subsidiary companies have created a sense of despair.
“It is not that just because this law has come, every company is going to get liquidated when a creditor sends a notice,” says Mona Bhide, managing partner at Dave and Girish and Co Advocates. “There is a lot of hue and cry. Whenever there is a new law, it’s always criticised and there are going to be teething problems.”
BANKRUPTCY FOR SPEED
The government enacted the IBC in May 2016 to ensure that debt resolution happens in a time-bound manner. The Debt Recovery Tribunals and civil courts, which handled these cases prior to IBC, were slow and often took years to settle cases eroding asset values.
A World Bank study shows that insolvency cases on an average took 4.3 years to get resolved in India. And lenders’ recovery rate was 26 cents to the dollar.
The IBC stipulates finalisation of resolution plan within 180 days of filing for bankruptcy in an NCLT, and one-time extension for a maximum 90 days. If no agreement is reached, the company goes into liquidation. If assets are not sold within two years of liquidation, they are transferred to lenders by the insolvency professional.
UPPER HAND FOR BANKS
Specified time limit for resolution under the IBC has breathed a new life into many creditors – be it financial ones like banks, or operational like suppliers, who also can use the law. While this is a welcome move with banks and others sharing the burden of bankruptcy, unlike in the past where lenders bore the brunt, the law is also being misused to settle minor disputes. Recently, employees of Aruna Hotels initiated bankruptcy proceedings against the company for failing to settle the dues owed to them. Although, many such claims are being addressed under IBC, they are ranked lower when the resolution happens. “These kinds of things will happen because it is part of any system,” says Shikha Sharma, chief executive at Axis Bank. “They may file for bankruptcy, but ultimately you still have to go through the process of 70% of creditors having to sit down and agree to the plan. Only then does it go through. One person single-handedly cannot do much.”
Yet another drawback is that there is hardly a distinction between the promoter shareholder of a company and the top management. With the promoter being hands on, it becomes difficult to take a company into bankruptcy because he can put a spoke in resolution. “All of us know that 90% of Indian businesses are familyrun and the nuances of the business are known to the family members,” says Rajesh Narain Gupta, managing partner at SNG& Partners, a law firm. In a case involving RS Polychem versus Ekadantam Infra, the New Delhi bench of the NCLT ordered that insolvency professional Rakesh Vadhwa be given police protection since the promoter was not cooperating and there was a possible threat to his life.
Police protection may not remain an exception but could become a norm if promoters indulge in delaying tactics. Since the law is strict on time limits, any delay would lead to degeneration of assets and loss.
“There will be resistance on the part of promoters about losing their business, which is natural,” says Sunil Srivastava, deputy managing director at State Bank of India. “It’s in everybody’s interest to resolve it as soon as possible. Now, if someone is not interested in doing it, then the force of the law comes into play.”
COURTS SHOW THE WAY
Indian judiciary is feared as much for the delays in resolving disputes as it is known for its fairness.
The nascent bankruptcy law itself has been thrown into a tailspin with the Supreme Court recently ruling that two parties can go for settlement even after initiating bankruptcy proceedings in the NCLT. The moment an IP is appointed, he invites all creditors to work out a resolution plan. If the two parties settle, then the entire process of bankruptcy collapses.
But other rulings have been encouraging. The Gujarat High Court dismissed the petition of Essar Steel challenging the Reserve Bank of India order in taking up 12 priority cases for bankruptcy and the NCLTs have been tough going by the rule book.
Though there are petitions seeking winding up of a company for trade disputes, there are precedents that bankruptcy cannot be initiated in such issues. The fear that bankruptcy may be abused by business rivals may be overblown.
“Now there is a distinction between operational creditors and financial creditors, which was never there,” says Bhide. “Earlier even a chaiwala (tea-seller) could send you a notice. The point is now the segregation has been made with a view to avoid too many irrelevant notices being issued. Whenever there was a recovery notice, it would be ‘we will sue with a winding-up petition’.’’
THE ROAD AHEAD
Strict bankruptcy laws may appear to be a monster for some, as the country is witnessing which it never had—a black and white process—where lenders can recover their money when businesses fail.
Just like the introduction of derivatives and opening up of the industry for global competition, bankruptcy is another step in making Indian business and associated judiciary international.
The role of banks, as we know, would come down. Once the processes are established and industry realises that they either pay up or lose the assets, distressed asset buyers like JC Flowers would troop in.
“A lot of things have to evolve, which is not difficult,” says Sridhar Ramachandran, founder Dharsha Advisors, a specialist in dealing with distressed assets. “Five years down the line, instead of dealing with bankers, the system would be dealing with hedge funds who would own these companies. Bankruptcy and revival would become a smooth process.”