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AFTER THE BUST

When it comes to ease of doing business, India seems to come up rather short. At least that’s what a recent study by the World Bank and the International Finance Corporation reveals. The study, titled Doing Business 2013 and released last month, ranks India 132 among the 185 countries surveyed. One of the parameters for ranking was “making it easy to resolve insolvency”. India was ranked 116 on this particular parameter.

The problem is that the laws governing corporate insolvency and bankruptcy are stuck in a different era — a fact that came into focus once again as Kingfisher Airlines hurtled towards bankruptcy recently. “Bankruptcy laws in India are ineffective. They have not changed with the times,” says Sangram Patnaik, managing partner, Patnaik and Associates, a Delhi-based corporate law firm.

In India, matters relating to corporate insolvency and bankruptcy revolve around four major laws: the Companies Act, 1956; the Sick Industrial Companies (Special Provisions) Act, 1985, (Sica); the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2003, also known as the Securitisation Act; and the Recovery of Debts Due to Banks and Financial Institutions Act, 1993.

What has made matters worse is that issues related to bankruptcy and insolvency are part of the concurrent list, empowering both the Centre as well as state governments to make laws related to the subject. “In the absence of a single unified code and overlapping jurisdictions, bankruptcy laws fail to be effective and dynamic,” says Patnaik.

There is a difference between bankruptcy and insolvency. “Insolvency” is a situation where the debtor company is unable to meet its obligations. “Bankruptcy”, on the other hand, is a legal manoeuvre in which an insolvent debtor or company seeks relief for its existence.

The Sica is considered the most effective central law to deal with industrial units that have become “sick”. The directors of a “sick” company can approach the Board for Industrial and Financial Reconstruction (BIFR), a quasi-judicial body established under the Sica. The law stipulates that a company older than five years can approach the BIFR if it has accumulated losses equal to or exceeding its net worth.

The BIFR in turn prescribes the measures to be adopted. It can either revive potentially viable units or, if it feels that they are unviable, refer the matter to the high court concerned to decide on the closure of a company.

“The erosion of the entire net worth is too late a stage to attempt restructuring. By the time the net worth is eroded the company is too sick to be revived,” says Patnaik.

But the biggest criticism against the BIFR is that it talks of reviving a sick company under the same management that drove the company to the ground in the first place. “It’s like asking an incompetent doctor to keep treating a critical patient. Unless you change the doctor, the patient will, in all likelihood, die,” says N.L. Mitra, former director, National Law School of India University, Bangalore, and currently a senior partner at FoxMandal Little, the law firm.

A critic of the BIFR, Mitra had, in fact, wanted the board to be disbanded when he was the chairman of a committee set up by the Reserve Bank of India (RBI) on bankruptcy laws in 2001.

However, some experts differ with Mitra on this front. “There are greater chances of the old management bringing in the resources for revival. Moreover, if it is supervised closely, a sick unit can be revived,” says G.V. Sunder, a Bangalore-based chartered accountant.

Another problem with our bankruptcy laws is that only manufacturing units can apply for relief. Experts says that since services didn’t form a major part of Indian industry when the Sica was enacted, they were kept out of the purview of the law. Hence, unlike in the US where airline companies such as American Airlines and Delta Airlines filed for bankruptcy protection and came out stronger after being restructured, a company such as Kingfisher Airlines cannot approach the BIFR. Instead, a service industry company facing bankruptcy is forced to approach creditors in the form of corporate debt restructuring packages as mandated by the RBI in 2001.

Concerns have also been voiced about the effectiveness of the BIFR, which, some say, lacks professionals to deal with corporate bankruptcy. “It is anything but professional. They are a bunch of bureaucrats who do not understand the workings of industry at all. Yet they are empowered to decide on a company’s future,” says Mitra.

But Y.K. Gaiha, a member of BIFR, thinks the board is not empowered enough. “Under the law, we cannot force anything down anybody’s throat. We can suggest the best possible steps, but it’s not necessary that everybody will agree with us,” he says.

The central government did try to replace the BIFR with the National Company Law Tribunal (NCLT) through an amendment to the Companies Act in 2002. This was to avoid multiplicity and levels of litigation before high courts and quasi-judicial authorities such as the BIFR. But the move was challenged in higher courts and stalled. Now that the Supreme Court has given the go-ahead to the setting up of the NCLT, the government has proposed to do it through the Companies Bill, 2011. The bill is yet to be passed.

There are those who say that India could learn a thing or two from the US law on bankruptcy. Popularly called Chapter 11, after a chapter of the Bankruptcy Code, this provides for court-led protection from bankruptcy through the reorganisation of the company. The bankruptcy court can consult all the stakeholders, and employ professionals to suggest remedies. The court-mediated restructuring plan is legally binding on those who approach it. And a company can reorganise its business and jump onto a new and a viable business plan, unlike in India were the company has to continue with the same business or liquidate its assets.

“In India we prefer liquidation to reorganisation. For instance, if a chocolate maker goes bankrupt and says that he can start a new business different from chocolates, there is no exit route for him under the current laws,” says Mitra.

According to Stephen Z. Starr of Starr & Starr, a New York-based bankruptcy lawyer, many countries have been inspired by the Chapter 11 provisions that talk of reorganisation of a sick or bankrupt company. “Most of the major European countries have revised their bankruptcy laws in the past two decades to include some aspects of reorganisation, as have a number of countries in east Europe, the former Soviet Union and Asia,” he says.

A committee set up by the Planning Commission had brought out a report in 2008 titled A Hundred Small Steps: Report of the Committee on Financial Sector Reforms where it observed that closing a business takes a long time in India because of the lack of effective bankruptcy laws. On as average it takes 10 years in India versus China’s 1.7 years.

There have been exceptions to the rule, however. The government did act swiftly when the Satyam fraud came to light in 2009. “In the Satyam case, the government’s intervention showed that it can act quickly to salvage a company through a very transparent process. If the government is serious about not allowing companies to go the Kingfisher way, it is important that a bankruptcy code comes into force,” says Bapu Heddur Shetty, a Karnataka High Court advocate.

The sooner that happens, the better it will be for corporate India.