The Modi Government is reportedly trying to bring a legislation which will overhaul the antiquated bankruptcy law. Now whether the government will succeed or face the same obdurate tyranny of numbers as recent other reform bills remains a matter of conjecture.
A couple of days back, a Bloomberg story caught my attention because the Modi Government is trying to bring a legislation which will overhaul the antiquated bankruptcy law. Now whether the government will succeed or face the same obdurate tyranny of numbers as recent other reform bills remains a matter of conjecture. Having got a bloody nose on one nation, one tax (GST) and a brutal vanquishing on the land bill, one cannot say what kind of appetite the government will show for reform in the winter session? Another imponderable will be the result of the Bihar hustings. Politics coming in the way of economics is so infuriating in India. According to Bloomberg, the government is attempting to unify more than four overlapping sets of rules, the code aims to slash the time it takes to wind up a dying company or recover dues from a defaulter. Since the current law is reported to be creditor unfriendly, a drafting panel is balancing it.
Kaushik Das, an economist at Deutsche Bank AG, wrote in an October 15 report. "The bankruptcy code will help reorganize a stressed business in a short of time without endless litigation which erodes the viability of an enterprise." Bloomberg said that under India's current bankruptcy laws, individuals can go to jail for failing to repay just Rs.500. But the reality is that nobody really goes to jail, Rajendera Sethia, however did. Sethia's Esal Commodities went down with debt of nearly £250 million, defrauding millions from various banks, some Middle Eastern but mostly London branches of Indian banks. RBI Governor Raghuram Rajan sounded profound when he stated in a recent speech, "Failure is inevitable in a free enterprise system," calling for a "speedy bankruptcy code" to resolve distress while still maintaining the priority structure of claims. The unfortunate reality in India is that there are no moral absolutes and hence bankruptcy is not part of a changing calculus.
Multiple avenues are available in India to roll over your debt and stay afloat.
Not realising that the bankruptcy model in US actually allows companies to reorganise their businesses.
Promoters and businessmen in India prefer to live in suspended animation, rather than seek closure on a failed business.
Chapter 11 is a chapter of the United States' Bankruptcy Code which acts as an enabler, permitting the reorganisation under the bankruptcy laws of the US. Chapter 11 bankruptcy is available to every business whether organised as a corporation or sole proprietorship, and to individuals, although it is most prominently used by corporate entities.
Once again who takes the hit - Indian banks? The Kingfisher tale of woe is worth repeating.A lenders' consortium led by State Bank of India got Rs 750 crore worth of equity shares and Rs 553 crore of preference shares. Kingfisher Airlines is no longer traded on the bourses, the company is defunct. As of September 30, 2014, SBI held 2.68 per cent of the equity, while IDBI Bank owned 2.13 per cent and Bank of India held 1.08 per cent. The promoter group held only 8.54 per cent. And none of these were pledged or encumbered -United Breweries Holdings 0.05 per cent, UB International Trading 4.95 per cent, Vijay Mallya 1.87 per cent, UB Overseas 1.68 per cent and Kingfisher Finvest less than 0.05 per cent.
The shares held by the banks and financial institutions were picked up as part of a debt recast programme at Rs 64.48 in March 2011 for the purpose of conversion against the prevailing market price of Rs 39.90 a share. As early as that the banks were under the cosh and one wondered why this was done?
The loss to the banks from this conversion of loans to equity is in excess of `620 crore. Slightly better than the value of the paper these shares were printed on. Let us come to part B where Rs 553 crore of preference shares were supposed to be converted to equity during a planned GDR issue.
That GDR (Global Depository Receipt) issue never fructified. Several bailout packages later, the airline is grounded and bust, the banks hold shares worth cipher and shareholders have got it in the neck.
Against this, see how Chapter 11 works in the US - "In the U.S., carriers including Delta Air Lines Inc. have used bankruptcy protection to restructure debt and shed costly pension and retiree benefit plans in the years after the 2001 terrorist attacks.American Airlines parent AMR Corp. filed for bankruptcy after failing to secure cost-cutting labour agreements.
With the filing, American became the final large U.S. full fare carrier to seek court protection from creditors." The most famous bankruptcy in recent times was the General Motors Chapter 11 sale of the assets of automobile manufacturer GM and some of its subsidiaries was implemented through section 363 of Chapter 11, receiving $33 billion in debtor in possession financing to complete the process. The paring down of GM as it was known in 2009 was spectacular - from 5900 dealership in the US to 5000, from 47 plants down to 34 plants in the US, from 91,000 employees to 68,500 and finally from a gargantuan $94.7 billion in debt whittled down to $17 billion.
No, but egos are bigger than everything else in India. They are the size of football fields.
Throw that into the washer with the absence of a cogent bankruptcy law in India and you have corporate entities limping along interminably and promoters continuing with their rich and famous lifestyles.
First the egotistical promoters flash their ambition by going over the top, taking business decisions which don't make any sense whatsoever and then there is a modus operandi to roll over their debt through recast and restructuring mechanisms, helped along the way by Indian banks whose money has been blown up by them in the first place.
It is clear that India requires a comprehensive and well rounded bankruptcy law which allows financially distressed companies to turn around faster.
Unfortunately, the system doesn't "provide a framework by which companies can take preventive measures to avoid a further downward spiral."
Checking on the net I found that rules and regulations in India allow companies that operated for at least five years and holding a factory license to approach the Board for Industrial and Financial Reconstruction if accumulated losses equal or exceed their net worth. The recourse is available under the Sick Industrial Companies (Special Provisions) Act of 1985.
Checking further, I discovered why the entire system is so protracted and painful - "Under the Indian Companies Act of 1956, firms can voluntarily wind up operations or a court can order their closure.
In a court-ordered shutdown, an official liquidator will be appointed to oversee the process and distribute the proceeds from sale of assets to creditors.
In 2001, as an alternative to the BIFR process, India's central bank allowed companies and their creditors to enter into a debt recast arrangement to help businesses return to financial health. The mechanism was limited to firms that had borrowed more than Rs 20 crore from a group of lenders."
The allowance for roll over is at the crux of the debate over the necessity for a water tight bankruptcy law in India. Till then the party continues. Without exception.
(The writer is a Visiting Fellow at Observer Research Foundation, Delhi)
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