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| Insolvency vs bankruptcy: A very thin line of difference |
| Kumkum Sen / New Delhi Mar 15, 2010, 00:20 IST |
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A reference to the “Twilight Zone” to many readers may evoke associations with the classic television series and film about strange and bizarre events. he general connotation, that of a transitional or ambiguous condition, has more serious implications in the business world – it is the Zone of Insolvency from which the companies emerge or perish. In colloquial parlance, though the terms are used interchangeably, insolvency and bankruptcy are not synonymous. Insolvency is a state of affairs in which the financial difficulties of a company are such it is unable to run its business at its current pace.
Warning signs could be drop in sales, delay in payments, erosion of share capital and increasing reliance on credit. Tests of insolvency are two fold –“cash flow” test where it is unable to pay debts, and the “balance sheet” test where the liabilities, including contingent and prospective exceed the realisable assets. Very often a company may have considerable assets, but illiquid, or the balance sheet reflects solvency, yet the company is unable to honour its debt obligations. The line of difference is thin, bankruptcy being a legal option, if the insolvency is not addressed — the end of the road of the twilight zone.
But insolvency is capable of being managed or resolved and a company does not have to declare bankruptcy. Most developed economies have recourse to debt management, consolidation or restructuring schemes as alternatives to bankruptcy in dealing with insolvency. Bankruptcy laws are more rehabilitation oriented and address cross border issues on both.
The Indian Bankruptcy regime is still rooted in the Companies’ Act, 1956. The processes are sluggish and cumbersome, and very often productive assets lie dormant and eventually perish. Official liquidators are attached to the High Courts, and the bankruptcy procedure is administered by the Company Judge.
Existing Insolvency laws are unconsolidated – the archaic Provincial and Presidency Towns Insolvency Acts which pertain to individual insolvencies continue to govern small and medium enterprises (SMEs). India’s Insolvency regulator, the Board for Industrial and Financial Reconstruction (BIFR) has been a nightmare zone for “sick industrial companies’ as defined under the Sick Industrial Companies’ Act (SICA), 1985. SICA defines “sickness” (sic) to apply only to industrial companies, the criteria being a track record of erosion of networth over a period of five years. That too, the industrial unit has to employ at least fifty “workers” as defined under the Industrial Disputes Act. With innovative management and sourcing of manpower, these criteria can be easily evaded. Delay and inherently faulty mechanisms have made a mockery of the regime, with the moratorium provision abused as a safe haven for unscrupulous promoters.
The SARFAESI brought relief to a class of secured creditors in enforcing their security, but it’s not a substitute for an ‘insolvency regime’. In fact, finding the balance between bank recoveries and revival of companies has effectively blurred the purpose of what should be achieved in the twilight zone. Companies are more valuable while operational, than sick or dead, and business should not be held to ransom by a few creditors. Yet showing too much tolerance to defaulters sets a bad precedent. If the existing framework is unable to provide effective rehabilitation or speedy recovery, then it needs to be trashed. Pushing the process through BIFR or a scheme of arrangement under Section 391 of the Companies Act are thankless tasks.
High expectations are pinned on the Companies Bill, which has promised a insolvency rehabilitation fund and a regime based on the UNCITRAL Trade law model. Unfortunately, the Indian experience in adopting UNCITRAL model in the Arbitration and Conciliation Act, 1996 has not been positive. Not all prescriptions work for all maladies, but in going cross border, Pakistan’s Corporate Rehabilitation Act (CRA) is worth emulating.
While relying on global best practices for guidance, they have rejected the Indian committee centered approach, as well as the English management takeover model, adapted the American model regime to local needs with fast track timeframes, early exit options, e.g. permitting vulture sales, and most importantly treating government dues at par with unsecured debts. Ultimately time is of the essence, and if a quick turnaround is not achieved, the twilight zone becomes purgatory.
Kumkum Sen is a partner at Rajinder Narain & Co., and can be reached at kumkumsen@rnclegal.com
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