Bankruptcy law needs a supportive ecosystem to succeed

The law must also be supported by a larger legal system to prevent resolution and liquidation plans from being stalled by an unending series of appeals

The draft insolvency and bankruptcy bill, which was submitted to the finance ministry on Wednesday, with two weeks provided for feedback, at first glance, appears to provide a comprehensive solution to a problem that has been plaguing the Indian economy for decades. Despite legislative interventions like the Sick Industrial Companies Act and the institutional mechanism that emerged from it, the Board for Industrial and Financial Reconstruction (BIFR), gridlock between various stakeholders was the typical outcome. The processes that were put in place simply did not have the power to force a resolution, thereby leaving huge numbers of assets hanging in limbo. The SARFAESI Act of 2003 went some steps further in empowering banks to seize assets from defaulters but it did not really offer an alternative solution to the problem of actually shutting down a business.

Chapter 11 of the Bankruptcy Code of the United States is generally seen as setting the benchmark for a quick, efficient and equitable resolution process. The draft bill has clearly been inspired by this approach. In its essence, it allows going concerns to continue to do business while going through bankruptcy proceedings. In the alternative, a business is shut down and can remain so for ever, doing none of the stakeholders any good - both its borrowers and lenders. By contrast, in a Chapter 11 proceeding, the process of negotiation goes on even as the business operates, with both owners and creditors agreeing to work within certain boundaries, which protect both sides' interests. The draft bill is also based on this very important premise. The first phase of the process relates to insolvency, which, the draft proposes, should go on for a maximum of six months, save exceptional circumstances. During this time, a restructuring plan is to be developed, which needs to be approved by creditors who hold at least 75 per cent of the debt. If such a plan does not emerge, then the business has to be liquidated. There are some other issues that the draft addresses, but this process is at its core and also its most significant contribution.

Of course, in order to accomplish this speedy resolution, a whole range of capabilities will be needed. One of the key constraints to resolution within the current framework is the abysmal shortage of capacity in the liquidation process. The draft bill explicitly requires an entirely new set of liquidators to be set up and, if the desired time frame is to be achieved, there will have to be a large number of them. Beyond this, the law must also be supported by the larger legal system to prevent resolution and liquidation plans from being stalled by an unending series of appeals. In effect, the success or failure of the proposed changes in the resolution framework will depend as much on whether appropriate changes are made in the supporting ecosystem as in the bankruptcy law itself. In Indian bankruptcy history, the experience of Satyam stands out as a role model on how to do things; the test for the new law will be whether it is able to institutionalise and implement on a large scale what the Satyam process achieved.