The financial services sector has been reeling under the pressure of mounting bad assets, including failed restructuring attempts, and the situation seems far from over. The proposed Bill on bankruptcy, consolidating the existing scattered laws relating to insolvency of companies, is a noteworthy move by the government for accelerating the winding up process for defaulting companies and providing a quicker exit route for lenders.
This draft bankruptcy code seems to have been inspired by the quick, equitable and efficient approach of resolution processes established under chapter 7 and 11 of the US bankruptcy code. Similar to chapter 11, the draft bankruptcy code provides for a resolution process where, in essence, it allows companies to continue doing business while going through bankruptcy proceedings. Nevertheless, the draft bankruptcy code differs also, with regard to some aspects such as management control. While under chapter 11, proceedings remains with the company, on the other hand under the draft bankruptcy code, the management control passes over to ‘insolvency resolution professionals’.
The Bill seems to be coming in at the right time with the banking regulator announcing a March 2017 deadline for the banks to clean up their balance-sheets and take measures for improving the quality of banks’ portfolios. According to the recent Financial Stability and Development Council (FSDC) report, the Reserve Bank of India (RBI) has clearly indicated that corporate sector vulnerabilities and the impact of their weak balance sheets on the financial system need closer monitoring.
In the current regime, initiating recovery procedures was not only challenging but also time-consuming for lenders/bankers. This led to a situation where, in some cases, non-performing assets (NPAs) were not being accounted for in the books, and in some cases companies were still provided additional ad hoc funding or extension of limits.
The Bill is expected to act as a catalyst in improving the NPA woes of banks. There are a number of key areas where the impact can be felt.
* The fixation of the 180-day time limit (extension of further 90 days in exception cases) for insolvency resolution shall help lenders take decisions about the viability of the business. Else, the liquidation process would be initiated. It also provides for a resolution process where, in essence, it allows companies to continue to do business while going through bankruptcy proceedings. This would help banks in salvaging the recovery value to a great extent.
* Decisions such as economic viability of the debtor company will be determined through negotiations with the creditors. This exercise will be facilitated by ‘insolvency professionals’ and not courts, thereby adding more credibility to the overall process.
* Early identification of financial distress and voluntary initiation of the insolvency process would further assist in easing out businesses that may have failed because of genuine reasons and desire to refrain from further losses.
Currently, there are more than 40 Acts and circulars pertaining (indirectly and directly) to insolvency and bankruptcy, and it is yet to been seen how all these are treated. Some laws would be required to be repealed and subsumed in the final bankruptcy code, and for some respective amendments would be required.
Additionally, there are various routes that the parties to an insolvency transaction may take, such as proceedings under:
(1) Debt recovery tribunal for recovery of debts;
(2) Winding-up petition in the high court;
(3) Enforcement action under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2000 (Sarfaesi);
(4) Corporate debt restructuring (CDR), joint lender forum (JLF) or strategic debt restructuring (SDR) mechanism proposed by RBI.
The Bill is now expected to be taken up in the next session of Parliament. However, the success of the Bill would largely depend on how effectively it is implemented, and if it is implemented in the exact shape and form it has been proposed—especially the structure of DRAT, NCLAT and setting up of an ‘insolvency regulator’ with requisite powers. In fact, according to RBI, “an early clearance of the proposed insolvency and bankruptcy Bill will play an important role in the face of mounting potential losses.”
An important aspect to consider and assess is the intent of the promoter/borrower at the time of initiating the insolvency process. While the time taken in the insolvency process would considerably reduce, the real recovery value to be derived would depend on existence and veracity of the underlying assets (whether stock, book debts, fixed assets or assets in other forms).
It would be imperative for banks to undertake thorough due diligence of the defaulting companies, including background checks of promoters, to gauge the genuineness of the state of affairs and act accordingly, especially in case of wilful defaulters. With the existing uncertainty in the environment and large corporate groups under the scanner for fraud or diversion of funds, it would be worthwhile to include ‘forensic’ related skills for ‘insolvency professionals’ to identify early warning signals.
Singh is partner & national leader and Babbar is executive director, Fraud Investigation & Dispute Services, EY