Professional Documents
Culture Documents
Module 1 - Unit 1
Module 1 - Unit 1
“The economy witnessed freedom of entry in the 1990s and the freedom to continue
business in the 2000s. The Insolvency and Bankruptcy Code, 2016 now provides the
ultimate economic freedom, freedom to exit, wherever required, and completes the suite
of economic freedom. This will unleash and realise the full potential of every person
and promote inclusive growth. By liberating resources stuck up in inefficient and
defunct firms for continuous recycling, it will change the script from ‘hopeless end’ to
‘endless hope.”
Dr. M.S. Sahoo, Chairperson, IBBI3
Bankruptcy: When
Liquidation: the
a person is
process of winding
declared incapable
up a corporation or
of paying thier due
incorporated entity
and payable bills
1
Module written by Mr. Pratik Datta from National Institute of Public Finance and Policy (NIPFP) and
edited by Dr. Vijay Kumar Singh, Associate Professor & Head, School of Corporate Law, IICA.
2
C. Waren, Bankruptcy in United States History 3 (1935), cited in McIntyre, Lisa J. (1989)
"A Sociological Perspective on Bankruptcy," Indiana Law Journal: Vol. 65: Iss. 1, Article 6. Available at:
http://www.repository.law.indiana.edu/ilj/vol65/iss1/6. Also read Teresa A. Sullivan, Elizabeth Warren,
and Jay Lawrence Westbrook, As We Forgive Our Debtors: Bankruptcy and Consumer Credit in
America, Oxford University Press, 1989
3
http://www.ibbi.gov.in/RW_ebrochure_GNLU_IBBI.pdf
Terminological Confusion
There is a deep- rooted confusion in the meaning and content of several terms used, in
this context, sometimes interchangeably. These terms are: bankruptcy, insolvency,
liquidation, dissolution. During pre-independent period India never used the word,
‘bankruptcy’ in its legal system. Insolvency was used for denoting an individual or a
firm not able to meet the liability. In the case of a company, the system included
winding up and dissolution. Bankruptcy and insolvency, both these words are used in
the Constitution of India. But there was no statute or regulation legislated upon
bankruptcy.
4
http://www.kirks.co.uk/faqs/bankruptcy/difference-between-bankruptcy-and-insolvency
5
Taken from the Masters Thesis of Danilo Penetrante Ventajar on Human Rights Perspectives in
Insolvency, DEPARTMENT OF GLOBAL POLITICAL STUDIES, Spring 2011
6
Thomas H. Jackson, ‘Bankruptcy, Non-Bankruptcy Entitlements, and the Creditors' Bargain’, 91 Yale
L.J. 857 (1982).
7
Elizabeth Warren, ‘Bankruptcy Policymaking in an Imperfect World’, 92 Mich. L. Rev. 336, 340 (1993)
unpaid debt from the insolvent company. Proceduralists believe that a collective
insolvency procedure is beneficial to all the creditors considering the savings brought
about by cooperation as well as the maintenance of the going-concern value of the
debtor whose assets may be dissipated and dismembered if creditors will not cooperate
with one another. The scenario is reminiscent of the famous game theory problem called
“prisoner’s dilemma”. To the proceduralists, however, the only reason secured creditors
would agree to an insolvency regime that allows for the collective enforcement of all
claims is if the unsecured creditors will continue to respect the so-called absolute
priority rule even during insolvency. In contrast, the traditionalists would allow the
disregard of an absolute priority rule and consequently “take into account the interests
of weaker or non-adjusting economic parties, such as employees, tort victims, or other
stakeholders with no formal legal rights.”
Recently, Hon’ble Chief Justice of India in the Jaypee Insolvency matter said
"This is a citizenry problem, a human problem of great magnitude. IDBI can't be selfish.
The homebuyers have invested their lifetime savings in these projects,"
http://economictimes.indiatimes.com/articleshow/60460909.cms?utm_source=contentofinterest&utm_medi
um=text&utm_campaign=cppst
Need for Insolvency Regime: Market participants need freedom broadly at three stages
of a business - to start a business (free entry), to continue the business (free
competition) and to discontinue the business (free exit). This enables new firms to
emerge continuously; and the firms do business when they remain efficient, and vacate
the space when they are no longer efficient. This ensures free flow of resources from
inefficient uses to efficient uses - the first stage ensures allocation of resources to the
most efficient use, the second stage ensures efficient use of resources allocated, and the
third stage ensures release of resources from inefficient uses for fresh allocation to
efficient uses - and consequently the highest possible growth.
muscle to sustain it, it effectively thwarts the competitors’ freedom to do business. India
came up with laws such as the Competition Act, 2002 that proscribed predatory pricing
to protect freedom of firms. The Act also provided level playing field to all firms. For
example, it treated a State Owned Enterprise at par with a private firm, unlike the
erstwhile Monopolies and Restrictive Trades Practices Act, 1969. Further, institutions
that support freedom such as competitive neutrality, contract enforcement, etc. were
strengthened during this phase of reforms.
But even a firm enjoying freedom of entry and freedom to do business could fail to
deliver as planned for a variety of reasons. It could be because of faulty
conceptualisation of business, inefficient execution of business, change of business
environment, or even mala fide design in rare cases. Regardless of the reason, such
failures could impact the macro-economy in multiple ways and need to be addressed
expeditiously. Such failures usually manifest themselves as default in repayment
obligations, indicating the firm in question in a state of insolvency. Default could arise
also from a mismatch between cash inflows and outflows. Default is the result of either
illiquidity or insolvency and is often a legitimate outcome of business operations. It
does not necessarily warrant the closure of a business, which destroys organizational
capital. To resolve insolvency in an orderly manner, an appropriate mechanism is
necessary. Indian policymakers have felt the absence of such a mechanism hitherto,
which has cost the Indian economy in a number of ways. The Insolvency and
Bankruptcy Code, 2016 fills in this lacuna in the Indian legislative landscape.
Part of the explanation for the low level of credit may lie in India’s credit infrastructure,
which is underdeveloped. Strong credit infrastructure is also useful when it comes to
dealing with distress and reallocating resources to their best use. This will become
increasingly important as India shifts out of mature low-skilled industries into high-
skilled frontier technologies in the process of catching up. All this has prompted
policymakers to consider various strategies to improve the Indian credit infrastructure to
remedy what is deficient.
Most borrowing takes place against collateral/security. It is important to ensure that real
assets can be pledged easily, information about pledged assets is easily accessible to
potential lenders through collateral registries, and the security interest is easily enforced
so it does provide security to the lender in case of default. Collateral registries that are
universally accessible are another important aspect of credit infrastructure development.
Perhaps the biggest source of collateral value in India in the years to come will be land.
This is also the form of collateral most easily available to rural India. Yet land mapping
is uneven, land title is not final, land registries typically do not have complete records,
records conflict with those maintained by the revenue department, and both are also
typically hard to access. Expanding the use of land as collateral is one of the more
important of the needed reforms, especially for the poor.
In order for debt financing to be available, creditor rights have to be protected. While it
is easy to feel sympathy for the distressed debtor, too easy violation of creditor rights, or
political agitation preventing creditors from enforcing interests, will make it harder for
potential borrowers to get access to credit. At the same time, debt will occasionally be
impossible to pay. Both the borrower (whether individual or firm), the society, and even
lenders can be better off if the debtor can restructure un-payable debts using a low-cost,
speedy framework that affords appropriate amounts of relief without vitiating the whole
culture of repayment. The key word here is balance. Too harsh and rigid a system of
debt enforcement will be both politically infeasible (in the sense that, even if enacted,
politicians will intervene constantly and will have public support in doing so) and
reduce borrowing as potential borrowers weigh the substantial costs of distress. Too lax
a system of enforcement will weaken lenders and reduce lending.
Evidently, many factors have contributed to the lack of development of a debt market in
India and consequently, the reduced financial inclusion. One factor that clearly stands
out as a large missing piece is the absence of a coherent and corrective mechanism for
resolving insolvency and bankruptcy. The Insolvency and Bankruptcy Code, 2016 was
enacted to redress this situation and help improve the credit culture in the country. IBC
gives a major boost to India’s contemporary credit infrastructure.
Even though a strong credit infrastructure seems to enhance creditor rights only,
research shows it also significantly enhances the capacity of individuals to borrow,
since creditors are now confident they will be repaid. Conversely, weakening the
infrastructure, which seems politically appealing, while seemingly letting borrowers off
the hook, also hurts their future access to credit. Despite progress on a number of fronts,
traditionally India had a weak credit infrastructure, a major factor in limiting financial
inclusion.
If India is to have a flourishing corporate debt market, corporate public debt, which is
largely unsecured, needs to have value when a company becomes distressed. This
means a well functioning bankruptcy code, that neither protects the debtor at the
expense of everyone else including employees, as our current system does, nor one that
allows secured creditors to drive a well-functioning firm into the ground by seizing
assets. A good bankruptcy code is especially needed for large complex infrastructure
projects, which typically have many claim-holders.
The Insolvency and Bankruptcy Code, 2016 is aimed at enhancing India’s credit
infrastructure by providing a sophisticated eco-system to efficiently handle both
corporate as well as personal insolvency. It is employed to deal with individual firms or
households in financial distress. In some cases, however, bankruptcy law is employed to
resolve or restructure systemically important financial firms. These are not addressed
by the Insolvency and Bankruptcy Code, 2016. Instead, the Ministry of Finance,
Government of India has recently proposed a new Financial Resolution and Deposit
Insurance Bill 8 to address the resolution of financial firms including systemically
important financial institutions.
8
The Bill seeks to provide for the resolution of certain categories of financial service providers in
distress; the deposit insurance to consumers of certain categories of financial services; designation of
systemically important financial institutions; and establishment of a Resolution Corporation for protection
of consumers of specified service providers and of public funds for ensuring the stability and resilience of
the financial system and for matters connected therewith or incidental thereto. The proposed legislation
together with the Insolvency and Bankruptcy Code, 2016 is expected to provide a comprehensive
resolution mechanism for the economy. Bill is available at
http://164.100.47.4/BillsTexts/LSBillTexts/Asintroduced/165_2017_LS_Eng.pdf
Non-payment by a debtor firm may be due to a short term cash-flow stress even when
the underlying business model is generating revenues or due to a fundamental weakness
in the business model because of which the business is unable to generate sufficient
revenues to make payments. As long as the debt obligations are met, equity owners
have full control and the creditors of the firm have no say in the running of the business.
When the debtor defaults on payments, the control transfers to the creditors and the
equity owners should have no further say. Upon default, the creditors have the
incentive to be the first to recover their amounts. Consequently, a race to collect may
ensue, with firm liquidation as the inevitable outcome. What should ideally happen is
that the creditors and the debtor should negotiate a financial rearrangement to preserve
the economic value of the business and keep the enterprise running as a going concern.
If however the default is due to a business failure, then the enterprise should be shut
down as soon as possible. The insolvency and bankruptcy law of the country provides a
framework through which these decisions can be taken and hence it assumes great
importance.
The insolvency and bankruptcy law of a country lays down a process by which firms in
financial distress can seek a resolution or an exit. When implemented efficiently, the
law provides protection to the creditors in the event of a firm insolvency. It provides
certainty to parties in a debt contract about the expected outcomes and this, ex ante,
enables the creditors to take better credit decisions in the pre-insolvency stage. An
insolvency law therefore impacts both pre-insolvency and post-insolvency actions of the
debtors and the creditors and is a critical element of the financial environment of a
country.
With a clear and coherent insolvency and bankruptcy law, there is lower contention
between the creditor and the debtor, and financial distress can be resolved rapidly.
Debtors can re-enter the enterprise arena quickly and with lower costs and creditors get
incentivised to repeatedly provide credit.
and a distribution of its remaining assets to creditors, and (iii) a reorganisation or revival
of the business, which results in a continuation of the business in some form or in the
sale of the business as a going concern.
The first of these options is a debt recovery procedure, while the latter two fall into the
camp of corporate insolvency procedures. Though closely related, debt enforcement and
corporate insolvency are distinct concepts. Debt enforcement refers to a mechanism by
which individual creditors attempt to recover the debt due to them upon a default by the
borrower, typically by enforcing the collateral securing the debt. By contrast, corporate
insolvency procedures provide a collective mechanism to deal with a distressed
company’s overall position and affect the rights of all stakeholders.
In India, the legal framework that deals with companies in distress is multilayered,
involving a combination of collective insolvency and debt enforcement laws. Further,
each of these types of legal proceedings are often applicable to specific stakeholders
(for example, only secured creditors or only banks and financial institutions) and are
dealt with in different legal forums. A brief description of the main pieces of legislation
that affect debtors in default and their creditors needs to be discussed.
Companies Act 2013, which provided for rescue and liquidation frameworks,
respectively, for all companies and take into account some of the criticisms of SICA,
have been introduced, but these provisions too were not notified. As a consequence, for
a very long time SICA remained the only statutory mechanism for the rehabilitation of
distressed companies, though it only covered a subset of companies.
[Unit 4 of Module 1 would discuss this in detail]
With effect from December 1, 2016, the SICA got repealed the Board for Industrial and
Financial Reconstruction (“BIFR”) and the Appellate Authority for Industrial and
9
Financial Reconstruction (“AAIFR”) stood dissolved . Now the process of
rehabilitation is in-built into the corporate insolvency resolution process under the
Insolvency and Bankruptcy Code, 2016 (IBC 2016).
9
S.O. 3568(E) and S.O. 3569(E) dated 25th November, 2016, Department of Financial Services, Ministry
of Finance
Another Act passed nearly 10 years after the RDDBFI Act was the SARFAESI Act
2002. This Act provides a mechanism for secured creditors to take possession of the
securities and sell them to recover debts due. The most interesting feature of
SARFAESI is that its enforcement does not require the involvement of a court or
tribunal. Section 13 of the SARFAESI Act allows secured creditors to take steps to
enforce their security interest in respect of any debt of a borrower that is classified as a
non-performing asset without the intervention of a court or tribunal if certain conditions
specified in the act are met. Any debtor who then wants to contest the action taken by a
creditor under the SARFAESI Act may do so through an appeal to the DRT within 45
days of the enforcement action being taken.
Among debtors, there were limitations on the firms that get covered under the two main
laws, Companies Act, 1956 and SICA, 1985. A large number of small, unregistered
enterprises with less than seven members may not get covered under the Companies
Act, 1956 or 2013. SICA, 1985, is only applicable to a subset of sick industrial
companies.
In a landscape dotted with multiple laws and special provisions, there was a lack of
clarity on what holds precedence in a given situation. In India, this had been a subject of
significant litigation. Under the Companies Act, the location of the registered office of
the debtor company determined which company court will have jurisdiction. In contrast,
under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 and the
Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002, the DRT within whose jurisdiction the cause of action arises, wholly
or in part, may also have jurisdiction. Since a part of the cause of action arises at the
location of the bank branch where the loan transaction had taken place, the DRT which
has jurisdiction over the bank branch is an eligible forum for an original application by
the bank. This has lead to much cross-litigation and conflicting orders between the
company court and the DRT. Besides, this has also given rise to the concept of “forum
shopping”, where both the creditor and the debtor firm can opt for the judicial
mechanism that suits their individual needs, at the cost of maximising the economic
value of the business. Added to this complexity, is the dearth of timely mechanisms
that are consistently available to all categories of creditors to resolve the insolvency of
all categories of debtor firms.
Moreover, SICA also did not deliver as envisaged. The existing literature suggests that
its moratorium and interim protection of management may have empowered debtor
companies to delay, and to leverage the threat of delay to extract concessions from
institutional creditors. Moreover, development of three judicial innovations significantly
affected the operation of the Act, slowing the liquidation of companies recommended
for winding-up by the BIFR. First, a judicial practice developed of enabling companies
to explore rehabilitation after the issuance of a liquidation opinion by the BIFR. Thus
debtors and their stakeholders had strong incentive to litigate for relief. Second, judicial
pronouncements eroded the BIFR’s liquidation powers. However, judicial practice
permitted companies to avoid immediate liquidation on exit from the BIFR by arguing
that there remained – on the merits – some prospect of rehabilitation. The effect of this
practice was to dilute, and in some cases entirely negate, the BIFR’s liquidation power.
Third, the cases reveal that while institutional creditors have generally been barred by
the moratorium from recovering, other creditors have been permitted to escape the
moratorium and recover in full.
The drafters of SICA envisaged a narrow role for the courts in the implementation of
their rescue procedure for sick industrial companies. Primary responsibility for the
rehabilitation of distressed but viable debtors, and for the decision to liquidate
‘unviable’ debtors, was entrusted to a specialist tribunal (the BIFR), and its decisions
were insulated from merits review by the courts. In practice, however, the courts
assumed a far greater role under the Act than originally envisaged. Judges in the High
Courts and Supreme Court diluted the power of the BIFR to issue a binding opinion for
the liquidation of companies found incapable of rescue. They deployed a range of
procedural devices to encourage the pursuit of further attempts at the rehabilitation of
these companies, often after reviewing the merits of the case. In the periods of delay that
resulted, judges also elevated the position of some stakeholders - particularly workers,
but also others perceived to be vulnerable – over others, such as institutional creditors.
These innovations appear central to understanding why SICA came to operate as it did,
as a slow procedure that was extremely costly to creditors (and particularly institutional
creditors). In short, they appear central to understanding the Act’s demise.
over the years along with their loan portfolios. Besides the systemic risk implications
due to the growing volumes of NPAs, lack of fresh loans available from banks is also
straining the growth of the Indian economy.
Moreover, India is unique in that equity is a larger source of financing than debt for
firms on average. While the debt-equity ratio tends to be around 3 for firms in
developed economies, it is around 0.5 for Indian firms. This is not surprising since the
recovery rates obtained in India are among the lowest in the world. When default takes
place, broadly speaking, lenders seem to recover 20% of the value of debt, on an NPV
basis.
Initiation of reforms
These factors ultimately prompted the Finance Minister to state in his Budget Speech in
July 2014 that: “Entrepreneur friendly legal bankruptcy (sic) framework will also be
developed for SMEs to enable easy exit”. In late 2014, MOF setup the Bankruptcy
Legislative Reforms Committee or the BLRC, led by Dr. T. K. Viswanathan, with the
objective of building a full-fledged bankruptcy code.
The work of the BLRC was placed in the FSLRC division of the Department of
Economic Affairs (DEA), so as to harness the institutional memory about the working
of FSLRC. The BLRC submitted a two volume report on 4 November 2015. The report
is similar to the output of the FSLRC: the economic rationale and design features of a
new legislative framework to resolve insolvency and bankruptcy was in Volume 1 and
the draft bill was in Volume 2. These materials were put on the MOF website. A
modified version of this bill, with public comments incorporated, was tabled in
Parliament in the winter session on 23 December 2015.
After the IBC was tabled, the Joint Parliamentary Committee on Insolvency and
Bankruptcy Code, 2015 (JPC) was set up on the same day to analyse the draft bill in
detail. The JPC submitted its report which included a new draft of the law. This is the
draft Insolvency and Bankruptcy Code (IBC) that was ultimately passed by both houses
of Parliament and enacted into a statute.
Once the IRP commences, power shifts from shareholders/managers to the Committee
of Creditors. This includes the power to take over management of the firm, the ability to
change management, to bring in fresh financing, to ask for all information required in
order to invite bids for commercial contracts, including from the existing creditors and
debtor, to keep the enterprise going. Decisions are made by voting in the Committee of
Creditors.
For firms who have significant organisational capital, the value of the firm as a going
concern in the eyes of a buyer would exceed the liquidation value of the assets of the
firm. Such firms are likely to attract bids where the value of the firm is more than the
value of its physical building blocks. However, organisational capital rapidly
depreciates. Hence, it is critical for the IRP to begin quickly and move forward quickly,
aiming to get closure while the firm is still a going concern, so as to avoid value
destruction with the firm becoming defunct.
Speedy resolution is incentivised in the IBC by having a time limit of 180 days for the
IRP. If, in 180 days, 75% votes in the Committee of Creditors do not favour one
resolution plan, the debtor is declared bankrupt. The IBC then provides clarity about
which assets are available for liquidation, and a clear prioritisation of who has rights to
these assets for recovery, in liquidation.
In general, the recovery rate for creditors is lower when a firm goes into liquidation.
This creates incentives for the creditors to be rational about their activities in the critical
180 days. The process of resolving insolvency is similar for firms and for individuals.
In the case of individuals, however, the final resolution plan must have the consent of
the debtor. There are additional innovations in the process of individual insolvency in
the IBC that will increase individual default resolution efficiency in India. One is the
concept of the Fresh Start, which gives a debt write-off for individuals who are below
certain thresholds of wealth and income at the time of default.
In order to make this work in India, IBC envisages four critical pillars of institutional
infrastructure: (1) Robust and efficient adjudication infrastructure will be required, on
the lines of the Financial Sector Appellate Tribunal that is proposed in the Indian
Financial Code; (2) A new regulated profession -- of Insolvency Professionals (IPs)
who can be Resolution Professionals and Liquidators -- is required. [These would be
discussed in detail in Module 2]. India has a long history of failure in regulation of
professions, as is seen with lawyers, chartered accountants, doctors, etc. The success
story here is the regulatory system run by exchanges for brokers. These ideas need to be
brought into making the insolvency profession work; (3) Delays destroy value, and
disputes about facts in India can drag on for years. A new industry of `information
utilities' (IUs) is required who will control trusted data, pertinent to the operation of the
IRP as well as used during Liquidation. This would draw on the success that India has
had with the working of the securities markets depositories; (4) A regulator is required,
to perform (a) The legislative function of drafting regulations which embed details
about the working of the IRP; (b) Legislative, executive and quasi-judicial functions for
the regulated industries of information utilities and the insolvency profession; and (c)
Statistical system functions.
Overall, the Insolvency and Bankruptcy Code 2016 creates a robust framework for
time-bound insolvency resolution of companies and individuals. The Insolvency and
Bankruptcy Board of India (IBBI) has been set up and has also issued detailed
regulations to regulate the functioning of IPs, IPAs and IUs.
“This (The Insolvency and Bankruptcy Code, 2016) is considered as the biggest
economic reform next only to GST.”
Ministry of Finance, Press Release dated 11th May, 2016
The World Bank’s Doing Business sheds light on how easy or difficult it is for a local
entrepreneur to open and run a small-to-medium-size business when complying with
relevant regulations. It measures and tracks changes in regulations affecting 11 areas in
the life cycle of a business: starting a business, dealing with construction permits,
getting electricity, registering property, getting credit, protecting minority investors,
paying taxes, trading across borders, enforcing contracts, resolving insolvency and labor
market regulation10. As may be noted one of the 11 parameters in assessing the ease of
doing business is resolving insolvency, i.e. the time, cost and outcome of insolvency
proceedings involving domestic entities as well as the strength of the legal framework
applicable to judicial liquidation and reorganization proceedings11. India ranks 131 on
this parameter with a recovery rate of 26 cents per dollar compared with 73 cents in
OECD high income and 32.6 cents in South Asia12.
10
http://www.doingbusiness.org/~/media/wbg/doingbusiness/documents/profiles/country/ind.pdf
11
http://www.doingbusiness.org/Methodology/Resolving-Insolvency
12
A detailed analysis may be seen at
http://www.doingbusiness.org/data/exploreeconomies/india#resolving-insolvency
Social Perspective13
Achieving a truly sociological understanding of bankruptcy will first require moving
beyond the study of bankruptcy as something that happens to individuals and looking at
the meaning of bankruptcy at the social level. Achieved stigma is a normative status;
and history tells us that bankruptcy has long been regarded as more than mere failure-it
is a serious moral indiscretion. At one time insolvency was a crime; debtors could be
imprisoned and (in England) even put to death. While, in time, people came to be more
sympathetic toward the plight of the debtor, personal bankruptcy continued to be
regarded as disgrace. Things though changed over a period, especially with reference to
corporate insolvency. Not all failures result in one being marked as the object of
disgrace or social reproach. This is true even of failures that have important
consequences. For example, the failure of a presidential candidate to win office, an
actress to win an Oscar, an athlete to win an Olympic gold medal, and a student to score
the highest mark on an exam are hardly failures that bring on opprobrium. Vince
Lombardi's famous (alleged) dictum notwithstanding, it must be noted that, if losing
does not bring honor, neither does it necessarily occasion disgrace. This aspect has
been noted by the Bankruptcy Law Reform Committee also and it has differentiated the
term financial and business failure, in particular ‘drawing the line between malfeasance
and business failure’.
Sullivan, Warren and Westbrook make many references to the notion that the current
rate of bankruptcy is a symptom of some larger "social pathology" or "social
problem."14 They emphasize this by drawing an analogy between bankruptcy law and
medical care:
The purpose of bankruptcy law, properly used rather than abused, is to serve as
a financial hospital for people sick with debt. If hospital admissions rise
dramatically, there are at least two explanations for the increase, It may be that
13
Based on the article McIntyre, Lisa J. (1989) "A Sociological Perspective on Bankruptcy," Indiana Law
Journal: Vol. 65: Iss. 1, Article 6
14
Farmers defaulting loans and loan waivers was considered to be not a good trend by bankers and
economists, is it setting up a culture of loan default?? “Waivers undermine an honest credit culture... It
leads to crowding-out of private borrowers as high government borrowing tend to (impose) an increasing
cost of borrowing for others,” Patel said after Thursday’s monetary policy announcement. “I think we
need to create a consensus such that loan waiver promises, otherwise sub-sovereign fiscal challenges in
this context could eventually affect national balance sheet.” Urijit Patel, RBI Governor, see
http://www.livemint.com/Politics/FLWzWep1Jdv8riZhMlNbtL/RBI-governor-Urjit-Patel-criticises-farm-
loan-waiver-schemes.html
doctors have started admitting patients who are not seriously ill and who could
be treated as outpatients. Or the crowded hospital wards may simply reflect a
breakdown of health in the community.
Life of a corporate entity has ups and downs like an animate person. There may be
many reasons for the same. Only a very competent Corporate Doctor can diagnose the
disease and administer therapy. Unfortunately, we are still talking about good corporate
governance, as if, such a thing is ubiquitous and an immortal one, once found shall
remain constant for all times to come. Like any animate person the health of a lega
persona, i.e., the corporate health is also subjected to innumerable virus and bacteria.
Bacteria in corporate entity may originate, as for example, due to bad governance
inefficient management, financial malfunctioning, and short supply of finance or
technology obsolescence. External causes for virus infection may be on account of
change of consumption habit, new products coming in the markets, or even inflation or
deflation in the economy. For some of these reasons, a corporate entity may be
restructured and for some other reasons the quick death of the entity is perhaps better
for the economy as a whole. Unfortunately in India there is no corporate doctor to
effectively diagnose and administer proper therapy at proper time. The corporate law
has not provided for any such measures that ensures good governance and at the
same time does not adequately protect of the health of an entity.
However, the analogy has limitations. Governance principles are effective only up to
voluntary and mutually beneficial negotiations. The need for a bankruptcy law comes
about in the context of a renegotiation of a set of contracts. When a company is unable,
or unwilling, to meet its contractual obligations to its stakeholders, the contracting
parties will have to decide whether the contract terms will be enforced or be allowed to
be breached. In other words, the contracts may have to be negotiated. The bankruptcy
court provides the framework within which such renegotiations can take place. The
bankruptcy institution, therefore, must give a very special emphasis on the lowering of
costs of transactions during bankruptcy procedures. Indeed, this must be its primary
objective.
It was observed that, in this context, bankruptcy procedures are irrelevant if companies
never face financial distress. Financial distress opens up the possibility of a breach of
contractual obligations. Consequently, all aspects of bankruptcy law will have to be
restricted to analysing such situations. For instance, shareholder protection should not
be a concern, or have the lowest priority, in a bankruptcy procedure. This is because
the shareholders are residual claimants and financial distress implies that the
corporation is valueless even after it meets only some of the claims that are senior to
those of the shareholders. Shareholders’ protection is better served by other parts of
corporate law where the express intention is to draw up the rules governing
15
https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/20811.pdf
The aforesaid discussion shows the wide spectrum of issues surrounding the concept of
insolvency and bankruptcy which has social, legal, economic and financial implications.
At times the law relating to insolvency and bankruptcy may be technical has to have the
different perspectives in its implementation. We would go through these aspects in
forthcoming modules and units.
References
1. Rajeswari Sengupta, Anjali Sharma, Susan Thomas, Evolution of the insolvency
framework for non-financial firms in India, IGIDR Working Paper WP-2016-018
2. Raghuram Rajan, A hundred small steps, Report of the Committee on Financial
Sector Reforms, 2008.
3. Aparna Ravi, Indian Insolvency Regime in Practice: An Analysis of Insolvency and
Debt Recovery Proceedings, Economic and Political Weekly, 2015.
4. Kristin van Zwieten, Corporate rescue in India: The influence of courts, Journal of
Corporate Law Studies 2015(1).
16
The Statement of Objects and Reasons for the aforesaid Act reads thus: “In order to mitigate the
hardship that may be caused to the workers who may be thrown out of employment by the closure of an
undertaking, Government may take over such undertaking either on lease or on such conditions as may be
deemed suitable and run it as a measure of unemployment relief. In such cases Government may have to
fix revised terms of employment of the workers or to make other changes which may not be in
consonance with the existing labour laws or any agreements or awards applicable to the undertaking. It
may become necessary even to exempt the undertaking from certain legal provisions. For these reasons it
is proposed to obtain power to exclude an undertaking, run by or under the authority of Government as a
measure of unemployment relief, from the operation of certain labour laws or any specified provisions
thereof subject to such conditions and for such periods as may be specified. It is also proposed to make a
provision to secure that while the rights and liabilities of the original employer and workmen may remain
suspended during the period the 89 undertaking is run by Government, they would revive and become
enforceable as soon as the undertaking ceases to be under the control of Government.”
17
In the matter of M/s Innoventive Industries Ltd. vs. ICICI Bank & Anr, Civil Appeal Nos. 8337-8338 of
2017 decided on August 31, 2017 [Coram R.F. Nariman and Sanjay Kishan Kaul, JJ).