We generally forget that social niceties and customs lie at the heart of legal reforms of a jurisdiction. Either they affirm them or shatter them. The recent Insolvency and Bankruptcy regime in India is an attempt at shattering the social nicety of India that Indian businesses cannot fail- they have too much riding on them.
More than anything else they are liable to churn employment for the ever-heaving population of a society which appreciates employees more than entrepreneurs who employ them. As we work in the present insolvency regime as a legal practitioner and debt restructuring consultant, we find more and more seasoned businessmen falling for the ‘What will people say?’ trap of looking at the insolvency regime. Perhaps some credit of this also goes to the branding of the law calling it ‘Insolvency and Bankruptcy’ instead of distinguishing between the ‘Corporate Rescue’ and ‘Liquidation’ portions of the Code.
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Mature world economies like Singapore and United States of America (USA) have sculpted their insolvency regimes on the corporate principle that insolvency is a corollary of a healthy entrepreneurial and risk-taking business culture. These economies understand the importance of corporate rescue and are often found calling pro-creditor insolvency regimes as ‘backward’ or ‘archetype’. Singapore specifically distinguishes corporate rescue as ‘judicial management’ and also allows for ‘Schemes of Arrangement’. The USA goes one step ahead and calls Chapter 11 bankruptcies as ‘Corporate Protection’ against insolvency. The corporate debtor retains control over the company during moratorium period so long as it is able to follow through on its restructuring plan.
When the list of the first 12 companies requiring restructuring was made public in India, we found people pointing fingers and calling them the ‘dirty dozen’. We have a lot of important people gaining sadistic pleasure at their downfall and asking the government to make an example out of them by punishing them and striping them off the management and control of their enterprises and ensuring they are never able to do business again in India. Let us not forget that these companies were not shell companies. They were functioning companies who have contributed to the growth of the economy sometime or the other and perhaps now are at the ebb of their business cycles.
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Of course, we should not discount corporate frauds and easy loans given by banks based solely on promoter face value. But there are a lot of financial institutions portraying themselves as victims to corporate bandits while years ago they willingly gave away disproportionate secured and unsecured debt without enough financial and legal due diligence. For an economy to really mature to its full potential neither corporate debtors nor financial creditors should expect a safety net for all their transactions. They are all subject to calculated risk assessment and mitigation strategizing.
Coming back to the story of IBC, as the corporate debtors scurried to make good of a bad situation, the insolvency regime came upon the conundrum of promoters trying to rescue their companies by offering to buy-out the company undergoing resolution process. This began when Essar group tried to buy back its Steel business or more recently when Binani Cement has an aggressive bidder in Ultratech.
Till 2016, a defaulting creditor could ‘evergreen’ its loan by opting for a haircut and subrogation of loan by another banker. To remedy this situation even before the insolvency regime was brought in, RBI and SEBI opted to define a ‘wilful defaulter’ sometime in 2015-16. The sum effect was that a wilful defaulter could not get debt finance and also could not raise capital from the open market. Now with the inclusion of Section 29A and other amendments via Insolvency and Bankruptcy (Amendment) Act, 2018, this wilful defaulter additionally cannot submit a resolution plan before the insolvency professional to rescue its company. This layer of protection is in addition to the discretion given to the committee of creditors to lay down standards and criterion before accepting any resolution plan for judging the presenter of the plan.
This is a lesson to Indian businessmen that ‘Jugaad in the banking sector’ is no more enough to survive in India, you also need a clean balance sheet. The law is not without loopholes, of course. For example, some promoters gifted away their shareholding in sister companies and resigned from boards so that the enterprise could remain ‘in the family’. There is also no bar on a neutral third party buying out the wilful defaulter and selling the company back to the same wilful defaulter post completion of corporate insolvency resolution process.
In a slightly different example, Anil Ambani’s telecom assets held by RCom is proposed to be acquired by brother Mukesh Ambani’s telecom company Jio which although related by blood, does not come within the definition of ‘wilful defaulter’ by law. The transaction has been challenged and stayed by minority shareholders HSBC Daisy Investments (Mauritius) at Supreme Court on the grounds of oppression and mismanagement allegedly for approving the transaction without holding a valid shareholder meeting and taking shareholder approval under Section 180 of Companies Act, 2013.
However, it is important to note that for the definition of wilful defaulters to be really objective and transparent the following changes should be considered: (a) While the RBI Master Circular on wilful defaulters makes fleeting reference to the fact that someone can be taken out of a wilful defaulter list, it does not provide guidelines and standards which the wilful defaulter ought to meet to do get whitelisted. It is important to lay down guidelines on how the wilful defaulter can repent and get a fresh start after a cooling off period; (b) To really have genuine wilful defaulters punished and more importantly save the defaulters who are not ‘wilful’, it is important to create a seamless and transparent credit rating and NPA classification criterion and process.
The present system is tilted towards the creditors without any opportunity of rectifying wrong information provided by the financial creditor to credit rating agency. Many industries are also plagued with faulty NPA classification by overcautious banks owing to wrong interpretation of RBI circulars; (c) It is important to evaluate the feasibility of classifying disqualified directors under Companies Act, 2013 as ‘wilful defaulters’ since most cases involve non- filing of annual returns as grounds for disqualification; and (d) Any person imprisoned for two years is also classified as a wilful defaulter. This is too broad a criterion and should at least be qualified by a cooling off period.
Once we have an objective criterion to detect wilful defaulters, it is important to apply this criterion to everyone without exception. In some cases, promoters know their company best and sometimes they are the right people to revive their companies. But sometimes it is the promoters who make the company toxic. Such wilful defaulters or just bad business managers need to be kept away from the rehabilitating company for the company to thrive and survive rehabilitation. Such decisions shall require commercial fortitude and nothing else.
Hence, a very fine balancing act is required between punishment of wilful defaulters and ensuring real corporate rescue. If we put enterprises against a wall leaving them with no option of finance, corporate businesses with the scope of recovery will be sold for peanuts only because financial institutions are now crying for their pound of flesh under pressure from RBI. Recently, the undue influence of the regulator on commercial decision making of financial creditors was censured by the Supreme Court in relation to the NPA of Jayaswal Neco group. Yet, if we allow toxic promoters and key managerial personnel to continue to run the company, it will lead to a similar situation as erstwhile SICA and CDR regimes.
Let us also remember that the financial institutions of India are newly experiencing debt restructuring or revival of companies. They come with clean instructions of ‘get the most out of it without implications of corruption by Central Vigilance Commission or RBI’. Most stakeholders including judges of NCLT come with a pre-conceived notion that declaring a moratorium period on a corporate debtor shall only mean liquidation. This pre-conceived notion may not be that wrong since public sector banks are on a witch hunt for defaulters and are refusing to vote for resolution plans which do not provide for sale of company assets or enforcement of security interest.
Some important features which we can adopt to balance the present pro-creditor regime and promote corporate rescue and protection based on international experience in Singapore and USA are as follows: (a) Super financing where debt given during insolvency resolution process gets priority over all other debts; (b) Punishment for ‘fraudulent trading’ where there was an intention to defraud creditors or ‘Wrongful Trading’ where the officer was aware the company shall be unable to pay off a debt when accepting it. The punishment should be aimed at indemnification and not prosecution centric. Efforts should be made to plough back finance back into the business by tracking the syphoned money or liquidation of personal assets of fraudulent employee or promoter. But no further stonewalling of efforts of a genuine promoter offering to buy-out an insolvent company should be made just to make an example out of the businessman; (c) Giving importance to ‘Voidable Transactions’ where questionable transactions of the company made to benefit certain individuals can be detected and clawed back by the committee of creditors and/or resolution professional; and (d) It is important that personal guarantees of promoters be allowed to be enforced during moratorium period so that if the promoter is unable to make good on the guarantee, the insolvency resolution of the promoter is also simultaneously brought before the National Company Law Tribunal. Law for doing this is already provided for in the Code.
The good outcome from all this is that the insolvency regime of India is finally coming of age. It is a beginning of looking at ‘insolvency’ as a natural part of business cycle. Let us not forget, business is a cyclic process and revival of a distressed company is possible in many cases. Liquidation of assets is not the only feasible resolution plan. Once the system cleanses out companies who are beyond repair owing to past tardy regimes, revival and corporate rescue should be emphasised on. It is important to change the way we look at the moratorium period which is a ‘time-please’ period for a company and not a ‘impending calm before the storm’. We need a positive, commercial outlook towards corporate rescue to ensure that innovation and entrepreneurship thrive in India. This is required so that the Wozniaks of this world do not rightly point out- “The culture here is one of success based upon academic excellence, studying, learning, practising and having a good job and a great life… but where is the creativity? The creativity gets left out when your behaviour is too predictable and structured, everyone is similar.”
Let us not forget that some of the biggest enterprises of the world like Apple, Walt Disney, General Motors and Ford had a brush with insolvency (some of them several times) in their life cycles to reach the pinnacle. Harsha Bhogle in his famous speech at IIM-A emphasized the role that failure plays in making any man a success. He used the fascinating example of a principle that the Australian Army uses when recruiting for an elite core team: “They look at your career record, your track record. And if you’ve never failed, they don’t pick you. They don’t pick you because they say ‘If this man experiences failure, will he know what to do?’”
A positive attitude towards corporate rescue is important for the Indian economy to peak. It is not job security that is going to help us achieve that goal, it is entrepreneurship, risk appetite and a ‘never say die’ attitude that is going to help us. And while we are at it, let us not behave like crabs and pull people down to come up on top.
With: Kritika Krishnamurthy