“Earlier, you could borrow and not repay. Now if you don’t pay, you lose your business” – Amitabh Kant (CEO, Niti Aayog)
It’s true. Earlier owners of failing businesses would try to buy their businesses out of bankruptcy. This left our economy wide open to corruption and crony capitalism as company owners would take on loans and/or shareholder investments with no intention of repaying it. Because of this, India’s pile of bad loans kept mounting (Rs. 10 trillion to date!), capital needed for economic growth was locked up in failing businesses and investors were never confident of their investments.
All this changed in December 2015. The Insolvency & Bankruptcy Code was introduced in Parliament, passed by Lok Sabha on 5th May 2016 and by Rajya Sabha a week later. With the IBC 2016, there was now a single framework for failing companies to wind up. What was once a tedious and bureaucratic process, taking up to 5 years to complete and leaving company assets tied up in litigation, would now happen in 270 days.
Compared to India’s sluggish ways of working, this is one of the world’s speediest bankruptcy processes in the world.
India’s Non-Performing Assets (NPA) Crisis & You
By 2015, creditors (largely Public Sector Banks) had given out loans worth Rs. 10 trillion to failing companies! When banks fail to retrieve this money, the one who suffers is the common man, who is doubly hit. Firstly because it is their bank deposits and savings that have been lent out by their bank to these companies, and secondly because it is the taxpayer money that bails these banks out via the Government. Compared to other major economies in the world, India’s proportion of stressed assets is massive (9.6%). We are only behind a few countries, like Italy (16.4%) and Greece (36.3%). The Insolvency & Bankruptcy Code 2016 hopes to clean up this “bad debt”.
The IBC does a lot more than clear up India’s dirty business landscape. It directly protects you too.
Anyone (even you) can file for bankruptcy
As the largest stakeholder in the business, insolvency was often the case of promoters wanting to recover as much of their holdings as possible. Prior to the IBC, only promoters of a business could initiate insolvency but with modern businesses operating through investments from creditors, any creditor can apply for initiation of insolvency – either private individuals (as equity shareholders) or organisations or banks. And these institutions get their money from ordinary citizens, who are looking to multiply their savings. That is why, when the Nirav Modi case came to light, where the Punjab National Bank lost Rs. 11, 400 crore to companies owned by Nirav Modi, fixed deposit holders of PNB panicked and rushed to empty out their accounts.
In most cases, these outside investors have the biggest stake in the business, but since they aren’t the owners of the companies, they couldn’t initiate insolvency. The IBC changed this. It added a power-sharing element to the insolvency process. Now any creditor can initiate the process, and get the money of their account-holders back. If one of the creditors initiates the process, every other creditor is automatically rescued since the insolvency process is against the company as a whole, not just the share of the company equivalent to the share of the debt owed to a particular bank. Alok Industries, with a loan default of Rs 22,075 crore, was taken to insolvency by the State Bank of India, but its other creditors (and by extension, their account holders) like Punjab National Bank, Bank of Baroda, IDBI Bank and Standard Chartered Bank will benefit too.
2. If you’re employed by a defaulting company, you will be secured
When a company is defaulting, it means it’s not making enough money to pay back its business loans. In most cases, these companies aren’t even making enough money to pay their employees. Months go by and employees are left waiting for their salaries. In power and heavy metal companies (the sectors where most of our currently defaulting companies come from) many employees are laborers who live hand to mouth and rely on every salary to pay their rent, utility bills, etc. They often don’t have enough savings to tide them through long periods of time. Since, the insolvency process took years, even wrapping up the business wouldn’t help them. Plus, without proper regulation, owners of bankrupt companies typically pocketed the recovered funds instead of settling outstanding payments.
Now thanks to the IBC’s ‘recovery’ tool, even operational creditors (a.k.a. employees and suppliers) can file for bankruptcy. Employees or groups of employers initiated 10 of the total 450 corporate bankruptcy cases filed so far. Since, you can file a case even if your owed Rs. 1 lakh, some cases are to recover unpaid salary as low as Rs 1.5 lakh. For example, Nitin Gupta, an employee of Applied Electro Magnetics Pvt. Ltd, filed for non-payment of full salary, saying the company hasn’t paid full salary since when he joined back in 2008 and now owes him Rs 46.77 lakh. He’s even demanding an 18% interest on the dues. Applied Electro Magnetics has admitted to non-payment of salary, but is disputing the amount due to be 28.84 lakh. In another case, a group of employees have started insolvency proceedings against Pune-based Phadnis Properties, saying the company owes them around Rs. 73 lakh in unpaid salaries.
3. Not only initiation, you can get involved in the liquidation process too
By creating guidelines for every part of the insolvency and bankruptcy process with a fine-toothed comb, the IBC has made sure to involve all the stakeholders at every stage. When a company files for bankruptcy or a case is filed against a company, an ‘insolvency professional(IP)’ is appointed by the National Company Law Tribunal (NCLT) – the adjudicating body appointed by the government – to take over the management of the company. Simultaneously, a ‘Committee of Creditors’ is formed with representation from everyone who is owed money by the company. The insolvency professional and the committee negotiate the terms of insolvency, whether the company should be resold and to who, whether it should be sold for parts or as a whole, and if they don’t reach a conclusion in 270 days, the automatic decision will be the complete liquidation, effective immediately. However, during the negotiation, 75% of the Committee of Creditors must agree to the terms of sale. This means the decision is mainly in the creditors’ hands, your hands. If you don’t like what the insolvency professional suggests, you can directly or indirectly (through your representative on the committee) vote against it.
Plus, if you’re part of the 25% that voted against the deal but didn’t get their way, you can present your argument for why the deal is a bad idea to an Appellate Tribunal of the NCLT for reconsideration. For example, an Appellate Tribunal recently heard a case against Jaiprakash Associates selling 760 acres of land to Jaypee Infratech for an undisclosed amount. The petitioners recently claimed that while most of the creditors had agreed to the sale, hoping to quickly recover their money, the land had been grossly undervalued and therefore the sale was unfair and fraudulent. The Appellate judgment in this matter is still pending.
4. It will be easier to find an investor for your business idea
As the above video mentions, bad debt in India had piled up to a whopping Rs. 10 trillion, all this money was chalked up as ‘non-perming assets’, that is, assets that don’t generate profit. With so much money tied up in companies that were failing, banks and private lenders had become extremely cautious about new projects and ideas, withholding investments in new innovations and businesses. If you went into your bank to secure a business loan, you would more often than not be rejected, because bankers had become extremely risk-averse. But not anymore.
Considering that investors can pull their money out of failing companies in as little as 9 months and redeploy it into a company that has a potential for profit is a gamechanger. 2 big sales, of Bhushan Steel and Electrosteel Steels, have already raised Rs. 44,000 crore. According to the RBI, after the cases of 10 other big companies are concluded, we’ll have collected 25% of our bad debts – that’s nearly Rs. 2.5 trillion. Banks will then redirect all this money to new big, medium and small businesses. They’ll be more open to invest in start-ups and encourage innovation. Of course, this is great for the ease of doing business in India, but it’s also great news for emerging entrepreneurs.
Back in 2016, the IBC as it is now was needed ASAP. The bad loans had piled up so high that they were genuinely denting our economy. But now, a couple of years later, the government is expanding the IBC to fight other financial battles too. One such battle is of homeowners. A common problem in urban India is that people tend to buy homes based on the builders’ plan and their payment is used as capital to complete the construction of the project. However, many times this money is misused by the builders and therefore they don’t have the funds to complete the project. According to the Insolvency and Bankruptcy Board of India, the body overseeing IBC changes, crores of rupees, directly invested by ordinary citizens are stuck in this way. The 2018 Insolvency and Bankruptcy Code (Amendment) is currently being reviewed in Parliament and allowing such homeowners to file bankruptcy cases against builders is one of the additions vis a vis the 2016 version. Once this amendment is passed, it will also be a big relief for many ordinary Indian homeowners.