Presumably, the new finance minister is made of sterner stuff. In his first Budget speech in July 1996, Mr Chidambaram promised a radical re-haul of the Sick Industrial Companies (Special Provisions) Act, 1985 (Sica), and the procedures that are followed by the quasi-judicial restructuring body called the Board for Industrial and Financial Reconstruction (BIFR). I understand that a new draft has been prepared, is being examined, and will be placed before Parliament either in the budget or in the monsoon session that is, if an ancient crone called Sitaram Kesri eventually understands that governing the country is far more important than his desperate prime ministerial ambitions. This article outlines some key aspects of bankruptcy reform.
First, a desirable bankruptcy procedure must avoid what statisticians call type I and type II errors. In other words, it must not attempt to restructure or rehabilitate companies that are beyond redemption, or liquidate those that are intrinsically viable. In the last seven years, BIFR has been prone to making the first type of error.
Second, one cannot have an extreme definition of corporate distress and then expect a turnaround. Sica defines sickness when accumulated losses wipe out net worth. This is akin to saying that a patient must have two cardiac infractions, three severe arterial blockages and acute emphysema before the doctor can consider him to be a case worthy of treatment. It has been shown that such an extreme definition of financial distress drastically reduces probability of a viable turnaround and, hence, the chances of creditors getting their dues. Since the debtor companies know this very well, they often use BIFR to extract large concessions at the expense of secured creditors which not only debases the disciplining role of debt but also does precious little to catalyse a turnaround.
Third, we need to, therefore, eliminate the notion of net worth erosion and make the trigger debt default for 365 days. All over the world, bankruptcy is defined in terms of debt default. There is absolutely no reason for India to claim exceptional status the more so when banks and FIs have to treat their loans as sick when there is a debt default of 180 days. Moreover, 50 per cent net worth erosion is neither here not there. Why 50 per cent? Why not 67 per cent? Or 33 per cent? And what is the logic? There is none.
Fourth, if the trigger is debt default, then the reference to BIFR must be voluntary and not mandatory. This is due to two reasons. (i) an earlier definition coupled with mandatory reference will swamp BIFR and, more importantly, (ii) we need to encourage faster debt renegotiation outside the formal structure of courts. This does not preclude either the company or the creditor(s) to refer the matter to BIFR.
Fifth, there must be no more of the debtor-in-procession procedure. Where the promoter continues to manage the firm while the matter is being decided by BIFR. Debtor-in-procession loads the die in favour of the defaulting company, allows existing management to use its informational advantages to keep creditors at bay, and generally compels creditors to settle for far less than what they might have got otherwise. Indeed, this is the greatest failure of Chapter II procedure in the US and has been extensively commented upon by US economists, lawyers and financial experts.
Sixth, it is absurd to have the secured creditor who has the greatest exposure in a defaulting company to be the objective operating agency working on behalf of BIFR. There are severe conflicts of interest and moral hazard issues. Banks and FIs ought to be more interested in recovering their dues than advising BIFR. If BIFR seeks such advice, it would be better off hiring the services of expert professionals on a case-to-case basis.
Seventh, if voluntary debt negotiations fail either outside of, or within a 30-day limit imposed by BIFR then the Board should immediately invoke a strictly time-bound sale procedure. This translates to: (i) advertising the sale of the company as a going concern, (ii) a 90-day period for prospective bidders to conduct due diligence and submit bids, (iii) two-part bids, where the first part would contain the details of the restructuring plan and the second, the amount that the bidder will pay. Secured creditors would initially vote on the first part according to their financial stake. Only those first-part bids that pass muster will have their second part opened. And, it stands to reason that, subject to secured creditors assent on the first part, the highest price bid in the second part is the best bid. The company would be transferred to the best bidder (who could also be the existing promoter) and would exit from bankruptcy. If no bid passes in the first stage, or if the best bid in the second stage is lower than the reservation price (or the liquidation value of the company), then the company would be recommended for winding up.
This simple process has several advantages. It is strictly time-bound, which is the key to a viable bankruptcy procedure. Today, the average time taken by BIFR to dispose a case is a little under two years. The suggested process would ensure that matters get settled in 180 days (see flow chart). Moreover, it is transparently market-driven and not subject to myriad interpretations by quasi-judicial personae. Besides, it would give a clear signal that BIFR can no longer be treated as yet another refuge of strategic debt defaulters as it has been in the past. Quite simply, if you cannot satisfy your secured creditors, then you must pay the price of being put up or sale. Yet, it is fair, because existing management can bid. Finally, it would re-orient members of BIFR to becoming market- driven facilitators instead of judges.
Who would dislike this procedure? Lawyers and accountants who do BIFR cases, for obvious reasons. Some BIFR members will also dislike it intensely especially those who nurtured a hidden desire to sit in judgement. Many companies will hate it, for it will put an end to their delaying tactics. And trade union representatives will scream murder, little realising that early detection and quick decision-making saves more jobs in the long run than late detection and interminable delays.
Three questions remain. Will the bill contain these provisions? Will it be moved in Parliament in the near future? And, will it be passed in the suggested form? The first depends upon the sagacity of our civil servants; the second on the actions of Mr Kesri; and the third upon the vision of the legislators. So, who knows?
