Bankruptcy & the Indian Bank - ICBC Code for all Borrowers

 Prof. Meera Aranha (Chair - PGDM Program in BFS) & Prof. Srinivasa Reddy, T A Pai Management Institute, ManipalThe recent spate of corporate bankruptcy resolutions using the ICBC code has brought respite to several Indian Banks. The CEO of a leading PSB hailed the recent resolution of EssarSteel and added about bankruptcy saying ‘Nowhere in the world do we have this stigma. It’s a natural process that some businesses will survive and some will fail. It’s ultimately the survival of the fittest’. The same CEO in the context of expanding the ICBC code to smaller SMEs opined that this would “clog the system”. In the economic survey 2020, the Chief Economic Advisor (CEA) highlighted the usefulness of ICBC code in reducing the time to recover. We examine the Indian perceptions of bankruptcy and why policy must keep at pace with the business environment.

History is replete with instances where businesses have gone into bankruptcy and risen from the ashes to succeed. Walt Disney emerged from bankruptcy to establish the famous eponymous company. Disney debuted a new character ‘Mickey Mouse’ in 1923 and the rest is history. Closer home, Amitabh Bachchan, created a new venture to reinvent his career but became bankrupt, with a little luck and hardwork he regained the losses and is worth many a million dollars today. Against the backdrop of these instances in this article, we discuss the triumvirate of law enterprise and societal stigma which together colour the discourse on bank ruptcy in India.

Bankruptcy Caused by Entrepreneurial Failure: In a brilliant video series ‘The Ascent of Money’, Niall Ferguson discusses bankruptcy in the American Midwest and shows that bankruptcy as a process helps American consumers and businesses to reconfigure themselves and establish themselves on the path to future business success. There are several examples of successes by entrepreneurs in the US, despite facing the hurdle of bankruptcy.Contrast this with the Indian system where we assume bankruptcy as the first step to the flophouse and associate the bankrupt entrepreneur with moral ills. This underlying difference in treating bankruptcy as the final destination creates enormous risks to the entrepreneurial business models in India. The right approach would be to go with the American model of treating bankruptcy as a business risk and not as moral turpitude on part of the businessman or individual.

Bankruptcy in Indian Law: The Contract Act (1872) lumps the bankrupt person along with minor children and lunatics as individuals incapable of contracting. It places the blame on the contracting party to determine the veracity of the person regarding his insolvent status. Such a contractor beware attitude treats bankruptcy as a terminal case. Under Indian law, the bankrupt person loses his rights such as standing for elections. Regarding lunacy, modern medicine has reclassified it into a taxonomy of illnesses such as depression, PTSD, anxiety disorders etc. What is needed is for bankruptcy to lose its legal stigma so that individuals caught up in business failure could have another chance to succeed.

Bankruptcy in Indian Society: The idea of bankruptcy commonly known
as Yellow notice, IP (insolvent person) is a small creditor's nightmare. Also, the utter shaming of the individual with social ostracism for unpaid debts is common. The protection of the law notwithstanding, bankruptcy is a shattering affair for the individual businessman.In the Indian social context, bankruptcy is the karmic fruit of moral turpitude by the businessman. The common Indian hears of the big scandals of Vijay Mallya or Nirav Modi and his instant reaction is that karma has hit back,that the businessman has paid for his excesses. The social costs of such high profile bankruptcies lead to the immediate result of reduced credit by the banksand by a prolonged series of investigations with the purported aim of ‘clamping down on excesses’. The stigma attached to bankruptcy affects the debtors who are filing for bankruptcy, by weighing down on their moral conscience that they should repay their debts. It also operates through societal disapproval and shaming after filing, when society holds debtors responsible for the wrong decisions that led to the situation. This stigma is burdensome and exacerbates debtors’vulnerability when it could provide a tool for debtors ‘fresh start’ by rescheduling the debts.

Bankruptcy in India becomes a death spiral, with creditors chasing to be the first ones to get their dues instead of investing time to think of a solution to revive the business altogether

‘Happy families are all alike; every unhappy family is unhappy in its own way’. This famous quote of Tolstoy dealt with intra family relationships but can provide insights into the plight of the debtors seeking bankruptcy relief. Each comes with a unique story. Our contention is that bankruptcy must be seen in the entrepreneur's context. In many a case, he is juggling a series of risks while struggling to make an economic profit. The risks may be bets on the economy, regulation,forex positions and customer growth. We may assess bankruptcy as a result of a series of bets going wrong, some well placed and several others not so. In this reading of bankruptcy, it is the inherent business model of the entrepreneur, rather than moral ills, that have to be clamped down. In this process view of bankruptcy, it is wise for the creditors to assessthe individual from the delivered results on the business model rather than an ossified legal view of insolvency.

Prof. Srinivasa Reddy
Alternate View of Bankruptcy: We posit that there are two kinds of insolvent persons, the entrepreneur who has a viable business model but temporarily not able to discharge the debt due to headwinds to the business and the second kind of entrepreneur who is a fraud in the disguise of an insolvent. This person has milked the value of the business by using ingenious approaches such as asset stripping, related party transactions. and only the shell of the business exists at the time of bankruptcy. Our suggestion is that while today’s law treats both the persons as equally insolvent before the law, we suggest that the creditors take a more lenient approach.

It is important that we treat these bankrupt persons differently. The key idea is for all players to understand that bankruptcy is not the end of a business, but a process of discovering the true value of a business undergoing severe stress. The ideal approach would be to look at both ends of the spectrum, namely, to assess if the business model could work if the stress in the economy, bad management, heavy debt is removed and assess the valuation of the business as a going concern whether the fixed and operating assets are productive and have not been fraudulently stripped. Approaching bankruptcy with these twin lenses would be an enlightened view. By not focusing on the aspect of business model stress, an issue that small businesses are apt to face, and looking only at valuations, bankruptcy in India becomes a death spiral, with creditors chasing to be the first ones to get their dues instead of investing time to think of a solution to revive the business altogether.

The startup entrepreneur of today is more likely to be a technocrat with no family backing or fixed assets.He has an idea and a laptop and is motivated. To create the right financial atmosphere for such entrepreneurs to succeed, legislations and banks must look at setting right the ‘strike wrong and pack off’ bankruptcy procedures. We advocate that an enlightened approach that treats bankruptcy as a business risk and allows the entrepreneur adequate breathing room is necessary.