India’s Bankruptcy Policy Will Cleanse Industry – OpEd

The recent Government of India’s move, such as continuing bankruptcy filings with the National Company Law Tribunal (NCLT) for some of the largest Non performing Asset (NPAs) in the country, the move to delist the shell companies, recapitalisation announcements for banks to resolve the distressed asset situation, have received mixed reaction.

What root cause for distress in companies?

A careful study of the performance of the distressed companies reveal the fact that the root cause of distress in most enterprises is a combination of shortcomings in their underlying business models and inadequacies in technical and management capability and the operating practices .

In the case of most of the distressed companies, it is evident that the contributory causes are lack of awareness with regard to the developing and impending adverse scenario, the poor forward planning strategies, misplaced priorities and sometimes search for solutions to the problems elsewhere instead of internally and of course, unethical diversion of funds.

Succession in top management positions by blood relations such as sons and daughters, in laws and nephew/niece of owners without dispassionately assessing their experience, capabilities and domain knowledge to the needed level, have also pushed down several units rapidly towards slide.

Of course, the global commodity cycle bust, overcapacities and infrastructural issues could have played a big role causing price fall and the losses, leading to defaults in debt repayment. However, in many cases, such issues could have been reasonably tackled by alert, skilful and timely measures.

All said and done, the inability of the top management to meet the challenges is the basic and central reason that have resulted in distress in most of the companies. This is more than evident from the fact that in number of cases, amongst the companies operating in the same field almost in identical conditions, one or two units collapse whereas others forge ahead successfully.

Arguments against bankruptcy policy

The critics of bankruptcy policy argue that the .knee jerk approach to resolve the distressed assets issue by declaring the companies to be bankrupt may sometimes lead to inadvertent liquidation and closure of the units rather than reorganisation and improvement in conditions.

In number of cases, the physical assets of firms in distress conditions may provide potential opportunities to invest in new areas or effect significant improvement in ongoing operations, if utilised in the right and appropriate way. With appropriate interim turnaround strategies and management and capital deployment, number of units can be restructured and eventually put on the recovery path. While there are such prospects, the panicky reaction of the banks and financing institutions leading to liquidation would be counter productive.

In the absence of adequate and updated information and understanding about the distressed firm’s strength and weakness and opportunities ahead for the units, new owners who take over the distressed firms, may not be able to chalk out any meaningful corrective steps and implement appropriate remedial plans in reasonable time frame.

Any auction or bid-based approach may lead to heavy loss of funds for banks and financing institutions, as the winning bid may not likely be anywhere close to intrinsic value of the asset. The lack of enthusiasm or dynamism in the private sector for investments may limit the number of potential buyers, which will increase the discount on the asset, if attempts are made by the financial institutions for a quick sale.

In the anxiety to throw out defaulting promoters, the liquidating of potentially recoverable companies should not result in loss of jobs and upsetting the industry growth. Liquidations should be avoided to the extent possible.

Arguments in favour of bankruptcy policy

In the past, the distressed companies that have defaulted in repayment of loan have been treated with kid glove by banks and financial institutions.

In most cases, the financial institutions have taken “soft and compassionate view” towards the defaulting companies and provided more fund support and repeated rescheduling of the repayment, so that the distressed units can recover and become financially strong to service the debt. In a very few cases like Haldia Petrochemicals, West Bengal, where the recent fall in crude oil price in global market helped the unit to find its way, the additional fund support was found helpful.

However, in the case of several other companies, such kid glove strategies have not worked, but have only resulted with more mounting debt. In the case of such companies, the financial institutions chose the easy option of giving more fund support but did not attempt to take a deeper and closer look to assess the capability and integrity of the directors, and thus let them go scot free. The new bankruptcy law seeks to change this situation sharply for the better.

The ground realities are that the directors of the distressed units have failed and it would be a calculated risk to put continued faith on them to bring the units out of distress situation. Even in the case of the revived Haldia Petrochemicals, it has to be noted that the management of the unit changed while it was getting additional fund support from banks, which considerably helped in reviving the company.

It is necessary to assess and distinguish the cause for the distress situation faced by the units between genuine reasons and other reasons such as lack of managerial competence, unethical diversion of funds, splitting of the companies to uneconomic and unviable size to accommodate sons and daughters, as if it is a property division etc. Careful assessment of reasons for distress conditions may reveal startling facts.

Argument bankruptcy law will drive units to liquidation is negative and pessimistic view

The other argument, that by inviting bids to take over such units, it will result in loss of funds for the financial institutions, can not be accepted, since otherwise the financial institution may end up losing the entire funds extended by way of loan to the companies.

The other argument, that the present Indian investment climate is poor and therefore, there would only be a few investors who would be willing to take over such distress companies is also unacceptable view, since the investors these days come not only from India but also from abroad.

Bankruptcy law is the appropriate way

In any case, having given the loan to the distressed units earlier and with little hope of getting back loan with or without interest from such units at any time, the financial institutions need a way out.

Bankruptcy law is the best way that can give positive and quick result to find new owners to manage the units and direct them on the growth path.

It is seen that , several Indian companies have become sick but directors and project promoters of these units never became sick and they virtually remained unaffected by the dismal performance of the units,which have defaulted in the repayment of loan and interest amounting to several crores of rupees. Such promoters are primarily responsible for such conditions but, their affluent life style remain undisturbed.

This scenario will significantly change with the implementation of bankruptcy law, which is necessary.