Tag Archives: Insolvency and Bankruptcy Code

Carte blanche to notify law requires reform

The provocative abuse of the power to choose when to put into effect a law passed by Parliament has reached a point where judicial intervention is warranted

By Somasekhar Sundaresan

It is a year since the Reserve Bank of India (RBI) picked specific cases of borrowers for action to be taken by banks to invoke the provisions of the Insolvency and Bankruptcy Code, 2016 (IBC). Much ink will be spilled about the year gone by. This column will not add to it.

However, the workings of the IBC and its impact on other laws, presents a good opportunity to note an important aspect of law making in India — the practice of government arming itself with legislation made by Parliament, with full liberty given to the government to decide when any provision of the law may actually be brought into effect. The legacy of legislation preceding the IBC underlines the extreme limits to which this can be stretched.

Originally, insolvency proceedings for “sick industrial companies” was governed by the Sick Industrial Companies (Special Provisions) Act, 1985 (SICA). In January 2003, the Companies Act, 1956 was amended to insert a Part VI-A titled “Revival and Rehabilitation of Sick Industrial Companies”. The government got Parliament to arm it with the power to notify such provision on such date as the government willed. Apart from provisions relating to setting up of tribunals, none of the provisions introduced into the 1956 company law to bring in an insolvency regime was notified into effect by the government.

In January 2004, a law to repeal the SICA was passed by Parliament, but this too empowered the government to notify the law as it chose and when it chose. Nothing happened for a decade. In 2013, new company law was introduced in the form of the Companies Act, 2013, again empowering the government to notify into effect various provisions on various dates as the government deemed fit. This law too contained provisions akin to Part VI-A of the 1956 Companies Act. Therefore, at this stage, two legislation governing company law, governing the same subject of insolvency was in existence but neither legislation was brought into effect. Finally, in May 2016, the IBC was passed by Parliament, again empowering the government to notify such provisions as it chose at such times as it chose.

The IBC contained provisions that would amend the law that had been passed to repeal the SICA — in other words, a law that had not been brought into effect was amended in its still-born state. The IBC also had provisions to delete the provisions introduced in the 2013 company law, but left out the provisions of the 1956 company law that is still on the statute book but not notified. Eventually, on November 1, 2016, through notifications, the provisions in the IBC that would amend the un-notified SICA repeal law were notified. On November 15, 2016, the government notified the provisions in the IBC that would delete the corresponding provisions in the 2013 company law (the 1956 law remained without notification). On November 25, 2016, the law repealing the SICA was notified to give it effect from December 1, 2016 — over 12 years after it was passed by Parliament. On November 30, 2016, the provisions of the IBC were notified with effect from December 1, 2016, to take over from the SICA.

Now, this tortuous journey of the law has other implications. A number of other legislation contained references to the SICA and its provisions — purely for example, exemptions from open offers in the Takeover Regulations and exemptions from delisting procedures under the Delisting Regulations. Not everyone is aware that the General Clauses Act provides that when a legislation is repealed and replaced, all references to the repealed legislation would automatically stand replaced in the eyes of the law by the newly introduced legislation. Therefore, the other regulatory authorities who are the authors of these legislation conduct a lot of activity proposing to amend their regulations to bring them in line with references to the new law; conducting debates over whether they should change the law; and handle voluminous unproductive work of dealing with procedures for making these changes.

The 2013 Companies Act in itself presented a piquant situation with the power given to the government to notify into effect such provisions as the government chose whenever it chose. When empowering itself with such a power, the government forgot to get Parliament to also empower the government with the power to notify the partial repeal of corresponding provisions of the 1956 Companies Act. Till date, enormous time, energy and monetary expense have been expended on litigation about how, in the absence of an explicit repeal of the old law, two provisions can or cannot co-exist and whether a provision can be said to have been “repealed by implication”.

Empowering the government to take its time to notify a law passed by Parliament is a practical feature, but equally, it is time those running Parliament gave thought to how they are abdicating their responsibility without seeking account of why a law has not been notified into effect despite being passed. The social conditions for which a law is introduced remain unaddressed when the notification is not effected — rendering the administration of the law completely arbitrary. Serious consequences have followed in welfare legislation due to this approach — cases in point being the law on domestic violence and the law prohibiting testing the gender of an unborn foetus.

The provocative abuse of the power to choose when to bring into effect a law passed by Parliament has reached a point where judicial intervention by a Constitutional Bench is warranted. In the past, the abuse of the promulgation of Ordinances by a state government had led to a limit of two times being imposed by the Supreme Court. The abuse of sticking the “money bill” label is another example of the courts being seized of such an issue. It is time to take a close hard look at how governments get Parliament to give them a “carte blanche” on use of this power.

This column was published under the title Without Contempt in all editions of Business Standard dated June 7, 2018

The IBC requires more attention

Questions persist on the legal standard that insolvency professionals – particularly those who replace the authority of the boards of directors of insolvent companies – must follow
By Somasekhar Sundaresan

It is insolvency and bankruptcy season. Be it the first several pages of business newspapers or the cause lists of company law tribunals, the appellate tribunal and the Supreme Court benches hearing these matters, the Insolvency and Bankruptcy Code, 2016, is hogging the limelight.

Interpretation of the new law that is almost two years old is maturing with a slew of orders from the Supreme Court clarifying various nuances and steadily reducing the uncertainty over the multiple questions that adversarial litigation would obviously throw up. The season of attempts at resolution plans will eventually come to a close in a few months, and then the inevitable journey to liquidation will follow for those who have not been resolved.

It is time to take stock and review how the law has performed and what needs to be done to clean things up. The Insolvency and Bankruptcy Board of India (IBBI) has its task cut out in creating a professional class of insolvency professionals. Questions loom large on the legal standard that these professionals must follow, particularly those who replace the very authority of the boards of directors of insolvent companies. For example, the insolvency professional gets vested with the authority to run an insolvent company to the exclusion of the board of directors.However, when he runs the business (incidentally, no litigation against the company would lie since an insolvent would be protected by a moratorium that could last nine months), there is no clarity on the legal liabilities and obligations that need to be discharged. These need to be addressed — examples abound.

First, let’s say an insolvency professional is running a company that handles hazardous substance (like a Union Carbide), and a massive environmental tragedy takes place like it did in Bhopal in the 1980s. Would the defunct Board of Directors be liable or would the insolvency professional be liable? Would the provision of insurance coverage to such a company be covered by the mandatory continuance of essential utilities in the teeth of the moratorium that would prevent litigation to recover dues from the insolvent? These questions have no answers yet, and one seems to be waiting for judge-made laws to fill in the gaps.

Second, take the insolvency professional’s own approach to running an insolvent company pending exploration of a resolution process. What is her fiduciary duty to shareholders, creditors and stakeholders? Are decisions that are evidently negligent or reckless, or even worse, partisan, to be excused? Would a moratorium against the company afford protection to the resolution professional even if evidence of malpractice can be brought to bear? The degree of subjectivity in evaluation of resolution applicants continues to remain high. Some simple and evident resolutions of conflicts among resolution applicants such as conduct of a time-bound online auction that can be completed within hours, are not resorted to. The liability of resolution professionals in taking decisions remains an unaddressed area for the outcome. It is no solace to say that the IBBI can act against her punitively — it would be like saying a stock broker can cheat investors and the only recourse is for the capital market regulator to punish him.

Third, all laws are always drafted with a presumption of bonafides. There is an even bigger presumption of lenders’ actions being bonafide. Now, if that trust is belied, is there a fiduciary duty owed by the lenders to stakeholders, for their conduct to be judged? Committees of Creditors, the forum comprising the financial creditors can easily seek and obtain a rent for the position of power and decision-making they occupy. For example, in a technical insolvency (say a case of illiquidity rather than of insolvency), where literally no financial creditor takes a hair-cut on his entitlement to recover, would the resolution not take the form of an equity M&A transaction? Worldwide, bankers have not covered themselves in glory in the past 10 years, and the presumption of bonafides on their part, while vital, also requires checks and balances.

Fourth, the stigmatising of insolvency is the biggest threat to the long-term future of this law. It is one who is experienced with business failure that can work out solutions to deal with failure. By outlawing participation by anyone associated with any failure anywhere in the world, the new law has been struck a serious blow. The government’s intervention through a sweeping hasty and ill-conceived Presidential Ordinance late last year, passed into formal law without much debate early this year, stigmatising anyone with a history of business insolvency, is now the centre for a bulk of the litigation action. This column has written about it in the past and will therefore not repeat the arguments here. In an election year, getting this reversed may be a pipe dream, for politically, the tone in society has become too high-pitched for any politician to risk being seen as helping loan defaulters.

Finally, the infrastructure for the tribunals that handle these matters remains under strain. Members of the tribunals are working odd hours and are having to focus on the disposal of cases rather than on laying down quality jurisprudence. The only silver lining is that since the track of litigation is through the tribunal system and not the regular courts, the cases reach the Supreme Court much earlier than usual. Be that as it may, the system is creaking at the seams, and something has got to give that could threaten the very capacity of the state to deliver on the rule of law.

The central investigating agencies are licking their chops to get a slice of the action. The pressure to treat insolvency professionals as “public servants” is gradually mounting. If a purely private sector bank that is majority-owned by foreign shareholders can be made amenable to the jurisdiction of central investigating agencies, this front may present an easy battle for them to win. It is indeed time to contemplate on the next five years for this law, although it is only recently that a committee to amend the law has given its recommendations.

This was published in the Without Contempt column in the Business Standard edition dated April 26, 2018 

Crisis that will hurt bank resolution law

Without serious confidence building measures being taken, and articulated well to the common man, the environment appears ominous
By Somasekhar Sundaresan

It is a crisis of confidence — and that too in a sector that inspires the highest expectation of an intensity of promise by a regulated institution. What was in recent weeks a crisis involving the state of health of state-owned banks, is now threatening to spiral into an expanded crisis involving the state of affairs in private sector banks. With this environment, politically, one can kiss goodbye to the proposed law on resolution of failing banks.

The biggest part of the solution to a problem is to acknowledge there is one. Consider the symptoms:

  • The break-down of systems at Punjab National Bank that led to the discovery of the alleged Rs 110-billion scam involving issuance of guarantee-like instruments raised serious concerns about how vulnerable any bank could be;
  • The public spat between the Reserve Bank of India and the central government with each pointing fingers at the other about duality of control and the regulator not having teeth over appointments of key personnel in banks;
  • The absence of clarity of purpose for the Bank Boards Bureau and the publicly-evident communication breakdown between the bureau and the government, with speculation about whether the bureau would continue having any role at all;
  • The chief executives of ICICI Bank and Axis Bank, both in the private sector staying on the front-page news headlines for days on end – the first about an alleged conflict of interest and insinuated corruption and the other about alleged non-performance and absence of sanction for it; and
  • The growing allegations of abuse of powers by creditors in the resolution process under the newly-minted Insolvency and Bankruptcy Code – allegations range from approving related party contracts by resolution professionals, a lack of transparency in evaluation of resolution applicants, and monetising decision-making powers in selection of winners.

One of the fundamental assumptions across all laws is that banks conduct themselves with utmost honesty and good faith. This is why records kept by banks are given an on-the-face-of-it validity as “prima facie” evidence of facts. Bankers are second only to lawyers as keepers of clients’ confidence (with a lawyer, the relationship is privileged by law to allow for a sacred space of interaction to enable clients to avail of the protections under the law — that concept is itself being tested severely but should be the subject of a different edition of this column.

With banks’ ownership and governance being closely regulated, the intensity of promise held out by banks is of the highest order. A bank once formed, is next to impossible to wipe out. Legislation governing public sector banks prohibit proceedings by their promisees to wind them up. The government keeps infusing taxpayers’ funds into these banks to keep them afloat. The United Bank of India lived through years of uncertainty about its real core strength. A series of exemption orders are being passed by the Sebi, the capital market regulator, exempting the government from having to make an open offer to shareholders, when it infuses more funds into banks’ capital to shore them up — a luxury that is never accorded to other listed companies.

Private sector banks are like normal companies but are never wound up. Global Trust Bank was force-merged into Oriental Bank of Commerce. Centurion Bank was revived by RBI-supervised induction of private equity. Bank of Punjab and Lord Krishna Bank were merged into Centurion Bank in succession over the years, and this merged entity of stressed banks eventually merged into HDFC Bank. Times Bank, another struggling bank merged into HDFC Bank. To begin with, public sector banks came into existence only because private sector banks were nationalised, many of them amid concerns about them being run to ground.

In short, banks are special. Literally and for all practical purposes, a bank once formed, is indelible and cannot be obliterated. The man on the street trusts his savings with the banks on the foundation of this promise. A bank that becomes “systemically important” (substantially, determined by scale and size of its operations) would get covered by the proposed resolution law. Under this law, to “resolve” and save such an institution, the obligations of the banks can be altered and varied by law. The layman thinks that banks that are not covered by this law would protect his deposits, but once such a law is in, those not covered by such law may (at least theoretically) would not be considered to be “too big to fail”.

The proposed Financial Resolution and Deposit Insurance Bill is with a Parliamentary Committee for now. The environment in the banking sector is hardly conducive for this important and material reform to see the light of day. If banks are not seen living up to the honesty presumed of them (in India, bankers still carry a reputation despite the history of the United States and United Kingdom in the last decade) even the common man is bound to question how is savings are squandered on cronies of bankers and how he would lose out even more when a weak bank is resolved, or how money from the taxes paid by him would go back into the very same banks to keep them afloat. Without serious confidence building measures being taken, and articulated well to the common man, the environment appears ominous.

This column was published as Without Contempt in Business Standard editions dated April 12, 2018

Three Extremes from 2017

2017 was marked by 3 extreme developments in law – surprising result in the 2G telecom case, changes in Insolvency and Bankruptcy Code and the push given to ‘Money Bill’ provisions of the Constitution


By Somasekhar Sundaresan


It is that time of the year — as 2017 draws to a close, it is tempting to look at developments in the area of law that impacted business enterprises during the year. It was a year marked by three extreme developments.


First, the biggest development that came at the fag end of the year – the all-surprising outcome in the 2G Telecom Scam (or should we now go back to saying “alleged scam case”). A classic example of a judicial overreach in cancellation of 2G spectrum licenses by a two-member bench of the Supreme Court, had led to the apex court correcting the law on allocation of natural resources when ruling upon a Presidential Reference. The Supreme Court had then taken great care not to disrupt the final ruling of the final court of the land in the 2G case, but had pretty much cleaned up the implications of the ruling for all other allocations of resources, doing away with the hard-and-fast rule of mandatory grant of resources to the highest bidder that the two-judge bench had earlier laid down.


Cut to 2017. The trial court judge, who through the trial, had pretty much denied every single interim application by every powerful applicant (whether it was from prominent industrialists seeking permission to travel, or from powerful political scions seeking bail) ruled that no case of criminality had been made out. Many commentators had been deeply invested in the idea that if the Supreme Court had already pronounced a bunch of persons guilty of impropriety, the criminal trial was just a formality to reach a foregone conclusion that the dramatis personae were guilty. They are still reeling in shock.  For now, the best way to summarize the situation is that all improprieties need not be criminal in nature although all crimes necessarily constitute impropriety.


The last word in the 2G case is not out. Appeals will follow. The zeal with which the earlier government had been attacked politically seems to be dead now. The zeal with which another bench of the apex court would eventually consider the last appeal that may eventually get filed many years down the line, will determine the real final outcome.  However, for this year, leaving merits of the specific case aside, this is a landmark development. The ruling cancelling telecom licenses were seen as bringing in uncertainty in the conduct of business. The ruling in the criminal trial underlines that the uncertainty can be uncertain.


Meanwhile, the silver lining is that regulators in the business of direct enforcement (without having to bother with proving themselves to courts of law in the first instance) would do well to learn that merely because they had taken strong positions on an interim basis, they do not have to conclude that violations took place. If the most high-profile case of the land can lead to acquittal, regulators must learn to look at every quasi-judicial trial presided over by them, with an open mind and without the fear of being seen as having sold their souls if they acknowledge that they were initially wrong.


Second, the law on insolvency affected business environment most materially this year. The very functioning of the newly-legislated Insolvency and Bankruptcy Code has taken off, with a bunch of cases reaching the apex court rapidly, and the law getting laid down. That even a newspaper vendor can initiate the insolvency process and bring a defaulter to his knees is good for business contracts. However, some extreme measures, however well-intentioned could kill the very efficacy of this law. One of them is the central bank taking charge of recovery decisions by banks — a position brought about through a Presidential Ordinance. The other is an evermore extraordinary Presidential Ordinance by which a blanket ban on anyone remotely connected to a defaulter gets disqualified from resolving any and every insolvent in the country.


Earlier, this column has analysed the unreasonable sweep of both these developments, here and here and therefore will not repeat itself. Course correction and tempering is expected, particularly with the latter.   For now, all that stout defenders have to say is: “Don’t expect the course not to be ever corrected — for now we need these imperfections.” Quite apart from this being a sorry position to take, if correction remains elusive, the new insolvency law could be stultified. Simply put, no affiliate of any insolvent anywhere in the world can bid to resolve an insolvent, if this position is not corrected.   And one is not being alarmist at all —indeed, this was the intention behind this latest Presidential Ordinance — since business failure and insolvency of every nature has been automatically stigmatised.

Finally, one would be remiss without reminding that the use of the “Money Bill” provisions in the Constitution of India — the only check and balance being the Speaker of the Lok Sabha, was taken to an extreme this year. Multiple tribunals constituted through Acts of Parliament passed by both Houses of Parliament have been abolished through a chapter in the Finance Act, 2017. In fact, the Foreign Exchange Management Act, 1999, which decriminalised violation of exchange controls by both Houses of Parliament, was re-criminalised through another recent Finance Act. That was not noticed loudly enough, and criminalising any conduct hardly evokes outrage in our society. The abolition and mergers of tribunals through this back door, certified by the Speaker to be worthy of a money bill legislation, will eventually be considered by the Supreme Court.

In a nutshell, the money bill envelope has been pushed to the farthest extreme. One could well be mistaken – a newer extreme may be achieved next year. Work on the Finance Bill, 2018 ought to have started in the cold corridors of North Block. Watch this space.
This was published as the Without Contempt column in the Business Standard editions dated December 28, 2017

Shun rhetoric, appreciate IBC problem

The IBC ordinance is another example of attempting to write a law to solve a problem that is not properly defined at the threshold

The debate over the presidential ordinance amending the Insolvency and Bankruptcy Code, 2016, (IBC) to insert disqualifications of potential participants in the resolution process of an insolvent has become bipolar and divisive. Television channels are going breathless airing alternative views on alternate days. Columns (including in this paper) have attributed motives and sought to call out “canards” — a classic “Hinduho-ke-Musalmaan” type of zeal seen only in “holy wars” claiming righteousness.


The very nature of this fight makes it evident that the ordinance is good politics. However, in the process, the sweep of the real problem posed by the ordinance, runs the risk of remaining unaddressed, thereby risking the very effectiveness of the IBC.


The disqualifications introduced should first be noticed. The ordinance lists various categories of persons who would stand disqualified from participating in any resolution plan for any insolvent under the IBC.  Any promoter of such disqualified person, and indeed any “connected person” with such disqualified person also stands disqualified. The term “connected person” includes all “related parties” and “associates” of the disqualified person. In other words, once any person is disqualified, the scope and sweep of the disqualification is wide and expansive.


Now, three categories of disqualifications in the list, clearly are amenable to the charge of not having been thought through, and will truly have mindless and unintended consequences.


First: the disqualification of any borrower that has been classified as a “non-performing asset” and has stayed in that status for over a year. At first blush, this would appear logical — obviously an entity that is unable pay its own debts cannot be involved in resolving the problems for any other insolvent. However, every “connected person” i.e. every “related party” of such entity and every associate too would automatically stand disqualified.


The term “related party” under the IBC is wide — for example, any company with common shareholding of just 2 per cent would be a related party. The term “associate” would be even more problematic — but the minute detail is not necessary to make this point in this column. Therefore, if a business goes bust for any reason whatsoever, every promoter of that business, and every related party and associate can never participate in any resolution plan for any other insolvent under the IBC. It is not even the case that only the participation of such related persons in the resolution of that disqualified person would be barred. Every resolution of every other insolvent under the IBC would also be barred.  This is extreme, an unreasonable restriction, and can substantially wipe out the supply of authors of resolution plans.


Second: the disqualification of any guarantor of any debt owed by any insolvent under the IBC. This is an inexplicable disqualification. A guarantor of a company’s debt is someone who believed in that debtor and agreed to guarantee that debtor’s promise. When a resolution plan is sought to be made, the guarantor would have skin in the game because it is his neck on the line.  While keeping out such a person from the resolution of the debtor is itself questionable, keeping out such a person and every person connected with him from every other resolution plan for every other insolvent under the IBC is not even intelligible.


Third: the disqualification of any person (and indeed, of every connected person, related party and associate of such person) to whom the capital market regulator may have issued directions not to deal in securities or access the securities market. No time frame of the period of prohibition on dealing in securities is set out. The capital market regulator is known to have been trigger-happy in the past, issuing such directions even on an “ex parte” basis (without a hearing). There is no settled science or rationale for the choice of the length of the directions in the law.  Courts disturb or uphold such directions on the basis of the human judgement of nature of the facts in the cases before them. This disqualification would remove from the resolution market for all insolvents, a wide range of persons for no plausible, objective or intelligible rationale.
Worse, the same principles of exclusion from the market, would apply to any affiliate outside India.  This would wipe out from the resolution market almost every single multinational company that has an interest in India.  If any person anywhere in the world has ever become insolvent, or has become a non-performing asset or has been issued any direction not to deal in securities. all affiliates of that person all over the world would be ineligible to participate in a resolution plan in India under the IBC.


One can go on to other disqualifications too — for example: the disqualification upon conviction with an imprisonment term for a period of two years, without regard to what the conviction was for. So, if one family member has had an unfortunate tragic criminal conviction, every relative and every “connected person” would be banned from participating in any resolution plan for any insolvent. However, the three examples above would suffice to show how the public debate is wrongly focussed on “good vs. evil” terms — without nuance, and with deployment of blunt weapons rather than sharp instruments.


The IBC ordinance is another example of attempting to write a law to solve a problem that is not properly defined at the threshold. If the problem sought to be solved was to keep out those responsible for the cause of an insolvency from the resolution of that insolvent, the ordinance as promulgated is not the solution.
The very concept of identifying persons responsible for causing insolvency is very difficult to define in a one-size-fits-all manner.  The ordinance has demonized the occurrence of insolvency instead of recognizing that business failure is a part of life.  Every star investor and global business would have insolvents among their related parties.
This is why the IBC clearly envisages a role for professional resolution professionals and bankruptcy professionals.  It is for these professionals to oversee a resolution plan for insolvent companies. A committee of financial creditors has to approve the resolution plan. It is open to the resolution professional and the financial creditors to weed out misfits from participation. If a resolution professional does not perform well, she is subject to regulatory intervention from the Insolvency and Bankruptcy Board of India, the regulator of these professionals. Instead of studying if this profession performs properly, the ordinance has put the very efficacy of IBC at risk, with an air of misplaced righteousness. It is time to cut out the noise and focus on the gravity of the problem.


A substantial part of this piece was published as the Without Contempt column in the Business Standard editions dated November 29, 2017

Between what’s said and left unsaid

If at the end of reading this piece, you feel it is an “impractical” and “theoretical” approach to “Indian realities”, you may not be alone. Yet, the following has to be said: Our policymakers just demonstrated doublespeak in relation to market integrity. They have flinched in making truth available to financial markets, a vital element for informed market decisions.

A terse one-line press release, appropriately drafted in passive voice, was issued by the (Sebi) on September 29, 2017. It read: “It has been decided to defer implementation of Sebi circular no CIR/CFD/CMD/93/2017 dated August 4, 2017, until further notice.”

The press release is significant for what it did not say rather than for what it did. What the circular being deferred was about, when it was meant to take effect, what weighed with the regulator in introducing it and what weighed with the regulator to indefinitely defer its introduction, what transpired in the time between the two events were all left unsaid.

This column is not another iteration of lawlessness in the process of law-making. Indeed, pre-legislative consultations are to be expected only for measures that the regulators are reluctant to introduce or repeal. On measures that could beget bouquets or brickbats, it is normal not to expect any pre-consultations.

Back to the circular that has been put off. On August 4, 2017, Sebi issued a circular to provide that effective October 1, every listed company would have had to disclose within one day, the occurrence of any default in payment of interest or principal on the due date. A simple measure that would have brought cleanliness and transparency to financial markets, it would also have spurred the solvent but indolent to buck up and ensure they did not inadvertently err in servicing financial obligations.

The measure was vital for integrating the with the rest of the financial market system. That a company is unable to meet its obligations when due could be material information that would inform investors’ decision on what to pay for or what to expect for the securities of that company. The disclosure obligation was introduced on this premise. However, the known inability to pay would make it clear to the market for banking and financial services that a company, which is unable to pay its debts when due, is borrowing from the system. This would enable a clearer profiling of the risk in dealing with such a borrower.

When the circular was issued, a retiring whole-time member of Sebi spoke about its virtues at length in public interviews. Sebi was happy to take credit for being the harbinger of a game-changing measure. The withdrawal, on the other hand, has been made in a whimper.

However, it seems these are not good times for dissemination of bad news.  Perhaps it was felt that a spate of disclosures of defaults would follow, lending credence to the gnawing belief that the economy is in a spiral, headed for a hard landing. Inexplicably, without any articulation of the cause for change of heart, the regulator has given credence to that assumption.

“India is not ready for it” is an argument one usually hears in relation to any inconvenient policy reform measure — for example, making an open offer to acquire all the residual shares during a takeover of a listed company; and getting every listed company to publish a prospectus-type document to bring material information about the state of affairs into the public domain even without a securities offering being involved.

This circular had also imposed a statutory obligation on listed companies to inform credit rating agencies about such defaults. Virtually every credit rating agency of relevance is facing proceedings with Sebi for not having downgraded a certain listed company’s debt-servicing capacity. When this company’s inability to service debt was discovered, the effect was so severe that a certain mutual fund with exposure to that debt had to shut the gate for redemption of units. If the regulator now believes that full and clear transparency to rating agencies is not in public interest, surely it should stop making fall guys out of them.

Sebi is quick and prone to lashing out with premature actions against alleged insider trading. Even bank accounts get impounded for periods longer than the law permits in the garb of securing proceeds of insider trading. The introduction of an obligation to make timely disclosures would have served the regulatory war against insider trading. It would have prevented wrongdoing and obviated punishment — the quicker the dissemination of material information, the lesser the scope for those in possession of it, thereby reducing the ability to trade ahead of the rest of the market, without fear of also violating the law mandating dissemination.

The leadership at Sebi has been actively involved in a policy game changer in the financial system — the introduction of the Insolvency and Bankruptcy Code, a legislation that has so far largely received a resounding endorsement from the higher judiciary. World markets were looking at this circular as a game changer in aiding the effectiveness of this new law. Now, it is not to be.

If media reports are to be believed, the circular was considered to be utopian enough to make many in the banking system chicken out. If we send a signal that bringing out the full truth would be unpalatable not only for listed companies but also for banks that have exposure to such listed companies, it would mean that we are happy to let the truth — not just about borrowing listed companies but also listed banking companies — be shoved under the carpet.

“Being practical” is in itself a dangerous phrase. Many a social problem today ranging from domestic violence to female foeticide has been compounded by living in denial and enforced silence. Perhaps, we just got the financial markets version. If inadvertent payment defaults by solvent companies sending avoidable panic signals to the markets was what the Sebi was worried about, it could have tweaked the timing of the mandatory disclosure to the date on which the cure period for the default expires without the default getting cured.


This column was published as Without Contempt in Business Standard editions dated October 5, 2017


Last resort shouldn’t turn into first choice

By Somasekhar Sundaresan
The of India is reported to have blessed a settlement between a litigating lender and a corporate borrower after the process for insolvency under the newly-legislated had been set in motion.


The parties settled their differences and their settlement terms were approved setting aside the process, using the court’s powers under of the  This is a material development and points to the need to take a close re-look at some of the policy choices made in the new bankruptcy law, which is now about nine months old.


First, the process brings on par with lenders, who may have thousands of crores in loans to a borrower, any operational creditor (say, supplier of furniture) who claims dues of just over a lakh of rupees, in the legal capacity to trigger the “resolution process” under the code.  The grounds on which the National Company Law Tribunal might refuse to set the process in motion are limited — for operational creditors, the primary ground is the existence of disputes before the claim is made. In other words, only uncontested dues on which there is a default would lead to the being attracted. The case in the was not of an operational creditor but of a financial creditor, but that does not matter for the analysis here.


Second, once the resolution process is set in motion, a moratorium kicks in. No debt can be enforced on the company against whom the claim was made. While this might seem normal about “bankruptcy protection” it works well only for companies that are truly bankrupt. For companies that are solvent but have bona fide disputes over claims made by counter parties, this results in a prompt trigger of pariah status. If your promises cannot be enforced against you, no one would transact with you. This is all the more reason for the setting of the process into motion to be done with a great deal of care and caution. Until a recent ruling by the National Company Law Appellate Tribunal, various benches of the National Company Law Tribunal, which administers the new law, had taken a position that unless actual litigation had been initiated, no claim of any operational creditor could be regarded as disputed.


Third, not only would a moratorium kick in, but also an “interim resolution professional” would stand vested with all the powers of the board of directors of the company. The powers of the board of directors would stand suspended forthwith. The moratorium and the change of control are certainly fantastic features to handle the best interests of stakeholders of a truly insolvent company but they are certainly poisonous and not medicinal for a company that is solvent but can be threatened with initiation of the resolution process. Therefore, the very threat of a possible initiation of this process leads to coerced recovery that could in fact hurt a larger segment of lenders, who truly have the long-term financial interests of the company at heart.


This is why HDFC Bank Managing Director Aditya Puri’s statement that resorting to the insolvency courts is not the best solution unless the borrower is a wilful defaulter makes immense sense. In his reported words, this is a law of “last resort” and not the “first thing”. The capacity of any goods or services provider — an operational creditor — to set such a serious process in motion as the first thing, is worrisome. Once the moratorium kicks in, even the financial creditors of a company for which a moratorium has kicked in, would get hit and be unable to recover their dues.


Indeed, the creditors’ committee that is supposed to work during the moratorium could comprise a majority of creditors, who see a future in the company and can drown out the voice of the lone creditor who does not. Therefore, theoretically, if one does call the bluff of an aggressive operational creditor or a disgruntled financial creditor, and stays the course, the initiation of the resolution process can eventually come to mean nothing. However, this is theoretical and not practical. Once the world at large rearranges its view of a company whose promises cannot be enforced and has to deal with a chartered accountant or company secretary acting as a resolution professional without experience in running a business, even a reasonable view of creditworthiness of a doubtful debtor has to change to a perception of a bad debtor.


In this context, the coding in the law that entails no roll-back once the resolution process is set in motion is a hard and blunt weapon of last resort, which can cause more injury than warranted when used as the first resort. When the uses “for doing complete justice” and takes on record the settlement terms between a creditor, who has set the resolution process in motion and the debtor on whom a moratorium has kicked in, it is because really unjust and unintended consequences can emerge from the working of this law.


For the long-term health of the effectiveness of the bankruptcy law, it would have been better to help the new law build its core strengths by generating capacity and getting the resolution professionals and bankruptcy professionals to build bandwidth and gain competence before unleashing the burden of handling the entire society’s corporate debts on them. The burden of private corporate debt recovery could have been held back from imposing itself on the enforcement machinery until the immediate task of serious financial debts working itself through. The Supreme Court, which has powers to intervene and roll back a moratorium in the interests of justice, having used this power, it is time for a serious and quick rethink and pilot short amendments to make this law effective with a review scheduled for after two years.


This column was published in the Business Standard’s editions dated July 27, 2017 under the title Without Contempt