Companies should not have nine lives | Business Line

Op-Eds by Corporate and Financial · March 18, 2019
Author(s): Shreya Prakash

The basic tenets of the IBC are slowly being compromised, to avoid liquidation even when a company is unviable

Since its enactment in 2016, the Insolvency and Bankruptcy Code has been the crowning achievement of the NDA government’s reform agenda. With the Finance Minister quoting recoveries of close to ₹3-lakh crore due to the IBC, there is little doubt that the IBC has helped dent the bad loan crisis in the country and has had some positive impact on India’s credit culture.

Key to the IBC’s success has been its push towards time-bound management of distress by relying on the commercial wisdom of the creditors and other market players. The IBC relies on the committee of creditors (CoC) to ascertain if a company is viable and if its business should be carried on, within a defined period of time. The CoC must invite resolution plans, and approve of a plan that is most feasible. Where the CoC ascertains that the company is not viable, they need not keep providing the company credit to keep it running, and may send it to liquidation. This process is aimed at freeing up capital to finance new businesses.

Thus, the IBC process clearly represented a break from the old insolvency and winding-up processes under the Sick Industrial Companies Act and the Companies Act where judicial practice was biased towards keeping even commercially unviable companies running. However, recent developments suggest that this practice may be making a comeback.

Dilution process
While passing the first amendment to the Code, the Parliament emphasised that the purpose of the Code is resolution and not liquidation, even though the Code was drafted to be outcome neutral. Thereafter, two Supreme Court judgments have declared that liquidation should only be a last resort, and should be avoided.

The NCLAT (National Company Law Appellate Tribunal) has gone a step further, and has now held that even where a liquidation order is passed, the liquidator must first attempt to revive the company and run it as a going concern before selling the assets of the company. This means that no matter whether the market sees value in the company, a long-drawn process to keep the company running at all costs will be carried on the orders of the NCLTs.

The view that liquidation should be avoided at all costs, and revival must be attempted even after a liquidation order has been passed emanates from the belief that keeping a company running will always be the best outcome. In the short-term, one can appreciate that keeping a company running may appear to be the best outcome since it saves the jobs of workers, and avoids the impression that banks have unfairly captured the wealth of the company.

However, India’s experience with the SICA and the Companies Act should make us re-examine this claim. The practice of exploring revival of the company even after the liquidation order was passed was common under these regimes. However, where a company is not economically viable anymore, the value of the assets of the company will erode while the liquidator keeps attempting to save it as a going concern. Keeping it running in such a state will only have long-term ill effects.

The capital of banks will remain tied up in subsidising the failure of value-less companies, and impede their ability to finance viable projects that can provide a higher number of economically useful jobs. It was to avoid these very consequences that the IBC explicitly repealed sections of the Companies Act that enabled the exploration of revival once a liquidation order had been passed (the now repealed section 289 of the Companies Act, 2013) and inserted prohibitions on the exploration of another round of resolution once liquidation is ordered (section 11(d), IBC).

The IBC, thus, should not become a mechanism to save value-less jobs for extended periods of time by avoiding liquidation even when a company is unviable. Workers’ woes must be dealt with robust social security schemes, and not by artificially extending the lives of companies that are better off liquidated.

Indeed, if the IBC mechanism is tinkered with to avoid liquidation, without making a distinction between viable and unviable projects, we might soon find ourselves in the pre-IBC days of exploring revival at all costs. This is likely to undermine the credit discipline and successes made since the enactment of the Code.

The writer is Coordinator at Vidhi Centre for Legal Policy, New Delhi.

Originally Published –

About Shreya Prakash:

Shreya is the Coordinator of the Vidhi Bankruptcy Research Programme & a Research Fellow with the Corporate Law and Financial Regulation vertical. Her research is focussed on insolvency law, corporate governance and financial regulation. At Vidhi, she has worked extensively with the Insolvency and Bankruptcy Board of India and the Ministry of Corporate Affairs, advising them on the implementation of the Insolvency and Bankruptcy Code, 2016 and the design of second-generation reforms, such as group insolvency, in the field. She is a member of the Joint Steering Committee of the Insolvency Research Foundation and the Taskforce on Insolvency Best Practices set up by the Society of Insolvency Practitioners of India. She has also worked on law and policy issues pertaining to companies law, debt markets, public finance, commercial remedies and regulatory architecture. Shreya is an alumna of the University of Oxford where she read for the BCL as the Zaiwalla scholar at the Oxford India Centre for Sustainable Development, and the National Law School of India University, Bangalore from where she graduated as a gold-medallist. She has previously written for publications such as Financial Express, Hindu BusinessLine & IndiaCorpLaw and served as an editor of the National Law School of India Review. Link to full bio