A new bankruptcy code tabled back in 2016 is all set to reshape the Indian business and startup ecosystem. Aimed particularly at making it easier for young entrepreneurs to kickstart their ventures, and for resolving a range of issues pertaining to the speedy winding up of insolvent companies, with redeployment of capital in a productive manner, and for lowering NPAs (non-performing assets); The Bankruptcy code is an exigent legislation for the Indian Industry and particularly for the SME segment, which has experienced an insignificant impact from the market reforms of 1991.
The major objective of the new law is multi-pronged, from assisting the startup business environment to preventing any future wrongdoings as well as for recovering outstanding loans.
The crux of the problems are two-fold. One is improving the relative 'Ease of doing Business' in the country, with special significance to entrepreneurial spirit and SMEs. According to the World Bank's Ease of Doing Business 2016 Report (World Bank, 2013), Indian ecosystem ranked 130 out of the 189 economies with respect to the regulatory climate for startups and entrepreneurship. Furthermore, it involves a total of fourteen procedures spanning about a month and costing 17% of the country's per capita income, as a prerequisite for simply starting a business. Compare that with figures for OECD high income countries, the averages are 4.7 procedures, 8.3 days and 3.2% per capita income respectively.
A number of other factors such as entrepreneur's limited access to finance and capital by has hindered the growth of SMEs. The formal financial market has remained largely out of the reach of startups and SMEs. Almost half of India's all SMEs borrow from informal sources, partly because of the lack of collateral and working-capital lines, according to Mckinsey Report (Kshetri, 2016). The Bankruptcy code is expected to address the barriers faced by low wealth households before starting an entrepreneurial venture, from the access to early seed funds and stock markets, to limited credit availability during substantial capital requirements at the initiation.
Second problem is rather more profound, and its manifestations can be evidenced by the seeking of refuge by corrupt tycoons in places like Antigua, Cyprus and London. The dual role donned by tycoons as 'Promoters' as well as founding shareholders of Indian companies has allowed them to thoroughly exploit the local corporate law loophole. This has thwarted banks' every attempt at seizing their companies upon loan defaults. On top of this, an imperfect court system has made the foreclosure all but impossible, thereby enabling the owners of even the sickliest of companies to spend lavishly without any fear of repercussions. All that is about to change with the Bankruptcy Code.
Specifically targeting the tycoons who had once robbed off bankers for decades despite repeated defaults, the Bankruptcy code is disposed towards inaugurating a fresh era in Indian capitalism.
In a bid to anticipate its actual impact, it will be interesting to measure the changes over time and whether or not the Bankruptcy Code lives up to its billing. According to David A. Skeel, professor of corporate law at the University of Pennsylvania, Law School and author of Debt's Dominion: A History of Bankruptcy Law in America - "The legal and institutional machinery in India meant for dealing with debt default has not been in line with global standards. An effective bankruptcy system can indeed make a significant difference, however its important not overstate its effects on GDP growth.
Providing here a timely retrospective of the new law as envisioned by the Indian finance ministry - The Bankruptcy Law is primarily for encouraging entrepreneurship and innovation. As a significant proportion of business ventures are destined to fail, swift handling and resolution would assist entrepreneurs and lenders instead of keeping them bogged down with decisions taken in the past. Several studies have found that a robust fresh start for consumers --- many of whom have small businesses --- is directly correlated with entrepreneurship.
The essential idea of the new law is that when a firm defaults on its debt, control shifts to a committee of creditors and away from the shareholders and promoters. The committee has no less than six months for evaluating proposals for either taking the company into liquidation and for resuscitating the enterprise. The Bankruptcy Code will go a long way at introducing an appetite for risk, as the country has only recently clambered on the startup bus.
The Corporate bankruptcy laws these days are discussed far and wide in the Indian business ecosystem. Note that according to the World Bank, it takes 7 years to close a business in India compared to the OECD average of 1.7 years. Among the measures outlined in the program is a 90-day window for startups to close businesses. This reduction is a welcome improvement concerning this important determinant of entrepreneurship.
The Bankruptcy code offers a fresh start, a helping hand in the case of honest but unfortunate individuals who cannot repay their creditors. Among other things, this safety net ensures that people are willing to take entrepreneurial risks in the first place. When they fail, they will be able to get back on their feet again. Without bankruptcy law, fewer would start enterprises. In this sense, corporate bankruptcy laws are a welcome move for entrepreneurs alike, the ones who've failed and also by the ones who've succeeded but would never have taken the risk without it. Further, without bankruptcy law, fewer enterprises would start, and the ecosystem could do with as many as possible, considering the rampant youth unemployment and poverty.
The list of embattled Indian tycoons who have cocked a snook at their bankers is growing with each passing decade. Subsequently, the anticipatory impact form Revamped Corporate Bankruptcy Regulations has been summed up adequately in a statement by Raamdeo Agrawal, Asset Manager at Motilal Oswal - "If you failed in business before, nobody thought there was a price to pay. Now, people aren't so sure."
The Indian Bankruptcy code is a welcome move, especially for the so-called failed entrepreneurs. According to Dr. Zoltan J Acks, Former Special Adviser (SME) to the President of USA, " In context to the American scenario, Failed Entrepreneurs are our biggest asset. The government itself takes measures to rectify aspect within their failure, and revamps them to success. However in India, "Failed Entrepreneurs" are looked down upon as "Social Evils," something unwanted in the society!
Operating within the earlier 'colonial era' regulations, the promoters could stay on as managers in the stricken firms and drain them of cash. Some of the unscrupulous moghuls at the helm leveraged their influence in negotiations with bankers, who often had little choice but to agree to debt reduction.
With the subsequent implementation of the new regulations, a dozen large firms that were in effect pushed into bankruptcy have attracted winning bids from groups like Tata Group and Vedanta. As of now, the new code has resulted in lively auctions for companies, whose liberation from their promoters' grasp was once believed to be impossible. Deep pools of capital have shown credible interest at purchasing the distressed assets, including the likes of private-equity firms, Canadian pension funds and the World Bank's commercial arm.