The Bankruptcy Code Alone Can’t Resolve Distressed Debt

Livemint     15th December 2020     Save    
QEP Pocket Notes

Context: In an economy with depressed expectations, bankrupt companies would be assumed to be unredeemable, even when viable, and consigned to liquidation. Hence, there is a call for softer bankruptcy laws during macroeconomic downturns.

COVID-19 and Bankruptcy law

  • Present status:
    • Operation of bankruptcy law has been suspended and there is a moratorium on repayment of dues.
    • Once the moratorium is over, a 2-year period for the restructuring of debt has been provided.
  • Indian Bankruptcy Code (IBC) in times of economic downturn:
    • Possibility of increased pressure on IBC after the resumption of its operation after current suspension.
    • Given the current economic stress, the IBC stands in imminent danger of being a final resting place for liquidation, rather than a spa for revival.
  • Way forward:
    • Strengthen processes for the resolution of distressed debt operating in a pre-bankruptcy phase, and thereby help companies avoid the label of being bankrupt. This can be done in two ways:
    1. By strengthening the hands of banks: Enabling them to negotiate partial repayment packages on a commercial basis without fear of reprisal by vigilance authorities.
    2. Well developed markets for distressed debt fuelled by private capital: ensuring that distressed debt can be sold to those equipped to derive value, as well as various ways of securitization and transfer of economic interests to facilitate the revival process.
  • Strengthening Asset Reconstruction Companies: created under Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act of 2002.
    • A possible enabler of market activity is allowing ARCs to buy distressed debt in the pre-non-performing-asset (NPA) stage.
    • Enable rescue packages at the SMA stage by allowing ARCs to bid for NPA assets. Such a move will benefit the stressed company, the ARC, and also the market for NPAs.
  • Definitive action by RBI: needed for enablement increased debt sales.

Conclusion: We must catch the problem early by ensuring that SMAs do not become NPAs, and NPAs do not trigger bankruptcy. The focus must shift to upstream markets for distressed debt.

QEP Pocket Notes