The Bankruptcy Code Alone Can’t Resolve Distressed Debt

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. 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.