Bankrupt Corporations Don’t Need Protection

We should object to not only the ‘bail-in’ clause of the FRDI Bill, but also to anything that is an unjustified drag on the system.

We all are stakeholders in the Indian business ecosystem, mostly as consumers, and as providers as well, depending on what we do. We are participants in the financial ecosystem as well—as investors and depositors. As customers of the financial system, we are concerned about not only the safety of our investments, but also the health of the participants in the financial system and fairness imparted by the government and various regulators.

In this context, there is a debate raging related to one aspect of the Swachh Bharat Abhiyan going on. This is about taking defaulting promoters to National Company Law Tribunal (NCLT), pulling up banks for putting the dirt under the carpet, and providing recapitalisation to banks after the write-offs. The point of debate is, whether the defaulting promoter should be allowed to bid for the assets, by out-bidding the other interested parties. By doing so, the promoter gets to retain his assets, but the bank takes a big hit, euphemistically called ‘haircut’.

Let us put certain facts on the table. It may sound like ‘I know this’, but this is to ensure that you and I are on the same page. 

• Capitalism is not about the state supporting inefficiency but about ensuring fair competition. 

• Capitalism has a mechanism of ensuring that money flows to efficient hands. 

• Business failure should not be funded by public money. 

Under the US Bankruptcy Code, there is a Chapter 7, which is liquidation bankruptcy, sometimes called “straight bankruptcy”. The debtor comes out without any future obligations on his discharged debts. However, bankruptcy does not wipe out most mortgages or liens. If a debtor wants to keep an item (for example, car or house) that is security for a loan, he must continue these payments. If the debtor wants to, for example, discharge that car loan, then he must surrender the car to the creditor that holds the lien. 

Then there is Chapter 13. It says the debtor must pay all or part of his debts from the future income over a period of 3-5 years. Most of the debt that is not paid as set forth by the plan of reorganization will be discharged or wiped out. In other words, if your plan provides for payment of only 10% of the unsecured debt, then the remaining 90% will be wiped out upon completion of your plan.

Chapter 11 is the chapter used by large businesses to reorganize their debts and continue operating. Corporations cannot use Chapter 13 to reorganize and must cease business operations if a Chapter 7 bankruptcy is filed. Chapter 11 generally provides for reorganization, usually involving a corporation. A Chapter 11 debtor usually proposes a plan of reorganization to keep its business alive and pay creditors over time.

My point is that this kind of state support is not required in India.

A clean-up effort of this magnitude is once in a lifetime. On his first day in office as governor of the Reserve Bank of India in September 2013, Raghuram Rajan said, “Promoters do not have a divine right to stay in charge regardless of how badly they mismanage an enterprise, nor do they have the right to use the banking system to recapitalize their failed ventures.”

The cost of pushing the dirt under the carpet, which was being done so far as a connivance between banks and a handful of promoters, indirectly falls on you and me. Banks deal with public money and any funding of banks by the government comes mostly from taxpayers’ money. Take for example the apprehension on the proposed ‘bail-in’ clause of the Financial Resolution and Deposit Insurance Bill (FRDI Bill), where, according to one interpretation, the depositors’ money can be utilized if the bank goes bankrupt. Clause 52 of the Bill says a bail-in shall not affect deposits to the extent covered by deposit insurance, which implies that deposits beyond the limits of insurance are susceptible. The finance minister has gone on record to assuage sentiments.

However, we can be sure only when the Bill, as and when it turns into an Act, properly modifies the controversial clause. If we take the logic of this apprehension ahead, it should be not only about the immediate safety of our deposits but on a broader level.

Let’s take a hypothetical example. The highest bidder among others (i.e., non-promoters) is at 40% value of the assets of a bankrupt company and the promoter is bidding at 50% valuation. The promoter has reasons to bid relatively higher. An opinion voiced by some people is that the highest bidder should be eligible, in which case the haircut suffered by lending banks is 50%, and not 60%. However, the ‘clean-up’ is not happening in this case. Let’s extend our example: the defaulting promoter, hypothetically, buys his own assets at 50% value and then turns around the business. He approaches the same bank for a loan. Can the loan application be rejected on the ground that the promoter had defaulted earlier? And, if the bank goes bankrupt, can they bail-in deposits beyond the limits of deposit insurance?

To conclude, we should object to not only the ‘bail-in’ clause of the FRDI Bill, but also to anything that is an unjustified drag on the system.


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