India’s Parliament has passed a bankruptcy law that promises to make it easier to wind up a failing business and recover debts in Asia’s third-largest economy.
The country’s banks are currently struggling with bad loans after the crash in commodity prices and a slowdown in infrastructure projects affected corporates’ balance sheets and their capacity to settle the debt.
Nonperforming assets at Indian banks at the end of December were 6% of total loans, and they have almost doubled in the past three years, according to the estimates from rating firm ICRA Ltd.
Once the president signs off on the Insolvency and Bankruptcy Code 2016, which the upper house of Parliament passed on Wednesday, the code will be law.
Here’s a brief explanation how it could make it easier to do business in India.
What Is India’s New Bankruptcy Code?
India currently has multiple laws to deal with insolvency, which leads to significant delays in winding up a company. The Bankruptcy Code will consolidate the existing framework and create a new institutional structure.
The new law will also likely create a new class of insolvency professionals who will help sick companies and banks with a smooth takeover of the insolvent company and manage the liquidation process.
The bill also proposes the setting up of a new entity, the Insolvency and Bankruptcy Board of India, which will regulate insolvency professionals and information companies — those which will store all the credit information of corporates.
The Bankruptcy Code proposes two authorities to deal with insolvency. The National Company Law Tribunal will adjudicate cases for companies and limited liability partnerships, while the Debt Recovery Tribunal will do the same for individual and partnership firms.
How Will a Company Be Liquidated?
An insolvency resolution plan has to be approved by 75% of voting share creditors. Once the plan is approved, it would also require the sanction of the adjudicating authority.
During the insolvency resolution period, the management of the debtor is placed in the hands of a resolution professional. The code proposes to protect the workers in case of insolvency, paying their salaries for up to 24 months will get first priority during the liquidation of assets.
“The code comes as a relief to workers and employees who are left unpaid by defaulting companies,” said Varun Gupta, a partner at KPMG in India. In the event of an insolvent debtor having assets abroad, India’s federal government can enter into an agreement with an overseas country to ensure enforcement of the law.
How Much Time Will the Law Save?
Currently, it takes an average of 4.3 years to resolve insolvency in India and the recovery rate of debt is very low compared with other countries, according to a report from Nomura. India also ranks 136 in the World Bank’s resolving insolvency ranking. This is below China, which ranks 55 and where it takes 1.7 years to resolve insolvency.
The new law introduces a time limit on the bankruptcy process. In the case of a default, the time-limit is 180 days, within which the resolution has to be completed. This can be extended by another 90 days by the adjudicator, depending on the process.
Analysts say the new time frame will help India improve its World Bank insolvency ranking.
How Useful is the New Law?
The new bankruptcy law isn’t a “magic wand,” says brokerage Religare Capital Markets. It sees the benefits flowing in after 3-5 years from now.
Analysts say the main challenge will be creating a large pool of insolvency professionals who will help with the fast implementation of the law. The new regulators will also need to draft procedural rules for insolvency professionals and information utilities among others.