Another Indian Holy Cow

DURING a conference in the mid-'80s, Professor Mrinal Datta Chaudhuri of the Delhi School of Economics came up with a brilliant critique on Indian policy-making. He said: "The problem with us is the incessant use of an obnoxious phrase called 'But in a country like India...'" Fifteen years later, I am amazed at how right Mrinal was—of the phrase being blithely used to justify ridiculous policies, design absurd systems and stymie reforms.

Bankruptcy restructuring and liquidation are classic examples of the destructive powers of that phrase. Most countries use 'bankruptcy' or 'insolvency' to define a state where a person or a company is unable to meet debt dues or payment obligations. But in a country like India, that won't do. So, we give corporate bankruptcy a biological dimension and call it 'industrial sickness'.

This has had devastating consequences. Once you use the word 'sickness', you subscribe to a Florence Nightingale worldview—that the sick and invalid need to be nursed back to health. Consequently, very little thought goes into whether the company is at all viable; whether the risky future payoffs from 'rehabilitation' are worth the while; and whether 'sickness' is just a clever strategy by defaulting businessmen to keep creditors at bay.

The four biggest problems in Indian bankruptcy reorganisation are:

Late detection: The Sick Industrial Companies Act (SICA) defines 'sickness' in its terminal phase—not as 90- or 180- or even 370-day debt default, but where a company's accumulated losses have wiped out its net worth. The Board for Industrial and Financial Reconstruction (BIFR) might as well post a notice outside its office: "We only examine terminal cases." When a company has no net worth left, the probability of a turnaround is very low. Not surprisingly, 89 per cent of the cases that BIFR considered worthy of adjudicating between July 1987 and November 1998 continue to be sick, if not sicker.

Cumbersome procedures: Now add to this BIFR's delays.The mean delay is over two years, caused by tedious quasi-judicial procedures, where cases go through multiple loops before a final decision is taken. Managements love such delays; these keep creditors at bay and allow management additional bargaining power.

Debtor in possession: In any company, management has great informational advantages vis-a-vis shareholders and creditors. And in a bankrupt company, when the cake is rapidly shrinking, management will do everything possible to prevent creditors from taking a slice. But in most cases, BIFR allows existing management to control and run a bankrupt company during reorganisation. Several studies have shown that the 'debtor-in-possession' procedure results in creditors taking big hits at the expense of promoters and management. India calls this 'sacrifices in public interest'—yet another example of "But in a..."

Violation of absolute priority rule: An inviolate principle of bankruptcy is that senior creditors should be settled before junior creditors are entertained. And all creditors need to be settled before shareholder claims are addressed. Obviously. Creditors have a contractual right to be paid irrespective of the state of the company; shareholders, as own- SAURABH ers, have claims only on the residual cash flow. BIFR procedures repeatedly violate this by rewarding incumbent management and shareholders (despite negative net worth) at the expense of fully secured creditors.

Is there a way out? Yes, if the government replaces SICA with legislation incorporating the features outlined below.