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Business corporations have been stormed with an imminent fear of bankruptcies. And they have ardently appealed to governments round the globe to forge safety nets against the economic downfall.
Paying heed to the general business sentiment, two distinct features have been adopted to battle out the crisis that looms large. First, the dismal-science monetary policy (easier credit availability) — which is beyond the scope of this article. Second, freezing bankruptcies and putting debtors on a ventilator.
Many countries have adopted unprecedented measures to mitigate the crisis. Bankruptcy codes have been amended to prevent a forced shutdown of otherwise viable firms. Temporary reliefs such as raising the threshold to initiate bankruptcy process and a defence against directors’ liability have become quotidian amid the pandemic.[i]
Prima facie, these efforts seem to be a step in the positive direction, especially to allay the fears of panic-stricken business community. But, in effect, the governments have gone overboard in intervening in the economy (going against Uncle Miltie’s principles) to keep businesses alive —some of which ought to have been put out of their misery.
The safety nets have rather become spider webs that have trapped the ‘undead,’ leading to burgeoning ‘zombie firms’ —unprofitable business outfits that require recurring bailouts to operate. The policies that have been formulated to mitigate might, in reality, perpetuate the mayhem.
Singling out India, the central government has adopted a hands-on approach to provide relief for distressed business entities by suspending its Insolvency and Bankruptcy Code, 2016 (“IBC”) in part on September 23, 2020.[iii] Resultantly, no application for initiation of Corporate Insolvency Resolution Process (“CIRP”) can be instituted for any default arising on or after March 25, 2020.
In bland terms, it rescues firms — all kind of firms — from being nudged into insolvency. We emphasize on “all kind of firms” because the blanket ban of IBC suspension also shields firms that would have performed dismally even if there were no pandemic.
But since the promulgation of the Ordinance (on June 5, 2020) suspending IBC, many critiqued the move, remarking that more conclusive and generous rescue designs should be adopted, following suit from the take-no-prisoners approach of Germany and, by the same token, over-arching approach of Singapore. We, on the contrary, opine that the unsentimental American approach for resolving the ailing firms could have been a much better way to tackle the crisis in the long run.[iv]
Abating the economic distress by suspending IBC is a proverbial squaring-the-circle task. This move will drip-feed the zombies and crowd out some deserving firms, hindering the redeployment of capital and labor to better prospects. We predicate our assertion on four arguments thus.
First, with IBC suspended and declaration of Non-Performing Assets (“NPAs”) proscribed[v], banks cannot assume their zombie-slaying roles by jabbing the IBC-knife. Also, voluntary insolvency resolution under Section 10 of the IBC is thrown out of the window.
There is no way via which an ailing entity can be resolved; no redeployment of resources is possible; labor also finds itself bogging down in zombie firms, which perforce have grim future prospects. This would stall the recapitalization of debt-laden firms or redeployment of their assets and staff to competent firms. And unemployment in the coming future will also witness an upsurge.
Second, protection of Micro, Small and Medium Enterprises (“MSMEs”) has been at the heart of India’s economic reforms (since this lot contributes around twenty-eight percent to the GDP.)[vii] To this end, MSMEs, apart from the IBC-suspension umbrella, will be receiving collateral-free loans to the tune of INR 3 lakh crore — this move, again, begs its own questions. And with the pandemic extant and the government fervent to inject money in MSMEs, the loans would be disbursed promiscuously, without filtering the undead from the healthy.
These state-backed loans will act as fleshy carcass for the zombie firms. Thus, we scruple not in saying that state-backed loans must be rolled over only after assessing the viability of individual businesses. Further, past events evince that state-pushed loans are fraught with risks of ballooning NPAs. For as it stands, a sector most dear to the Indian economy will soon become a hotbed for zombie infestation.
Third, one of the reasons attributed to the suspension was a dearth of competent resolution applicants. With businesses plummeting, willing resolution applicants might be inadequate to bid for revival of an ailing firm. In fairness, this seems to be a valid cause, and the reluctance of resolution applicants to funnel in capital in an ailing firm while business sentiment is slumped is well warranted.
But a six-month or a year-long suspension is not going to preternaturally fill the pockets of those resolution applicants; nor is this halt going to make it any better for the firms which have no growth prospects left. On the one hand, it would linger on the liquidation of the undead firms that need to be delivered the coup de grâce, and, on the other hand, it would also prevent wiling resolution applicants from restructuring the firms that currently have some scope of recovery.
Once the suspension is lifted, even the chance of bringing the viable firms out of the pit would be lost. Therefore, it will not only keep the undead alive; it would also guillotine the otherwise sparing business entities.
Fourth, aside from the economic ramifications of the pandemic, we also have to draw on notions of a permanent shift in consumer habits. A theatre company that was thriving before the pandemic, and now shored up by state policies and aid may struggle if consumers’ preferences shift permanently, for instance.
The defunct IBC will keep them alive, but it will also make them postpone some hard choices that need to be made about their present business models. This will create a charade to deny reality.
An all-but-indiscriminate succour against bankruptcy may dole out dividends in the short-run but will be of little avail in the long run. Not least, it will swell the ranks of zombie firms amid the pandemic, ushering us into a zombie dawn — a scourge we might not be able to disarm even after the pandemic.
The IBC must accommodate to the change. And, to this end, bankruptcy process should be made less cumbersome and much wieldier to recapitalize the debt-laden firms, and to redeploy the resources and assets of the ones beyond salvation. Easing bankruptcy routes might result in a blizzard of bankruptcies[vii], but this will ward off zombie firms, which may otherwise spawn.
We must grasp the nettle firmly. The courts should have the power to revive the firms with reasonable prospects and to liquidate the undead firms.
To abate the economic crisis, the living must be fed, not the undead.
[i] See, for eg., COVID-19 (Temporary Measures) Act 2020 (Singapore); Coronavirus Economic Response Package Omnibus Act 2020 (Australia); Corporate Insolvency and Governance Act 2020 (The United Kingdom).
[ii] Ailing Companies: The Corporate Undead, The Economist, September 26 – October 2, 2020, pp. 69-70.
[iii] Insolvency and Bankruptcy Code (Second Amendment Act), 2020, No. 17, Acts of Parliament, 2020 (India)
[iv] The Corporate Undead: Zombies at the gates, The Economist, September 26 – October 2, 2020, pp. 14-15.
[v] Gajendra Sharma v Union of India, Writ Petition(s) (Civil) No (s). 825/2020. https://main.sci.gov.in/supremecourt/2020/11127/11127_2020_34_16_23763_Order_03-Sep-2020.pdf
[vi] Insolvency and Bankruptcy Code, 2016, No. 31, Acts of Parliament, 2016 (India), § 10A.
[vii]Ministry of Micro Small and Medium Enterprises, Government of India, Annual Report 2018-19, p. 27 https://msme.gov.in/sites/default/files/Annualrprt.pdf
[viii]Euler Hermes Global, CALM BEFORE THE STORM: COVID-19 AND THE BUSINESS INSOLVENCY TIME BOMB, 16 July, 2020, p. 7. https://www.eulerhermes.com/content/dam/onemarketing/ehndbx/eulerhermes_com/en_gl/erd/publications/pdf/Final-2020_07_16_InsolvencyTimeBomb.pdf
(The authors are students at the Faculty of Law, University of Delhi. If you would like to make a student submission, please see the details here )