An evening with Mr Sumant Batra: Building a safe to fail culture in India

On Friday, August 25, we had a very insightful session by Mr Sumant Batra, a globally renowned lawyer with three decades of experience in insolvency and related laws. Mr Batra explained the importance of shaping a culture where failure is ok and is considered a stepping stone to success.

About Mr Sumant Batra

Mr Sumant Batra has been rated amongst the top 30 restructuring lawyers in the world by Global Restructuring Review.

Mr Batra is International Fellow of American College of Bankruptcy and Distinguished Fellow of the Indian Institute of Corporate Affairs, Ministry of Corporate Affairs, Government of India. He is the President of Insolvency Law Academy. He sits on multiple expert committees and working groups in India and other jurisdictions. As a senior international consultant to the IMF, the World Bank, OECD, the ADB and other developmental institutions, he has worked in over 15 jurisdictions.

Mr Batra holds the distinction of being the youngest President of INSOL International. During his tenure, he was extensively involved in global benchmarking and standards setting in the field of insolvency.

Mr Batra is a member of the Advisory Board of Asia Business Law Institute; International Insolvency Institute, and many other global and Indian institutions.

Mr Batra’s book, Corporate Insolvency– Law & Practice is considered the foremost scholarly work on fundamental principles and approaches to the insolvency system. He has also co-authored Making of New India – Transformation Under Modi Government, Co-edited by Dr. Bibek Debroy, Anirban Ganguly and Kishore Desai.

Introduction

India is a young country when it comes to demographics. With an average age of 29 and a youth population of 28%, the country has significant untapped potential. The country’s youth want to try out new things and have great aspirations. By embracing entrepreneurship, their dreams can be translated into innovative solutions. This can lead to personal prosperity and economic advancement for the nation.

Despite India's rapidly growing entrepreneurial ecosystem, the low tolerance for failure poses a challenge. Nurturing a culture that embraces failure as a stepping stone to success is vital for the nation's progress. Encouraging such a shift can unleash the latent entrepreneurial talent of young Indians.

Failure is a part of the road to important achievements. Following the successful launch of Chandrayan III, the ISRO scientists acknowledged that learning from the failure of Chandrayan II had made a great contribution to this achievement.

In short, the country needs a suitable economic environment and legal framework that encourages people to take risk and be more comfortable with failure.

Lessons from the US

At the time of independence, the US chose to be a free market economy. The state decided to play the role of watchdog, facilitator and shape the ecosystem. But it would not directly take part in wealth creation. The business environment in the US has enabled entrepreneurship to flourish, producing some of the most well-known companies in the world.

Enabling the Indian youth

About 30-40 years ago, young people in the country were influenced by their family members to pursue traditional careers such as engineering, medicine, law, etc. Today, the young have their own dreams and ideas. They want to experiment with their lives. The business environment must be enabling. Young people should feel confident while pursuing an idea. If they are backed with venture capital, it will result in innovation and IP creation.

Risk capital will be available to entrepreneurs only when the environment is conducive in many ways:

• It is easy to start a business without excessive burden in terms of regulatory procedures and filings.
• It is easy to continue to run the business. Cost of regulatory compliance should not be too high.
• Dispute resolution is easy and fast.
• Easy exit is possible if things are not working. There should not be any collateral damage for the entrepreneur while exiting a business.

Dealing with failure

When entrepreneurs fail, they should be allowed to make a dignified exit. They can then get started with a new idea. Bankruptcy should be seen as a way to give a second chance to people. Of course, we need rail guards to ensure that entrepreneurs do not misuse these privileges.

We need a change in mindset at all levels: law makers, lenders, government, society, etc. We should treat failure with dignity. We must provide the support necessary to failed entrepreneurs so that they can bounce back. Donald Trump and Richard Branson faced major setbacks. Yet, they came back to build successful empires. Failure should be viewed as the other side of the coin. The Insolvency and Bankruptcy Code is designed to enable a dignified exit.

About IBC

The Insolvency and Bankruptcy Code (IBC) was enacted in 2016 to address the shortcomings of the previous legal framework, which was criticized for being inefficient in handling insolvency and bankruptcy.

The IBC emphasizes a fast-track process and aims to resolve cases within 180 days, with a provision for a 90-day extension if necessary. The process is managed by licensed Insolvency Professionals (IP) to ensure efficient and impartial proceedings.

The National Company Law Tribunal (NCLT) and the Debt Recovery Tribunal (DRT) have been designated as the adjudicating authorities for companies and individuals, respectively.

The IBC establishes a committee of creditors, who have a say in the resolution plans and can negotiate terms with the defaulting debtor. The Code specifies the order of priority for distribution of assets during liquidation.

IBC has been a game changer. The implementation has been efficient, backed up by political will, stakeholder engagement and demonstration of world class jurisprudence.

There are still some delays in admitting cases and in resolution. The NCLT is overwhelmed with cases. There are not enough professionals to hand the huge volume. But the political will has remained intact. The government is on its feet daily to remove bottlenecks. Many amendments have been introduced.

IBC has unlocked idle assets, enabled recovery of debt and capital redeployment, and provided opportunities for various professionals to contribute and make their mark. IBC has strengthened India’s global reputation. The country has demonstrated that it can conceptualize and implement new laws that improve the business environment. International investors have become more enthused about investing in India in view of the clearly laid down exit policy.

Process of resolution

Globally, there are two types of Insolvency regimes: Debtor in control and Creditor in control.

Debtor in control regime

The debtor initiates the process, often to gain relief from crippling debt and liabilities while seeking to continue operations. The debtor retains more control over the assets and operations of the company during the process. In some regimes such as Chapter 11 in the U.S., the existing management may continue to run the day-to-day business under court supervision. The focus is generally on restructuring the business to make it viable again, although creditors still need to approve the restructuring plan. The ideal outcome is a restructured, healthier organization. But liquidation remains a possibility if restructuring is not feasible. Chapter 11 in the U.S., Administration in the U.K., and the Debtor-in-Possession (DIP) model in Germany are largely debtor-led processes. During the period of restructuring also called the moratorium/standstill/thaw period, creditors cannot pursue any legal action against the debtors.

Creditor in control regime

The process is usually initiated by creditors who believe that the debtor is insolvent and unable to meet its obligations. Creditors, often through a committee, have significant control over the proceedings, including the choice of insolvency professional, evaluation of claims, and approval of the resolution plan. The primary goal is often to maximize recovery for the creditors, which may or may not include the survival of the debtor entity. Depending on the jurisdiction and specific circumstances, the result may range from restructuring of the debt to liquidation of the debtor's assets. India follows this regime mainly because the Debtor in possession laws passed in 1986, have not been effective.

Under IBC, a petition is filed for insolvency based on a default (more than Rs 1 crore).The proceedings can be initiated by the debtor or the creditor. As soon as the petition is admitted, the Insolvency Professional (IP) is appointed. The IP acts as a single member board and supersedes the existing board. The management must report to the IP and work under his/her guidance. There is a moratorium period during which no legal action can be initiated by the creditors and no asset sale can be made by the debtors. A public announcement for filing claims is made. All the claims are segregated. From the financial creditors, a committee of creditors is formed. The voting rights of the members are in proportion to their claims. The NCLT must be informed within 21 days that the Committee has been formed. Within a week, the Committee should meet. The first decision is whether the interim IP should continue or a new IP should be appointed.

The IP then prepares the Information memorandum which contains all relevant details. The IP also arrives at the enterprise and liquidation value.

The Committee of creditors decides on the profile of people needed to implement the resolution. Accordingly, an expression of interest is invited through an RFRP (Request for Resolution Plan). After checking that the plan is meeting compliance requirements, negotiations begin. Through voting, one of the plans is approved. This is binding on everyone.

If the plan is rejected, a fresh attempt can be made. If no resolution plan is approved, liquidation is the only way and a liquidator is appointed. The liquidation may happen on a going concern basis or on a piece meal basis.

The proceeds are distributed according to a waterfall (pecking order). Secured creditors and employees (upto 12 months of unpaid salary) get the priority followed by unsecured creditors and finally the government. The IP will investigate the affairs of the company and check if any preferential payments have been made or undervalued/fraudulent transactions undertaken. In that case, the IP may insist on a claw back of the paid amounts.

On the large hair cuts and the low recovery value

Recoveries have not been high. The main reasons are as follows:

No secondary market for distressed assets. In the west, there are Special Situation Funds who will step in and trade distressed assets. In India, Asset Reconstruction companies are becoming more active in this space. But this will take time.

Slow process. A lot of time is spent in the courts. The longer this period, the lower the value of the assets. In addition, repatriation is very difficult for foreign investors.

Litigation funding is missing in India. Such funding can enable asset sales much faster and ensure that the creditors get some money back quickly.

Last mile funding is also missing in India. Such funding is needed to preserve the assets and ensure that they do not lose value.

More than the amounts recovered it is the speed of resolution that is frustrating for most creditors. The admission of a petition can take 6 months against the recommended 40 days.

Mr Batra pointed out that the insolvency process is becoming adversarial. People go to the courts at the drop of a hat. We need a change in mindset and move towards a culture of negotiation. The promoter driven culture in India as opposed to a financial investor driven culture has made things more difficult for resolution.

Later, Mr Batra added that there is a big gap between the targeted and actual recoveries. A parliamentary committee has expressed concern in this regard. Yet, the amount recovered is not trivial. Moreover, the process being followed is more effective than going to court.

On resolution vs liquidation

Under IBC, the creditors are free to decide what makes more sense: resolution or liquidation. The Supreme Court has ruled that resolution is preferable and liquidation must be the last report. This has resulted in kicking the can down the road.

If liquidation is the only option, why delay it? Indeed, liquidation has its own merits. Some assets will be unlocked. Even assets which we think do not have a market value can be sold if the right buyers are identified. Thus a ceramic tile manufacturing machine making small tiles which are no longer in fashion today in India, may find a customer in Africa.

On how a safe to fail culture can create value

Laws that facilitate organized treatment of assets being left behind, can enable the entrepreneur to exit without any stings attached and start again on a clean slate. This can make a big impact on the business environment in the country.

The failed entrepreneur can protect his business goodwill and relationships if all stakeholders are satisfied that they have got the best outcome under the prescribed and accepted legal mechanisms. The failed entrepreneur will not have to worry about being hounded by creditors.

Timely and fair resolution can protect the social fabric of the country. A nation cannot make progress if the citizens do not enjoy good physical and mental health. A failed entrepreneur who is stigmatized and traumatized will not have good mental health. Such a person will not be able to take care of his/her family. This will also have a big impact on the community. (Think of the unfortunate Mr VG Siddartha of Café Coffee Day.)

On how entrepreneurs can remain motivated even in the face of failure

When dealing with a setback, hope is important. If the entrepreneur knows there is light at the end of the tunnel, he will keep walking.

The entrepreneur should be confident of discharging his responsibilities towards family members despite the failure.

Entrepreneurs should not hesitate to seek advice from experts when they face challenges. Such advice should not be expensive.

Advice to entrepreneurs

It is important to dream and take risk. But the risk must be assessed carefully. The idea alone is not enough. The challenges in implementation must be thought through.

Governance is important. Financial management should be above board. The best practices in corporate governance must be embraced. There must be disciplined decision making.

Knowledge should be institutionalized. There must not be excessive dependence on any one person. If that person leaves, there will be a big problem.

Growth needs seed capital and growth capital. That calls for complete transparency with investors. Proper systems for information management are a must.

Entrepreneurs should be open to seeking advice from experts wherever required.