Thursday, November 20, 2008

A Look At Chapter 11 Bankruptcy in America And Its Equivalent In India

With so much talk of companies going bankrupt in USA, I decided to dig into the details. To a common man, like myself, if a company has gone bankrupt, the company is history. Ceases to exist. Dead. Apparently not.

First some definitions ... ( I am not insulting your intelligence. I am trying to make it clear for myself).
A debtor is the one who owes some money (or debts) to others.
The 'others', mentioned in the statement above, are the creditors.
Thus, if I am a company and I have taken a huge loan from a bank, I am debtor and the bank is the creditor. I need to pay off the debt I owe to the bank.

But if I am a shareholder, I am not a creditor of the company. I own the company, you see. Just a tiny bit of the company, But still an owner and hence a debtor.

However, if I have a fixed deposit with the company, then the company owes me my money. So, I am a creditor.

Now, when a company cannot repay its debts, the company can voluntarily file for bankruptcy under chapter 7 or chapter 11.

If the company files for bankruptcy under chapter 7, then the assets of that company is sold off and the debts repaid to the creditors. So, the company is now actually dead. Liquidated. (I like the word liquidated. Very graphic. You can actually see in your mind, the fixed assets of the company being squeezed into liquid cash and flowing from the company to the creditors).

However, bankruptcy filed under chapter 11, means the company is still alive but not kicking as hard. The control remains with the existing management (which is kind of funny! If these guys could manage, why would a company go bankrupt in the first place?) What makes it a little more baffling is that initially the same jokers who brought the company to this state have the exclusive right to propose the restructuring. Of course, the creditors have to agree to it. This is ensured by a bankruptcy court. If there is no agreement, the court can move the bankruptcy from chapter 11 to 7. Sometimes, when it is determined that the management is utterly useless, a trustee is appointed by the bank to take care of the restructuring.

Chapter 11 bankruptcies are politically more expedient. Since the company doesn't close down completely, people have jobs, the suppliers can still operate. (Remember the unpaid amount to a supplier is also a debt.)

So, do companies recover from a chapter 11 bankruptcy? In recent memory, as far as I remember, post 9/11, Delta and Northwest Airlines filed for Chapter 11 bankruptcy. Both emerged after restructuring and subsequently they merged to form the biggest airlines in the USA.

That is all in USA. Wikipedia has lot of material on this.

What about India? Not so good news, I am afraid.

First, getting information on Indian Laws is a task by itself. A paper by one Mr. N. S. Tomar (then a 5th year student in a law college) - I think this paper is written in 2002 (see here) - concludes:

"Indian insolvency law failed to keep pace with the domestic and international developments. Both, the Companies Act, 1956 under which winding up of companies is carried out and SICA which deals with revival of companies fail to capture the true relevance of the insolvency law besides not meeting the dynamics of the modern economic system. The two laws were enacted to cater to meet the expectations of industries thriving in a protectionist environment unexposed to competition in a closed economy. Both the laws do not provide for engagement of professionals and their skills in the insolvency system."

I got hold of a book called Wadhwa's Corporate Law. This is a 2001 edition. The Sick Industrial Companies (Special Provisions) Act 1985 is covered in Part IX. It states in the introduction: "An act to make in the public interest, special provisions with a view to securing the timely detection of sick and potentially sick companies ...".

The word bankruptcy doesn't seem to occur. A "sick industrial company" is defined as "an industrial company ... which has at the end of any financial year accumulated losses equal to or exceeding its net worth." So, this is it.

More information is available here

This piece of editorial in the Economic Times concludes:

"It took barely 72 hours for Lehman Brothers to be acquired after it declared its bankruptcy in the United States. In India, a bankrupt company would have had to go to a court, which in turn, would have taken its own time to appoint a liquidator for the sale of assets. Why can’t we execute the sale of companies declared bankrupt within 72 hours? This is the crux of the issue."

Only a professional will be able to wade his way through. So, if this blog is being read by a person who deals with insolvency and bankruptcy, please add value.

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