MAKING INDIA A DEVELOPED COUNTRY IN 25 YEARS: IMPORTANCE OF ROBUST INSOLVENCY ECOSYSTEM & EFFICIENT CONTRACT ENFORCEMENT

On August 15, 2022, as the nation marked 75 years since independence from British rule, the Hon’ble Prime Minister Narendra Modi pledged, from the ramparts of the Red Fort, to raise millions out of poverty and turn India into a developed country¹ in the next quarter-century. To achieve this, the Hon’ble Prime Minister said India would be guided by the ideals of self-reliance and the spirit of international partnership to attain excellence in science and technology, set up industries, and attain food and energy security. He said the journey of the last 75 years had seen ups and downs with India battling against all odds with resilience and perseverance. He called upon the people to remove any trace of a colonial mindset. ‘It is a big resolution, and ‘we’ should work towards it with all our might’, he said.

To become a developed nation, reforms are required in various areas which have long been hamstringing India. Futuristic and visionary policies will have to be formulated at multiple levels. Besides, India will need to meet the threshold of high-income country in terms of economic indicators.² Applying the criteria prescribed³ by the World Bank for high-income countries and the unchanged population base for India over the next 25 years, the Indian economy would need to grow at a particular rate to reach the goal. While reforms and policy initiatives in multiple areas are needed to support the grand target of turning India into a developed country in the next 25 years, two areas which assume greater importance and demand priority attention in the early years of Amrit Kaal⁴ are, judicial reforms to expedite enforcement of contract; and making the country’s insolvency system, more robust, and globally, palatable. These two areas, inter-linked in many ways, are the emphasis of this article.

EFFICIENT CONTRACT ENFORCEMENT

Efficient contract enforcement is essential to economic development and sustained growth.⁵ Economic and social progress cannot be achieved without a well-functioning judiciary that resolves cases in a reasonable time and is predictable and accessible to the public.

Economies with a more efficient judiciary, in which courts can effectively enforce contractual obligations, have more developed credit markets and a higher level of development overall. Overall, enhancing the efficiency of the judicial system can improve the business climate, foster innovation, attract foreign direct investment and secure tax revenues.⁶ Enforcing a contract through the courts in developed jurisdictions takes significantly less time than it takes in India. For instance, it can take less than 10 months in Singapore and New Zealand.⁷ Many studies and reports have spoken aloud about the pressing need for reforms in area of enforcement of contract in the country. The Government of India has been monitoring an array of legislative and policy reforms to strengthen the enforcing contracts regime in India. These incremental steps, although commendable and in the right direction, have helped, but it is time to adopt some path breaking reforms, to meet the laudable goal set by the Hon’ble Prime Minister.

ROBUST INSOLVENCY SYSTEM

Every year, billions of rupees in business value, jobs, and capital are lost or side lined as a result of businesses becoming insolvent and closing their doors. An efficient insolvency system encourages enterprise, underpins investment and economic growth, and creates wealth. It helps create a sound climate for investment, and enable market participants to more accurately price, manage and control default risks and corporate failure. An effective exit law ensures maximum play in a fair reallocation of assets to more efficient market users. A robust corporate restructuring can prevent many viable businesses in financial distress from continuing as going concerns when they are in a state of insolvency. In 2016, India introduced the Insolvency and Bankruptcy Code, 2016 (IBC/ Code) paving the way for a much-needed modern framework to deal with the insolvency and bankruptcy of corporate entities in India. The Code has moved forward in leaps and bounds in a very short span of time. Due to effective implementation of the Code, green shoots have already emerged. While the speed with which the Government acted to enact and implement the Code is applaudable, continued absence of significant provisions, like the cross-border insolvency, group insolvency and others, and delays in appointment to National Company Law Tribunal (NCLT) and in approval of resolution plans by NCLT is starting to take some sheen off an otherwise shining piece of legislation.

To support the goals set by the Hon’ble Prime Minister, India needs a robust insolvency system that ranks amongst the best in the world and an adjudication authority (as part of the judicial framework) that complements such insolvency system. No degree of substantive law improvement—even world’s ‘best practice’ substantive law—will bring the Code robust without effective enforcement from one end of its spectrum to the other. Better performing courts have been shown to lead to more developed credit markets.⁸

LEAP OF FAITH DECISIONS

This article suggests, some macro and other micro, but bold and out-of-box decisions, reforms and other measures needed that will contribute to formulating the collective ‘might’, as referred by the Hon’ble Prime Minister referred in his address, to achieve the target set by him. Implementing some of these would require a leap of faith.

New approach: Ministry of Economic Affairs

In the Amrit Kaal, the names and businesses of many ministries, both in the Central and State Governments, should represent the aspirations of the new age India and its global status. A Ministry of Economic Affairs could be formed to be made the charge-de-affairs for fulfilling the nation’s economic aspirations, and to serve as the nodal ministry for judicial reforms, reforms in other economic laws, including further reforms in the insolvency laws, as also in the laws that orbit around such economic laws. The judicial independence and the strength and efficiency of judiciaries are directly associated with economic growth. However, when people think of how courts affect them, they typically think in a public law mindset. They think about the ‘big issues’ decided under the Constitution. That type of judicial action dominates both public perception and legal scholarship. Thus, when people think about how courts affect them, they think more about hot-button political issues and the ubiquitously reported criminal cases. This slant toward thinking predominantly about public law is readily apparent in the multiple stories presently covering arrests and standard criminal trials and marquee constitutional litigation. Private law often gets shunted to the back of people’s minds because they think of it as solely affecting the parties. Far less coverage is given to contract actions involving businesses or individual citizens in their economic lives. This perception, and mis-understanding of the role of Judiciary has, for many decades, undermined the importance of judiciary in economic prosperity of the country. Furthering commerce has to be one of the central goals of the courts, alongside protecting the rights of the citizens. Similarly, insolvency law is an essential part of any country’s financial architecture, as emphasised in the earlier paragraphs. There are many other economic laws that play key role in the economic development.

Bringing the inter-linked areas of the ministries that are responsible for administrative rules of business for the judiciary and other economic ministries together, under one ministry, will provide the much required co-ordinate approach, result in greater cooperation, avoid delays on account of inter-ministerial consultations, centralise the reform process and help accelerate delivery. It will also send out a powerful message and give a thrust to the narrative to make the goal set by the Hon’ble Prime Minister, a national mission. From a perception advantage, it will help break away from the mindset shackles of the past.

Thinking big: India as next restructuring capital

Indian insolvency regime is just over five years old. It is still to deepen its roots. Yet, the development of a sophisticated insolvency system in a short period of time shows that the Indian Government and its institutions have the capacity to implement complex economic laws with great maturity, its stakeholders are quick learners, and the Indian professionals are capable of providing high quality services. To top it all, it has the judges who can produce high-end jurisprudence in a branch of economic law new to the country. Therefore, there is no reason, why India should not shift gears and press the accelerator on upgrading the insolvency ecosystem. India should set the aim to become to most attractive jurisdiction for restructuring. Creditors and debtors prefer to choose the most efficient jurisdiction for resolution of insolvency. A developed country is a natural claimant of this space as it has the supporting infrastructure to effectively apply a sound legislation. India need not wait to become a developed country to stake claim for this space. It should aspire to become a global capital for restructuring, sooner. This will require a world-class insolvency ecosystem. A case in study for this purpose is Singapore.

Singapore has put in place a national strategy to become a global hub for dispute resolution in economic matters, including commercial arbitration, and to pitch the country as an effective and efficient jurisdiction for restructuring. They are rapidly creating soft and hard infrastructure to support this mission. Global institutions are being encouraged to set up regional shops in Singapore. Both, the judiciary and the executive are working in tandem and cooperation to advance this national goal, as is evident from the architecture and mission of Asian Business Law Institute.⁹ A similar national strategy by us. 

Use of soft power to build awareness about the Code

Soft power is the most critical diplomatic tool. Countries package their soft power by emphasising the qualities of governance, culture, diplomacy, education, and business innovation. This packaging requires innovative use of public and private resources to subserve the larger national purpose. As implied by its absence from ‘The Soft Power 30 Index’¹⁰(India does not figure in a list of top 30 countries in terms of soft power), India does not yet benefit as much from international awareness, positive associations or investments in cultural diplomacy as many other countries. Most cultural diffusion to overseas audiences through private sector is limited, from yoga to Indian food, to Bollywood, and other select areas. One of the pillars of the soft power is business and trade. Soft power has a significant impact on the decisions made by the people, businesses, entrepreneur, and the governments. The perception of a country/nation forms a key component in economic development and for corporate. The Code is considered one of the most significant economic reforms in Independent India. The Indian judiciary stands alongside the best, globally. We need to make an effective use of soft power to communicate this through the use of soft power. India should encourage this through an integrated approach that amalgamates public diplomacy at the global level with a creative economy at the local level by involving stakeholders and artists, entrepreneurs, academics, policy makers and civil society. Films, literature and other creative modes, subtly provide information and create impressions, and help maximise the reach. This, over time, develops into a narrative. A coherent effort is needed to raise India’s brand value abroad regards the insolvency system and judiciary, by use of this creative soft power. There should be a shift from the  past and outdated narrative. This will have significant implications for the conduct of Indian diplomacy and the broader economic role of India, globally, in the coming years.

G20 Presidency as a catalyst for reforms 

The G20 over the years has become a premier platform for global economic co-operation. The G-20 initiative is a coalition of the world’s most-powerful economies plus the EU. It’s role as an influencer, has expanded over the years. India will hold the G20 Presidency from December 1, 2022 to November 30, 2023, and host the 18th G20 Summit in 2023. Hundreds of official meetings will be held around employment, health, digital economy, trade, investment, climate, anti-corruption, tourism, culture, socio-economic development, education, and women empowerment will continue to stay on course. There will be academic interactions and meetings around the international financial architecture, financial inclusion and sustainable finance, financing for infrastructure, climate finance, and tax matters. These conversations must continue on the sides of the bigger issues. India’s presidency of the G20 grouping next year presents an enormous opportunity to accelerate sustainable growth within India, in the emerging world, and beyond, and become the launch pad for rolling out the agenda of policy decisions and reforms needed to accomplish the aspiration turn India into a developed country in the next quarter century. The G20 members and delegations should be showcased, through public and private sector interactions, the progress made in the areas of enforcement of contracts and insolvency, as well as the supporting infrastructure. Path breaking reforms, including the judicial reforms and upgradation of insolvency system to make it truly global, should be launched during the G20 Presidency, by implementing the reforms in pipeline. Cross-border insolvency, group insolvency, introduction of hybrid insolvency system, mediation, law for financial institutions insolvency resolution, and other reforms should be planned for introduction and implementation during the G20 Presidency. Agenda for more futuristic reforms should also be set during this period.

Adopt hybrid insolvency system

Our legal system is based the common law system – a system of law based on recorded judicial precedents- came to India with the British East India Company. Many of these laws continue even after 75 years of Independence. As the Hon’ble Prime Minister said, we should word missing the colonial mindset. Free markets operate efficiently in countries that were not colonies of the British.

Like many common law countries, India has a ‘creditor-in-control’ style insolvency model. The Code enables taking control of the company away from the owners and give it to the creditors through appointing an independent Insolvency Professional. The thinking being that we shouldn’t leave company control in the hands of the very parties that got the company into its financial problems. The creditor-in-control model comes from the scale to which the country relies on credit to fuel the growth of its economy and subsequently, the country’s social tolerance to accepting business failure to promote risk taking and entrepreneurship. Chapter 11 bankruptcy in the United States of America, on the other hand, is a popular debtor-in-possession model. Around the world, insolvency laws are evolving to incorporate more forgiving debt relief and restructure arrangements. Many countries are thus, making room for debtor-in-possession system in their insolvency framework, and adopting a hybrid model. This hybrid process comes with the debtor-inpossession and creditor-in-control model. In 2017, Singapore introduced new restructuring laws, adopting parts of the Chapter 11 bankruptcy laws, reducing the barriers of entry for distressed businesses to seek support. In Australia, piecemeal changes were made to soften the perceived ‘creditor favouring’ insolvency laws through introducing safe harbour in late 2017 and a stay on ipso facto clauses in mid-2018.

In 2021, India introduced a ‘debtor-in-possession’ style of arrangement through the pre-pack regime for small and medium business restructure. Through this reform, the government has set the stage to allow directors to retain control of their businesses while seeking external professional support. India should consider making a recalibration of the balance between debtor and creditor control, to attract investors from both, the ‘creditor-in-control’ and ‘debtor-in-possession’ jurisdictions. This will help make the Code, globally palatable.

Rethink the structure and composition of NCLT 

The delays in deciding cases by NCLT has shaken the confidence of some stakeholders, albeit not irretrievably. There is a definite need for improvement in the functioning of NCLT to make it more efficient. Although efficiency is only one aspect of the quality of a judiciary, it nonetheless is measurable, unlike some of the other essential qualities. One important aspect of efficiency is time to disposition of a case.¹¹One of the common complaints by NCLT and other stakeholders is lack of resources. More money and especially more judges would presumably, other things equal, lead to faster disposition of cases and perhaps more effective judiciaries. Although budgets are a big problem, it is reasonably clear that neither budgets nor numbers of judges are the heart of the problem. Ecuador and Peru have only one judge per 100,000 people, but Singapore has less than one judge per 100,000 people (compared to 27 per 100,000 in Germany and 10 per 100,000 in France).¹² While a score of measures are needed to address this issue, there is a need to go back to the drawing board and reimagine the adjudicating authority. The NCLT structure was introduced nearly two decades ago. We are a different nation now, 20 years later. In a free market dynamic economy, where private sector is the central engine of growth, it is imperative that NCLT (in its reinvented avatar) should have an adequate representation from the private sector. An equal percentage of judicial members should be appointed by inviting senior and experienced members of the Bar, and from other expertise available in the market. They will bring with them the readily usable experience. Reputed professionals guard their reputation through their conduct and behaviour. The establishment should show trust in reputed professionals. In National Company Law Appellate Tribunal, the experience of technical members is not optimally used as appeal proceedings are mainly on questions of law. Their experience can be better utilised in other forums. Other structural changes are required.

Pre-insolvency resolution and preventive insolvency process

Pre-insolvency proceedings, at their core, inhabit a space on the spectrum somewhere between a pure contractual workout and a formal insolvency or rehabilitation proceeding. They are restructuring proceedings that corporate debtors can access before they become insolvent with the aim of avoiding insolvency. They entail a surgical debt restructuring and an early intervention at the first signs of distress, concentrating on financial creditors rather than creditors of the operating business, permitting no, or limited, court involvement, avoiding stigma and reputational damage. Such proceedings may preserve value better than later-stage intervention through formal insolvency proceedings that implicate all stakeholders, and almost invariably result in distressed asset sales of one form (liquidation, break up) or another (pre-pack designed to achieve a going concern, or at least a ‘better than liquidation’ outcome). Ever since the fall of Lehman Brothers and the financial crisis that followed, the world has witnessed a proliferation of various ‘light touch’ financial restructuring techniques in the form of pre-insolvency proceedings. These proceedings inhabit a space on the spectrum of insolvency and restructuring law, somewhere between a pure contractual workout, the domain of contract law, and a formal insolvency or rehabilitation proceeding in the domain of insolvency law. Policymakers, especially in the European Union, have responded to market developments by embarking on an aggressive new phase of corporate rescue oriented legislative endeavour that focuses on so-called pre- insolvency or preventive insolvency proceedings. This current vogue for pre-insolvency proceedings is the latest phase of a global effort to fashion a comprehensive range of debt resolution tools for use at various stages of the corporate life cycle. While pre-pack process has been introduced for small and medium enterprises, it has not been used by its consumers due to complex legal and regulatory provisions. It is time to develop a simple, effective and efficient pre-insolvency resolution toolkit, which also includes tools to prevent insolvency, which should be available to all classes of debtors. This will benefit the Indian corporate and financial sectors, immensely.

Develop the legal and regulatory framework for out-of-court dispute resolution (arbitration and mediation) and debt recovery

Time taken in insolvency resolutions concluding has been a matter of contention and debate. The commencement of an insolvency case reveals the debtor’s problematic financial situation and hinders business. Mediation provides strong incentives for both parties to engage in fast and efficient dispute resolution and look for a common business solution. Insolvency is not an adversarial process. Yet, disputes arise between parties, which has clogged the NCLT with avoidable cases. It also adds to the cost of resolution and provides uncertainty. As of now mediation has not been utilised for resolving of insolvency disputes. Mediation can be a viable option in a country like India, where the population is enormous, and wealth is not equally distributed. It is time for the framework of the Code to make room for mediation. Mediation is rapidly becoming as an acceptable mode of dispute resolution in insolvency in many countries with advanced insolvency systems as it allows the parties to reach an agreement through persuasion and ‘party-driven solutions’. India should start preparing the legal framework for mediation which can deliver top end mediation through qualified and trained cadre of professionals to complement the efficiency of the Code. This is likely to reduce the over-bearing workload of the benches of NCLT. 

Develop a community in pursuit of scholarship

Another key initiative needed by the country is to strengthen the interaction between the Government and academics in public policy making in due course. Academic knowledge, evidence and expertise can help inform, design, improve and test policy-and ultimately make government policy better. Research based analysis bridges the gap between policy and practice, and can leads to strong, inclusive and thorough implementation of the insolvency regime. The policy makers can build on experience of scholars. In developed countries, academics continue to play a very important role in supporting policy development, industry research and finding innovative solutions. As a country, we should aim to develop a community in pursuit of education, research and scholarship in the field of economic laws, in particular insolvency laws.

Development of stressed assets market

India’s stressed assets market is estimated at $115 billion. The enactment of the Code has created an efficient market for resolution of distressed assets. A massive amount of capital is needed among the intermediaries in the resolution process of stressed assets. A secondary market for distressed assets can reduce the debt collection burden on banks and free up resources and capital to support new lending. It can also enhance bank’s risk management strategy by providing another instrument to manage credit and market risks. In a developed economy, market participants are less reliant on loans from banks to finance their projects. The stressed assets funds and investors are looking for opportunities to invest in India. There is a genuine interest amongst global investors in the distressed assets investment markets with their inherent ‘buy low-sell high’ potential. But they are hesitant to take the leap of faith in the absence of an ecosystem that enables quick acquisition, provides an early closure of transactions, leaves no uncertainty from litigations challenging the resolution plans approved by the NCLT and allows repatriation of funds. We need to make the insolvency system more robust to attract these players.

CONCLUSION

To achieve the high target set by the Hon’ble Prime Minister, India needs to show persistent and unprecedented resolve and efforts. India should catch the bull by its horns and launch the next generation reforms which will propel the country to amongst the top thinkers on the global insolvency table and establish its leadership in the subject. This will require taking a leap of faith. It would be a boon, not just to every Indian, but to the world at large, if India becomes a developed nation13 by 2047, lifting millions of Indians out of poverty.