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India’s New Bankruptcy Code: Will anyone risk their neck to give a haircut?

India’s new bankruptcy code is a promising development in a jurisdiction where it is difficult to start a business and a nightmare to shut it down.

Global distressed debt funds are focusing on India and there is great potential to clear out bad loans and zombie companies. Anyone in the finance industry or with existing operations in India should pay close attention.

On balance, it’s a positive development.

But will any banker in India take a haircut on a loan, whatever the new code says?

A banker cutting a deal under current political conditions risks an investigation by India’s anti-corruption and other law enforcement agencies. India’s genuine progress is addressing high-level systemic corruption has become an unintended impediment to clearing out the deadwood of non-performing assets (“NPA”) that lays like tinder under the Indian economy.

While the bankruptcy code is not simply about helping lenders clean up their balance sheets, without that flexibility there is little hope for implementing the code effectively. The problems are largely self-inflicted.

Discussions about non-payment of loans in India are burdened with morality, according to Raghuram Rajan, the Governor of the Reserve Bank of India, the country’s central bank. There is a knee-jerk impulse to seek criminal sanctions against loan defaulters, and to investigate the bankers who made such loans.

"It is a completely separate issue of who to blame and whether there is criminal liability involved. In some fraction of the cases there may be criminal liability involved. That should be separated from the whole issue of putting the assets back on track," Rajan has said.

Allowing businesses to discharge debt through bankruptcy runs counter to the Indian political desire to demonstrate populist credentials. There are also genuine reasons to treat NPAs with suspicion.

Bad loans in developing markets are often the residue of corruption, where banks make economically unviable loans under political pressure. In addition, kickbacks to bankers for commercial loans are a routine occurrence in both public and private banks in India.

The enforcement risks to bankers are very real. India’s central law against domestic corruption, the Prevention of Corruption Act, covers actions by public sector banks and bankers. A recent court decision extended coverage of the act to private sector bankers.

And while conviction rates in India for such offences are typically very modest, the pain inflicted by an investigations is a very real threat. Bankers fear that investigative agencies will continue to routinely look into legitimate business decisions, according to industry sources. As a consequence, public sector lending volume has declined significantly in the past year. The government is publicly discussing some form of protection for banks and bankers to help ameliorate the threat of prosecution, but the political sensitivities involved in such a program are significant.  

So while the effectiveness of the bankruptcy code will take years to assess, there are some immediate practical implications.

Anyone investing or acquiring a business with loans in India needs to scrub those obligations very carefully for potential corruption or other risks. Tax authorities in India are also aggressive in inspecting any re-evaluation of assets. The potential for political involvement in routine commercial activities involving loans is significant and difficult for outsiders to predict.

As for Indian banks and bankers -- until the political environment cools and the bankruptcy regulations mature, they should lawyer up and keep their heads down.


Russell Stamets is a Contributing Editor of the FCPA Blog. He was the first non-Indian general counsel of a publicly traded Indian company and was general counsel for a satellite broadcasting joint venture of a large Indian business house. He'll be a speaker at the FCPA Blog NYC Conference 2016.