A weak resolution environment is negative to promote entrepreneurship
COVID 19 exposes the vulnerability of MSMEs in the face of uncertain events. This shows a need for a robust resolution mechanism to deal with creditors and find a viable path forward.
I met with a group of partners of a restaurant business who had been doing extremely good till the COVID 19 pandemic started. The format was very unique in the industry and has the potential to be replicated elsewhere. In fact, the promoters had drawn an ambitious plan to expand the footprint through the franchisee route to take it is to different parts of the city as well as pan India. Pandemic and consequent sudden lockdown had made the calculations go haywire.
The business just slipped out of control. They could not salvage the business. The creditors and suppliers demand was too much to bear with. The bank loan which was well within the normal level till the lockdown suddenly became too much to digest as there was no income flow. The leased property, wherein they invested more than Rs 1 crore to create a unique theme, had to be demolished as the rent payment becomes burdensome. With the removal of the store from the place which was part of their brand, there was no chance to return to the normal business. The condition deteriorated to the level beyond their imagination in the wildest of dream and all happened in just a matter of a few months.
Now the partners are helplessly watching the unfolding of recovery actions from the multiple lenders who have extended business loan at a high rate of interest with a short maturity.
The absence of policy support to deal with uncertain times is the central issue
The pandemic was unanticipated rather an uncertain event. Equally the lockdown was sudden and there was no time to think of alternative options. None of these was under their control.
Today we are in a situation wherein there is no regulatory or legal framework to enable entrepreneurs troubled by uncertain events to carve out a viable path to return to normalcy. The uncertain events affect all in equal measure. However, what is missing is a legal framework that will distribute the pain without letting anyone in the contract to be benefitted or remain unaffected whereas another the party will remain in an advantageous position at the previous level or better. For instances when the lender is a party to the contract, the borrower undergoing the uncertain event will remain indebted to the fullest extent because there is no statutory binding for the bank to sacrifice a fraction of the loan to make the business viable or allow to service the debt with a haircut and a longer schedule.
This unequal position in fact deteriorates the situation further as it will bring in too much uncertainty in the minds of entrepreneurs who will have to deal with the enlarged ego of the other party. This will divert the focus away from resurrecting the troubled business and end in the destruction of the enterprise. Destruction of an economic enterprise brings agony to not only the entrepreneurs & his family but also but the larger society as it will also suffer loss in many ways.
This unequal position is not a stand-alone event affecting a few. It is visible very widely. The entrepreneur will have to answer the same question from many others such as suppliers, unsecured creditors, tax authorities etc. They in turn will have to face a similar situation with others. In all, it is a challenge for the whole society.
Thus there is a need for a standing mechanism to support those victims of uncertain events. The mechanism should be able to help them to withstand the immediate pressure on cash flow and stabilise the business. Once the business returns to normalcy they should be compelled to make the payment to obligors be it bank, creditors suppliers alike.
In the face of uncertainty, the most important support an entrepreneur require is to stand firmly against the wind flow and thus preventing the run on the business. This will create breathing space and allow the firm to review its business and find a viable path forward.
In the process, it may require the creditors have to make a sacrifice in the immediate future with or without a clawback option to recover the loss in the medium to long term depending upon the circumstances and viability.
Resolution support in India:
There were few attempts to create a window of opportunity for distressed firms to review and rework a path forward. The very comprehensive support mechanism was enshrined in the 2015 circular of the Govt of India (Framework for Revival and Rehabilitation of MSMEs). It indeed addressed the concerns. Unfortunately, it suffered from the lack of enforceability of the guidelines. Rather it remained a wishful policy framework and its adoption is purely voluntary.
However, enactment of the Bankruptcy Code in 2016 had raised hope for many. Though Insolvency and Bankruptcy Code (IBC) has the power and scope for stressed business firms to seek relief as in many advanced countries, it is not fully implemented covering all types of the constitution rather limited to LLC(Limited Liability Companies) and LLPs(Limited Liability Partnerships). For the rest, though the law provides for, Govt has not notified yet.
It is time for Govt makes IBC law accessible to all forms of businesses uniformly. There were apprehensions that bankruptcy tribunals will be overwhelmed with litigations. It is not the correct position. Because having an option in the hand will facilitate dialogue among the creditors with the firms and will help to find a viable solution voluntarily. If you look at the history of litigations in Bankruptcy Tribunals(NCLTs), the voluntary understanding that arrived among the stakeholders forms a significant proportion of resolutions than otherwise.
MSME Prepack- A welcome step
There are discussions in various fora that the Govt will bring in a Prepackaged resolution solution under IBC to simplify the process and expedite the resolution for the benefit of MSMEs. The process under the pre-pack insolvency envisages formulation of a resolution plan before the initiation of a formal court process. It is a welcome step and it should be made available to all forms of the business including proprietorship firms and partnership firms along with LLCs and LLPs.
Resolution support de-risks the operating environment and hence promotes entrepreneurship:
A populous country like India needs to encourage entrepreneurship to create employment opportunity and improve the competitiveness of the economy. However the journey of entrepreneurship is filled with experiments, adventurism, and itself is a learning curve for many. It is unlikely to be smooth and cannot be predicted to proceed as planned.
Having a support mechanism for those who may suffer along the path of the entrepreneurship journey to revisit the journey will create a great enabling environment for many to take entrepreneurship. In the long run, the country will win.
A law like IBC is much needed for businesses at this point in time than ever in the history of organized business because the uncertainty in the operating environment is at an elevated level. The entrepreneurs require a sense of assurance through the legal framework to seek a solution if the business proposition fails to yield the desired result. This way the resolution support can promote entrepreneurship.