India: What "Friendly" Bankruptcy Code Meant For Failed Startups… Fail Fast, Fail Cheap, And Move On!!

Last Updated: 22 September 2016
Article by Harvinder Singh

There has been a remarkable, and rather unfortunate, trend in India of startups shutting shop within a few months of their initiation. These comprise of services ranging from food and grocery delivery to fashion and logistics services and included the likes of PepperTap, Ola Store, Fashionara, Klozee, Dazo, Spoonjoy, Langhar, DoneByNone, TalentPad, to name a few. The trend is more prevalent in e-commerce and more specifically e-commerce platforms which are bleeding money due to heavy cash funded business model, which take several years of hard work, persistence and patience to break-even.

Bankruptcy is likely to be the last thing the founders of these ventures have in mind. Some of these failed startups have admitted the reasons behind closure: these range from premature or early expansion of the business across cities due to investor pressure despite lack of funds to sustain the same, inability to hold on their own against competition, inability to sustain deep discounts, unfit business models for the Indian market, high customer retention costs and technological and logistical challenges. Any lingering on with the business would have meant debt increasing with every day of operation and risk of personal losses.

However, as easy as it may have seemed for these founders to start their ventures by way of easy access to initial funding from various investors, the Indian legal framework has not been kind to such failed startups where it comes to quick and clean closures of their businesses. There are multiple overlapping laws and adjudicating forums dealing with financial failure and insolvency of companies and individuals in India such as Companies Act, 2013, the Limited Liability Partnership Act, 2008, the Sick Industrial Companies (Special Provisions) Act, 1985, the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, the Presidential Towns insolvency Act, 1909 and the Provincial Insolvency Act, 1920.

A lengthy liquidation process with an uncertain outcome add to the financial distress of already struggling company and serve as a powerful disincentive for those thinking of opening up shop.

Modi Government recognized that there is a direct link between "Friendly" bankruptcy laws and increased entrepreneurship, and introduced the Insolvency and Bankruptcy Code, 2016 ("Code"). The Code offers a uniform, comprehensive insolvency legislation encompassing all companies, partnerships and individuals. It strives to lay down processes which will deal with the same in a time bound manner and enhance growth in the value of assets of such entities and individuals.

The first and most significant feature of the Code is resolution of corporate insolvency within a 180 days' period, which is further extendable by 90 days. These timelines ought to encourage more entrepreneurs to venture into startups, without fear of the cumbersome and time-consuming task of closing their startups in case of failure and allowing for an easy and clean exit from the same. The Code proposes a new institutional framework, consisting of a regulator, insolvency professionals, information utilities and adjudicatory mechanisms to ensure a time bound insolvency resolution process.

One of the fundamental features of the Code is that there are provisions for Insolvency Resolution Process, which allow creditors to assess the viability of a debtor as a business decision, and agree upon a plan for its revival or a speedy liquidation. This is a significant departure from the existing position under which the primary onus to initiate a reorganisation process lies with the debtor, and lenders may pursue distinct actions for recovery, security enforcement and debt restructuring.

During the Insolvency Resolution Process, there are provisions for 'calm period' during which no judicial proceedings for recovery, enforcement of security, disposal of assets, or termination of essential contracts can take place against the debtor.

Similar to UK insolvency laws, Insolvency Resolution Process will be administered by 'Resolution Professional' who will take over the management and operate the business as a going concern under the broad directions of a committee of creditors.

For corporate entities, the adjudicating authority for insolvency and bankruptcy proceedings shall be the National Company Law Tribunal ("NCLT"), which has finally been set up by the Ministry of Corporate Affairs, only recently on June 1, 2016. If the creditor's committee does not approve a resolution plan within 180 days (or within the extended 90 days), then NCLT can pass an order of liquidation and impose a moratorium on the pending legal proceedings against the corporate debtor, and the assets of the debtor (including the proceeds of liquidation) vest in the liquidation estate.

The flow of distribution of the sale proceeds from the liquidation estate, is also noteworthy and falls in the following manner of priority :

  • Costs of insolvency resolution process and liquidation;
  • Workmen's dues for up to 24 months prior to liquidation commencement date and debts owed to secured creditors who have relinquished their security
  • Employees'(other than workmen) wages for up to 12 months prior to liquidation commencement date;
  • Unsecured creditors;
  • Dues to Central and/or State governments;
  • Any remaining debts and dues;
  • Preference shareholders;
  • Equity shareholders or partners.

Though the Code does look promising, it remains to be seen how the proposed framework will take off once the bodies and professionals described there under including Insolvency and Bankruptcy Board of India, which will be a regulator for all insolvency and bankruptcy related matters, have been established and resolution proceedings for corporates commences under the Code.

However, all in all, the Code would be welcomed by startups and entrepreneurs looking to venture into fresh and innovative territories in India. After all, failure, although painful for the entrepreneurs is not bad for the economy and offering a fresh start to such an entrepreneur by protecting his potential for future earnings from old claims, is an initiative in the right direction. So, now in India startups can afford to 'Fail Fast', 'Fail Cheap', and 'Move On'.

This article has been published in under the section ReTales- Blogs by Retails Gurus

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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