Why Investors and Banks Must be Protected When Firms and Tycoons Go Bankrupt

Why Bankruptcies are Inevitable and How the Indian Laws Handle the Process

Bankruptcies are painful and messy affairs which must be avoided at all costs.

However, in Free Market Economies, it is inevitable that Business Tycoons and Firms go bankrupt due to the ravages of the Boom and Bust cycles.

When such events happen, the Arbitrators and the Liquidators who oversee the bankruptcy process ensure that the assets of the firms and the tycoons are seized and then dispose them off to pay off the creditors.

In recent years, the Corporate World and especially in India was witness to several high profile bankruptcies including the Kingfisher and its high flying owner, Vijay Mallya, the so-called King of Good Times and the Anil Ambani led firms that was also characterized by the personal default of the former.

these and other several such cases led the Indian Government to pass a Bankruptcy Act that would formalize the bankruptcy process and ensure that there is an orderly and just and transparent monetization of the assets and the protection of the Investors and the Banks thereby. Indeed, the whole idea behind the Act was to protect interests of the investors and the banks.

How the Indian Realities Saddle the Banks with NPAs and Burden the Investors

However, this situation exists in theory and in practice; there have been several instances including the aforementioned cases where Investors are yet to get back their money, lenders, including banks are yet to be paid back the loans they have given.

Given the tedious and the cumbersome process that bankruptcies usually become, there must be some tempering of expectations from the investors, the lenders, and the banks.

However, even in a realistic timeline basis, Indian courts and the Arbitrators have been extremely slow in executing the aftermath of the bankruptcies that have been aided by the system of appeals and counter appeals in the NCLT or the National Company Law Tribunal.

In addition, it does not help that many of these Tycoons are powerful and well connected and on the “right side” of the ruling dispensation, which is more than eager to help them instead of the banks and the associated investors.

The problem with this approach is that it creates a situation known as Moral Hazard in addition to burdening the banks with Distressed Loans and saddling them with NPAs or Non Performing Assets.

This in turn impacts the common person as lending and borrowing become difficult and lethargic.

What is Moral Hazard, Why It Must Not Be Encouraged, and Sending the Right Message

Let us review what Economic Theory has to say about Moral Hazard.

This term refers to the practice of incentivizing Bad Behaviour and Rewarding Risky Business Practices by encouraging those who indulge in them and worse, penalize those who played by the rules.

While the Theory of Moral Hazard has always been used to explain these cases, it is only after the Great Recession of 2008 that it is being used extensively.

In a manner similar to which the Regulators and the Federal Government in the United States let banks off the hook during the Great Recession, the Indian Judicial and Executive as well as Legislative branches too seem to be going easy on the Indian Tycoons, several of whom, even fled the country leaving the investors and the bank High and Dry.

Indeed, this is precisely the reason why the Indian Banking System is in a Mess as none of the High Profile Borrowers whose loans turned sour are being held accountable thereby sending a wrong message to the others that risky lending and reckless borrowing would be encouraged.

Thus, the Moral Hazard of such questionable practices harms the entire system creating a vicious cycle of bankruptcies and crises.

What the World Can Learn from the Chapter 7 and Chapter Bankruptcy Laws in the US

Having said that, it is not that this situation cannot be remedied.

To start with, if the personal assets of the Tycoons are seized and then disposed off quickly to pay off the investors and the banks first, then there would be a smooth recovery process.

After all, Bankruptcies are meant to let the firms and the Tycoons start afresh and hence, the laws must enable the Rejuvenation rather than the Regression of Business.

On the other hand, the courts too must be given a mandate to speed up the cases and the trials that involve High Profile Businesspersons.

Indeed, in the United States, the Chapter 7 and the Chapter 11 bankruptcies are designed with a view to ensure speedy and just disposal of the assets and the resolution of liabilities.

Given that the Indian Economy is being fashioned into such a Free Market Model, the Indian Government must let the Market Forces resolve the bankruptcies rather than meddle in the process.

This is the so-called Hidden Hand of Markets at Work that was theorised by the Pioneer of Modern Economics, Adam Smith.

Therefore, the way to go would be to protect Investors and Banks from the effects of bankruptcies.

Ensuring Justice to All

Last, it should also be noted that Defaulters and those who run away leaving a mess behind must be held accountable as well.

While we are not advocating a Trial by Media or a Vengeful Hunt of the Tycoons who default, there must be some personal responsibility that must be attached to them so that at least future businesspersons do not draw the wrong lessons and repeat the same behaviour.

Indeed, the whole purpose of the Bankruptcy process must be to deliver justice to the employees as well.

To conclude, bankruptcies are inevitable and they must be handled with care.

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