Insolvency is a state whereby an individual or company cannot pay back its lenders. In other words, it’s when someone is bankrupt. The harsh reality of businesses is that they can suffer financial distress as a result of many factors. Thereby, they suffer pressure from creditors. A sound insolvency regime strikes a balance between the competing needs of the debtors and the creditors. It means that a debtor prioritises debt repayment while the creditor seeks the best recovery, at times even through foreclosure.

For policymakers, sustained businesses and job creation are as important as protecting financial lenders. Lenders, such as banks, are handling the investment and lending stemming from the deposits of the common person. When lenders face uncertainty, it can destabilise the economy. At the same time, foreclosing businesses disincentivises entrepreneurs and fuels unemployment. Finding the right balance is all too critical. This is where a good insolvency regime can help!

The prime instrument that steers the country’s insolvency regime is a 25-year-old law, the Bankruptcy Act of 1997. It has not been revisited since it was enacted. In a fast-moving world financial system, investment-related policies need quick adjustment. Hence, it goes without saying that Bangladesh’s insolvency regime needs modernising. To Bangladesh’s credit, its government has declared its intention to amend the Bankruptcy Act of 1997. Investors will want to observe closely what this modernisation will look like.

The triggering factors

Insolvency is triggered when a debtor, say someone who took out a loan from a financial institute, finds it/him/herself unable to discharge the liability to pay what is due. When the debt grows beyond the assets of the debtor, by law the debtor becomes bankrupt.

In a situation of financial distress, unpaid loans, outstanding invoices, arrears of rents and unpaid salaries or taxes reach a critical point whereby all the creditors claim against the assets of the debtor. This can lead to liquidation of all of the debtor’s assets, causing bankruptcy. The debtor’s business may be shut down and people will lose jobs. This is a typical bankruptcy situation.

In a modern insolvency regime, this bankruptcy situation can be better managed. Here, the aim is to maximise the recovery rate for creditors while helping debtors continue doing business. Such regimes have been put in place in many economies, such as India and the US. Bangladesh should also move towards such a modern legal regime for a better investment climate.

The current state of affairs

Bangladesh’s prime insolvency instrument, the Bankruptcy Act of 1997, does not address financial distress and the insolvency component. It encompasses a narrowly construed process that forces bankruptcy. As its title suggests, bankruptcy is the only solution to the challenge here. Even within this, the Act covers only individuals: it misses out corporations. The Act is thus practically speaking ineffective for the commercial world. Moreover, the bankruptcy process has procedural issues that incur delays. This is frustrating for creditors.

Since 1997, there have been only a handful of bankruptcy proceedings in Bangladesh. As of mid-2022, 179 bankruptcy cases are pending in the courts, 111 of which were filed by financial institutions. Of these, 55% have been stayed by order of the country’s High Court. This means that these financial institutions are unduly unable to access their money.

In 2003, another landmark law in the insolvency regime, the Money Loan Court Act (locally called Artho Rin Adalat Ain), was enacted in Bangladesh. This was meant to provide a better solution for financial creditors. It was very popular with the banks and other financial institutions. However, it did not protect business creditors. This meant it was applicable to only one type of creditor. The main two prescriptions in the law were related to foreclosure and asset-selling for recovery.

Looking back, Bangladesh’s Money Loan Court Act of 2003 ended up yielding poor results, even for financial creditors. The recovery rate was USD 0.29 on the dollar. To put this in context, it is one-third of that of European countries. Meanwhile, the average recovery rate is USD 0.70 in Organisation for Economic Co-operation and Development high-income countries and USD 71.6 in India. The process is also time-consuming. What takes 4 years in Bangladesh takes only 1.6 years in India. In some European countries, like Ireland, it takes less than 120 days!

… Bangladesh’s Money Loan Court Act of 2003 ended up yielding poor results, even for financial creditors.

It is clear that the Money Loan Court Act of 2003 did not improve Bangladesh’s insolvency regime. Instead, it induced loss of employment and productivity in the economy.

The path forward

The days when asset liquidation could maximise a business’ value are dwindling. The value of a company is increasingly being based on its technical know-how, brand loyalty, goodwill and human skills, rather than its physical assets.

Liquidation is the easiest and quickest option for creditors. However, its low recovery rate means it is not impactful. Modern insolvency and bankruptcy practices have moved towards higher recovery processes. These preserve a debtor’s business through restructuring and transferring control to creditors. This is a common practice in the US, where liquidation laws are less pursued. Likewise, India modified its insolvency regime in 2016. India allows businesses in financial distress to continue without harming the creditors.

A reformed modern insolvency regime for Bangladesh can inculcate nine points:

1) Reorganisation and restructuring: Bangladeshi regulators can view reorganisation as a tool for insolvency practice. This also has a societal element. When debtors get a second chance, this will send a positive signal to the entrepreneur class. Overall, the private sector is bound to At the core of it all, it saves families who are affected by the closure of a business. A good model to follow here is the bankruptcy prediction model of the US. This outlines the process of reorganisation through the restructuring of debts.[1]

Alternatively, creditors can take the driving seat in the struggling business. They can oversee operations and steer the debtor’s business strategically, in the hope that it will become profitable. In this way, creditors are likely to recover more than the assets sold off. They could reconstitute the governing board and the executive management of the business in order to stake control, perhaps through a ‘creditors’ committee.’ This policy will make it easier for distressed Bangladeshi businesses to survive and protect their employees. A revised law would surely be more progressive than the existing framework.

2) Extending coverage to corporations: Under Bangladesh’s current legal structure, only an individual debtor can opt for bankruptcy. And only financial creditors can initiate the process. The usual means for this is the Money Loan Court Act of 2003, not the Bankruptcy Act of 1997. A revised law should introduce provisions for both corporate debtors and corporate creditors to initiate corporate bankruptcy. All corporate entities, debtors and creditors should come under the insolvency regime.

Furthermore, operational creditors should also be allowed to initiate proceedings if a debtor’s business starts going south. In this case, the operational creditor can mitigate its supplies to the concerned business while increasing its recovery probability without harming the business’ growth. There are good examples of this from around the world. The Bankruptcy Code in the US allows small businesses to file for relief under a fast-tracked process. Similarly, the Indian Insolvency and Bankruptcy Code recognises operational creditors and operational debt in the recovery process.

3) Revisiting the Money Loan Court Act of 2003: In Bangladesh’s current insolvency regime, creditors (the majority of which are banks and financial institutions) are forced to opt to use the Money Loan Court Act of 2003. The reason for this is that recovery is quicker (in four years on average) even if it is at a nominal amount of USD 0.29 on the dollar. This is a beggar’s choice for creditors. Unfortunately, insolvency stakeholders have become too comfortable with this arrangement. So, for meaningful reform to the law, the principle of reorganisation first needs to be introduced. Liquidation should be the next step, should reorganising fail. The core purpose should be to save the debtor’s business operation and its employees.

Currently, there are too many delaying tactics inscribed in the law. The reformed law must incorporate time efficiency and a ‘resolution plan’ clause in order to ensure stakeholders’ buy-in. Here, if resolution cannot be reached, the law should require an expedition so that creditors are not stuck for another four years.

4) Efficient time management: The timeframe of an insolvency proceeding in Bangladesh is usually long. The current four years under the Money Loan Court Act of 2003 should be scrapped. An insolvency proceeding should take place in real time, with a six- to nine-month timeframe to reach a resolution.

The timeframe of an insolvency proceeding in Bangladesh is usually long.

If the majority of the creditors cannot reach resolution, then an ‘insolvency practitioner’ can intervene with a three-month extension. Here, Bangladesh’s specialised Money Loan Courts play in to ensure that the timeline of 6 months (180 days) is effectively implemented. Implementing this reform will need two vital resources: trained regulated insolvency practitioners (also called resolution professionals) and judicial allocation.

5) Regulated trained insolvency practitioners: An insolvency practitioner acts as the bridge between the court and stakeholders during the bankruptcy negotiation process. They are critical in ensuring all dealings are fair, transparent and timely. Usually, an interim insolvency practitioner takes control of all assets, liabilities and operations of the debtor, and initiates a resolution plan negotiation. The interim insolvency practitioner records the claims of all creditors, and helps form a ‘creditors’ committee’ under the court’s supervision. Thereafter, the creditors’ committee can appoint a new insolvency practitioner.

It is clear that insolvency practitioners are vital to an insolvency regime. For Bangladesh, these professionals need to be formally trained, and regulated via licensing. Currently, conventional poorly experienced practitioners, who mostly deal with another old-age law, the Arbitration Act of 2001, play the role of insolvency practitioners. This needs to change with regulatory intervention.

6) Allocation of judicial resources: Judicial resources, particularly dedicated ‘bankruptcy benches,’ are crucial to a modern insolvency proceeding. This is needed in Bangladesh. At present, bankruptcy matters are shoulder to the ‘district judges,’ who are the senior-most judges at the district level. These judges are already overburdened with work. As a reform, a fast-track for commercial disputes or a dedicated judge at the local district level is needed. Their specific responsibility will be to address bankruptcy matters.

In Bangladesh’s case, there is no need to form a new special court for bankruptcy matters.

In Bangladesh’s case, there is no need to form a new special court for this matter. The existing mid-level ‘joint district judges,’ with support from the Supreme Court, should be enough, especially if there are professional insolvency practitioners in the system. This mechanism can be locally piloted in some high-commerce districts with bankruptcy cases. In this process, the existing Money Loan Courts can be further empowered. Streamlining the existing system will be the most efficient reform process.

7) Continuing operation as an ongoing concern: For Bangladesh to have a modern insolvency regime, foreclosure and asset liquidation cannot be the go-to option. The regime must allow a debtor’s business to continue as an ongoing concern, as part of the reform package. Reorganising the business should be the first priority. Otherwise, the cumulative cost to the economy is too high, whereby the foreclosure entails selloff of machinery, stocks and other assets, and destabilising the workforce. All for a recovery which, as the record shows, is just nominal share of the debt.

Continuing operation under financial distress means continuing business as usual. Here, all supplies and production should continue, while the recovery plan is implemented. The court should bar any discontinuation attempt, including permit cancellations. Such a policy has yielded good results in India, where the country’s bankruptcy code was reformed to help with the continuation of troubled businesses.

8) Automatic stay and relief from stay: The rationale behind reorganising a business with bankruptcy looming is to give it/him/her a second chance. This, of course, needs to be done in a controlled environment. Bangladesh’s current insolvency regime does not reflect this principle. The law should be revised, whereby all liquidation proceedings during reorganisation should be automatically stayed. If the automatic stay is being abused, creditors should be able to seek relief so that the time sought for resolution is well

9) Wilful vs innocent defaulter: In a reformed insolvency regime, it is imperative that the law distinguish clearly between a wilful and an innocent defaulter. A typical wilful defaulter will provide false information to obtain credit and does not honour the debt. An innocent defaulter usually suffers genuine financial distress owing to unforeseen circumstances. The benefits of reorganisation should apply only to innocent defaulters. A debtor who plays foul during a reorganisation process should also be disqualified from the benefits. India’s bankruptcy code is a good example to look into in this case.

Concluding remarks

Bangladesh’s insolvency regime is archaic, and much below international standards. It needs modernisation. The country’s regulators are aware of this. Bangladesh’s go-to agencies, the Ministry of Finance and the central bank, are set for a revision process.[2] Reform to such a crucial regime will have a change-impact. This needs to be optimised. Any amended law should include the recommendations in this article, such as business restructuring procedures and a time efficiency clause. These changes will put Bangladesh at par with international standards.

This is also a rights issue. A modern insolvency regime will protect the debtor and the creditor alike. Implementing such a reform will not be an easy task. Bangladeshi regulators will have to comprehend global trends and then of course integrate domestic demands and commercial culture into the insolvency framework.

 

[1] Chapter 13 of the Bankruptcy Model of the US ensures a higher recovery rate through restructuring of debts, repayable in affordable instalments spanning a longer period.

[2] The Financial Institution Division in the Ministry of Finance is the lead here.

 

Photo ©️ Mahmud Hossain Opu

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Ferdausur Rahman is a partner of A.S & Associates and an advocate at the Supreme Court of Bangladesh. He is a lawyer. He specialises in labour issues, corporate governance and strategic investment. He was a legal consultant at the International Finance Corporation, Bangladesh Investment Development Authority and Bangladesh Power Development Board. He was the highest-rated lawyer in Asialaw’s Client Excellence Rating 2021. He pursued his graduate studies in Law at the University of London in 2006 and was called to the Bar of England and Wales by Lincoln’s Inn of the UK.
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Shenin Serjin Promi is a research associate at A.S & Associates. She is a lawyer and an entrepreneur. She is the co-founder of Bangladesh Thrift. She specialises in corporate regulation, labour and employment, e-commerce, start-ups and intellectual property rights. She pursued her undergraduate studies at the University of London.