The Insolvency of State-owned Enterprises

The Insolvency and Bankruptcy Code, 2016 (IBC) marked a significant turning point in India’s approach to resolving the financial issues of a company. The primary aim was to streamline the resolution process, improve credit culture, and protect stakeholders’ interests. When it comes to Insolvency of State-owned Enterprises (SOEs) implementing the IBC framework introduces unique challenges as it plays an important role in the economy. Thus, handling their insolvency demands balancing commercial and socio-economic factors throughout the process. 

Understanding SOE Insolvency – Legal & Economic Implications

What Are State-Owned Enterprises?

Insolvency of State-owned Enterprises are government-owned corporations or entities that are either wholly or partially controlled by the state. They generate most of their income from selling goods and services. For instance, public sector banks, oil companies, infrastructure corporations, and telecom firms.

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Why Do SOEs Face Financial Distress? 

Insolvency of State-owned Enterprises often face financial distress due to a combination of factors. Governments may prioritise social objectives over profitability, forcing SOEs to operate in unprofitable markets or provide subsidized services, leading to financial strain. Many SOEs operate under political influence, leading to non-performing assets (NPAs) and unsustainable debt burdens. As they are government-owned, such entities may not face the same competitive pressures as private companies, leading to complacency and reduced efficiency.  Government interference slows down resolution efforts, increasing financial losses. Further, SOEs face restrictions in restructuring due to labor laws, subsidies, and political considerations.

Legal Framework for SOE Insolvency Under IBC

The IBC is the primary law in India that covers insolvency for individuals and corporate entities, including Insolvency of State-owned Enterprises , unless explicitly exempted. While any creditor can file an IBC application against an SOE, the government often needs to provide necessary approvals before the process can proceed due to the sensitive nature of such entities. Under section 3(7) of the IBC the definition of “corporate person” applies to government companies as well. The IBC also protects actions taken in good faith by the government, its officers, and insolvency professionals in section 233. Further, section 238 grants the  IBC overriding authority over conflicting laws.

Challenges in Applying IBC to SOEs

Government Ownership & Policy Interventions: Governments create SOE to address market failures and improve social welfare, which can create challenges for monitoring performances. As governments shape decision-making and structure as shareholders, policymakers, and regulators, can lead to conflicts of interest and ultimately affect creditor negotiations.

Public Interest Concerns: The socio-economic responsibilities of SOEs, particularly in providing essential services, make liquidation an option that is not viable. The politically sensitive nature of SOEs means that their insolvency may lead to corruption, governance, and impact economic performance.

Resistance from Employees & Unions: Layoffs and downsizing can have undesirable effects on those individuals who are terminated from the SOEs as the lack of pay, benefits, and meaningful work has negative implications for the financial aspects of employees and unions. Therefore, large-scale layoffs and salary reductions face strong opposition.

Case Studies – SOE Insolvency & Restructuring

The Supreme Court in the Hindustan Construction Company Ltd. ruled that the IBC applies to government companies that are not performing sovereign functions or are not instrumentalities of the State. The court also explained the treatment of the resolution process for Infrastructure Leasing & Financial Services (IL&FS). The court held that it was a financial services company that was promoted by the public sector and financial corporations. It was not an SOE but was a core investment company registered with the Reserve Bank of India. Therefore, IL & FS was an SOE-like entity with government backing and a government-appointed resolution framework was used instead of the insolvency process.

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Conclusion 

The IBC has significantly improved India’s approach towards resolving SOEs’ financial struggles. By enabling a more structured process for resolving distressed companies, the IBC has established an expedited and inclusive resolution for SOEs.  However, its application requires careful consideration because of the socio-economic importance of such companies. This means that the insolvency cannot be treated purely financially. Hence, there needs to be a policy-driven approach to balance economic stability with business resolution.