Corporate Insolvency And Restructuring
In Search of Efficient and Effective Law
Generally speaking, it is almost impossible to conceive of a business that is completely insolvency-free. Laws relating to corporate insolvency and restructuring seek to serve several objectives, namely, to restore the debtor company to profitable trading where this is practicable; to maximize the return to creditors as a whole where the company itself cannot be saved; to establish a fair and equitable system for the ranking of claims and the distribution of assets among creditors, involving a redistribution of rights; and to provide a mechanism by which the causes of failure can be identified and those guilty of mismanagement brought to book, and where appropriate, deprived of the right to be involved in the management of other companies.
And we all know that the legal framework for businesses to enable sustainable economic reform having focus on emerging economic scenario, good corporate governance and protection of the interests of the stakeholders, including investors, need efficient and speedy procedures for exit as much as for start-up. World over, insolvency procedures help entrepreneurs close down unviable businesses and start up new ones. This ensures an overall economic growth. Even though India has made much progress on economic reform since 1991, the economy is still limping by excessive rules and a powerful bureaucracy with broad discretionary powers which often goes against the general interests of business.
Although the Indian insolvency law has been an ardent follower of the UK insolvency laws, yet, while the UK has moved to a consolidated insolvency law, the similar well directed move is not forthcoming. Much has been said and done to bail out corporate insolvency and restructuring process in order to make the laws ‘efficient’ and ‘effective’; many a doctors have prescribed and administered ‘fair’ dose; numerous law making processes deliberated in recent years involving law makers, professionals and different interest groups, yet, for reasons unknown, the requisite teeth is still missing. It is wondered as to how a just less than a month is needed to register a business in India, but when it comes to winding up and revival of a company, it can drag as long as 10 years or even more in ‘appropriate’ case!
Apparently, weaknesses in the root of the Indian corporate insolvency & restructuring system are as follows:
• The Companies Act, 1956 governing liquidation has been working more of as time-consuming machine;
• Sick Industrial Companies Act 1985 (SICA) governing restructurings has been an abject failure being subject complete abuse by debtors seeking to delay creditors;
• Rampant asset stripping;
• Lack of machinery to provide credit bureau information to track delinquent debtors;
• Lack of sanctions against management resulting in poor corporate governance in insolvency situations.
Another concern which cripples as to who calls the shot for regulating the companies when it comes to corporate governance, there is a classic dichotomy in regulation. On the one hand, it is the Ministry of Company Affairs that is largely responsible for the implementation of the Companies Act, 1956, while it is SEBI (for listed companies) that is responsible for implementation of the corporate governance norms, which is contained in Clause 49 of the listing agreement. These are not mutually exclusive and there is bound to be overlap. However, a certain amount of confusion does prevail as to the separation of powers between the Ministry of Company Affairs and SEBI.
On a different note though, according to the Reserve Bank of India's (RBI in short) Review of the Recommendations of the Advisory Groups constituted by the Standing Committee on International Financial Standards and Codes in 2004, considerable progress has been made in improving bankruptcy laws in the country from the time the Standing Committee on International Financial Standards and Codes submitted its Report in 2002. Although it is far from satisfactory, when evaluated against the best practice norms, the situation has markedly changed since then. Several legal changes have materialized. Though a comprehensive law has not been enacted, the objectives of the same have been sought to be achieved through the changes to the Companies Act, 1956 by repeated amendment. In general, there has been an improvement in the corporate insolvency and restructuring regime.
Laws, Law-Making Initiatives And Their Effects
Laws relating to insolvency of companies in India is governed by the Companies Act 1956 and restructuring of ‘sick’ or ‘potentially’ sick companies in certain specified industries are covered under the Sick Industrial Companies (Special Provisions) Act 1985 (SICA in short). The Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (SARFAESI in short) provides for the establishment of asset reconstruction companies (ARC in short), which would undertake the management/realisation of non-performing loans acquired from secured creditors by taking over, change the management. While winding-up and schemes of arrangement are carried out under the aegis of the Courts, the Board for Industrial and Financial Reconstruction (BIFR in short) has been set up (under SICA) for the restructuring/rescue of sick companies.
There are other categories of companies incorporated under various specific statutes, including public sector banks and insurance companies are to go by liquidation and reconstruction process in accordance with government regulatory process and such are more of administrative in nature.
In 1981, the RBI appointed T. Tiwari Committee to examine the legal and other problems faced by the banks and financial institutions in rehabilitation of sick industrial units and to suggest remedial measures for effectively tackling the problem of sickness. Following the recommendations of the Tiwari Committee, the Government of India enacted the Sick Industrial Companies (Special Provisions) Act, 1985, (SICA) in order to provide for timely detection of sickness in industrial companies and for expeditious determination of the preventive, ameliorative, remedial and other measures and for enforcement of the measures. Although, the object of the Act was laudable, the Act was factually misused by the erring promoters' to defeat the object of the Act, the most notable of such provisions was the protection under Section 22 of the Act. Due to such inherent defects of SICA and again, for some unexplained reasons, BIFR failed to fulfill the purpose and mandate as envisaged therein.
Then came Justice V.B. Balakrishna Eradi Committee Report in 1999 recommending, inter alia, setting up of a National Company Law Tribunal (NCLT in short) to be vested with the functions and power with regard to rehabilitation and revival of sick industrial companies, a mandate presently entrusted with BIFR under SICA and forming of a liquidation committee consisting of creditors of the company in the lines of Section 141 of the Insolvency Act, 1986 of UK to assist the Liquidator and by adopting the necessary principles enunciated under International Monetary Fund’s propagated norms for ‘Orderly and Effective’ insolvency procedures. The statement (financial) of affair, which took the most time, is now to be filed, in case of voluntary winding up, along with the winding up application, and in case of an involuntary proceeding, at the time of the first defense. The liquidation program is bound to be time bound.
In 2001 came the Report of the Advisory Group on Bankruptcy Laws, called the N L Mitra Committee appointed by the RBI which made several recommendations on bankruptcy law reforms, the first among which was consolidation of bankruptcy laws into a separate code. However, no legislative steps have still been taken in this regard.
In line with the Eradi Report and long felt need and widespread criticism from different quarters, we saw the Companies (Amendment) Act, 2002 and repeal of SICA proposed to the new regime of tackling corporate rescue and insolvency procedures in India with a view to creating confidence in the minds of investors, creditors, labour and shareholders. The amended Act has suggested for change by combining the powers of the Courts, the BIFR and the CLB in one specialized NCLT in respect of liquidation of companies, schemes of arrangement/compromises and restructuring of sick companies, thus streamlining the regime. However, six years on, the intended Tribunal is yet to be constituted.
Then we saw JJ Irani Committee Report 2005 formulated to review the laws concerning liquidation and restructuring of the companies recommended several revisions to the Companies Act, more particularly for a transparent and globally acceptable insolvency and restructuring procedures, in short. According to the report, “it is important that the basic principles guiding the operation of corporate entities from registration to winding up or liquidation should be available in a single, comprehensive, centrally administered framework”. Having recognised the need for a single centre of control, the report goes off on a tangent on this issue. For instance, about the need to demarcate the respective jurisdictions of the MCA and SEBI, the Irani Report states that “this perception is misplaced”. More importantly, the report does not recommend which government or regulatory agency should be held principally accountable if there is gross incompetence or worse in the management of companies. Almost three years have passed since the Irani Report was finalised and submitted, companies law currently being revamped, yet to be put in place.
In the meanwhile, tireless efforts of the RBI need to be noted. The RBI approval is given to asset reconstruction companies under SARFAESI Act. Amongst approved, Asset Reconstruction Company India Limited (ARCIL in short), a loan player, thereby, has been very active in assets reconstruction of the sick or potentially sick companies who are in default of repayment of loans. Recent changes in foreign investment policy allowing foreign direct investment in asset reconstruction companies is expected that pending licence applications will be processed expeditiously. According to the guidelines issued by the RBI, Indian banks excepting foreign banks, and financial institutions have entered into contractual arrangements for the Corporate Debt Restructuring (CDR) of companies with multi-lender involvement. The RBI has recently issued a revised set of CDR guidelines. The RBI recently issued separate guidelines for the restructuring of small to medium-sized enterprises (with less than Rs100 million in plant and machinery).
Lastly, the new Credit Information Companies Act of 2005 covers the rights and responsibilities of credit bureaus to both maintain accurate credit reporting and safeguard customer confidence.
Enforcement Of Security Interest And Equity
Corporate insolvency and restructuring proceedings are based on equity – and it may be an arguable issue as to whether a non-judicial body as the NCLT can deliver equitable justice. Despite welcome changes by Eradi and Irani Committee Reports, there is still a need for a thorough overview, from viewpoint of consistency, of at least two significant related fields:
As far as reorganization proceedings are concerned, the provisions inserted in the Companies Act are substantially a restatement of the existing provisions of the SICA. First of all, there is no delineation of the circumstances in which reorganization under Section 424A will be applicable, and those under which a winding up order may be passed under Section 433. For example, inability to pay a debt is a ground for winding up, which is also a ground for treating a company as a sick company. A creditor may possibly make reference/application under either provision, and since the adjudicating body is the same under both the provisions, there ought to be clear guidelines as to cases where revival should be the first consideration and those where liquidation shall be ordered. For instance, under the US Bankruptcy law, the Court must be satisfied that the recoveries under a reorganization plan will not be worse than those in case of a liquidation.
Secondly, enforcement of security interests, and enforcement of claims of special creditors is dealt with by several statues in India, including the SARFAESI Act in case of secured creditors being banks, Recovery of Debts due to Banks & Financial Institutions Act 1993 in case creditors being banks or financial institutions, and State Finance Corporations Act in case of creditors being State Finance Corporations, etc. So often it is found that enforcement overlaps with each other, thus creating confusion.
Most of these laws provide for sweeping security enforcement provisions, without regard to the equities and interests that Corporate insolvency and restructuring laws seek to preserve.
Enforcement of security interests by the secured creditor is a global norm, but in India, a special position has been conferred on the workers by proviso to Section 529, and Section 529A of the Companies Act. Workers have been put at par with the interests of the secured creditor: if this is true for winding up, it is difficult to understand why this should not be true in cases which will certainly lead to winding up. For instance, if floating charge-holders were allowed to enforce security interests under the SARFAESI by declaring a default, there would be no assets left with the company.
While this is sure to lead to bankruptcy of the company, the interests of workers that Section 529/529A seek to preserve are completely frustrated.
Having said so, we have found that the primary drawback of the Indian corporate insolvency and restructuring regime is the lack of a comprehensive law to do timely and equitable justice in today’s complex business scenario. Another argument rounds the corner is that the Indian in general has teething problems as regards its application and implementation. And hence, despite there being so much of deliberation, enactment and issuance of guidelines etc., laws as such remain allowed to be an academic realm rather than practitioners delight in its proper perspectives what it ought to be.
The Irani Committee has observed that there is a need to balance liquidation and restructuring processes, and has recommended the easy conversion of proceedings from one process to another, providing a reasonable opportunity for rehabilitation. It has further suggested that the option of rehabilitation should be extended to all insolvent companies, not just those with industrial undertakings. Further, the test for determining ‘sickness’ should be based on the principle of ‘liquidity’ rather than that of ‘negative net worth’. Further, the committee favours a limited standstill period where specifically requested with the approval of majority creditors. However, the committee’s recommendations are still under government scanner and have not been given a legislative force.
The SICA requires that a mandatory reference to the Board (BIFR) be made upon net-worth erosion. This criterion often results in a scenario where there is limited scope for rehabilitation. Further, the overall process takes a long time, with up to three or four years elapsing before the BIFR explores possible rehabilitation options and decides on winding-up by recommending to the High Court, proceedings begin afresh and the appointment of the official liquidator takes some time. And since the winding-up process is a protracted affair, resulting in low realisable value for creditors.
Several chambers of commerce and industry have suggested that the winding up provisions should be separated from the company law and a new insolvency Act enacted as India’s judicial system is more akin to that of the UK, the Insolvency Act, 1986 of the UK may be more suitable to the Indian circumstances. The insolvency law must take into consideration the protection to creditors and to enforce their respective claims against the company under liquidation, expeditiously, effectively and fairly.
Another concept of the Eradi Committee recommendation for a fund for revival, rehabilitation of companies and for preservation and protection of assets of the companies may be created under the supervision and control of the Government. Companies formed and registered after the establishment of the proposed NCLT are required to contribute annually a specified percentage, say 0.1 per cent of its turnover, immediately after commencement of the business. Existing companies have to contribute annually from the financial year immediately succeeding the year in which the tribunal is established. According to some, this may not be desirable. The charge is not against profits but against turnover which will put an extra burden for newly set up companies. How to define the term commencement of business is something is hotly debated, yet no convincing answer forthcoming. The same could lead to further litigations as has been our experience in the case of Income-Tax Act.
We have seen that genuine efforts have been made to formulate laws through recommendations, enactment etc. Yet, like any other branches of law, corporate insolvency and restructuring laws in India lacks teething. Authorities concerned need courage of conviction with clear mindset and will at heart in order to make the current laws more efficient and effective with an element of a definitive and predictable time frame. And the judicial process ought to take commercial approach towards revival of the sick companies. All supporting pillars i.e. accounting and auditing; statutory & legal framework; monitoring & enforcement; education & training; need to be strengthened and disciplined.
The corporate insolvency and restructuring laws should prescribe a flexible but transparent system for disposal of assets efficiently and at maximum value. Secured creditors’ claim should rank pari passu with workmen and government dues. The law should also provide for mechanism to recognize and record claims of unsecured creditors as well.
Finally, in the model of Public-Private-Partnerships (PPP) to facilitate corporate insolvency and restructuring, an Insolvency Fund with optional contributions by companies may be created with Government grants and incentives to encourage contributions by companies to the Fund. Companies which make contributions to the Fund should be allowed certain drawing rights in the event of insolvency. And since proposed Insolvency Fund shall have commercial element, the same may not be linked/credited to Consolidated Fund of India (or of a State).
This article is a product of practice experience of the author and legal research undertaken by him. Views expressed are his personal and mistake, if any, is his own. He is grateful to the Reserve Bank of India for the great contents posted in its website, Mr. R. Umergi, a noted expert; Mr. Sumant Batra, Insolvency Law expert and author’s one time guru; contents posted at Ministry of Company Affairs (MCA), International Association of Insolvency Regulators (IAIR) websites and writings of Prof Sir RM Goode, Mr. Vinod Kothari. The author also has been inspired by Reports of the Justice Balkrishna Eradi Committee, N L Mitra Committee and JJ Irani Committee, all on insolvency law reforms.
Due to limited scope, this paper aims to make an assessment of the legal provisions and the regime for insolvency in India and does not aim to criticize or provide a comprehensive review in itself of the insolvency regime, the provisions of the Companies Act, and the various Expert Committee Reports on Corporate Insolvency and Restructuring.
The author can be reached at: email@example.com