AIIFL Symposium on
Corporate Rescue in China:
Chinese and Comparative Perspectives
7 October 2002
Insolvency Experts’ Local Questionnaire
Response of Sumant Batra (India)
1. Background Information
A. India is an Agriculture based developing economy. Pursuant to attainment of independence in the year 1947, India embarked on the path of industrialization in order to attain self-reliance for the needs of the country. However, due to lack of infrastructure conducive for rapid industrialization, the initial thrust was given for development of infrastructure through various programs sponsored, funded and aided by the Government of India. The initial initiatives for development were aimed with a social objective with creation of Public Sector Enterprises controlled by the Government of India. Subsequently with active support of the Government through Financial Institutions and Banks owned and controlled by the Government, gradually economic development through initiatives of family owned business houses and individual entrepreneurship by way of Private Sector Enterprises also grew.
B. In view of the fact that initially setting up of various enterprises for development of country were aimed with a social objective with Government being in control and management of such enterprises, it lacked professionalism and business-man like approach to reap benefits and profits. Gradually with reduction in aid and funding from the Government and unprofessional management of the enterprise, the enterprises started suffering losses. Thus involvement of Government directly or indirectly through Government controlled agencies with a social objective contributed in unprofessional working, delays and red-tapism in taking appropriate decisions at appropriate and relevant point of time, which could be taken to be a systemic factor responsible for insolvency of the banking.
C. In India, at present there are two enactments relating to corporate insolvency, namely, (i) Sick Industrial Companies (Special Provisions) Act, 1985 ; and (ii) Companies Act, 1956. While Sick Industrial Companies (Special Provisions) Act,1985 deals with the revival and rehabilitation of corporate entities, the Companies Act,1956 deals with their liquidation and winding up.
In August 2001, the Companies (Amendment) Bill, 2001 and the Sick Industrial Companies (Special Provisions) Repeal Bill, 2001 were introduced in the Lok Sabha (Lower House of the Parliament). The Bills are the legislative products of the recommendations of Justice V.B. Eradi Committee which was set up by the Government of India in the year 1999 for remodelling the existing laws relating to insolvency and winding up of companies and bringing them in time with the international practices in this field.
The Bills, if passed in their present form will bring the curtains down on the Sick Industrial Companies (Special Provisions) Act, 1985 and will restructure the Companies Act, 1956 in a big way leading to the new regime of tackling corporate rescue and insolvency procedures in India.
D. The justice delivery system in India is in place and is respected by all. However, due to pendency of huge number of cases before it, the disposal of the cases is quite slow and as such, cannot be stated to be very effective.
2. Structure of Business Organizations
A-C. The business organizations in India can be broadly divided under two categories, namely, Public Sector and Private Sector. The Public Sector organizations are owned, controlled and managed by the Government. The Private Sector comprises of large, medium and small-scale enterprises owned, managed and controlled by private individuals, families or corporate bodies.
D. The business organizations are required to adopt the accounting standards prescribed by the Institute of Chartered Accountants of India. Usually the business organizations employ internal accountants and also have outside accountants.
E. In case of Companies incorporated and registered under the Companies Act, 1956, the Companies are required to file duly audited annual returns for each financial year before the Registrar of Companies. In case of a listed Company certain compliances are also required to be made with the Securities & Exchange Board of India.
F. In India, there is lack of strong ethos of corporate governance and disclosure. In order to overcome the lack of such ethos the Government of India is contemplating some changes in the Companies Act for corporate governance and disclosure.
3. Nature of Financing for Business Organizations
A. Sources of financing: The Banks and Financial Institutions (FIs) remain the major source of financing for Business Organizations in India. For the purposes of long/medium term financing normally the financial assistance is obtained from FIs. However, in the case of short-term borrowings, the source of financing could be either FIs or Banks. The source of financing also depends on the amount and nature of borrowing by a Business Organization. In case the amount of borrowing is large and for a long/medium term, the source of financing is normally FIs. The source of financing could be through equity participation either by public at large or through private placement or FIs/Banks in the case of a Company incorporated under the Companies Act, 1956.
B. Both the modes of financing, viz. debt and equity are employed in India by the Business Organizations. However, the percentage of debt remains to be more as compared to equity. In India, considerable percentage of business organizations are family owned and/or closely held and controlled by families and in such cases, the percentage of debt remains on a low side as compared to non-family owned or controlled business organizations. The finances are commonly raised by way of (a) Share Capital in case of Companies, (b) Long Term borrowings by way of Term Loans and (c) Short Term borrowings.
C. As stated above, the finances towards acquisition of fixed assets is normally of a longer duration/tenure i.e. Term Loans. The duration of Term Loan ranges from 5 years to 10 years. The requirement of long duration Term Loans or where the amount of Term Loans being large, has been catered to All India Public Financial Institutions, namely, Industrial Development Bank of India, IFCI Limited, ICICI Limited to name a few. Of late, the Public Sector Banks have also started lending Term Loans to Business Organizations, however, the exposure of Banks in the amount of Term Loans remains to be on a lower side as compared to All India Public Financial Institutions. The funds borrowed by way of Term Loans are primarily deployed towards acquisition of fixed assets, namely, land, building, plant and machinery etc.
For carrying out day-today operations the source of financing is working capital finances provided by Banks, internal resources of business organizations and short-term borrowings by way of unsecured or secured borrowings.
The borrowings by the All India Public Financial Institutions is secured by way of first charge by way of mortgage and hypothecation of the fixed assets. The personal/corporate guarantees of promoters are also stipulated. The current assets are normally charged as security for the working capital borrowings. In case, the exposure by way of working capital finance being large, the Banks also insist for a second charge on the fixed assets of the business organizations. As Banks also insist for personal/corporate guarantees of promoters as security for their exposure. In case of defaults on the part of the borrowing Business Organization, the remedy available to the Banks and the Financial Institutions is filing of suit for recovery before the court of law. In view of pendency of litigation involving large number of cases filed by the Banks and Financial Institutions before the courts, the Government of India in the year 1993 enacted an Act, namely, Recovery of Debts due to Banks and Financial Institutions Act, 1993 thereby establishing Special Tribunals for adjudication and disposal of recovery cases of the Banks and Financial Institutions against defaulter Business Organizations. Recently, the Government of India also promulgated an Ordinance, namely Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Second) Ordinance, 2002 whereby the Banks and Financial Institutions have been granted, amongst others to take over the charged assets and sell them without intervention of courts, subject to certain conditions as envisaged therein.
D. The normal lending practice of Banks is dependent both on cash flow as well as assets lending. In case of working capital financing, normally the practice is to make the limits available to the Borrowing Organizations subject to the cash flow as well as value of assets. Even the sanction, continuance, enhancement, decrease of limits etc. from time to time depends on the said factors.
E. In case of term lending, the disbursement of sanctioned loan amounts is made dependent on the completion of stages in development and/or establishment and/or procurement of the fixed assets for which the loan has been sanctioned. Periodic monitoring and submission of verification reports by an independent professional agency is asked for. In case of working capital finance, normally quarterly reports of cash flow statement and stock statement are called for to determine the extent of limits for the next quarter.
F. It is very difficult to identify the most common type of financing in India as the financing depends on the nature of financing being required by a particular Business Organization.
4. SECURED CREDITORS
A. The usual forms of security are :
(i) Equitable Mortgage over the Immovable properties of the borrower
(ii) Hypothecation over its Movable properties including book debts ;
(iii) Corporate/Personal Guarantees of the promoters/associated companies and individual properties ;
(iv) Opening of Escrow Accounts in case of very high value financing ;
(v) Pledge of Shares of promoters/promoter companies.
B. Commonly employed type of security-
(i) Immovable property – Mortgage
(ii) Hypothecation of Movable assets
(iii) Personal Guarantees of promoters
C. System of registration for any types of security -
Yes. The charge created over Immovable and Movable properties is required to be registered with the concerned Registrar of Companies. This is as per the requirement of Companies Act, 1956 (Sec. 127 of the Companies Act) to ensure a valid and legal charge over the assets of the Company
D. Priorities regulated between competing types of security –
If a particular security is charged under a Consortium financing, then all the members subject to their otherwise agreeing, have first pari pasu charge over the properties. However subsequent charge can also be created with another Lender with the approval of earlier charge holders and they may accede a first or a second charge. Normally the term loan lenders share first charge over immovable properties and the bankers (which extend working capital assistance) share charge over hypothecated assets. At times, however if the working capital assistance is on the higher side, the banks do have second charge over immovable properties and institution/term lenders vice- a –versa.
E. Available options open to a security holder to enforce its security interest-
Under the Recovery of Debts due to banks and financial Institutions Act, the secured creditors can file an Application for recovery of their debt and release monies due (more than one million rupees) out of the sale of the assets charged in the case the amount due is not paid. A mortgage suit can also be filled in the same form. Under the said act, an expeditious process is branded for disposal of Recovery Applications. If the amount is less than one million rupees, the proceedings have to be initiated in an ordinary Civil Court.
Recently, in August, 2002, the President of India promulgated an Ordinance on Asset Reconstruction and Realisation of Security Interest namely, Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Ordinance,2002 (Ordinance). Under the said Ordinance, the lender has been granted following powers with regard to its security :
§ Take-over of the management of the business of the borrower.
§ Sale or lease of a part or whole of the business of the borrower.
§ reschedulement of payment of debts payable by the borrower.
§ Enforcement of security interest in accordance with the provisions of the ordinance.
§ Settlement of the dues payable by the borrower.
§ Taking possession of secured assets.
In case the borrower is a corporate entity and it is ordered to be wound up, the official liquidator disposes of the assets under the supervision of the company court the secured creditors can file claims before the OL and receive the sale proceeds in order of provision set out in the companies Act. However the Secured Creditors have an option to remain outside the winding up proceeding and enforce securities before DRT.
F. Security holders self-enforce their interest-
In case of Lease Finance the secured creditors can enforce their rights by taking possession and selling the assets. However it is only private and public institutions, which opt for this means. Statutory corporation like financial corporations can dispose of the assets directly by taking possession and selling them by way of auction.
G. Though the legal system is quite in place and has been adequately strengthened over the past decade by way of reforms, the enforcement is not as effective as it ought to be. Though it is quite common to injunct the borrower for disposing of the assets, the appointment of Receivers, expeditious disposal of assets is still wanting. The delay depletes the value of assets and at the end of the day there are very few buyers for such properties/assets/securities. Also, most of the times because of depreciation, the securities even if sold do not fetch any thing close to the amount to be recovered.
H. There is no hard and fast rule on the straightjacket approach. If the difficulty of the corporate debtor is genuine and for reason beyond its control and the debtor has the potential to come out of the difficulty and service the debt, the creditors do consider restructuring of loan.
If the corporate is in difficulty because of mis-management and has lost the confidence of the creditors, distress proceedings are the only option exercised though One Time Settlement of dues is also considered if the value of securities is far less than the amounts due.
5. UNSECURED CREDITORS
A. The realization of debts owed by an Unsecured Creditor is very bleak and most of the time it has to be remain contend with left over, if any from the sale proceeds of the assets of the borrower charged to the financial institution or a bank. Most of the time, the Unsecured Creditors do make an attempt to find out the alternative uncharged assets of debtors and try to get them attached.