India Does Not Have a Composite Law Dealing with Insolvency of Companies. While Sick Industrial

PREFACE

India does not have a composite law dealing with insolvency of companies. 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.

On 30August 2001, Mr. Arun Jaitley, the Union Minister of Law, Justice and Company Affairs introduced in the Lok Sabha,[1] the Companies (Amendment) Bill, 2001 and the Sick Industrial Companies (Special Provisions) Repeal Bill, 2001. 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, the law presently in force in India to deal with the revival and rehabilitation of companies 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.

This paper brings out some of the salient provisions of both the existing legislations and highlights some of the draw backs in them as experienced over the last many years. It also discusses, briefly, the reasons for the complete failure of Sick Industrial Companies (Special Provisions) Act, 1985 as a legislation enacted for turning around sick companies.

The paper points out some of the significant changes proposed to be introduced by way of the new enactments. The analysis of the new provisions and the suggestions made in the last chapter of the paper are however, strictly authors own opinion based on his perception of the proposed legislations.

A. The history and evolution of insolvency laws in India 4

Corporate Insolvency4

B. The prevailing corporate insolvency system 5

Sick Industrial Companies (Special Provisions) Act, 19855

Board for Industrial and Financial Reconstruction (BIFR)5

Structure of BIFR5

Invoking jurisdiction of SICA5

Sick Industrial Company6

Registration of Reference6

Enquiry by BIFR6

Preparation and sanction of scheme 7

Operating Agency7

Circulation / Sanction of scheme8

Winding up of sick industrial company8

Suspension of legal proceedings and Contracts9

Appellate Authority 9

2. Companies Act, 1956 9

Cases in which a company may be wound up by the court 9

Who can present the petition for winding up ?10

Power of court on hearing petition 10

Appointment of Official Liquidator11

Custody of company's property11

Voluntary winding up11

Application of insolvency rules in winding up of insolvent companies 11

Stay of legal proceedings on winding up order 12

Preferential payments12

C. Authors anaylsis of existing laws13

Sick Industrial Companies (Special Provisions) Act, 198513

Failure to revive sick companies 13
A heaven for defaulting companies13
Procedural and legal delays13
Defective policy for appointment of members to BIFR14
Inadequate strength of BIFR14
Defective trigger point to invoke SICA jurisdiction14

2. Companies Act, 1956 14

Lengthy procedures14

Bureaucratisation of winding up proceedings15

Onset of reforms in insolvency and related laws16

Setting up of Eradi Committee16
National Tribunal17
Winding up of companies17
Liquidators17
Sick Industrial Companies (Special Provisions) Act, 1985 18
Cross-Border Insolvency18

Broad features of the proposed Bills 20

National Company Law Tribunal20
Jurisdiction of NCLT20
Structure of proposed Tribunal20
Invoking jurisdiction of NCLT21
Sick industrial company21
Net worth21
Declaration of sickness22
Enquiry by NCLT22
Preparation and sanction of scheme 22
Operating Agency23
Circulation/Sanction of scheme23
Winding up of sick industrial company24
New time frame 24
Appellate Tribunal24
Cases in which company may be wound up by the court 24
Formation of Rehabilitation and Revival Fund25
Appointment of Official Liquidator25

Authors perception of the new bills26

Comprehensive Bankruptcy Code26
Road Map to bankruptcy26
National Tribunal 26
Over Burden27
Time frame for filing reference27
Definition of net worth and sick industrial company27
Certificate by Auditors28
Lack of severe penal consequences28
Suspension of proceedings28
Trustees28
Bankruptcy proceeding for banks and financial institutions 28
International insolvency in India29

F.Conclusion30

A: THE HISTORY AND EVOLUTION OF INSOLVENCY LAWS IN INDIA

CORPORATE INSOLVENCY

The first Indian Act, regarding companies, was the Joint Stock Companies Act, 1850, based upon the English Act of 1844. This Act was replaced in 1857 which underwent a number of amendments from time to time. Presently, the said Act is in operation in the form of Companies Act, 1956. The Companies Act, 1956 deals with winding up of companies.

However, the Companies Act, 1956 did not deal with the revival and rehabilitation of companies.

The Reserve Bank of India set up the Tiwari Committee to look into the causes of industrial sickness, assess the depth of problem and suggest remedial measures.

In 1985, based on the recommendations of the Tiwari Committee, Sick Industrial Companies (Special Provisions) Act, 1985 was enacted for expeditious determination, by a panel of experts, of the ameliorative, remedial, preventive and other necessary steps and strict enforcement and implementation thereof, to arrest sickness, as far as possible.

B: THE PREVAILING CORPORATE INSOLVENCY SYSTEM :

As stated earlier, India does not have a composite law dealing with insolvency of companies. While Sick Industrial Companies(Special Provisions) Act,1985 (hereinafter also referred to as SICA) deals with the revival and rehabilitation of corporate entities, the Companies Act,1956 deals with their liquidation and winding up. Following are the salient features of both the legislations:

1. SICK INDUSTRIAL COMPANIES (SPECIAL PROVISIONS) ACT, 1985

Board for Industrial and Financial Reconstruction

The Legislation is basically and predominantly remedial and ameliorative in so far as it empowers the quasi judicial body, Board for Industrial and Financial Reconstruction(hereinafter also referred to as BIFR) to make appropriate measures for revival and rehabilitation of potentially viable sick industrial companies and for liquidation of non-viable companies.

Structure of BIFR

BIFR comprises of a Chairman and not less then two and not more than fourteen members and shall be persons who have been or are qualified to be High Court judges or are persons or ability and integrity and have special knowledge and professional experience of not less then fifteen years in the field of science, technology, economics, banking industry, industrial reconstruction, investment, law, labour matters, industrial finance, industrial management, accountancy, marketing, administration or any other matter.

Invoking jurisdiction of SICA

SICA requires that when an industrial company has become a sick industrial company, the Board of Directors of the said company shall, within sixty days from the date of finalisation of the duly audited accounts of the company for the financial year as at the end of which a company has become a sick industrial company, make a reference to BIFR for determination of the measures which shall be adopted with respect to the company. However, if the Board of Directors has sufficient reasons even before finalisation of accounts to form an opinion that the company has become a sick industrial company, it shall, within sixty days after it has formed such an opinion, make a reference to the BIFR.[2]

The Central Government or Reserve Bank of India or a State Government or a public financial institution or a State level financial institution or a scheduled bank may, if it has sufficient reasons to believe that any industrial company has become a sick industrial company under SICA, make a reference in respect of such company to the BIFR.[3]

Sick Industrial Company

For the purposes of SICA, a sick industrial company means an industrial company (being a company registered for not less than five years and employing fifty or above workmen) which has at the end of any financial year accumulated losses equal to or exceeding its entire net worth.[4] Net worth[5] has been defined as the sum total of the paid up capital and free reserves. For the purposes of networth, “free reserves” means all reserves credited out of the profits and share premium account but does not include reserves credited out of re-valuation of assets, write-back of depreciation provisions and amalgamation.

Registration of Reference

The reference filed by a sick industrial company or by any of the parties prescribed under SICA is registered by the Registry of BIFR and notice is sent to all the secured creditors of the company, the State Governments and concerned statutory authorities.

Enquiry by BIFR

On a reference received, the BIFR may make such inquiry, as it may deem fit for determining whether the company has become a sick industrial company.[6] If BIFR deems necessary or expedient so to do for the expeditious disposal of an inquiry, it may appoint any Operating Agency to enquire into and make a report with respect to such matters as may be specified in that order. If the BIFR comes to the conclusion that the company is not a sick industrial company, it shall reject the reference.

Preparation and sanction of scheme

If after making an inquiry about the sickness of the company, the BIFR is satisfied that a company has become sick, the BIFR shall decide whether it is practicable for the company to make its net worth exceed the accumulated losses within a reasonable time. If the BIFR decides that it is practicable for a sick company to make its net worth exceed the accumulated losses within a reasonable time, the BIFR shall give such company, such directions as it may deem fit to make its net worth exceed the accumulated losses.[7]

If the BIFR decides that it is not practicable for a sick industrial company to make its net worth exceed the accumulated losses within a reasonable time and it is necessary in the public interest to adopt remedial measures, it may direct any Operating Agency to prepare a scheme providing for such measures in relation to such company as it considers necessary from out of the parameters laid down under the Act.[8]

The Operating Agency, if possible, prepares a scheme providing, inter alia for any one or more of the measures – the financial reconstruction of the sick company by change in or take over of the management of the sick company; the amalgamation of the company with any other company; the sale or lease of a part or whole of any industrial undertaking of the sick company; the rationalisation of managerial personnel; such incidental, consequential or supplemental measures as may be necessary; change in Board of Directors etc.[9]

Operating Agency

The Operating Agency acts as an extended arm of the BIFR. Generally, BIFR appoints any financial institution or bank on its panel to act as the Operating Agency. The role and responsibility of the Operating Agency is to, on the basis of the information furnished by the company and out of its own experience and expertise, prepare, if possible, a scheme for the rehabilitation of the sick industrial company in accordance with the guidelines set out by the BIFR and assist BIFR in the discharge of its functions.

Circulation / Sanction of scheme

Where the scheme prepared by the Operating Agency relates to preventive, ameliorative, remedial and other measures with respect to any sick industrial company, it may provide for financial assistance by way of loans, advances or guarantees or reliefs or concessions or sacrifices from the Central Government, State Government, any scheduled bank or other bank, a public financial institution or state level institution or any institution or other authority to the sick industrial company.

Every such scheme is required to be circulated to every person to provide financial assistance for its consent within a period of sixty days from the date of such circulation, If no consent is received, it is deemed that consent has been given and the BIFR shall sanction the scheme and on and from the date of such sanction, the scheme shall be binding on all concerned.

If the consent so required is not given, in that case the BIFR may adopt such other measures, including the winding up of the sick industrial company, as it may deem fit.

Winding up of sick industrial company

Where the BIFR comes to the conclusion that it is not possible to revive the company and that it is just and equitable that the company should be wound up, it shall record and forward its opinion to the concerned High Court. The High Court, on the basis of this opinion, may order winding up of the company and may proceed and cause to proceed with the winding up of the sick industrial company in accordance with the provisions of the Companies Act, 1956.[10]

Suspension of legal proceedings and Contracts

Where in respect of an industrial company, an inquiry is pending or any scheme is under preparation or consideration or a sanctioned scheme is under implementation or where an appeal is pending, no proceedings for the winding up of the industrial company or for execution, distress or the like against any of the properties of the industrial company or against its guarantor or for the appointment of a Receiver shall lie or be proceeded with further except with the consent of the BIFR or as the case maybe, the Appellate Authority.[11]

Appellate Authority

There is an Appellate Authority for Industrial and Financial Reconstruction (AAIFR) which comprises of a retired High Court Judge and other members. The AAIFR hears appeals from the parties aggrieved by the orders of BIFR.

2. COMPANIES ACT, 1956

Companies Act, 1956 inter alia deals with the winding up or liquidation of the companies incorporated under the said Act. The winding up of a company under the Companies Act, 1956 can be by an order of court or voluntary. The voluntary winding up, however, can also be carried out under the supervision of the court.

Cases in which a company may be wound up by the court

(a) The court may wind up a company[12]

(i)if the company has by special resolution resolved that it be wound up;

(ii)if the company does not commence its business within a year from its incorporation, or suspends its business for a whole year;

(iii)if it is unable to pay its debts[13] ;

(iv)if a default is made in delivering the statutory report to the Registrar or in holding the statutory meeting ;

(v)if the number of members is reduced in the case of a public company below seven and in the case of a private company below two ;

(vi)if the court is of the opinion that it is just and equitable that the company should be wound up;

Who can present the petition for winding up ?

An application to the court for the winding up of a company, can be by way of a petition presented[14]

by the company ;

by any creditor or creditors including contingent or prospective ;

by any contributory or contributories;
by the Registrar of Companies;
in a case falling under Section 243 of the Companies Act,1956, by any person authorised by the central government in that behalf.[15]

Power of court on hearing petition

On hearing a petition, the court may dismiss it or adjourn it conditionally/unconditionally or make any order of winding up or pass any interim order or make any other order as it may deem fit, including appointment of Provisional Liquidator.[16]

Appointment of Official Liquidator

An Official Liquidator appointed by the Central Government shall be attached to each High Court who shall be a whole time officer unless the Central Government considers that there will not be sufficient work for a whole time officer in which case, a part time officer may be appointed.[17]

Custody of company's property

Where a winding up order has been made or where a Provisional Liquidator has been appointed, the Liquidator shall take into his custody or under his control all the property, effects and actionable claims to which the company is or appears to be entitled. All the property and effects of the company shall be deemed to be in the custody of the court as from the date of the order for the winding up of the company.[18]

Voluntary winding up

A company may be wound up voluntarily when the period if any, fixed for the duration of the company by the Articles has expired or the event, if any, has occurred on the occurrence of which the Articles provide that the company is to be dissolved and the company in general meeting passes a resolution requiring the company to be wound up voluntarily or if the company passes a special resolution that the company be wound up voluntarily.

Application of insolvency rules in winding up of insolvent companies

In the winding up of an insolvent company, the same rules shall prevail and be observed with regard to debts provable; the valuation of annuities and future and contingent liabilities; and the respective rights of secured and unsecured creditors as are in force for the time being under the law of insolvency with respect to the estates of persons adjudged insolvent provided that the security of every creditor shall be deemed to be subject to a pari passu charge in favour of the workmen to the extent of the workmen’s portion therein and where a secured creditor instead of relinquishing his security and proving his debt opts to realise his security, the Liquidator shall be entitled to represent the workmen and enforce such charge .

Stay of legal proceedings on winding up order

When a winding up order has been made or the Official Liquidator has been appointed as Provisional Liquidator, no suit or legal proceeding can be commenced, or if pending at the date of the winding up order, can be proceeded with against the company except by leave of the court and subject to such terms as the court may impose.[19]

The court which is winding up the company shall have jurisdiction to entertain or dispose of any suit or proceeding by or against the company; any claim made by or against the company.

Any suit or proceeding by or against the company which is pending in any court other than in which the winding up of the company is proceeding may be transferred to and disposed of by that court.

Preferential payments

In the winding up of a company, workmen’s dues and debts due to secured creditors to the extent such debts rank parri passu with such dues, shall be paid in priority to all other debts. The debts payable shall be paid in full unless the assets are insufficient to meet them in which case they shall abate in equal proportions.[20]

C: AUTHORS ANAYLSIS OF EXISTING LAWS