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| “There is a clear need for changes in the Indian legal regime” |
There are a number of ways insolvent companies can restructure or liquidate in India. They can wind-up under the Companies Act 1956 (the Act); use schemes of compromise or arrangement under the Act; restructure under the Sick Industrial Companies (Special Provisions) Act 1985 (Sica); carry out informal corporate debt restructuring governed by the Reserve Bank of India (RBI) and reconstruct assets under the Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.
While most of the regulatory regime is contained in the above, certain entities incorporated under various specific statutes, including public sector banks and insurance companies, are governed by such statutes and the above mentioned laws may not be applicable.
This article sets out the general legal regime governing insolvency and restructuring of companies in India as well as proposed legal reforms.
Winding-up
The court or the National Company Law Tribunal (NCLT), when made effective by notification, may order the winding up of a company in certain circumstances, including inability to pay its debts or the shareholders resolving to wind up the company. The company, its creditors or shareholders may initiate the process by filing a petition.
A company may be voluntarily wound up if its members pass a special resolution (75% majority) to that effect or on the expiry or occurrence of a period or event (specified in its articles). If the company is solvent and the directors make a declaration to this effect, the liquidator may be appointed by the shareholders. However, if the company is not solvent, a creditors' meeting must be held to discuss the company's affairs and the creditors will have the right to nominate a liquidator. Where this differs from the liquidator appointed by the shareholders, the creditors' nomination will prevail.
Upon an order for winding-up, the estate of the company shall vest in the liquidator for purpose of its administration and for payment of debts. The company would stop carrying out its business except for its winding-up process. No legal proceedings can be initiated and no pending proceedings against the company may be continued except with the leave of the court or NCLT. If the company has entered into certain transactions, or created any floating charges, within a certain period prior to the winding up, the same may also be set aside by the court or NCLT.
Distribution of assets and priority of payments
The creditors must establish that their debt is in order to participate in the distribution of the assets of the company. Secured creditors can either enforce their security outside the winding up process (their security being subject to a pari passu charge towards workmen's dues) or relinquish their security and prove their claims before the liquidator at par with unsecured creditors. Foreign creditors have the same rights as those available to Indian creditors and have to prove their debts before the court or NCLT.
Subject to the rights of secured creditors and workmen's dues, the sale proceeds of the assets of a company shall be distributed in the following order of priority:
(i) Preferential payments: all revenues, taxes, and other amounts owed to the government and the wages or salary due to the workers shall be paid first.
(ii) Creditors' dues: The dues of the unsecured creditors and such secured creditors who have relinquished their security shall be paid next; and
(iii) Surplus amounts: the surplus, if any shall be paid to the shareholders.
The Act does not provide any timeframe for the winding up of companies and the same is usually fairly protracted, taking an average of 10 years and often yielding low recoveries and significant losses in the value of assets.
Legal reforms
The government has introduced the Companies Bill, 2008 (Bill) before the parliament. The Bill proposed making several changes to the company law of India including changes to the law that governs winding up. The key elements are as follows:
(i) NCLT: the Bill reintroduces the concept of the NCLT and attempts to address the concerns which had previously hindered its notification and establishment.
(ii) Time period: The Bill attempts to reduce the time period required for winding up an Indian company.
(iii) Involvement of professionals: The Bill seeks to use the services of professionals like chartered accountants and company secretaries to act as the company liquidators. The Bill also makes a provision for registered valuers for shares and asset valuations.
(iv) Summary process: The Bill provides for a summary process of winding-up for certain categories of companies.
However, the Bill has not yet been ratified and lies pending before the legislature.
Compromise or arrangement under the Act
Debtor companies may enter into a scheme of compromise or arrangement with their creditors or members, under the Act. In a compromise with creditors, the creditors affected by the scheme are divided into appropriate classes and a meeting of each class is conducted to obtain their consent to the scheme. The scheme must be approved by a 75% majority of creditors in each class present and voting at the meeting. The NCLT or court must sanction the creditors' meetings, as well as the scheme after its approval by each class of creditors. The approved scheme will also bind the dissenting creditors. The NCLT or court would ordinarily sanction the scheme approved by the majority creditors unless it believes that such a scheme is unfair or detrimental to the interests of the company. While sanctioning the scheme, the NCLT or court may modify it or stipulate additional conditions; however, it would not examine the commercial merits of the scheme. The company may apply to the court for a moratorium in respect of all actions by its creditors pending the approval of the scheme.
This process has been successfully carried out in several recent cases. Although it can be a time consuming process, because the NCLT or court would have to hear all objecting creditors, it is effective in binding dissenting creditors once the majority have agreed.
Legal reforms
The proposed Bill provides certain changes in this regard, key examples being:
(i) Regulatory notifications: Requirement to send notification of meeting to multiple regulators including the RBI, the Securities and Exchange Board of India (Sebi) and the Competition Commission
(ii) Dissenting parties: An increase in the threshold of shareholding or debt required for dissenting shareholders or creditors to voice objections.
(iii) Disclosure: Increased disclosure requirements for applying to court or NCLT for meetings.
Restructuring under Sica
Under Sica, if a company with one or more industrial undertaking, were to become sick (its accumulated losses are equal to or exceed its net worth), the company's directors are obliged to refer the company to the Board for Industrial and Financial Reconstruction (BIFR). If the BIFR is satisfied that restructuring is appropriate, it will appoint an operating agency (usually the lead lender) to prepare a restructuring scheme. Under Sica, the powers conferred on the BIFR for restructuring a sick company are very wide and once it sanctions a scheme, it is binding on the members and creditors of the company.
The main problem with this process is that once that company has been referred to BIFR, there is an automatic statutory moratorium on enforcing security and initiating legal proceedings against the debtor. This process also did not provide a timeframe for rehabilitating a company and was difficult to implement because the consent of each creditor had to be obtained in respect of any concessions or reliefs required to be granted under the scheme.
The process has been extensively used by companies but is viewed largely as a means of defeating creditor claims. It rarely results in successful restructuring because of either delays in preparing the scheme or objections by the company or the affected creditors.
The Act was amended in 2002 to make up the NCLT (which has also been entrusted with the task of reconstructing sick companies) and introduced provisions such as no automatic moratorium, a fixed timeframe and the requirement for industry experts to be involved in preparing the scheme. However, these amendments have not yet been notified and therefore have no legal effect.
The proposed Bill also provides the following key changes to the law relating to revival and rehabilitation of sick companies:
(i) Scope: the provisions shall apply to any company and not just an industrial company.
(ii) Reference: reference may be made only if the company has been unable to repay within 30 days of a demand from secured creditors of a company representing at least 50% of its outstanding debt. This is a significant shift from the earlier position of non-repayment of any amounts on demand from a creditor within the three consecutive quarters or accumulated losses in any financial year equal to 50% or more of its average net worth during four years immediately preceding such financial year.
(iii) Creditor's role: The NCLT has had much of its discretionary powers stripped and the creditors have a very dominant role in proceedings once the company is deemed to be sick. In the event that the creditors do not approve the scheme for reviving the company, the tribunal shall have to order winding-up of the company.
Corporate debt restructuring
Companies with multi-bank financing and outstanding debts of more than Rs100 million ($2 million) may be restructured by their creditors under the corporate debt restructuring scheme (CDR Scheme). The restructuring scheme must be approved by the creditors within 90 days (extendable to 180 days) of submitting the case to the restructuring process. Once 75% of the lenders by value and 60% in number agree to the scheme, it becomes binding on all creditors. However, the CDR guidelines also offer exit options to any creditor that does not agree to the restructuring package. A dissenting creditor can sell its stake to any majority creditor at a price to be agreed, or to any other lender that agrees to be bound by the terms of the restructuring.
This system is purely contractual and operates on the basis of a creditor-debtor agreement and inter-creditor agreements, and outside the BIFR and other legal proceedings. Accordingly, it is restricted to those creditors that have acceded to the relevant contractual arrangements (most Indian banks and financial institutions). However, non-CDR signatories are allowed to join the CDR mechanism on a case-by-case basis. The CDR signatories have agreed not to initiate legal proceedings for debt recovery and enforcement of security while the process is pending.
This system is fairly quick and has been widely used by Indian banks in several recent cases. From December 31 2008, cases involving Rs90,888 crores have been referred to CDR of which 173 cases involving an aggregate debt of Rs84,510 crores have been restructured. The CDR Scheme has emerged as an effective platform for out-of-court restructurings, especially in multi-lender exposure cases.
The Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 (SRFAESI)
The SRFAESI provides for establishing asset reconstruction companies (ARCs), which manage non-performing loans acquired from creditors. It envisages a competitive private sector ARC model, with no direct government support. The SRFAESI grants certain special rights on ARCs, including the right to take over the management of a company and appoint any number of people to the board of directors. However, this right is suspended and cannot be exercised until such time that the RBI does not issue guidelines for the exercise of the same. This process therefore remains untested.
One advantage of this legislation is that it allows secured creditors (if 75% by value exercise any of the self-help remedies available) to decrease any procedure pending before the BIFR. Also, no reference may be made to the BIFR where secured creditors have taken enforcement measures under the SRFAESI.
Conclusion
The importance of a robust and effective legal framework governing insolvency and restructuring of corporate entities has been underlined in the context of the global economic slowdown. The insolvency regime remains largely unsatisfactory despite recent initiatives of the government and the RBI and there is a clear need for changes in the Indian legal regime in this regard.
The following issues remain outstanding and must be addressed to bring the existing insolvency into line with international practices:
- Enact a comprehensive bankruptcy code;
- Establish the NCLT as a common authority with full competence for winding-up, including powers to rehabilitate and revive companies;
- Time-bound bankruptcy proceedings;
- Procedures for the quick sale of available assets and subsequent adjudication of claims and distribution of proceeds, and
- A dedicated bench of judges as a bankruptcy court and replace the role of official liquidator with insolvency practitioners, professionals and experts.
The Bill, which remains pending before Parliament, incorporates several, but not all, of the above suggestions and is also broadly in line the principles of the UNCITRAL Legislative Guide on Insolvency Law. It is expected to be placed, possibly with several modifications from its present draft, before the new legislature following the upcoming elections. It is vital that the final form of the legislation addresses the issues enumerated above and provides the necessary legislative framework, especially in the present economic scenario.
| Author biographies |
Cyril Shroff
Amarchand & Mangaldas & Suresh A. Shroff & Co.
Cyril Shroff is a managing partner at Amarchand Mangaldas with 25 years of experience in a wide range of practice areas, including corporate, banking, infrastructure amongst others. Cyril has been consistently rated as India's top corporate, banking and project finance lawyer by several international surveys including those conducted by International Financial Law Review (IFLR), Euromoney, Chambers Global, Asia Legal 500, Asialaw and others.
A leading practitioner in the field of securities law, Cyril has been associated with a significant number of high-profile and complex mergers & acquisitions and securities market transactions by Indian issuers. He has been a member of several government and other regulatory committees on law reform concerning corporate and securities market, bankruptcy laws, commercialisation of infrastructure, etc.
Cyril has authored several publications on legal topics. He is a part time lecturer of securities law at the Government Law College. He is a member of the Centre for Study of the Legal Profession established by the Harvard Law School and a member of the Advisory Board of National Institute of Securities Markets. He has also participated in several Technical Assistance (TA) projects of the Asian Development Bank in relation to the reform of laws relating to secured lending, bankruptcy and other related topics.
He is a solicitor, High Court of Bombay, since 1983. |