BY MEGHANA SRINIVAS
LEGAL INTERN, H.K. LAW OFFICES
INTRODUCTION
The globalisation of economy invited its own set of pros and cons. An issue that has assumed greater significance is that of corporate insolvency.
The realms of cross-border insolvency law has multiplied on a macro level considering that the Indian economy opened up its gates for investments made by foreign creditors, alongside the Indian Corporates making investments in foreign companies.
An insolvent company is one wherein the assets aren’t adequate to pay off its liabilities and debts. The two-fold explanation for the same could either be because they face cash-flow insolvency[1] or due to balance-sheet insolvency[2].
Unlike the process of liquidation, where the company is made to close down, there exists a broad connotation that as long as a failing company remains economically viable, it should be subjected to a re-organisation process. This would mean, engaging in a process where the costs are cut, debts are renegotiated, and the company may be downsized, in order to return to profitable operations.
The legal paradigm governing cross-border insolvencies[3] face several challenges in todays World. The absence of a comprehensive CBI framework is the chief among them. The following conflicts between legal systems results in the wastage of numerous valuable resources. It also leads to disparate treatment of foreign and domestic creditors, which can be very problematic. A few important attempts to address these concerns include: the EC Regulation on Insolvency Proceedings[4], The UNCITRAL Model Law on Cross-Border Insolvency[5], International Bar Association Cross-Border Insolvency Concordat[6] and the American Law Institute’s NAFTA Transnational Insolvency Project[7].
This article aims to evaluate the current standing of corporate insolvency laws in India, the impact it has had on companies and a macro level analysis of the same.
EVOLUTION AND DEVELOPMENT
In India, the line of insolvency laws can be segregated principally under two fronts:
Personal Insolvency, which deals with partnership firms and individuals governed by Provisional Insolvency Act, 1920 and Presidency Towns Insolvency Act, 1908 and Corporate Insolvency, which resulted in the winding up of the company under the Companies Act, 1956.
Now coming to Corporate Insolvency– With regard to corporate law, the word “insolvency” has neither been defined nor used. However, Section 433 (e) of the Companies Act[8] paves the way for clarification. The inability of a company to pay its debts would essentially mean a company’s entire capital is lost [in heavy losses], and no accounts are prepared and filed, resulting in a hiatus for business for a time period of one year. In such a circumstance, the Registrar of Companies[9] will make out a case of inability to pay debts. These debts, however, would be restricted to the losses incurred after the legal incorporation of the Company. The provision has been amplified in Section 434 of the Companies Act.
In 1999, the Government of India created a High-Level Committee headed by late Justice V.B. Balakrishna Eradi to remodel the existing laws relating to Insolvency and winding up of companies and bringing them on par with the international practices which existed in the field.
The Committee completed its work with 8 substantive proposals and submitted its report to the Government in 2000. This resulted in the Companies (Amendment) Bill, 2001 and the Sick Industrial Companies (Special Provisions) Repeal Bill, 2001, which were introduced in the Parliament of India. These Bills, if passed in their present form, would bring the curtains down on the Sick Industrial Companies (Special Provisions) Act, 1985 and will restructure the Companies Act, 1956 in a huge way leading to a new regime of tackling corporate rescue and insolvency procedures in India with a view to establish confidence in the minds of creditors, and shareholders.
Issue of Lack of extra territorial jurisdiction-
Insolvency laws in India neither contain extraterritorial jurisdiction nor do they recognize the existing jurisdiction of foreign courts in respect of foreign banks that operate in India. Meaning that if a foreign company is taken into liquidation outside India, the Indian business would be treated as a separate issue and would not be affected automatically unless an application is filed before an insolvency court for the winding up of its branches in India.
Taking into account the recommendations made by the Eradi Committee have been translated into the Companies (Amendment) Bill, 2001 and the Sick Industrial Companies (Special Provisions) Repeal Bill, 2001 leading to the tribunalisation[10] of justice. Lastly, the misuse of the said forum in making an entry by feigning sickness/manipulating records exist and must be curbed by strict penal consequences for such misuse.
Currently, the GOI is considering adopting the UNCITRAL Model Law on Cross-Border Insolvency to meet the demands of globalization of the economy and deal with international Insolvency as a whole. This will radically change the orientation of Indian law and make it suitable for dealing with the challenges arising from the increasing integration of Indian economy with the world economy.
COMPARATIVE ANALYSIS WITH UNITED STATES OF AMERICA
Juxtaposing India and the United States of America.
To understand how insolvency codes are interpreted around the World, I will be doing a brief comparative analysis of the corporate insolvency codes in India and the United States of America.
The Indian Bankruptcy Code[11] is a recent invention.
The insolvency process in India previously included the simultaneous operation of multiple statutory instruments. Including (i) the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; (ii) the Recovery of Debt Due to Banks and Financial Institutions Act, 1993; (iii) the Sick Industrial Companies Act, 1985; and (iv) the Companies Act, 2013.
These statutes provided for a disparate process of debt restructuring and asset seizure and realisation to facilitate the satisfaction of outstanding debts. Despite this, a plethora of legislation dealing with Insolvency and liquidation has led to a confusion in the legal system, and there exists a grave necessity to overhaul the insolvency regime. A hamstrung court system and the existence of multiple legal avenues led to a huge pile-up of NPA[12] in India, resulting in the creditors having to wait for years to recover their money. The Code consolidates pre-existing laws relating to the Insolvency of corporate bodies and individuals into a single legislation. The Code has unified the law relating to the enforcement of creditors’ statutory rights and streamlined the way a debtor company can sustain their debt without annihilating the rights of creditors.
We find the following when we contrast this with the orderly state of play in a US bankruptcy scenario. Principally, the US framework puts the claim holders into three brackets: secured creditors, unsecured creditors, and equity holders.
Firstly, we have secured creditors who ought to conduct a robust credit appraisal mechanism, evaluating and factoring in the robustness of the business plan. In both the US and India, secured lenders have priority over other creditors. Lower-valued outstanding collateral is added to the secured pool in the US, and the balance goes into the unsecured pool. In India, the entire process is about recovery for secured lenders.
Secondly, we have unsecured creditors who ought to take a balanced risk and reward position. As part of a distressed company’s re-organisation in the US, unsecured creditors are expected to become the Company’s new owners and, therefore, have a key role in shaping how the Company emerges from bankruptcy. This is where there is a severe discord between the US and India regimes. In India, an operational creditor has little or no role to play.
Thirdly, we have equity holders who have gambled on the Company’s upside and lost. By virtue, this sect should go empty-handed. This principle is true for the both the US and Indian regime, but, practically, equity holders and management more often than not, do not go empty-handed. In India, large owner-managers have made back the money they put in multiple times over when a project is on the verge of bankruptcy. In the US, the same phenomenon manifests itself just before a Chapter 11[13] filing, when management issues large bonuses to themselves, presumably as compensation for operating in a ‘high risk’ environment.
The corporate bankruptcy provision in India has some way to go before it begins to approach the maturity of its US counterpart. Having said that, the creation of the IBC, while undeniably imperfect at present, is a significant step in the right direction for the bankruptcy resolution process in India.
CONCLUSION
In the process of liberalisation and deregulation, many restrictions on undertaking industrial activities have been withdrawn and relaxed.
Interference by the Government or court or any tribunal should only be in the event of any damage to the shareholders or under the Competition Act to prevent monopolies, fraud or restrictive trade practices. While undertaking reforms in the Insolvency Laws, the need to shift focus from strict regulation of the activities of companies to granting freedom to the industry in conducting its business activities arises while the norms for the protection of interest of stakeholders is laid down.
Alongside this, for the Insolvency law to be practical, it must be applied in tandem with other laws such as tax laws, the debt recovery laws and labour law. The debt recovery laws, if effective, can discourage solvent debtors from abusing the reorganisation process. These recovery laws must provide for the enforcement of both secured and unsecured debts.
SUGGESTIONS
When it comes to corporate Insolvency, the intricacies that surround the legal process can be cumbersome. To tackle the same it is of utmost importance that the provisions of the legislature protect the said companies, or rather provide an alternative. Creditors Voluntary Liquidation [CVL] is also a viable solution wherein the Company’s members declare that the Company can no longer satisfy its debts and are likely to become insolvent. Suppose a business is unable to meet its liabilities, the Company’s members must decide what action to take to maximize the return to creditors and avoid the plausibility of insolvent trading[14].
[1] When there isn’t enough revenue from sales being collected in the form of cash, the company risks failing to meet its short-term debt obligations such as loan payments.
[2] Balance-sheet insolvency is when a person or company does not have enough assets to pay all of their debts. The person or company might enter bankruptcy, but not necessarily.
[3] Hereafter referred to as CBI.
[4] Council Regulation (EC) no 1346/2000 of 29 May 2000 on INSOL… – eur-lex, EUR, https://eur-lex.europa.eu/legal-content/en/LSU/?uri=CELEX%3A32000R1346#:~:text=ACT-,Council%20Regulation%20(EC)%20No%201346%2F2000%20of%2029,May%202000%20on%20insolvency%20proceedings.&text=the%20recognition%20of%20legal%20decisions,of%20claims%20by%20foreign%20creditors. (last visited Jul 12, 2022).
[5] Cross border insolvency: Un model allows automatic recognition of foreign rulings The Indian Express, https://indianexpress.com/article/business/economy/cross-border-insolvency-un-model-automatic-recognition-foreign-rulings-7646416/#:~:text=The%20UNCITRAL%20model-,The%20UNCITRAL%20model%20is%20the%20most%20widely%20accepted%20legal%20framework,with%20cross%2Dborder%20insolvency%20issues.&text=The%20law%20allows%20automatic%20recognition,COMI%20for%20the%20distressed%20company. (last visited Jul 12, 2022)
[6] The cross-border insolvency concordat and its … – iiiglobal.org, https://www.iiiglobal.org/sites/default/files/2-_Landolt_0.pdf (last visited Jul 12, 2022)
[7] The American Law Institute Nafta Insolvency Project, https://core.ac.uk/download/pdf/228611042.pdf (last visited Jul 12, 2022)
[8] Provides that in cases where the company is unable to pay its debts the court can order winding up. The expression ‘unable to pay its debts’ has to be taken in the commercial sense of being unable to meet current demands though the company may be otherwise solvent.
[9] The Registrar of Companies ( ROC ) is an office under the Ministry of Corporate Affairs (MCA), which is the body that deals with the administration of companies and Limited Liability Partnerships (LLPs) in India.
[10] The ‘tribunalisation’ of justice is driven by the recognition that it would be cost-effective, accessible and give scope for utilizing expertise in the respective fields.
[11] Hereafter referred to as IBC.
[12] Non-Performing Assets.
[13] Chapter 11 is a form of bankruptcy that involves a reorganization of a debtor’s business affairs, debts, and assets, and for that reason is known as “reorganization” bankruptcy. It is most often used by large entities, such as businesses, though it is available to individuals as well.
[14] Insolvent trading is the law under the Corporations Act section 588G that says that if a company is insolvent and a director allows the company to incur a new debt, then the director can be personally liable for the new debts incurred.
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