Brief Introduction of BIFR and its functioning
In the wake of sickness in the country’s industrial climate prevailing in
the eighties, the Government of India set up in 1981, a Committee of
Experts under the Chairmanship of Shri T.Tiwari to examine the matter
and recommend suitable remedies therefore. Based on the
recommendations of the Committee, the Government of India enacted a
special legislation namely, the Sick Industrial Companies (Special
Provisions) Act, 1985 (1 of 1986) commonly known as the SICA.
The main objective of SICA is to determine sickness and expedite the
revival of potentially viable units or closure of unviable units (unit here in
refers to a Sick Industrial Company). It was expected that by revival, idle
investments in sick units will become productive and by closure, the
locked up investments in unviable units would get released for
productive use elsewhere.
The Sick Industrial Companies (Special Provisions) Act, 1985
(hereinafter called the Act) was enacted with a view to securing the
timely detection of sick and potential sick companies owning industrial
undertakings, the speedy determination by a body of experts of the
preventive, ameliorative, remedial and other measure which need to be
taken with respect to such companies and the expeditious enforcement
of the measures so determined and for matters connected therewith or
incidental thereto.
The Board of experts named the Board for Industrial and Financial
Reconstruction (BIFR) was set up in January, 1987 and functional with
effect from 15th May 1987. The Appellate Authority for Industrial and
Financial Reconstruction (AAIRFR) was constituted in April 1987.
Government companies were brought under the purview of SICA in 1991
when extensive changes were made in the Act including, inter-alia,
changes in the criteria for determining industrial sickness.
SICA applies to companies both in public and private sectors owning
industrial undertakings:-
(a) pertaining to industries specified in the First Schedule to the
Industries (Development and Regulation) Act, 1951, (IDR Act) except the
industries relating to ships and other vessels drawn by power and;
(b) not being "small scale industrial undertakings or ancillary industrial
undertakings" as defined in Section 3(j) of the IDR Act.
(c) The criteria to determine sickness in an industrial company are (i) the
accumulated losses of the company to be equal to or more than its net
worth i.e. its paid up capital plus its free reserves (ii) the company should
have completed five years after incorporation under the Companies Act,
1956 (iii) it should have 50 or more workers on any day of the 12 months
preceding the end of the financial year with reference to which sickness
is claimed. (iv) it should have a factory license.
Restructuring and Liquidation
1. Businesses 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 that the human and economic resources of a
country are continuously rechannelised to efficient use thereby
increasing the overall productivity of the economy.
2. However, as businesses grow in size there is also a danger that
poor management, bad business judgement or plain fraud may
result in a business becoming unviable. In such cases it is possible
for the productivity of the enterprise to be restored at a low cost
and without attendant trauma for the stakeholders by providing
more capable managerial talent an opportunity to run it. In fact
recent times have shown possibility of growth by entrepreneurs,
some of them Indian, who have become dominant business
entities internationally by achieving turnaround of sick firms and
revitalization of dormant capacities.
3. The Indian system provides neither an opportunity for speedy
and effective rehabilitation nor for an efficient exit. The process for
rehabilitation, regulated by the Sick Industrial Companies (Special
Provisions) Act 1985 through the institutional structure of BIFR is
amenable to delays and does not provide a balanced or effective
framework for all stakeholders. The process of liquidation and
winding up is costly, inordinately lengthy and results in almost
complete erosion of asset value.
4. The Committee noted that a beginning towards reform was
made with the enactment of Companies (Second Amendment) Act,
2002, which in addition to significant changes in the restructuring
and liquidation provisions provided for the setting up of a new
institutional structure in the form of the National Company Law
Tribunal (NCLT)/Tribunal and its Appellate Body, the National
Company Law Appellate Tribunal (NCLAT). However, the process
is not complete and a lot yet needs to be done. The constitution of
the Tribunal is facing legal challenge and many parts of the
enactment have not yet been notified.
5. Globally, reform in insolvency processes is recognized as an
important means of improving competitiveness of any economy. It
is particularly so in Indian context. Under the supervision of the
United Nations Commission on International Trade Law
(UNCITRAL), a Legislative Guide on Insolvency Law and Model
Law on Cross Border Insolvency have been formulated and
circulated to all countries. Similar initiatives have been taken up by
other multilateral institutions. The Committee has had the benefit
of consideration of such initiatives. Occasionally, a doubt is
expressed as to whether developing countries should consider
incorporation of such legal frameworks. The Committee feel that
the Indian economy is now at a stage where articulation of a
comprehensive framework that addresses insolvency issues would
make a material difference to the productivity of the economy. The
Committee is of the view that a review of the system for
addressing corporate insolvency in the Indian context is urgently
called for and recommends the following to the policy planners in
India.
Insolvency Law
6.1 An effective insolvency system is an important element of
financial system stability. It is, therefore, essential to provide for a
sound framework for restructuring and rehabilitation of companies
along with a framework for winding up and liquidation. The
framework should seek to preserve estate and maximize the value
of assets; recognize inter se rights of creditors and provide equal
treatment of similar creditors while dealing with small creditors
equitably. It should enable a timely and efficient resolution of
insolvency and establish a framework for cross border insolvency.
The present framework does not provide a balanced resolution of
various stakeholder issues, is time consuming and inefficient. 6.2
Corporate insolvency should be addressed in the Company Law.
There is no need of a separate Insolvency Law for the present.
Liquidation and Rehabilitation
7.1 The Insolvency law should strike a balance between
rehabilitation and liquidation. It should provide an opportunity for
genuine effort to explore restructuring/ rehabilitation of potentially
viable businesses with consensus of stake holders reasonably
arrived at. Where revival / rehabilitation is demonstrated as not
being feasible, winding up should be resorted to. 7.2 Where
circumstances justify, the process should allow for easy
conversion of proceedings from one procedure to another. This will
provide opportunity to businesses in liquidation to turnaround
wherever possible. Similarly, conversion to liquidation might be
appropriate even after a rehabilitation plan has been approved if
such a plan was procured by fraud or the plan can no longer be
implemented. Committee noted that the Companies (Second
Amendment) Act, 2002 had brought about significant changes in
the provisions dealing with rehabilitation/winding up / liquidation of
companies in the present Act and had also proposed that an
institutional structure for the purpose be set up in the form of
NCLT/NCLAT. This Institutional Structure, which would provide the
desirable single independent forum is yet to be constituted. The
Committee hope that this is done speedily and are of the view that
its establishment would provide a major initiative for the reform of
the insolvency system in the country.
Focus on Rehabilitation
8. Law should provide a reasonable opportunity for rehabilitation of
a business before a decision is taken to liquidate it so that it can be
restored to productivity and become competitive. However this
opportunity should incentivize genuine effort. Special care should
be taken to ensure that this is not misused by any stakeholder to
delay proceedings, strip asset value or otherwise work to the
detriment of the business and other stakeholders.
Time bound proceedings
9.1 A definite and predictable time frame should be provided for
attempt at rehabilitation and for the liquidation process. The
existing time frame in India is too long and keeps precious assets
locked in proceedings for many years, destroying their value in the
process. 9.2 A period of one year should be adequate for
rehabilitation process from commencement of the process till
sanction of a plan. There should also be a definite time period
within which proceedings may commence from the date of filing of
the application for rehabilitation. 9.3 The process should limit the
possibility of appeals at every stage so that the process is not
delayed through frivolous appeals or stalling tactics. 9.4 On an
average a time frame of two years should be feasible for the
liquidation process to be completed. 9.5 A fixed time period should
be provided for each stage of rehabilitation and liquidation
process. Extension at every stage should be rare and allowed only
in exceptional circumstances and in any case without effecting the
outer time limit provided for the process.
Applicability and Accessibility
10.1 The Insolvency process should apply to all enterprises or
corporate entities including small and medium enterprises except
banks, financial institutions and insurance companies. 10.2 The
concept of sick industrial company should be replaced by insolvent
company or enterprise to bring it in harmony with the principles of
the proposed Insolvency Law. 10.3 Both Debtors and Creditors
should have fair access to the insolvency system upon showing
proof of default. 10.4 Rather than erosion of net worth principle,
test should prescribe default in payment of matured debt on
demand (liquidity test) within a prescribed period. The balance
sheet test tends to be more costly as it generally requires an
expert that the company may revive. 10.8 The law should require
the provision of relevant information about the Debtor to be made
available for effective consideration of the scheme. The law should
enable obtaining by the Tribunal, independent comment and
analysis of that information by experts.
Duties and prohibitions on admission
11.1 On admission of application for rehabilitation, the law should
impose certain duties and prohibitions to apply to debtors and
creditors for an effective resolution of Insolvency and balancing the
stakeholders’ interests in the process. 11.2 There should be an
automatic prohibition on Debtors’ rights to undertake transfer, sale
or disposition of assets or parts of the business. Permission may
be granted only to the extent necessary to operate the business,
with the approval of the Tribunal. This would protect the assets,
build confidence of secured creditors and encourage them to
participate in the insolvency process.
Summary Dismissal of proceedings
12. The law should vest with the Tribunal the power to summarily
dismiss the proceedings for not meeting commencement
standards with cost / sanction. Once rejected no further reference
should be maintainable. Filing of repeated references by debtor in
spite of earlier rejection has led to abuse of the process.
Moratorium and suspension of proceedings
13.1 A limited standstill period is essential to provide an
opportunity to genuine business to explore re-structuring. 13.2 The
law should, therefore, impose a prohibition on the unauthorized
disposition of the Debtors’ assets and suspension of actions by
Creditors to enforce their rights or remedies against the Debtor on
the assets for a limited prescribed period to preserve and protect
assets besides maximizing its value. This will facilitate
unobstructed conduct of Insolvency process by the Tribunal
without having to deal with complexities of multiple creditor actions
in Debt Recovery Tribunals to be insured in the law where there is
a compelling, commercial, public or social interest in upholding the
contractual rights of the counter party to the contract.
Governance/Management (Rehabilitation proceedings)
14.1 In regard to the potentially insolvent companies, it is essential
that self-regulatory measures be required to be taken by a
company to protect the interests of various stakeholders, preserve
assets and adopt such other on of stakeholders interest, the role of
Operating Agency envisaged under the existing law should be
performed by on independent Administrator or such other qualified
professional as may be prescribed. Currently banks and financial
institutions are appointed as Operating Agency. Engagement of
experts will also enhance the efficiency of process. The banks and
financial institutions should participate in the operation through
committee of creditors.
Governance/Management in liquidation
15.1 The management of the going concern should be replaced by
a qualified Administrator appointed by the Tribunal in consultation
with the secured creditors with board authority to administer the
estate in the interest of all stake holders. An independent
Administrator would be able to provide the best treatment to the
assets and preserve its value and take other necessary decisions
in the best interest of the business. 15.2 The law should provide
for Administrator to be able to prepare and file a scheme for
turnaround of the company, if the business is viable in which case
the creditors and ex-management should have an opportunity to
comment on the scheme. 15.3 The Administrator should have the
same obligation as the management to secured creditors with right
of information and supervision.
Governance : Secured Creditors and Creditors Committee
16.1 Secured creditors interests should be safeguarded by
establishing a Committee of secured creditors. The Committee
should enable creditors to actively participate in the insolvency
process, monitor the process, and serve as a conduit for
processing and distributing relevant information to other creditors
and organizing creditors to decide on critical issues. This would
provide a platform to all kinds of secured creditors to discuss the
divergent views and build consensus and agreement on the issues
that arise for consideration and decision. The process would also
assist in expediting the insolvency process. 16.2 Law should
provide for major decisions by general creditors assembly. There
should be rules for appointment of members in the Creditors
Committee and to determine the Committee’s membership,
quorum and voting rules, powers and conduct meetings. 16.3 The
Law should enable appointment of professional experts and
specialists by Creditor Committee to advise them on various
technical and legal issues. 16.4 Directors of a debtor corporation
should be required to attend meetings of Creditors Committee so
that the decisions can be made on a well informed basis.
Governance : Unsecured Creditors
17.1 Unsecured creditors have no representation in the
restructuring process. Lack of information leads to suspense and
anxiety on their part resulting in multiple legal and other
proceedings. This impacts the overall efficiency of the
rehabilitation process. 17.2 A separate Committee to represent
other categories of creditors and unsecured creditors and
stakeholders could be formed with limited right to represent and
hearing without right to vote on the plan and other decisions.
Separate and independent rules for appointment of the creditors
(other than secured) committee may be made with details of
procedures for membership, quorum and voting rules, powers etc.
17.3 Enabling provisions would be required to coordinate meetings
of unsecured and secured creditors to take decisions to move
claims. 17.4 The law should provide for mechanism to recognize
and record claims of unsecured creditors in preparation of the
rehabilitation plan.
Administration of Insolvency : Administrator and Liquidator
18.1 A panel of Administrators and Liquidators should be prepared
and maintained by an independent body out of professionals with
appropriate experience and knowledge of insolvency practice. The
panel should be of individual advocates, accountants, company
secretaries, costs and works accountants and other experts rather
than the firms so that the independence and accountability of
individuals may be determined. The panel should be prepared in a
fair and transparent manner. This would also ensure that
appropriate professionals who are appointed on the strength of
their knowledge and experience provide the service rather than the
other partners or colleagues in their firms. The law should however
provide power to the Tribunal to make exceptions to the rule and
appoint firms. 18.2 The Tribunal should have powers to appoint
Administrator and Liquidators out of the panel maintained by the
independent body and Official Liquidators from panel of officials
made available by the Government.
Identification, Collection, Preservation, Disposition of Debtor
assets and Property
19.1 Law should provide a framework that incentivizes
maximization of estate value. 19.2 The law should identify the
assets that constitute the insolvency estate including assets of
debtor (including those subject to security interest) and third party
owned assets (such as leased and hypothecated assets) wherever
located and provide for collection of assets forming part of
insolvency estate by Administrator/ Liquidator. In the cases of
rehabilitation, leased assets should form part of insolvency estate.
19.3 The law should provide for avoidance or cancellation of pre-
bankruptcy fraudulent and preferential transactions, completed
when the enterprise was insolvent or that resulted in its insolvency.
19.4 The suspect period prior to insolvency, during which the
payments are presumed to be preferential and may be set aside,
should be short to avoid disrupting normal commercial and credit
relationsValuation of debtor estate.
2.
20.1 The Tribunal should appoint accountancy experts /
professionals to ensure that true and fair picture of accounts of the
debtor enterprise and financial assets is available. 20.2
Independent experts may be appointed as valuers for valuation of
assets of a business concern under liquidation. 20.3 Debtors and
Creditors should have the power to scrutinize and challenge the
value before final order of fixing value. 20.4 There should be
powers for annulment in appropriate cases with
recovery/disgorgement.
Claims Resolution : Treatment of Stake holders Rights and
priorities on liquidation
21.1 The law should provide for prompt and interim distribution of
claims to creditors in line with priorities determined by law. 21.2
Rights and priorities of creditors established prior to insolvency
under commercial laws should be upheld to preserve the legitimate
expectations of creditors and encourage greater predictability in
commercial relationship. 21.3 The status of secured creditors
should be pari passu with employees in respect of their claims
after payment of claims related to costs and expenses of
administration of liquidation. Remaining proceeds
International considerations
Recommendations of the Committee
The Committee recommended that:
§ The jurisdiction, power and authority relating to winding up of
companies should be vested in a National Company Law Tribunal which
should 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.
§ The 1956 Act should be suitably amended to take the power away
from High Court and the transfer of the pending winding up proceedings
to the Tribunal.
§ The adoption of the international trend in law relating to corporate
bankruptcy, namely, sell the assets first as quickly as possible, and
relegate to a later stage the adjudication of claims and distribution of
proceeds.
§ An in depth assessment of the office of Official Liquidators, in view of
inadequate and incompetent manpower and absence of latest office
equipments and technologies.
§ A liquidation Committee consisting of creditors of the company on the
lines of Section 141 of the Insolvency Act, 1986 of UK be set up to assist
the Liquidator.
§ The repeal of SICA and recommended the ameliorative, revival and
reconstructionist procedures obtaining under it to be reintegrated in a
suitably amended form in the structure of the 1956 Act except that there
is no stand still provision like Section 22 of SICA.
§ Part VII of the Companies Act, 1956 should incorporate a new
substantive provision to adopt the UNCITRAL Model Law as approved
by the United Nations and the Model Law itself may be incorporated as a
Schedule to the Companies Act, 1956, which shall apply to all cases of
Cross-Border insolvency.
§ Adopt the necessary principles enunciated under the heading "Legal
Framework", "Orderly and Effective Insolvency Procedures - Key
issues", to bring the provisions of the Companies Act, 1956 in line with
international practices.
The Committee completed its work and submitted its report to the
Central Government in the year 2000.In August 2001, the Companies
(Amendment) Bill, 2001 and the Sick Industrial Companies (Special
Provisions) Repeal Bill, 2001 were introduced in the Parliament of India.
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
with a view to creating confidence in the minds of investors, creditors,
labour and shareholders.
Scheme of Insolvency Laws
The stream of insolvency laws can be segregated chiefly under two
heads: Personal Insolvency, which deals with individuals and partnership
firms governed by Provisional Insolvency Act, 1920 and Presidency
Towns Insolvency Act, 1908 and Corporate Insolvency, whose
consequence is winding up of the company under the Companies Act,
1956.
In the process of liberalization, deregulation and adopting market
economy, India is experiencing a massive growth of retail loans to
individuals, housing loans and credit card users. On account of
phenomenal rise in retail lending it will be necessary in the near future to
give a re-look at the personal insolvency laws to ensure that any
insolvency proceedings against individuals are also expeditiously
decided.
However, the basic tenets of corporate insolvency can be classified as:
restoring the debtor company to profitable trading where it 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; placement of the assets of the company under external control;
substitution of collective action for individual pursuits; avoidance of
certain transactions and fraudulent conveyances, dissolution and
winding up etc.
In context of corporate laws, the word "insolvency" has neither been
used nor defined. However, Section 433 (e) covers a company, which is
"unable to pay its debts", and thus constitutes a ground for winding up of
the company. Inability to pay its debts would be a case where, a
company's entire capital is lost in heavy losses and no accounts are
prepared and filed and no business is done for one year. In such
circumstances, the Registrar of Companies makes out a case of inability
to pay debts. These debts however, would only include debts, incurred
after the legal incorporation of the Company. Inability to pay debts has
even been amplified in Section 434 wherein, a creditor with a due of Rs.
500 or more serves a demand by registered post and the company
neglects to pay, secure or compound the same in 3 weeks, in cases
where the execution of a decree returned unsatisfied and also where the
Court is otherwise satisfied that the company is unable to pay its debts.
Institutional Machinery
High Court is the Court of proper jurisdiction for handling winding up
proceedings and power sought to be transferred to the NCLT with the
onset of reforms by way of a proposed Bill. The official liquidator is the
liquidator in compulsory winding up. 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. The Creditor's Committee on inspection may
be appointed .In relation to corporate insolvency, the official liquidator as
an officer of the Court or the Court receiver as an officer of the Court are
dealing with insolvency related procedures.
Pursuit of Individual Claims
In the sphere of insolvency laws in India, where all the suits are stayed
on making of the winding up order, parties may pursue individual claims
in certain circumstances.
§ Winding up procedure implies all personal rights be converted into
right to prove debt in winding up.
§ Under section 446, stay on all suits and the winding up Court to decide
all suits by or against the company.
§ A secured creditor may enforce security interest without a suit and
therefore, real rights of secured creditors are protected.
§ Criminal proceedings or proceedings against directors or officers are
not stayed.
§ Income tax proceedings will continue against the liquidator.
Compromises & Arrangements
Apart from the lengthy and time consuming winding up procedure, all the
companies liable to be wound up under the Companies Act may resort to
the alternative of compromise or arrangement. The Court may make
orders to enforce these remedies and where a meeting of creditors or
class of creditors or members or any class of members is called upon,
certain disclosures shall be made. The orders passed by the Courts
include transfer of property to another company and to facilitate
amalgamation, merger and demergers. Even reduction of capital to the
extent that the capital is lost, or capital is in surplus is permitted.
An Analysis
The institution of BIFR has hardly satisfied the call for revival and
rehabilitation of sick industrial undertakings and SICA has proved to be a
complete failure. The lenders i.e. the banks and financial institutions, find
SICA to be the biggest obstacle on their road map to recovery of dues.
The existing legal framework of corporate insolvency faces several
follies, which may be rectified once the proposed amendments are
notified in the Official Gazette.
Procedural delays
There are inherent defects both, procedural and legal in proceedings
before BIFR. The BIFR takes nearly one year to determine whether a
company is sick. Thereafter, it takes around one year to formulate revival
strategy. Consideration of the same also takes substantial time since
banks and financial institutions have their own hierarchy in decision
making, leading to avoidable delays. The decisions by the banks are
also neither transparent, nor subject to judicial review. By the time
decisions are taken and communicated, the plan, which had been
conceived, has lost its viability resulting in failure of revival schemes
even after sanction.
Lack of timely commencement of proceedings
Under the existing law, a company can approach the BIFR for adopting
steps for its revival, on erosion of its entire net worth. The erosion of
entire net worth is too late a stage to attempt restructuring as by the time
the net worth is eroded the company is too sick to be revived and has
lost its resilience to restructure and revive itself.
Poor enforcement mechanism
The mechanism for its implementation is so poor that violations take
place fearlessly leaving no fear for law. The misuse of the said forum in
making an entry by manipulating must be curbed by strict penal
consequences for such misuse, which should be demonstrably used to
ensure that no entity attempts to misuse these provisions. However, this
aspect and solution to this problem has to be found out in the proposed
legislation.
Misuse of protection against recovery proceedings
Under SICA, an automatic stay operates against all kind of recovery and
distress proceedings against all creditors once the reference filed by the
company is registered. This is the principal drawback of the existing
legislation as this has led to BIFR becoming a haven for defaulting
companies. Erring debtors have misused SICA to seek protection and
moratorium from recovery proceedingsThis problem arises due to the
fact that unscrupulous promoters enter into the process of rehabilitation
by manipulating sickness; take undue benefits arising out of delay in
decision making of BIFR. If the reference is rejected, a fresh reference is
filed with respect to accounts for the next year and the cycle goes on
endlessly. There is no fear of reprisal or punitive action against the
companies indulging in this malpractice.
Lack of extra territorial jurisdiction
Indian insolvency laws do not have any extra-territorial jurisdiction, nor
do they recognize the jurisdiction of foreign courts in respect of branches
of foreign banks operating in India. Therefore, if a foreign company is
taken into liquidation outside India, its Indian business will be treated as
a separate matter and will not be automatically affected unless an
application is filed before an insolvency Court for winding up of its
branches in India.
Conclusion
In the process of deregulation and liberalization, number of restrictions
on undertaking industrial activities has been withdrawn and relaxed.
There is a need to take the process of liberalization a step further and
recognize that so long as a company is acting in the interest of
shareholders and otherwise observing the law of the land it should have
the freedom to manage its affairs, merge, amalgamate, restructure and
reorganize or otherwise plan its affairs as it considers best in the interest
of the stakeholders. Interference by the Government or court or any
tribunal should only be in the event of any detriment to the shareholders
or under the Competition Act to prevent monopolies or restrictive trade
practices. While undertaking reforms in the Insolvency Laws there is a
need to change the focus from strict regulation of the activities of
companies to granting freedom to the industry in conducting its business
activities and lay down norms for protection of interest of stakeholders.
