Charting a course


Neerav Merchant explains the options available for insolvency and bankruptcy of companies in India

A buoyant economy and a foreign investment regime that is regularly being liberalized have made India a preferred destination for investments in many sectors. But while US$24 billion in foreign investment poured into India in 2010, the current uncertainty in global markets has turned the spotlight on exits, insolvency and restructuring laws.

Neerav Merchant
Neerav Merchant

Bankruptcy or insolvency involves a legally declared inability or impaired ability to pay one’s creditors. Unlike the US, India does not have a single or comprehensive source of insolvency law. Personal insolvency is regulated by the Provincial Insolvency Act, 1920, while corporate insolvency is dealt with by three separate acts: the Companies Act, 1956; the Sick Industrial Companies (Special Provisions) Act, 1985 (SICA); and the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest, Act, 2002 (SARFAESI).

Winding up

Winding up necessarily results in a company’s liquidation. The Companies Act prescribes three methods for winding up a financially distressed company: (a) voluntary winding up; (b) winding up by the court; and (c) winding up subject to the supervision of the court.

Once a winding-up order is made against a company, or an official liquidator is appointed, all civil legal proceedings are stayed. Creditors have to file a proof of claim in the winding-up proceedings to prove their claim.

However, despite the stay, a creditor may ask the court to allow a specific civil proceeding which may have commenced before the winding-up proceedings were initiated, or even ask the court to allow initiation of new proceedings. The courts are open to considering such applications.

Generally, funds from the liquidation of a company are first applied towards pending workmen’s compensation payments, then for tax arrears or other dues payable to a government body. Remaining funds are used for: employees’ wages/salaries; accrued holiday remuneration due to employees; amounts due to employees under the Employees’ State Insurance Act, 1948; amounts payable on account of death or disablement of any employee under the Workmen’s Compensation Act, 1923; amounts due to any employee from a provident fund or any fund for the welfare of employees; and payments to secured creditors, unsecured creditors and others.

Turning around

SICA is India’s equivalent to chapter 11 of the United States Bankruptcy Code. It provides for the restructuring of a sick industrial company – generally one which has accumulated a loss equal to or exceeding its entire net worth at the end of any financial year – under the supervision of the Board for Industrial and Financial Reconstruction.

For a company to qualify for restructuring under SICA, it must have been registered for at least five years and have a factory licence. However, SICA may be repealed under the Sick Industrial Companies (Special Provisions) Repeal Act, 2003. It is also likely that the provisions relating to sick industrial companies may be incorporated into the Companies Act or a new piece of company law legislation, which is also on the anvil.

Cashing out

SARFAESI is ground breaking as it empowers banks and financial institutions that have been notified by the government to recover non-performing assets without going to court. An asset is non-performing if the interest on it or instalments of the principal remain unpaid for more than 180 days.

SARFAESI provides three methods for recovery of non-performing assets: taking possession; selling; and leasing the assets underlying the security interests.

Ripple effect

In a globalized world, insolvency in one country can have repercussions in several others. In a recent case of a bankruptcy of a major international company, individual administrators were appointed to protect creditors’ interests and to help the company function and revive.

This required the administrators to take control of the company’s assets in different jurisdictions, coordinate a multijurisdictional effort to sell its property, and do all things necessary for the realization of the company’s property.

In another case, a major multinational company was unable to pay off its debts due to the global financial crisis. Instead of liquidation, the company chose to use the corporate debt restructuring (CDR) mechanism provided by the Reserve Bank of India, to protect its creditors’ rights and get time to revive itself.

The CDR mechanism is a voluntary process that is not backed by any legislation.

It came into force in 2001 to ensure that the Indian legal system does not hamper a quick revival of bankrupt companies. The CDR mechanism has not been as effective as was envisaged as many companies continue to drag their feet over their commitments to the creditors.

India has tried to be proactive in reviving sick companies; however, the tardiness of the Indian legal system hampers this at times. One would like to believe that the proposed amendments to the Companies Act will help rectify the problems and create a robust and expedient insolvency framework. But for now, one will have to wait and watch.

Neerav Merchant is a Mumbai-based partner at Majmudar & Co, advising clients in relation to commercial disputes (arbitration and litigation), real property and general commercial law. The firm has offices in Mumbai, Bangalore, Hyderabad, New Delhi and Chennai.