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The Corporate Insolvency Framework in India

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IFMR Finance Foundation is working on understanding the regime for corporate and individual insolvency in India, as part of our mandate on financial systems design. We will be regularly showcasing our learnings on this front as a part of this new blog series called “Insolvency in India”. We start off by looking at the legal framework for corporate insolvency in India.

By Jayanth Srinivasan, IFMR Finance Foundation

The legal framework governing insolvency (i.e. the recognition by the formal court system of any entity’s “bankruptcy”, as commercially understood) in India comprises two distinct regimes – one for individual insolvency, and another for corporate insolvency – with the two having no interface with one another. The legal framework for corporate insolvency has seen a series of enactments, shadowed by administrative changes and judicial decisions.

India does not have a single comprehensive and integrated statute underpinning its legal framework governing corporate insolvency, as is the case in certain other jurisdictions1. Instead, the framework comprises several statutes and administrative authorities with occasionally overlapping provisions and authority, with several changes having taken place over the decades.

The historical evolution of the corporate insolvency framework may be divided into three phases: (a) the 1950 – 1990s; (b) the 1990s – 2012; and (c) the forthcoming enactment of the Companies Bill, 2011.

The first phase witnessed the passing of the Companies Act, 1956 – a statute encompassing not just routine corporate legal provisions but also the insolvency process for corporate entities. The procedure for “winding up” of “sick companies” is dealt with in substantial conceptual and procedural detail across 135 sections in Part VII of this Act. Importantly, the authority of administering the process was vested with the relevant High Court. Over the years, the processes became prone to the same delays plaguing other judicial proceedings, resulting in significant NPV write-downs, if not outright write-offs, for creditors. In a first attempt at reform, the Sick Industrial Companies Act, 1985 (SICA) was passed – with the creation of a mechanism for the potential revival of “sick, industrial” companies and also specialised tribunals with prescribed procedures to steer the process (in the form of the Board for Industrial and Financial Reconstruction (BIFR) and the Appellate Authorities for Industrial and Financial Reconstruction (AAIFR)), thus reducing the extent of involvement of the High Courts.

In the second phase – spanning the 1990s to 2011 – a series of measures were taken to revamp the then-existing imperfect and time-consuming framework2. Two major committees formed to study the issue made a series of recommendations. The first, the High Level Committee on the Law relating to Insolvency of Companies (headed by V.B.Eradi3) , recommended in 1999, inter alia

(a) the creation of a tribunal for a centralised winding up process, with professional liquidators;
(b) the harmonisation of Indian with international law/international best practices, both substantively (for instance, the “first sell, then adjudicate priorities” rule) and procedurally (for instance, smoothen the process for cross-border insolvencies using the UNCITRAL Model Law on Cross Border Insolvency as guidance).

The second, the Advisory Group on Bankruptcy Laws4 , headed by N.L.Mitra, went one step further in 2001, recommending the disbanding of the BIFR / AAIFR and the consolidation of insolvency laws into a separate comprehensive bankruptcy code to govern corporate insolvencies.

In response, the Government appeared to have accepted the former suggestion of the Advisory Group (though not the latter) – with the Companies (Second Amendment) Act, 2002 providing for the creation of a consolidated tribunal – the National Company Law Tribunal (NCLT), and its appellate authority, the National Company Law Appellate Tribunal (NCLAT) – to take over the functioning of the BIFR and AAIFR and the High Courts as regards insolvency; and the SICA (Special Provisions) Repeal Act, 2003 formally abolishing the BIFR and AAIFR. However, these changes did not come into effect for two reasons:

(a) the constitutionality of the provisions in the Companies (Second Amendment) Act, 2002 creating the NCLT / NCLAT were challenged on the ground of excessive judicial delegation – a petition not disposed by the Supreme Court until 2010 (when the constitutionality was upheld in principle but changes were recommended in certain specifics such as appointment criteria to such bodies); and
(b) various other provisions in the Companies (Second Amendment) Act, 2002 and the SICA (Special Provisions) Repeal Act, 2003, were not notified, and therefore not brought into effect by the Government through publication in the Official Gazette.

As a result, the Companies Act, 1956 continues to prevail as does the SICA, 19855. Consequently, in terms of administrative machinery for the insolvency framework, the BIFR/AAIFT also continue to function.

Other reforms to the insolvency process that are part of the second phase include the SARFAESI Act, 2002 – allowing a specific class of creditors (namely, banks and financial institutions “notified by the Government of India”) to attach assets of defaulting creditors in specific circumstances without court intervention (and thus circumventing any insolvency proceedings); and the RBI Guidelines on Corporate Debt Restructuring6 – provide a timely and transparent mechanism for restructuring the debts of otherwise viable corporate entities facing temporary difficulties with multiple creditor institutions outside the purview of BIFR and other legal proceedings.

The third phase may be seen as beginning with the expected enactment of the Companies Bill, 2011, which attempts to simplify the corporate law framework (including the corporate insolvency law framework), based largely upon the recommendations of the Expert Committee on Company Law (headed by J.J.Irani) in 20057. Apart from the consolidation of winding up proceedings under the ambit of the NCLT / NCLAT, and incorporating the Supreme Court’s recommendations in its 2010 judgment upholding their constitutionality, the Bill introduces no substantive change from the prior winding up process under the Companies Act, 1956. The Bill received Cabinet clearance in December, 2011 for introduction before Parliament.

With this major statutory overhaul on the present Government’s agenda, significant change can be expected on this front shortly.

1- Chapter 7, Title 11″ proceedings in the United States
2- A World Bank survey (“Doing Business in 2005: India, A Regional Profile”) pointed out that it took 10 years on average to wind up / liquidate a company in India as compared to between 1 and 6 years in other countries
5- As the SICA Repeal Act, 2003 is yet to be notified
6- Original version of the guidelines, with modifications over the years, is available on the RBI website

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