Co-Author - Jehangir N. Mistry Mulla & Mulla & Craigie Blunt & Caroe
Co-Author - Shireen Pochkhanawalla Mulla & Mulla & Craigie Blunt & Caroe
This article was published in Bankruptcy Law360 and Corporate Finance Law360 on May 23, 2011. © Copyright 2011, Portfolio Media, Inc., publisher of Law360.
India is on the fast track to liberalization and as a preferred investment destination for IT services, infrastructure, manufacturing and many other industrial sectors, foreign investments into India have been growing rapidly over the past few years ($24 billion in 2010). In addition, recent softening of the restrictions on borrowings outside India is expected to further increase the amount of corporate lending into the country.
The increasing investment into India and growth in the amount of foreign lending into the country have turned the spotlight on the complexities of the legal and regulatory framework for bankruptcy and insolvencies in India and made it an important focus point for foreign investors and foreign lenders doing business in India.
Which Laws Govern Insolvency in India?
India does not have one single comprehensive and integrated statute on corporate insolvency similar to a Chapter 7 or Chapter 11 insolvency and bankruptcy regime in the United States. Instead, the insolvency and bankruptcy regime in India is made up of several bodies of laws and administrative authorities with sometimes overlapping and conflicting provisions and authority, which makes navigating the insolvency landscape in India treacherous for the unaware.
The most relevant laws governing corporate insolvency and bankruptcy in India are:
- The Companies Act of 1956 (the Companies Act). The Companies Act governs liquidation of a company in financial distress via: (i) voluntary winding-up; (ii) involuntary winding-up by the courts; or (iii) winding-up subject to supervision by the courts.
- The Sick Industrial Companies (Special Provisions) Act, 1985 (SICA). SICA was developed as India’s version of a comprehensive bankruptcy framework for “sick” industrial companies (defined below) and provides a program for the reconstruction of these companies under the supervision of the Board for Industrial and Financial Reconstruction (BIFR). SICA, however, only applies to “sick” companies in select industries that have been incorporated for at least five years, have at least 50 workers on any day in the preceding 12 months and have a factory license. Although technically, SICA has been repealed by the Sick Industrial Companies (Special Provisions) Repeal Act, 2003 (the Repealing Act), it still continues to be good law today because, to date, the Repealing Act has not yet come into force.
- The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 (SARFAESIA). SARFAESIA empowers banks or financial institutions with a presence in India or which have been notified by the Government of India to recover on non-performing assets without court intervention. An asset is classified as non-performing if interest or installments of principal due remain unpaid for more than 180 days. SARFAESIA provides three alternative methods for recovery of non-performing assets, including taking possession, selling and leasing the assets underlying the security interests such as movable property (tangible or intangible, including accounts receivable) and immovable property without the intervention of the courts. The SARFESIA is not available to secured creditors, which are not Indian banks, or financial institutions notified by the Government of India.
What Are the Regulatory Agencies Involved in Insolvency and Bankruptcy Proceedings in India?
Currently, three different agencies are involved in insolvency and bankruptcy proceedings in India: the High Courts, the Company Law Board and the BIFR.
The High Courts are the principal civil courts of original jurisdiction and the highest courts of appeal in any state. High Courts have the power to order the winding up and liquidation of companies under the Companies Act.
The Company Law Board has been constituted by the Central Government of India as an independent quasi-judicial body to exercise powers conferred on it by the Companies Act, or the powers of the Central Government delegated to it.
The BIFR is a quasi-judicial body established and empowered by SICA to prescribe appropriate measures for the revival and rehabilitation of potentially viable sick companies and recommend the liquidation of non-viable companies to the High Courts.
What Is the Test of Insolvency in India?
There are various definitions of insolvency in India.
For the courts commercial insolvency of a company means that the company is unable to pay its liabilities as they arise in the normal course of business. In applying this test, the courts ascertain whether a company is able to meet its current liabilities or those anticipated to occur in the future and whether the company has enough existing assets to meet such liabilities.
Under the Companies Act, a “sick” industrial company is an industrial company that at the end of any financial year had accumulated losses that have eroded 50 percent or more of its average net worth during the four years immediately preceding that financial year, or has failed to repay debts to its creditor(s) within three consecutive quarters on demand made in writing for such repayment.
How Can a Company End Up in Insolvency and Bankruptcy Proceedings in India?
There are several ways for a company to end up in insolvency and bankruptcy proceedings in India:
- Winding up by the Courts: The High Court may, upon an application by the company; its creditor(s); its contributory(ies); the company registrar; or, in certain circumstances set out under Section 439 of the Companies Act, a person authorized by the Central or State Government; wind-up the company under the following circumstances:
- the company passes a special resolution at a general meeting to wind up its affairs
- there is a default, in holding the statutory meeting or in delivering the statutory report to the Registrar of Companies
- the company fails to commence its business within one year from the date of its incorporation, or suspends its business for a whole year
- the number of members in a public company is reduced to less than seven, and in a private company to less than two
- the company is unable to pay its debts
- the court is of the opinion that the company should be wound up.
If the court orders the winding up of the company, it will appoint a liquidator to wind up the affairs of the company. Proceedings involving a liquidator in India are usually very lengthy.
- Voluntary Winding Up: A company may voluntarily wind up its affairs if the purpose for which it was formed has been accomplished or if it is unable to carry out its business or meet its financial obligations upon:
- a declaration by the Board of Directors that the company has no debt or can pay off its debts within 3 months, or
- the Board of Directors calling a creditors’ meeting, which in turn shall resolve that the company should be wound up.
In a voluntary winding up, either the shareholders of the company or the creditors, as applicable, will need to appoint a liquidator to liquidate the company. If the liquidator does not complete the liquidation of the company within a year, the liquidator will call a general meeting of the shareholders of the company and will give an account of the winding-up procedures followed in the past year. Again, proceedings involving a liquidator in India can be very lengthy. Typically, in a voluntary winding up, the courts do not play any role, unless an application is made requesting court supervision by any person described in Section 439 of the Companies Act or the official liquidator. Upon such application, the court may order that the voluntary winding up continue subject to the supervision of the court.
What Is the Framework for Restructuring Companies in India?
The SICA established a framework for corporate restructuring of certain “sick” industrial companies under the supervision of the BIFR. The Board of Directors of a company may refer the company as a “sick” company subject to the supervision of the BIFR within 60 days of its audited financial statements, which would show that it qualifies as a “sick” company under SICA.
Based on an initial review, the BIFR will either register or decline to register a reference made by the Board of Directors of a sick company. Upon registration, the BIFR will engage in a fact-finding process to determine whether the company is sick and if BIFR is satisfied that there are sufficient grounds to find the company “sick,” BIFR may either recommend closure or sanction a rehabilitation scheme. If, on the other hand the BIFR does not find sufficient grounds it will dismiss the referral.
When the BIFR sanctions a rehabilitation scheme, it appoints an operating agent to examine the viability of rehabilitation and formulate an appropriate scheme. The operating agent requests a proposal for rehabilitation from the company and based on such proposal the operating agent prepares a rehabilitation scheme, which it submits to BIFR for finalization and publication.
The BIFR’s authority ends when it declares that a company should be wound up, in which case it will refer the matter to the High Courts, which have the authority to order the liquidation and winding up of the company.
Pursuant to Sections 391 to 396 of the Companies Act, the sick industrial company, any of its members, or any of its creditors may make an application to the High Court to approve a compromise/arrangement between the company and its members and/or its creditors. Generally, the court will approve such a compromise/arrangement if a majority in number, representing three-fourths in value of the members and creditors present and voting, agree to the compromise/arrangement.
How Long Do Indian Insolvency Proceedings Take?
Insolvency and bankruptcy proceedings in India are extremely lengthy, running anywhere from three to four years and as long as 10 years in certain cases. The establishment of the BIFR was an attempt by the Indian regulators to streamline and expedite insolvency proceedings in India. This goal, however, was defeated in practice due in large part to fraud and manipulation of the regime by companies that desired to avoid paying their debts or companies willing to manufacture their books to avoid BIFR proceedings entirely.
Are Other Proceedings Stayed When Winding-Up Proceedings Are Commenced in India?
Proceedings before a High Court. Once a winding up proceeding is commenced against a company before a High Court or under the supervision of a High Court, all civil legal proceedings are stayed and all personal rights of creditors are required to be proven in the winding-up proceedings by filing a proof of claim. Although civil proceedings are stayed, Indian courts have taken the position that the secured creditors have a right to realize their security by means other than civil proceedings, which do not require assistance from the courts. For example, a secured creditor’s right to sell its security interest is not stayed and banks or financial institutions with a presence in India, or that have been notified by the Government of India, under certain circumstances could proceed with their recovery under SARFAESIA. Even in circumstances in which civil proceedings are stayed, an application may be made to the Court to permit a civil proceeding, initiated prior to the winding-up proceedings, to continue or, in the alternative, to permit the applicant to initiate new proceedings. Courts will consider such applications on a case-by-case basis.
Proceedings before the BIFR: Under SICA, once a proceeding before the BIFR has been initiated by a sick company, all legal proceedings and contractual rights against the company are suspended, notwithstanding anything contained in the Companies Act, such company’s memorandum and articles of associations or any contract with such company.
What Are the Rights of Secured and Unsecured Creditors in India?
Unsecured creditors may enforce rights in each procedure. However, in a compromise/arrangement the unsecured creditors will be bound by the compromise/arrangement.
Secured creditors can either enforce their security interests outside the winding-up process or relinquish their security interests and prove their debt in the winding-up process where they will be treated on par with the unsecured creditors. However, in BIFR proceedings, secured creditors cannot enforce their rights before the BIFR unless secured creditors representing not less than three-fourth in value of the amount outstanding against financial assistance disbursed to the company have taken measures to recover their secured debt under the SARFAESIA. In such event the BIFR proceedings will abate.
Enforcement of security interests is not dealt with by one regulation but by several regulations including the SARFAESIA. Most enforcement provides for sweeping security enforcement provisions, without regard to the equities and interests that corporate insolvency and restructuring laws in the United States seek to preserve. If a secured creditor elects to enforce its security, it must share the proceeds from the sale of the assets with the liquidator for workmen’s compensation payments on a pari passu basis.
What Are the Priorities Under Which Money Realized Upon Liquidation is Applied?
Upon liquidation, the proceeds realized from a company’s assets will first be applied by the liquidator towards workmen’s compensation payments and payments to secured creditors to the extent such secured creditors have paid any money to the liquidator for workmen’s compensation out of the proceeds from the sale of assets underlying their security interests. Thereafter, all remaining realized funds are used to pay expenses incurred during the liquidation, including the liquidator’s remuneration. Finally, the realized funds are distributed on a pari passu basis to:
- taxes due to the central/state government or any local authority
- employees’ wages/salaries
- accrued holiday remuneration due to employees
- amounts due in respect of contributions payable as an employer under the Employees’ State Insurance Act 1948 or any other law
- amounts due in respect of any compensation or liability for compensation under the (Indian) Workmen’s Compensation Act (1923) due to the death or disablement of any employee
- sums due to any employee from a provident fund or any fund for the welfare of employees
- expenses of any investigation held in certain circumstances
- claims of unsecured creditors
- payments to shareholders, according to their rights and interests.
Does India Have Laws Related to Cross-Border Insolvency Issues?
No, India does not have such codified laws. Although case law suggests that (i) a foreign company doing business in India can be wound up by the Indian courts as any other unregistered company; (ii) when a company is in liquidation creditors, both national and international, may lodge a proof of claim with the liquidators and each such creditor will be treated on par; and (iii) if the assets of a company being wound up are located outside India, the Indian courts will only attach such assets with the consent of the courts with jurisdiction over such assets.
Are Foreign Lenders Better Off Seeking a Judgment Before a Foreign Court to Enforce Their Creditors’ Rights?
India is not a party to any special international conventions on insolvency. In addition, India has reciprocity treaties with a limited number of countries. The lack of participation in international conventions and the limited reciprocating treaties creates a challenge for the institution of foreign insolvency actions with respect to Indian companies.
If a foreign court orders the winding up of an Indian company, such an order will not be enforceable in India because, under Indian laws, only an Indian court has the jurisdiction to wind up an Indian company.
Foreign judgments will be effective, however, against the foreign assets of an Indian company located in the jurisdiction of the foreign judgment. With respect to assets located in India, however, foreign judgments will be difficult to enforce in India. For those assets, if the attachment is ordered by a foreign superior court of a reciprocating territory, then such judgment will generally be enforceable as a decree passed by a domestic Indian court. In such event, the Indian courts will appoint local agents to help the trustee appointed by the foreign courts to enforce the foreign order. If the assets of the Indian company situated in India are not sufficient to satisfy such foreign judgment, then the foreign creditor may commence winding up proceedings in India before a court of competent jurisdiction. Note that even with reciprocity, there are other criteria that need to be met to enforce judgments in India, which are not discussed here.
If, on the other hand, the order is of a court belonging to a territory that is a non-reciprocating territory, then a fresh suit will have to be filed in an Indian court based on the foreign judgment. Consequently, the appointment of a trustee from a non-reciprocating territory will not be recognized by an Indian court. Note that at present the United States is not a reciprocating territory.
What Is the Status of Pending Amendments to the Indian Insolvency and Bankruptcy Regime?
Reforms to the insolvency and bankruptcy regime are slowly making their way through.
In 1999, the Indian government set up a High Level Committee headed by Justice V.B. Eradi, to examine existing law and make recommend changes to the winding-up provisions. In 2000 the committee filed its report and recommended, among other things, that: (i) the winding-up and liquidation process be centralized with a tribunal called the National Company Law Tribunal (NCLT), instead of splitting it between the High Courts and the BIFR; (ii) India adopt the international trend in law relating to corporate bankruptcy of first sell assets as quickly as possible and thereafter relegate to a later stage the adjudication of claims and distribution of proceeds; (iii) liquidators be appointed from a panel of professionals to be prepared by the government; (iv) SICA be repealed and the ameliorative, revival and reconstruction procedures be reintegrated into the Companies Act; (v) the Companies Act be amended to adopt the UNCITRAL Model Law, as approved by the United Nations, to all cases of cross-border insolvency: and (vi) the Companies Act be amended to add provisions that will bring insolvency procedures in India in line with international practices.
Following the recommendation of the Justice V.B. Eradi Commission, in December 2002, the Companies (Second Amendment) Act, 2002 (the “Amendment Act”) was passed. Though the Amendment Act is passed, only the portion of the Amendment Act that sets up the NCLT is currently operational because the entire Amendment Act has not been notified to the Official Gazette to date.
Furthermore, the implementation of the NCLT portion of the Amendment Act was held up by a constitutionality challenge, which was only resolved in May 2010. Accordingly, the NCLT has not yet been established.
How Is the Amendment Act Different from SICA?
The Amendment Act is definitely a step in the direction of reform and is significantly different from the SICA regime, although it does little to expedite and simplify insolvency or liquidation procedures or to resolve all the problems faced under SICA. The most reformatory effect of the Amendment Act is that the moratorium provision under SICA, which imposed an unlimited stay that blocked creditors from pursuing debts owed by sick companies, has been taken away.
However, if the entire Amendment Act is notified, the Amendment Act could have a significant impact on India’s insolvency regime. For starters, the Companies Act will undergo significant changes under which the winding-up proceedings and liquidation process of a company will no longer be bifurcated between the BIFR and the High Courts but instead will be under one umbrella of the NCLT. In addition, once the Amendment Act comes into force, the Repealing Act will become effective, giving Indian insolvency laws a major overhaul instead of a mere face lift.