CHAPTER I: GENERAL FRAMEWORK OF INSOLVENCY LAWS IN INDIA

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1 CHAPTER I: GENERAL FRAMEWORK OF INSOLVENCY LAWS IN INDIA HISTORICAL 1 BACKGROUNDP0F P The need for an insolvency law in India was first articulated in the three Presidency-towns of Calcutta, Bombay and Madras. The earliest rudiments of insolvency legislation can be traced to sections 23 and 24 of the Government of India Act, 1800, which conferred insolvency jurisdiction on the Supreme Court at Fort William and Madras and the Recorder's Court at Bombay. These Courts were empowered to make rules and order for granting reliefs to insolvent debtors on the lines intended by the Act of the British Parliament called the Lord's Act passed in P1F P The passing of Statute 9 in 1828 (Geo. IV. c. 73), can be said to be the beginning of the special insolvency legislation in India. Under this Act, the first insolvency courts for relief of insolvent debtors were established in the Presidency-towns. Although the insolvency Court was presided over by a judge of the Supreme Court, it had a distinct and separate existence. The Insolvency Court was to sit and dispose of insolvency matters as often as was necessary. But the Court at Calcutta was to sit at least once a month. The Act of 1828 was originally intended to remain in force for a period of four years, but subsequent legislation extended its duration upto 1843 and also made certain amendments therein. P 2F3 A further step in the development of Insolvency Law was taken when the law in 1848 (11 & 12 Viet.c.21) was passed. The Act presumed the distinction between traders and non-traders in certain respects on the lines of the corresponding Bankruptcy statutes, then in force in England. It continued the Courts for the relief of insolvent debtors established by the Act of 1828 in the Presidency towns and in their place the present High Courts were set up. The insolvency jurisdiction in the Presidency towns was thus transferred from the Supreme Court to the High Court. The Provisions of the Indian Insolvency Act, 1848, were, however, found to be inadequate to meet the changing conditions. In the eighteen seventies Sir James Fitzjames Stephen proposed an Insolvency Bill for the whole of India modeled on the Bankruptcy Law then in force in 1 Prepared in the Directorate of Academics and Professional Development, the ICSI 2 J P S Sirohi, Law of Insolvency(1985) 3 See Mulla Law of Insolvency in India(1958), P.16 1

2 P as EMERGING INSOLVENCY IN INDIA: ISSUES & OPTIONS England. But this proposal was dropped, as the conditions in India in general were not favourable for a compulsive legislation on the subject. The Act of 1848 continued in force in the Presidency-towns until the enactment in 1909 of the present Presidency-towns Insolvency Act, While there was special insolvency legislation for the Presidency-towns, there was no insolvency law in the rural areas. The main reason for this difference was the absence of any flourishing trade and commerce therein. In the rural areas for a considerable period the ordinary principle of distributing the sale proceeds pronotes among decree-holders after satisfaction in full of the amount due to the attaching decree holder seems to have prevailed. The first attempt to introduce insolvency law in the rural areas was made in Some rules were incorporated in Chapter 20 of the Code of Civil Procedure, 1877, which conferred jurisdiction on the district Courts to entertain insolvency petitions and grant orders of discharge, these rules were re-enacted with certain modifications in Chapter 20 of the Code of Civil Procedure, The Provisions in the Civil Procedure Code of 1859 were describedp3 F 4 the "germ and nothing more than a germ of an insolvency law." The provisions were limited to cases in which legal proceedings were instituted and judgment obtained. Creditors of a debtor were not entitled to file an insolvency petition. These defects were removed by the provincial Insolvency Act, This Act created a special Insolvency Jurisdiction laying down the conditions under which a debtor could be adjudicated on his own petition or on a petition by a creditor. The Act of 1907 was repealed by the provincial Insolvency Act, 1920 which is the Act now in force in the areas other than the Presidency towns. CENTRAL AND STATE LEGISLATIONS On January 26, 1950 the Constitution of India came into force. The Laws/Acts enacted after its adoption are called the Central Laws/Acts. For Example the Companies Act, 1956, Limited Liability Partnership Act, 2008 (LLP) etc, (this contains the detailed process for the winding up of the corporate entities). These are called the Central Acts, wherein the Companies/LLPs are 4 See Mulla Law of Insolvency in India (1958), P.16. 2

3 required to get themselves registered with the Central Registry known as the Registrar of Companies /LLP in order to become corporate entities. However, before the adoption of the Constitution of India, many laws/acts governing the insolvency procedures were in operation like the Provisional Insolvency Act, 1920, and the Presidency Towns Insolvency Act, Government of India saved these Acts so that they do not get repealed and allowed for State Amendments wherein the entities provided for under those Acts are regulated by different States and the States were given the authority to modify or make provisions in these Acts. Since, the personal insolvency is a subject matter of State List over which laws can be made by the State Legislation. Hence any amendment in these Acts will require acceptance or assent, from all the States or the States can individually amend these laws/acts. CURRENT SCHEME OF INSOLVENCY LAWS IN INDIA 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, In context of corporate laws, the word "insolvency" has neither been used nor defined in India. However, Section 433 (e) of the Companies Act, 1956 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 of the Companies Act, 1956 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 three 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. P4F5 ******* 5 Sourced from: 3

4 CHAPTER II: A FRAMEWORK FOR REHABILITATION OF COMPANIES INTRODUCTION India started her quest for industrial development after independence in The industrial policy resolution of 1948 marked the beginning of the evolution of the Indian Industrial Policy; and thereafter with the economic and social development there has been shift in the industrial policy from the directed and regulated economy in the 1948 and 1956 Policy Resolution, to the free market economy in During the initial years, there was also the problem of industrial sickness entailing social costs in terms of loss of production and un-employment and waste of capital assets. The problem of industrial sickness and its consequential fall out on the nation s economy and also the problem faced by financial institutions (which have invested much of the public funds in such industries) in the matter of recovery of their dues and the rehabilitation of the sick industrial company led to enactment of the Sick Industrial Companies (Special Provisions) Act, P5F6 INDUSTRIES DEVELOPMENT AND REGULATION ACT [I (D & R) A], 1951 The [I (D & R) A] is an important piece of legislation for the development and regulation of certain industries. It contains provisions for the regulation of industries to prevent industrial undertakings from falling sick and consequently hampering the production of materials necessary for the economic development of the country. P6F7 SICK INDUSTRIAL COMPANIES (SPECIAL PROVISIONS) ACT, 1985 (SICA) AND [I (D & R) A] The two Acts i.e.; the [I (D & R) A] and SICA operate in different fields though they would appear to be overlapping. The [I (D & R) A] was enacted for the development and the regulation of certain industries. The [I (D & R) A] applies to industries mentioned in the schedule to the Act and the SICA is applicable to those very companies having industries as mentioned in the schedule to the [I (D & R) A]. Chapter III of the [I (D & R) A] contains provisions for the regulation of the industries. The Act is more of preventive nature so that the industrial undertakings do not fall sick. Section 15 of 6 Taxman s new law relating to Sick Companies by D.P. Mittal 2003 edition 7 Taxman s new law relating to Sick Companies by D.P. Mittal 2003 edition 4

5 the Act gives power to the Central Government to move to the High Court for permission to make or cause to be made investigation into a company which is to be wound up for the purpose of running or restraining an industrial undertaking in the interest of the general public and, in particular, in the interest of production, supply or distribution of articles or classes of articles relatable to the concerned Scheduled Industry. Under section 16, the Central Government has been authorized to issue directions to the industrial undertaking after investigation had been made under section 15 of the Act. Chapter III A deals with the power of the Central Government to assume management or control of the industrial undertaking in certain cases where the industrial undertaking to which directions have been issued in pursuance of section 16 of the Act has failed to comply with such directions, or the industrial undertaking in respect of which an investigation has been made under section 15 of the Act, is being managed in a manner highly detrimental to the Scheduled Industry concerned or to the public interest. Under sub-section (2) of section 18A of the Act, a time limit is prescribed within which the management of the industrial undertaking can be taken over by any person or body of persons so authorized. There is no such limitation for any scheme under SICA containing measures for the proper management of the sick industrial company by change or takeover of the management.p7f8 LIQUIDATION OR RECONSTRUCTION OF COMPANIES UNDER [I (D & R) A] Chapter III AC of the [I (D & R) A] dealing with liquidation or reconstruction of companies requires the Central Government after the takeover of management of the industrial undertaking or part thereof, to ensure that the purpose of the takeover is being achieved. It is for this reason that section 18FC of the Act confers powers on the Central Government to call upon the authorized person to submit a report on the affairs and working of the industrial undertaking whose management or control has been taken over under Section 18A, 18AA, or 18FA of the Act. Section 18FD of the Act provides two alternatives to the Central Government in respect of receipt of the report from the authorized person. The Central Government can either decide to 8 Taxman s new law relating to Sick Companies by D.P. Mittal 2003 edition 5

6 sell the undertaking as a running concern or it may decide to prepare scheme for reconstruction of the company. The decision to sell undertaking as a running concern may be taken by the Central Government on being satisfied that; In the case of the company owning the industrial undertaking, which is not being wound up by the High Court, its financial conditions and other circumstances are such that it is not in a position to meet the current liabilities out of its assets and the interest of the general public makes it expedient to sell the undertaking as a running concern and also proceedings for winding up of the company by the High Court should be started simultaneously; In the case of the undertaking concerned owned by a company and is being wound up by the High Court, its assets and liabilities are such that in the interests of its creditors and contributories, the industrial undertaking should be sold as running concern. In terms of sub-section 2 of section 18FD of the Act the decision to prepare a scheme of reconstruction of the company owning the industrial undertaking may be ordered by the Central Government, if it is satisfied that; It is in the interest of the general public, or It is in the interest of the shareholders, or Such a course of action is necessary to secure the proper management of the company owning the industrial undertaking. In case the scheme of reconstruction is to be prepared in relation to an undertaking owned by a company being wound up by or under the supervision of the High Court, prior permission of the High Court is to be obtained. P8F9 SICK INDUSTRIAL COMPANIES (SPECIAL PROVISIONS) ACT, 1985 (SICA) A sick industrial company means an industrial company (being a company registered for not less than five years and employing fifty or above workmen), which has at the end of any financial year accumulated losses equal to or exceeding its entire net worth. Net worth has been defined as the sum total of the paid up capital and free reserves. 9 ICSI Module on Economic and Labour Laws. 6

7 The scheme of the Act deals with establishment of the Board for Industrial and Financial Reconstruction (BIFR) by the Central Government to exercise the jurisdiction and powers and discharge the functions and duties conferred or imposed thereon by or under the provisions of the Act. Section 5 of the Act envisages constitution of an Appellate Authority to be called Appellate Authority for Industrial and Financial Reconstruction for hearing appeal against the orders of the BIFR. Section 14 of the Act pronounces that the proceedings before the BIFR or the Appellate Authority are deemed to be judicial proceedings. P9F10 SICA requires that when an industrial company has become a sick industrial company, the Board of Directors of the said company shall, within sixty days from the date of finalisation of the duly audited accounts of the company for the financial year as at the end of which a company has become a sick industrial company, make a reference to the BIFR for determination of the measures to be adopted with respect to the company. If the Board of Directors has sufficient reasons even before finalisation of accounts to form an opinion that the company has become a sick industrial company, it shall, within sixty days after it has formed such an opinion, make a reference to the BIFR. SICA is predominantly remedial and ameliorative in so far as it empowers the quasi judicial body, BIFR to make appropriate measures for revival and rehabilitation of potentially viable sick industrial companies and for liquidation of non-viable companies. But, where the BIFR comes to the conclusion that it is not possible to revive the company and that it is just and equitable that the company should be wound up, it shall record and forward its opinion to the concerned High Court, on the basis of which the Court, may order winding up of the company and may proceed and cause to proceed with the winding up of the sick industrial company in accordance with the provisions of the Companies Act, Reserve Bank of India (RBI) has issued policy guidelines for revival of sick industrial companies and the role to be played by lead institutions or Operating Agencies appointed for revival of industries declared to be sick under SICA. P10F11 10 Taxman s new law relating to Sick Companies by D.P. Mittal 2003 edition

8 ISSUES ARISING OUT OF IMPLEMENTATION OF SICA The functioning of SICA has not been found to be satisfactory as many issues have been identified during its implementation. Some of the deficiencies were restrictive definition of sickness under the Act and belated cognizance thereof by BIFR, slow pace of BIFR intervention, excessive protection to sick industries under Section 22 of the Act providing for automatic stay of all legal proceedings, necessity of consensus amongst secured creditors before finalisation of revival scheme, lack of monitoring of sanctioned revival schemes, and delay in winding up of sick companies. Apart from these, frequent appeal to High Courts against the decisions/ orders of the BIFR was also one of the factors responsible for delay in timely disposal of the cases. PROCEDURAL DELAYS There are inherent defects both, procedural and legal in proceedings before BIFR. The BIFR takes substantial time to determine whether a company is sick and thereafter, to formulate a 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, loses 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 completely eroded the company is too sick to be revived and loses its resilience to restructure and revival. 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 the BIFR to become a haven for defaulting companies. Erring debtors have misused SICA to seek protection and moratorium from recovery proceedings. The companies are able to enter easily into the reference, sometimes by manipulating their accounts to reflect net worth erosion and then able to attract immunity 8

9 against the recovery action by the creditors and this benefit is then attempted to be perpetuated. This 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. P11F12 [Year Wise Performance of the BIFR as on is placed at Annexure A].P12F13 *******

10 CHAPTER III: ASSET RECONSTRUCTION: SARFAESI ACT, TBACKGROUND With an aim to provide a structured platform to the Banking sector for managing its mounting Non-Performing Assets (NPAs) stocks and to keep pace with international financial institutions, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 was put in place to allow banks and Financial Institutions (FIs) to take possession of securities and sell them. As stated in the Act, it has enabled banks and FIs to realise long-term assets, manage problems of liquidity, asset-liability mismatches and improve recovery by taking possession of securities and selling them and reducing their NPAs by adopting measures for recovery or reconstruction. Prior to the Act, the legal framework relating to commercial transactions lagged behind the rapidly changing commercial practices and financial sector reforms, which led to slow recovery of defaulting loans and mounting levels of NPAs of banks and 14 FIs.P13F P After the enactment of the SRFAESI Act, 2002 borrowers have become the first applicants before the Debts Recovery Tribunal (DRT). Earlier only lenders were the applicants. P14F15 This new Act empowered the lenders to take into their possession the secured assets of their borrowers just by giving them notices, and by not going through the rigors of Court procedure. Initially this brought in a lot of compliance from borrowers and many defaulters coughed up the Bank dues. However the tougher ones punched whole in the new Act too. This led Supreme Court to strike down certain provisions of the Act and allowed the borrowers to have an adjudicatory forum, before their properties could be taken over by the lenders. The adjudicatory forums were the DRT. The DRT deals with extraordinary complex commercial laws. Over the years the DRTs have evolved into fine bodies with lots of expertise. There is a plethora of judgments from the Supreme Court as well as the various High Courts which have paved the way for the DRT to 14 Sourced from: 15 Sourced from: 10

11 chart their courses. The Debts Recovery Tribunal of India have become model institutions for many a country to follow.p15f16 ASSET RECONSTRUCTION COMPANIES (ARCs) ORIGIN OF ARCS Asset Reconstruction Companies (ARCs) are established under SARFAESI Act, 2002 as specialized entities for NPAs resolution. These ARCs are established to acquire, manage and recover illiquid or NPAs from Banks / FIs. This process relieves the banking system of the burden of NPAs and allows them to focus better on their core function of financing and development of new business opportunities so as to further strengthen the economy. The ARCs would maximize recovery value with optimal costs through their innovative NPA resolution methods. ASSET RECONSTRUCTION COMPANIES 1. Arcil It is the first Asset Reconstruction Company in the country to commence business of resolution of NPAs upon acquisition from Indian banks and FIs. It commenced business immediately after enactment of the SARFAESI Act, As the premier ARC, Arcil has been playing the pioneering role in setting standards for the industry in India. Arcil has recently launched retail NPAs resolution initiative through Arcil-Arms (a division of Arcil).5T 5TARCIL is promoted by ICICI Bank, State Bank of India and IDBI. P16F17 2. India SME Asset Reconstruction Company Ltd (ISARC) It is the country's first ARC supported by a large number of public sector banks and undertakings. It strives for a speedier resolution of NPAs with a focus on Micro Small and Medium Enterprises (MSME) sector. ISARC endeavors to unlock the idle NPA assets for productive purposes which facilitates greater and easier flow of credit from the banking sector to the MSMEs. P17F

12 3. Reliance Asset Reconstruction Company Limited Reliance Asset Reconstruction Company Limited (Reliance ARC) is a premier asset reconstruction company, the principal sponsor / shareholder of which is the Reliance ADA group (through Reliance Capital Limited). The other sponsors / shareholders are Corporation Bank, Indian Bank, GIC of India, Dace croft and Blue Ridge. Reliance ARC has adopted a buyer driven model for acquisition of NPAs (individual as well as portfolio cases) in cash (if selling banks choose to remain invested, they will have the option to subscribe to the Security Receipts). P18F19 ******* 19 Sourced from: 12

13 CHAPTER IV: CORPORATE DEBT RESTRUCTURING INTRODUCTION Corporate Debt Restructuring (CDR) means the reorganization of a company's outstanding obligations, by reducing the burden of the debts on the company, by decreasing the rates paid and increasing the time by which the company has to pay its obligation back. This allows a company to increase its ability to meet the obligations. Also, some of the debt may be forgiven by creditors in exchange for an equity position in the company. The need for a CDR often arises when a company is going through financial hardship and is having difficulty in meeting its obligations. If the troubles are enough to pose a high risk of the company going bankrupt, it can negotiate with its creditors to reduce these burdens and increase its chances of avoiding bankruptcy CDR, which was set up in , is a mechanism for faster disposal of restructuring cases involving multiple lenders, however foreign banks are yet to join the platform. In August 2008 The Reserve Bank of India (RBI) had revamped the norms for restructuring advances, including non-industrial credit. Now, the non-industrial companies can also use CDR mechanism. Reserve Bank of India s (RBI s) revised norms harmonise the prudential norms across all debt restructuring mechanisms. While banks work on cases with the hope of recovery, rating agencies consider cases referred for restructuring as weak assets. STEPS IN CORPORATE DEBT RESTRUCTURING A number of companies are now taking a good look at business debt restructuring to resolve their unmet financial obligations. This is often a preferable solution to bankruptcy probably because it is less expensive and more discreet. But just like bankruptcy, CDR also involves a systematic process. The Steps involved in CDR are as follows; The Consultation Process As business debt restructuring is nothing but an aggregate loan agreement, the lender seeks a series of consultation sessions with the borrower. During these meetings, the lender assesses the company's overall financial situation. It is at this point that all the company's financial 13

14 obligations are evaluated against the expected regular cash flow. Primarily because of this, small business debt restructuring works differently than that of big corporate restructurings. The Negotiation Process Once the assessment procedure is finished, the lender then settles an agreement with all the borrower's creditors and vendors. The main idea is to arrive at a solution that is acceptable to all the parties involved. When that is achieved, the lender can proceed to implement the solution as agreed upon. The liquidation of assets The liquidation of the business's assets is the next step in the process, if found to be necessary by all parties concerned. In some cases, restructuring the existing debt may require a large amount of up front money to be paid. If the lender is not able to cover that, there is no other choice but to liquidate some of the assets. But most of the time, the liquidation strategy is only used to get the profitability of the business back. The restructuring process This is the step where the contract is signed and the agreement is enforced. The borrower, and in this case the business, agree to the aggregate loan amount and to other details including the monthly payment obligation, the interest rate, and the term of payment. After everything is accounted for, the business which officially under a debt-restructuring program is expected to make payments as stipulated. This is the last level of debt help available to the business before a filing for bankruptcy. CDR is a process that has to be critically evaluated to ensure the ultimate fate of the business involved. P19F20 ******* 20 Sourced from: 14

15 CHAPTER V: ENFORCING CREDITORS RIGHT RECOVERY OF DEBTS DUE TO BANKS AND FINANCIAL INSTITUTIONS ACT, 1993 Banks and financial institutions have been experiencing considerable difficulties in recovering loans and enforcement of securities charged with them. The procedure for recovery of debts due to the banks and financial institutions, which was being followed, resulted in a significant portion of the funds being blocked. The Committee on the Financial System considered the setting upon the Special Tribunals with special powers for adjudication of such matters and speedy recovery as critical to the successful implementation of the financial sector reforms. An urgent need was, therefore, felt to work out suitable mechanism through which the dues, to the banks and financial institutions could be realised. In 1981 a committee had examined the legal and other difficulties, faced by banks and financial institutions and suggested remedial measures including changes in law. This committee also suggested setting up of Special Tribunals for recovery of dues of the banks and financial institutions by following a summary procedure. Keeping in view the recommendations of the above Committees, the Recovery of Debts due to Bank and Financial Institutions Bill, 1993 was introduced in the Parliament and after which it was enacted as the Recovery of Debts Due To Banks and Financial Institutions Act, 1993.P20F21 The Recovery of Debts Due to Banks and Financial Institutions Act, 1993 is almost more than a decade old. As with any legislation breaking new ground, the Act has been challenged in various fora including the High Courts for its summary nature, the ousting of the jurisdiction of the Civil Courts, the provisions which allow borrowers to proceed against the bank or financial institution in the Debt Recovery Tribunals (DRT) and the latest challenge to the constitutional validity of the Act. Whatever may be, the Act of 1993 was a welcome step taken by the legislature in ensuring speedy recovery of bank dues. Overriding effect of the Act Section 34 of the Act states that the "Act to have overriding effect i.e. 21 Sourced from: 15

16 (1) Save as provided under sub-section (2), the provisions of this Act shall have effect notwithstanding anything inconsistent therewith contained in any other law for the time being in force or in any instrument having effect by virtue of any law other than this Act. (2) The provisions of this Act or the rules made there under shall be in addition to, and not in derogation of, the Industrial Finance Corporation Act, 1948, the State financial Corporations Act, 1951, the Unit Trust of India Act, 1963, the Industrial Reconstruction Bank of India Act, 1984 and the Sick Industrial Companies (special provisions) Act, 1985." The Act has thus an overriding effect over all other legislations except for the ones mentioned in sub-clause (2), THE NON-OBSTANTE CLAUSE The non obstante clause in the Act and the non obstante clause in the Companies Act were considered in Industrial Credit and Investment Corporation of India Ltd v. Vanjinad 22 LeathersP21F P where the court opined that Section 18 of the Act creates a bar on jurisdiction of other authorities and courts except the Supreme Court and High Courts under Articles 226 and 227 of the Constitution. The court also stated that the Act and the Companies Act is special legislation. However since the Act was enacted after the Companies Act, 1956, the Parliament would have certainly in mind the provisions in the earlier special law namely the Companies Act. Therefore the latter special law will prevail over the former. P22F23 DEBT RECOVERY TRIBUNAL The Debt Recovery Tribunal (DRT) is governed by provisions of the Recovery of Debt Due to Banks and Financial Institutions Act, The object of the DRT is to receive claim applications from banks and Financial Institutions against their defaulting borrowers. For this purpose, the Debt Recovery Tribunal (Procedure) Rules 1993 have also been framed. Keeping in line with the international trends on helping financial institutions recover their bad debt quickly and efficiently, the Government of India has constituted thirty three Debt Recovery Tribunals and five Debt Recovery Appellate Tribunals across the country. P23F24 22 AIR 1997 Kerala Sourced from: 24 Sourced from: 16

17 The Debts Recovery Tribunal deals with two different Acts, namely the RDBFI Act as well as the SARFAESI Act. While the aim of both the Acts is one and the same, but their approach is different. THE DRTS HAVE MORE POWERS THAN THE CIVIL COURTS: SUPREME COURT In matters of Recovery of Debts to Due to Banks and Financial Institutions, the DRT enjoys far greater powers than do the civil courts. The Recovery Officer of a DRT has even more powers to issue a variety of orders for enforcing the Recovery Certificate. In a case the Supreme Court has held that the powers of Debts Recovery Tribunal are far wider than those of a civil court. The Debts Recovery Tribunal can pass interim as well as adinterim orders, with or without hearing the opposite parties. The only fetter on Debts Recovery Tribunals is that they should follow the Principles of Natural Justice. Rule 18 of the DRT Act empowers the Tribunals to pass other kinds of orders in the interest of justice. P24F25 LAWS AND PROCEDURE OF DRT IN INDIA While initially the DRT did perform well and helped the Banks and Financial Institutions recover substantially large parts of their non performing assets, or their bad debts, but their progress was stunned when it came to large and powerful borrowers. These borrowers were able to stall the progress in the DRTs on various grounds, primarily on the ground that their claims against the lenders were pending in the civil courts, and if the DRT adjudicate the matter and auction off their properties irreparable damage would occur to them.p25f26 ******* 25 Sourced from: 26 Sourced from: 17

18 CHAPTER VI: WINDING UP OF COMPANIES 4TMEANING Winding up of a company is defined as a process by which the life of a company is brought to an end and its property administered for the benefit of its members and creditors. An administrator, called the liquidator, is appointed and he takes control of the company, collects its assets, pays debts and finally distributes any surplus among the members in accordance with their rights. At the end of winding up, the company will have no assets or liabilities. When the affairs of a company are completely wound up, the dissolution of the company takes place. On dissolution, the company's name is struck off the register of the companies and its legal personality as a corporation comes to an end. The Companies Act, 1956 lays down the provisions and the procedures for winding up operations leading to the dissolution of the company. Winding-up is different from insolvency and dissolution. MODES OF WINDING UP There are three ways, in which a company may be wound up. They are: 1. Winding up by the court. 2. Voluntary winding up, o Members Voluntary winding up. o Creditors Voluntary winding up. 3. Winding up subject to supervision of the court WINDING UP BY THE COURT Section 433 of the Act, lays down the circumstances by which a company may be wound up by the Court. Note: 1. Till the Tribunal is constituted the powers in this regard are vested with the Courts. Here, the court means "High Court". 2. Jurisdiction of Court: the Court having jurisdiction in relation to the place where registered office of the company concerned is situated will be authority in respect of ordering winding up. 18

19 P EMERGING INSOLVENCY IN INDIA: ISSUES & OPTIONS The following are the grounds for Compulsory Winding Up or Winding up by the Court P26F 27 a. If the company has, by a Special Resolution, resolved that the company be wound up by the Court. b. If default is made in delivering the statutory report to the Registrar or in holding the statutory meeting. c. If the company fails to commence its business within one year of its incorporation, or suspends its business for a whole year. d. If the number of members is reduced below the statutory minimum e. If the company is unable to pay its debts. f. If the Court is of the opinion that it is just and equitable that the company should be wound up. g. If the company has made a default in filing with the Registrar its balance sheet and profit and loss account or annual return for any five consecutive financial years. h. If the company has acted against the interests of the sovereignty and integrity of India, the security of the State, friendly relations with foreign States, public order, decency or morality. i. It the Court is of the opinion that the company should be wound up under the circumstances specified in section 424(G) of the Act, i.e. winding up of Sick Industrial Company. Note: The clauses g, h and i have been added by the Companies (Second Amendment) Act, Power of Court to Stay or Restrain Proceedings against Company [Section 442] At any time after presentation of a winding up petition and before a winding up order is made, the company, or any creditor or contributory, may- Where any suit or proceeding against the company is pending in the Supreme Court or in any High Court, apply to the Court in which the suit or proceeding is pending for a stay of proceedings therein; and 27 Section 433 of the Companies Act,

20 Where any suit or proceeding is pending against the company in any other Court, apply to the Court having jurisdiction to wind up the company, to restrain further proceedings therein. The Court to which the application is so made may stay or restrain the proceedings accordingly, on such terms as it thinks fit. ORDERS OF THE COURT (SECTION 443) The court may pass any one of the following orders on hearing the winding up petition. 1. Dismiss it, with or without costs 2. Adjourn the hearing conditionally or unconditionally 3. Make any interim order, as it thinks fit, or 4. Pass an order for winding up of the company with or without costs, or any other order that it thinks fit. THE OFFICIAL LIQUIDATOR An Official Liquidator (OL) appointed by the Government, is attached to each High Court. The Court, after passing the winding up order, appoints the liquidator. In situations of compulsory winding up, by virtue of his office and the order of the Court, the Official Liquidator becomes the liquidator of the Company. He then takes charge of the affairs of the company and caries out the process of winding up in accordance with the provisions of section 444 of the Act. He may however apply to the Court for directions if any required with regard to any matter relating to winding up. CONTROL OF CENTRAL GOVERNMENT/COURTS OVER THE LIQUIDATOR The Official Liquidators are officers appointed by the Central Government under Section 448 of the Companies Act, 1956 and are attached to various High Courts. The Central Government may also attach one or more deputy or assistant Official Liquidators to assist the Official Liquidator. The Central Government has the responsibility under Section 463 of the Act of exercising overall control over the Official Liquidators to ensure that they faithfully perform their duties and duly observe all the requirements imposed on them under the Act or the Rules there under. Organizationally, the Official Liquidators are under the administrative charge of the respective Regional Directors, who are senior field functionaries under the Ministry of Corporate Affairs 20

21 and who supervise the functioning of Official Liquidators on behalf of the Central Government. In the conduct of winding-up of affairs of the companies, however, Official Liquidators act under the directions of the High Courts. Thus, once the winding up order is passed by the Court and the OL appointed as Liquidator for a company under liquidation, further process, as also the actions of the OL in pursuance of the same with regard to the Company, take place under the supervision and the orders of the Court. Disposal of assets and settlement of claims When a company is wound up by any mode, its liabilities shall be discharged in accordance with the priorities provided in section 529A and 530 of the Act. The order of priority as provided in the Act is as under: 1. Workman's dues. 2. Debts due to secured creditors. 3. All taxes, cesses and rates due from the company to the Central Government or a State Government. 4. All wages and salary of any employee due within four months. 5. All accrued holiday remuneration becoming payable to any employee. All such debts shall be paid in full. If assets are insufficient to meet them, they shall abate in equal proportions. Dissolution of Company [Section 481] The court shall order dissolution of the company, when: 1. the affairs of the company are completely wound up, or 2. the official liquidator is unable to carry on the winding up procedure for want of funds. Appeal: [SECTION 483] An appeal from the decision of Court will lie before that Court, before whom, appeals lie from any order or decision of the former Court in cases within its ordinary jurisdiction. Such order or decision, however, must be a judicial and not an administrative or a procedural one. All administrative orders would be an order, which is directed to the regulation or supervision of matters as distinguished from an order which decides the rights of parties or confers or refuses to confer rights to property, which are the subject of adjudication before the Court. 21

22 2. WINDING UP SUBJECT TO SUPERVISION OF COURT* Winding up subject to supervision of court, is different from "Winding up by court." Here the court only supervises the winding up procedure. Resolution for winding up is passed by members in the general meeting. It is only for some specific reasons, that court may supervise the winding up proceedings. The court may put up some special terms and conditions also. However, liberty is granted to creditors, contributories or other to apply to court for some relief [Section 522]. The court may also appoint liquidators, in addition to those already appointed, or remove any such liquidator. The court may also appoint the Official Liquidator as a liquidator to fill up any vacancy. The liquidator is entitled to do all such things and acts as he thinks best in the interest of the company. He enjoys the same powers as if the company is being wound-up voluntarily. The court also may exercise powers to enforce calls made by the liquidators, and such other powers as if an order has been made under section 526 of the Act for winding up the company altogether by court. The object of the supervision order is to safeguard the interest of the company, shareholders and creditors. When an order is made for winding up subject to supervision, the Court may, by that or any subsequent order, appoint an additional liquidator or liquidators. * Note: Omitted by the Companies (Second Amendment) Act, 2002 WINDING UP OF UN-REGISTERED COMPANIES Apart from a company registered under the Companies Act, 1956 there are other companies as well the winding up procedure for which is different from a company registered under Companies Act, These companies are:- 1. Unregistered Companies [ Section 583] In simple words, an unregistered company is a company which is not registered or covered under provisions of the Companies Act, 1956 [section 582]. An unregistered company cannot be wound up voluntarily, or, subject to super vision of court. 22

23 However, the circumstances, in which unregistered company may be wound up, are as follows: o If the company, is dissolved, or has ceased to carry on business, or is carrying on business only for the purposes of winding up, it's affairs, o If the company is unable to pay it's debt o If the court is of opinion, that it is just and equitable, that the company should be wound up. A foreign company, carrying on business in India, which has been dissolved, may be wound up, as unregistered company. 2. FOREIGN COMPANIES [SECTION 584] A foreign company is a company which is incorporated outside India, and having a place of business in India. Winding up of such companies is only limited to the extent of it's assets in India. In respect of assets and business carried outside India, Indian courts have no jurisdiction. Winding up of a foreign company can only be made through Court. Even if the company had been dissolved or ceased to exist in the country of its incorporation, the winding up order can be made in India. Even if a foreign company has been wound up according to foreign law, the courts in India still protect the Indian Creditors. The surplus assets, after paying the creditors, should be distributed among the shareholders equally in the same proportion, as the assets to the total issued and paid up capital. Pendency of a foreign liquidation does not affect the jurisdiction to make winding up order. The Assets can be of any nature and do not take to be in the ownership of the company and can come from any source [(1944) 2 All.E.R. 556] 3. GOVERNMENT COMPANY Section 617 of the Companies Act, 1956 defines a Government Company as any company in which not less than fifty one per cent of the paid-up share capital is held by the Central Government, or by any State Government or Governments, or partly by the Central Government and partly by one or more State Governments. A subsidiary of a Government company is also treated as a Government Company. 23

24 Winding up procedure for a Government Company registered under the companies Act, 1956, is nearly similar to normal winding up procedure. However, Courts, take public interest into consideration, and gives priority to them, as the main function of a government company is to provide services to them. VOLUNTARY WINDING UP A company may voluntarily wind up its affairs either by passing an ordinary resolution where the purpose for which the company was formed has been achieved; or the time period, for which the company was formed, has expired; or by way of special resolution if it is unable to meet its financial obligations. A company may voluntarily wind itself up in the following two modes: a. Members voluntary winding up b. Creditors voluntary winding up Both types of resolutions must be passed in the general meeting of the company as provided under section 484 of the Act. Once the resolution for voluntarily winding up is passed the company may be wound up, either through members voluntary winding up or creditors voluntary winding up. In case of members voluntary winding up, the board of directors has also to make a declaration to the effect that either the company has no debts or the company is solvent in terms of provisions of section 488 of the Act. Where the board of directors is not in a position to give a declaration as to the solvency of company, the process of creditors winding up would be initiated. Once voluntary winding up commences, the company is required to appoint one or more Liquidators and fix his/their remuneration in a general meeting of the shareholders. On the appointment of the Liquidator, all the powers of the board of directors come to an end except where the company or the Liquidator sanctions them to continue. Once appointed, the Liquidator takes necessary steps to liquidate the company and dispose of its business or property by sale or any other arrangement approved by a special resolution of the company. 24

25 Distribution of Property upon Voluntarily Winding Up Once the company is fully wound up and assets of the company are sold or distributed, the proceeds collected are utilized to pay off the liabilities. The proceeds so collected shall be utilized to pay off the creditors in equal proportion. Thereafter any money or property left may be distributed among members according to their rights and interests in the company. Distribution of the companies in liquidation by their mode of winding up during to (Sourced: nd 52P P Annual Report of the Ministry of Corporate Affairs for the year ending ) Sl No. Subject Pending as Received Total (Col Disposed Pending as on during the 3+4) during on to period the to period Members Voluntary winding up 2. Creditors Voluntary winding up 3. Winding up by Court 4. Winding up subject to supervision of Court Total ******* 25

26 CHAPTER VII: DEALING WITH DEFUNCT COMPANIES MEANING A defunct company means a company which never commenced business or which is not carrying on business and has either no assets or has such assets as shall not be sufficient to meet the cost of liquidation. A company is, however, not considered defunct if the cessation of business is due to the conduct of winding up. The policy which is followed with regard to weeding out the defunct companies is that where it appears from the latest available balance sheet of a defunct company that it has adequate realisable assets, steps are taken to take the company into compulsory liquidation. It is only where the latest available balance sheet shows that the company has no assets or has such assets as would not be sufficient to meet the cost of liquidations; steps are taken to strike its name off the register of companies under section 560 of the Companies Act, Also sub-section (5) of section 3 introduced by the Companies (Amendment) Act, 2000 states that if a company, private or public, has failed to meet the paid-up capital norm, it shall be deemed to be a defunct company and the Registrar of Companies (ROC) shall strike off the name of the company from the register. PROCESS FOR DISSOLUTION OF A DEFUNCT COMPANY (SECTION 560) Section 560 of the Act, provides for the dissolution of the defunct companies. The process for dissolution is as follows; Where the registrar has reasonable cause to believe that a company is not carrying on business or in operation, he shall send to the company by post a letter inquiring whether the company is carrying on business or is it in operation. If the Registrar does not within one month of sending the letter receive any answer thereto, he shall within fourteen days after the expiry of the month, send to the company by registered post a letter referring to the first letter, and stating that no answer thereto has been received and that, if an answer is not received to the second letter within one month from the date thereof, a notice will be published in the Official Gazette with a view to striking the name of the company off the register. 26