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INFORMAL RESCUE OF INSOLVENT

COMPANY IN INDIAN LEGAL REGIME

NAIRITA CHAKRABARTY 1082044 BBA-LLB (A)

INFORMAL RESCUE OF INSOLVENT COMPANY IN INDIAN LEGAL REGIME

Modern corporate and banking practices around the world have, over the years, adopted various measures to deal with distressed companies and distressed debts/loans. Various factors, such as size of company, extent of distress, extent of individual lender exposure, future viability etc. plays a part in the final decision and actions therein. The particular insolvency regime involved is a major factor which determines the ease with which one particular option can be exercised as compared to the other. Thus a creditor-oriented regime makes it easier for the lenders to take charge of proceedings and pursue measures to recover their dues, which ultimately may lead to the winding up of the debtor company. In contrast, a debtor-friendly regime leans towards recuing the company. Since the present scenario is a result of a systemic failure rather than individual instances, winding-up of companies do not look like the best option to be followed. Rescuing companies and putting life back into them (provided they are viable for the future) is what is being pursued commonly. Rescue mechanisms are of two kinds, formal and informal. The formal rescue process would involve a court-led or supervised procedure which ultimately leads to rescuing of a company, through measures such as change in management and debt restructuring. Out-of court rescue procedures through workouts/debt restructurings have seen a gradual but steady growth worldwide. Workouts typically involve a reduction of debt and an extension of payment terms. The main costs associated with debt restructuring are the time and effort to negotiate with bankers, creditors, vendors and tax authorities thus making it a less expensive and preferable alternative to winding up proceedings. Companies facing short-term liquidity problems find such workouts a viable mechanism to get back on track. Creditors would also find that the possibility of getting higher returns would be much greater in case they are able to successfully restructure the debts of the company and keep it as a going concern. This would be more evident in cases of companies having high debt exposures and showing high going concern value. India's insolvency regime prior to 2001 can be said to have been marred by the absence a viable mechanism for restructuring. Rather than encouraging an in-depth debt restructuring strategy after scrupulous cash-flow analyses and consolidated negotiations, the Indian strategy was more or less one of rehabilitation by way of some kind of relief or concession on a superficial level. There were two connected issues which were the main causes of concern. Firstly the rapid rise in Non-performing Assets (NPAs) in India. Secondly the weak insolvency laws of the country. Following the sudden opening up of the economy through the liberalization measures of 1991, mushrooming industries in India were commonplace. Unlike in UK, this was not complemented by a rush by banks to provide funding for the same. Banks were still restricted by a strict monetary policy, which meant that the interest rates remained high.

India's insolvency regime, in any case was not helping matters. Company winding-ups were a long drawn process, taking on an average 10 years, with instances of some cases taking up to 50 years. The restructuring regime had been initiated by the passing of the Sick Industrial Companies Act (SICA) in 1985. The task of reviving sick companies was handed to a quasijudicial body called the Board for Industrial Financial Reconstruction (BIFR). Under the Act, it is up to the Board of Directors of a sick company to refer the matter to the BIFR for consideration. The BIFR would look into the matter, and if necessary, appoint an Operating Agency (OA), usually a major creditor of the company to prepare a report on the feasibility after reviewing the financial position of the company. If the BIFR was satisfied that the company was sick and that restructuring would be a viable option, it would direct the OA to prepare a scheme of reconstruction of the assets. Under the SICA, a reference could be made to the BIFR only if the company under consideration was sick'. The definition for sick company' provided that the company's accumulated losses must equal or exceed its net worth. This meant that only a company which was technically insolvent could be referred to the BIFR for reconstruction. Thus a company with temporary liquidity problems or losses was not eligible for reconstruction and BIFR intervention would only be at a stage when the losses accumulated have made any meaningful reconstruction impossibility.

CORPORATE DEBT RESTRUCTURING

Having realized the need for a more efficient restructuring mechanism which facilitates out-of-court settlements and quickens the recovery process in a fast moving economic climate, and also having taken note of the success of informal recovery mechanisms around the world, the Reserve Bank of India issued a Circular on August 23 2001 providing for the implementation of a Corporate Debt Mechanism (CDR) system and guidelines regarding the same. The objective as stated by the RBI was to ensure a timely and transparent mechanism' and involving other stakeholders through an orderly and coordinated restructuring programme for restructuring the corporate debts of viable entities facing problems,' not coming within the ambit and scope of BIFR or any other legal proceedings. The CDR structure and procedure has undergone various amendments, the latest being in 2008. Corporate Debt Restructuring owes its success mainly to the fact that the Indian economy is still on the path of growth, and in many ways, is nascent, compared to banking dominated economies such as UK and other developed economies of the world. This probably explains the reason why a system which has slowly but surely begun to lose its sheen in UK still finds popular acceptance and success in India. One of the main reasons why CDR has been till date successful is due to the dominant Government presence in the banking sector. Most of the major creditors are public-sector banks, and thus are even-minded regarding issues which come up during restructuring.

ASSET RECONSTRUCTION COMPANIES

Asset Reconstruction Companies (ARCs) in India provide another redressal mechanism to distressed debts. However rather than involving in restructuring, it plays a rehabilitating role. The ARCs essentially remove the non-performing assets from the banks' balance sheet, thereby freeing up capital for further investment. These assets are then recovered by enforcing of security or by creating a secondary market for the assets by working on them employing expert advice and guidance. Banks are increasingly turning to ARCs for their non-performing assets (NPAs) since this represents an easy mechanism to get the assets off their books. Further the banks don't have to indulge in the CDR process, spending time and money in the process. The importance of an ARC comes to light more in times of a systemic crisis, than in individual cases of bad lending tendencies. This is because in an individual case, the bank may be at a better position to gauge the borrower and may want to maintain the relationship with the borrower. However, in times of a crisis situation, as is evident in the present economic climate, banks generally fear further write-downs and bad debts, thus adopting a policy of no lending. The role of the ARC is essentially based on the fact that in such cases, more specialized knowledge and focus is required to resolve the problem of non-performing loans, leaving the banks free to pursue further lending activities and stimulating the economic growth. Both systems of informal restructuring and workout mechanisms existent in India are laudable as far as their objective is concerned. With regard to their implementation a lot more needs to be done so as to provide for a more viable mechanism.