Will the Companies Bill treat ‘sick’ firms better?

India is a growing market where businesses use both capital and debt for their financial needs. But sadly, the laws on insolvency and bankruptcy haven’t kept pace and debt providers, in recovery proceedings against defaulters, find it strenuous to deal with inadequate and outdated laws. Though some legal headway has been made in the past, it is not enough.

Chief Economic Advisor Raghuram Rajan’s 2008 report on financial sector reforms had expressed concerns on slow procedures for bankruptcy and liquidation in India. Rajan will soon be heading the Reserve Bank of India. It is interesting that the announcement of his appointment has more or less coincided with the Companies Bill, 2012 getting the nod of the Rajya Sabha as well.

The Bill, set to soon become an Act, has provisions to modernise our laws on bankruptcy, liquidation and the revival of sick units, although it does suffer some few defects.

Currently, India has a dual legal system: While the revival of sick companies is looked into by the Board for Industrial and Financial Reconstruction (BIFR), their liquidation falls under the domain of high courts. Hereafter, both these functions will vest with the National Company Law Tribunal (NCLT), which should ease the process.

Also, the new test of sickness will be the inability of a company to pay secured creditors, instead of erosion of 50 per cent of its ‘net worth’. That makes it more realistic, since a positive net worth does not always mean the ability to repay debts. These provisions will, moreover, apply to all companies and not only to industrial companies as is the case now.

Negatives and positives

One defect in the new law is that it gives the right for approaching the NCLT only to secured and not unsecured creditors. Secured creditors representing 50 per cent or more of outstanding debt can file for declaring a company ‘sick’ if it fails to pay the debt within 30 days of demand.

The only limited right (or little say) that unsecured creditors have is to approve by a one-fourth vote in value whenever the scheme of revival and rehabilitation comes up. However, this right is minimal. It would have been proper if the rights given to secured creditors were also extended to unsecured creditors.

But coming to the positives, currently once an application is filed with the BIFR, all proceedings against a company declared sick are automatically stayed. No suit remains or is proceeded with for recovery of money or for the enforcement of security against the company. The experience till now shows that this provision has been misused. Many promoters and companies file applications with the BIFR just to seek a stay of proceedings against them.

This will now stop, as the new Companies law provides that such a stay is possible only if the NCLT orders it (on a case by case basis); also, this provision will apply only for 120 days. If the NCLT thinks the company will be able to pay its debts within a reasonable time, it will give that much time through an order.

Further, if the secured creditors representing three-fourth the value of outstanding debt vote that it is not possible to revive the company, then it will be wound up.

On the other hand, if the secured creditors resolve that the company be revived, a scheme of revival and rehabilitation will be prepared by an administrator appointed for the job. The company administrator will be selected from a data bank consisting of professionals with relevant experience in the field.

Rehabilitate and liquidate

That again is a good move.

The new legislation also provides that in case it is found to be difficult to implement the scheme, the company may be wound up if the secured creditors so decide. Besides, the entire process has been made time bound to ensure the speedy disposal of cases. The new law also provides for a ‘rehabilitation and insolvency fund’ for sick companies. This will comprise grants from the Central Government, amounts deposited by the company, and funding from other sources.

As far as liquidation is concerned, the Bill that has been passed doesn’t differ much from the Companies Act, 1956. Also, contrary to one’s expectations, the process has not been made simpler and nothing substantial has changed. This, even though a new concept of summary procedure for liquidation has been introduced, which will simplify the process for small companies with assets of book value not exceeding Rs 1 crore.

Liquidators may be appointed from a panel of professionals. Any creditor (not necessarily a secured creditor) can file for winding up if the company fails to pay debts exceeding Rs 1 lakh within 21 days of demand. The concept of a winding-up committee has also been introduced.

One provision that has been talked a lot about is the payment of two years’ salary as compensation to employees on winding up of a company. But, interestingly, a reading of the fineprint of the Bill only says that if salaries are due for two years, their payment will be given priority over other debts (including secured debts). Some clarity may be required on this.

( The author is a partner with J. Sagar Associates. The views are personal .)

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