Cos Act Ep#15: Sick Companies
The new company law was meant to provide India a modern bankruptcy regime, in which sick companies are given some tender loving care for revival and terminally ill companies are allowed to die or wind up in the most efficient manner possible. Does the Companies Act, 2013 – in its provisions for revival and rehabilitation of sick companies and winding up - fulfill these needs? CNBC-TV18’s Menaka Doshi puts that question to Alok Dhir, Founder, Dhir & Dhir Associates; Fereshte Sethna, Partner, Dutt Menon Dunmorrsett & MR Umarji, Chief Adviser- Legal, Indian Banks’ Association.
Doshi: I would like to start by focusing this episode with Chapter XIX which is revival and rehabilitation of sick companies. Chapter XIX makes a radical departure from SICA by providing that any company- not just a manufacturing one- can be determined to be sick if 50 percent of its secured creditors demand a debt repayment and the company fails to pay the debt within 30 days and a secured creditor or the company itself or even a public financial institution or the government moves the National Company Law Tribunal (NCLT). Networth erosion is no longer the sickness threshold. The applicant may also apply for a stay of up to 120 days on winding up proceedings, execution against any company assets or apply for the appointment of a receiver and that no recovery suit shall be proceeded with. Once a sickness application has been filed, the company cannot sell any of its assets or properties, nor can its Board take any action detrimental to creditors.
If secured creditors representing 50% or more debt demand repayment
And Company fails to repay debt in 30 days
Any secured creditor can file application with Tribunal asking company to be declared sick company
Company may also file application on similar grounds
Central Govt, RBI, State Govt, Public FI or State level Institution can make application too
Section 253 (2)
Applicant can also apply
- for stay of any winding up proceedings
- for execution, distress or the like against any property and assets of the company
- for appointment of a receiver
- that no suit for the recovery of any money or for the enforcement of any security against the company shall lie or be proceeded with
Section 253 (6)
Where an application has been filed -
(a) the company shall not dispose of or otherwise enter into any obligation with regard to, its properties or assets except as required in the normal course of business
(b) the Board of Directors shall not take any steps likely to prejudice the interests of the creditors
The Tribunal has 60 days to determine whether the company is sick or not. If found to be sick, the Tribunal must decide if it is practicable for the company to repay its debt and accordingly grant the company time to do so.
Tribunal shall within 60 days
- Determine whether company is a sick company
- Whether it is practicable for the company to repay its debts
- Give such time to the company as it may deem fit to repay debt
Doshi: I think the most important thing is the definition of sick has gone through a sea change. It was earlier linked to networth erosion; it no longer is linked to that at all. It is just simply the inability to pay back 50 percent of your secured creditors. That is a good thing according to you?
Dhir: According to me, it is a very grey area. There is now at this point of time no definition of a sick industrial company at all or a sick company per se at all. What are the factors which will weigh with the Tribunal to determine whether a company is sick or not is not clear. The rules do throw some light, the rules provide that while determining the company as sick or otherwise, the question will be the reason for default. The second is position of debts owed by the company - not relating to these secured creditors but others also will be there. Those are the only two factors to be considered. When there is no definition of what a sick company would be, how is the Tribunal going to determine sickness; I don’t know.
Doshi: Does it give the Tribunal flexibility to determine, based on the facts at hand, whether the company is sick or not?
Sethna: The width and amplitude is precisely what the new provisions intend to usher in. So that level of discretion which is clearly vested with the Tribunal is a welcome requirement because it allows really for secured creditors to get in while the company is still afloat rather than waiting for networth erosion. So it is absolutely a step in the right direction.
Umarji: And 30 days default is a very clear basis on which the company can be declared as a .....(Interrupted by Anchor)
Doshi: And so they try to nip the problem in the bud as opposed to waiting for the company’s networth to erode and then try and fix something that is probably unfixable.
Umarji: The other issue which is very relevant is that this application can be filed by the company itself. So I am running a business- if I am in a problem, I can always come forward and tell the Tribunal that I am not going to be able to comply with the terms of payment, there is going to be a default and so I want a revival scheme to be formulated for me.
Doshi: So the initiative then is in the hands of the creditors, the company, in some cases public financial institutions, scheduled banks, state governments - depending on their exposure to the company - for them to take the call saying let’s move ahead as opposed to waiting for things to get so worse that there is no way to fix it.
Dhir: I may just point out that in 2002 when the Companies (Amendment) Act was framed, they had actually given two guideline factors. One was 50 percent erosion of networth and the other was inability to pay debt - now there is no such criteria anymore. While I accept that there would be discretion in the hands of the NCLT but every discretion has to be based on some parameters and unfortunately no parameters whatsoever are given. So determining whether a company is sick is one issue, knowing that the company is under financial stress is another.
Sethna: As a matter of fact the Standing Committee on Finance 2012 did examine precisely this issue which was flagged off for consideration and they came to the conclusion that clearly we can live without a definition. So to circumscribe is really not necessary in the best interests of anyone.
Doshi: The process so far is as I have put it quite simply. Is there anything else here that is cause for alarm in any fashion. This is up to the Tribunal to determine within a 60 day period whether this company should be sick or not.
Dhir: In my view, the 60 day period is too short.
Doshi: Why? I thought the whole idea was to speed this up?
Dhir: Yes, that is true but the legal process being what it is if an application is filed by a creditor, certainly an advance notice is required to be given to a company, the company may have its own reasons, it may file its own replies, it is good to have a timeline but if the timeline is rigid and within the manner of litigation that goes on in the country and in the manner in which we have seen in sick industrial companies with very firm parameters such a long time being taken in determining whether the company is sick or not, in a situation like this it will never happen. In 30 days they can’t decide. They won’t even have a…(Interrupted by Anchor)
Doshi: But isn’t it the whole purpose of setting up National Company Law Tribunals as specialized Tribunals that will not come with the baggage that our courts do or that Board for Industrial & Financial Reconstruction (BIFR) or Company Law Boards have suffered all these years and therefore will be able to move faster?
Dhir: How do you do this? I mean if you are going to ask somebody to give a response - an application is filed by a creditor saying that I am sick in the situation that we now know there are no parameters for determining this, they will come back with some sort of reply you need to give them time. There is natural justice, when they come with a reply the creditor needs to come back with a rejoinder, how are we going to compress all this within 30 days, it is a rigid timeline.
Doshi: 60 days is too little?
Umarji: No, according to me it is the right provision. It confirms to recent guidelines issued by Reserve Bank on stressed asset management. There also, the time limits are same that special mentioned account is after 30 days default, then special mentioned account 2 is after 60 days default. Now this is a time within which you are supposed to work out a scheme.
Sethna: The point I want to make is this. The fact is that this new provision -Sec 253 specifically- imposes upon a secured creditor an immense level of responsibility to take upon itself the onus of actually wanting to shut you down because you have defaulted. You are in potential default, they are watching you closely. To my mind the point that Alok Dhir made with regards to notice, according to me the very fact that you are on the verge of default is something best known to you in any case; so you better start setting your house in order unless you really want to sort of face Chapter19.
Doshi: And really how long should you wait because the longer you wait the more pointless this entire process gets at the end of the day.
Sethna: Rs 1,94,000 crore of non-performing assets! What are we talking about in this country anymore? Public funds need protection.
Doshi: If a company has been determined sick, a secured creditor can within 60 days of such determination apply to the Tribunal to recommend revival measures unless of course secured creditors representing three-fourths of the debt have already recovered assets using SARFESI or if the assets have been sold to an ARC. In that case, the ARC must consent to such a revival scheme.
If Tribunal determines company to be sick
- Any secured creditor can apply within 60 days for Tribunal to consider measures for revival & rehabilitation
Unless secured creditors with 3/4ths of the debt have taken measures to recover assets using SARFESI
If the assets sold to Securitisation company/ ARC, then its consent to revival scheme needed
On receiving a revival application, the Tribunal shall call a hearing within 90 days and appoint an Interim Administrator to determine, in consultation with a committee of creditors, the workability of such a revival scheme. If a revival scheme has not been submitted by the company itself, then the Tribunal may direct the Interim Administrator to take over the company management. Thereafter, based on the vote of creditors representing three-fourths of the company’s debt present and voting at the meeting, the Tribunal can either decide to wind up the company or revive it.
On receiving Revival application, Tribunal shall
- Fix date for hearing not later than 90 days
- Appoint Interim Administrator to convene creditors’ meeting in 45 days
Committee of Creditors
- Maximum 7 members, representing every class of creditors
- To consider whether it is possible to revive the sick company
- To submit report to Tribunal within 60 days
If no draft revival scheme has been offered by the company, the Tribunal may direct Interim Administrator to take over management
Based on vote of creditors representing 3/4th in value of debt present and voting
- Tribunal shall order winding-up of sick company
- Tribunal shall order revival of sick company & appoint Company Administrator to prepare Scheme of Revival
Govt databank of Company Secretaries, CAs, Cost Accountants, any such professionals…
Doshi: Does it come anywhere close to Chapter XI in the US?
Sethna: Absolutely; because creditor committee is straight out of there. Creditor committee is a huge step forward and that is something that is perhaps going to be the turning point if we stack them up right. So that is again going to be critical because it is going to be the creditors who will make or break these companies eventually.
Doshi: This is the first time in this provision and in this chapter that the representation of unsecured creditors comes in because the creditors committee will cut across all classes of creditors.
Sethna: And as a matter of fact, the UNCITRAL Rules for legislation on insolvency 2005 specifically envisage the significant role the creditor committees can play in the process of an insolvency or potential insolvency. So, technically this is something that has been far and wide recognized globally as a matter of fact; not just necessarily in Chapter XI. So it is the step in the right direction in my mind and I am quite sure that we should see the benefits of that as we move forward. But as I was saying to Mr Umarji, just a short while ago, it is about 10 years minimum before we see the benefits of this legislation paying off.
Doshi: How do you see this process?
Umarji: I fully agree with her. It is in conformity with the UNCITRAL recommendations on insolvency and the appointment of an administrator who can be a professional is going to change the entire scene.
Doshi: Why; because he will bring more integrity to the process, speed to the process?
Umarji: Speed to the process. So we are going to have a new category of professionals who are insolvency practitioners.
Doshi: Which is good, right?
Umarji: Who are there in other countries, in developed countries, they are operating. So it is going to be a new specialized professional who is an expert in insolvency proceedings and formulating schemes for turning around companies under stress.
Dhir: I think creditors committee is absolutely a step in the right direction. Appointment of insolvency professionals is also a very major move forward and I think more than anything, they will bring professionalism into the whole process. The official liquidators of the past were very bureaucratised, the insolvency professionals in all possibility will come from the branches of law and accounting and finance and will have abilities to prepare quickly schemes and they will have administrative abilities to manage the affairs of the company in a more meaningful manner and to be able to conduct the creditors committee meetings and the process of rehabilitation and revival of the company far more swiftly because now there is a professional entity. Currently, under the BIFR, you have operating agencies which happen to be usually one of the secured creditors of the company and unfortunately, the task slips from senior officers to junior officers and to even more junior officers till you end up noticing that only a manager level person is actually conducting the operations of what an operating agency is required to do. I think it is a huge step forward.
Doshi: You don’t think it is too much power in the hands of the Interim Administrator because that is maybe a complaint that promoters could likely have of companies saying he could even take over the management of our company that is provided for in this Section. I am not sure if that is a bad thing because once you have been determined sick then I am not sure how much right you have over management but that could be the complaint that comes out.
Dhir: In my view, it is very important to take the company out of the hands of the defaulting people. What happens is that it will require a great deal of expertise for some interim administrator or a company administrator to step in into a company which is live and operating and take over the reins in quick time as is prescribed is not going to be easy. It is going to require a lot of expertise, a lot of experience, a lot of maturity and a lot of understanding of the business but it is something that we have to look forward to and as Sethna very rightly said, 10 years down the line, we will see the fruits of this coming up. In other jurisdictions in the world, this is happening and I see no reason why it should not happen here. Having said that, since you compared Chapter XI, let me just point out one-two issues. In Chapter XI, there is a voluntary filing i.e. any company which feels that it is under financial distress can file.
Doshi: It says the company can file
Dhir: It can but it is only subject to the notice under 253(1).
Doshi: So you are saying they should have at least made the provision for a company without having failed to repay its debt to consider making an application.
Dhir: That would have satisfied me more because then the criteria of sickness would not have been so relevant but since you are not allowing a company to file and secured creditors can move an application therefore the criteria became necessary in my view.
Doshi: Unsecured creditors have a limited role to play so far in the process and I would think that is right; I cannot see any reason for them to complain.
Dhir: They have a far more say than we are assuming at this stage because the stage at which the meeting is to be held because as soon as 250(4)(1) application is filed, there is a meeting which is required to be held. It is just three-fourth of the creditors, it doesn’t say secured or unsecured.
So when you start weighing secured creditors versus unsecured creditors, you would see many situations where unsecured creditors outweigh the secured creditors in terms of volume of debt. So in my view they have far more say than we are assuming that they would have. We can’t proceed beyond that step unless they also agree.
Doshi: If the creditors vote for a revival, the Tribunal shall appoint a company administrator to prepare a scheme of revival within 60 days and allow him to take over management of the company if so required. The revival scheme may provide for financial reconstruction, management change, asset sales, labour cuts, restructuring of debt etc. The scheme needs the approval of 25 percent of unsecured lenders and 75 percent secured lenders and a final nod from the Tribunal within 60 days.
In order to effectively implement the scheme, the Tribunal has considerable powers. For instance, not only can it keep the company administrator in charge, it can modify or cancel any contract of the company. If the revival scheme is not approved of by the requisite number of creditors or it fails during implementation, then the Tribunal may order winding up.
Tribunal may direct Company Administrator to take over assets/management of sick company
Company Administrator shall prepare Scheme of Revival within 60 days
Scheme may provide for
- Financial reconstruction
- Management change
- Asset sales
- Rationalisation of staff
- Debt restructuring
Section 264 (1)
‘The Tribunal shall, for the purpose of effective implementation of the scheme, have power to enforce, modify or terminate any contract or agreement or any obligation pursuant to such agreement or contract entered into by the company with any other person’
If the Revival Scheme
- Does not receive requisite approval from creditors
Tribunal shall order winding-up of sick company
What I like is that there are clear timelines put in but you have already expressed that you don't agree that these timelines are adhereable; so to speak?
Dhir: I am very apprehensive of timelines across the board. And frankly let me tell you if you put all the timelines - it is 367 to 427 days. It is a long time.
Let me explain to you how it works. Once the report has come from an administrator, the NCLT has 60 days within which to sanction a scheme. Now they have to publish the scheme also in the newspapers; that is required in law. They have to hear objections from others, there are vested interests. Creditors are not the only entities which are involved with this. Labour will be involved; there would be other people who have contracts as you said some contracts can even be set aside. So they will all have a say. How are we going to do it within 60 days?
Doshi: So on one hand you are saying look even if you add up all the defined timelines head to toe, it is 420 days approximately; that in itself is a fairly long period, but then you are saying even that is not enough.
Dhir: The reason why I say it is it was possible for them to compress this whole thing. As I said there are three levels of meetings, there could have been only two and sometimes it does take time. If you go to Chapter XI, it sometimes takes years for them to get a restructuring scheme in place. Where the creditors and the defaulting borrowers are in sync with each other, you could actually rush through a scheme under Chapter XI within months. The problem with this enactment is that it is just too rigid.
Umarji: No, it is not rigid. See if there is a consensus, you are going to be able to move fast. If there are persons who are obstructing the entire revival scheme, then ultimately it may mean that if the company is unable to convince them and agree to a revival scheme it will end up into a winding up of that company. And the other point in this is that there is already a corporate debt restructuring scheme of RBI which is non-statutory, it is already operating but it has some restrictions, it applies to multiple banking.
Doshi: It leaves out foreign banks; it leaves all unsecured and all of that.
Umarji: This is making a statutory provision for corporate debt restructuring.
Doshi: So it will replace CDR altogether you think?
Umarji: No it is becoming available to everybody, all the companies. If only a single bank is the lender even then it will apply whereas CDR is not applicable to single bank lending cases. So therefore it is fitting in the similar provisions as in CDR into a statutory provision.
Sethna: Honestly we have seen the evils of the system where you had endless adjournments and I think it is time that we crack down on that.
Doshi: Before the discussion Mr Umarji told me the average time that it took for a company to wind up in this country which is the next stage after this is 15 years.
Umarji: It continues to be 15-20 years.
Sethna: 20 and counting.
Doshi: I don’t know who gains from that because if you are a creditor you have lost all that money and gained nothing?
Umarji: Assets get deteriorated and this will result in putting the assets to productive use.
Dhir: Let me tell you rehabilitation and revival is not financial restructuring. The error we are making is we are putting down the entire concept of revival and rehabilitation of sick companies as a simple financial restructuring exercise. It is far more than that but what happens to the workmen? What happens to statutory dues? What happens to various litigations which are going on with respect to sales tax, customs, excise?
Doshi: Statutory dues; isn’t that taken care of in the very first Section itself where they say that if the manufacturing units are in that region, can it itself file the petition for sickness or the application for sickness?
Dhir: But where is the process? There is a secured creditor, there is a sales tax due in a certain State which has a priority over secured creditor. How are you going to revive this company?
Umarji: The stage at which this is getting down is 30 days default and the entire scheme will have to take care of all the liabilities of the company.
Dhir: It is wishful thinking my friend; how do you deal with the sales tax department in 30 days.
Umarji: This is what the company has to provide for and if there is a winding up, the sales tax dues or the other dues of the government do not have a priority.
Dhir: The Commercial Bank judgment of the Supreme Court.
Umarji: Section 529A and 530 is very clear. The government dues come subsequent to the secured creditors. It is a very clear statutory provision and that is repeated in the new Act of 2013.
Dhir: There are now many judgements, the sales tax department in some States where the enactment has provided them to have priority over the dues of secured creditors, the Supreme Court has also held that the priority is established. There are certain States where they have amended the Sales Tax Act in this way; there are certain States where they have not amended the Sales Tax Act in this way. You are aware that with respect to labour dues, there is a pari passu charge.
Umarji: But this is where there is no winding up. You see in case of winding up, a Central Law is making a contrary provision and that will prevail over the State law.
Dhir: In fact, if I may say so, if there is no winding up under the judgment of the Supreme Court, Canara Bank v Allahabad Bank, an unsecured creditor can take priority over a secured creditor. So it is a very complex environment in which we are dealing.
Sethna: My view is that there is no doubt about the fact that a secured creditor is going to be immensely responsible when he takes his decision because ultimately everybody knows that there are all different stakeholders.
Doshi: What about Alok’s point that it is leaving out labour?
Sethna: That is the point, you must know that ultimately as a secured creditor when I am sitting where I am, I am going to be looking at the entire slew of issues that are going to arise.
Doshi: Does this put too much power then in the hands of this slew of creditors?
Sethna: As a matter of fact it does.
Doshi: Is that the right thing to have done?
Sethna: In my mind it has to because otherwise how do you recover public money, that is the bottom line.
Dhir: To go into winding up, I don’t mind that.
Umarji: If it doesn’t work out the secured creditor will make an effort to work it out. If it doesn’t work out 75 percent in value have power to take possession of everything and sell it.
Doshi: So then the final question- is this better than the current provisions that we have given that Chapter 19 is not yet notified and therefore in force. Is this better than what we had under SICA, BIFR, CLB and all of that?
Sethna: 10 years from now we will know exactly where we were.
Doshi: But on the face of it?
Sethna: For sure.
Doshi: On paper?
Sethna: For sure, no question about it.
Umarji: Yes, it is much better than all of that.
Doshi: Much better for everybody involved; all stakeholders?
Umarji: Everybody involved, all stakeholders and it is going to benefit the corporate sector.
Doshi: Not just creditors?
Umarji: Yes, not just creditors.
Doshi: Since you played skeptic all this time?
Dhir: Yes and no- there are certain provisions in this which certainly progress the entire concept of rehabilitation and revival.
Doshi: Like the committee of creditors.
Dhir: Like the committee of creditors, insolvency practitioners and I must again say the focus on the creditors. Creditors are very important in any rehabilitation and restructuring. The only reservation I have is that they are not the only entity which is interested in the process of rehabilitation.
Sethna: Eventually when we come back to Sec 253; let’s just get back there because that is really the parent provision under Chapter 19. It vests an immense level of responsibility with the secured creditor and we have to trust the secured creditor to take a decision in the interests of all concerned.
Dhir: I am sorry, I really don’t see that. I don’t see any secured creditor, every secured creditor has a responsibility to recover his money and the best that he will for himself.
Umarji: Secured creditors are also interested in upgrading an account which is classified as non-performing which will allow them to write back the provision, to charge interest and recover interest on their loans which otherwise they can’t charge if it is in the category of non-performing asset. And if this method is going to result into turning around the company and they start repaying installments of the loans and all that, why should they not be interested.