The terms insolvency and bankruptcy are used with reference to the financial position of a person. They are often considered to mean the same. Actually, the terms mean differently. Individuals and corporates are both amenable to insolvency and bankruptcy. The term, insolvency is a state and bankruptcy an effect of that act. While Insolvency is a condition of not being able to pay one’s debt and bankruptcy is a legal surrender of one’s remaining goods into the hands of creditors in consequence of a real or supposed insolvency. Bankruptcy is the condition of insolvency when it passes into the recognition of law and its liabilities are dealt in accordance to principles established by legislation. Leading distinction between bankruptcy and insolvency in the proper technical sense of the words consists in the character of the persons upon whom it is designed to operate. Line of distinction between bankruptcy and insolvency law is not so distinctly marked as to define what belongs exclusively to the one and not to the other class of law.
Thrust on consumerism caused retail segment advances by banks to swell. This pushed up demand for goods, production picked up and economies boomed seeming never to look back. Global financial market disaster in the year 2008 led to recession all over the world including India. Persons were hit by loss of jobs resulting in EMI defaults on credit cards, housing mortgages, consumer and personal loans. FIs, Banks and NBFCs resorted to recovery of loans through muscle men who even resorted to physical assault before going to courts. Borrowers ran from pillar to post for guidance in vain. Small borrowers faced hard times as they had borrowed to go with the tide of consumerism without being able to predict the disaster which upset everything. Reports of suicide by defaulters surfaced. RBI was forced to intervene. Court Orders were passed to stop Banks using muscle men. During this period review of the personal insolvency laws surfaced. The two laws regulating personal insolvency in the country are Presidency Town Insolvency Act of 1902 (PTIA) covering Kolkata, Chennai and Mumbai and the Provincial Insolvency Act, 1920 (PIA) applicable to the other places. With increase in volumes in the financial sector with reference to the retail segment there arose an urgent need to make the personal insolvency laws compliant with the prevailing economy.
Recession post September, 2008, saw borrowers and lenders running aimlessly while the former tried to clear off their debt the latter tried hard to recover defaults. Legal action through the application of the provisions of S 13 of the SARFASEI Act, 2002 was applied, money suits, mortgage suits, criminal complaints increased. Sudden change in the economic scenario caused many individual borrowers to apply before the court to declare themselves insolvent. In the month of April, 2010 the High Court at Calcutta passed an interesting order. It ordered investigation into irregularities in bankruptcy declaration by individuals on an application filed by five private sector banks submitted before the Court that a racket was in operation to help people to declare themselves insolvent. During the years 2000 to 2010 total insolvency applications aggregated to 1427 out of which 1018 were filed in 2009. High Court ordered appearance of the persons declared insolvent since April, 1, 2008 in person or through Authorised Representative. The Registrar of the court has been asked to not to accept insolvency applications till further order passed by the court. The incident goes to reveal that our personal insolvency laws immediately requires a re-look and the people should be educated on the subject. Prosperity and adversity are common to an economy and we cannot afford to ignore the insolvency laws. There must be measures to deal with such situation. The report of the High Court at Calcutta is an eye opener to the weak legal system prevailing in the country in dealing with individual insolvency and insolvency as a whole. Immediate steps to make it compliant with the present economy is considered essential.
2. Insolvency and bankruptcy
Late sixties saw the decline in the number of industries specially in the state of West Bengal. It started with the jute industry concentrated in the state being the aftermath of partition of the country. Industrial unrest, sickness, closure spread to other industries specially engineering. Take-over of weak and sick companies by the Central/State Governments became the only answer to save jobs and the economy as a whole. Instances of nationalization of companies followed. The policy proved too costly to the Government to check companies from the outset, the Sick Industrial Companies (Special Provisions) Act, 1985 (`SICA’) was passed. Manufacturing companies in existence for more than five years employing fifty or more persons in which the net worth stood eroded by not less than fifty per cent referred to as a sick company were required to file an application to the Board of Industrial Finance and Reconstruction(`BIFR’). Objective of passing the Act was to rehabilitate or wind up the company if it was found unviable by the Board. SSIs are not covered by the act. Insolvency of corporates is considered serious for an economy. Advanced countries have an efficient insolvency dealing mechanism in place. Chapter 11 dealing with filing by corporations for bankruptcy protection under the Bankruptcy Code is very significant in the US. Filing by corporations under the code have rocked the economy of countries specially when the corporations have international presence. Enron and Lehman Brothers of the USA , Dawooe of Korea and JAL of Japan caused international concern on their filing bankruptcy applications to protect against insolvency. An insolvent corporation is one whose property is insufficient to meet the amount outstanding with creditors; also one which is not able to pay its debts.
Bankruptcy is another situation in the economic system with reference to a financial position of a person. It refers to a condition when assets of a person are insufficient to meet debts. As stated earlier bankruptcy is a legal surrender of all of one’s remaining goods into the hands of one’s creditors in consequence of a real or supposed insolvency. Bankruptcy is the condition of insolvency, when it has passed into the recognition of the law, which deals with the case and its liabilities according to principles established by legislation which may vary in different nations. An insolvent person whose property is administered for, and distributed among his creditors in accordance with the provisions of a system of law is called bankruptcy or insolvency law.
3. Insolvency, Bankruptcy and Liquidation of companies registered in India.
Liquidation process in India is fairly protracted. Time taken involves 7 to 10 years compared to 1 to 6 years in other countries. The process of liquidation involves procedure which usually results in insignificant recoveries from the assets compared to the debts owed leading to substantial waste of resources and funds. Long period taken to complete the liquidation process lead to damage of assets of the companies under liquidation which practically do not have any utility when the steps completed. Having a systematic and efficient liquidation procedure is essential for an economy. The Companies Bill, 2009 has included specific provisions for quick disposal of corporate insolvency. Over and above, the Government has plans for an independent insolvency law to make the process effective and time bound. Plans for a single legislation on insolvency is afloat . Insolvency provisions for all types of business operations being a company, partnership, limited liability partnerships (LLPs) and sole proprietorship form of business is planned to be dealt under one authority.
Presently winding up of a company is regulated by the Companies Act . Personal insolvency is covered by the two personal laws. The new companies bill is pending with the parliamentary standing committee formed for the purpose. However, it refers to only corporate insolvency. Sole proprietorsip form of business continues to be the most popular form of business. Laws for protecting insolvency of tiny, small and medium units are inadequate. Coming to companies, there are about 8 lac companies registered with the 21 Registrar of Companies,(ROCs). Out of the above 6.5 lac companies are operational. 1.5 lac are defunct companies which means they continue to be included in the Register of Companies with the ROC but do not submit the Balance Sheet and Annual Return as required to by filed as per the Act. Of the operational ones, 3,70,196 companies did not file balance sheet and 3,71,110 Companies did not file Annual Return for the year 2008-09. In the Budget Speech for the year 2010-11 the Government has stressed on sound corporate governance. The judgment passed on 11th May,2010 by the Supreme Court pertaining to the validity of the constitution of the National Company Law Tribunal and National Company Appellate Tribunal would help to speed up having a central authority to deal with corporate insolvency.
4. Supreme Court Order on constitution of the National Company Law Tribunal and National Company Appellate Tribunal.
On 11th May, 2010 the five-judge constitution bench of the Supreme Court including CJI K.G.Balakrishnan, J R.V.Raveendran,J D.K.Jain,J Pathasivasm and J Panchal upheld the legality of the Companies ( Second Amendment) Act,2002 which came into force on 13th December,2000 providing for the establishment of the National Company Law Tribunal (NCLT) and National Company Appellate Tribunal (NCLAT) to deal exclusively with companies and their issues. Verdict was passed on the two appeals filed by Union of India and Madras Bar Association against the order of the Madras High Court which had said that the amendment to the Companies Act, 1956 by the amendment act of 2002 to set up NCLT and NCLAT was unconstitutional. Earlier a three judge bench of the Supreme Court headed by the CJ referred the appeals to a five judge constitution bench stating that the issues raised in the appeals are of `seminal importance’ and could have serious impact on the very structure and independence of the judicial system.The order is expected to speed up disposal of company cases. All jurisdictions exercised by the High Courts with respect to companies would be transferred to the NCLT and NCLAT. However, the judicial review power under Arts. 226 and 227 of the Constitution will remain with the High Courts. Now all petitions pending before the CLB and BIFR will also be transferred to the NCLT and NCLAT. The presiding officers in the NCLT and NCLAT would be of the rank of High Court Judges or persons meeting the qualification criteria meant for High Court Judges.
The order of the Apex Court is likely to clear corporate suits and speed up disposal of new cases to be filed in future. Time taken for completion of the liquidation process of sick companies would stand shortened from the present average of 7 to 10 years. The order of the Apex Court came in at the time when Government is gearing up to have a clear vision of insolvency procedure in the country realizing the fact that insolvency laws need to be looked into considering globalization in business and the economy of the country which is viewed internationally. To-day downfall of the economy of one country is bound to have an impact on other countries examples being the present economic turmoil in Greece and the meltdown in the US in 2008-09 and other advanced countries.
5. Weakness of the Indian Insolvency System
The Companies Act, 1956 governs liquidation. Average time involved is 7 to 10 years. The Sick Industrial Companies (Special Provisions) Act,1985 (`SICA’) was enacted to restructure sick companies but it is felt that it failed to deliver expected results. Reports of wrong use of the provisions of SICA by debtors seeking to delay payment to creditors are known. Instances of asset stripping are common. Until recently there was little support to track delinquent debtors. Lack of sanctions against management of failed companies resulted in far reaching effects with them promoting other companies as well without being penalized for being responsible to manage other company.
6. Importance of time span in liquidation of business
Survey reveals that on an average time taken to close down a business specially a company in India is about 7 to 10 years. It is too long compared to the time taken in other countries. Time taken in Australia is 1.0 year; Canada 0.8 year, Ireland 0. 4 year; Japan 0.6 year and Singapore 0.8 year. If the corporate culture is strengthened and the Financial Institutions, Banks and Creditors are to be given their due then the period covered needs to be shortened. Need for a comprehensive insolvency legislation becomes important as the proposed bankruptcy code in the Companies Bill, 2009 will not be applicable to all cases. With the steep increase over the last 5 years in retail lending, experts opine that it is necessary to re-look at the personal insolvency laws to ensure insolvency proceedings against individuals also end quickly. The proposed bankruptcy code forming a part of the companies bill is an improvement in the insolvency reforms process. A comprehensive legislation would be the next generation reforms to make winding up process expeditious and more effective. An area which still needs to be addressed is cross border insolvency considering the globalization of buisness. Irani committee set up by the government to suggest reforms to the business environment in the country , emphasized the need to speed-up liquidation proceedings. It suggested two-year time frame for completion of such proceedings.
7. Reference to Global Corporate Insolvency
15th September, 2008 witnessed one of the worst set backs in the world financial market. Lehman Brothers the 158 year old investment banker of US with international presence filed application under Chapter 11 of the Bankruptcy code. Merrill another financial giant was sold and AIG the insurance major was taken over by the Government. Merrill had 60,000 employees on their rolls while Lehman Brothers employed 25,000 persons. It did not end there. Banks were forced to close down and mergers and acquisitions followed to eliminate weak companies. There were restructurings all around in the financial sector. Some of the other significant bankruptcies applications filed under Chapter 11 in the US include 1. Worldcom Inc declaration of a debt of $ 103.91 billion. 2. Conseco Inc involving a sum of $ 61.39 billion 3. Texaco Inc for a sum of $ 35.89 billion 4. Financial Corp of America debt valued at $ 33.86 billion 5. Refco Inc for $ 33.33 billion.6. Global Crossing Ltd involving a debt of $ 30.19 billion. 7. Pacific Gas and Electric Co. for $ 29.71 billion. 8. UAL Corpn involving a sum of $ 26.71 billion. 9. Delta Air Lines Inc debt amounting to $ 21.8 billion 10. Adelphia Communication for a sum of $ 21.5 billion.
8. Background of Corporate Insolvency Law
Corporate insolvency law was passed for the first time in 1844 with the ‘British parliament enacting the Joint Stock Companies Act, 1844. The Act aimed at incorporation of a company as a distinct legal entity with unlimited liability of members. Thereafter, the Joint Stock Companies Winding-up Act, 1844 was enacted. The act provided for declaration of bankruptcy by a company in the same manner as an individual. The Joint stock Companies Winding–up Acts 1848 and 1849 followed suit and conferred general winding–up jurisdiction on the Court of Chancery, a jurisdiction overlapping that of the Bankruptcy Court until the passing of the Joint Stock Companies Act, 1856 and the Joint Stock Companies Winding-Up (Amendment) Act,1857. With the enactments the Court of Chancery was granted exclusive jurisdiction. This formally separated bankruptcy and winding procedure.
9. Development of Corporate Insolvency Law
Corporate insolvency law in India is based mostly on common law principles and the inherent jurisdiction of the court. Winding up was influenced by the creative power of the courts. The principle of pari passu distribution of assets among ordinary unsecured creditors, which under the Bankruptcy Act 1914 was developed by the courts to develop the fundamental concept of insolvency law having the most profound repercussion on validity of pre-liquidation contracts and dispositions entered between the company and creditors and creditors inter se. Statutory provisions delimiting assets available for distribution predicate that attachment, perfection and priority of security interest and other real rights are to be determined by the general law applicable to transactions outside winding up, most of it being non-statutory. Finally, the court’s inherent jurisdiction over its own officers enable it to empower the liquidator appointed by the court rights and remedies to which he is on the face of it entitled by law where the exercise of those rights or remedies would in the opinion of the court be unfair or inequitable.
10. Historical perspective of Indian personal and corporate insolvency law .
In India the two Insolvency Acts applicable to individuals are PTIA and PIA. Bankruptcy and Insolvency is specified in the entry 9 of the List III (Concurrent List) of the Seventh Schedule under Art. 246 of the Constitution. The statutes were amended several times. Common features in the two statues appear in the definitions; petition procedure and adjudication; administration of properties and discharge of the insolvent. The statues prescribe what constitutes offence and they attach criminal liability for certain acts of the debtor.
Corporate insolvency law applicable to companies governed by the Companies Act,1956 has the following four objectives : (a) restore the debtor company to profitable trading where this is practicable; (b) maximize the return to creditors as a whole where the company itself cannot be saved; (c) establish a fair and equitable system for the ranking of claims and the distribution of assets among creditors, involving a limited re-distribution of rights; and (d) provide a mechanism by which the causes of failure can be identified and those guilty of mismanagement brought to book and, where appropriate, deprived of the right to be involved in the management of other companies. To ensure fulfillment of the aforesaid objective, insolvency law provides for a number of legal and administrative instruments and institutional structures.
Instruments include placement of the company and its assets under the control of an external manager with wide powers of investigation and management, disposal or closing down of business; suspension of rights of individual pursuit of claims and their replacement by a collective debt collection process, followed by distribution of net realizations to a statutory system of priorities; avoidance of transactions by the company which are improper or which would otherwise be unfair to allow to stand, recovery of misapplied assets; imposition of civil and criminal sanctions including disqualification for improper conduct on directors; and qualification requirements for insolvency practitioners designed to ensure their integrity and competence. Insolvency law provides for ultimate death of a company in winding up by following a procedure of dissolution. The Companies Act, 1956 adopts the rules of insolvency laid down in the laws and provides the procedural law for corporate insolvency.
10 Existing system of supporting corporate solvency in India
Companies in India are governed by the following insolvency and restructuring procedures, rules and regulations and laws :
a) Preparation of schemes of arrangement or compromise under the Companies Act, 1956; b) Restructuring `sick’ companies in certain specified industries under SICA; c) Recovery of Debts due to Banks and Financial Institutions Act, 1993;.d) The Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest Act,2002; and e) Winding-up under the Companies Act,1956.
S 529 of the Companies Act, 1956 states that in the winding up of an insolvent company, the same rules shall prevail and be observed with regard to :
(a) debts provable;(b) the valuation of annuities and future and contingent liabilities; and
(c) the respective rights of secured and unsecured creditors;
as are in force for the time being under the law of insolvency with respect to estates of persons adjudged insolvent.
The terms insolvency and bankruptcy are significant for an economy. Unless they are dealt in the proper perspective the economy is affected. Advanced countries have strengthened laws on the situations and India is also working towards the direction. It is heartening to know that the Government is taking steps to speed up corporate liquidation process and is also drafting a law to deal with the SME sector. The order passed by the Apex Court on 11th May,2010 will help to stream line the liquidation process of companies in the country and help in their rehabilitation as the case may be. Companies being cared for will now call for setting the personal insolvency laws in place so that there is appropriate application for the benefit of the nation.