This article focuses on the core difference between the earlier #SICA attempt and CODE. What is it that makes the CODE more effective than SICA?

The first in this Series of articles had looked at the timelines of the process (while the second had reviewed the quality of the process output.

According to Dictionnaire des Antiquités Grecques et Romaines, the word Sica comes from Proto-Indo-European root sek-, meaning “to cut”, “to section”. SICA was a popular weapon in South Eastern Europe, mostly seen as a side arm with Dacians and Jews. It looks very similar to the Khukri valued by the Gorkha Regiment. May be the bureaucrats did not consider the acronym while drafting Sick Industrial Companies Act.

V.P. Singh, former Prime Minister and one of the chief architects of SICA in 1985, conceded in an interview to Business Line on 7th March 2001, that the BIFR did not achieve much in tackling industrial sickness.

An important SICA provision was establishing two quasi-judicial bodies – the Board for Industrial and Financial Reconstruction (BIFR), and the Appellate Authority for Industrial and Financial Reconstruction (AAIFR). #BIFR was set up as an apex board to contain the industrial sickness issue, including reviving and rehabilitating potentially sick units and liquidating non-viable companies. AAIFR was set up to hear appeals against BIFR orders.

Sick industrial unit was defined as a unit or a company (having been in existence for not less than five years) which to be found at the end of any financial year to have incurred accumulated losses equal to or exceeding its entire net worth.

An industrial unit was also regarded as potentially sick or weak unit if at the end of any financial year, it had accumulated losses equal to or exceeding 50 per cent of its average net worth in the immediately preceding four financial years and failed to repay debts to its creditor(s) in three consecutive quarters on demand made in writing for such repayment. It is to be noted, that sickness was linked to networth and not directly to any default triggers.

The Board of Directors would have to (legally obliged) make a reference to the BIFR for determination of the remedial measures with respect to their company.

Such reference was to be made within sixty days from the date of finalisation of the duly audited accounts of the company for the financial year at the end of which the company had become sick. Besides the #Corporate Debtor, a reference to the BIFR could be made by the GoI, RBI, State Governments, FIs, or SCBs.

Born in Jan 1987, the BIFR had a Chairman and from two to fourteen other members, all qualified as High Court judges or else had at least fifteen years of relevant professional experience. In short it was a legal heavy governance framework that reviewed large and sick industrial units.

BIFR would order an operating agency to enquire into the matter and complete the inquiry as expeditiously as possible, which would then lead to appointment of one or more persons as special director(s) of the Company for safeguarding the financial and other interests of the Company.

If after making an inquiry, the BIFR was satisfied that the company was indeed sick, it would take either of the following decisions:-

a. give time to the company to make its net worth exceed the accumulated losses.

b. may order to prepare a scheme providing for such measures like:

1. The financial reconstruction of the sick industrial company;

2. The proper management by change in or take over of the management of the company;

3. The amalgamation of the sick industrial company with any other company;

4. The sale or lease of a part or whole of the sick industrial company;

Eventually as and when the BIFR realized that the sick industrial company is not likely to make it, BIFR would decide to wind up the company. This decision would be forwarded to the concerned High Court. The High Court would on the basis of the opinion of the Board, order winding-up of the sick industrial company in accordance with the provisions of the CA 1956. That was the theory and more or less also the practice.

In short, a business decision of closing down an unviable business was taken legally, in the Court of Law. It was triggered by an accounting entry of the networth erosion, and not defaults, over a long period of time, and then the sickness was cured over an even longer period of time.

Unlike in philosophy, where time itself is a good healer, in business and particularly in a failing business, Time happens to be Money, and a failing business sees erosion of Business Capital on a daily basis.

Once a sick company was admitted into the BIFR Hospice, then no proceedings for winding-up of the industrial company or for execution, distress or the like against any of the properties of the industrial company could be made. It was literally like a sick man lying in a hospice not be disturbed with any bad news.

Also, no suit for the recovery of money or for the enforcement of any security against the industrial company or of any guarantee in respect of any loans, or advance granted to the industrial company was allowed to be proceeded with further. The sick unit was molly coddled to the end.

Needless to say in the Indian scheme of things, with the abundance of unscrupulous promoters and complicit bank officials,

#SICA was grossly misused by the debtor company as a reference with BIFR was deliberately filed to seek an automatic stay on creditor enforcement against the company. The moratorium of the hospice was a effective cover behind which the promoter could happily continue with his business as usual, bleeding the company further or continuing with his asset stripping. SICA shielded the debtor company from creditor enforcement, instead of providing genuine rehabilitation and restructuring.

In terms of numbers, while there are no exhaustive numbers available across the entire lifespan of SICA, in the first fifteen odd years, i.e. till Dec 2000, BIFR had registered 3,296 cases, out of which it had sanctioned rehab plans for only 557 units or just about 17%.

V.P. Singh, former Prime Minister and one of the chief architects of SICA in 1985, conceded in an interview to Business Line on 7th March 2001, that the BIFR did not achieve much in tackling industrial sickness.

The numbers did not improve later, for example, between 1987 and 2006, a total of 5,412 references were made to the BIFR, of which 1,707 were dismissed as non-maintainable, 218 were dismissed as repeat references, 1,303 were referred to the High Courts for liquidation, and only 760 were approved for rehabilitation.

Besides the overall stats, there were splashes of brilliance with some examples of successful recovery like #BHEL in the 1980s, and #Arvind Mills more recently.

In hindsight there were many problems with the SICA process. Some of these like, the lack of technology tools that can crunch timelines, are obvious and cannot be blamed on the SICA process design itself. There was simply no internet, or computers for that matter in the first half of its life.

However some design elements, like the accounting trigger of networth erosion instead of business trigger like default for defining sickness, or overall legal governance oversight of the process, or the debtor control of assets during the process, were definitely design flaws of the SICA process.

It was primarily dependent on the legal framework, as each case that it decided for winding had to be referred to the High Court, where it would be tangled up in complicated multiple cross litigations. The lawyers found ways and means to keep each case in perpetuity, quite often facilitated by the socialist kind hearted mindset of the judiciary that did not approve of closing of units due to unemployment considerations. BIFR or even the HC decisions were always subject to be questioned by multiple stakeholders across multiple forums.

There was no definitive timeline defined in the SICA, which enabled the story to be narrated across generations. More than thousand units have lived in the BIFR hospice for over two decades, as next generations inherited the sick units that had paid for their education, both formal classroom and hands-on industrial experience.

But the most important differentiator between SICA and the Insolvency Code, many would point out is the lynchpin around which the entire Code revolves, the Insolvency Professional, and we shall come to see how the Insolvency Professional changes the equation in the resolution process of sick businesses.

SICA was repealed and replaced by Sick Industrial Companies (Special Provisions) Repeal Act, 2003. The new Act diluted some of the provisions of SICA and plugged certain loopholes.

It aimed not only to combat industrial sickness but also to reduce the same by ensuring that companies do not view declaration of sickness as an escapist route from legal provisions after the failure of the project or similar other reasons and thereby gain access to various benefits or concessions from financial institutions.

The Ministry of Finance, on November 25th, 2016 notified that the Sick Industries Companies Act (Special Provisions) Repeal Act, 2003 would cease to exist on December 1st, 2016, when the Insolvency & Bankruptcy Code replaced. #NCLT and #NCLAT was constituted on 1st June 2016.

Another mechanism that was tried to address issue of sickness and stress was Corporate Debt Restructuring (CDR) System (established in 2001) which was purely a contractual arrangement between lender and corporate.

#SDR aimed to provide the lenders an option to initiate a comprehensive turnaround by taking control, giving them a fair shot at reviving sick companies by partnering with a more capable promoter. This was a diametrically opposite approach to that of SICA. Banks saw rapid conversion of their debt book into equity stakes, and yet things did not work out.

Within five months of introducing SDR, SCBs had converted over Rs 40,000 cr of debt into equity. It had immediate gratification inbuilt as the moment the debt was converted in to equity, no more provisioning was required, although the MTM on the equity valuations would still continue to impact the balance sheet.

Also they could not run the business indefinitely and had to exit within eighteen months. SDR was doomed from the beginning as bankers had no expertise in either managing large business directly or by influencing the Board, classic case being #Kingfisher Airways, where the debt book was converted into equity stake in the hope of a turnaround and subsequent offloading of the equity to new investors.

S4A, the aptly named initiative from #RBI, tried to turn things back away from the SDR approach but did not achieve much results. CDR, SDR or S4A, were primarily a banking response, driven by the Regulator, aimed at tackling the #NPA problem that afflicts the SCBs in India.

The most recent effort in the form of #SARFAESI Act, actually is the most potent, as it does help secured creditors, in recovering the liquidation value of the assets they hold as collateral. It effectively skips the Courts. Significantly it does not give any protection to unsecured creditors. Unsecured creditors required to pursue remedies for debt recovery in the civil courts, or if they are a bank or a notified FI, under the RDDBFI Act.

Strategically these measures were destined to fail for multiple reasons.

Firstly, the banking regulator has no business to get into NPA management of the SCBs, it is supposed to regulate not micro manage banking operations. This micro management had the unexpected but anticipated side effect of promoters and bankers learning and mastering the art of ever-greening bad accounts.

Secondly, bankers got used to following the directions coming down the command chain, from the Mint Street, to the Bank HO, to the Bank ZO and so on to the last link in the chain, the branch manager, who diligently complied with the directions, and reported back, but there were no results.

Thirdly, these initiatives were focused on NPA resolution. Even if there was an honest banker at the lowest end of the chain, who would want to help a stressed promoter to resolve his business problem the top-down directives would tie him down. The Vigilance sword was always there to restrain the occasional CowBoy banker.

Fourthly and finally, the complementary structural framework required to ensure that either a business shapes up or ships out smoothly was simply missing.

None of the banking response, CDR, SDR, S4A, SARFAESI or RDDBFI filled in the missing structural framework that caused the failure of SICA. Their focus was on helping the bank alleviate NPA pain not help the business.

Promoters were not assisted in either closing an unviable business nor were they helped in resuscitating a potentially viable business. This job would be assigned to the Insolvency Professional.

“An Act to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms, and individuals in a time bound manner for maximization of value of assets…”

The Insolvency and Bankruptcy Code was promulgated in late 2016, with Resolution being the soul of the Code. There are many pillars of the Code, but when it comes to implementation, the main pillar is time bound execution, to be carried out by the Insolvency Professional.

Conceptually, the #Insolvency Code took a diagonally approach regarding management control while the recovery process is underway. Instead of leaving control with the Promoter as SICA did, the Insolvency Code handed over the management of the sick unit to the Insolvency Professional, u/s 17, which states,

“(a) the management of the affairs of the corporate debtor shall vest in the interim resolution Professional;

(b) the powers of the board of directors or the partners of the corporate debtor, as the case may be, shall stand suspended and be exercised by the interim resolution professional;

(c) the officers and managers of the corporate debtor shall report to the interim resolution professional and provide access to such documents and records of the corporate debtor as may be required by the interim resolution professional; “

This is further emphasized by Section 19 which requires a complete support to the Insolvency Professional,

“The personnel of the corporate debtor, its promoters or any other person associated with the management of the corporate debtor shall extend all assistance and cooperation to the interim resolution professional as may be required by him in managing the affairs of the corporate debtor.”

SDR had failed because of lack of business management expertise amongst bankers. Concerns were also expressed on the ability of an individual to be entrusted with the task of managing a business, and that too a stressed business.

The Insolvency Law Committee constituted was presented with this problem in early 2018,

how a #chartered #accountant/insolvency professional who may not have the necessary management credentials could run a highly technical company?”

This question came up inspite of existing provision in the Code, u/s 20, that empowers an Insolvency Professional to,

(a) to appoint accountants, legal or other professionals as may be necessary;

(b) to enter into contracts on behalf of the corporate debtor or to amend or modify the contracts or transactions which were entered into before the commencement of corporate insolvency resolution process;

(c) to raise interim finance provided that no security interest shall be created over any encumbered property of the corporate debtor without the prior consent of the creditors whose debt is secured over such encumbered property:

The learned Committee concluded,

“The qualifications and experience of the Insolvency Professionals are encapsulated in the IP Regulations, which includes the requirement to pass an examination. This examination tests the competence of a person to be able to abide by the Code, including managing a company. Further in terms of Sec 20, read with Sec 23 of the Code, the Insolvency Professional, can appoint other professionals to assist her in running the company, in areas which are technical. Thus, the concerns are pre-mature as any professional takes time to develop and evolve.”

It is probably too early to evaluate the performance of the Insolvency Code process, but a comparison with the erstwhile SICA would be incomplete without checking the early trends of the Code, which were covered in detail in the first article, that reviewed the process performance in terms of timelines achieved, and the second article that looked at the quality of the process output.

The intial quarters saw the process find its feet, as the six cases admitted in Jan 2017, took an average of 264 days for closure, while the eleven cases filed in Sep 2017, took (median & average) of 184 days to closure. Not just the average is coming down but the falling variation has brought much needed predictability to the process.

Of the 701, 525 are still in the Hospice, undergoing treatment. Of the 176 released, 22 have been resolved with an average haircut of 50%. In terms of numbers critics may point out that the numbers are not very different from SICA process. However, as we said, these are early trends, as long as the process is different, the results would be different.

 And the differentiator is the Insolvency Professional.

In Fourth article, we will look at the new profession which is an institution in the making, as it institutionalizes the legacy of the Turn Around Artist, the Insolvency Professional.

—————

The Code Series: An attempt to spread awareness of the Insolvency Reform

First: Need for Speed, reviews the process productivity in terms of time taken.

Second: Designer Haircut, reviews the process quality in terms of haircuts taken in the resolution process.

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