07 April 2010

Recommendations of the Indian Financial Sector Assessment Committee: Assessment of Effective Insolvency and Creditor Rights Systems

As a 15-year veteran of bankruptcy practice in American bankruptcy courts and professor of law who has taught bankruptcy many times, I reviewed Chapter VI of the Assessment and made several unsolicited recommendations of my own.  The first pertained to Section 11 (Summary of Recommendations), Part C (Legal Framework for Insolvency).  The Assessment concluded that “[t]he law should provide for an extension of financial aid during the rescue process only to such an entity as would have suffered losses as a result of matters beyond its control and not to those entities that have suffered loss due to maladministration and recklessness.”  I observed that the problem faced by any court or tribunal at the outset of a proceeding is that it is very difficult to determine whether extrinsic or intrinsic factors caused a company’s financial distress.  It is usually a combination of such factors that lead a company to seek protection.  In my opinion, it would be valuable either to amend the Companies Act or the Companies (Court) Rules to provide for an expedited hearing on proper notice where a decision would be made whether to continue the rehabilitation process or proceed directly to liquidation.

Second, under the heading of Reorganization Proceedings, the Assessment provided that “[i]t would be necessary for the legal provisions to limit the number of plans that can be submitted for sanction before the court will provide for the automatic lapse of a scheme if the same is not approved within a specified period, say within three months or six months from the date of submission.”  Based on my experience as an attorney practicing in the United States Bankruptcy Courts, it was commonly the case that a plan of reorganization would not be approved within six months.  Recent amendments to United States Bankruptcy Code have shortened the period within which management of a reorganizing debtor has the exclusive right to propose a plan of reorganization; nonetheless, as larger Indian firms with more complex capital structures seek to rehabilitate their financial affairs, I believe that an arbitrary deadline of six months will prove too short.

Third, in paragraph B2 of Annex 1 (Detailed Assessment) to the Assessment, there was a discussion of recovery of transfers made within six months before commencement of winding-up proceedings.  American bankruptcy law provides for recovery of all such “preferential” transfers made within 90 days before filing of a bankruptcy petition coupled with a one-year recovery period for transfers made to defined set of “insiders.”  It seems wise to me to treat those who had the power to control a company’s disposition of assets differently from typical creditors.

Fourth, in paragraph C.2 of the Annex, it stated that “[u]nder the Sick Industrial Companies Act, in the event of rehabilitation of a company, every bank which has lent to the company in consortium has to provide financial assistance (lend) pro rata to such company.”  Under whatever provision of Indian law would permit rehabilitation, it will necessary for additional funds to be made available to the company.  However, the American experience has demonstrated that there are lenders who will specialize in financing rehabilitations, which strikes me as a better solution than compulsory lending by pre-rehabilitation lenders.

Fifth, at C10.1 of the Annex, there was an excellent discussion of what should be done with executory contracts in an insolvency proceeding.  I believe that providing both the liquidator and the rehabilitating company with extremely broad powers to assume/assign such contracts will prove valuable to recovery by the creditors.

Sixth, C12.3 of the Annex addressed two points that struck me as significant.  First, the Annex notes that under the Companies (Court) Rules, the liquidator need give creditors only fourteen days notice of the date by which to fix their claims.  This struck me as unreasonably short.  The subsequent paragraph goes on to acknowledge continued right of set-off between an insolvent company and a creditor.  The American bankruptcy law likewise permits the continuing right of set-off; however, it further provides a tool by which to limit a creditor’s right of set-off when right has arisen by virtue of “manufactured” transaction between the insolvent entity and the creditor. I believe some such similar provision should be created under Indian law. 

Finally, C14.1 of the Annex recommends the amendment of the law to create creditors’ committees.  I fully support such an amendment and write only to suggest that the amendment contain a provision by which the expenses of such a committee will be reimbursed from the assets of the rehabilitating company.

In short, Indian insolvency law need to be brought from the mid-twentieth century to the present day.  Modern insolvency laws are necessary for modern market economies.  India’s insolvency laws were designed for a socialist economy and should be updated to insure that assets continue to be deployed to their most valued uses with a minimum of, shall we say, financial friction. 

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