Analysis Of Corporate Insolvency Laws Law Company Business Partnership Essay

Published Date: 02 Nov 2017

Comparative Study of the insolvency Regulations in US and UK Regimes vis-a-vis India

DISSERTATION 3rd & 4th CHAPTER

Submitted by:

JISHNU.M.L

Roll No. 53

LLM II

Under the Guidance and Supervision of

Prof. Aradhana Nair

INDEX

UK INSOLVENCY CODE

3.1. Introduction

3.2. UK Insolvency Code

3.3. US Bankruptcy Code

3.4. Comparison between USA & UK

INDIAN LAW OF INSOLVENCY

4.1. Introduction

4.1. The Sick Industrial Companies (Special Provisions) Act, 1985

4.1.1. Eradi Committee Report

4.1.2. NL Mitra Committee

4.1.2.1. Interim Recommendations

4.1.3. The JJ Irani Committee Report

4.1.4. Proposed Changes in the Insolvency Law

4.2. SARFESI Act, 2002

4.3. Asset Reconstruction Companies (ARCs)

4.4. Corporate Debt Restructuring

4.4.2. Steps in Corporate Debt Restructuring

4.5. Recovery of Debts Due to Banks and Financial Institutions Act, 1993

4.5.1. Debt Recovery Tribunal

4.5.2. Laws and Procedure of DRT in India

4.6. Informal Workouts for Industrial Undertakings

4.6.1. Work-outs for Non-industrial Business Enterprises

4.6.2. Other Measures for Settlement of Defaulted Accounts

4.6.2.1. One-Time Settlements

4.6.2.2. Secured Lending Procedures

4.6.2.3. Margins for Working Capital

4.6.2.4.Term Lending

4.6.2.5. Credit Information System

4.7. RBI Guidelines

4.8. Conclusion and Recommendations

CHAPTER 3

UK & US INSOLVENCY LAW COMPARISON

3.1. Introduction

A comparative analysis of the UK and USA insolvency code is done by the researcher in this part. The Indian insolvency laws are based on the UK insolvency code and hence the study of the same helps throw a better light on our insolvency laws. The USA is an economic superpower in the world and the insolvency codes are considered to be one of the best for economic growth. The problem of industrial sickness is nothing peculiar to our country or any other developing country. It is also present in the developed countries, but there it is considered prudent to shut down the units if they are sick. But in developing countries like India, one cannot afford to do so as it will lead to substantial national capital to go waste and will create unemployment of those already employed, when additional employment is the need of the hour.

3.2. UK Insolvency Code

Rescue, Recovery, Renewal this tripartite approach to company restructuring has become an axiom in modern English and Welsh insolvency law and practice [1] . The Enterprise Act 2002 (EA02) reforms [2] were in part envisaged to further enhance the rescue ethos that was originally engendered in the Insolvency Act 1986 (IA86). The IA 86 itself was a product of the seminal Cork Report, [3] which introduced the concepts of administrative receivership, [4] administration [5] and company voluntary arrangements (CVAs) [6] into the corporate insolvency law landscape. The last two of these regimes are aimed at saving businesses.

Prior to the 1986 Insolvency Act there were three possible routes to formal reorganization: 1) liquidation, 2) receivership, and 3) company voluntary arrangements. An additional procedure, administration, was introduced in 1986.

The focus of English and Welsh insolvency law and practice has certainly changed over the last twenty-five years towards a full commitment to the rescue culture. The Insolvency Service has defined this rescue culture as, "a willingness to assist companies, whenever possible, to overcome what may be temporary financial difficulties so as to avoid liquidation and to continue trading." [7] The Enterprise Act 2002 reforms were intended to facilitate a rejuvenation of the rescue ethos by placing a hierarchical order of primacy on the purposes of administration. [8] The hierarchy of purpose is to be viewed within the context of an officeholders overarching duty to all creditors. [9] An attempt at the rejuvenation of the rescue culture had of course occurred prior to the Enterprise Act 2002, most notably in the Insolvency Act 2000 (IA2000).

The most widely used route is the liquidation code, which in 1990 accounted for about three quarters of all formal reorganizations, while receivership accounted for a further 22%. [10] 

The objective of the liquidator is to sell sufficient of the firm's assets to repay creditors. The liquidator can sell the company as a going concern or in a non-operating state, but he cannot use funds belonging to creditors to delay the sale, otherwise he risks dismissal or legal action [11] .

Receivership can only take place when one or more of the firm's creditors have a particular kind of lien on the firm's assets, known as a floating charge, which is a claim on moveable assets such as stocks and work in progress. The receiver is appointed by the creditor with the floating charge, and represents the interests of that creditor with virtually no duty of care to other creditors.

The powers of the receiver are significant. He has complete control of the firm, and does not require permission from the court or from other creditors for his actions. Although the receiver does not have the power to stay the claims of the firm (i.e., to postpone interest and capital repayments), he may terminate any of the firm's contracts with other parties such as suppliers and contractors. The receiver can also raise funds to keep the firm as a going concern, although any new borrowing will be junior to existing loans. An important constraint on the receiver's discretion are liens (known as fixed charges) held by other creditors on particular assets such as plant, equipment, and buildings. Creditors with fixed charges can repossess those assets even if those assets are vital for maintaining the firm as a going concern. In that event, the receiver must negotiate with the creditors or risk repossession. In order to avoid being held to ransom by other creditors, the creditor with the floating charge will attempt to obtain liens on fixed assets as well.

In the absence of a creditor with a floating charge, a receiver cannot be appointed and the only alternative available pre-1986 was liquidation. The position of administrator was established in the 1986 Insolvency Act and was intended to fill that gap.

Whereas the appointment of the receiver does not usually require the permission of the court, the administrator can only be appointed by the court. Approval will only be given if there is a good chance the firm can emerge as a going concern. Within three months of his appointment the administrator must propose a reorganization plan to be approved by a majority of all creditors, or seek an extension. Whereas in receivership control rights rest with the creditor with the floating charge, the administrator's actions require a vote by all creditors. However, the number of administrations has been limited in part because the creditor with a floating charge always can pre-empt the appointment of the administrator by appointing a receiver instead. He or she may wish to do so because the creditor represented by the receiver has greater control rights than he or she would in administration.

The United Kingdom through its Insolvency Act (UK IA) has, since 1986, consolidated personal and corporate insolvency laws into a single insolvency regulatory framework although extensive cross-reference is made in the company’s legislation to the insolvency legislation. [12] 

Prior to 1986, insolvency law was specifically structured in favour of creditors and geared toward pursuing fraudulent debtors. No procedure existed whereby the insolvent debtor could voluntarily liquidate his affairs and no alternative process was viable for the small trader. In 1976, the government established a committee under the chairmanship of Sir Kenneth Cork to reappraise the entire insolvency system. The Cork Committee 1980 advised that the time had come for a new law governing insolvency and criticised the predilection for "retributive and punitive justice toward the debtor."

It recommended that the balance of the system be tilted away from punishment and toward rehabilitation, but cautioned that "high standards of commercial morality" must be guarded so as to retain the public confidence. Today, UK insolvency law is based on the Insolvency Act of 1986 (and corresponding Insolvency Rules), and the Companies Act of 1985. While an ostensible effort has been made to rehabilitate the debtor and to facilitate the recovery of the insolvent business, in practice the primary objective of the law remains the protection of creditors [13] The aims and objectives of the current law can be inferred from the powers granted to creditors or to the Official Receiver acting on behalf of the creditors:

(a) To remove directors from management. It is a long-standing principle of UK law that those in power when a company fails should have no significant continuing management role [14] 

(b) To suspend individual actions by creditors. This is central to an orderly insolvency pro- cessing, but in the UK there are special cases in all forms of insolvency wherein certain classes of claimant's individual rights are not affected. For instance, an unsecured creditor can put a company which is already in administrative receivership into liquidation over the objections of other creditors [15] ;

(c) To ensure an orderly and fair ranking of creditors and a distribution of assets which reflects that ranking. This is important in the specific case of company liquidation when a large number and variety of creditors are present;

(d) To prevent or void transactions which are unfair to creditors. This involves legal constraints on directors and insolvency practitioners. Should a director allow trade when he/she knows the company is insolvent or should a practitioner diminish the value of a company in his/her care through trade, they can be pursued for damages by creditors and the former can be disqualified [16] 

(e) To investigate the causes of company failure and to punish culpable management by directors and officers. It is a basic principle of the law that those unfit to manage should be punished for losses caused to creditors and employees [17] 

(f) To facilitate the recovery of companies. Insolvency practitioners are charged to seek the best possible outcome for creditors. This may mean that a company in receivership or administration can trade out of insolvency. [18] 

The important inference to draw from this list is that insolvency's primary victims in law are creditors and that, whilst company directors may not be criminally culpable, they are at least guilty in failing in their duties to creditors. Only the last named objective deals with recovery and it is not a strongly emphasized power so much as a high- lighted possibility. In many ways, for an insolvency practitioner to attempt to trade a company out of insolvency might be seen as contradicting his/her responsibility to avoid diminution of company asset value. To carry on in business is to risk just that. [19] 

3.3. US Bankruptcy Code

History

U.S. bankruptcy laws have their roots in English laws dating from the sixteenth century. Early English laws punished debtors who sought to avoid their financial responsibilities, usually by imprisonment. Beginning in the eighteenth century, changing attitudes inspired the development of debt discharge. Courts began to nullify debts as a reward for the debtor's cooperation in trying to reduce them. The public increasingly viewed debtors with pity, as well as with a realization that punishments such as imprisonment often were useless to creditors. Thus, a law that was first designed to punish the debtor evolved into a law that protected the debtor while encouraging the resolution of outstanding monetary obligations.

England's eighteenth-century insight did not find its way into the first U.S. bankruptcy statutes; instead, laws based largely on England's earlier punitive bankruptcy statutes governed U.S. colonies. After the signing of the Declaration of Independence, individual states had their own laws addressing disputes between debtors and creditors, and these laws varied widely.

In 1789, the U.S. Constitution granted Congress the power to establish uniformity with a federal bankruptcy law, but more than a decade passed before Congress finally adopted the Bankruptcy Act of 1800. This act, like the early bankruptcy laws in England, emphasized creditor relief and did not allow debtors to file for relief voluntarily. Great public dissatisfaction prompted the act's repeal three years after its enactment. [20] 

Philosophical debates over whom bankruptcy laws should protect (i.e., debtor or creditor) had Congress struggling for the next forty years to pass uniform federal bankruptcy legislation. The passage of the Bankruptcy Act of 1841 offered debtors greater protections and for the first time allowed them the option of voluntarily seeking bankruptcy relief. This act lasted eighteen months. A third bankruptcy act passed in 1867 and was repealed in 1878. [21] 

The Bankruptcy Act of 1898 endured for eighty years, thanks in part to numerous amendments, and became the basis for current bankruptcy laws. The 1898 act established bankruptcy courts and provided for bankruptcy trustees. Congress replaced this act with the Bankruptcy Reform Act of 1978 (11 U.S.C.A. § 101 et seq.), which, along with major amendments passed in 1984, 1986, and 1994, is known as the Bankruptcy Code.

Current Scenario

In contrast to the decline in business failures, personal bankruptcy climbed steadily. Prompted by a rise in personal bankruptcy in the 1960s, Congress initiated an investigation of bankruptcy law that culminated in the Bankruptcy Reform Act of 1978, which replaced the much amended 1898 Bankruptcy Act. The Bankruptcy Reform Act, also known as the Bankruptcy Code or just "the Code", maintains the menu of options for debtors embodied in the Chandler Act. It provides Chapter 7 liquidation for businesses and individuals, Chapter 11 reorganization, Chapter 13 adjustment of debts for individuals with regular income, and Chapter 12 readjustment for farmers. In 1991, seventy-one percent of all cases were Chapter 7 and twenty-seven percent were Chapter 13. Many of the changes introduced by the Code made bankruptcy, especially Chapter 13, more attractive to debtors. The number of bankruptcy petitions did climb rapidly after the law was enacted. Lobbying by creditor groups and a Supreme Court decision that ruled certain administrative parts of the Act unconstitutional led to the Bankruptcy Amendments and Federal Judgeship Act of 1984. [22] The 1984 amendments attempted to roll back some of the pro-debtor provisions of the Code. Because bankruptcy filings continued their rapid ascent after the 1984, recent studies have tended to look toward changes in other factors, such as consumer finance, to explain the explosion in bankruptcy cases.

The federal government has express constitutional power to enact bankruptcy laws; the states have also such power in less extensive sense so long as the federal government does not legislate upon the subject, but upon the enactment of the federal law, the state legislation for practically all purposes becomes suspended. Legislative Jurisdiction of the Subject of Bankruptcy in the United States is covered under section 3. [23] 

The federal constitution provides that "Congress shall have power" "to establish uniform laws on the subject of bankruptcies throughout the United States." [24] 

Is this power, thus expressly given, exclusive? It is well settled that if there is no federal law in force, each state may pass insolvency and bankruptcy laws. But upon the going into effect of a federal law, the state law is suspended, in so far as it covers the same ground. It is not abrogated or repealed by the federal act, but merely suspended to come again into force upon the repeal of federal law. [25] 

The power of the state to enact bankruptcy laws is qualified in a twofold way. First: it cannot pass such a law to affect the credits of a citizen of any other state, unless such citizen voluntarily submits to jurisdiction; [26] and, second: it cannot enact a law whereby debts may be discharged which take their inception prior to the enactment. [27] 

The second qualification follows from the provision of the constitution that no state shall pass any law impairing the obligation of contract. Manifestly a law providing that a debt arising out of an already existing contract should be discharged without the consent of the creditor, would be an impairment of a contractual obligation. But a contract entered into after the enactment of a state bankruptcy law, is made with the knowledge of the possibility of that law being appealed to, and may therefore very properly be said to be subject to that law. But in the case of the federal government, the constitutional inhibition does not apply; it relates in terms to action by the state. The federal Act need not, and in fact does not save from its operation already existing indebtedness. [28] 

There are two main bankruptcy procedures in the US for corporations: Chapter 7 and Chapter 11. Chapter 7 is the liquidation provision. It provides for the appointment of a trustee by the court to oversee the liquidation of the company. Invariably, the firm is closed down prior to sale and the assets auctioned.

Chapter 11 allows a firm to remain in operation while a plan of reorganization is worked out with its creditors. To facilitate this, the directors of the corporation are permitted to remain in charge and substantial rights are given to the firm, often referred to as the debtor-in-possession. The rationale is that existing management representing equity holders will have greater incentives to maintain the firm as a going concern in order to preserve some value for equity's claim. In almost half the cases, the existing management remains in control, and in the large majority of remaining cases, new management is appointed [29] .In a few cases, the court appoints a trustee, but this is usually a temporary measure until new management is appointed.

Most firms enter Chapter 11 only after attempting an informal reorganization or workout outside of the bankruptcy process. A workout can take the form of an exchange offer for outstanding debt, renegotiation of bond covenants, or the negotiation of a reduction in interest payments and an extension of loan maturities. Workouts generally involve lower direct costs than Chapter 11 cases because the time spent in reorganization is much shorter, taking 17 months as compared with 27 months for Chapter 11. The shorter period reflects that only a subset of the distressed firm’s liabilities is usually involved in the exchange compared with all liabilities in Chapter 11. In addition, in a workout the court does not supervise the affairs of the distressed company in contrast to Chapter 11, where the day to day affairs of the company are under the scrutiny of its creditors and the court.

Some firms attempt to combine the lower administrative costs of a workout with the non-unanimity requirements and tax benefits of Chapter 11, by filing a "pre-packaged" bankruptcy petition. In this case, a plan of reorganization is arranged with the main creditors outside formal bankruptcy, the firm then enters Chapter 11 and the plan is immediately submitted to the judge and then to creditors for approval so as to take advantage of the code's non-unanimity provisions. Court approval also has the advantage of forestalling future litigation. "Pre-packs" constitute an important trend in recent filings for Chapter 11 and accounted for 43% of filings in the first six months of 1993 for firms with assets greater than $100 million.

The majority of bankruptcies are processed through Chapter 7. For example, in the Central District of the California Bankruptcy Court there were 57,752 Chapter 7 cases pending as compared with only 6,739 Chapter 11 cases as of December 1993.6 The preponderance of cases in Chapter 7 reflect mainly a deficiency of cash flow necessary to keep the business running as a going concern. Although Chapter 11 is designed to be used for companies which can be maintained as a going concern, management will often wish to liquidate in Chapter 11 rather than in Chapter 7 because they retain control of the business and continue to draw an income.

Since its inception in 1800, the bankruptcy law in the US has undergone several reforms, which were always alleged to be more in favour of the creditors. In early 2005, the US Senate gave its approval to the Bankruptcy Abuse Prevention and Consumer Protection Act, a bill that was put on hold for eight years. The proponents of the bill claim that it would curb the abuse of the bankruptcy law as a financial planning tool and would place personal responsibility on the debtors to pay off their debts. However, critics of this bill argue that, when enacted, the bill would place an onerous task on those debtors, who are genuinely burdened with huge medical expenses, job losses and low income levels. [30] 

Presently no information has been available on any special international conventions of insolvency to which India has acceded. In view of the Company Court and the existing Indian Law, international conventions will not hold the field as rules of private international law declare that no convention has a priority over domestic private law which is inconsistent with the convention or a treaty.

3.4. USA & UK LAW COMPARISON

It is well known that the UK and the US have very different legal procedures to deal with insolvent corporations. England has a "tight" procedure, strictly protecting the rights of the debt holders; America has a "soft" procedure which is much more favourable to going concerns.

UK law was developed by lenders and borrowers exercising their right to contract freely. Thus, it was left to the parties to design their own insolvency procedure, and to write it into the debt contract. Eventually, those procedures were standardized into law. The role of the State in this process was relatively limited, largely confined to enforcing the contract as intended by the parties. In contrast, the US Constitution gave Congress the power to legislate a new bankruptcy law. [31] 

Federal courts innovated new procedures to preserve the railroad, sometimes in blunt violation of freely contracted agreements, and how this bias towards going concerns stayed with the American system to the present day.

The purpose of bankruptcy law is to allow debtors to be discharged of the financial obligations and debts they have accumulated. Bankruptcy is a federal, court-supervised procedure.

Bankruptcy cases are filed at the United States Bankruptcy Court.

Types of Bankruptcy

Broadly speaking, Chapters 1, 3 and 5 of the Bankruptcy Code apply to all types of bankruptcy. Chapters 7, 11 and 13 each relate specifically to the three most common types of bankruptcy. A Chapter 7 bankruptcy involves the straight liquidation of the debtor’s non-exempt assets. Property is sold (liquidated) to pay off as much of the indebtedness as possible, while leaving the debtor with sufficient assets to carry on. .

Under Chapter 11 bankruptcy reorganization, the debtor/business entity acts as its own trustee. The debtor will file a disclosure statement and a plan of reorganization with the Bankruptcy Court. This plan will detail a payment structure that will impair the rights of many or all of the debtor’s creditors. Creditors must then approve the filed plan of reorganization. This type of bankruptcy is used by financially struggling businesses to reorganize their affairs. It is also available to individuals. Individuals who consider Chapter 11 bankruptcy usually have debts in excess of the Chapter 13 bankruptcy limits or own substantial non-exempt assets, such as several pieces of real estate.

Chapter 13 is the most common type of bankruptcy for consumers. .It involves a reorganization for individual debtors/petitioners with a regular income, having unsecured debts of less than $250,000 and secured debts of less than $750,000. A plan of repayment must be submitted within 15 days of filing the petition and it is not to exceed five years in duration.

Conclusion

Bankruptcy law continues to evolve. To understand the evolution of bankruptcy law is to understand why groups of people came to believe that existing debt collection law was inadequate and to see how those people were able to use courts and legislatures to change the law. In the early nineteenth century demands were largely driven by victims of financial crises. [32] In the late nineteenth century, merchants and manufacturers demanded a law that would facilitate interstate commerce. Unlike its predecessors, the 1898 Bankruptcy Act was not repealed after a few years and over time it gave rise to a group with a vested interest in bankruptcy law, bankruptcy lawyers. Bankruptcy lawyers have played a prominent role in drafting and lobbying for bankruptcy reform since the 1930s. Credit card companies and customers may be expected to play a significant role in changing bankruptcy law in the future.