A STUDY OF CORPORATE INSOLVENCY LAW IN INDIA

Kristin van Zwieten

John Collier Fellow in Law, Trinity Hall, Cambridge

Outline• A framework for inquiry

• Introducing Indian corporate insolvency law: the formal rescue and liquidation procedures

• Designing a study: avenues for potential research; methodological challenges

• Results of research on India’s liquidation procedure• The law on the books: a UK transplant• The law in practice: evidence of the ‘failure’ of liquidation law in India• Explaining the operation of the law in practice: new evidence of the role of

the courts in influencing the operation of liquidation law• Reflecting on the implications of the Indian case:

• The design of the UK liquidation procedure• Common law adjudication and the challenges of economic transition• The role of the regulator, practitioners, and the academy

A framework for inquiry: introducing the subject

• Indian corporate insolvency law: two formal (collective) procedures(1) Liquidation under the Companies Act 1956

• A UK transplant, with few differences ‘on the books’

(2) Corporate rescue under the Sick Industrial Companies Act 1985• Available only to one class of debtor: industrial (manufacturing) firms• For non-industrial companies: only formal route to reorganisation is the scheme

of arrangement (also a UK transplant)

• The law’s failure• India ranks 128 (of 183) in the ‘resolving insolvency’ WB Doing Business ranking• Consistent record of extraordinary delays and poor returns to creditors:

• Why failure matters: impact on availability and cost of finance• Reform promised since 1990s but has to date faltered; now reportedly imminent

India has the dubious distinction of being among the countries where it takes the longest time to go through bankruptcy in the world (10 years on average). Consequently, recovery rates are also very low… (Chakrabarti et al, 2007)

A framework for inquiry: designing a study• Potential avenues for research:

• Why does Indian corporate insolvency law function as it does? (explaining delay)

• What impact has the law’s functionality had on creditor/debtor behaviour?

• How should Indian insolvency law function?

• My project• Focuses on the primary empirical question: explaining the law’s functionality

• Virtues – under-explored in the existing literature; immediate reform implications

• Pitfalls – multiple variables at play, not all equally susceptible to analysis

• Managing the methodological challenges:

• Long-range study (1956 to present day), traversing both key economic periods

• Multi-method approach (systematic case law review, archival research, qualitative

fieldwork and quantitative data collection), grounded in the literature

• Acknowledging the limitations of research output

The best [empirical] research uses a variety of methods to provide a more nuanced understanding of law, legal institutions and legal processes than can be provided by any one methodology alone due to the complex nature of the social world in which they operate (Nelson)

Results: research on India’s liquidation procedure (I)

• Introducing Indian liquidation law ‘on the books’: formal similarities with UK• A colonial transplant (1866, modelled on English Act of 1862)

• After independence: Companies Act 1956 enacted

• Colonial transplant trend continues, with one key exception (the liquidator)

• Between 1956 and today:

• Relatively few changes in either liquidation regime (UK: wrongful trading; undervalue

transactions; abolition of Crown preference; prescribed part); India (preferential debts)

• Result: core framework from colonial period remains intact, with strong similarities

between the two jurisdictions persisting

• Area of most significant difference: allocation of responsibility for administration of

compulsory liquidation

[Mr Peacock] thought that it was very desirable that… the law… should be nearly alike as the circumstances…would permit; so that persons forming themselves into partnerships on the principle of limited liability in England, and desirous of carrying on either the whole or a portion of their business in India, might know that the Law in both countries was substantially the same, and that they would incur no greater risk in India (1856)

Results: research on India’s liquidation procedure (II)

• Introducing Indian liquidation law in practice: striking differences with the UK• Consensus that the procedure is a ‘failure’: ‘it is virtually impossible to liquidate and

wind up an unviable firm’ (Goswami Committee, 1993)• Consistent anecdotal reports of delay and associated loss in value/returns: ‘the

process of liquidation is costly, inordinately lengthy, and results in almost complete erosion of asset value’ (Irani Committee, 2005)

• Evidence of delay:• In the process of winding up: anecdotal reports of 10 year average (Schroff, 2006)

• As at 31.12.1999, 15% of compulsory liquidations had been pending for 25+ years, and a further 18% for 15-25 years

• 1993 analysis of firms in liquidation in 14 High Courts: 186 cases (10%) at 30-40 years, further 44 cases (2%) at 40-50 years

• Between presentation of petition and order in compulsory liquidation: further delays• Consequences of delay:

• ex post – asset wastage; asset siphoning• ex ante – recourse to liquidation (liquidation as a disciplinary device); cost of credit

Results: research on India’s liquidation procedure (III)

In 1958, 961 companies limited by shares registered, 469 wound upIn 2008, 54,343 companies limited by shares registered, 376 wound up

1957 1967 1977 1987 1997 20070

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Company registrations and liquidations over time

companies limited by shares registered companies wound-up

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Results: research on India’s liquidation procedure (IV)• Break-down by procedure

• Comparison with UK: pre-crisis year 2006-2007

• Overall: Indian liquidation procedure as defunct, not merely dysfunctional

Year No. registered

No. CLs No. CVLs No. MVLs No. subject to super.

2005-2006 54,020 380 0 84 0

2006-2007 51,708 247 2 75 0

2007-2008 65,359 236 4 86 50

2008-2009 64,582 135 0 61 0

2009-2010 67,570 140 4 81 0

Total 303,239 1,138 10 387 50

2006-2007 No. registered No. CLs No. CVLs

England and Wales 308,800 5,165 7,342

India 51,708 247 2

Results: research on India’s liquidation procedure (V)

• Explaining the demise of India’s liquidation procedure: existing research• Little in-depth scholarship on this question• Existing literature does offer some explanations for delays in compulsory

liquidation:

1. Administrative/regulatory capacity: under-resourced liquidators, over-burdened courts, un-cooperative managers

2. Judicial preference/practice: attempts to rescue after winding-up order made (interim payment orders), and also before any order is made

• The reform agenda – hypothesis (1)

It is normally observed that there is a substantial time lag between the date of presentation of the petition for winding up and the date of winding up order…. It was pointed out [to the committee] that courts usually allow time to the company to pay off the creditors and ensure that the instalments fixed for the purpose are finally paid and this results in delay in disposal of such petitions (Eradi Committee, 2002)

Results: research on India’s liquidation procedure (VI)

• Explaining the demise of India’s liquidation procedure: new research• Original analysis of all petitions to wind-up company by creditor, 1956-today• Hand-collected dataset of approx. 450 judgments, reviewed and catalogued• Results:

• New evidence of striking judicial innovations in liquidation practice of the High Courts, which altered law’s functionality

• Overwhelming theme: emergence of ‘revival imperative’ in judicial treatment of creditor petitions

An order of winding up declaring company insolvent amounts to killing a juristic person. Therefore in all cases of inability to pay debt, the Court does not order winding up. The norm is to infuse new life into a company whose life is ebbing out and avoid euthanasia. A company is not mere association of people to increase net worth of their capital. It has economic, human and public concerns not only to members but also to the society at large including work force toiling to increase wealth. These and other aspects have necessitated Indian Courts to evolve tests to be applied while considering creditor's petition for winding up (Walnut Packaging Private Limited v Sirpur Paper Mills, 2008, Rao J)

Results: research on India’s liquidation procedure (VII)

Four innovations:

① Procedure – increased complexity in initial stage of admitting petition• Mandatory additional pre-hearing stage for disposal of all petitions,

whether or not contested

② Procedure – the pay-to-exit innovation• At both admission and hearing stage, multiple opportunities for respondent

to escape liquidation by payment or part-payment of petitioner’s debt

③ Substantive treatment of disputed debts and of solvency• Robust approach to characterising the petitioner’s debt as ‘disputed’• Cautious approach to characterising the respondent as ‘insolvent’

④ A catch-all ‘discretion’: the court as revival trustee

Conclusion: reflecting on the results

• Lesson-learning:• The design of the UK liquidation procedure:

• The central role of the adjudicator (the statute as an incomplete code)• Liquidation as a disciplinary device (the law’s non-collective functions)• The effect of the availability of alternatives to liquidation• Case-management; practice and procedure

• Common law adjudication: precedent ‘lock-in’ effects, and the challenges of economic transition

• Dialogue between judges, the regulator, practitioners and academics• Data collection and reporting• Robust, comprehensive and critical secondary literature

Questions?