According to the Reserve Bank of India's (RBI) Review of the Recommendations of the Advisory Groups Constituted by the Standing Committee on International Financial Standards And Codes in 2004, considerable progress has been made in improving bankruptcy laws in the country from the time the Standing Committee on International Financial Standards and Codes submitted its Report in 2002. The Standing Committee initially observed that bankruptcy law is one area where the Indian situation is far from satisfactory, when evaluated against the best practice norms. India did not have a comprehensive or satisfactory legal framework in this regard. The situation has markedly changed since then. Several legal changes have materialized. Though a comprehensive Act was not enacted, the objectives of the same have been achieved through the changes to Companies Act. However, progress in relation to cross-border insolvency suggested by UNCITRAL Model Law has been slow and there is a need to provide for appropriate legal provisions for the same. In general, there has been an improvement in the bankruptcy regime. However, there is insufficient publicly available information regarding India's compliance with the Principles and Guidelines for Effective Insolvency and Creditor Rights Systems promulgated by the World Bank.

General Overview

In a report issued by the U.S. Department of Commerce in 2005, it is pointed out that, even though India has made much progress on economic reform since 1991, the economy is still hobbled by excessive rules and a powerful bureaucracy with broad discretionary powers. Moreover, India has a decentralized federal system of government in which the state governments possess broad regulatory powers. Regulatory decisions governing important issues such as zoning, land-use and environment can vary from one state to another. Opposition from labor unions and political constituencies has slowed reform in such areas as exit policy, bankruptcy, and labor law reform. (U.S. DoC 2005, p. 113)

The Reserve Bank of India (RBI) remarks that the Indian approach to standards and codes has been guided by the Standing Committee on International Financial Standards and Codes that was set up by the RBI in consultation with the Government of India in December 1999. The Standing Committee subsequently constituted eleven Advisory/Technical Groups that broadly corresponded to the core areas identified by Financial Stability Forum. The Advisory Groups had members who were experts from outside RBI or the Government. (RBI 2004, p. 3)

According to the Review of the Advisory Groups in 2004, considerable progress has been made in improving bankruptcy laws in the country from the time the Standing Committee on International Financial Standards and Codes submitted its Report in 2002. The Standing Committee initially observed that bankruptcy law is one area where the Indian situation is far from satisfactory, when evaluated against the best practice norms. India did not have a comprehensive or satisfactory legal framework in this regard. The situation has markedly changed since then. Several legal changes have materialized. Though a comprehensive Act was not enacted, the objectives of the same have been achieved through the changes to Companies Act. However, progress in relation to the cross-border solvency suggested by UNCITRAL Model Law has been slow and there is a need to provide for appropriate legal provisions for the same. In general, there has been an improvement in bankruptcy regime. (RBI 2004, p. 77)

The RBI Standing Committee points out that provisions have been made for timely restructuring to prevent bankruptcies. A Corporate Debt Restructuring (CDR) Mechanism was started in August 2001 and the mechanism was strengthened in February 2003. It seeks to provide a timely and transparent mechanism for restructuring corporate debts of viable corporate entities affected by internal or external factors, outside the purview of Board for Industrial & Financial Reconstruction (BIFR), Debt Recovery Tribunal (DRT) and other legal proceedings. The CDR mechanism provides separately for restructuring of standard and sub-standard assets (category 1) and doubtful assets (category 2). However, the mechanism is voluntary in both cases based on the Debtor-Creditor Agreement (DCA) and Inter-Creditor Agreement (ICA), with the latter being legally binding amongst creditors. A legally binding limited period standstill agreement is also provided for under DCA. (RBI 2004, pp. 77-78)

The Standing Committee also remarks that the legal regime for recourse to assets has been strengthened through the SARFAESI Act, which has contributed towards improving the insolvency regime, especially in case of non-performing assets (NPAs). Until the enactment of SARFAESI, there was no legislation in India that provided for restructuring of standard assets and NPAs. Enforcement of rights of secured creditors now depend on DRTs, CDR or civil courts. Special provisions in the Companies Act provide for secured creditors of insolvent companies to remain outside the liquidation process and to realize the securities subject to the pari passu charge of workmen's due on the assets of the company. The SARFAESI Act provides for securitization or reconstruction of NPAs as well as standard assets by transfer of rights of a bank or FI in relation to financial asset to the securitization company or reconstruction company. The constitutional validity of this Act was upheld by the Supreme Court in its judgement of April 8, 2004 in the case of Mardia Chemicals Ltd. vs. Union of India and others. The implementation of the Act is being strengthened in the backdrop of the Mardia Chemicals judgment. Changes through ordinance to the SARFAESI Act to provide for clear procedure for taking possession of secured assets, conferring power to Debt Recovery Appellate Tribunal (DRAT) to transfer pending DRT applications to one DRT, empowering RBI to call for periodic returns and information from securitization companies and ARCs and to provide for taking over of management of the debtor is expected to remove difficulties in the smooth implementation of SARFAESI Act from now onwards. (RBI 2004, p. 78)

In a paper presented at the Forum on Asian Insolvency Reform (FAIR) in 2004, the author explains that the legal system operates on the basis of statutory laws and the Constitution of India, which provides the basic structure of the judiciary and powers of judicial review to the High Courts and Supreme Court. A policy heavily loaded in favor of protection of employment of labor, has its implications on the Insolvency Law. Hence in India the process of winding up of companies is regulated by the Companies Act and is under the supervision of the court. Although article 19 (1)(g) of the Constitution of India gives freedom to practice any profession or to carry on any occupation, trade or business to the citizens of India, there are restrictions on closure of any industrial undertaking. Such restriction is justified on the ground that it is in public interest to prevent unemployment. As a result of such policy there is a freedom to undertake any industrial activity, but there is no freedom to exit. In the process of deregulation and liberalization a number of restrictions on undertaking industrial activity have been withdrawn and relaxed. The author claims that there is a need to take the process of liberalization a step further and recognize that so long as a company is acting in the interest of shareholders and otherwise observing the law of the land it should have the freedom to manage its affairs, merge, amalgamate, restructure and reorganize or otherwise plan its affairs as it considers best in the interest of the stakeholders. Interference by the Government or court or any tribunal should only be in the event of any detriment to the shareholders or under the Competition Act to prevent monopolies or restrictive trade practices. While undertaking reforms in the Insolvency Laws there is a need to change the focus from strict regulation of the activities of companies to granting freedom to the industry in conducting its business activities and lay down norms for protection of interest of stakeholders. (Umarji 2004, p. 2)

The Indian Parliament passed the Companies (Second Amendment) Act 2002 to restructure the 1956 Act leading to a new regime of tackling corporate insolvency. In the same month, the Indian Parliament passed the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) to regulate, for the first time in the country, the securitization and reconstruction of financial assets. SARFAESI also deals with the enforcement of secured interests by secured creditors without the intervention of court. (Batra 2003, pp. 1-2)

The Second Amendment stops short of providing a comprehensive Bankruptcy Code to deal with corporate bankruptcy. In the fast changing scenario of growing cross-border investment, trade and commerce, cross-border insolvency problems are bound to increase and a comprehensive Bankruptcy Code alone can address such issues taking into consideration international practices. It does not introduce the required road map of the bankruptcy proceedings viz. application for initiating bankruptcy proceedings; appointment of Trustee; empowerment of the Trustee; operational and functional independence; accountability to the court, including the power of the court to remove Trustee in case of mismanagement; relationship with current management; monitoring or substitution; day-to-day operation, etc; time-bound restructuring/recognition plan; procedure of acceptance; mechanism to sell off; pro-active initiative of the Trustee; number of time-bound attempts for restructuring; and strategies for realization and distribution. (Batra 2003, p. 16)

In the paper presented at the Forum on Asian Insolvency Reform (FAIR) in 2004, the author also suggests that the reforms required in the insolvency laws in India need to be directed towards eliminating delays in concluding insolvency proceedings. There is also a need to streamline statutory provisions in regard to rehabilitation of sick industrial companies and workout schemes for revival of such companies. Another aspect of insolvency law which again is related to expeditious completion of insolvency proceedings relates to the claims of unsecured creditors and other claimants. On account of strong recognition of rights of secured creditors and statutory provisions for certain preferential payments due to the Government and labor, in many cases there are no assets available for satisfying the claims of unsecured creditors even partially. Reforms are urgently needed for expediting decisions in insolvency proceeding to prevent deterioration of the assets to be sold and for ensuring better realization of the assets and also a possibility of selling the business enterprise as a going concern which can take care of the claims of unsecured creditors to certain extent. (Umarji 2004, p. 8)