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India’s Sick Industrial Companies legislation – impact on arbitration awards
Georgina King, Lawyer T +61 2 9391 3228 F +61 2 9391 3099 E gking@hunthunt.com.au W www.hunthunt.com.au
Introduction
Two decisions handed down during 2006 by India’s highest court establish that, where applicable to an Indian company, the nation’s controversial Sick Industrial Companies legislation will prevent enforcement of domestic and possibly foreign arbitral awards against that company.
The Sick Industrial Companies (Special Provisions) Act 1985 (SICA) is designed to assist with revival and rehabilitation of financially ‘sick’ Indian companies by affording them various forms of assistance and protection, including a moratorium on all forms of legal action against a ‘sick’ company.
Extreme controversy surrounds the legislation due to its widely reported operational defects and easy misuse by companies seeking to avoid payment of debts. While the Supreme Court of India’s decisions about the SICA relate to arbitral awards made in India, there is a significant possibility that the same approach will be taken to enforcement of foreign arbitral awards in India. In light of the nature of the SIC legislation and its use by Indian companies, the SICA is a significant factor to keep in mind when assessing the risks involved in any transaction or arrangement being entered into with an Indian company.
The SICA process
A company* obtains registration under the SICA by presenting audited accounts which show that it has, at the end of the most recent financial year, accumulated losses equal to or exceeding its entire net worth*. Alternatively, the company Board of Directors can apply for registration if, even before company accounts are finalised, it has sufficient reason to believe that the company has become a sick industrial company.
Once a company is registered, the Board for Industrial and Financial Reconstruction (BIFR), a quasi-judicial body, begins investigating whether the company is in fact ‘sick’ and if it is ‘sick’, whether it should be wound up or a scheme for revival and rehabilitation of the company should be put in place. Decision-making is also undertaken by the banks and financial institutions required to assist with any proposed rehabilitation scheme.
The SICA prohibits commencement, operation and enforcement of all proceedings and actions taken against a registered company from the time the company is registered under SICA up to completion of the various decision-making processes and any subsequent rehabilitation scheme, unless such action is taken with the BIFR’s consent.
Issues with operation and misuse
At first glance, the process under SICA does not appear significantly different to the voluntary administration process under the Australian Corporations Act (2001).
Under the Corporations Act voluntary administration process, if company directors decide a company is, or is likely to become, insolvent they appoint an administrator to investigate and report to creditors regarding the company’s circumstances and the different options open to them. Until creditors make their decision regarding the company’s future, the Corporations Act places an automatic moratorium on actions and proceedings against the company.
However, the Corporations Act places strict limits on the time by which creditors must make their decision about the company’s future and thereby end the automatic moratorium. Generally that decision must be made at a meeting of creditors convened within 21 days of the administrator’s appointment
It has been reported that the BIFR’s investigation and decision-making process takes anywhere from two to four years and that decision-making by the banks adds further delay.
Throughout this time, unless a debtor is able to obtain consent from the BIFR, it can take no action or measure of enforcement against the company.
The delay not only means that a conceived rehabilitation plan has often lost its viability by the time of implementation, but also makes registration under the SICA an attractive option for companies seeking to avoid proceedings being taken or threatened against them.
This is sometimes done by manipulation of company accounts to reflect erosion of net worth and even if a company’s application for registration under SICA is eventually rejected, the moratorium on proceedings against the company may be extended by filing a fresh application under SICA for the next financial year.
In the Morgan Securities case discussed below, Justice Balasubramanyan observed:
“occasions are not infrequent when not so scrupulous debtors approach B.I.F.R. to stall the proceedings and to keep their creditors at bay. The delay before the B.I.F.R. is sought to be taken advantage of.”
In 2003 India’s Parliament moved to introduce some level of reform by passing the Sick Industrial Companies (Special Provisions) Repeal Act (2003). However, the date for commencement of the Repeal Act is still yet to be notified and accordingly the SICA continues to set the current regime.
Effect of SICA on enforcement of arbitral awards made in India
One of the key principles of the UNCITRAL Model Law on International Commercial Arbitration, on which India’s Arbitration and Conciliation Act (1996) (Arbitration Act) is based, is minimisation of judicial interference in arbitral processes. To this end, section 5 of the Arbitration Act states:
“Notwithstanding anything contained in any other law for the time being in force, in matters governed by this Part, no judicial authority shall intervene except where so provided in this Part.” The Arbitration Act limits the grounds (Grounds) for judicial intervention into a domestic arbitral award to: incapacity of parties, non-existence or invalidity of the relevant arbitration agreement, lack of jurisdiction on the part of the arbitral decision-maker, lack of due process, the subject-matter of the dispute not being arbitrable under Indian law or the arbitral award being in conflict with the public policy of India.
Unless a Ground is found to apply to an arbitral award, that award is final and binding on the parties. However, in each of the two decisions discussed below, the Supreme Court of India concluded that proceedings and orders under the SICA overrode domestic arbitral awards to which the Arbitration Act applied. In accordance with that view the Court allowed Indian companies deemed to be ‘sick’ to avoid or at least delay enforcement of domestic arbitral awards.
The decisions raise the question of whether Indian courts will reach the same conclusion regarding enforcement of foreign arbitral awards against ‘sick’ companies.
The cases
Case 1
Jay Engineering Works Ltd. –v– Industry Facilitation Council & Anor
[JT 2006 (12) SC 171] (14 September 2006)
The Facts
In 1994, the appellant company made a reference to the BIFR under SICA. The appellant was declared ‘sick’ and a rehabilitation scheme was framed by the BIFR.
From 1996 to 2000, the second respondent supplied products to the appellant.
In 2001 the rehabilitation scheme framed by the BIFR was declared to have failed and the Industrial Development Bank of India was appointed as an operating agency of the appellant. In 2003 a fresh report was submitted by the operating agency and accepted by the BIFR who then sanctioned a fresh rehabilitation scheme.
The second respondent was classified under Indian law as a Small Scale Industrial Unit and to recover payments the appellant owed to it for the products, the second respondent initiated arbitration proceedings under India’s Interest on Delayed Payments to Small Scale and Ancillary Industrial Undertakings Act (1993).
The first respondent, the Industry Facilitation Council, made an award in favour of the second respondent. The appellant had contended before the Council that it was a ‘sick’ company and was entitled to protection under the SICA. The Council, however, held that the BIFR’s declaration that the appellant Company was ‘sick’ did not bind the Council in any way. The arbitral award was executed by the second respondent.
An appeal to the High Court against execution of the arbitral award was dismissed and the matter was then appealed to the Supreme Court.
Hunt & Hunt | India’s Sick Industrial Companies legislation – May 2007 | Page 2
Supreme Court The Supreme Court upheld the appeal. The Court concluded that the Facilitation Council’s arbitration award was an award made under the provisions of the Arbitration Act and held that all such awards are subject to the wide-reaching protection the SICA provides for companies against all forms of legal action. In considering the nature of the SIC legislation, the Court noted that it was enacted in the interest of the public.
Case 2
Morgan Securities and Credit Pvt. Ltd. –v– Modi Rubber Ltd case No.: CA 2572 / 2006, Supreme Court of India (14 December 2006)
Facts
The appellant, Morgan Securities and Credit Pvt Ltd (Lender), gave an advance to the respondent company, Modi Rubber Ltd (Borrower) by way of an Inter Corporate Deposit.
The Borrower defaulted on repayment and the Lender commenced arbitration proceedings in accordance with the arbitration clause in the loan agreement. The arbitrator ordered the Borrower to repay the loan with interest and ordered that until the loan was repaid the Borrower was restrained from transferring or alienating its assets. The Lender also filed a successful application for winding up of the Borrower with the Allahabad High Court.
In addition to the arbitrator’s order of restraint, the High Court and the Appellate Authority of Industrial and Financial Reconstruction had passed orders restraining the Borrower from dealing with or in any way encumbering its assets without permission.
The Borrower made a reference to the BIFR under the SICA and also appealed to the Division Bench of the Allahabad High Court against the winding up order.
The High Court set aside the winding up order and directed that the winding up proceedings be kept in abeyance until the reference under SICA had been dealt with.
The Borrower then filed an application under the SICA seeking permission to dispose of shares it held. The BIFR dismissed the application holding that in view of the various orders restraining the Borrower from disposing of its assets, it could not agree to the Borrower proceeding with sale of the shares.
The Borrower appealed to the Delhi High Court questioning the legality of the BIFR’s decision.
The Delhi High Court granted the orders sought by the Borrower and the Borrower sold the shares and deposited the sale proceeds with the BIFR.
The Lender appealed to the Supreme Court arguing that the Arbitration Act and its restriction of judicial interference with arbitral awards, overrides the SICA. Supreme Court The Court held that the provisions of the SICA override section 5 of the Arbitration Act on the basis that the application of section 5 is limited to judicial intervention and the effect of the SICA is not to intervene in an arbitral award but to merely suspend operation of it.
The Court also contended that the SICA has been enacted to achieve a higher goal and larger public interest than that of the Arbitration Act.
The SICA and foreign arbitral awards In dealing with the issue of SICA and judicial intervention into domestic arbitral awards the above judgments do not specifically address the issue of whether the SICA will override enforcement of a foreign arbitral award.
In line with the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards, section 48 of the Arbitration Act limits the grounds on which a court may refuse to enforce a foreign arbitral award to the same grounds as those listed earlier in this article in relation to judicial intervention.
However, by analogy with the Court’s reasoning in Morgan Securities a question arises as to whether a court would find that allowing the SICA to prevail over a foreign arbitral award constitutes a ‘refusal to enforce’ the award or merely amounts to a decision to delay enforcement. While logically it is difficult to not characterise any move to disallow enforcement as a refusal to enforce, the above decisions provide some indication of what approach the courts may take.
Alternatively, the courts may accept that they are refusing to enforce a foreign arbitral award but find that they are entitled to do so because allowing the SICA to be overridden by an award would be contrary to the public policy of India. This will depend on the meaning and scope the courts attribute to the public policy exception.
In Renusagar Power Co. Ltd –v– General Electric Co. (1994) AIR 860 the Indian Supreme Court took a relatively restrictive approach. The Court held that to attract the bar of public policy, enforcement of a foreign arbitral award must be contrary to a) fundamental policy of Indian law, b) the interests of India or c) justice and morality. The court expressly stated that mere violation of the law of India would not provide sufficient justification for a refusal to enforce. Conversely, in Oil and Natural Gas Corporation –v– SAW Pipes (2003) 5 SCC 075, a case involving an arbitral award made in India, the Supreme Court held the concept of public policy should be interpreted broadly to include all matters which concern public good and public interest. The Court held that, in addition to the grounds outlined in Renusagar, an award will be contrary to public policy if it is “patently illegal” or is so unfair or unreasonable that it “shocks the conscience” of the Court.
In light of the comments made in the Morgan Securities and Jay Engineering judgments regarding the public interest nature of the SICA it certainly seems possible that Indian courts will invoke the public policy exception where enforcement of a foreign arbitral award would contravene protective measures granted under the SICA.
Hunt & Hunt | India’s Sick Industrial Companies legislation – May 2007 | Page 3
Conclusion
In its present form, India’s Sick Industrial Companies legislation is a significant factor for parties from any country to consider when entering into agreements and arrangements with Indian companies to which the SICA might apply. While this article has focused on the impact of the legislative regime on parties relying on arbitration awards, clearly the regime can affect any form of legal action taken by a party to recover amounts owing to it.
Accordingly, it is important to take into account both the inherent risk presented by the SIC legislation and the nature and extent of information obtained about a company, prior to entering into any agreement or arrangement.
*
The SICA only applies to companies which have been registered for not less than 5 years and which employ 50 of more people.
*
Net worth has been defined as the sum total of the paid up capital and free reserves.
Secondary resources for this article:
‘Financing Firms in India’, co-written by several authors and published at:
http://knowledge.wharton.upenn.edu/ papers/1326.pdf
‘Corporate Insolvency Laws in India’, written by Rohan Bagai and published at:: http://www.legalservicesindia.com/ articles/corin.htm
‘Proposals for Reforms - The Indian Position’, presented by Mr. Sumant Batra at the Second Forum for Asian Insolvency Reform and published at: http://72.14.253.104/search?q=cache: IOiMNC8bF1IJ:www.oecd.org/ dataoecd/42/10/2490751.pdf+india+sick +industrial+companies+regime&hl=en&c t=clnk&cd=6&gl=au
‘NPA ordinance – Empowering the financial sector’, written by S.D. Naik and published on the internet edition of Hindu Business Line, 7 August 2002: http://www.blonnet.com/2002/08/07/ stories/2002080700050800.htm
‘What Next for Indian Arbitration?’, by Aloke Ray and Dipen Sabharwal, White
& Case, and published at: http://www.whitecase.com/files/
Publication/cfee45a1-1484-42339a98-21226c148e18/Presentation/
PublicationAttachment/9ab9418b-755a4639-9f75-03a96723d26a/What_Next_
for_Indian_Arbitration_Article2.pdf
‘The New Insolvency Regime: J.J. Irani Expert Committee Report with Special Emphasis on Reconstruction & Winding-up’, by Rupinder Singh Suri and
published at:
http://72.14.235.104/search?q=cache:
bLP23XBcu3YJ:www.insolindia.com/
newInsolvencyRegime.pdf+india+sick+in
dustrial+companies+reform&hl=en&ct=cl
nk&cd=36&gl=au
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