Sick Industrial Companies: Is rehabilitation the Answer?

Abhishek Kumar & Sidhartha Mahopatra INTRODUCTION "The important thing is not being afraid to take a chance. Remember, the greatest failure is to not try. Once you find something you love to do, be the best at doing it." - Debbie Fields, Founder of Mrs. Fields Cookies Industrial growth in India is guided by the Industrial Revolution of 1956.1[1] The problem of industrial sickness has been growing at an annual rate of about 28% and 13% respectively in terms of number of units and outstanding number of bank credit. It is reckoned that as of today there are more than 2 lakhs sick units with an outstanding bank credit of over Rs 7000 crore nearly 29000 units are added to sick list every year. It seems that the deterioration of the sick industries appears to be faster than the growth of sick industries. Industrial sickness especially in small-scale Industry has been always a demerit for the Indian economy, because more and more industries like cotton, Jute, Sugar, Textile small steel and engineering industries are being affected by this sickness problem. Loss making industries, both in the private sector and public sector are contributing for the downfall of industrial economy. There has been an increase in industrial sickness, both in the large and small sectors, in India. By consoling that this is, to some extent, a corollary of industrial growth, one shall not belittle the seriousness of the problem. Industrial sickness affects not only the owners, employees and creditors but also causes wastage of national resources and social unrest. It is, therefore, considered very much essential to devise suitable measures for dealing with sick units as well as to make suitable arrangements for detecting symptoms of industrial sickness at an early stage so as to take measures to prevent sickness.

1[1] See, Balan K, Managing Industrial Sickness, 1st edition, Mittal Publications, 1996

The progress of industrial sickness has been highlighted from the period before Independence to the present prevailing condition. The Rehabilitation given to sick industrial companies is not the answer and solution for them. I. HISTORICAL BACKGROUD OF INDUSTRIAL SICKNESS a. Pre-Independence Position

Before 1947, the Indian economy was predominantly agricultural in nature. The development of producers was almost negligible and was inadequate to meet the demands of the market. Only those industries survived who served the interests of the Britishers. There was dearth of private players in the market. The market was unorganized because of the reluctant attitude of the Britishers and due to lack of proper communication facility as well as the shortage of power. This issue was further aggravated with the lack of any proper bank or financial institutions to finance the industrial projects. And, if at all, any help was available from the money lenders, they charged exorbitant rates of interest along with arbitrary terms and conditions. There was also minimal intervention of the Government in the promotion of the industries. As a result, it was difficult for any trader to survive in the market on a long terms basis. Also there were no proper implementation of any policy in regard to the efforts of the Government in the revival and rehabilitation of sick industries.2[2]

b.

Post-Independence Period:

After the Constitution came into force, the primary aim was to convert India from a colonial country to a socialist welfare society, as envisaged in the Preamble and the Directive Principles of State Policy. The Government was prompted to go for rapid industrialization of basic and heavy industries to convert India from agricultural to industrial economy. Soon, the Government realized that a large number of units are turning sick. In order to check the growth of the sick units, the Government adopted strategies to takeover of the sick industrial units and restrict the problem if unemployment, labour unrest and

2[2]See, Bhaskar Amit, A Study Of Restructuring Of Sick Industrial Companies Under Part Via Of The Companies Act
Vis-A Vis Sick Industrial Companies (Special Provisions) Act,1985. The article can be viewed at : http://employment.indlaw.com/search/articles/?3c5970ff-a184-4025-a14a-5de6182c55ee,last accessed on 18th October, 2009.

social unrest.3[3] The Government also took the initiative of taking over the management of sick industrial undertakings for a brief period and returning it back to the owners once the sickness is removed. The Government in its aim of preventing the growth of sickness was given support by various agencies such as RBI, IDBI etc. II. SYMPTOMS OF SICKNESS

Timely action is required for identification of sickness. For this we need to analyze the symptoms which would help us identify the sickness of the unit. This can be traced from the signals that get displayed by the sick units. The signal may be in the form of financial distress starting with short term liquidity problems, revenue losses, operating losses and moving in the direction of over use of external credit until it reaches a stage where it is overburdened with debt and nor being able to generate sufficient funds to meet its obligations.4[4] In case of large units whose shares are quoted in stock exchanges, a signal of sickness is sent when dividends are skipped and share price sharply declines. This measure, therefore, will have to be used very cautiously with other identifiable symptoms to judge whether skipping dividends indicates sickness or represents a temporary downward slide in financial performance.5[5] The existence of these signals and symptoms provides a ground for suspecting that the industrial unit concerned is prone to sickness .

3[3] Ibid 4[4]See, Prof (Dr.) Sreerenganadhan K, Miss Varghese Roshna, Management of Industrial Sickness
http://www.mgu.ernet.in/DLR/DLArchive/sre06.pdf, last accessed on 18 October, 2009.
th

5[5]See, Dholakia H Bakul, Industrial Sickness in India: Weed for Comprehensive Identification Criteria. The article
can be viewed at http://www.vikalpa.com/pdf/articles/1989/1989_apr_jun_19_24.pdf, last accessed on 18th October, 2009.

III.

SICK INDUSTRIAL COMPANIES ACT, 1985

Based on the recommendation of a Committee of Experts under the Chairmanship of Shri T.Tiwari, the Government enacted a special legislation named as the Sick Industrial Companies (Special Provisions) Act, 1985 commonly known as SICA. The Board of Industrial and Financial Reconstruction (BIFR) and the Appellate Authority for Industrial and Financial Reconstruction (AAIFR) were also established in 1987 to look after the matters covered under the purview of SICA. SICA was further amended in 1991 to bring government companies under its purview and again in 1993 certain changes were brought out in the act for the determination of industrial sickness. Hence, in short, we can conclude that the main objective of SICA is to determine sickness, expedite the revival of potentially viable units and effect closure of unviable units. A. 1. OBJECTIVES OF SICA

To evaluate the techno-economic viability of sick industrial companies with a view to either to

rehabilitate them, if the public interest so demanded and their rehabilitation was possible, or to close them down, if continuing them would be impossible. 2. To stop continued drain of public and private resources for the overall economy of the country. 3. To protect employment as far as possible.

In the case of Testeels Limited & Arvindbhai N. Talti vs. Radhaben Ranchhodlal Charitable Trust & Testeels Limited,6[6] it was held that SICA had been enacted to safeguard the economy of the country and protect the viable sick units.

B.

INDUSTRIAL SICKNESS

As per section 3(1) (o) of SICA, an industrial company is a sick company, when its accumulated losses are equal to or exceeding entire worth. Further as per section 23 of SICA of the accumulated losses of an industrial company as at the end of any financial year have resulted in erosion of 50% or more of peak net worth of immediately preceding four financial years is considered to be a potentially sick industrial company. To fall under the purview of SICA: A company should be engaged in any scheduled industry (i.e any industry specified in First Schedule to Industries (Development and Regulation) Act, 1951. Scheduled industries include metallurgical industries, telecommunication, transportation, chemicals, textiles but not financial services and software technology. Criteria of sickness Such company should have at the end of any financial year accumulated losses equal to or exceeding its entire net worth. C. BOARD OF INDUSTRIAL AND FINANCIAL RECONSTRUCTION

Board of industrial and Financial Reconstruction (BIFR) was established by the Central Government, under section 3 of the Sick Industrial Companies (Special provisions) Act, 1985 and it became fully operational in May, 1987. BIFR deals with issues like revival and rehabilitation on sick companies, winding up of sick companies, institutional finance to sick companies, amalgamation of companies etc. BIFR is a quasi judicial body. The role of BIFR as envisaged in the SICA (Sick Industrial Companies Act) is:

6[6] 1988 INDLAW GUJ 54

(a)Securing the timely detection of sick and potentially sick companies (b) Speedy determination by a group of experts of the various measures to be taken in respect of The sick company (c)Expeditious enforcement of such measures BIFR has a chairman and may have a maximum of 14 members,7[7] drawn from various fields including banking, labour, accountancy, economics etc.8[8] It functions like a court and has constituted four benches.

D.

PREPARATION AND SANCTION OF SCHEME FOR REVIVAL

Once a company has been found sick, the BIFR may grant time to the sick company to enable it to make its net worth positive and bring the company out of sickness, without any external financial assistance. If it is found infeasible for company to make its networth positive without any external financial assistance, or if the BIFR decides that the company can not make its net worth positive within a reasonable time, then the Board appoints an operating agency under section 17(3) of the Act, then the operating agency is required to prepare and submit a schedule in respect of the referred company by providing any or more of the following measures: i. ii. Financial Reconstruction of the sick industrial company;

The proper management of the sick industrial company by change in, or takeover of, the management of the sick industrial company; iii. Amalgamation with another company or vice-versa; iv. v. Sale or lease of its undertaking; Rationalization of its staff;

7[7] Section 4(2) of SICA,, 1985 8[8] Section 4(3) of SICA, 1985

vi. vii.

Any other preventive or remedial measures; and Incidental or consequential measures.

The revival package may vary from case to case depending on the nature of the problem and may include additional financial assistance, postponement of recovery of loan already lent by banks and financial institutions, change in management, amalgamation, sale of redundant assets, lease of assets or any other suitable measure. The revival package should be submitted to the BIFR within a time limit of 90 days or such extended period as may be granted by the BIFR.

E.

REHABILITATION BY GIVING FINANCIAL ASSISTANCE

On submission of the revival package by the operating agency, the BIFR sends the revival package in a draft form to all the interested parties (i.e., the sick industrial company, the banks/ financial institutions who have given financial assistance to the sick company, the operating agency, the transferee company (if there is a recommendation in the revival package for amalgamation) etc., eliciting their views/suggestions on the revival package. The BIFR will also publish particulars of the draft revival package in newspapers inviting suggestions/objections, if any, from the shareholders of the sick company, creditors and employees of the sick company, transferee company and any other interested party. On receipt of views/suggestions/objections on the draft revival scheme, the BIFR may, if deemed fit; afford an opportunity to the interested parties to be heard. After careful examination of all the aspects, the BIFR will sanction the revival scheme with or without any modifications.

IV.

CAUSES OF SICKNESS

Some industries are born sick; sickness is thrust upon some,9[9] while others become sick due to a number of causes. The general belief is that the incidence of sickness results from the changing economic factors and the external influence, which tilt the economic viability.10[10] The causes of sickness may vary from one unit to another. But the most common causes of sickness can be grouped under two heads internal and external. In India, the Tiwari Committee in its report outlined the causes of sickness into several heads. They can be classified as: A. Internal Causes - These are those factors which are within the internal control of the management. Sickness arises because of the disorder of the following concerns: 1. Planning a. Technical feasibility:11[11] Inadequate technical know-how, locational disadvantage, outdated production process. b. Economic Viability: High Cost of Inputs, uneconomic size of project, under estimation of financial requirements, unduly large investment in fixed assets, over-estimation of demand. 2. a. Implementation:

Cost over-runs resulting from delays in getting licences/sanctions etc., inadequate mobilization of finance. 3. Production

a.

Production management: Inappropriate product mix, poor quality control, high cost of production, lack of adequate timely and adequate modernization, high wastage, poor capacity utilization. b. Labour management: Excessive high wage structure, inefficient handling of labour problems, excessive manpower, lack of trained/skilled component personnel.

9[9]This happens due to change in Government policy, over-spending on essentials, absence of control on
borrowings, dishonest practices on the part of the management, etc.

10[10]See, Balan K, Managing Industrial Sickness, 1st edition, Mittal Publications, 1996 11[11] According to the Tiwari Committee, 14 per cent of the large sick units suffered from technical factors and
faulty initial planning.

c.

Marketing management: Dependence on limited number of customers, poor sales realization,

defective pricing policy, weak market organization, lack of market feedback and market research, lack of knowledge of marketing techniques. d. Financial Management: Poor resource management and financial planning, liberal dividend policy,

application of funds for unauthorized purposes, deficiency of funds, over-trading, inadequate working capital, lack of effective collection machinery. e. Administrative Management: Over centralization, lack of professionalism, lack of feedback to management ( management information system), lack of adequate controls, lack of timely diversification, excessive expenditure on R&D, incompetent and dishonest management. B. a. External Causes:

Infrastructural bottlenecks Non-availability/irregular supply of critical raw materials or other inputs, chronic power shortage, transport bottlenecks.

b.

Finance Constraints: Another external cause for the sickness of SSIs is lack of finance. This arises

due to credit restrains policy, delay in disbursement of loan by govt., unfavorable investments, fear of nationalization. c. Government control, policies, etc. Government price controls, fiscal duties, abrupt changes in Government policies, procedural delays on the part of the financial/licensing/other controlling or regulating authorities (banks, RBI, financial institutions, Government departments, licensing authorities, MRTP Board). d. Marketing Constraints: The sickness arrives due to liberal licensing policies, restrain of purchase

by bulk purchasers, changes in global marketing scenario, excessive tax policies by govt. and market recession. e. Extraneous factors: Natural calamities, political situation (domestic as well as international), war, sympathetic strike, multiplicity of labour unions. The Government taking into consideration all the factors resulting into industrial sickness, accepted the recommendations of the Tiwari Committee with some modification, and thus, the Sick Industrial Companies (Special Provisions) Act, 1985 was, accordingly enacted.

V.

SHORTCOMINGS OF SICA

The functioning of SICA proved inadequate to cater to the needs of the sick units. The reasons of sickness can be outlined as poor and slow functioning of BIFR12[12], abuse of Section 22, delay in Winding up Procedure and defective Policy and inadequate strength of BIFR13[13] VI. COMPANIES BILL, 2009

Certain changes were proposed to be made for the rehabilitation and revival of the sick units as from the proposed Companies Amendment Act, 1956.The criteria of sickness was changed to include inability to pay debts due to secured creditors representing 50% or more of the outstanding debt.14[14] Further the scope of the filing for the determination of sickness which was restricted to the Board now included the creditor or the company. Even powers were granted to the creditors to decide on the issue of winding up or the revival of the company by passing a special majority among the creditors.15[15] Moreover, the greater powers have been conferred on the creditors to supervise a rescue plan and restrict the powers of management in the rehabilitation of a sick company.16[16]

VII.

RECOMMENDATIONS OF THE JJ IRANI COMMITTEE ON COMPANY LAW (2005)17[17]

12[12]See, http://indiabudget.nic.in/es2005-06/chapt2006/chapter7.pdf, last accessed on 23rd October, 2009. 13[13] This inadequate strength of members have also contributed to the delay in disposal of cases. 14[14]See, Section 229(1) of the Companies Bill, 2009 15[15]See, Section 237(2) of the Companies Bill, 2009 16[16]See,
http://www.prsindia.org/uploads/media/Company/Legislative%20Brief-rd

companies%20bill%202009.pdf, last accessed on 23 October, 2009.

17[17]See, http://www.mahavirlunawat.com/html/[2005]061SCL0047(MAG).html, last accessed on 24th October,

2009.

JJ Irani Committee wanted to omit the term sick industrial company and replace it with insolvent company and thereby erase the sickness test on the basis of erosion of networth with that of the liquidity test. Moreover, it recommended that CA/CS/CWA/law professionals should play an active role in the insolvency process so that there would be expertise persons dealing with the specialized, commercial and technical characteristics of insolvency law. It also recommended the establishment of the National Company Law Tribunal on a speedy basis. Further, it enunciated that the rehabilitation by cess to be replaced by the Insolvency Fund with optional contribution by companies. It also allowed the debtors to approach the Tribunal with the rehabilitation scheme. Power was also given to the creditors to oppose the scheme of rehabilitation. 18[18] VIII. IS REHABILITATION THE ANSWER?

No Rehabilitation, it is not the answer and solution for sick industrial companies. It should be closed down as it is undue exercise and puts additional burden upon the government to take care of them. In addition, it also places burden upon all the existing well running industrial units SICA impose cess on companies to build up a fund for rehabilitation of the assets of the sick companies. It is opposed by the Federation of Indian Chambers of Commerce & Industry of India (FICCI) on the ground that healthy and sound companies should not suffer for faults of others.19[19] The government should not intervene into the affairs of the industrial company and let the market forces decide it, whether company can be run or not. It should leave the industrial company on its own condition and should afford an opportunity to the company to decide its own fate in this era of cut throat competition. The theory of survival of the fittest should be applied in this particular realm, it says competition for survival or predominance and survival of those who are better equipped for surviving .20[20] The government should segregate itself from the affairs of the industrial company and should do its own job. CONCLUSION AND SUGGESTIONS

18[18]See,http://www.luthra.com/Admin/presentations/Images/Risks%20and%20Strategies%20of%20Bankruptc
y%20MA%20-%20An%20Indian%20Perspective.pdf, last accessed on 24th October, 2010. 19[19] See, http://www.financialexpress.com/news/review-definition-of-sick-co-ficci/74076/, para 2, last visited on 2nd November, 2010. nd 20[20] See, http://en.wikipedia.org/wiki/Survival_of_the_fittest, last visited on 2 November, 2010. The theory was propounded by Herbert Spencer in 1864 in his book Principles of Biology .

Industrial sickness is a problem all economies big and small have to face. What is important is to evolve a proper regulatory and institutional mechanism to deal with the situation. While there should be a mechanism to safeguard the interests of workers, a suitable exit policy for the non-viable units should form an integral part of the new approach. A stringent mechanism should also be devised so that the directors of the company should not play fraud on the unit to bring it within the purview of sickness. NCLT should also be made to come into force to ensure speedy disposal of cases looking into the sluggishness of the disposal of cases by BIFR. The approach of the government towards rehabilitation of a sick unit being very selective, the government is now convinced that there is no point in throwing away further resources in support of the units which are irretrievably sick. Only such units which are found to be potentially viable need to be taken up for formulation of rehabilitation packages to restore them to health. Package consisting of concessions from banks, financial institutions, government (Central/State), government agencies, shareholders, labour, and suppliers of goods should be provided to those units where chances are subsisting for the revival of the sick unit. The enactment instead of fruitful it proved burdensome on the healthy companies. The rehabilitation fund are created by imposing tax on the good working companies which puts additional burden on them without their own fault. The Parliament itself is not sure whether rehabilitation should be given to the sick company which is evident from the act of the parliament itself. Parliament repealed the very first enactment of SICA after seventeen years just because it did not confirmed the purposes set out in the enactment and inserted few sections in the companies Act, 1956.

Sick industrial company should be left on their own condition and let the market forces to decide the fate of the company. Government should refrain itself from intervention. If at all government wants to do fruitful help for the industrial company, it should help taking the affairs of the industrial company in its own hand for a particular period of time.