Sick Industrial Units

Sickness in industry in our country is a phenomenon, which has existed along with healthy industrial enterprises. It has registered a quantum jump with the onset of the new economic order, ushered in by liberalization and globalization. The approach to handle sickness in industry has undergone a gradual change.

While earlier when the socialist approach was pre-dominant, the view towards sick companies was that no sick company should be allowed to die or close down, as employment shall be lost. But with time, the approach changed and any unit which would turn sick would be taken over by healthier units or by the government until it revived.

This paper seeks to analyze the concept of industrial sickness by understanding its historical background and the various stages which eventually led to the passing of a consolidated legislation to govern the sickness in industries in India. However, before understanding the concept of industrial sickness in further detail it is important to understand the meaning of the same. Prior to the repeal of Sick Industrial Companies Act. 1985, a sick industrial unit was defined as:

"An industrial company (registered for not less than 5 years) which has at the end of any financial year accumulated losses equal to or exceeding its entire worth." ‘Net Worth' means the sum total of the paid-up capital and free reserves. 'Free Reserves' means all reserves credited out of the profits and share premium account but does not include reserves credited out of revaluation of assets, write-back of depreciation provisions and amalgamations.

The new definition of 'sick industrial company' is contained in Section 2(46AA) of the Companies Act, 1956 which defines a sick industrial company as an industrial company which has:

1. The accumulated losses in any financial year equal to 50% or more of its average net worth during 4 years immediately preceding such financial year; or
2. Failed to repay its debts within any 3 consecutive quarters on demand made in writing for its repayment in writing for its repayment made by a creditor or creditors of such company.

BACKGROUND OF INDUSTRIAL SICKNESS

The background of industrial sickness in India can be studied in various stages starting right from the early 1950s to the present. Each stage has been discussed separately and in extensive detail.

STAGE I- Position in early 1950s

In early fifties, a number of industries were becoming sick. They were closing down their production. Most of the goods and services were in short supply in the country and were not within the reach of the citizens. The magnitude and incidence of industrial sickness became a matter of concern to the Central and State Governments, Reserve Bank of India, financial institutions and commercial banks. It was therefore considered essential that all necessary steps, whether legislative or executive, should be taken by the Government, financial institutions and industrialists to prevent, as far as possible, industries from going out of production.

SATGE II- Nationalization of Industries

The nationalization of industries was an era wherein industries considered vital or essential for national economic prosperity, whether sick or healthy, domestic or foreign, were being nationalized in many countries of the world. The maximum number of nationalizations of industries took place in developing countries.

Thus, in keeping with the international trend, one of the measures to prevent closure of industries due to sickness that was considered feasible in the country by the Government at that time was to take over sick industrial undertakings. The arrangement planned was that as and when an industrial undertaking would become sick, the Government should nationalize it. Thus, in fifties and sixties a large number of sick industrial undertakings were nationalized.

STAGE III- Position after Nationalization

Most of the sick industrial undertakings which were nationalized became a heavy burden on the exchequer. When these undertakings became sick, their plant and machinery was old and worn out; their technology was outdated and obsolete; they had labour force many times more than their actual requirement; they had huge liabilities of workers’ wages, unpaid taxes and duties, debts of financial institutions and banks, market dues, etc.

The cost of production was very high and they were unable to compete with other industrial undertakings in the same field. Hence, it became essential not only to pay compensation or amount but in order to revive such undertakings, to meet some of the aforesaid liabilities. Money was also required to put the plant and machinery in workable condition so as to be able to produce goods. In brief, nationalization of sick industrial undertakings resulted in huge investments of capital which the country at that stage of development could least afford.

STAGE IV- Temporary take-over of Management

Another measure that was simultaneously adopted to check industrial sickness was that the Government took over management of sick industrial undertakings for a brief period and managed them for some time. After the sickness was removed and the undertaking became healthy, it could be returned to the owners. It was thought that such an action by the Government would no doubt cost the exchequer heavily, but it would prevent the loss of industrial production and unemployment considered vital for national economic well-being. Further, the advantages in terms of industrial production would outweigh the cost consideration.

STAGE V- Position in the 1970s

In the seventies, it was realized that the measures till then adopted by the Government for preventing industrial sickness, that is nationalization or take-over of management of a sick industrial undertaking were not effective, efficient and economical measures to control industrial sickness. Both these measures needed enormous investment in terms of money, man-power and resources.

It was, in course of time, experienced that in a sizeable number of cases, one-time investment was not sufficient to revive the sick units. They needed constant and periodical financial and other support. In spite of all possible investment and support, many industrial sick industrial undertakings did not show any symptoms of viability for various reasons.

STAGE VI- Position became worse

Options available to the Government were few and even after having made enormous investment, the industrial undertakings which were still unhealthy, could not be denationalized. During the period when the management of such sick industrial undertakings was with the Government, huge sums of money were required to be invested in them to meet past liabilities of unpaid wages, taxes and duties, and for working capital. In spite of all these efforts and investments, when such undertakings could not be made viable, it was proposed that they may be returned to their original owners.

The owners, however, refused to take the undertakings back as they were reverting to them in "more sick condition" with added liability of Government investment which was legally required to be paid back as a debt to the Government by the owners. Hence, the sick industrial undertakings whose management was taken over were also fit to be wound up. The result was that both the measures failed in protecting production, preventing unemployment, ensuring payment of Government taxes and duties, recovery of loans of financial institutions and banks etc.

FACTORS LEADING TO SICKNESS OF INDUSTRIES

Before delving further, an insight into the causes of sickness could throw light on the measures, which can be taken for revival. A company could turn sick, either due to the management's failure to control the situation, or due to factors beyond the control of management. Multiple factors are responsible for spreading sickness in the Indian industries. These factors can be classified under two main categories, namely, internal and external. Industrial sickness may be caused due to either of these factors or a combination of both these factors.

Internal factors include:

• Mismanagement in various functional areas of a company like finance, production, marketing and personnel;
• Wrong location of a unit;
• Overestimation of demand and wrong dividend policy;
• Poor implementation of projects which may be due to improper planning or managerial inefficiency;
• Poor inventory management in respect of finished goods as well as inputs;
• Unwarranted expansion and diversion of resources such as personal extravagances, excessive overheads, acquisition of unproductive assets, etc.;
• Failure to modernize the productive apparatus, change the productive mix and other elements of marketing mix to suit the changing environment;
• Poor labour-management relationship and associated law workers; morale and low-productivity, strikes, lockouts etc. External factors include:
• Energy crisis arising out of power cuts or shortage of coal or oil;
• Failure to achieve optimum capacity due to shortage of raw-materials as a result of production set-backs in the supply industries, poor agricultural output because of natural reasons, changes in the import conditions etc,;
• Infrastructural problems like transport bottlenecks;
• Credit squeeze;
• Situations like market recession, changes in technology etc.;
• International pressures or circumstances, etc

Industrial sickness has a number of adverse consequences on the economy as a whole, some of which may be enumerated as follows:

• It leads to substantial revenue to the Government and enhances its public expenditure;
• It locks up necessary resources and funds in the sick unit. This also increases the non-performing assets (NPAs) of banks and financial institutions;
• It leads to loss of production and productivity in the economy;
• It aggravates the problem of unemployment in the economy;
• It vitiates the industrial atmosphere and leads to worker-management disputes, strikes, lockouts etc.;
• It undermines the public confidence in the functioning of the organized sector in the country which in turn affects the overall investment climate of the economy.

BACKDROP TO THE SICK INDUSTRIAL COMPANIES ACT

The Reserve Bank of India which was periodically monitoring industrial sickness was also busy in finding out some solution to the problem. It had also appointed a number of Committees and Commissions for suggesting sufficient safeguards for the financial institutions and how best to recover the advances made by them. The first such effort was made by it in 1975 when Tandon Committee was appointed. However, the work done by the Tandon Committee was inadequate and subsequently other such committees had to be appointed.

Work Done by Tandon Committee:

This committee was constituted in 1975 by the Reserve Bank of India. In fact, it was not a committee but a Study Group, though popularly it came to be known as Tandon Committee. In its report, this Committee made some useful suggestions for the revival of sick industrial units. It suggested a two-pronged strategy to effectively deal with industrial sickness. The first was the intervention by the Banks, who had given loans and advances to the unit, in their management. Secondly, it suggested the reorganization or the financial structuring of the units including reliefs like additional financial assistance, rescheduling of existing loans.

Work Done by H.N. Ray Committee:

In 1976, the Government of India constituted a committee under the chairmanship of Shri H.N. Ray, the then Secretary of the Ministry of Finance, Government of India. This Committee was asked to look into the question "whether it was feasible to merge productive enterprises which were in financial difficulties or were sick with healthy units, so that the combined undertaking could function more effectively". The Committee submitted its Report to the Government in July 1976, making certain recommendations.

Work Done by Tiwari Committee:

In 1981, the Reserve Bank of India constituted a Committee under the chairmanship of Shri T. Tiwari, Chairman of the Industrial Reconstruction Corporation of India. It was decided that the Government should also participate in this Committee so that the Committee could examine the issues comprehensively and make its recommendations to prevent industrial sickness and the measures that should be adopted, including legislative measures, to revive the industrial undertakings which had already become sick. Thus, the Government appointed representatives of the Ministries of Finance (Banking Division), Industries (Department of Industrial Development), and Law (Department of Legal Affairs).

The Recommendations Made by the Tiwari Committee:

The Committee held discussions with the various representative bodies of trade and industry like chambers of commerce, central labour organizations, commercial banks, term-lending institutions etc. and after an in-depth consideration of the problem of industrial sickness from all angles, submitted its Report to the Government in September 1983. The Committee made a large number of recommendations covering all aspects of sickness and recovery of dues of financial institutions.

The course of making amendments in existing laws like Monopolies and Restrictive Trade Practices Act, 1964, Industries (Development and Regulations) Act, 1951, Companies Act, 1956, etc., was not favoured because of the divergent objectives of the particular enactments and the fact that a very large number of amendments, substantive as well as consequential, would be needed to very statutes.

Need for a Special Legislation:

The Committee, inter alia, suggested a comprehensive special legislation designed to deal with the problem of sickness laying down its basic objectives and parameters, the remedies necessary for the revival of sick units and the body which should provide these remedies. The draft of the proposed legislation recommended the setting up of an exclusive and an independent quasi-judicial body to be called the Board of Industrial Revival, with powers of a Civil Court, for taking appropriate measures with respect to sick units expeditiously, also giving finality to the decisions of the said body by ousting the jurisdiction of civil courts in matters to be considered by the Board.

The Government, after detailed consultation with all those who were concerned with industrial sickness accepted the recommendations of the Committee for bringing forward a special law concerning the sick industrial companies, of course, after incorporating certain important modifications in the contents thereof. The Sick Industrial Companies (Special Provisions) Act, 1985 (SICA) was accordingly brought on the statute book by the Parliament.

THE MATERIAL DEPARTURES MADE

• The name of the quasi-judicial body was altered from Board of Industrial Revival to Board of Industrial & Financial Reconstruction (BIFR).
• The strength of the Board was increased to 14 (excluding the Chairman), instead of a 3-member Board.
• An Appellate Authority for Industrial & Financial Reconstruction (AAIFR) to hear appeals against orders of the Board was established, as against the Committee’s recommendation to confer powers of review of its orders to BIFR itself and an appeal to Supreme Court on point of law.
• The Act covers only a company as defined in Section 3 of the Companies Act, 1956 owning one or more industrial undertakings and not a co-operative society, as originally suggested by the Committee.
• The Committee had suggested that the scheme sanctioned by the Board should be binding on not only the sick industrial undertakings but also on all creditors, members, banks and financial institutions and all other persons or authorities whose rights or interests are involved. The Act however made no mention of the binding effect of the scheme on parties other than the sick industrial company or the industrial company in which it may be merged under a scheme and the shareholders of both these companies.
• The provision suggested by the Committee to the effect that if the Board decides that a particular sick industrial undertaking cannot be revived under a proposed scheme, a copy of its finding should be simultaneously sent to the Central Government does not find a place in the enactment.
• The provisions contained in the Act, as to the formation of opinion as to the winding up of a sick industrial company found to be non-viable and the concerned High Court being bound to take winding up proceedings on the basis of the said opinion were not a part of the Committee’s report.
• Unlike the provisions contained in the enactment, in Committee’s recommendations, the concept of a potentially sick industrial company was non-existent. Rather the definition of a sick industrial of a sick industrial company, among others, was based upon the criterion of erosion of 50% or more of net worth of an industrial company. This was at variance with the prescription of one of the important criteria for a sick industrial company specified in the Act, that is, of erosion of 100% or more of the net worth of an industrial unit by reason of accumulated losses.
• Yet another aspect bearing upon strengthening the impartiality and credibility of the quasi-judicial bodies, viz., BIFR and AAIFR, is the existence of provisions in the Act which prohibit the removal of the Members thereof by the Central Government except on specified grounds and in the event of acquisition of interest prejudicial to their functioning as a Member and abuse of position, only on the basis of an enquiry held by the Supreme Court in the matter. The Act makes specific provisions prohibiting the variation of conditions of service of the Chairman and other Members of BIFR and AAIFR to their disadvantage, after their appointment.
• The Committee had defined ‘sick industrial undertaking’ to mean an undertaking as may be notified by the Central Government and could even include Government undertakings. The Act, however, contained a self-contained definition of sick industrial company and kept the Government companies outside the purview- which were later brought in 1991.

NATURE OF LEGISLATION

SICA was basically predominantly remedial and ameliorative insofar as it empowered the quasi-judicial body- (BIFR) to take appropriate measures for revival and rehabilitation of potentially viable sick industrial companies and for liquidation of non-viable companies and was regulated only to a limited extent.

Under the Act, no adverse proceedings as such were involved and the bodies set up thereunder, were not called upon to adjudicate upon any lis between any parties or upon any rights and obligations of parties. The right of appeal to AAIFR by a person aggrieved against BIFR's order had been given in the context of the need for avoidance of arbitrariness on the part of BIFR and for constitutionally sustaining the exclusion of jurisdiction of civil courts with respect to matters decided by BIFR, by providing an alternative effective remedy, which the Courts have insisted upon for the purpose.

FAILURE OF SICA

Though SICA was conceived well, unfortunately, it was not only failed to reduce sickness, but also the spread of industrial sickness. SICA was perceived by some companies as an 'official exit route'. Financial Institutions have to give various concessions and reliefs to a sick company. They preferred to give these through the medium of SICA to avoid any audit queries and objections. SICA gave protections from suits etc. during the nursing period u/s 22. Some companies approached SICA only with the intention of getting such protection. Section 22 of SICA created havoc in banking sector and Non-Performing Assets (NPAs) started mounting.

SICA has now been repealed and work of rehabilitation of sick industrial companies has been entrusted to National Company Law Tribunal (NCLT) constituted under Companies Act, 1956. Many provisions of SICA have been incorporated in Part VI-A of Companies Act (sections 424A to 424L) in a considerably diluted form. Powers of BIFR will be exercised by NCLT. Appeal against order of NCLT will be before National Company Law Appellate Tribunal (NCLAT) instead of AAIFR.

OVERVIEW OF THE NEW PROVISIONS

The provisions in Chapter VI-A of the Act are more or less on the pattern of SICA. A sick company is required to make a reference to NCLT, along with its scheme for revival and panel auditor's certificate giving reasons for sickness. NCLT will decide whether the company can revive on its own or preparation of a scheme is necessary. If it is of the opinion that preparation of 'scheme of rehabilitation' is necessary, it will ask an 'Operating Agency' (bank or financial institution or some expert body) to prepare a scheme.

If the scheme involves providing financial assistance/concessions/reliefs, consent of concerned Bank, Financial Institution or Government will have to be obtained. NCLT has to specifically sanction the scheme in writing before its implementation. If Tribunal is of the opinion that the company is not likely to revive, it can (and perhaps, will) or winding up of the company.

CONCLUSION

The country has witnessed a change in the approach of the Government in handling sickness of companies. The Government has switched the mode from a socialist approach, which aimed at preserving employment at every cost, towards a capitalist approach where efficiency of the capital employed is of prime concern and the inefficient may be shown the door and the fittest allowed to survive.

It is prudent to align one's economic order with the world's order of allowing only the efficient/fittest to survive. At the same time, a humane approach, to the problem of sickness of companies might be followed, keeping in view the fact that a fast tracking winding up of companies may also bring about miseries in the lives of people who would be affected by reason of the loss of their jobs.

On the legislative front, the Government deserves credit for creating an effective legal framework, wherein, the banks/financial institutions will now not hesitate to provide capital assistance to industrial undertakings. However, the absence of well-developed secondary markets in India raises considerable doubt regarding the effective enforcement of recovery proceedings. The lack of institutional framework for sale of assets of the sick unit delays the process, thereby diminishing the realization value of the asset.

The need of the hour is specialized firms that exclusively work for the revival and rehabilitation of sick/potentially sick units. This does not however undermine Government's responsibility to institute proper administrative measures to dissuade deliberate efforts from delaying the regulatory mechanism.

Contributed by – Kritika Vij