Money & Banking
New Insolvency Law a Rude Awakening to Defaulters
Fifteen years ago, when the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (also known as the SARFAESI Act) was passed, first as an ordinance and later as an Act, it took quite some time for borrowers in the country to fathom that the scene has changed drastically. It was not possible any more, after the getting the default notice from the bank, to run to a lawyer to get a stay from a court and then relax for years together. The new law was completely non-adjudicative and, once there was a default on an instalment of interest or principal to a bank, it could simply demand the entire loan within a defined timeline, failing which the bank could come calling to grab the secured property.  The country’s borrowers were so used to a regime where there would be hearings, adjournments, elaborate legal arguments, and finally an attachment order, before a repossession – the SARFAESI Act had none of that.
The Insolvency and Bankruptcy Code is another such rude awakening. The business community of the country is so used to the Sick Industrial Companies Act (SICA) regime, where the law could be used as a weapon to drag the process on for years. Borrowers, big and small, are finding to their astonishment that on the mere happening of a default, a lender can file an application to the National Company Law Tribunal (NCLT). The latter can then send the borrower into an insolvency process, which would mean that the business would temporarily come under the control of an insolvency practitioner. All management, in fact even the operation of bank accounts, will come under the control of the insolvency practitioner. The first reaction is:  Is this process meeting the basic requirements of natural justice, a concept that is so much a part of our legal system?
Scheme of the law
While the jury is still out on the question as to whether the borrower, having defaulted on a financial obligation, still deserves a hearing before disposal of an application for insolvency, the larger thrust of the law, which is entirely creditor-driven, should be clear. 
A financial creditor, essentially including a lender, or debenture-holder, may pull the borrower into insolvency proceeding if there is a default. It is not even necessary that the loan should have become a non-performing asset (NPA) in the books of the lender. A threshold default amount is stipulated (currently Rs1 lakh), but that is too small to be of any consequence. The lender proves the default with reference to records of an information utility, akin to a credit information bureau such as CIBIL. Currently, as information utilities are yet to be registered, the evidence may be of any objective form – including the records of the lender, or the correspondence of the borrower evidencing default. Once a default is proved, the NCLT will, in what appear like autopilot proceedings, pass an order putting the borrower into insolvency proceedings.
The immediate result of the insolvency order is that an insolvency practitioner, called Interim Resolution Professional (IRP), takes over the management of the borrower, sending the existing board of directors into a state of animated suspension. Once this happens, the borrower cannot do any private settlements with any of the lenders. So much so that he cannot even pay up the petitioning creditor to avert the implications of the insolvency proceedings. There is a complete moratorium on all transactions, except in the ordinary course of business. The control over the management of the entity, including on its finances, will come into the hands of the IRP.
Should lenders file for insolvency?
While the law enables the lender to file for insolvency in the event of a default, the larger issue is whether he should choose the insolvency law as his first choice. A lender has to choose his weapon carefully. Insolvency is not self-service; it is service to all, because once the borrower is put into insolvency, the borrower cannot do any settlement with the lender. Also, enforcement of security interests, including SARFAESI proceedings, will be stalled during the moratorium period. Post the moratorium, while SARFAESI action is possible, the lender will have to stay out of the resolution proceedings. In short, the lender has to evaluate whether he would like to enforce security interest on whatever asset is under his exclusive charge, or to join the rest of the creditors in preparing the resolution plan.
Evidently, insolvency proceedings cannot be the first choice, because this is an irreversible process. Once initiated, it either will end up killing the target and sending him into liquidation, or will succeed in reviving the company for the benefit of all. Therefore, insolvency proceedings are necessarily a collective remedy, and generally speaking, the last remedy.
Borrower’s defense
Can a borrower defend a filing for insolvency or, on what grounds can it be defended? The question is being raised in several forums currently. A technical reading of the law seems to suggest that the copy of the application for insolvency that the lender files with the NCLT is served on the borrower as well, but there is no apparent scope for the borrower to put up any defence at the stage of admission, if the default is clear and incontrovertible.  
However, the other side of the argument is the principle of natural justice enshrined in section 424 of the Companies Act. Natural justice, a legal concept, necessarily implies an opportunity of hearing. The issue is whether the hearing is limited to whether there is a default or not, or does it go any further? The scheme of the law clearly suggests that the only ground to be verified by the NCLT at the stage of admission is the existence of default. Therefore, even if there is a hearing around admissibility, it has to be on the factual existence of default, and cannot go beyond that.
This is precisely where there may be a cultural shock for borrowers, lawyers, and a new learning for the judicial and quasi-judicial forums. Insolvency is a drastic step, but the insolvency law is a drastic law and, factually, all that it requires for initiating the process is a default. A default on a financial obligation is a breach of promise on the part of the borrower. The underlying philosophy on which the law works is that once such promise is breached, the breach itself is an indicator of inability to pay, which shifts the control from the hands of the owners to those of the creditors. The creditors will take a call on whether the entity should be resurrected, restored, restructured, or simply liquidated. The fact of default deprives the borrower of the right to seek any justice.
When the SARFAESI law was enforced, there were several rulings of the courts, including the Supreme Court, which went into the scheme of the law, holding that there is no adjudication prior to a repossession action. The insolvency law is a collective law, whereas SARFAESI is a law of self-help by creditors. Under the SARFAESI Act, there is no opportunity for the borrower before repossession. Under the insolvency code, there does not seem to be any such right, and the question whether such a straight, undefended action deprives the borrower of some fundamental need for justice, is yet to be answered. But the chances are fairly strong that it is only a question of realisation, much against the impression people would have formed over decades. The default itself is the trigger that leaves the lenders empowered and the borrower powerless.
(Vinod Kothari is a chartered accountant, trainer and author. Mr Kothari, through his firm, Vinod Kothari and Company, is also engaged in the practice of corporate law for over 25 years.) 



surender tyagi

2 months ago

Yesterday I got my money in my account.

khajapeer maditheti

3 months ago

I had deposited some old notes in the rbi,Chennai on06-02-2017.My Tender receipt No.isCHE 003847.Iwould be happy if the credit value is remitted to my account.

Vinod Kothari

7 months ago

Just to add, defaults by NBFCs are currently not covered by this law. Defaults by non-banking non-financial companies are covered. The total default amount must be Rs 1 lac or more for application to be filed. The applicant creditor pays the fees, as well as the cost of the person who appears before the NCLT, cost of public advertisement, etc. The costs may be quite a burden on small depositors. Please review this before stepping into action.

Vinod Kothari

7 months ago

Fixed deposits are also financial claims. Hence if the amount of default adds to Rs 1 lac or above, application can be made under sec. 7.

k.mohanarangam k.mohanarangam

7 months ago

yes! i repeat mr.Balachandran"query
if this new legal remedy is applicable we
will be happy.


7 months ago

Do you know if this remedy is available for Fixed Deposit holders?


7 months ago

Considering the huge pile of NPAs in our banking system, and citizens not being tax compliant, I feel this is a step in the right direction rather than having demonetisation once more, which I was given to understand, will be enforced sooner or later with more vigor.

Parimal Shah

7 months ago

If you know how our laws are implemented you will be amazed. If the tax is deducted at source and not deposited by the deductor the IT department pulls up the tax payer saying there is no tax paid - the government money is actually with the party that deducted the tax at source. Instead of that party getting penalized for usurping government money the IT department penalizes the tax payer. Natural justice! Are you joking?

Trump Said He Made USD 21 Million in Income From His New York Contracts. He Actually Made a Lot Less

When he was running for president last May, Donald Trump released 104 pages of details about his finances, including a claim that he earned nearly $21 million through contracts with New York City to run two skating rinks in Central Park and a Bronx golf course.


Much of what Trump asserts remains unverified since he has thus far declined to release his tax returns. But ProPublica obtained the financial records and receipts Trump submitted to New York City for the two leases and they show that he cleared a lot less from those deals, earning no more than half of what he claimed. (Check out the documents.)


Of course, the skating rinks and golf course are but a tiny corner of the Trump financial empire. Still, the records add to the suspicion — originally advanced by Fortune, Forbes and other news organizations — that Trump's official disclosures exaggerate his accomplishments as a businessman by reporting gross receipts rather than actual profits.


Trump submitted the listing of his financial holdings to the U.S. Office of Government Ethics, a requirement for presidential candidates. He reported income from the New York City leases of $20.8 million but did not disclose the expenses he incurred while running those operations.


The Office of Government Ethics reviews financial disclosures for compliance. It doesn't audit the filings, leaving it up to candidates to decide whether to report gross revenue or net income from their business dealings. Either is allowed on the form, as long it's clear.


In the disclosure Trump filed, the numbers for the New York leases are listed under "Income Amount." Former government ethics attorneys say that while most previous nominees understood this to require reporting income net of expenses, the requirements are vague enough to allow either interpretation.


"It's sufficiently ambiguous that, while Trump may meet their reporting requirements, it's really misleading," said Virginia Canter, who served as associate counsel for ethics in the Clinton and Obama administrations and ethics adviser for the International Monetary Fund.


Wealthy political candidates and Cabinet picks have reported income with expenses subtracted, repeating the numbers reported on their income tax returns. For example, former Commerce Secretary Penny Pritzker, a Chicago billionaire with sizable real-estate assets, reported on her financial disclosure form that she earned at least $164 million, a figure described as taxable income. Even then, Pritzker had to file an amended form after she understated her income.


The Trump Organization did not respond to requests for comment. The White House did not respond to a request for comment about the president's income but said in a statement that Trump is "exempt from conflicts" under federal law. (While it is true that the president and vice president are exempt from any criminal penalties resulting from conflicts of interest, that does not preclude the existence of such conflicts.)


New York City documents released to ProPublica in response to a public-records request show that in previous years, Trump spent at least $4.5 million annually on employee salaries, subcontractors, insurance, taxes and benefits at the skating rinks. Separately, he paid at least $2 million a year to the city in rent in 2015 and 2016.


Trump has yet to report his expenses for 2015 and 2016. But if past experience is a guide, it would appear that he spends about $6.5 million annually on the two rinks.


The financial disclosure form Trump filed covers the period from January 2015 to May 2016. In those months, he disclosed an income of $12.9 million for the two rinks, roughly the same amount as our estimate of his expenses for that period.


We estimated that his expenses for those months were above $12 million, given that most of the skating business takes place in the winter months.


This left Trump with a profit, by our estimate, of several hundred thousand dollars. That's in line with Trump's predictions to New York City, which is that he expected to make a profit, after taxes, of less than $500,000 annually.


We found a similar pattern when we looked at the golf course.


There, the Trump Organization projected expenses of more than $4 million a year in 2015 and 2016, including spending on salaries, the pro shop, marketing and maintenance of the greens.


According to city records, the golf course's total receipts for 2015 and first five months of 2016 were $8.1 million. That's roughly what Trump reported as income ($7.9 million) on the federal disclosure forms for that period.


Projecting conservatively, we estimated that Trump spent at least $5 million on expenses in those months — $4 million for the previous year and at least $1 million from January to May, leaving him, at most, a profit of $3 million.


Trump took over operations of Wollman Rink and the smaller Central Park ice rink in 1986 after they had fallen into disrepair. He signed another contract with the Department of Parks and Recreation in November 2001 to manage the rinks for another 10 years and later extended it to last until 2021.


In extending its contract with Trump, city officials described the Trump Organization as an "exemplary concessionaire" and noted that, with the low profit margins at the ice skating rinks, it had "no other viable options" to manage it. The rink has a decidedly Trumpian quality; nearly everything at the rink is emblazoned with the Trump name, from the rental skates and water to the Zamboni.


In 2012, the Trump Organization also signed a 20-year contract to operate the 192-acre golf course in the Bronx. The course is on the site of a former garbage dump redeveloped by the city at a cost of more than $200 million. Trump agreed to fund various improvements and start sharing revenues with the city in 2020; a weekend game of golf costs $172, triple that of other municipal golf courses.


"Generally speaking, golf is a shrinking sport but the city made a promise to the community and that's what they wanted," said Adrian Benepe, who was the city's parks commissioner under former Mayor Michael Bloomberg from 2002 to 2012 and who negotiated the Bronx golf course contract. "We kind of felt lucky, given the sport's declining popularity and that this site was a long-festering wound, an exposed garbage dump."


Despite pledging to distance himself from his business empire, Trump is still listed as the ultimate owner of the two New York City contracts. To transfer ownership of the contracts, the Trump Organization has to get the written approval of New York City Parks Commissioner Mitchell J. Silver.


Any changes in management and operation of the rinks need approval from the commissioner. "Failure to comply with this provision shall cause the immediate termination of this License," the contracts read.


The Trump Organization has yet to make those changes, city officials said. In response to questions from ProPublica about the management changeover, the Parks and Recreation Department said it is trying to get more information.


In January, Trump said that he would distance himself from his business empire by creating a trust that would oversee his companies. But the trust, run by his eldest son, Donald Trump Jr., and a longtime employee, ultimately benefits the president, D.C. licensing documents obtained by ProPublica show.


Al Shaw contributed reporting.


ProPublica is a Pulitzer Prize-winning investigative newsroom. Sign up for their newsletter.











Hot and Cold Stocks of Mutual Funds in Jan 2017

In the month of January 2017, ICICI Bank, Infosys and Indian Oil Corporation were the most preferred stocks of Indian mutual funds. ICICI Prudential Mutual Fund purchased Infosys shares worth Rs296.06 crore, out of the net purchase of Rs432.88 crore by all mutual funds. HDFC Bank, Tata Consultancy Services and Reliance Industries were the most sold companies. ICICI Prudential Mutual Fund...

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