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. 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.

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.

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 social unrest. 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. 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. The existence of these

signals and symptoms provides a ground for suspecting that the

industrial unit concerned is prone to

sickness                                                                                           

  .

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.     OBJECTIVES OF SICA

1.      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, 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:

(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,

drawn from various fields including banking, labour,

accountancy, economics etc. 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.            Financial Reconstruction of the sick industrial

company;

       ii.            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.            Sale or lease of its undertaking;

       v.            Rationalization of its staff;

     vi.            Any other preventive or remedial measures; and

    vii.            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,

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. 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: 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.      Implementation:

a.       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.

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.     External Causes:

a.       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 BIFR, abuse of Section 22, delay in

Winding up Procedure and defective Policy and inadequate

strength of BIFR

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. 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. 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.

VII.           RECOMMENDATIONS OF THE JJ IRANI

COMMITTEE ON COMPANY LAW (2005)

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.

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.

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”. The government should segregate itself from the

affairs of the industrial company and should do its own job.

CONCLUSION AND SUGGESTIONS

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.