India Law Journal

Introduction
The essence of insolvency consists in a debtor’s ultimate inability to meet his or her financial commitments. In 1997, the United Nations Commission on International Trade Law presented the UNCITRAL Model Law on Cross-Border Insolvency at the UN General Assembly. The Wharton’s Law Lexicon defines insolvency as the state of one who has not properly sufficient funds for the full payment of his debts. According to Shardul Shroff, an eminent lawyer, corporate insolvency law has the following objectives:

To restore the debtor company to profitable trading where this is practicable;
To maximise the return to creditors as a whole where the company itself cannot be saved;
To establish a fair and equitable system for the ranking of claims and the distribution of assets among creditors, involving a redistribution of rights and;
To provide a mechanism by which the causes of failure can be identified and those guilty of mismanagement brought to book, and where appropriate, deprived of the right to be involved in the management of other companies.

The term of ‘insolvency’ is often confused with another having a very similar meaning- that of bankruptcy. While insolvency is employed to mean a state of financial distress, the term bankruptcy is usually used to refer to the proceedings that mark a person as an insolvent. However, usually the two terms are used interchangeably. There are two well-established tests for determining whether a person is solvent or otherwise. The first is the Balance Sheet Test or ‘absolute insolvency’. This states that a person is insolvent if his or her liabilities outweigh the assets. The other test is the Cash Flow Test, a condition referred to as ‘liquidity crisis’. This states that if a person is unable to pay his or her debts as and when they arise, that person would be deemed as an insolvent. Insolvency may apply to all persons whether, real or juristic.

Cross-border insolvency is a term used to describe circumstances in which an insolvent debtor has assets and/or creditors in more than one country. Firms are increasingly organising their activities on a global scale, forming production chains including inputs that cross national boundaries. With the advent of sophisticated communications and information technology, cross-border trade is no longer the preserve only of large multi-national corporations. A cross-border insolvency matter would arise with regard to a company in the following scenarios:

A company may have dealings with parties situated in countries other than of its incorporation.
The company may own or have an interest in properties in other countries.
Liabilities may be owed to whose forensic connections with a different country than which the debtor is connected
The relevant obligations may be governed by foreign law, may have been incurred outside the debtor’s home country, or may be due to be performed abroad
The diversified state of the debtor’s activities may be such that the conditions for opening insolvency proceedings are simultaneously met with regard to more than one country, giving rise to the possibility multiple proceedings in different jurisdictions.

Given such scenarios, in the case of bankruptcy proceedings against such a company, certain difficulties arise in the adjudication of solvency of the company and if found insolvent, the consequent realisation of assets and distribution of the proceeds thereof to the various creditors and contributories.

Risks of cross-border insolvency

One of the risks that all businesses face is that of a trading partner's failure. Most domestic laws provide for the handling of an insolvent enterprise. Typically, in the case of corporate insolvency, domestic laws will prescribe procedures for:

Identifying and locating the debtors’ assets;
‘Calling in’ the assets and converting them into a monetary form;
Identifying and reversing any voidable or preference transactions which occurred prior to the administration;
Identifying creditors and the extent of their claims, including determining the appropriate priority order in which claims should be paid; and
Making distributions to creditors in accordance with the appropriate priority.

In a cross-border insolvency context, additional complexities that may arise include:

The extent to which an insolvency administrator may obtain access to assets held in a foreign country;
The priority of payments: whether local creditors may have access to local assets before funds go to the foreign administration, or whether they are to stand in line with all the foreign creditors;
Recognition of the claims of local creditors in a foreign administration;
Whether local priority rules (such as employee claims) receive similar treatment under a foreign administration;
Recognition and enforcement of local securities over local assets, where a foreign administrator is appointed; and
Application of transaction avoidance provisions.

The additional complexities surrounding cross-border insolvencies necessarily result in uncertainty, risk and ultimately costs to businesses. Given India’s place in the world economy, it is especially important to adopt policies that promote efficiency, reduce legal uncertainties and transaction costs and enhance international trading efficiency.

Cross-border insolvency exemplifies the usual characteristics of the conflict of laws process. A number of issues arise in dealing with cross-border insolvency and indeed most areas of law involving Private International Law. These are as follows:

Whether courts of a given country can legitimately exercise jurisdiction over a particular case;
If so, what law is to apply;
Either in the form of specially formulated provisions of the law of the forum in question or;
Through the operation of the choice of law process;
Whether the validity of foreign judgments may be recognised.

There are a number of theories revolving around cross-border insolvency, with an attempt to explain the operation of this area of law. One is the theory of Unity. This states that in the case of cross-border insolvency, all courts, foreign, national and local, must defer to the authority having the jurisdiction over the locale where the company is situated or incorporated. Of course, this would not apply with reference to nations governed by a treaty providing for the determination of jurisdiction of the matter at hand.

A variation of the theory of Unity occurs when a number of concurrent winding up proceedings are underway in different jurisdictions. There exists and is recognised a main proceeding, either dealing with the actual winding up process or with regard to the disbursement of assets and a number of other, ancillary proceedings related to the same matter, usually with regard to assets owned within the jurisdiction of the peripheral authorities. This is known as the principle of Plurality as opposed to that of Unity.

There is also the principle of Universality, which states that the winding up process extends not only to the assets located in the jurisdiction in which the insolvent is located or incorporated but also its assets all over the world. This is applicable to both the theories of Unity and Plurality as with the theory of Unity, along with jurisdiction over the matter, the courts also hand over jurisdiction of the properties belonging to the company in question.

Usually there are a number of conflicting claims of different jurisdictions and the alleviation of these difficulties depends upon the acknowledgement of one of the jurisdictions as the main one and the others as having an ancillary role, especially with reference to assets. Although insolvency may be described in a manner that is universally acceptable, national attitudes towards the phenomenon of insolvency vary from country to country. These variations may take the form of the manner in which insolvency proceedings may take place, or even the extent the creditor’s loss is ameliorated. There is obviously an underlying balance with the debtor’s predicament on one hand and the creditor’s loss on the other.

On 15 December 1997, the General Assembly of the United Nations passed a resolution (inter alia) recommending that all States review their legislation on cross-border aspects of insolvency to determine whether the legislation met the objectives of a modern and efficient insolvency system.

The Model Law does not attempt any substantive harmonisation of insolvency law.
More than the provisions of the Model Law, it is the annexed ‘Guide to Enactment’ that sheds light upon the nature of the Model Law and the intention of the UN. It contains detailed explanations of the Articles of the Model Law and how they may be incorporated into a municipal, pre-existing, insolvency law regime. It also contains information about the objectives, formation and feature of the Model Law. In effect, while the text of the Model Law provides for the substantial portion for the regulation of cross border insolvency, the ‘Guide to Enactment’ gives us the procedural aspects of the same.

The Model Law itself is divided into five chapters, each dealing with a different aspect of cross border insolvency. The objectives of the Model Law, as enumerated in the Preamble are as follows-

Cooperation between the courts and other competent authorities and foreign States involved in cases of cross-border insolvency,
Greater legal certainty for trade and investment,
Fair and efficient administration of cross-border insolvencies that protects the interests of all creditors and other interested persons, including the debtor,
Protection and maximization of the value of the debtor’s assets and
Facilitation of the rescue of financially troubled businesses, thereby protecting investment and preserving employment.

Therefore, the Model Law reflects practices in cross-border insolvency matters that are characteristic of modern, efficient insolvency systems. It is the collective nature of an insolvency procedure, which is the cornerstone on which the Model Law on Cross-Border Insolvency is built. Foreign insolvency proceedings will only be recognised if they fall within the definition of the term ‘foreign proceeding’ set out in article 2(a) of the Model Law. Use of the term ‘collective’ distinguishes between a regime operating for the benefit of creditors as a whole and a regime, which operates for the benefit of a particular creditor. An example of the latter is a floating charge debenture pursuant to which a secured creditor may appoint a receiver and manager over the undertaking of the debtor business.

Chapter I lays down the scope of application of the law, certain definitions and other preliminary provisions and defines the terms ‘foreign insolvency proceeding’ and ‘foreign representative’. It also differentiates between a main and non-main proceeding. Where the debtor has the centre of his main interests, the proceeding in that jurisdiction is known as the main proceeding and all other proceedings are deemed ancillary or ‘non-main’. There are certain exceptions to the application of the Model Law, such as the public policy of the enacting State and the additional assistance rendered by the pre-existing laws of the enacting State.

Chapter II provides for the access of foreign representatives and creditors in insolvency proceedings having a trans-boundary nature. It gives foreign representatives and creditors the right to apply to and participate in insolvency proceedings in much the same manner as creditors belonging to the State. If any statutory notification has to be sent to creditors belonging to the State, it is mandatory to send the same notification to foreign creditors. It also devised processes designed to recognise foreign insolvency proceedings and to give effect to them within the State in which assets were located. These processes included the ability for the courts of the States in which application was made to grant relief on the application of the foreign insolvency representative.

Chapter III provides for the recognition of foreign proceedings and associated relief. Upon an application for recognition, by a foreign office- holder, the courts of the enacting State have a discretionary power to grant interim relief to the foreign office-holder (pending the outcome of the application for recognition). If foreign insolvency proceedings are recognised (in an enacting State) as main proceedings, Article 20 of the Model Law automatically affords the following relief:

A stay over commencement or continuation of individual proceedings concerning the debtor’s assets, rights, obligations or liabilities in the enacting State in which the foreign insolvency proceedings have been recognised;
A stay over any type of execution against the debtor’s assets in the enacting State in which the foreign insolvency proceedings have been recognised; and
A suspension of the debtor’s rights to transfer, encumber or otherwise dispose of any assets.

The Enacting State in question can also impose exceptions to the above automatic relief afforded by Article 20, subject to the same being based on any such exceptions already existing in domestic insolvency law. Whether foreign proceedings are recognised as ‘main’ or ‘non-main’ proceedings, Article 21 of the Model Law confers a general discretionary power upon the Courts of the Enacting State to grant the office-holder ‘any appropriate relief’.

Another important element of the Model Law was the emphasis placed upon co-operation between courts in different jurisdictions and the insolvency representatives themselves. Chapter IV is concerned with this very issue. The whole topic of direct communication and co-operation is one on which a lengthy article or commentary could be written but it is sufficient for the present purposes of this paper to note that the Model Law has acted as an impetus to the holding of joint audio and video conferences among courts in different jurisdictions in an endeavour to deal in a pragmatic way with the difficult issues which arise in cross-border insolvency cases. In particular, these rules assist in the expeditious completion of an insolvency regime and facilitate early payment of dividends to creditors.

Articles 25-27 are intended to provide a regime for co-operation between foreign insolvency courts, and foreign office-holders. The regime for co-operation is to be put, in practice, through allowing direct communication between respective states’ Insolvency Courts, and between the Insolvency Courts of an Enacting State and a Foreign Office-Holder.
Articles 28-32 compliment the provisions for co-operation, through specific directives concerning procedures to be followed in cases where there are ‘concurrent proceedings’ under the laws of different states. These articles are intended to secure optimum co-ordination between the insolvency regimes of the states in question.

At present, only the United States of America, Canada, Australia, New Zealand, South Africa, Japan, Mexico, Poland, Romania, Serbia and Montenegro have enacted the Model Law. While India is yet to begin deliberations upon the enactment of the Model Law, certain committees have already recommended that the Model Law be enacted in full.

Both the Justice Eradi Committee as well as the N. L. Mitra Committee have recommended for the implementation of the Model Law. The Indian Law on insolvency is governed by the Presidency Town Insolvency Act, 1909 and the Provincial Insolvency Act, 1920, both of which are based on English Law. In questions of choice of law, Indian courts apply the concept of lex fori, using the law of the forum where the proceeding has been initiated. This in itself outdated, as the modern day insolvency laws provide for a regime based on lex situs, or the law of the forum where the property is situated.

However, certain provisions of the Companies Act, 1956 also throw light upon the situation of cross border insolvency laws in India. Winding up proceedings under the Companies Act, 1956 apply to two categories of companies. One, companies which are registered in India under the Companies Act, 1956 and two, companies that are not registered.

As far as the first category is concerned, Indian courts have jurisdiction to hear and adjudicate upon proceedings irrespective of the fact that the main business of the company may be carried out elsewhere. In such proceedings, Indian as well as foreign creditors can prove their debts. Even in cases of unregistered companies, winding up proceedings may be initiated under Section 584 of the Companies Act, 1956. However, such proceedings may be initiated if it had a place of business in India and in the following circumstances:

In case of recognition of foreign judgements and proceedings, however, the law is clear in India. Sections 13 and 44A of the Code of Civil Procedure provide for the treatment of foreign judgments in reciprocating countries as conclusive barring certain exceptions, such as fraud, judgment not based on merits of the case, no competent jurisdiction, etc. In spite of the existing provisions in the Companies Act and the Code of Civil Procedure, Indian laws on cross border insolvency are inadequate and need to be revamped in order to provide for a regime conducive to transnational activity in terms of investment and security.

As far as India’s stand on the Model Law goes, although recommendations have been made by both the Justice Eradi Committee as well as the N.L. Mitra Advisory Group on Bankruptcy Laws, nothing concrete has been done.

The Eradi Committee Report, taking into account the fact that globalisation of trade and opening up of the economy has taken place and with these sweeping changes, that the issues relating to cross border insolvency have become increasingly important, recommended that the Model Law be implemented in India. It called for amendment of Part VII of the Companies Act, 1956 in order to correspond to the provisions in the Model Law, in particular, those relating to in-bound requests for recognition of foreign proceedings, out-bound requests for recognition of foreign proceedings, co-ordination of proceedings in two or more States and the participation of foreign creditors in insolvency proceedings taking place in enacting States.

The N. L. Mitra Committee noted that Indian laws on cross border insolvency are outdated and that they are not comparable to any standards set in international legal requirement and as such, stands apart and alone. It also noted that in the event of an international insolvency proceeding involving an Indian company, Indian courts are unlikely to provide any aid or assistance to a foreign liquidator or other insolvency official if this were to be prejudicial to the companies’ creditors on the basis of how those creditors are or would have been treated under any equivalent Indian law insolvency proceeding.
Although insolvency may be described in a manner that is universally acceptable, national attitudes towards the phenomenon of insolvency vary from country to country. These variations may take the form of the manner in which insolvency proceedings may take place, or even the extent the creditor’s loss is ameliorated. There is obviously an underlying balance with the debtor’s predicament on one hand and the creditor’s loss on the other.

In order to have greater co-operation between courts of various states, fair and efficient administration of cross-border insolvencies that protects the interests of creditors as well as the debtor, and other objectives, the UNCITRAL Model Law on cross-border insolvency is a mammoth step forward in removing the difficulties faced in this area law so far.
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ARJYA B. MAJUMDAR is an associate with FoxMandal Little & Co. at its New Delhi office.