When an individual or organisation can no longer meet its financial obligations with its lender or lenders as debts become due. Insolvency can lead to insolvency proceedings, in which legal action will be taken against the insolvent entity, and assets may be liquidated to pay off outstanding debts.Although the Nepalese Insolvency Act, 2006 has not defined insolvency per se, it has defined ‘being insolvent’ as meaning a state of being unable, or appearing to be unable, to pay any or all of the debts due and payable to or payable in the future to creditors or a situation where the amount of liabilities ofa company exceeds the value of the assets.When an individual or organisation can no longer meet its financial obligations with its lender or lenders as debts become due. Insolvency can lead to insolvency proceedings, in which legal action will be taken against the insolvent entity, and assets may be liquidated to pay off outstanding debts.Although the Nepalese Insolvency Act, 2006 has not defined insolvency per se, it has defined ‘being insolvent’ as meaning a state of being unable, or appearing to be unable, to pay any or all of the debts due and payable to or payable in the future to creditors or a situation where the amount of liabilities of a company exceeds the value of the assets.
In other words, Insolvency in its own right is simply a word used in the ‘trade’ to refer to a situation where a company is unable to pay its debts.
The history of Insolvency Law goes back to a statute of Henry VIII in 1542.With regard to the Nepali perspective, the concept of insolvency law in Nepal began with the personal bankruptcy law, which was introduced in 1853 and was governed by the Chapter on Bankruptcy (Damasahi Ko Mahal) of the Muluki Ain (the Country Code). However, there have never been any reported cases of personal bankruptcy.
Prior to the commencement of the Insolvency Act 2006, laws relating to insolvency were scattered across relevant wider acts in each area. For instance, the insolvency of government corporations were governed by their respective acts of incorporation even though, in some cases, the liquidation of some government-owned autonomous business entities were not defined.The Banks and Financial Institution Ordinance 2005 governed insolvency of commercial banks. Liquidation of companies with limited liability was governed by the Companies Act 1997, which covered both voluntary and involuntary liquidation but lacked detailed provisions. The PartnershipAct 1963 dealt with the dissolution and insolvency of partnership firms.
However, over time the limitations of that regime were recognised as cases of insolvency emerged with the expansion of the corporate culture.
Some of the difficulties the creditors needed to initiate liquidation proceeding included;
1. Only creditors representing a minimum of 50% of the total outstanding dues could apply
2. Very lengthy process
3. Liquidation could only be filed after one year of the outstanding due not being paid
4. Individual shareholders could not initiate proceedings
5. No mechanism existed to look after the insolvency process
6. Lacked any provisions for re-organisation.
7. Anyone can be the liquidator
Furthermore, the Company Registrar was responsible for handling all administrative matters relating to Insolvency law in Nepal. However, this proved to inefficient with the Registrar already over burdened with managing companies as well as lacking the necessary skills and manpower to fulfill this role.
To counteract the drawbacks of the old Regime, the Government of Nepal promulgated the Insolvency Act on November 20, 2006 with the following objectives
a. To have proceedings of companies which are insolvent or going to be insolvent
b. To make provisions restructuring of the companies which were insolvent
Thus, the Act is based on the principle of ‘one law, two systems’ as it covers both the law of liquidation and the law of rescue/restructuring.
The prevailing Insolvency Act (IA) covers all typesof companies incorporated under the prevailing company laws of Nepal as well as any corporate body having limited liability (s. 2(a) and s. 4). However, no application may be made to the Court for insolvency proceedings in relation to the following company without obtaining prior approval of the following authority (s. 8 IA):
In the case of a bank or financial institution carrying on banking and financial business, the Nepal Rastra Bank, or
In the case of an insurance company carrying on insurance business, the Insurance Board formed pursuant to the Insurance Act 1992, or
In the case of a company which cannot undergo voluntary liquidation without approval of the competent body or authority, except Bank and Financial Institution or Insurance Business.
The Act has tried to resolve the drawbacks of the insolvency culture of the Nepalese corporate environment introducing restructuring the insolvent companies.
Major features of the Insolvency Act 2006
a. Liberalised Application Procedure
Under the Act, 10% of the creditor(s) who have lent the money, or 5% of the total shareholders of the company, or 5% of the debenture holders can initiate insolvency proceedings. Previously it was a minimum of 50% of the total outstanding dues, which is why investors or lenders were always at risk; it is expected thatthese provisions will help root out insolvent companies from the market as well as encourage business innovation and stimulate the economy.
b. Commencing insolvency proceedings
Prior to the enactment of the IA 2006 there was no mechanism to look after or supervise the insolvency proceeding, however section 3 of the act provides that no proceeding can be initiated without the order of the court.
c. Restructuring Scheme
The Act recognises both liquidation and restructuring. In addition, it provides for liquidation subsequent to restructuring if the restructuring fails or a change from a restructuring procedure to a liquidation procedure if it is found appropriate. The restructuring proposal prepared by the restructuring manager requires the approval of the court for its implementation. Once approved by the court, it is binding on all creditors, directors and shareholders. However, it does not bind secured creditors unless they have agreed to the program. Nor are the lessors and the owners of property used by the company bound by the restricting program ordered by the court. But, the court can issue orders to secured creditors, the lessor and owners of the property used by the company, if it is proved that the restructuring program will fail if the secured creditors or lessor of the property enforce their security or take back the leased property. However, the court shall require an assurance that the rights of secured creditors and lessor are properly protected under the restructuring scheme.
d. Insolvency and Restructuring System
Insolvency is one of the steps to liquidate the Company formally, which the old regime had not recognised therefore many challenges needed to be tackled in the past. However the Act has made the provision to appoint the Liquidator to insolvent company so that company and related persons need not receive any kind of prejudice. Similarly, liquidator may make necessary motion to restructure the company if deemed possible.
Any person who wants to work as the inquiry officer, restructuring manager or liquidator in the course of carrying out insolvency proceedings under the prevailing Act has to obtain license from the Insolvency Administration Office. S/he must be of minimum age 35 years, should be a member of the prescribed professional body, and should have degrees in commercial law, business studies,management or any other prescribed subjects from a recognised university.
e. Insolvency Administration Office
While liquidating the company it is very important to regulate the procedure and to safeguard the file and documents prepared by the insolvency professionals. Before promulgation of the Act there were no supervising and regulatory body to look after the procedures and documents prepared for the purpose of the insolvency. The Act has now provided that by notification in the Nepal Gazette the Insolvency Administration Office may be established to perform the following functions;
1. To administer insolvency practice,
2. To register insolvency practitioners, issue licenses to them, and renew such licenses,
3. To carry out general supervision of the management of companies which have become insolvent,
4. To conduct investigations of the code of office required to be observed by insolvency practitioners,
5. To maintain records of each company which has become insolvent, and
6. To perform such other functions as prescribed.This Office aims to inspect the progress of the insolvency and more importantly restructuring progress.
f. Securing the property of the company
Considering the interest or base of the principle of no harm on second parties of the company such as creditor or any other persons who has interest on/in the transactions of the company or even to secure the good management of the company, by the order of the court companies are obliged to do or not to do certain works. And if deemed necessary the court may issue an order to appoint any appropriate person as the Interim Administrator of the company for the management of the company for the duration of the interim order.
The rationale behind setting the forth issue interim order is to prevent loss or damage of the entire related persons of the company.
The Insolvency Act 2006 has certainly concretised the issues in relation to Corporate Insolvency, its procedure and mechanisms to supervise the process. However, the basic pre-requisites of an effective insolvency regime, such as a commercial bench and qualified insolvent practitioners are insufficient. Nevertheless the commercial bench has been established but its implication is not found so well, Furthermore, the minimum requirement to gain a license to practice insolvency administration is very low. The Act has not recognised the necessity of experience as a qualifying factor to be an insolvency practitioner. Similarly, the law curriculums of Nepali universities do not cover insolvency law in much depth, if at all. Meanwhile, the act deems graduates of commerce, management accounts or any other prescribed subjects as qualified to be an insolvency practitioner. Therefore, it is necessary that these seminars and trainings are facilitated by concerned organisations for the benefit of these individuals. These can be based on long established insolvency laws of foreign countries to accelerate the development of this area in Nepalese law.
Worse still though, is that almost five years of promulgation of the IA 2006, the Government of Nepal, pursuant to section 65 of the Act, has not established the Office of Insolvency Administration. The negative effects not doing this could be grave. Further, commercial benches have not been established in all courts. Thus, it is of utmost importance that government and political commitments are fulfilled so as to develop the insolvency law and its practice as expected. One of the object as indicated in the preamble of the Act is to restructure any company which is going to be a insolvent, despite the fact that the Act has not provided any ground of restructuring. However, courts have authority to judge on the proposed programs laid down for the restructuring the company.
Hence, despite its shortfalls, the Act has tried to overrule the old regime of insolvency environment in the corporate sector. The Act has highly emphasised the role of the court to provide justice to the parties affected by an insolvent entity.
Shikhar Pandit is a Cardiff University graduate who is currently a Managing Associate at Gandhi and Associates, a leading corporate law firm. He can be contacted via email@example.com