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Directors and the Twilight Zone

Info: 2019 words (8 pages) Essay
Published: 6th Aug 2019

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Jurisdiction / Tag(s): Indian law

Corporate governance is nothing but supervision of the management of a company and managing the risks arising there from so as to carry out business in a competent manner with due regard to the interests of stakeholders. Given the current unstable financial environment, corporate governance issues are particularly prominent for directors of a company if they are to strike a balance with existing competing interests.

Discipline, accountability and transparency all three are essentials for good governance, which assume greater importance in the Twilight zone. [1] Twilight zone is considered to be the duration between the point where there is no possibility of avoiding liquidation of a company due to insolvency and the commencement of insolvency procedures. [2]

The Twilight zone has serious implications in the business world, it is this zone from which the companies may either emerge or perish. Twilight zone is concerned primarily with insolvency; which in turn is a state of affairs in a company wherein the company is faced with financial hardships and is therefore unable to carry out its activities efficiently. If insolvency remains unaddressed in the Twilight zone, then bankruptcy acts as the legal option for companies. Debt management, reconstruction act as alternatives to bankruptcy procedure in today’s time and age and are often resorted to by companies in developed and developing economies.

Twilight zone is a duration when the company may have become a sick one and may have been registered with the Board of Industrial and Financial Reconstruction (BIFR), or a company against which a winding up petition may have been filed, therefore in both these situations the company is in a condition wherein it is unable to pay its debts.

Corporate Governance calls for sickness in a company to be recognized at the earliest. In India it is often seen that the Board of directors is not keen to accept that the company’s sickness, and this delay in acknowledgement of the company’s situation poses a great threat to the already pitiable condition of the company. Therefore it is required that the condition be reported as soon as detected because, as time passes, the revival procedure becomes even more long drawn and complicated.

The duties of directors of the company may stand to be affected as a result of uncertainty involved regarding the company’s financial conditions. Although the duties of a director are in relation to the company, and shareholders as a whole, during the Twilight zone the directors are under a duty to protect the interests of the creditors prior to that of the shareholders. So in essence the twilight zone leads to a shift in duty of the directors from the shareholders to the creditors. [3]

Special attention is given to creditors at this stage because only if the interests of the creditors are secured will the financial institutions be willing to lend money to the company. The directors are also under a duty to ensure that the company does not incur any debts during this period. Simultaneously, efforts are also directed towards rehabilitation and revival of the company for the benefit of the economy as a whole. However in the event of failure in revival efforts the liquidation process is given a green signal, so as to retrieve the maximum from assets in order to pay off the creditors. Among other things Twilight zone deals with striking a balance with competing interests such as recovery, reconstruction and liquidation.

Directors of the company should avoid incurring liabilities, they should avoid disposing the asset of the company at a value lesser than that prevalent in the market, or preferring one creditor over another. [4] It is important to note that lack of awareness regarding the insolvency situation of the company is no defense and a director is reasonably expected to have known. [5]

The Companies Act requires the directors of a company in liquidation to co-operate with the liquidators and realize the assets of the company and further redistribute it to the creditors and other stakeholders of the company.

However a matter of debate is; should the directors of a company be under any special duty during the Twilight zone, as they are already considered to be under a continuing, ongoing obligation starting from the time they joined the Board of Directors. So the question that arises is, is there really a need for bringing about greater responsibility upon the directors in the Twilight zone.

It appears as though the above seems to have been settled after the Dr. J. J. Irani Committee Report which clarified as to when the reporting should be made, and what should be the duty of directors in such circumstances. [6]

In the event of it appearing that a particular transaction has been carried out with an intention to defraud the creditors of the company, or for other such purposes, the Court, on application of the Official Liquidator, or the liquidator or any creditor of the company, may opine that any persons who were party to such malafide transaction shall be held liable for all or any of the debts of the company as the Court may ascertain.

Attempting to examine duties of the directors in the Twilight zone, there should be a duty to disclose one’s interest in a proposed transaction because an interested party contract is a transaction deemed bad in law. It is important to note that the directors should not be made completely risk averse in the Twilight zone, and at the same time a balance is required to be struck wherein the director is not reckless in his decisions.

A pressing concern in this context is a situation wherein there are creditor directors and also shareholder creditors on the board of a company, what then is the solution, as there is a prima facie conflict of interest. The matter remains unsettled even though, as there is no judgment in this regard.

The Indian legal system approaches the liability of the directors and other officers at the time of insolvency, by giving a specialized governmental agency known as National Company Law Tribunal (NCLT) the power to examine the affairs of the company and or formulate a plan for the company’s rehabilitation and revival, or issue a liquidation order. The NCLT may invoke liability of directors in the cases of fraud on creditors [7] and, or disposal of corporate assets.

Another matter of international debate is regarding the manner in which the Twilight issue is to be dealt with, the Indian legislations dealing with the same are the Companies Act 1956 and the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act). However it is important to note that the NCLT has maximum powers to deal with such companies, and has within it the authority of both the High Courts as also the Company Law Board. [8] The NCLT has the authority to inquire into the financial soundness of a company and its future expected growth or strength, moreover the government by way of the NCLT has been given a pivotal role in the management of insolvency procedures of companies in India.

As is the case in the United States in the context of a Chapter 11 ‘going concern’, the Board of Directors of an Indian company may exercise the option of rehabilitation and revival of the company. [9] However the procedure applicable is specific to India, wherein the auditors of the company are required to provide a statement in support of the Board’s decision in the vent of the Board opting to rehabilitate and revive the company. After the proposal of a rehabilitation plan the NCLT is required to issue an order placing a scheme for rehabilitation. However approval of such a scheme requires the consent of all parties providing financial assistance to the company within a specified period. Under the Indian legal system, several rounds of formulating rehabilitation plans are permitted, this procedure places utmost power with respect to the company’s future, in the hands of those who are funding the activities of the company. [10]

The SARFAESI Act’s self help measures empowers creditors to foreclose their investments in a company in the absence of judicial intervention may have certain adverse effects as was seen in the case of Vinedale Distilleries Ltd. And Another v. Dena Bank [11] The Court in the said matter took pro bank decision, wherein the facts started from a time period before enactment of the SARFAESI Act and continued till after the commencement of the Act. The Court was of the opinion that the company was in the process of rehabilitation when its creditors decided to enforce its security interests. This dimension of the Act, gives rise to conflicts between creditors, other stakeholders and equity investors of a company; moreover this imbalance finds the directors of the company in a rather uncomfortable situation. It seems that the Act is unable to provide over all effective rehabilitation or recourse of the required nature and the situation needs revised concentration.

It is important to note that the Sick Industrial Companies Act already prescribes for duties under sections 15 and 17(2). It encapsulates that in situations if after the company’s duly audited accounts, it is found that there is potential sickness, the same is required to be reported and also a rehabilitation and revival plans is to be formulated. Further the Act lays down procedures as to the appointment of a special director to take care of the petitioned creditor or any other person who may have filed the sickness application.

In light of the aforementioned it is important to state what the legal system has touched upon and the issues that still remain to be addressed in the context of directors and the Twilight zone, the debate at the forefront in most jurisdictions deals with questions such as, whether the first signs of insolvency should have a freezing effect on the directors or whether they should attempt to accelerate the business of the company so as to attempt to bring it out of potential insolvency; or when exactly should there be a shift in the duties of the directors.

Further what may be advisable for a particular kind of company may not be favourable for another; therefore the duties and role of directors differ with respect to the kind of company in the Twilight zone.

In conclusion it is important to state that very high expectations are pinned on the Companies Bill, for it provides for a Corporate Rehabilitation Fund, based on the UNICTRAL Trade Law Model.

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