Industrial Sickness - Management of Small Business

Industrial Sickness

DEFINITION

BY SICK INDUSTRIAL COMPANIES(SPECIAL PROVISIONS) ACT, 1985, SEC 3(1) (0)

“Industrial company(being a company registered for not less than five years) which has at the end of any financial year accumulated loss equal to or exceeding its entire net worth and which has also suffered cash losses in such a financial year immediately preceding such financial year”.

BY THE COMPANIES(SECOND AMENDMENT) ACT, 2002

Defines a sick company as one:

Which has accumulated losses in any financial year to 50 percent or more of its average net worth during four years immediately preceding the financial year in question, or

Which has failed to repay its debts within any three consecutive quarters on demand for repayment by its creditors.

STAGES OF INDUSTRIALSICKNESS

CRITERIA TO IDENTIFY INDUSTRIAL SICKNESS

Continuous decline in gross output compared to the previous two financial years. Delays in repayment of institutional loan, for more than 12 months.

Erosion in the net worth to the extent of 50 percent of the net worth during the previous accounting year.

SIGNALS OF INDUSTRIAL SICKNESS

Decline In Capacity Utilization Shortage Of Liquid Funds

Inventories In Excessive Quantities

Irregularity In Maintaining The Bank Accounts Frequent Break Downs In Plant & Equipments Decline In The Quality Of Products

Frequent Turnover Of Personnel Technical Deficiency

EXTERNAL CAUSES

Improper Credit Facilities

Delay In Advancing Of Funds

Unfavourable Investment Climate Shortage Of Inputs

Import Restrictions On Essential Inputs

Liberal Licensing Of Projects

Change In International Marketing Scene Excessive Taxation Policy Of Government Market Recession

INTERNAL CAUSES

(FINANCIAL CONSTRAINTS)

Inappropriate Financial Structure Poor Utilization Of Assets

Inefficient Working Capital Management Lack Of Proper Costing And Pricing

Absence Of Financing, Planning & Budgeting Improper Utilization Or Diversion Of Funds

Consequences

Huge financial losses to the banks & financial institutions Loss to employment opportunities

Emergence of industrial unrest

Adverse effect on perspective investors and entrepreneurs

Wastages of scarce resources Loss of revenue to government

Governmental measures to combat industrial sickness

The Industrial Finance Corporation of India (IFCI) in 1948 - to provide medium & long-term credits to the public sector limited companies in order to facilitate post-war rehabilitation & development.

2. The State Financial Corporations (SFC) were established at state level in 1951 to supplement the work of

IFCI by financing medium and small-scale industrial concerns.

3. Industrial Reconstruction Corporation of India or (IRCI) was set up with its head quarters at Calcutta in 1971

•         to revive and revitalise the closed and sick industrial concerns by removing the shortcomings.

•         to reconstruct and restructure the financial base as well as the management of the assisted units, besides providing financial assistance and technical/managerial guidance.

The control measures adopted by IRCI included :

i.           transfer of major shares in the name of IRCI;

ii.           appointment of IRCI nominees in the Board of Directors of the sick unit;

iii.          appointment of personnel and nominees in key managerial post and purchase/sales committees;

iv.            frequent plant and factory inspections and so on.

4. Industries (Development & Regulation) Act, 1951 was further amended in 1971 -empowering the Central Government to take over industrial undertakings which special emphasis on sick units.

5. By Amendments in the relevant Act the IFCI with effect from 1972 was empowered to extend its assistance to Pvt Ltd Cos.

6 Foreign Exchange Regulation Act (FERA) 1973 – limited the share of foreign companies to 40% of the total capital.

Governmental measures to combat industrial sickness

7.  The Reserve Bank of India set up Tandon Committee, in 1975- guideline was laid down governing the participation of banks in the management of various sick industries.

8. The RBI in 1979 conducted a study to identify the causes of sickness in 378 such large industrial units

9. Further the government came up with several industrial policies in order to revive the sick units

These policies were:

i.           Soft loan scheme-

•         introduced in 1976 to provide financial assistance to five selected industries (jute, cotton, cement, textile and sugar) on concessional terms for modernization & rehabilitation of their old machineries.

•         Was Being operated by the IDBI in collaboration with IFCI & ICICI.

•         In 1984 this scheme was modified into soft loan scheme for modernization –all categories of industries are eligible for financial assistance for up gradation of process/technologies/product, export orientation/import substitution,energy saving, anti-pollution measures and improvement in productivity.

ii.           Merger policy of 1977 –

•         For merger of sick units with the healthy ones

•         Healthy was allowed to carry forward and set off the accumulated losses & unabsorbed depreciation of the sick unit against its own tax incidence.

•         Sick units to be eligible for merger should have >100 employees & assets worth >50 lakh. Governmental measures to combat industrial sickness

iii.          Policy guidelines on sick units-1978

•         Made it clear that financial institutes should involve themselves in the management of the sick units in which they have substantial stake by setting up group of professional directors to look after the management of these units.

•   These directors will be nominated to the board of the sick units and they will be required to report to the financial institutes regularly regarding the various measures required to be incorporated.

•   Further the respective state government in collaboration with the financial institutes should provide financial & managerial assistance for the restructuring and rehabilitation of the sick units.

iv.              New strategy 1981-

•         Aimed at preventing industrial sickness, quick rehabilitation, & early decisions on the future of such units.

•         Units employing >1000employees of having an investment of 9 crore or more should be nationalised if

The line of production is critical to the nation‟s economy

Its a mother unit with large ancillaries

Its closure would cause dislocation and unemployment of such a large number of people that allocation of alternative jobs is not possible.

v. Different committees and industrial sickness-

Government has from time to time formulated several committees like the Standing Committee On Industrial Sickness, State Level Inter-Institutional Committee, Guidance Committee & others to examine the problems of growing industrial Sickness

vi. Legal framework-

Various provisions for the revival of the sick industries were introduced like The Relief Undertaking Act,

Sec 72(a) Of The Income Tax Act, IRBI Act Of 1984,SICA 1985, and others.

The important provisions of SICA were:-

It provided for the constitution of two quasi-judicial bodies, that is, Board for Industrial and Financial Reconstruction (BIFR) and Appellate Authority for Industrial and Financial Reconstruction (AAIFR).

BIFR was set up as an apex board to tackle industrial sickness and was entrusted with the work of taking appropriate measures for revival and rehabilitation of potentially sick undertakings

and for liquidation of non-viable companies.

AAIFR was constituted for hearing the appeals against the orders of the BIFR.

BIFR would make an inquiry as it may deem fit for determining whether any industrial company had become sick.

BIFR may appoint one or more persons as special director(s) of the company for safeguarding the financial and other interests of the company.

The measures include:-

     The financial reconstruction

The proper management by change in or take over of the management of the company; The amalgamation of the sick industrial

The sale or lease of a part or whole of the sick industrial company;

Such other preventive, ameliorative and remedial measures as may be appropriate;

Such incidental, consequential or supplemental measures as may be necessary or expedient in connection with or for the purposes of the measures specified above.

The important provisions of SICA were:-

Under the Act, whosoever violates its provisions or any scheme or any order of the Board or of the Appellate Authority, shall be punishable with imprisonment for a term which may extend to three years and shall also be liable to a fine.

Sick Industrial Companies (Special Provisions) Act,1985 (SICA) was repealed and replaced by Sick Industrial Companies (Special Provisions) Repeal Act,2003.

The new Act diluted some of the provisions of SICA & aimed to combat industrial sickness ,reduce the same by ensuring that companies do not view declaration of sickness as an escapist route from legal provisions after the failure of the project or similar other reasons and thereby gain access to various benefits or concessions from financial institutions.

Under it, the Board for Industrial and Financial Reconstruction (BIFR) and Appellate Authority for Industrial and Financial Reconstruction (AAIFR) were dissolved and replaced by National Company Law Tribunal (NCLT) and National Law Appellate Tribunal (NCLAT) respectively.

RBI guide lines…

•         RBI has constituted a standing coordination committee to consider issues relating to coordination between commercial banks and lending institutions.

•         A special cell has been set up within the rehabilitation finance division of IDBI to attend the case of sickness.

•         RBI has issued suitable guidelines to the banks to ensure the potentially viable sick units receive attention and timely support from banks.

•         RBI has clarified that units becoming sick on account of wilful mis-management, wilful

default should not be considered for rehabilitation.

Rehabilitation Programme:

a)     Change management

b)    Development of a suitable management information system

c)     A settlement with the creditors for payment of their dues in a phased manner, taking into account the expected cash generation as per viability study

d)    Determination of the sources of additional funds needed to refinance.

e)     Modernization of plant and equipment or expansion of an existing programme or even diversification of the products being manufactured.

f)      Concession or reliefs or assistance to be allowed by the state level corporation ,financial institutions and central government.

RECOMMENDATIONS:

I.           A Financial reorganisation may involve some sacrifices by the creditors and shareholders of the undertaking which can be in several forms:-

1.                   Reduction of the par value of shares.

2.                   Reduction in rates of interest.

3.                   Postponement of maturity of debt.

4.                   Conversion of debt into equity.

5.                   Change in the nature of claim or obligation such as from secured to unsecured.

6.                   Concession by the Government in the form of reduction or waiving of indirect taxes, electricity dues etc.

II.           Monitoring and nursing the sick units during infancy

III.          Incentives should be provided to professional managers helping in reviving sick units

IV.   Issuing guidelines on major aspects that affect the image of the company

V.          Brain storm with a select group to get creative ideas for improvement

VI. Adopt better practices, right technology, better work culture and professional management so that the sick industries can improve their health as well as the economy.