INSOLVENCY IN NEPAL
Bharat Upreti, Nepal
l. Background Information
(a)
Nepal has adopted multi party democracy since 1990 and introduced market-based
economy after the restoration of democracy. Historically, trade business was
dominated by a certain community in Nepal's multi ethnic society. Most people were
unaware of the modern trading system. However, the local market was opened for
foreign investment in early 90's. Policies are frame with the objective of attracting
foreign investment. State is moving towards opening market for private sector and as
a result, the process of privatization is moving on a slow pace. This has helped to
increase the competition, in otherwise uncompetitive market. The consumers are
becoming more conscious about their choice and rights. Hotel, Trekking, Banking,
Education, and Information Technology has attracted more investment as compared
with other fields. The growing size of small and medium scale industries also shows
the culture of investment evolving in the country. Furthermore, Nepal is also
preparing its accession to World Trade Organization (WTO). Thus, legal and
economic environment is developing to meet the minimum standard of the WTO.
(b)
Insolvency practice is not very common for Nepal. Existing laws only deal with the
liquidation of insolvent company. Judiciary has no jurisdictions over the matter of
insolvency. However, a separate Insolvency Act is in the making to overcome issues
relating to insolvency.
2.Structure of Business Organizations
(a)
The most common form of business organizations in Nepal are Companies,
Partnerships, Cooperatives and Private firms. Most of them are medium sizes and
majority of them are private owned. Most of the large business houses are family
owned. Most of the public companies listed in the security market are banks, financial
institutions and hotels. In addition to this there exist a large number of state owned
enterprises operating in various fields like airlines service, trading of oil and other
essentials commodities and other production activities like sugar, cigarette, milk
products etc.
(b)
Under the existing laws business enterprises should keep their account under double
entry book keeping system. The companies incorporated under the companies Act
should also appoint an independent auditor. Generally, this provision is also extended
to the companies which are established under other Acts for example commercial
banks etc. So far the regulatory body is concerned, the Office of the Company
Registrar is empowered to supervise the companies incorporated under the Company
Act, whereas Central Bank (Nepal Rastra Bank) is authorized to supervise and
monitor the liquidation of the banking and financial companies.
(c)
The concept of corporate governance has been gradually developing in the corporate
sector. The Central Bank has also issued directions applicable to the Banks aiming to
strengthen corporate governance. The existing Company Act 1997 also provides for
disclosure and reporting requirement to bring transparency. However, the existing
laws are not adequate. In practice corporate governance is not visible and the
management of the companies are not committed to the good practice of corporate
governance in general.
3. Nature of Financing for Business Organization
(a)
Promoters, Shareholders, Bankers and Financial institutions are the main sources of
financing for these organizations. The equity and loan are the usual types of finance.
The law is silent on the specific issues such as duration of financing, usual parties and
the types of expenditure usually funded. In practice, the financial institutions provide
for both long term and short term finances. Several Acts i.e. Nepal Rastra Bank Act
2001, Commercial Bank Act 1974, Companies Act 1997 etc. deals with the
financing of organizations.
(b)
There is not a clear demarcation whether bank lending is based on the cash flow or
asset lending. It depends on the satisfaction of the lender bank based on reputation of
the borrower and the quality of collateral. Generally, banks have adopted asset
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lending in practice. Nepal Rastra Bank (The Central Bank of the Country) is
empowered to monitor and supervise commercial banks and is authorized to give
instruction. Likewise, commercial banks are also empowered to examine whether the
loan granted by them is utilized for the same purpose for which it has been granted.
Most of the business organizations prefer loan as a source of finance as compared to
equity. This is because the equity is not applicable to all organizations. For example
the equity is a source of finance only to the public limited companies. Moreover,
equity financing may change the management composition of the company and
creates several rights to the equity holder, which may not be desirable to the
management.
4. Secured Creditors
(a) Existing law has recognized various forms of securities such guarantees issued by
His Majesty Government of Nepal, guarantees issued by foreign government,
securities on immovable assets, securities on movable property, securities on equity,
debenture, negotiable instruments and personal guarantee etc. However securities of
immovable assets i.e. Land, Buildings etc are most commonly employed in practice.
The securities of immovable assets should be registered with the Land Revenue
Office after its creation. The law is silent regarding priorities between the competing
types of securities.
(b) If the security holder violates the contract or fails to make payment within time or
utilize the loan for the purpose other than it has been granted for the bank can recover
its debts by “self help power” granted to it by the Commercial Bank Act 1974 i.e. by
selling the assets held as security. There is no requirement for a court order. If the
market value of the assets held in security decreases, the bank can demand other
additional assets to hold as security for the same loan. If the assets held in security
can not cover the whole debts of the bank it can be recovered by selling other assets
of the debtor even though those assets were not part of the security. Hence, the law
provides for effective means for the enforcement of secured rights and overly
protects the rights of the secured creditors. The existing law has failed to strike a
proper balance between the interests of debtor and secured creditor.
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(c) So far as the efficacy of the legal system is concerned there are several Acts dealing
with the issues of money lending and transactions. Banking Acts have extensively
protected the interests of secured creditors. Likewise Country Code 1963 and the
Contract Act 1999 protect the interests of individual secured creditors. In addition
Parliament has also enacted the Loan Recovery of Bank Act 2002 dealing with the
recovery of bank loan. However, the said Act is not yet in force.
(d) The law is silent on the matter of enforcement of the creditor rights against security
when the corporate debtor is in financial difficulty. In practice the secured creditors
often enforce the security if the corporate debtor is unable to pay its debts. However,
in case of reputed corporate houses, the banks do negotiate suitable financial
arrangement. This is very rare in practice.
5. Unsecured Creditors
Unsecured creditors and non-banking secured creditors do not have power to recover
their debts using “self help”, though they can file a claim for the recovery of their
debts. The unsecured creditors are not well protected as in the case of secured
creditors. The only way the unsecured creditors can enforce their right is through the
help of the courts. In Nepal, there is no culture of negotiating a suitable financial
arrangement and creditors tend to enforce there right at the first instance.
6. Overall Insolvency Law Regime
(a) Different Acts govern the insolvency of different enterprises. There are separate laws
dealing with the insolvency of natural and juristic persons. Under the existing law,
there is no system of restructuring or reorganization of the financially ailing
companies. The Country Code 1963 regulates the insolvency of a natural person.
Companies Act 1997 provides the liquidation of the companies incorporated under the
Act. Similarly, the Commercial Bank Act governs the liquidation of the banking
companies and Corporation Act regulates the liquidation of State Own Enterprises
(SOEs). The SOEs established under the Corporation Act 1964 have unlimited
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liability and can be dissolved by publishing a notice by the government in Nepal
Gazette. Thereafter all the rights and liabilities of such SOEs transfers to the
government.
(b) The main legislation governing insolvency of companies is Companies Act 1997. The
Act however does not provide for detail provision and only way out for financially
ailing companies is dissolution rather than restructure.
(c) The insolvency practice in Nepal is not very common and the practice is still at
developing stage. The economy of Nepal never required for such practice. Therefore
it is difficult to have statistics of insolvency in the country. Courts have no
jurisdictions to be involved in the matter of insolvency and the individual insolvency
professionalism has not yet been developed. The Office of the Company Registrar is
the sole authority to regulate the issues of liquidation. The office is empowered to
initiate the procedure, to receive the application, to hear the petition against the
application and to give order of liquidation. It appoints the liquidator and auditor
where it decides to liquidate the company.
7.Liquidation and Formal (Court-Based) Restructuring
(a) The creditors representing at least 50 percent of the outstanding loan can apply to the
Office of Company Registrar for the liquidation of defaulting company. The law is
silent on the time frame about the liquidation process and there is not any set
practice in this regard. Liquidator is empowered to certify the validity of the claim
by various creditors. It is not possible to determine what percentage of the debts do
creditors generally recover because liquidation is not very common in our context.
(b) The director of the company or the applicant can challenge the order issued by the
Office before the Court of Appeal within thirty days from the date of issue of the
order.
(c) After the order of liquidation is issued by the Office the right of the directors to act
as such ceases from that date. The directors and officers of the company are liable to
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the fraudulent and wrongful trading but the law does not impose any criminal
liabilities. The law is silent on the right of the secured creditors on the secured assets
after the liquidation order is issued. Generally, once the order of liquidation is passed
the liquidator is entitled to take all the assets of the company in his custody. The
priority of claim is provided by the law and no change can be made on that priority.
This provision is also applicable to the unsecured creditors as well. The law is also
silent on status of workers after the order issued.
8.
Evaluation of the existing laws.
The Insolvency regime in Nepal is still at its infancy stage. The laws are scattered in
various Legislation. The Country Code 1963, Company Act 1997, Corporation Act
1964, Commercial Banks Act 1974 are the main legislation in this regard. The
insolvency of natural person and legal person are covered by different legislation. The
insolvency of natural person is very rare.
The insolvency of legal person is part of the Company Act 1997. This is also not very
effective in practice. This is due to mainly, (i) law is defective and incomplete, (ii)
poor enforcement of the corporate laws. The process of winding up of the company
are not normally undertaken and the company is left as it is without legally putting it
to end. The regulators fail to take action on these matters, (iv) there are not any set
institutional mechanisms to oversee the insolvency process and there is lack of
professionals to conduct insolvency process fairly and efficiently.
Insolvency regime focuses on cash adequacy/liquidity test. The liquidation proceeding
can normally be initiated by the creditors representing 50 % of the outstanding dues.
However, in practice this is rarely done. This may be because most of the loan are
secured and institutional creditors ( commercial banks) are over protected under the
existing law. The existing law is not developed in equitable basis and fails to strike a
proper balance between the interest of the debtors and the secured creditors.
Under existing laws, there is no provision for restructuring as means of rehabilitating
the financially ailing companies.
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To over come these issues, the government has drafted the Insolvency Bill 2002.
8.
Salient features of Insolvency Bill 2002:
8.1
The Insolvency Bill 2002 has recently been drafted. The Bill aims to
overcome the shortcoming of the insolvency procedure in the existing laws.
Under the Bill the order of Court of Appeal is required for initiating
liquidation procedure and provides the details procedure. The Bill has
departed from existing law regarding to application for liquidation for example
by creditors holding 5% debt, shareholders holding minimum of 5% of total
shareholdings, debenture holders holding minimum of 5% of debentures can
initiate liquidation process. It incorporates the provision for the publication of
the notice, at least twice in a national newspaper, of the notice given by the
liquidator to the creditors to submit their claim. The notice gives 15 days for
the submission of the claim.
8.2
The Bill also contains the provision for review of insolvency proceedings by
the order of Court of Appeal. The Bill has incorporated both, balance sheet
and liquidity for financial distress test.
8.3
The Bill also contains the provision for the restructure of the company which
has become insolvent, if it is possible to operate the company commercially by
restructuring the capital, capitalizing the liability, fulfilling liabilities by
selling any part of the assets, by merger or changing the management of the
company.
8.4
Significant changes have been made regarding to the priority of payment. The
Bill also provides for establishment of Insolvency Administration Office
which shall be responsible for administration of the insolvency practice, issue
or renew licenses of insolvency practitioner etc. There is also a mandatory
provision for obtaining license of insolvency practitioner and their
qualification is also provided by the Bill.
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8.5
As per the provisions of the Bill, the employees are automatically terminated
from the service after liquidation order, except otherwise decided by the
liquidator. The Bill also incorporates the provision for the adjustment of the
debt.
The preferential transaction made before or within six months of
initiation of insolvency proceeding is void. The preferential transaction made
between the company and related persons like directors, their children spouse,
shareholders etc before or within one year after initiation of liquidation
proceeding is also void. The Bill also contains the provision for the removal of
a liquidator on proved failure to properly carry out the functions entrusted to
him.
8.6
To sum up, the Bill goes much further than the existing laws. At least it gives
an alternative for restructure of the financially week companies rather than the
sole option of liquidation as under the existing law.
8.7
The Bill is expected to be passed by the Parliament within a year. Therefore
the picture of insolvency law of Nepal, in one year’s time, will be totally
different.
Bharat Upreti
Mr. Upreti is a founding and senior partner of Pioneer Law Associates, Kathmandu,
Nepal practicing in banking, insurance and other commercial matters. He is actively
involved in developing Insolvency law in Nepal. He was involved in drafting of
Nepal’s first Insolvency Bill and Secured Transaction Bill. He has written books on
Contract and Company laws. He is also an editor of the book on Constitutional Law
of Nepal. He retired as an Associate Professor after having taught at Faculty of LawTribhuvan University for 20 years.
He is the council member of Nepal Bar Council, regulatory authority of legal
profession of Nepal and also a Vice-President of Saarclaw. He is a life member of
Law Asia and member of International Bar Association.
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