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Dear Nenova,

By Jill Stephens,2014-01-14 04:33
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Dear Nenova,

    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 Law-

    Tribhuvan 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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