The Corporate & Commercial Law Society Blog, HNLU

Author: HNLU CCLS

  • PCA Framework as an Effort to Contain the Contagion Effect

    PCA Framework as an Effort to Contain the Contagion Effect

    by Abhishkha Moyal, 5th year law student at RGNUL, Patiala.

    Introduction

    A non-banking financial company (“NBFC”) means, (i) a financial institution which is a company; (ii) a non-banking institution which is a company, with principal business of receiving deposits under any scheme or arrangement or in any other manner, or of lending in any manner;; (iii) such other non-banking institution or class of such institutions, as the Reserve Bank of India may, with the previous approval of the central government and by notification in the official gazette, specify.

    Every NBFC in India deals with substantial number of customers as well as with other NBFCs. NBFCs also partners with digital lenders who have restrictions on lending funds on their own accounts by reason of regulatory issues. Hence, the NBFCs form an important part of the financial system of India and enormously impact the economy as a whole. Any default made or any financial discrepancy caused by a single NBFC can create a substantial risk for the financial system of our country, thereby causing a ‘contagion effect’, that is, escalation of economic crisis in one market or region leading to economic downturn in other national or international markets or regions due to interconnectivity between them. . However, the regulatory framework for NBFCs is lenient in comparison to that for the banks due to which the financial system of India in recent times has suffered various jolts like the collapse of Infrastructure Leasing & Financial Services group in 2018, and bankruptcy of Dewan Housing Finance Corporation in 2019 and Reliance Capital in 2021.

    The Reserve Bank of India (“RBI”) introduced the Prompt Corrective Action (“PCA”) framework for NBFCs on December 14, 2021 in order to intervene at the appropriate time to initiate and implement remedial measures in a timely manner, so as to restore financial health of NBFCs which are at risk. The framework will be effective from October 1, 2022, on the basis of financial position of NBFCs on or after March 31, 2022.

    Working of the PCA Framework

    The applicability of PCA framework shall extend to all deposit taking NBFCs (except government companies), and all non-deposit taking NBFCs in middle, upper and top layers
    (except- NBFCs not accepting or intending to accept public funds; government companies; primary dealers; and housing finance companies). The key areas for monitoring in PCA framework will be capital and asset quality, and indicators to be tracked would be Capital to Risk Weighted Assets Ratio (“CRAR”), tier I capital ratio and net non-performing assets (“NNPA”) ratio. The NBFCs will face restrictions when such indicators fall below the stipulated levels.

    The PCA framework provides for three risk thresholds for NBFCs, violation of any of which by any NBFC may lead to invocation of PCA framework by the RBI against such NBFC. The norms which RBI may impose on such NBFC will get stricter as and when such NBFC moves from the first to the third threshold. First risk threshold will be invoked for the NBFCs when the CRAR of such NBFC falls 300 basis points (“bps”) below the regulatory minimum of 15% or when tier I capital ratio falls 200 bps below the regulatory minimum of 10% or in cases where NNPA ratio exceeds 6%. In such cases, it will be mandatory for the NBFC to restrict dividend distribution/remittance of profits. Further, it will be mandatory for promoters/shareholders of such NBFCs to infuse equity and reduce leverage. 

    Similarly, the second risk threshold will be invoked when CRAR falls up to 600 bps below regulatory minimum of 12% or when tier I capital ratio falls up to 400 bps below the regulatory minimum of 8% or in cases where NNPA ratio exceeds 9%. In such cases, it will be mandatory for the NBFCs to restrict their branch expansion, in addition to the restrictions imposed after breach of first risk thresholds. 

    Further, the third risk threshold will be invoked when CRAR falls more than 600 bps below regulatory minimum of 9% or when tier I capital ratio falls more than 400 bps below the regulatory minimum of 6% or in cases where NNPA ratio exceeds 12%. In such cases, it will be mandatory for the NBFCs to impose restrictions on their variable operating costs and capital expenditure, except capital expenditure on technological upgradation within limits approved by their board of directors. In addition to the above restrictions, the PCA framework gives discretionary powers to the RBI to take certain other actions against the defaulting NBFCs relating to governance, capital, credit risk, profitability etc. 

    NBFCs can exit from the PCA framework and the restrictions imposed against them and the PCA framework can be withdrawn under two conditions. Firstly, there should have been no violations of risk thresholds in any of the parameters for four continuous quarterly financial statements, one of which should be annual audited financial statement (subject to assessment by RBI); and secondly, on the basis of supervisory comfort of the RBI, including an assessment on sustainability of profitability of NBFCs.

    Impact

    The PCA framework was introduced for the banking companies in 2002. Eleven public sector unit banks and some private banks were put under the framework; restrictions were imposed on such banks to improve their financial health as a result of which their financial health improved over the years. At present only the Central Bank of India is governed by the PCA framework, however, it has also enhanced its financial position and no longer requires working under the framework. 

    As mentioned earlier, the PCA framework will come into effect from October 1, 2022, based on the financial position of NBFCs on or after March 31, 2022. This will give NBFCs sufficient time to strengthen their financial position, which may have been affected by the Covid-19 pandemic, and avoid any other issues. 

    Imposition of the PCA framework will enable the RBI to (i) regulate NBFCs struggling with financial issues; and (ii) help such NBFCs to resolve such issues in a timely and effective manner. Moreover, empowering the RBI to intervene with the working of struggling NBFCs in order to strengthen their financial position will prevent such NBFCs from advancing risky loans and will encourage them to be more cautious in undertaking lending and other activities. However, this may have a negative impact on the growth of the NBFCs, as imposition of the PCA framework on the NBFCs will tighten their credit norms and their operational focus may shift towards collection activities.

    Conclusion 

    The PCA framework for banks has already been in place since 2002 and has helped the RBI and many other banks to improve their financial health. As NBFCs have become closely integrated with the banking and financial system of India, hence, regulating them is the need of the hour in order to maintain a stable financial system. 

    Moreover, as the Covid-19 pandemic has adversely affected many businesses around the world, it would be rational for NBFCs to lend their funds discreetly in order to avoid financial difficulties at later stages. When remedial measures are implemented in a timely manner for NBFCs at financial risk, it will help in containing the contagion effect on the economy.

  • The Spain-Colombia BIT and What it Holds for the Future of Dispute Resolution

    The Spain-Colombia BIT and What it Holds for the Future of Dispute Resolution

    by Abhay Raj and Ajay Raj, third-year and fourth-year students at Jindal Global Law School and Symbiosis Law School PUNE, respectively.

    On 16 September 2021, the Kingdom of Spain’s Prime Minister, Pedro Sánchez and Republic of Colombia’s President, Iván Duque Márquez singed the ‘promotion and reciprocal protection of investments’ (the ‘BIT’). This has been done with a view to provide legitimate rights to both the parties, to achieve the objective of public interest, and to ultimately secure reciprocal protection for their investments. With that, the BIT aims to ensure more independent, impartial, transparent, and coherent arbitration procedures for dispute resolution. While the BIT is not in the public domain yet, however, once in force, it will replace the 2005 Colombia Spain BIT. Owing to a review process that lasted for more than three years (began in December 2017), there are certainly high expectations with the new Colombia-Spain BIT, including inter alia, substantive protections and procedural rights.

    Over the past few years, Spain and Colombia, two of the largest economies in the world, have undertaken notable reforms in the regime of international investment agreements and its framework. Including but not limited to Colombia’s revamping its Model BIT and Spain focusing on European Union’s investment protection policy. While Spain’s reform has largely been motivated by its experience in investor-State arbitration, Colombia’s reform directly emanates from its inactivity in investor-State arbitration before the year 2006. Common to both is the reform to modernise their investments with a focus on managing their exposure to investor claims. The reforms undertaken by both countries has led to the signing of the BIT.

    Spain’s Outlook

    The Colombia-Spain BIT fits into the narrative of being symbolic and following a systematic reform. The decision to modernise and renegotiate the 2005 BIT appears to follow the coeval discussions in the investment arbitration regime, including the conventional investor-state dispute settlement (‘ISDS’) system, Organisation for Economic Co-operation and Development (‘OECD’), and post-Treaty of Lisbon and European Union framework which authorised the European Commission for negotiating international investment agreements (‘IIAs’) with non-European Union states (regulation 1219/2012). Thus, the Spain government had to obtain authorization from the European Commission, before carrying out the negotiations with Columbia, ensuring a focus on EU objectives and policies.  

    The new BIT, 2021, assists in aligning Spain’s interest in investment commitments governing bilateral relations, with the European Union objectives and principles and European Union’s investment protection policy. These objectives and principles are broader policy considerations, for instance, promotion of democracy, human rights, sustainable development, fundamental freedoms, rule of law, standard of treatment, FET clause, and other features (briefly discussed in the latter part of the article). Despite Spain’s inactivity and non-participation in the realm of international investment, it has been one of the most competitive and attractive markets in the European Union. This is demonstrated by the fact of Spain’s being the third-largest in the investment market in the EU and thirteenth recipient of foreign investments in the world. The 2021 BIT is significant because of the fact that Spain signed a BIT after more than 10 years, and its far-reaching mandate maybe its advent into the area of international investment.

    Colombia’s Outlook

    The Republic of Colombia, following 2006, has been mindful of signing and negotiating BIT’s with different States. Colombia till the year 2006, only signed two BIT’s with Peru (1994), and Spain (2005). Following that, it signed more than fourteen BITs. With that, the Republic of Colombia felt the need to renegotiate the existing BIT of 2005 with Spain to follow the trend after 2006 and the Colombia BIT Model, 2017.

    The investment agreement between Colombia and Spain is symbolic from Colombia’s standpoint. Firstly, it is the first agreement that was renegotiated after Colombia’s Model BIT, 2017. The Model BIT, 2017 itself came after Colombia’s experience with the investor disputes (including, Glencore International AG and CI Prodeco SA v Republic of Colombia, ICSID Case No ARB/16/6; Ame ́rica Mo ́vil SAB de CV v Republic of Colombia, ICSID Case No ARB(AF)/16/5;  Eco Oro Minerals Corp v Republic of Colombia, ICSID Case No ARB/16/41; Gas Natural SDG and Gas; and in total 13 such cases) concerning old BIT’s (Model BIT-2003, 2006, 2009, 2011).

    Secondly, the Colombia-Spain BIT has followed the Colombian Constitutional Court’s judgement (available here), which conditioned on issuance of a joint interpretative note of the provisions entailed in the BIT. According to the Colombian Constitution, the Court’s must assert whether the international treaties signed (and before ratification) are constitutionally valid or not. As such, if the Constitutional Court rules that the treaty’s clauses are unconstitutional, it is unfit to enter such treaty into force.

    Features

    The changes introduced by the renegotiated Colombia-Spain BIT precisely include: (i) Replacing the conventional Investor-State Dispute Settlement with the Multilateral Investment Courts once the treaty comes into force and replaces the 2005 BIT; (ii) Explicitly stating the non-consideration of holding companies as investors, i.e., explicitly excluding companies that merely hold financial interest; (iii) Excluding the fulfilment of the commitments assumed by the Contracting Parties in commercial and economic integration projects and implying that most-favoured-nation treatment cannot be reached into other treaties; and (iv) Miscellaneous changes (reviewing of the Standard of Treatment, the Fair and Equitable Treatment standard, Denial of Benefits clause, and inclusion of Transparency Rules of the United Nations Commission for International Trade Law (‘UNCITRAL’)).

    • Multilateral Investment Courts

    As a BIT that is signed at an hour when the world is calling reforms in the Investor-State dispute settlement, (for instance, India; Bolivia; Ecuador; Venezuela; Pakistan have refrained from ICSID Convention), the Interpretative Declaration has catalysed Multilateral Investment Court (‘MIC’) and replaced the conventional ISDS system. The proposal of MIC which began with the UNCITRAL Working Group III suggestion (by the European Union and to which Spain is a member state) has come into play with the recent BIT. Such a Court would adjudicate upon claims brought under IIAs, which the member States have decided in assigning the authority. Both of the bodies shall be staffed by decided adjudicators and would be paid on a permanent basis by the member states, with a secretariat to support them.

    Such a negotiation is correlated with the EU’s efforts in calling for a global level reform in the ISDS system. As also evident in the 2019 Final Dutch Model BIT, the EU is taking steps against replacing the conventional system with a permanent investment court arbitration tribunal; for instance, the EU council provided the European Commission for establishing a MIC under the auspices of UNCITRAL.

    The renegotiation has been placed ensuring independent, coherent, impartial, predictable, and transparent arbitration procedures. However, the BIT could have worked on bringing reforms to the conventional ISDS system. For instance, the new BIT could have provided explicit provisions regarding the advisory centre, third-party participation, claims on public money, and third-party funding (as suggested in the UNCITRAL Working Group III session). The BIT could have drawn a fine balance between the conventional ISDS and State’s exposure, by incorporating several exclusions/reservations with respect to the applicability of the system.

    Notwithstanding that, as also discussed in the blog piece by Andreea Nica, the MIC can effectively cater to the concerns regarding duration and cost of the proceedings, appointment of arbitrators, arbitral decisions’ predictability and consistency, and regarding diversity, independence and transparency. Adoption of MIC, thus, acts as a catalyst in providing a better arbitration regime for both the countries (since it mitigates the above mentioned flaws in ISDS system). With that, being a permanent first instance tribunal, MIC would provide for effective enforcement of the decisions in the BIT. Because of the far-reaching implications of the BIT protection standards, MIC would help in an effective process that works transparently and with highly qualified arbitrators. Spain and Colombia being active protectors of the key legal principles of the international investment law, will definitely be able to uphold the principles through the reforms in the BIT, in particular, the ISDS system.

    • Non-Consideration of Holding Companies as Investors

    The BIT concluded for the first time, the non-consideration of holding companies as investors in Articles 1, 2, and 3. This is reflected by the Interpretive Declaration’s view that “the concept of investor explicitly excludes companies that merely hold financial interests”, which is in contrast with the previous IIAs which did not have such a provision for holding companies. Such a view was observed in the Colombia’s Model BIT, 2017, that the investment shall include a closed list of assets, in place of an exemplary list.

    • MFN Treatment

    The most favoured nation treatment has been subject to controversies in investor-state arbitration. However, both Colombia-Spain BIT, 2005 (Article 3) and Colombia Spain 2021 contain the clause of most-favoured-nation (MFN). The Interpretative Declaration clears the exclusion of MFN clause to the extent of the treatments that are derived from the fulfilment of the commitments assumed by the Contracting Parties in commercial projects. This in turn creates a level-playing field for all the foreign investors by prohibiting the host states in discriminating between investors from different countries, and as such, the investors won’t be able to indulge in treaty-shopping. The same was observed in many of the Brazilians BIT’s, for instance, with Chile, Colombia, and Mexico, wherein it stated ‘excluded from the scope of the MFN clause the benefits deriving from regional economic integration’.[i]  

    Comparing it with Colombia’s Model BIT, 2017 in which, the MFN provision was specifically designed to avoid the usage of standards of protection to ‘import’ procedural and substantial provisions from other IIAs.[ii] The model BIT provided for the MFN standard to be invoked only in cases where measures such as administrative acts, or judicial decisions violate the provision of equal treatment of the foreign investors that are a competitor.

    • Miscellaneous changes

    At present, the Interpretative Declaration shall assist us in, little if any understanding, of its stand on the clauses such as the FET clause, Denial of Benefit clause, UNCITRAL rules, and standard of treatment clause.  f the above-mentioned clauses.

    1. The Fair and Equitable Treatment

    The present BIT has thoroughly revised the Fair and Equitable Treatment (‘FET’) standard to minimise the interpretative margins of the Courts. FET clause will thus, act as a catalyser in encouraging investments in the host state by the investors; by not only protecting the investors rights, but also the autonomy of the states. The changes in the BIT vis-à-vis FET standard has followed the recommendations made by the United Nations Conference of Trade and Development (UNCTAD) and the EU investment protection agreement’s approach.

    2. UNCITRAL Rules

    For the first time in history, Spain has agreed to include the Transparency Rules of the United Nations Commission for International Trade Law (UNCITRAL rules) in an attempt to advance its emphasis on independence and impartiality of the members of the Tribunal and the transparency of the procedure. 

    3. Standard of Treatment

    The contents in the BIT, 2021, regarding the standard of treatment has been reviewed in an attempt to circumscribe the tribunal’s margin of interpretation and promote correct interpretation in investor-state disputes. The other mandate is to mitigate the exposure in consideration of the ambiguous wording. It is ideal attempt to clarify the wide spectrum in treaty standards, and simultaneously, it also acts as a catalysers for promoting investment (because of the explicit mention of the provision). With that, it also helps in regulating the autonomy of the States (because of the revision of treatment standard).

    Conclusion

    Although the full text of the BIT is not in the public domain yet, only the Interpretative Declaration, the New BIT definitely includes certain symbolic changes. The new BIT, 2021 is a fresh expression of the speedily shifting landscape in the investment arbitration, and reflects the significant changes since the 2000s. The renegotiated Colombia-Spain BIT addresses a number of conceptual and semantic difficulties that have emanated from the 2005 BIT or that have emerged after the difficulties in the conventional ISDS system. Therefore, the renegotiated Colombia-Spain BIT is anticipated to cater to the interpretative uncertainties that are left to the realms of Courts and mitigate both Spain’s and Colombia’s exposure to non-meritorious claims. When the investor-state dispute settlement system is going through a paradigm shift, the Spain-Colombia BIT, 2021, definitely makes hay while the sun shines, in an attempt to protect investor rights, sovereign prerogatives and public interest.

    [i] Henrique Choer Moraes, Pedro Mendonça Cavalcante, The Brazil-India Investment Co-operation and Facilitation Treaty: Giving Concrete Meaning to the ‘Right to Regulate’ in Investment Treaty Making, ICSID Review – Foreign Investment Law Journal, 2021; siab013, https://doi.org/10.1093/icsidreview/siab013.

    [ii] Kabir AN Duggal, Daniel F García Clavijo, Samuel Trujillo, María C Rincón, Colombia’s 2017 Model IIA: Something Old, Something New, Something Borrowed, ICSID Review – Foreign Investment Law Journal, 34(1), 224–240 (2019), https://doi.org/10.1093/icsidreview/siz004.

  • Zee vs Invesco: Shareholder Activism or Struggle for Power?

    Zee vs Invesco: Shareholder Activism or Struggle for Power?

    By Monika Vyas and Ayushi Narayan. Monika is an associate at Khaitan & Co. Ayushi is an associate LexInfini.

    Shareholders Activism inter alia includes a situation wherein the shareholders of a company use their equity stake in the company to try and make governance decisions by influencing or controlling the actions of the directors of the corporation. Such structural changes or an attempt to improve the corporate governance are made by the shareholder activists to improve their returns on the investments made in the company. Recently, there has been a trend of rising shareholder activism in the Indian equity market. This article will discuss the recent trend of shareholder activism in India in the wake of the recent case of Zee Entertainment Enterprise Limited and Invesco Developing Markets Fund. The Bombay High court order is analysed in relation to the recent treatment of shareholder activism in India.

    Rise in shareholder activism

    Few examples of shareholders activism in the recent years are that of Cyrus Mistry being removed as the director of Tata Sons by an EGM held on February 2017. In March 2020, during market crash, Vendanta Ltd. was a company which wasunsuccessful in delisting itself from the stock exchange as it received resistance from its shareholders. Further its institution shareholder Life Insurance Company, tendered its share at a high price which forced the promoters to withdraw the offer. Puneet Bhatia, head of TPG Capital Asia was removed from the board of Shriram Transport Finance Corporation Ltd (“STFC”), as the minority shareholders voted against a resolution to re-appoint him as a member of the board due to his lack of sufficient attendance in board meetings. Interestingly, just after a week of Bhatia’s removal from the board of STFC, he was renamed to the board vide a press release from STFC.

    Facts of the case 

    One of latest examples of shareholders activism in India has been that of Invesco Developing Markets Fund (“Invesco”) against Zee Entertainment Enterprises Limited (‘Zee”). As a way of background, it may be relevant to note that Invesco which along with OFI Global China Fund LLC, hold a 17.88% stake in Zee, was interested in Zee to strike a deal with Reliance Industries Ltd. However, the discussions between Zee’s CEO and Reliance Industries didn’t turn out to be fruitful. On the other hand, Zee has now finalised merger with Sony Group Corporation’s India Unit, after conducting three months of due diligence. The dispute arose when Invesco requisitioned the board members of Zee to call for an extraordinary general meeting (“EGM”), for the purpose of making structural changes in the company by revamping the board and removing the managing director and Chief Executing Officer and suggesting six new independent board members.

    Zee rejected the proposal made by Invesco with respect to the change in board of members of the company and cited legal infirmities in Invesco’s request. As Zee denied Invesco’s request to revamp the board, Invesco sent a requisition notice to Zee for removal of the managing director and CEO Punit Goenka and to further appoint six new independent board members identified by Invesco. As per the provisions of the Companies Act, a shareholder holding more than 10% stake in a company can seek an EGM. In the event the board declines, the shareholders as per Section 100 of the Companies Act, can convene the EGM itself. Upon Zee’s denial to act upon the said notice, Invesco considered ZEE’s behaviour to be oppressive and filed an appeal before National Company Law Tribunal (“NCLT”) to direct ZEE to act upon Invesco’s notice for EGM. While the said matter was pending before the tribunal, Zee filed an appeal before the Bombay High Court for an injunction against Invesco’s notice for EGM. In the said appeal, Zee stated the notice to be illegal and that it could not implement the same. Further, Zee’s refusal to implement the said notice was within the purview of law and justified.

    analysis of the issues

    Issue of Requisition of EGM

    The issues in this case are quite complex and leads to different outcomes based on the interpretation. The first issue is, whether Zee is obligated to call EGM upon a valid requisition. The court issued the injunction whereby the requisition for the EGM was not granted based on the rationale that objections of Zee were justified and resolutions were illegal. It observed that if the Board itself cannot act call for EGM on such resolutions, then there’s no way that the shareholders would be kept at higher pedestal.

    Opinion- Section 100(2)(a) of the Companies Act, 2013 empowers the Board to call for EGM on requisition of minority shareholders. It reads as thus: the Board shall, at the requisition made by, in the case of a company having a share capital, such number of members who hold, on the date of the receipt of the requisition, not less than one-tenth of such of the paid-up share capital of the company as on that date carries the right of voting, call an extraordinary general meeting of the company within the period specified in sub-section (4). We should interpret the word ‘shall’ in Section 100 of the Companies Act, 2013 to find the legislative intent behind this section. The choice of word ‘shall’ indicates that is must to call the EGM. However, the literal interpretation can sometimes overlook the intent of the legislation. By giving the alternative route in Section 100(4) itself of conduction of the EGM lest the Board shall fail to act, the word ‘shall’ should not be used as ‘must’. It reads as thus: If the Board does not, within twenty-one days from the date of receipt of a valid requisition in regard to any matter, proceed to call a meeting for the consideration of that matter on a day not later than forty-five days from the date of receipt of such requisition, the meeting may be called and held by the requisitionists themselves within a period of three months from the date of the requisition. 

    Thus, we can say that the Board is well within its right to use discretion otherwise it can always be held hostage to the whims of the shareholders who intend to misuse the provisions. Having said this, it is also unclear why this in-built remedy of shareholders proceeding to hold the meeting was not granted to Invesco by the Court. 

    Issue of Legality of Propositions in the Resolutions

    This brings us to the next issue of whether the proposed resolutions were legal for requisition of EGM. For this, interpretation of the word ‘valid’ in section 100(4) of the Act was made the issue. The shareholders are allowed to hold the EGM themselves in case the Board fails to act within the stipulated time provided the requisition is valid. The court concluded that there was no question of interpretation of word ‘valid’ but only of the illegality of the resolutions proposed. It was established that the represented matters by the shareholders were illegal and hence could not be implemented. It held this based on the following reasoning:

    • Non-compliance of Ministry of Information and Broadcasting (“MIB”) guidelines, SEBI (Substantial Acquisition of Shares and Takeovers) (“SAST”) Regulations, 2011 and Competition Act, 2002

    The guidelines of MIB require that before effecting any change in CEO/Board of Directors, its prior approval must be taken. Approval of Competition Commission of India (“CCI”) is also required in the eventuality that Invesco is in control if it succeeds in appointing majority of directors. It also attracts the provisions of SEBI SAST Regulations, 2011 which provides for such regulatory approvals. In this case because the approval was not taken from either of them, the resolution was termed illegal by the court on grounds of non-compliance with the guidelines and the statute.

    Opinion-It is unclear whether the word ‘change’ applies to only fresh appointments or its scope covers resignations/removals too as in this case. The guidelines cannot be meant to stop someone from quitting. 

    Secondly, one must also question if the mere non-compliance with the guidelines and statutes would amount to illegality. As it is, the passage of resolution is contingent upon the approval of MIB and CCI. One cannot term it illegal when it is in its nascent stage and yet to fulfil the conditions for its acceptability. If, at all, it is inconsistent, the same would be declined by the regulatory body and need not be decided by the court. Thus, terming the resolution illegal when it is still premature cannot be held in good faith. Also, it would be Invesco who would be responsible for the consequences of not having the approval of competition commission. Hence, on this ground one cannot term the resolution illegal. 

    • Violation of SEBI LODR Regulations and Section 203 of Companies Act, 2013

    Invesco proposed six independent directors to be appointed named by it in the resolution. This is violative of Regulation 17 of SEBI LODR which states that the company should have optimum numbers of executive and non-executive directors processed by the nomination and remuneration committee. Further, the court was of the view that the proposition to remove the managing director and CEO infringed upon section 203 of the Act which envisages that every company must have CEO, managing director or manager.

    Opinion-While SEBI LODR talks about appointment through nomination and remuneration committee, it also envisages situation where appointments are initiated by the board of directors. Thus, the court through its order has created the situation of polarisation between the Companies Act, 2013 and SEBI LODR Regulations. Further, the violation under Section 203 of the Act is curative in nature meaning whereby it can be cured within six months of the removal of CEO.

    Concluding remarks

    There is no doubt that the order of the court is detrimental to the shareholder activism in India. From the above analysis, we can see that Invesco is not entirely in the wrong. However, Invesco has stepped on its feet by not being transparent about the issues why it wants to remove the CEO. The intention of Invesco is not clear as to whether the proposed resolutions are on account of bad governance issues of Zee or to exercise control by appointing independent directors, the names which it has not justified for appointment. Earlier, this year, it had also approached Goenka, CEO with the proposalto merge Zee with media entities of Reliance Industries Ltd. which failed. It is not clear why it did not approach the Board directly. However, the court could have been lenient in its interpretation of the provisions since the order wards off the shareholder activism which could have been for the benefit of the company. However, as Invesco has contested the Single Bench decision and the case has now been taken up by the Division Bench of Bombay High Court, one can be hopeful that the decision ushers in towards welcoming this concept. It would be especially interesting to see how the case unfolds in light of the recent merger with Sony which has facilitated the continuation of post of CEO being held by Punit Goenka.

  • Claim Period and Enforcement Period in Bank Guarantees

    Claim Period and Enforcement Period in Bank Guarantees

    Manasvini Vyas, an NLU-O graduate currently practicing in Mumbai

    On 28 July 2021, the Delhi High Court in the case of Larsen & Toubro Limited vs. Punjab National Bank passed a landmark ruling clarifying the scope of exception 3 of section 28 of the Indian Contract Act 1872 (ICA). The order passed by a Single Judge Bench has set aside the circulars issued by the Indian Banking Association (IBA) that recommended an unalterable claim period of 12 months for bank guarantees. 

    Before delving further into the judgment, it is imperative to analyse the background against which the judgment holds significance.

    Background 

    Bank Guarantees (BG) are independent contracts that confer upon the beneficiary the right to claim performance from the bank in case of default by the principal borrower. On default, the beneficiary can invoke the guarantee by making a claim within the lifetime of the BG i.e. the “validity period”. This period is mutually determined by the creditor and the principal debtor and it expires on a decided date. Often, a BG provides for an additional grace period over and above the validity period for making a claim before the bank, which is known as the “claim period”. Stipulating a claim period is not a mandatory requirement and inclusion of the same depends solely on the discretion of the contracting parties.  If the bank defaults in honouring its obligations, the beneficiary is entitled to approach the court of law and the period within which the beneficiary is permitted to enforce their rights from the date of default is called the “enforcement period”.   

    The enforcement period is prescribed under the Limitation Act 1963 (Limitation Act) and any agreement that limits the time within which a party may enforce its rights is hit by section 28 of the ICA. According to the provision, an agreement is void 

    1. if it absolutely restricts a party from enforcing their rights under a contract or if it limits the time within which a party can enforce their contractual rights, or 
    2. if it extinguishes the contractual rights of a party or it discharges a party from any contractual liability on the expiry of a prescribed period such that the rights cannot be enforced beyond it.

    exception 3 appended to the provision states that if a contract for bank guarantee stipulates a term for extinguishment of rights or discharge of liability on the expiry of a given period, such a clause would not be void provided the said period is not less than one year from the date of the specified event.  

    History behind Exception 3

    Prior to 1997, the courts created a distinction between ‘remedy’ and ‘right’ and an agreement which barred a remedy to sue beyond the prescribed time period was void under section 28 but an agreement which relinquished rights under the contract was held to be valid[1]. The Law Commission, in its 97th Report dated 31 March 1984, observed that such a distinction was not practical and it gave a dominant party the power to limit the period of remedy by limiting the period of relinquishment of rights because if rights didn’t exist, the remedy would also be extinguished. Consequently, clause (b) was added to section 28. 

    As a result of this amendment, banks were concerned that they could no longer limit their obligations under the BGs and would be required to maintain their BGs for 30 years in case of government contracts and 3 years for private contracts pursuant to the Limitation Act. It was feared that the high cost of maintaining BGs would severely affect the banks’ ability to issue fresh guarantees. In order to assuage the concerns of the banking sector, exception 3 was added to section 28 by way of the Banking Law (Amendment) Act, 2012 (The 2013 Amendment) on the recommendations of Sh. T.R. Andhyarujina Committee. 

    The aftermath of the 2013 Amendment

    Post the 2013 amendment, there was confusion whether the exception dealt with the claim period or the enforcement period. The IBA was of the view that the exception concerned the claim period and therefore it issued circulars recommending banks to stipulate a minimum claim period of 12 months in BGs. It was further believed that if the banks stipulate a claim period of less than 12 months, they will lose the benefit under exception 3 and the period specified under the Limitation Act would be applicable.  

    The confusion was further compounded after the Supreme Court’s observations in the case of Union of India & Anr. vs. M/s Indusind Bank Ltd. & Anr. (2016). Here, the Apex Court was concerned with an issue concerning section 28 as it stood before the 1997 amendment. In this case, the BG stipulated an invocation period of three months beyond the validity period, however, the BG was invoked after the expiry of three months. The Court held that since the clause did not provide for a time limit for lodging a claim before the court, the same will not be hit by section 28. Further, in its obiter, the Court noted that:

     “… Stipulations like the present would pass muster after 2013 if the specified period is not less than one year from the date of occurring or non-occurring of a specified event for extinguishment or discharge of a party from liability.” 

    In this case, the Court was dealing with the time period for filing a claim with the bank and not the period for enforcing the guarantee before the courts. Therefore, when it mentioned “stipulations like the present would pass muster after 2013”, it seemed that the Court had interpreted exception 3 to mean that it provided for a mandatory claim period of minimum one year, thereby, worsening the already unsettled position with respect to exception 3.  

    Notably, a BG is a costly affair for the borrower as it has to maintain margin money/collateral security in support of the guarantee and has to pay commission charges at regular intervals. In such a scenario, a mandatory claim period of 12 months poses a financial burden on the borrower. Not only is the borrower forced into paying commissions for an additional period of one year, but funds locked in as margin money results in increasing the working capital requirements. A 12 month claim period would be even more commercially unviable in cases of short-term guarantees. For example, a BG with an original validity period of six months would be required to be kept open for a period of 18 months! In view of this, critics of exception 3 sought another amendment to section 28 to rectify the anomaly. 

    The decision in  Larsen & Toubro Limited vs. Punjab National BankIn this case, L&T had filed a writ petition against PNB, IBA and the RBI before the Delhi High Court challenging their interpretation of exception 3. As noted above, IBA, in its circulars dated 10 February 2017 and 5 December 2018, had recommended a minimum claim period of 12 months for BGs. It was also stated that, in the absence of such a clause, limitation period as per the Limitation Act would be applicable.

    L&T challenged this clause on the grounds that the extended claim period grossly affected its ability to sign new contracts and affected its fundamental right under Article 19(1)(g) of the Constitution of India to carry on business. It was also contended that a claim period is contractually agreed term between the borrower and the creditor and it may or may not be present in BGs. After scrutinising the tumultuous amendment history of section 28, the Court concluded that exception 3 provides for enforcement period and not a claim period. In coming to this conclusion, the Court observed that exception 3 curtails the limitation period within which the beneficiary can approach the appropriate forum for enforcing its rights. [SS3] The said provision, in no way, limits the period for filing a claim with the bank and the same is to be contractually agreed between the creditor and the debtor. Therefore, IBA’s interpretation that exception 3 dealt with a claim period does not hold ground. The Court also distinguished the obiter in the case of IndusInd with the present case and stated that “the judgement cannot be relied upon since the clauses in question dealt with the enforcement period i.e. curtailment of the limitation period and not the claim period of a bank guarantee”. 

    Concluding remarks

    The 2013 amendment, though well intended, had thrown open a can of worms. BGs, which should ensure smooth flow of cash in business, were rendered ineffective by the weight of exception 3. The confusion surrounding the provision often stood in the way of claims under guarantees and severely affected the ease of doing business in India. In view of this, the judgment of Delhi High Court is a welcome move as the parties can now choose to incorporate a claim period that suits their needs, thereby, significantly bringing down the cost of maintaining the guarantee. 

    [1]Shakoor Gany v. Hinde &Co (AIR 1932 Bom. 330); Kerala Electrical & Allied Engineering Co.Ltd. v. Canara Bank & Others (AIR 1980 Ker 151)

  • Funding of Food Aggregators & Competition law: A Post Covid Analysis

    Funding of Food Aggregators & Competition law: A Post Covid Analysis

    By Rohan Mandal and Jeezan Riyaz, fourth and third year students at USLLS, GGSIPU, Delhi and NLIU, Bhopal respectively.

    In an exclusive arrangement as part of its strategic push, the food delivery giants, Zomato and Swiggy are all set to raise more than $1 billion, which will help them to leverage a position of dominance in the food delivery business. Duopolistic designs, coupled with pricing below the belt, and the viability of recuperating losses have led to a strategic dominance for these entities in the food delivery market, thereby harming the consumers in the long run.  Accordingly, the food aggregators have been under the constant radar of the Competition Commission of India (“CCI”) for manipulating pricing, deep discounting and offering of rebates with an intention to distort competition.

    At the heart of the Competition Act, 2002 (“The Act”), lies the principles of fair competition and therefore any activity or strategy that abuses the ongoing competition in the marketplace, is said to fall within the ambit of the anti-competitive activities.  The Act in the explanation under section 4(2) defines “dominant position”, as a position of strength or dominance, enjoyed by any enterprise which enables it to: (a) individually dominate or function without the competing opponents in a marketplace; or (b) manipulate the consumers in a sense, that is grossly disadvantageous to the other forces of the market. This gains more traction particularly in light of the increased use of these apps and reluctance to dine out in light of Covid.

    • Abuse of Competition & Appetite for market dominance

    Section 4(2)(a)(ii), of the Act disallows an enterprise from engaging in predatory pricing, which is understood as selling goods below cost to drive out competition. While, 4(2)(c) prohibits those activities that deny access to the market and lead to foreclosure of competition. Economies of scale may lead to dominance, and if deep discounting and new rounds of funding received by the food aggregators is viewed holistically, a conclusion to that effect can be drawn.

    With Zomato having acquired Uber Eats and other small start-ups alongside its strategy to rechristen Zomato gold to Zomato pro (a premium subscription model), it gets a strategic edge to dominate the marketplace. Swiggy, on the other hand has launched their initiative called Swiggy Super, which has forced small start–ups to wind up their operations by diverting the consumer base to their platform. This comes at a time when people do not have the luxury of going out to a restaurant due to the ongoing pandemic and are reliant on food delivery apps. Section 19(4) lays down relevant factors to be considered to ascertain abuse of dominance, which include the economic power of the entity vis-à-vis their competitors and market share of the enterprise. The Food aggregators have control over the listing of restaurants and have access to consumer data, which is being leveraged for their benefit and to promote their in-house kitchens. Therefore, an argument can be made thatabuse of dominance is prevalent in the marketplace.

    Further, CCI in its report on e-commerce states that the food aggregators have benefitted immensely by establishing cloud kitchens (cooking spaces without a dine-in-option). These aggregator-run-establishments have an edge over normal restaurants on the app in terms of the user data available to them, preferential listing provided and by forcing other restaurants to purchase items from them. This has led to an unequitable profit earning structure, thereby exhibiting anti-competitiveness from the legal standpoint. Therefore, with data in the hands of these in-house-kitchens in the present digital economic paradigm, they are in a better position to maximize sales and entice consumers.

    In Matrimony.com Ltd. v. Google LLC, Google was accused of violating anti-trust provisions by manipulating their search algorithms and giving preferential listing to its own products and features. This caused the complainant to be listed lower, and thereby affected their business. It was held by the CCI that Google was directly manipulating the consumers by diverting their attention from rival services to their own. Google abused its dominant position to exert pressure on other players to exit the market, which was accordingly dealt with under section 4(2)(e). The CCI has laid down in MCX v. NSE, that  activities which are covered under section 4 such as predatory pricing and denying access endanger competition in the market. In a similar vein, it can be argued that the food aggregators are abusing their position of dominance through their in-house kitchens.

    • Assessment of dominance and abusive conduct: CCI analysis

    Fueled by the stiff domestic competition among restaurants, lack of alternative dine-in-options and buoyed by the ever-expanded funding inthe food delivery business, it has paved a way for a duopoly in the Indian paradigm. This makes it imperative on the part of the CCI to conducta thorough investigation from a competition law standpoint.

    In the new normal of the restrictions worldwide, the food delivery aggregators are engaging in anti-competitive practices such as predatory pricing, violation of platform neutrality, exclusivity, barriers to entry and obliging the already existing rivals to exit. Thus, impacting footfalls and diverting the entire consumer rush to their own benefit. The National Restauranters Association of India’s (“NRAI”), a body which represents over 5,00,000 restaurants, in their complaint to the CCI also echoes this sentiment, wherein they allege abuse of dominance by the aggregators. In their complaint they allege that aggregators charge restaurants exorbitant fees, give preferential listing to restaurants on payment of fees, and engage in deep discounting (non-adherence to deep discount schemes means lower visibility for the restaurants).

    The COMPAT in  Schott Glass appeal case, had observed that abuse of dominance and predatory pricing involves the satisfaction of two important requirements: (i) unequal treatment of similar transactions; and (ii) harm meted out to the competition in the marketplace. This places all the sellers on an unequal footing and is disadvantageous to the interests of the buyers. In another important case, the XYZ v. REC Power Distribution Company related to abuse of dominance, the CCI held that “establishing a denial of access”, indicates exclusivity and sizeable degree of market power being controlled by those in position of dominance.

    The NRAI complaint to the CCI has also alleged that the practices of the deep funded aggregators have forced several restaurants to shut down. Consequently, there is a need to reach a middle ground to ensure that there is stability and transparency in the process and that capitalism doesn’t hamper the very essence of competition as abuse of strength can impact both the competition and the consumers in the long run.

    • The Impact of IPO and the new rounds of funding

    The Zomato IPO will raise Rs. 9,375 crores against the backdrop of Zomato posting losses of Rs. 886 crores in the last financial year. On the other hand, Swiggy is set to raise Rs. 9,297 crores  in their newfunding round against losses of Rs. 3,768 crores in the 2019-2020 accounting year. This inflow of cash against the continued loss-making nature of these food aggregators, makes the market interesting from a section 4 standpoint as the entities will have the financial capability to strengthen their grip on the market, while posting losses, therefore, adversely affecting competition. In Uber v. CCI, the Supreme Court dealt with a case involving taxi aggregators offering rides at lower rates while making losses. The Hon’ble Court held that continued losses incurred by aggregators is prima facie indicative of abuse of dominance because predatory pricing helps them to drive out competition and control the marketplace at the same time. The CCI was ordered to investigate the activities of the aggregators. Although, the Commission would later give the taxi aggregators a clean chit, but the principle that continued losses merit an investigation by the CCI still stands, and should be applied in the present case.

    Zomato and Swiggy have stated that they will continue to make losses in the near future in order to develop business. This would be done by starting operations in new cities, and also diversifying to the item delivery market. At the same time, they also continue to give deep discounts and preferential treatment to certain enterprises. These activities should be investigated under section 4 and the possible appreciable adverse effect on trade under section 3 needs to be looked at. This becomes necessary, particularly in light of the fact that the CCI has also investigated such models in the case of taxi aggregators and e-commerce giants,  Amazon in Lifestyle v. Amazon. In this case the CCI held Amazon guilty under the Act  for not granting visibility to the products of the complainant. The decision of the CCI in Ashish Ahuja v. Snapdeal is also relevant for this purpose, where Snapdeal was accused of granting exorbitant discounts on their platform, which affected the business of their competitors. The CCI held that discounts coupled with harm to the market amounts to abuse of dominance. In the current paradigm, it is evident that the food aggregator market is dominated by two players, whose activities such as continuous deep discounts and preferential listing is prima facie indicative of abuse of dominance, and this merits an investigation by the CCI.

    All these factors have been put forward in the NRAI complaint. Further, the new cash inflow means that the aggregators will have the capacity to continue with the above-mentioned activities, which if left unchecked could have serious effect on the market.

    • Conclusion

    To sum up the above discussions, the authors submit that two important factors need to be considered, namely, the new funding and the previous activities of the food aggregators. When these two factors are looked at in tandem, it becomes imperative that a thorough investigation is conducted by the CCI, to gauge the market situation and address the apprehensions of the NRAI. Zomato and Swiggy have maintained that they will continue to make losses in the near future in order to develop business, which further makes it important for the CCI to probe the allegations against the aggregators. Covid has resulted in the popularity of food delivery giants soaring to greater heights. Therefore, there is a need to critically analyze the legal impediments of anti-competitive strategies that form the basis of the competition laws in India.

  • Potentially Anticompetitive? The Need for a New Standard for Judging Competition Law Effects

    Potentially Anticompetitive? The Need for a New Standard for Judging Competition Law Effects

    By Esha Goyal, fourth-year student at NLSIU, Bangalore.

    Introduction

    On 21st January, 2020 Zomato acquired Uber Eats India in an all-stock transaction which gave Uber (the parent company of Uber Eats) a 9.9% stake in Zomato. At the time, Zomato was the second largest player in the delivery sector of the food service industry in India and Uber Eats was the third.  Competition Commission of India [‘CCI’] did not investigate this deal or hold it to be anticompetitive, and hence void immediately, and is only investigating now, a year after the acquisition concluded. The CCI was unable to act – even though it was cognisant of the allegations of price and supply manipulations against the two entities, which would potentially be aggravated by the acquisition – because the current threshold for holding a deal to be anticompetitive is very high and only capable of being addressed ex post. However, this article argues that the creation of a middle standard – of potentially anticompetitive deals being closely monitored by the CCI – would be more suited to fulfilling the goals of the Competition Act, 2002.

    The CCI published its findings of the Market Study on E-Commerce in India where the food service industry was specifically analysed. The report noted that there were only three dominant players in the industry in terms of market share and transaction value: Swiggy, Zomato and Uber Eats, in that order. It further noted the allegations by restaurants against these three platforms which were first, though search results and restaurant ranking were touted as being objective to the customers, the platforms discriminated between sellers by offering better ranking and visibility to the restaurants paying them higher commissions. Second, the platforms unilaterally decided the discount schemes even though the costs of such discounts had to be borne by the sellers, who additionally, were penalized for non-participation. The CCI concluded this report by suggesting self-regulation by the industry by adopting clear and transparent policies for search algorithms, pricing and discount policies. Since this was not a formal investigation, these guidelines were not binding for any of these platforms.

    Balancing the goals of the Competition Act

    Section 3 of the Competition Act, 2002 [‘the Act’] states that “any agreement in respect of production, supply, distribution, storage, acquisition or control of goods or provision of services, which causes or is likely to cause an appreciable adverse effect on competition within India” shall be void. In this context, it is proposed that the acquisition ought to have been held as void as per a strict reading of section 3(2) of the Act. This is of significance in light of the goals of the Act as have been highlighted in the preamble. The Act not only has to protect customers but also has to ‘ensure freedom of trade carried on by other participants in markets,’ which would include the restaurants listed on Zomato and Uber Eats. Further, since the acquisition combined two of the three most dominant entities in the market, it can directly and indirectly affect sale price and limit the market and the provision of services within that market by converting the industry into a duopoly. By giving the resultant food delivery service provider (Zomato) even more economic and market control over restaurants, they would lose the option to migrate to other platforms or control their visibility, pricing or discounts and thus be completely at the mercy of the food delivery service provider. This is especially true in the aftermath of the CCI report which had already recognised the adverse effects of the trade practices being carried on by these two entities, it can be said to have an ‘appreciable adverse effect on competition’ as per sections 3(3)(a) and 3(3)(b).

    However, one faces a dilemma at this point. Currently, as per a conjoint reading of section 3(3) and 3(4) of the Act with 3(1) and 3(2), whether a deal is anticompetitive or not is within the sole discretion of the CCI but rather has to be based on an objective analysis of facts and the market position subsequent to the deal to determine what the real impact on competition in that industry has been. Though the report noted the existence of price manipulations – partially brought about due to the dominance of three platforms to the exclusion of all others – a mere two weeks before the acquisition, CCI nevertheless had to let the deal go forward.

    One reason for this could be the standard of proof required to hold a deal as anticompetitive. The Act itself is broad enough to include even the possibility of an adverse effect on competition by accounting for indirect effects. However, the meaning of the term ‘anti-competitive’ has been held to a higher threshold by the CCI, as is evident from the present case itself, with very few deals being held void for being anticompetitive at the preliminary stage. This standard implicitly adopted by the CCI in practice seems to correspond to the higher standard of ‘beyond reasonable doubt’ analogous to that followed in criminal law, even though section 3(1) itself seems to favour the lower standard of ‘preponderance of probabilities.’ Given that the Act currently envisages only a binary of competitive-anticompetitive, and the severe consequences of holding a deal to be anticompetitive, CCI has taken upon itself to test deals on actual adverse effect on competition and abuse of dominance, instead of the mere possibility of being so, even though section 3(1) seems to grant the Commission the power to nullify the latter.

    However, this leads to an anomalous situation where the goals of the Act have to be sacrificed to meet the standard of proof required by the Act. As mentioned earlier, one of the purposes of the Act is to protect freedom of trade, which could be in the form of breaking down entry barriers or safeguarding against predatory pricing. At the same time, the CCI cannot hold too many deals to be anticompetitive because that itself would vitiate the general goal of efficiency and impose heavy costs on the market and its players by increasing transaction costs. In this scenario, a middle ground is needed to reconcile the Act’s protective goals with the economic development of the country.

    A New Middle Ground

    This could be fulfilled by amending the Act to differentiate between the powers of the Commission for acts which actually have an ‘appreciable adverse effect on competition’ and those which merely have the potential to do so.  While the former would retain the consequences of being held void and other penalties, the latter, instead of being wholly unregulated could warrant a mandatory investigation for a fixed period of time to analyse its consequences. Following this standard in the Zomato-Uber Eats deal would hence require the allegations brought forward by the E-Commerce Report against the practices of these companies to be reviewed for a few months following the acquisition, after which CCI could take an informed decision as to whether it was anticompetitive or not.

    The difference between status quo and the proposed model lies in the fact that while the former deals with ex post measures following the damage to the consumers and the market, the latter through its monitoring of all potentially anticompetitive deals as they happen would be able to prevent anticompetitive behaviour to a large extent and thus sustain a healthy competition in the markets while also protecting the interests of the consumers as well as other market participants, just as the preamble envisages. In the case at hand, it would imply a study of the actual effects of the acquisition on the market, brought on by the mere fact of the acquisition, rather than brushing it under the carpet till the anticompetitive behaviour cannot be ignored any longer.

    Some might argue that the proposed model would give CCI overbearing powers or lead to increased conservatism at the expense of market freedom and economic efficiency. However, the author posits that economic efficiency in the form of lower regulation is not the sole purpose of the Act. It has to be balanced against other goals of sustaining market competition, protecting consumer interest, and ensuring freedom of trade for all market participants. Perhaps as a compromise, a minimum threshold defined in terms of market share, as opposed to the current threshold of net revenue or asset value as mentioned in Section 6 could be a good starting point to determine which cases need to be examined instead of creating unnecessary delay by scrutinizing every single deal in the market. Thus, the proposed middle ground would only further this objective, rather than derogating from it.

    Conclusion

    This article proposes a new way of viewing competition law; instead of merely using it as a post-facto tool to correct a grossly unbalanced market, it should be used as a preventive, regulatory measure as well, similar to the Federal Trade Commission in the USA which also has under its mandate “practices that are likely to reduce competition”. As the Zomato-Uber Eats deal has been used to illustrate, some deals might not be out rightly anticompetitive, but are only one step away from being so because of the market situation at the time. Whatever be the reason, the monitoring of such deals by the CCI would not only fulfil the aims of the Act itself but would also help reduce long term social costs.

  • Sanctity Of The Commercial Wisdom Of CoC’ Vis-À-Vis ‘Interest Of The Dissenting Financial Creditors’ Under IBC : A Curious Case

    Sanctity Of The Commercial Wisdom Of CoC’ Vis-À-Vis ‘Interest Of The Dissenting Financial Creditors’ Under IBC : A Curious Case

    By Vijpreet Pal and Sanskar Modi, third-year students at NLIU, Bhopal.

    Introduction

    Before the enactment of the Insolvency and Bankruptcy Code (Amendment) Bill of 2019 (‘2019 Amendment’), there were no provisions to guide the Committee of Creditors’ (‘CoC’) discretionary power in the approval of the resolution plan. However, the 2019 Amendment demystified the distinction between the secured and unsecured creditors under the resolution plan and illustrated distinct provisions for dissenting Financial Creditors. The Amendment added, “the manner of distribution proposed, which may take into account the order of priority amongst creditors as laid down in sub-section (1) of section 53, including the priority and value of the security interest of a secured creditor,” to Section 30(4) of the Insolvency and Bankruptcy Code (‘IBC’).

    However, this amendment gave rise to the conundrum that whether the secured financial creditors can challenge the approved resolution plan by arguing that enforcement of the entire security interest is their prerogative and henceforth they must be awarded a higher amount. The Honorable Supreme Court (‘SC’) in the recent case of India Resurgence Arc Private Limited vs. Amit Metaliks Limited & Another resolved this dubiety by holding that it would be against the objectives of IBC if the secured creditor is allowed a higher amount than entitled under the approved resolution plan on the basis of security interest available to him over the corporate debtor’s assets. The Court basically tried to create a balance between the established principle of sanctity of the commercial wisdom of CoC and the interests of the dissenting secured creditor post 2019 amendment. This article shall briefly delineate upon the misconstrued understanding of the 2019 amendment. It will also examine the inequitable scenario which would be created if the financial creditors are awarded higher amount than proposed in the resolution plan for the same class of creditors.

    Background to the dispute

    The appellant company i.e India Resurgence Arc Pvt. Ltd. was the secured financial creditor of the corporate debtor i.e. Amit Metaliks Ltd. (respondent). In the Corporate Insolvency Resolution Process (‘CIRP’) commenced against the respondent, the appellant expressed his dissatisfaction on the share being proposed with reference to the value of security interest held by it and remained a dissentient financial creditor. However, the resolution plan proposed by the resolution applicant got appreciably approved by the CoC with 95.35% votes. Since all the mandatory compliances prescribed under Section 30 of the IBC were fulfilled and entitlements of all the stakeholders were taken care of, the National Company Law Tribunal (‘NCLT’) Kolkata approved the resolution plan. On an appeal before the National Company Law Appellate Tribunal (‘NCLAT’), the appellate tribunal relying upon the judgment of Committee of Creditors of Essar Steel India Ltd. vs. Satish Kumar & Ors.(Essar) observed that the amendment to Section 30(4) falls into the exclusive domain of the CoC and therefore, it is a discretionary, a non-mandatory power conferred upon the CoC to take into account the security interest like considerations.

    Aggrieved by the NCLAT’s ruling, the appellant challenged it before the SC. The major contention of the appellant was the failure on the part of CoC to consider the value of security interest even after the amendment made to Section 30(4). The appellant urged that the value of the security possessed by him was INR 12 Crores, still he was offered the minimal amount of INR 2.026 Crores against the admitted claim of the amount INR 13.38 Crores. 

    It was strongly postulated by the appellant that Section 30(4) manifestly requires the CoC to consider the waterfall mechanism (if a company is being liquidated, secured financial creditors must be first paid the full extent of their admitted claim before any sale proceedings are distributed to any other unsecured creditor) as laid down under Section 53(1), including the value of the security interest created by the secured creditor and CoC cannot shut their eyes to the value of security interest while considering the viability and reasonableness of the proposed resolution plan.

    Judicial Review of the Resolution Plan confined to Section 30(2)

    The Honorable SC on the issue regarding judicial review of the approved resolution plan held that it is undisputed that the scope of judicial review of the commercial wisdom of CoC is limited within the mandatory requirements mentioned under Section 30(2) of the IBC.

    Placing reliance on K. Sashidhar vs. Indian Overseas Bank & Ors., the court noted that the legislature while enacting the IBC has knowingly not provided any ground to challenge the commercial wisdom of the CoC before the Adjudicating Authority (‘AA’) and that the decision of CoC’s commercial wisdom has been made non-justiciable. Further, relying upon Jaypee Kensington Boulevard Apartments Welfare Association and Ors vs. NBCC (India) Ltd. & Ors (Jaypee Kensington), the court observed that the powers of the AA dealing with the resolution plan do not extend to examine the correctness of the commercial wisdom exercised by the CoC. AA by exercising its power under Section 30(2) is only authorized to examine that the resolution plan does not contravene any of the provisions of law and it confirms other requirements like payment of IRP Cost, payment of Debts of operational creditors, payment of debts of dissenting financial creditor, management of affairs of corporate debtor after the approval of resolution plan and implementation and supervision of resolution plan. It is not vested with the power to assess the resolution plan on the basis of qualitative analysis and therefore, the dissatisfaction of every secured creditor like the appellant cannot take a legal character under the IBC.

    The CoC accountable for equitable treatment of similar class creditors

    The appellant reiteratively contended that the CoC has not prioritized its claims as per the amended provision of Section 30(4) which obligates the CoC to take into account priority and value of security interest of the secured creditor. The Court clarified this issue by referring to the Essar ruling which observed that the amended provision of Section 30(4) only amplified the considerations for the CoC while exercising its commercial wisdom so as to make an informed decision regarding the feasibility and viability of the resolution plan.  The business decision of the CoC does not call for interference unless creditors belonging to a similar class are denied fair and equitable treatment. Similar reasoning could be traced from the case of Hero Fincorp Limited v. Ravi Scans Private Limited & Others wherein the NCLAT ruled that IBC does not provide any discrimination among financial creditors on the ground of their dissenting status, post the 2019 amendment made to Section 30(2)(b).

    In the instant case, the court noted that the proposal for payment to the dissenting financial creditor (appellant) is equitable and is at par with the percentage of payment proposed to other secured financial creditors. Therefore, the dissenting secured creditors like the appellant cannot suggest a higher amount to be paid by relying on the value of the security interest held by them.

    Amended S. 30(2)(b)- Not a panacea for the dissenting Financial Creditors

    The SC further observed that the amended provision of Section 30(2)(b), on which the excessive reliance has been placed by the appellant, only states that the dissentient financial creditor shall be provided with the payment of a debt which shall not be less than the amount paid to such creditors in accordance with the waterfall mechanism enshrined in Section 53(1).

    The Insolvency Law Committee Report of 2018, which lead to 2019 amendment, has also observed that providing priority to the dissenting financial creditors will not be prudent as it may encourage financial creditors to vote against the plan and may consequently hinder resolution. The objective behind the 2019 amendment was never to provide the enforcement of the entire security interest available with the secured creditors. The only intention was to grant security to dissenting financial creditors who may be cramped down by the secured creditors holding majority votes, overpowering dissenting financial creditors and giving them nothing or next to nothing for their dues.

    Such creditors are only allowed to receive payment to the extent of their entitlement and that would satisfy Section 30(2)(b) of the IBC which mandates that a dissentient secured creditor be provided with a certain minimum amount which shall not be less than the amount paid to such creditors in the event of liquidation.

    As a result, the Court while dismissing the appellant’s claim observed that any dissenting secured creditor like appellant cannot interfere in the CIRP process by urging a higher amount to be paid with reference to the value of their security interest.

    The ruling of the Court, henceforth, leads to two main observations-:

    • Commercial Wisdom of CoC can’t be interfered.

    The commercial wisdom of CoC is amenable to judicial review as long as it goes in consonance with the basic provisions and objectives of the IBC.

    • Equitable Treatment among the creditors is the main objective.

    The Resolution Plan submitted under Section 30 does not advocate equal treatment among all the creditors, rather it obligates a fair and equitable treatment.

    Therefore, the interest of the dissenting secured creditor like appellant can’t be satisfied under the guise of ‘Security Interest’ and the commercial wisdom of CoC prescribing the equitable treatment of creditors shall prevail in such cases.

    Conclusion

    The instant judgment gives an important observation on the issue when the commercial wisdom of the CoC in respect of the distribution of assets is challenged by the secured financial creditor. The Court while answering in favor of the commercial wisdom of CoC noted that a resolution plan under the IBC cannot be challenged by a dissenting financial creditor just on the ground that he is entitled to a higher amount based on the value of security interest. If the reasoning as contended by the appellant were to be accepted, the process will witness more liquidation than resolution with every secured financial creditor choosing to dissent. Therefore, by reiterating the principles of ‘limited judicial review’ and the ‘supremacy of the commercial wisdom of CoC’ after the approval of the resolution plan, the Court has bolstered the objectives of the IBC which is balancing the interest of all the stakeholders by maximizing the value of assets of interested persons.

  • Bar of Limitation on Arbitral Proceedings under the MSMED Act

    Bar of Limitation on Arbitral Proceedings under the MSMED Act

    By sudipta choudhury and arnav singh, fourth-year students at nalsar, hyderabad

    Introduction

    The applicability of the Limitation Act, 1963 (‘Limitation Act’) to certain statutes has been a contentious issue in India. One aspect of this issue was recently settled by the Supreme Court in the case of M/s. Silpi Industries etc v. Kerala State Road Transport Corporation &Anr. (2021) where the Court addressed the applicability of the law of limitation on arbitration proceedings initiated under section 18(3) of the Micro, Small and Medium Enterprises Development Act, 2006 (‘MSMED Act’). In holding that the Limitation Act would be applicable to the said arbitral proceedings, the Court upheld and endorsed the reasoning of the Kerala High Court in this regard, dismissing the appeal against it. This article aims to analyse the judgment and unpack its implications.

    Legal Issue

    The Court in the present case was faced with a two-fold question. Firstly, whether the Indian Limitation Act would be applicable to arbitration proceedings under section 18(3) of the MSMED Act, and secondly, whether it would be possible to maintain a counter-claim in such arbitration proceedings. This article deals with the first issue and attempts to break it down in the context of precedents surrounding it. 

    The Apex Court’s Findings


    On the question of applicability of the law of limitation to arbitration proceedings initiated under the MSMED Act, the Court noted that a perusal of the provisions of the MSMED Act indicates that in the event of a dispute arising out of a sale agreement between parties, the same shall be referred to the MSME Facilitation Council under sections 17 and 18 of the MSMED Act which lay down the ‘recovery mechanism’. Once such reference is made, it was noted that the MSME Facilitation Council is conferred with the power to initiate arbitration or conciliation or refer the matter to any other alternative dispute resolution body or institution, under sections 18(2) and (3) of the MSMED Act. In any case, the Apex Court observed that such an arbitration or conciliation arising out of the MSMED Act shall be governed by the Arbitration and Conciliation Act, 1996 (‘Arbitration Act’), as though initiated in accordance with an arbitration agreement between the parties, under section 7(1) of the Arbitration Act, or in case of conciliation, it would be applicable as though initiated under part III of the Arbitration Act.

    In addition to this, in the case of Andhra Pradesh Power Coordination Committee & Ors. v. LancoKondapalli Power Ltd. & Ors. (‘AP Power’).  the Supreme Court held that the arbitration proceedings conducted under the MSMED Act fall within the scope of the Limitation Act. The reasoning of the Court in the aforementioned case is in consonance with a plain reading of section 43 of the Arbitration Act which lays down that the Limitation Act shall apply to arbitrations, in the same manner as it applies to court proceedings. With due regard to this, the Court in the present case opined that section 43 shall survive in its operation and applicability to arbitration proceedings within the MSMED Act and accordingly, the Limitation Act will apply. Thus, the assailed judgment of the Kerala High Court was upheld, insofar as it placed reliance on the Apex Court’s reasoning in AP Power, and interpreted the impugned provisions of the three Acts to hold that the Limitation Act would be applicable to the proceedings initiated under the MSMED Act.

    Analysis

    It is important to note that despite the MSMED Act is silent about the applicability of limitations on disputes referred to MSME Facilitation Councils, the Court’s reasoning is largely hinged upon the arbitration proceedings being governed by the Arbitration Act, and thus, being subject to the operation of the Limitation Act. However, it is also pertinent to not be remiss of the fact that section 2(4) of the Arbitration Act bars the application of the Limitation Act under section 43 to proceedings initiated under an enactment. The MSMED Act, being one such enactment, gives way to a plethora of questions and confusion. The question of applicability of the Limitation Act to the arbitration proceedings under the MSMED Act has thus been mired in ambiguities that have been addressed by the Courts in a catena of decisions.

    A perusal of the initial judgments in the area shows that the Courts were faced with the question of applicability and the prevalent argument was that there were two remedies under the MSMED Act: one, before the MSME Facilitation Council and another, before a civil court. Thus, for the sake of consistency in proceedings, it was argued that if the Limitation Act is applicable in court proceedings, it shall also apply to disputes before the MSME Facilitation Councils.

    This came up before the Bombay High Court squarely in the case of Delton Electricals v. Maharashtra State Electricity Board, along with the question of section 2(4) of the Limitation Act explicitly excluding arbitration proceedings arising out of an Act from its ambit. On the first question, the Court took note of the availability of two separate trajectories under the MSMED Act, and observed that if one resolution mechanism before the civil court is subjected to the Limitation Act, while another resolution mechanism before the MSME Facilitation Council is not, it will lead to an “incongruous situation.” On the question of express exclusion of statutory arbitration, the High Court noted that the provisions of the Arbitration Act are made applicable to arbitral proceedings arising out of the MSMED Act, and no specific exception is made therein for section 43 of the Arbitration Act which lays down that the Limitation Act shall be applicable to arbitrations in the same manner as it applies to court proceedings. Thus, it was held that the provisions of the Limitation Act would be applicable to arbitrations under section 18(3) of the MSMED Act, in the same manner as they would apply to arbitrations arising out of an arbitration agreement between parties under section 7(1) of the Arbitration Act.

    Further, in AP Power, the Apex Court dealt with a dispute arising out of the Electricity Act, 2003, which provides for statutory arbitration before the Electricity Commission. The issue that arose before the Court was whether, in the absence of a limitation provision in the Electricity Act, the same had to be presumed in order to ensure uniformity with arbitral or civil court proceedings. This was so because otherwise the parties concerned stood a chance of getting enriched in a manner, not contemplated in the pursuance of an ordinary suit, due to the operation of the bar of limitation. Further, the Court noted that no right was vested through the Electricity Act that could permit claims otherwise barred by limitation. Therefore, such a claim will not survive because it is not recoverable as an ordinary suit owing to being time-barred. The Court, placing reliance on the object and the intent of the Electricity Act, further observed that “not only because it appears to be more just but also because unlike Labour laws and Industrial Disputes Act, the Electricity Act has no peculiar philosophy or inherent underlying reasons requiring adherence to a contrary view” (para 29)

    Thus, a primary view of the Court’s reasoning points to its inclination to examine the legislative intent behind an Act, in addition to the rights it seeks to confer, and the “philosophy” it follows, indicating a purposive and well-rounded interpretation of the enactment.

    In consonance with the Court’s rationale in AP Power, it is submitted that the legislative intent and the philosophy of the MSMED Act should also be taken into account while considering whether it should be subjected to the Limitation Act. A perusal of the MSMED Act’s Statement and Objects reveals that it is aimed at the expeditious resolution of disputes and legislative intervention is intended to secure an efficacious remedy for timely payment. Thus, the MSMED Act should be interpreted in a manner which allows it to facilitate timely payment to suppliers. The author submits that instead of recognising new rights which are not expressly conferred by the statute, the MSMED Act should be interpreted in a manner which allows the facilitation of timely payment to suppliers. This is in consonance with the principle that disallows claims from ordinary suits on account of being time barred, unless it is explicitly allowed in the statute. 

    Thus, it is submitted that the present case, in so far as it addresses the first issue, correctly applies the rationale laid down in the AP Power, and places due reliance on the legislative intent behind the MSMED Act, effectively bringing its objects to full fruition by ensuring that there is uniformity in the adjudication proceedings across civil courts and arbitration tribunals. It has done so by engaging in a purposive reading of the statute that allows the applicability of the Limitation Act to arbitration proceedings arising out of the MSMED Act.

    Conclusion

    The Supreme Court has laid the matter to rest by discerning the scope of the Limitation Act vis-à-vis arbitration proceedings under the MSMED Act. It has ensured that claims under MSMED Act would be subject to limitation, like any other commercial claim, while also effectuating the legislative intent of the MSMED Act, which is aimed at providing a speedy redressal of disputes. Although a welcome development, the matter remains to be a subject for debate as the question of the extent of applicability of the Arbitration Act, especially in the event of clashes with the MSMED Act, remains ambiguous. For instance, section 18(5) of the MSMED Act lays down that every reference shall be decided within 90 days, in contrast with the Arbitration Act, which stipulates the time period for passing an award as twelve months from the date of completion of pleadings under section 23(4).

    However, the Court’s reasoning in subjecting the proceedings to the bar of limitation is in consonance with the larger intent of the MSMED Act, and fits with the scheme of other civil and arbitral proceedings. Thus, it largely remains successful in settling the dispute and interpreting the provisions involved.

  • Analysis of NN Global Mercantile Pvt. Ltd. v Indo Unique Flame Ltd. vis-à-vis Doctrine of Separability

    Analysis of NN Global Mercantile Pvt. Ltd. v Indo Unique Flame Ltd. vis-à-vis Doctrine of Separability

    By Anurag Mohan Bhatnagar and Amiya Krishna Upadhyay, third-year students at NLUO, Orissa.

    Introduction

    In the case of NN Global Mercantile Pvt. Ltd. v. Indo Unique Flame Ltd. (‘NN Global’), a division bench of the Apex Court recently pronounced that an arbitration agreement would not be deemed ineffective just because stamp duty on a commercial transaction was not paid. It would be safe to see the pronouncement as a source of impetus towards creating an impartial process of arbitration in India. It pronounced that the view has become obsolete, and has to be done away with. With the onset of the particular judgment, Indian legislation has now come in similar lines with a lot of jurisdictions in the world of arbitration.

    To comprehend the legal issue at hand, the article intends to evaluate (a) the coherence of the Stamp Act 1899 (‘the Act’) vis-à-vis the doctrine of separability; (b) application of the doctrine of separability; (c) cross-jurisdictional analysis with the legislations of the USA, the UK and Singapore; and lastly, (d) conclude with suggestions on the basis of the discussion on the aforementioned elements.

    Factual Matrix of the Case

    The case raises pertinent issues with regards to the future of arbitration proceedings in India, and the importance of getting the arbitration agreement stamped as per the relevant Act. Indo Unique was a company put in for a grant for work of washing of coal to the Karnataka Power Corporation Ltd. (‘KPCL’) in an open tender, which, later awarded the Work Order to Indo Unique. Later, Indo Unique furnished Bank Guarantees in favor of KPCL. Subsequently, Indo Unique entered into a sub-contract with Global Mercantile for the process of transportation. As per the contract, Global Mercantile also furnished a bank guarantee in favor of Indo Unique to secure the stocks. Later, KPCL invoked the bank guarantee furnished by Indo Unique owing to certain disputes between the two, due to which, Indo Unique also invoked the bank guarantee furnished by Global Mercantile under the sub-contract.  

    Stamp Act- Coherent with Doctrine of Separability?

    Anyone with legal authority is required by Section 33 of the Act, “to scrutinize the instrument in front of them and determine whether it is properly stamped; if it is not, the relevant authority may appropriate the instrument and command the parties to bill the adequate stamp duty with the added penalty of five or ten times the amount of the inadequate portion”. Under Section 35 of the Act, “an unstamped instrument cannot be used as evidence or acted upon”. Section 40 of the Act entails the procedure for instruments which have been impounded. It is necessary for the instrument to be endorsed within one month of the date of impounding as per Section 42(1) of the Act. Section 42(2) states that a document that has been lawfully stamped is admissible as evidence and can be acted upon. However, the Apex Court, in SMS Tea Estates Pvt. Ltd. v M/s Chandmari Tea Co. Pvt. Ltd. (‘SMS Tea’) failed to consider Section 3 read with Schedule I of the Act which states that only an arbitration award needs to be stamped and not an arbitration agreement. The court misinterpreted the basis behind the fiction of separability and erroneously linked the arbitration agreement to that of the fundamental substantive contract.

    Finally, the court took a shift in its approach in N.N Global. The Apex Court concluded that there should be no legal hinderance in the enforcement of an arbitration agreement. This hinderance can be considered as the “outstanding payment of stamp duty” on the substantial contract. This is the reason for which the Court held that the arbitration agreement is not included as a stamp duty-chargeable instrument under the Maharashtra Stamp Act 1958.

    Inconsistent and Indeterminate Approach Finally Settled?

    The doctrine of separability was pronounced in the case of Heyman v Darwins Ltd. by the House of Lords. It held that, “an arbitration agreement is collateral to the substantial stipulations to the contract”. The application of the theory of separability of an arbitration agreement from the fundamental substantive contract into which it is incorporated presents severe issues. The Apex Court examined the rationale on an agreement of arbitration in an unstamped contract in SMS Tea.  Due to the lack of stamp duty payment, the arbitration agreement would remain void until the contract was seized and the tax and penalty were paid.

    Following the 2015 Amendment, the Apex Court revisited the issue of stamp duty and arbitration agreements under Section 11 of the Arbitration and Conciliation Act (‘Arb. Act’) in Garware Wall Ropers Ltd v Coastal Marine Constructions (‘Garware Ropers’).  When a court determines that a contract is unstamped as a result of an application under Section 11 of the Arb. Act, the Stamp Act requires the court to impound the contract and ensure that stamp duty and penalty are paid until the agreement as a whole, can be acted on. The phrase “in a contract” of Section 7(2) of the Arb. Act was provided due weightage while analysing the fundamental meaning of an arbitration agreement in the Garware Ropers case. As a result, the arbitration clause in such a contract is incompatible with separation. This particular stand was upheld in Dharmaratnakara Rai v M/s Bhaskar Raju and was also affirmed in Vidya Drolia v Durga Trading Corporation, by a division bench.

    However, the Apex Court in NN Global reverted from their previous stand and overruled the judgment in the previous cases. On the aspect of separability, it held that “an arbitration agreement is separate and different from the underlying commercial contract”. It is a contract that specifies the method for resolving disputes and can stand alone from the substantive contract. The Court further observed that non-payment under the Act was a corrigible fault; therefore, arbitration could not be postponed until stamp duty was paid. Thus, the court adopted a harmonious construction between the provisions of the Act and the enforcement of arbitration agreements. Hence, it held that, failure to pay a stamp duty on the commercial substantive contract would not make the arbitration agreement included therein null or unenforceable.

    Cross-Jurisdictional Analysis

    One of the abstract and practical cornerstones of domestic and international arbitration is the doctrine of separability. Article 16(1) of the United Nations Commission on International Trade Law (‘UNCITRAL Model Law’) recognizes the doctrine of separability and provides that “an arbitration clause which forms part of a contract shall be treated as an agreement independent of the other terms of the contract. A decision by the arbitral tribunal that the contract is null and void shall not entail ipso jure the invalidity of the arbitration clause”. Despite its limited scope, this regulation is followed by several jurisdictions. Most of the countries which have ratified the New York Convention, have accepted the idea of separability.

    In English law, Section 7 of the Arbitration Act 1996 (‘AA 1996’) enshrines the idea of separability. The theory of separability, according to English courts, “is solely intended to give legal force to the parties’ choice to settle disputes through arbitration rather than to separate the arbitration agreement from the underlying contract for all purposes”. This approach by the courts could be called partial separability in layman terms. The Supreme Court of USA recognized the concept of separability in the case of Prima Paint Corp v Flood & Conklin Mfg. Co.case.

    In the context of Singaporean arbitration, the Singapore High Court, in the case of BNA v BNB held that doctrine of separability is a “tool of arbitration law that treats an arbitration agreement as distinct from the substantive contract containing it”. In the case at hand, the High Court held that “the doctrine of separability could be used to save an arbitration agreement even where the purported defect was inherent to the arbitration agreement itself”. All in all, the judgment propounded in the NN Global case has now made the Indian arbitration regime consistent with UNCITRAL Model Law, New York Convention, and both the English as well as Singaporean jurisdictions, as far as the doctrine of separability is concerned.

    Conclusion

    The stand of various High Courts has been varied as far as the doctrine of separability is concerned. Needless to say, the Apex Court’s decision in NN Global will be welcomed by arbitration practitioners in India. As far as the foreign jurisdictions are concerned, the ruling will now be consistent with the New York Convention countries and the legislation in Singapore. The judgment in the case of NN Global has to be applied widely and practically. With the help of this ruling, the judiciary has resolved the dilemma that had been lingering owing to prior instances, and the court’s decision may be safely regarded as a stand that will benefit arbitration procedures in India.

  • The Three Musketeers of Pre-Packaged Insolvency – Transparency, Administration, and Role of the Courts

    The Three Musketeers of Pre-Packaged Insolvency – Transparency, Administration, and Role of the Courts

    By abhigyan tripathi and anmol mahajan, fourth-year students at rgnul, patiala

    Introduction

    One of the primary objectives of the Insolvency and Bankruptcy Code,  2016 (“IBC”) is to facilitate the rescue of the Corporate Debtor (“CD”) as a going concern. In furtherance of fulfilling the IBC’s legislative intent, MS Sahoo was appointed to chair a sub-committee and recommend a regulatory framework for Pre-packaged Insolvency Resolution Process (“PPIRP”). The President, on the basis of the sub-committee’s suggestions, promulgated the IBC (Amendment) Ordinance, 2021 which allows MSMEs to go for PPIRP.

    One of the ways of rescuing a corporate entity is through the PPIRP wherein the objective is to establish a balance between the creditors’ interests and the business and assets of the Corporate Debtor (“CD”). PPIRP is an insolvency procedure involving a smooth transition of its assets by the CD to the prospective buyer prior to the appointment of a Resolution Professional who facilitates the corporate restructuring. The aim of this piece is to engage in a cross-jurisdictional analysis of the aforementioned Ordinance and test its efficacy in the Indian market scenario on the basis of three parameters, i.e., transparency, debtor-in-possession methodology, and the role of the adjudicating authority.

    I. Analysing the Pre-packaged Insolvency Framework in the United Kingdom

    Following the suggestions put forth by the Cork Report, the United Kingdom (“UK”) introduced its first wave of insolvency reforms in 1986 which envisaged the concept of ‘Corporate Rescue’.[i] The second wave of these reforms was introduced when Part 10 of the Enterprise Act, 2002 revised and improved the Insolvency Act of 1986. Even though the bare texts of both aforementioned statutes do not make a mention of “pre-packaged insolvency”, the UK always has had a Debtor-in-Possession based insolvency procedure, namely the Company Voluntary Arrangement (“CVA”). The CVA is analogous to PPIRP in the sense of the same being an informal and voluntary method of going through the insolvency process. Keeping in mind the pandemic situation, the UK has made even further attempts to make the insolvency framework more “debtor-friendly” by introducing the Corporate Insolvency and Governance Act, 2020. Since a company availing the CVA is required to couple it with the formal Administration procedure for a court-ordered moratorium, it cannot be used as a tool of financial restructuring. Therefore, this Act aims at providing financially riddled enterprises a chance at informal restructuring through a standalone moratorium on adverse creditor action.

    1.1 Transparency

    Ms. Teresa Graham, CBE, an Advisor to the UK Government and a renowned accountant, was given the responsibility to carry out a review of the PPIRP practice in the UK in 2013. As a result of the same, ‘The Graham Review of 2014’ was released. As was anticipated, the review was in favour of PPIRP practice in the UK but highlighted the lack of transparency as a major concern specially for unsecured creditors. A set of voluntary measures were suggested by the review to counter the transparency issue.

    One such solution proposed was setting up a group of experienced business people called ‘pre-pack pool’. This group shall be responsible to carry out an independent scrutiny of the pre-pack sale and suggest improvements to the same. Another solution to tackle the issue of transparency, as suggested by the Review, was the Statement of Insolvency Practice (SIP) 16 that may be understood as guidance for Insolvency Practitioners to conduct Insolvency Administrations. SIP16 provides for disclosure to be made by the Insolvency Practitioners to the creditors explaining and justifying the reasons for which a pre-packaged sale was undertaken.  

    An enterprise can still go through with a pre-pack deal even if a pre-pack pool member issues a negative statement, though the same has to be reflected as per the SIP16 requirements. In case the pre-pack member issues a positive statement, it would also be referred to in the SIP16 statement. The Insolvency Practitioners’ Association adopted these voluntary measures in November, 2015.

    1.2 Administration of the CD

    In the UK, the management of the debtor company rests with an administrator who is appointed for this purpose. Such an appointment can be made (a) by the Court, (b) by the holder of the floating charge, or (c) by the company or its directors. The administrator has the primary objective to rescue the debtor company as a going concern.

    1.3 Role of the Courts/Tribunals

    The role of courts can be looked at from both a positive and negative prism. The positive aspect of court involvement will not only protect the interests of the unsecured creditors but also will act as a grievance redressal mechanism. The final stamp of the court will also provide a credible authority to the procedure. However, the negative aspect is that such an intervention of the courts is discretionary and time taking which defeats the basic purpose of a pre-packaged insolvency.

    The UK has a mixed solution to this, on one hand where the insolvency practitioner is entrusted with finalizing the pre-pack transaction, on the other hand the creditors can approach the court if they have any grievance with either the administrator or the transaction via a complaints gateway.

    II. Analysing the Pre-packaged Bankruptcy Regime in the United States

    The United States insolvency regime provides for three kinds of proceedings: pre-packaged bankruptcy proceedings, pre-arranged bankruptcy proceedings, and pre-plan sales. These procedures are an amalgamation of both out-of-court and formal mechanisms. It is therefore necessary to gauge the three procedures on the basis of the following criterion:

    2.1 Transparency

    The provisions of the US Bankruptcy Code, 1978, have been able to ensure a substantial amount of transparency through its provisions since they require approval of any resolution/reorganization plan within Chapter 11 by all the classes of creditors for bankruptcy proceedings to move forward. As per section 1123(a)(4) of the Code, every interested party in a class of creditors is required to be treated equally through the reorganization plan envisaged by the CD. To avail the benefits of flexibility within the ambit of Chapter 11, a CD has to ensure that the interested stakeholders are on board at every step and therefore cannot ignore the rights of even unsecured creditors as per section 1129(a).

    Even pre-plan sales under section 363 of the US Bankruptcy Code, though not requiring approval from all the interested stakeholders, need to be approved by the requisite Bankruptcy Court.[ii][1] In the context of section 363 sales, a bidder used to set the purchase price floor for other prospective buyers to know the minimum bidding amount is termed as the ‘stalking-horse’. The stalking-horse bidding, which is often engaged in by the debtors, helps in ensuring a proper due-diligence by the interested buyers. This has resulted in highly successful restructurings since the creditors are able to reap the benefits of high-value sale of the CD’s assets.[iii]

    2.2 Administration of the CD

    The pre-packaged/pre-arranged bankruptcy regime in the United States does not involve an automatic appointment of a Trustee (analogous to RP or Administrator in the UK) since the CD assumes the role of a debtor-in-possession and performs restructuring responsibilities while being in control of its assets under Chapter 11. A debtor remains in possession till the approval of the reorganization, dismissal of the same and subsequent liquidation proceedings (under Chapter 7) or the appointment of a court appointed trustee.

    2.3 Role of the Courts/Tribunals

    In both the pre-packaged and pre-arranged bankruptcy proceedings, the CD is required to file a Chapter 11 petition with the concerned bankruptcy court after having completed the procedure associated with voting and negotiation upon the reorganization plans. Even the section 363 pre-plan sales require the court’s stamp over the validity of asset sale. 

    There are various bankruptcy-specific courts in the United States which analyze the reorganization plans in an expedited manner. They ensure that there is no gross discrimination against any impaired class of creditors while clamping-down upon the minority dissenting creditors if the reorganization plan is fair and equitable as per the requirements of the Bankruptcy Code under section1129(b).

    Such flexible structures and procedural guidelines ensure that restructurings are successfully wrapped within two and four months for pre-packaged and pre-arranged bankruptcy proceedings as compared to 11 months for traditional Chapter 11 proceedings. Pre-plan sales under section 363 take only as much time as the auction process and the courts only require the CD to have successfully served the notice of asset sale to all stakeholders.[iv]

    Conclusion and Analysis

    Insolvency in India and the rules governing it are still at a nascent stage of development. The COVID-19 pandemic led to a complete standstill of the framework since the Central Government paused all fresh filings of insolvency proceedings. Hence, the introduction of pre-pack insolvency comes as a breath of fresh air.

    Firstly, with respect to transparency, concerns surrounding transparency in the process have not yet been addressed but the analysis of the UK and US models of pre-pack above gives valuable input. The introduction of a pre-pack pool as seen in the UK regime can be a game changer in this regard. Not only will this make the process more transparent but will also help in the corporate rescue of the debtor. Additionally, the pre-pack pool might have been even more effective in the UK, if referral to the same was mandatory. The authors believe that mandatory referral to a similar body may have been conducive for medium and large enterprises in India.

    Secondly, with respect to the administration of the CD, the recent ordinance provided for the debtor-in-possession regime, wherein unlike the CIRP, the CD is responsible for protection of its assets so that the position of the creditor is not jeopardized. One important advantage of this regime is that it will minimise the obstacles to business during PPIRP since the CD is empowered to continue running its business operations, with the express objective of working in the best interests of the creditors. It is essential to derive insight from the UK framework and mould the Indian model in a manner which lets the Insolvency Resolution Professional proceed with the implementation of the plan while giving the creditors a right to approach the court if they have any grievance with either the administrator or the transaction via a complaints gateway as is done by the UK.   

    Thirdly, as far as the role of NCLT is concerned, the procedure requires an initial application for moving forward with PPIRP before the NCLT under section 54A(1) by a CD which falls under the category of MSME. Thereafter, the NCLT has 14 days to either reject or accept the same. Furthermore, the approval of a resolution plan requires a 66% vote by value in its favour by the creditors, post which it is submitted to the NCLT for consideration. Therefore, the highly overbearing role of NCLT as per the procedure defined by this ordinance might possibly help in reducing the problem of delays and discretion which already plagues CIRP.  Therefore, the NCLT needs to adopt a fast-track approach which is similar to the one adopted by Courts in the US. Sub-tribunals specialized in dealing with insolvency matters in a more efficient fashion (as compared to the current regime) may be instituted which can make sure that restructuring plans, if in accordance with equity and fairness envisioned by the IBC, are approved and applied to successfully rescue the CD.

    Despite the Ordinance having been passed to counter the adverse effects of COVID-19 on insolvency, the expedite nature of PPIRP can potentially benefit the Indian insolvency regime as a whole. It should also be kept in mind that maximising returns from this PPIRP framework requires a great amount of transparency during the entire process to ensure that certain categories of creditors do not partake in backdoor negotiations, which might result in a win-lose position between the concerned stakeholders. The authors are of the opinion that PPIRP framework for MSMEs is a first step in a series of reforms and if implemented properly, goes a long way towards ease of doing business in India as a whole.

     

    [i] Cork Report of the Review Committee, Insolvency Law and Practice, (Cmnd 8558, 1982), para 198.

    [ii] Bo Xie, Pre-pack Approach in Corporate Rescue (Edward Elgar Publishing, 2016), 205-206.

    [iii] Ben Larkin et al, Restructuring Through US Chapter 11 and UK Prepack Administration, para 8.51.

    [iv] Ibid.