The Corporate & Commercial Law Society Blog, HNLU

Category: Insolvency Law

  • Section 69 (2) Of The Partnership Act – High Time For a Definitive Interpretation

    Section 69 (2) Of The Partnership Act – High Time For a Definitive Interpretation

    BY SHAGUN SINGHAL, THIRD-YEAR STUDENT AT NATIONAL LAW INSTITUTE UNIVERSITY, BHOPAL

    Introduction

    The Partnership Act, 1932 (“Act”) was enacted after repealing certain provisions of the Indian Contract Act, 1872. Under this Act, the registration of partnership firms has been given due relevance under Schedule VII. The same, however, has not been made mandatory by law. Even though registration under the Act is not compulsory, the absence of the same can lead to certain disadvantages. One of these disadvantages has been laid down in Section 69(2) (“Section”) of the Act. The Section states; “no suit to enforce a right arising from a contract shall be instituted in any Court by or on behalf of a firm against any third party unless the firm is registered and the persons suing are or have been shown in the Register of Firms as partners in the firm.” Although this Section has been heavily relied upon over the years, it suffers from some glaring ambiguities. In this blog post, the author, first, lays down the uncertainties in the Section and thereby asserts that the Courts, have, till date, not been able to solve these conundrums and second, concludes that the only way to reach an unambiguous solution is by amending the wording of the Section altogether.

    Applicability of Section 69(2) of the Partnership Act on insolvency proceedings

    Recently, in the case of M/s Shree Dev Chemical Corporation v. Gammon India Limited, the National Company Law Tribunal (“NCLT”) answered the question of applicability of the Section on insolvency proceedings. While rendering its decision, the NCLT stated that procedures under the Insolvency and Bankruptcy Code, 2016 (“IBC”) are, undisputedly, ‘proceedings’ under law. Hence, relying on the strict interpretation of the Section, it opined that since suits and proceedings are different in nature, the bar under this Section can only be applicable to the former i.e. suits.

    In another case of M/s NN Enterprises v. Relcon Infra Projects Limited, the NCLT, while considering the same question of law, held that the absence of the term “proceedings” in the Section itself indicates the intention of the legislature. In addition to these interpretations, the tribunals have also been of the view that Corporate Insolvency Resolution Process (“CIRP”) is not a term arising out of a contract. Rather, it is a statutory right that accrues to the IBC. Therefore, as per these cases, the bar envisaged in this Section cannot, in any case, be applicable to the insolvency proceedings.

    However, in contrast to the aforementioned judgements, Section 69(3), which is read in conjunction with Section 69(2), distinctly mentions the applicability of the bar to “other proceedings”. It states, “the provision of Section 69(1) and (2) will apply to a claim of set-off or ‘other proceedings’ to enforce a right arising out of a contract”. Earlier, the term “other proceedings”, as construed in this Section, was understood to be in relation to a claim of set-off. However, the Court, in the case of Jagdish Chander Gupta v. Kajaria Traders (India) Ltd adjudged otherwise. It asserted that the word “other proceedings” should receive its full meaning, which should not be limited to a claim of set off. Hence, as per this judgement, it is clear that the instant Section can be made applicable to insolvency proceedings. Therefore, presently, there are two differing opinions of the Courts for matters pertaining to this issue.

    However, to add on to the already existing conundrum, the Court, in the case of Gaurav Hargovindbhai Dave v. Asset Reconstruction Company (India) Limited and Another, while considering the application of Limitation Act on IBC, held that cases filed under the latter are applications and not suits. Hence, it would only attract Article 137 of the Limitation Act, 1963. By adjudging this, it ruled out the relevancy of Article 100 of the same Act, which, distinctively, is applicable to “other proceedings”. If this decision is related to the instant issue, the bar in the section cannot, in any situation, be applicable to the insolvency proceedings. Further, in case it is not applicable, no Court has provided a justification citing the reasons for the same, thereby making its exclusion to be arbitrary in nature.

    In furtherance to these complications, it might be contended that this issue, even if resolved, would only matter if the right arises out of a contract. Thus, to prove that CIRP is a right arising out of contract, it is pertinent to refer to the landmark judgement of Swiss Ribbons Pvt. Ltd. v. Union of India. The Court in this case explicitly affirmed that the creditors can ‘claim’ for CIRP when a debt is due, in the case of an operational creditor and when it is ‘due and payable’, in the case of a financial creditor. In any case, claim, as defined under the IBC, arises in cases of a breach of contract, when such breach gives rise to a right to payment. Hence, since the initiation of a claim is through a contract itself, it cannot be understood as a right accruing solely to a statute.

    Interpretation of the term “persons suing”

    The Section, as mentioned, has vaguely used the words ‘persons suing’, without acknowledging its applicability in certain situations. For instance, in a circumstance wherein a change in the partnership takes place, does it become imperative for the new partner(s) to submit their names to the Register of firms before initiating a suit ?

    The Punjab High Court in the case of Dr. V.S. Bahal v. S.L. Kapur & Co. answered this question in the affirmative. In this case, the firm was initially run by three partners. However, one of them eventually retired and a new partner had to replace him. The name of this partner, while filing the suit, had not been submitted to the Register of Firms. Accordingly, while considering the aforementioned question of law, the Court held that since all partners names were not registered, the suit, as per Section 69(2), cannot be maintainable in law. In addition to this, the Court in the case of Firm Buta Mal-Dev Raj v. Chanan Lal & Ors, asserted that the ascertainment of the word “persons” in the impugned section is deliberate in nature. This is because, singular, in certain cases, can imply plural, but it is never the other way round. In conjunction to this, it further went on to state that the plural form, in this instance, implies that all partners should be registered while filing a suit. Therefore, relying on these cases, the Courts have affirmed that the registration of all partners (new or old), while filing a suit, is mandatory in law.

    While Punjab High Court has ruled on the non-maintainability of such suits, the Patna High Court, in the case of Chaman Lal v. Firm New India Traders, has adjudged otherwise. Similar to the aforementioned case, three new partners had joined the firm, whose names were yet to be registered. Taking the same question of law into consideration, the Court held that the non-registration of their names had no effect on the maintainability of the suit. The view taken by the Punjab High Court, according to the author, is erring for several reasons. First, the Section nowhere mentions that all names of the partners have to be registered at the time of filing a suit. Hence, adjudging the same would amount to reading imaginary words into the applicable law, which thereby shall contravene the general rule of interpretation. Moreover, usage of word “persons” cannot necessarily imply all partners at the time of filing a suit. It could mean partners when the cause of action arises, or partners when the firm was formed. Hence, relying on grammar alone could result in an incorrect interpretation of the Section in toto. Second, Order XXX Rule 1 of Civil Procedure Code (“CPC”), which lays down the procedure of such suits, permits two or more of the partners to sue, as long as they represent the firm. Therefore, relying on the legislature’s wordings in this provision, the Punjab High Court’s decision, as per the author, is contrary to the law in force.

    Conclusion

    This Section, even though modelled after the English Statutes of 1916 and 1985, has used several vague terms. Due to this ambiguity, the Judges, since its enactment, have had the discretion to interpret the terms, based on their own individual understanding. It is only because of this reason that the Courts, till date, have not been able to finalise the impugned words definite reasoning. Hence, the author is of the opinion that the only way to arrive at an unambiguous position is by changing the wordings of the Section altogether. This can be implemented in two ways, first, the words “proceedings” and “applications” can be added to Section 69(2) itself. Through its addition, the Courts will be certain that the bar, as envisaged in this Section, can be made applicable to suits, proceedings as well as applications. This will further remove the irrationality behind it being made applicable only to suits, when the others, similarly, are initiated to pursue a remedy. Second, a proviso can be added, which clarifies that the non-registration of new partners will have no bearing on the maintainability of a case, as long as the original partners are registered. However, it should mention that their registration must be filed, along with the suit. The reasoning behind this is that registration in usual circumstances can take around two weeks or more, which in certain instances, can unnecessarily delay the filing of a suit. Therefore, in such situations, the non-registration of certain members should not serve as a bar for initiating a court procedure. The author thus concludes that these alterations should be made, for the long-standing conundrum to end. Otherwise, the Courts shall continue to base their interpretations on their own psyche, which ultimately shall result in unjust decisions being rendered, time and again.

  • The Future of Financial Institution Resolution Mechanisms: FRDI to Make a Comeback?

    The Future of Financial Institution Resolution Mechanisms: FRDI to Make a Comeback?

    By Anirudh Rao Saxena and Anupriya Nair, Fourth-year students at NALSAR, Hyderabad

    An air of uncertainty and impermanence surrounds the future of the Indian financial system as a result of COVID-19. On 11th July 2020, speaking at the State Bank of India (SBI) economic conclave, RBI Governor Shaktikanta Das voiced his concerns pertaining to a likely increase in cases of capital erosion and non-performing assets (“NPA”) in the banking sector, as a result of the pandemic. As a contingency response to these vulnerabilities, he proposed the setting up of a resolution corporation (“RC”) with requisite legislative support to aid in the insolvency management of financial firms.

    Chronology of Events

    The necessity to establish an RC for insolvency and liquidation proceedings of Financial Service Providers (“FSPs”) was originally observed in the controversial Financial Resolution and Deposit Insurance Bill, 2017 (“FRDI”). The late Finance Minister (“FM”), Arun Jaitley, in August 2017, launched the FRDI in the Lok Sabha. Subsequently, in August 2018, interim FM Piyush Goyal withdrew the FRDI owing to public anxieties surrounding a ‘bail-in’ clause which was put in place to combat issues of inadequate deposit insurance.

    In February 2020, FM Nirmala Sitharaman announced that although the revival of the FRDI is in the works, the Ministry of Finance cannot commit to a timeline for it to be tabled in Parliament. Currently, media reports suggest speculation around a forthcoming revised Financial Sector Development and Regulation (Resolution) Bill, 2019 (“FSDR”) in accordance with a briefing note prepared by economic affairs secretary, Atanu Chakraborty.

    A Primer on FRDI

    The prime reason for the introduction of FRDI was due to the increasing interaction between the public and the financial sector. It was owing to this very reason that the government felt a need to protect the interests of the depositors. Furthering this intention, the government introduced the contentious FRDI Bill, 2017 in the Lok Sabha.

    Presently, India lacks an all-inclusive and integrated legal framework for the resolution and liquidation of financial firms. The responsibilities and powers for resolution are dispersed amongst regulators, Courts and the Government under multiple laws. These powers are quite limited, therefore banks are typically restricted to two methods of resolution i.e. winding up of the bank or mergers. Further, the impact of failure in case of a traditional insolvency procedure is limited to the creditors of the insolvent firm, however the failures of financial providers have a much wider ramification on the economy of a country (Cypriot Financial crisis). Thus, just as the Insolvency and Bankruptcy Code, 2016 (“IBC”) has provided a comprehensive resolution mechanism for non-financial firms, the FRDI Bill aims to do the same  for financial institutions.

    What Triggered the Withdrawal of FRDI?

    The foremost trigger behind the withdrawal of the FRDI was the questionable ‘bail-in’ clause found in Section 52 of the Bill. This section allowed for, if the RC saw fit, the internal restructuring of liabilities (deposits). Moreover, further sub-sections of the clause provided for the cancellation and modification (into long-term bonds and equity) of deposits. It is notable that the extent of the powers of the RC in this regard would be applicable on deposits only beyond the insurance cover amount of INR 1 lakh. Inevitably, this clause led to apprehension among depositors owing to the possibility of being left with a mere 1 lakh in case of bank failure.

    In response to public concerns surrounding the ‘bail-in’ clause, not only the Ministry of Finance, but the late FM Arun Jaitley himself, presented the clause as a transparent means of granting additional protection to deposits. Au contraire, The Associated Chambers of Commerce & Industry of India (“ASSOCHAM”) argued against the clause, bringing focus to the dangers of diminishing trust in the banking system and of the consequent routing of public investment into unsuccessful avenues leading to the eventual erosion of the banking system. The competing objectives of the Bill, and that of the depositors, led to debate resulting in the withdrawal of the Bill.

    The Revival of FRDI in 2020: Understanding its functioning

    FRDI aims to provide establishment of a RC and a regime which would enable a timely resolution of failing financial firms. The RC will consist of representatives from all financial sector regulators (the Reserve Bank of India, the Securities and Exchange Board of India, the Insurance Regulatory and Development Authority of India and the Pension Fund Regulatory and Development Authority), the ministry of finance as well as independent members. It aims to achieve timely intervention by classifying firms into 5 categories – low, moderate, material, imminent, or critical. Determining the health of a financial entity, ensures that a timely decision can be taken before it’s classified as a weak entity and there is no other option left but to liquidate the firm.

    The liquidation waterfall mechanism sets up a priority in terms of dispersal of payments  on the occurrence of liquidation. According to the hierarchy, first priority is given to secured creditors, followed by unsecured creditors, and finally by operational creditors. Under the current regime regulated by Deposit Insurance and Credit Guarantee Corporation (“DICGC”), the deposits are insured up to INR 1 lakh  over which the deposit is treated on par with unsecured creditors. However, as per the provisions of the FRDI Bill, these uninsured deposits will be placed above unsecured creditors and Government dues. FM Nirmala Sitaraman, in her 2020 budget speech, announced that the limit for insured deposits would be increased to INR 5 lakhs. This move would ensure improved protection of the rights of the depositors since a larger sum of deposits are protected. For this transition to occur in a seamless way, the FRDI Bill would have to transfer the deposit insurance functions from the DICGC to the RC which would then result in an integrated approach to the depositor’s protection and resolution process.

    Decoding the Status Quo

    The status quo of FRDI may be ascertained from the assertions made by RBI Governor Shaktikanta Das as part of his recent speech at the aforementioned SBI economic conclave. On account of similarities between his proposal and the FRDI with respect to the suggestion to set up an RC, the re-emergence of a revised FRDI may be easily perceived.

    First, Das drew attention towards the increased relevance of resolution as opposed to liquidation of banks. He cited resolution (wherein the bank remains a going concern) as being more effective in providing depositors with a higher value of return.

    Second, the traditional merger approach often utilized to save failing banks by merging (The merger of Corporation Bank and Andhra Bank with Union Bank ) with larger banks, doesn’t provide the same return as the resolution process.

    Third, Das stressed upon the necessity to have the RC acting beyond simple implementation of corrective measures. The primary focus of the RC, as he stated, is not to correct, but to monitor, foresee and assess emerging risks as and when they surface.

    Interim Mechanism

    On 15th November 2019, the Ministry of Corporate Affairs (“MCA”) notified the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019 (“Rules”) with the objective to provide a framework for insolvency and liquidation proceedings of FSPs other than banks.

    The Rules shall be applicable to FSPs (to be notified by the Central Government) as per Section 227 of the IBC including discussions with appropriate regulators, for the purpose of conducting insolvency and liquidation proceedings within a specified time frame. It is imperative to comprehend the provisional nature of the framework provided under Section 227 as it has been set up as an interim mechanism until either a revised legislation is enacted, or the IBC is amended.

    The Way Forward

    It is important to analyze and address the position FSDR will take in its proposed reforms. The bail-in clause was problematic in the FRDI owing to the lack of coherent legal framework within which it operated. This ultimately resulted in disproportionately disadvantaging individuals while leaving the corporate and financial sectors unharmed. In order to preserve financial stability, it is essential that the new Bill is strategically designed to establish a balance between the rights of private stakeholders and public policy interests.

    The FSDR should consider including the “no creditor worse off test” in order to safeguard stakeholder interests. This move will convince investors that the bail-in provision is merely a way in which the bank buys time to restore its strength and long-term viability. This framework has been tried and tested during the 2011 Denmark financial crisis, and was advocated by the International Monetary Fund. It is of utmost importance that the bail-in framework is carefully structured to ensure effective implementation in the FSDR.

    Additionally, owing to the constant changes in the dynamics of the banking sector with various mega sector banks undergoing mergers, it would be ideal to wait until there is better clarity on the future of the banking sector before introducing a new Bill. In order to better incorporate the legislative framework of other acts with the functioning of a new Bill, multidisciplinary research should be conducted before its enactment.

  • Lifting the Suspension On Section 10 Of IBC- Need Of The Hour?

    Lifting the Suspension On Section 10 Of IBC- Need Of The Hour?

    By Chirali Jain and Chahak Agarwal, fifth-year students at NLU, Jodhpur

    In a recent development, a PIL has been filed by Mr. Rajeev Suri in the Delhi High Court, challenging the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 (‘the Ordinance’) by way of which applicability of section 10 has been suspended for a period of 6 months owing to the current pandemic. The petition challenges the Ordinance as it suspends the operation of sections 7, 9 and 10 of the Insolvency and Bankruptcy Code, 2016 (‘the Code’), depriving the corporate applicant of the ability to initiate the Corporate Insolvency Resolution Process (‘CIRP’). Following submissions have been made through the petition to challenge the suspension of the aforementioned provisions:

    a. Such suspension in these extraordinary times is “irrational, arbitrary, unjust and mala fide” as it stops a corporate applicant from exercising its statutory rights.

    b. It will push the companies towards liquidation, discourage entrepreneurship and defeat the objectives of the Code.

    c. Suspension is ultra vires Articles 14 and19(1)(g) of the Constitution of India.

    d. It would result in further deterioration of the affairs of the corporate debtor and result in making the restructuring/ revival of the corporate debtor unviable.

    The Delhi High Court has issued a notice to the Union Ministry of Law and Justice and Insolvency and Bankruptcy Board of India on July 28, 2020 and sought a reply till August 31 in the matter. 

    Background

    The current pandemic has impacted small and large businesses in various sectors across the economy. The Government, in an attempt to provide some relief to the distress caused by the pandemic, introduced a slew of changes to the insolvency framework of the country. 

    On June 5, 2020, the President promulgated the Ordinance with immediate effect. The Ordinance introduced section 10A to the Code, thereby effectively suspending the operation of sections 7, 9 & 10 and consequently section 14 of the Code with respect to defaults arising on or after March 25, 2020 for a period of six months, extendable up to a maximum period of one year from such date as may be notified. The proviso to section 10A also bars any insolvency application from ever being filed, for any default occurring during the Suspension Period. 

    Sections 7 and 9 of the Code, allow filing of an insolvency application against the corporate debtor, by a financial creditor and an operational creditor, respectively, when a default occurs above the threshold limit. Section 10, on the other hand, allows corporate entities to voluntarily file an insolvency application against themselves, where a default has occurred. By giving the corporate debtor the right to approach the adjudicating authority for initiation of CIRP, this provision affords the defaulting entity a chance to revive themselves through the resolution of debt. However, by suspending the applicability of this section, the Ordinance, despite having the aim of protecting corporate entities from creditors, does considerable harm to the corporate debtor.  It takes away the much needed resort, available to the corporate debtor, to subject itself to an insolvency proceeding for resolution of debt or revival of the entity. Moreover, the inability of creditors to file insolvency applications against intentional defaults or for debts that are not linked to Covid – 19, may further impede the flow of financial resources to the commercial sector in India. That said, the Ordinance does not render the corporate debtors and creditors remediless as there are other remedies available to them which are discussed later in the post. By way of insertion of section 66(3), the Ordinance also seems to exempt liability of directors or partners of corporate debtors in case of potential losses to creditors during the exemption period, due to lack of due diligence. However, this may provision may be misused and lead to further deterioration of realisable value for creditors.

    It may be observed that the Ordinance protects companies and promoters from liability arising due to no fault of their own. However, the position regarding the liability of promoters is still not clear, owing to the fact that proceedings can still be initiated against personal guarantors.  

    Implications Of Suspension Of Section 10

    The rationale behind suspending the applicability of section 10 is not clear. Suspending the applicability of section 7 and Section 9 may be seen as a necessary or a justifiable move in order to revive economic activity and provide temporary relief to companies under severe distress caused on account of the Covid-19 pandemic and the national lockdown. However, suspending section 10 has sparked massive debate as move may cause more harm than the intended benefit. This provision has been used as a tool for companies to opt out of the market in times of extraordinary financial distress. This refusal of freedom to companies during this uncertain period acts as an impediment to the fulfilment of the spirit of the Code.

    Suspension of section 10 is further detrimental to companies under huge financial distress, whose value of assets is deteriorating rapidly and their only viable option is to file for insolvency. Instead of enabling quick sale of assets so as to realise some value, suspension of this provision will only lead to more problems. A huge influx of insolvency applications could further impede the capital flow of the economy and can bring unexpected economic disruptions during COVID-19 when  ideally the target should be to get the capital flow moving. This move can also affect India’s position in the context of Ease of Doing Business which has been the guiding light for a lot of changes introduced by the government recently.

    The suspension also deprives the corporate debtor from exercising the fundamental rights guaranteed under the Constitution. Article 19(1)(g) of the Indian Constitution guarantees every citizen the right to practise any profession, or to carry on any occupation, trade or business. Rights to carry on a business also include rights to start a business, right to continue a business and right to close a business.

    In Excel Wear V. Union of India, the Supreme Court held that the right to carry on any business also provides an inherent right to close the business as no person can be compelled to carry on the business in case of losses or other circumstances. The act of the government to close the exit route for the corporate debtor by striking off section 10 of the Code is infringing the fundamental right provided to the corporate debtor under Article 19(1)(g) of the Constitution of India. Moreover, this would only result in keeping the industry alive forcibly to suffer the pain until it collapses.

    However, the right to close the business comes along with reasonable restrictions as per Article 19(6) of the Constitution. The Court while considering this right has to take into account the background of the facts and circumstances under which the order was made, the nature of the evil that was sought to be remedied by such law, the ratio of the harm caused to individual citizens by the proposed remedy and to the beneficial effect reasonably expected to result to the general public. It will also be necessary to consider in that connection whether the restraint caused by the law is none than was necessary in the interests of the general public. Here, it is important to note that keeping Section 10 operational would not harm the creditors or any other stakeholders in any manner, thereby not violating public interest.

    The Way Forward

    The Ordinance has taken the corporate debtor to the pre-IBC era and uses alternative remedies which would defeat the whole purpose of the enactment of the Code. Some of these remedies are application under Section 230 of the Companies Act, 2013, application for recovery of money under Civil Procedure Code, applications under SARFAESI before DRT, bank negotiated restructuring, etc. 

    However, even after resorting to these alternative remedies, they would still be less efficacious as the insolvency proceedings under the IBC because (i) the corporate debtor would still be liable to pay through the restructuring of debt despite being in a dubious position; (ii) the benefits of moratorium on legal proceedings would not be available; and (iii) it would have a low binding effect.

    An alternative option could be the introduction of pre-packaged insolvency schemes, which are already prevalent in the UK and the US, as an aid to the current insolvency framework. An exception may also be created under the Code with respect to section 29A of the Code, in order to allow promoters to participate in pre – packaged schemes who have defaulted due to economic reasons stemming from the pandemic.  

    It will also be beneficial to take a look at the approaches being followed in various countries such as the UK, Australia and Singapore. These countries have managed to keep the doors open for voluntary insolvencies while suspending any action by creditors against the companies in case of default. In UK, wrongful trading provisions of the Insolvency Act have been suspended,  effective from 1 March until 1 June 2020. This change seeks to remove the threat of directors incurring personal liability for ‘trading while insolvent’ during the pandemic. In Australia, due to the provision of voluntary insolvency proceedings, Air Mauritius, second largest airline of the country filed for insolvency. In Spain, companies can file voluntary bankruptcy applications, and in case of pending declarations on voluntary bankruptcy applications, judges might declare insolvency if waiting for too long might cause irreparable damage. Further, Singapore has provided relief by introduction of moratorium against commencement of insolvency of only an affected debtor.

    Therefore, it is the opinion of the authors that while suspending section 7 and section 9 is justified, suspending section 10 is an extreme step and is not in accordance with the inherent spirit of the Code. 

  • IBC Ordinance: A Double-Edged Sword for MSMEs

    IBC Ordinance: A Double-Edged Sword for MSMEs

    BY JUBIN MALAWAT AND BHAVYA KALA, SECOND-YEAR STUDENTS AT RGNUL, PUNJAB

    Introduction

    CoVID-19 has created worst ever recessional conditions in the markets worldwide leaving everyone in distress. In light of the prevalent market conditions and the anticipated future contraction in the market, the government of India has introduced a few stabilizing and corrective measures keeping in mind the vulnerability of the Micro, Small and Medium Enterprises (‘MSMEs’) in these challenging times. One of the best examples of the measures adopted by the Union Government is the vision of making India self-reliant, ‘Atmanirbhar Bharat’. The government has also introduced a few changes in the Insolvency and Bankruptcy Code, 2016 (‘IBC’) with an intent to safeguard the MSME sector from the leash of CoVID-19 and improve the ease of doing business.

    Although the intent of the government behind the promulgation of ordinance dated 5th June 2020 was to amend the IBC to provide some breathing space to the MSME sector, the measures have had some unintended effects on the sector. This piece analyses the impact of the recent ordinance to amend the IBC on the MSME sector and highlights the gaps which are to be bridged. Bridging of these gaps would not only make MSMEs sustainable in the times of economic downturn but also help India become ‘Atmanirbhar’. 

    Highlights of the ordinance introducing sec. 10A to the IBC:

    1. Suspension of S. 7, 9 and 10 of the IBC for default arising on or after 25.03.2020 till 25.09.2020 and extendable up to 25.03.2021.
    2. No new application shall be allowed to initiate fresh CIRP from 25.03.2020 for a minimum period of 6 months extendable up to 12 months as and when notified.
    3. No application shall ever be filed for the initiation of CIRP of a corporate debtor concerning any default arising during disruption period starting from 25.03.2020.
    4. An application seeking initiation of fresh CIRP shall be allowed only if the following two conditions are fulfilled:
      • The default arose before 25.03.2020.
      • The said default amount is greater than Rs.1 Crore. 

    Impact on MSME Sector

    Micro, Small and Medium Enterprises, as defined in S. 7 of MSMED Act 2006, contribute significantly to the economy of the nation. It employs around 111 million people and accounts for approximately 48% and 28% of the nation’s export and GDP respectively. Hence, it is clear the MSME sector remains the backbone of the nation’s economy and deserves to be protected in these unprecedented times. The legislators with a similar intent promulgated an ordinance amending the IBC but the letter didn’t seem to match to the authority’s intent.

    Recent changes in the IBC, including the rise in the default threshold under S. 4, suspension of S. 7, 9, and 10, and insertion of the proviso in S. 10A providing blanket protection to the debtors defaulting during the disruption period starting from 25th March have raised debates as to whether the ordinance helps MSMEs or harms them. Owing to the recent ordinances, MSMEs have been impacted in two ways, i.e. being a creditor and being a debtor.

    MSMEs being the Operational Creditors

    As per the study by the Brickwork Ratings, MSMEs have approximately Rs.303 lakh crore of their funds stuck with large corporates in the form of receivables. Hence, it can be asserted that MSMEs play a vital role in the economy being operational creditors to the large corporate houses. In the times of CoVID-19 when the whole economy is struggling to escape from the rippling effect over the economy, it becomes all the more important to ensure that the smaller firms contributing to the nation’s economy on such a large scale are duly paid back.

    • Suspension of S. 9 adding to the plight of MSMEs

    The un-amended IBC framework facilitated negotiating leverage to the smaller firms against the mighty corporates as the MSMEs could enforce S. 9 of the IBC to recover their dues in a time-bound manner. But the recently introduced ordinance, although passed to provide breathing space to the distressed firms, has made the MSME firms helpless by disabling them to invoke insolvency proceedings for the recovery of their dues. In numerous cases, it has been that the corporate houses, fearing wide-ranging ramifications, settled their debts against the smaller firms after the application for insolvency proceeding was filled but before the same was taken up by the tribunals.

    According to the data provided by the Insolvency and Bankruptcy Board of India, up to March 2020, 157 applications for corporate insolvency resolution process were withdrawn under S. 12A of the IBC, of which 64 cases involved amounts less than Rs.1 crore. The reasons for early withdrawal of cases were full settlement with the applicant and other settlement with creditors.

    Now under the garb of amended IBC framework, the corporates who earlier feared harsh consequences of the insolvency proceedings would now fearlessly strong-arm the smaller firms by defaulting the repayment of their dues. Furthermore, the redressal forums other than NCLT fail to provide timely redressal adding to the plight of the creditors.

    • Proviso incentivizing corporate debtors to default

    Apart from the above-stated problems, the proviso in the newly introduced S.10A has placed the MSMEs in a vulnerable position by allowing complete amnesty to the corporate debtors who default during the disruption period. The expression “no application shall ever be filed” has opened the flood gates of varied interpretation.

    Recently, the Hon’ble National Company Law Tribunal, Chennai Bench in Siemens Gamesa Renewable Power Private Limited v. Ramesh Kymal interpreted the proviso to S. 10A and held that there shall be no insolvency proceedings ever against the defaults which arise after 25.03.2020. This interpretation allows an exemption to the defaulting debtors whether or not such default has arisen due to the economic downturn in the times of the pandemic.

    If such an interpretation is taken up, it would incentivise the non-payment of dues by the corporates and would lead to the MSMEs turning up into non-performing assets. In these trying times when the economy is struggling to move out of the rippling effect, fall of MSME sector would adversely impact the nation’s economy. Among other things, a decline in MSME sector would cause a steep rise in the unemployment rate and set off India’s ambition of becoming self-reliant. 

    MSMEs being the Corporate Debtors

    Objectives of IBC include maximization of the value of assets, to promote entrepreneurship, availability of credit and balance the interests of the stakeholders. In consonance with the objectives, S.10 facilitates an exit route to a corporate debtor wherein the loss-making business is transferred to a prospective resolution applicant based on a resolution plan to revive the sick enterprise. The resolution plan is sanctioned by the adjudicating authority keeping in mind the interests of all the stakeholders.

    Blanket suspension of S.10 defeats the core objective of the IBC to revive and not to liquidate the enterprise. Suspension of the section would lead to a slow death of the business enterprises which could be revived with a prospective plan. The ordinance would not only deprive the corporate debtor of rehabilitating the business but also force him to continue the distressed business. This would not only deplete the value of assets rather than maximizing them but also lead to the winding-up of a potentially viable business.

    Conclusion

    In the testing times of this pandemic, although the government has tried to modify the provisions of the IBC with a bonafide intention to provide safeguard to the MSMEs, it has ended up worsening the situation for them. The recent ordinance adding S. 10A in the IBC and the notification has created loopholes which would act against the interest of the MSMEs. These would make the smaller businesses vulnerable in the hands of larger corporates.

    Furthermore, these additions and modifications to the IBC would act as a barrier for MSMEs to pull off under the government’s “Atmanirbhar Bharat” initiative. The liquidity crunch faced by the MSMEs owing to the suspension of S. 7 and 9 of IBC would compel the MSMEs to avoid further payments of their debtors and undergo unnecessary litigation which would certainly raise the burden of the MSMEs in the near future. Moreover, blanket suspension of S. 10 of IBC will destroy every hope of reforming viable MSMEs.

    Keeping in mind the flickering market conditions and the upcoming competition in domestic as well as international market, more focused actions are called for on the part of the authorities. As pointed out by the Hon’ble Finance Minister in her press note, a special insolvency framework needs to be introduced under S. 240A of IBC accompanied with other focused initiatives. This would not only provide leverage to the MSMEs against the powerful corporates but also help India holdup its ambition of self-reliance.

  • Suspension of IBC: Is India ready for pre-packaged insolvency?

    Suspension of IBC: Is India ready for pre-packaged insolvency?

    by Swapnil singh, a student of fifth year at rmlnlu, lucknow

    Implementation of Insolvency and Bankruptcy Code, 2016 (“IBC”) has shown favorable outcome with India’s rank improving from 136 to 108 in 2018 to 52 in 2019 in the ‘Resolving Insolvency’ bracket of the Ease of Doing Business ranking, released by World Bank. IBC has exponentially reduced the time taken for an insolvency resolution. However, in the current crisis and lockdown, the resolution process will undoubtedly suffer an inexorable delay.

    The Central Government’s decision to suspend any fresh filing under Section 7, 9 and 10 for next six months which may be extended up to a year is seen as step in the positive direction but the fact that instead of solving a lot of issues, it is putting them on a back burner which will ultimately lead to a greater number of cases and increased burden on the Tribunal.

    Considering this and the persistent resolution delay in cases under IBC by NCLT, without any alternative mechanism for resolution of distress could lead to rapid depletion in asset value and huge losses for a number of stakeholders. Pre-packs are seen as a desirable solution to be incorporated to solve this issue and there are certain issues which will pose a challenge to smooth implementation of pre-packs within the existing regulatory system.

    The concept of pre-packaged insolvency

    Pre-packaged insolvency, often referred to as “pre-pack sale”, has been defined by the Association of Business Recovery Professionals (a trade association for the United Kingdom’s insolvency, restructuring, advisory, and turnaround professionals) as “an arrangement under which the sale of all or part of a company’s business or assets is negotiated with a purchaser prior to the appointment of an administrator and the administrator effects the sale immediately on or shortly after his appointment”. It is different from traditional bankruptcy because in a case of a pre-pack the restructuring takes place prior to filing of application before the adjudicating authority.

    With the suspension of IBC, it becomes pertinent that alternative solutions to address the stress in the system be explored and pre-packs are a promising option due to its strongly built around the tenets of value preservation and timely resolution, which form the lifeblood of any insolvency law. In the Indian scenario, if introduced, it will be a subset of the existing pre-insolvency resolution instruments therewith providing financial creditors and corporate debtor a platform to negotiate in advance on the resolution strategy of the corporate debtor with the advice of an Insolvency Professional, before the filing application under IBC.

    The possibility of pre-packs to be introduced under IBC has always been a topic of debate in the Bankruptcy Law Reforms Committee (BLRC) and it was advanced that Indian market is not developed enough to go for pre-packs. However, NCLT has time and again recognised that the corporate insolvency resolution proceeding(“CIRP“) is broad enough to include a discussion and negotiation done beforehand, about the resolution plan. In the case of Essar Steel Ltd an objection was raised on the that application for commencement of CIRP pointing out that admitted Essar was already negotiating with its lenders. NCLT rejected the objection stating that these negotiations can later become basis of resolution plan under IBC. It is pertinent to note that in Lokhandwala Kataria Construction Pvt. Ltd. v. Nisus Finance and Investment Managers LLP, the Supreme Court used its power under Article 142 of the Constitution to accept the out of court settlement for the benefit of all the stakeholders and for meeting the ends of justice. 

    India has taken some steps in the direction of outside restructuring when Reserve Bank of India introduced Bank-led Resolutions through Prudential Framework for Resolution of Stressed Assets wherein a bank can try resolution before formally filing for insolvency but it only covers RBI-regulated creditors. The Ministry of Corporate Affairs has also invited comments from stakeholders regarding the introduction of pre-packs in India.

    Challenges in India

    Introduction of pre-packs in India will require developing a robust jurisprudence to address the number of challenges that will arise thereafter. To safeguard and protect interest of each stakeholder while maintaining transparency, following challenges will have to be worked upon:

    Role of Insolvency Resolution Professional and Shield of Moratorium

    Currently under IBC, Interim Resolution Professional (“IRP”) is appointed as soon as the application is admitted and is given the responsibility to manage the business of the debtor during the whole CIRP process. However, during a pre-pack process, the role of IPR will be performed by the debtor as he would ensure that interests of all stakeholders are taken into consideration similar to the ‘Debtor-in-Possession’ concept in US. There have been a lot of objections regarding debtor managing the whole process without any interference from NCLT.

    A shield of moratorium helps the debtor once proceeding is started under Section 7 and Section 9 of IBC. In absence such an automatic stay on the legal proceedings for pre-pack under IBC, nothing would stop the creditors from approaching the tribunal at any stage of the negotiations. This will put the company in a vulnerable position as the creditors can enforce their rights and remedies anytime while the corporate debtor is negotiating a pre-pack resolution.  

    Involvement of Promoters

    One of the reasons for the directors of a corporate debtor to undertake a pre-pack is to regain control of its business or assets, however, under a different identity. It is arguable that this roundabout manner of regaining control of the debtor company can result in circumvention of the insolvency laws. This concept is very popular as ‘phoenixing’ in the UK. This can raise a problem in cases where the company is facing huge losses primarily due to promoter or managerial inefficiency.

    Pre-packaged insolvency is a debtor-initiated process by a go-ahead company in distress which is willing to negotiate with its lenders, before the initiation of a formal CIRP under Section 7 or 9 of the Code. Hence, Section 29A of the Code will not be applicable as it to the pre-packaged insolvency process. Therefore, taking into consideration the aforementioned premises, it may be inferred that if a provision similar to Section 29A is made applicable to the entities willing to go for pre-packaged insolvency, it may tend to defeat the very objective of such a scheme as it would act as a barrier in a pre-pack process where the debtor is mainly in charge of management and negotiations.

    Lack of Cooperation and Sale of Assets

    Pre-packs are supposed to work on a degree of cooperation from side of both the corporate debtor and the creditors. The management of the debtor having the control of the process, if doesn’t share all the information with the creditors or if creditors are unable to come together due to their varied interest, it will be difficult to come to a conclusion.

    Further, sale of assets by debtor to another company before filing insolvency application can be one of the tools of pre-pack restructuring. The earning from these sales goes to the creditors, this helps in keeping the company afloat without any hassle arising due to dilution of assets’ value or loss of clientele. Sometimes due to contractual terms, creditors possess the right to give consent before debtor can dispose-off any asset. If the creditors become apprehensive, either in the divestment or because of the fact that the debtor is facing bankruptcy, it will jeopardise the whole process. Moreover, unsecured creditors will be left outside the picture, having absolutely no say in the matter as they wouldn’t have any contractual right.

    Lack of transparency and the plight of Operational Creditor/ Unsecured Creditors

    Pre-pack processes are usually confidential and do not involve open bidding process. These arrangements are usually agreed by the management of the corporate debtor and, therefore, there may be a possibility that the interests of the management and the secured creditors will be placed at a higher pedestal than that of the unsecured creditors/operational creditors. The independent Graham Review Report into Prepack Administration of June 2014 noted that the “lack of transparency disenfranchises creditors, especially unsecured creditors particularly where the purchase is being made by a connected party.”

    The potential harm of lack of transparency also comes into picture if undervalued transactions are involved. The wealth maximisation model focuses on the idea that creditors would prefer a system that keeps the size of the pool of assets as large as possible. This raises real doubts about the objective of wealth maximisation owing to the lack of transparency and open marketing of the business. There may also be instances where the business of the corporate debtor may be transferred to entities without keeping in mind the interests of the creditors or other stakeholders.

    Such a transaction would not carry the seal of approval of a court (unless the same is undertaken as a court approved scheme such as a scheme of arrangement under the Companies Act, 2013) and would, therefore, to that extent, be open to challenge by creditors if they were to object to such a transaction and require clawback, which is a safeguard provided to creditors under the Code. IBC provides for a claw-back in cases where any transactions are found to be preferential, undervalued, extortionate or undertaken to defraud creditors. An avoidance application is filed before the NCLT for appropriate relief, including for the transaction to be set aside.

    Conclusion

    With the suspension of any fresh filing under IBC, it is time to strengthen the outside restructuring process in India. This will make sure that instead of piling up of cases, there will actually be timely resolution of any insolvencies and bankruptcies. Pre-packs will have far reaching impact on corporate rescue in India but it has to be done with correct implementation, keeping in mind the Indian market and stakeholders. It is pertinent to note that this model has been there in the UK and the US for quite some time, for this reason there needs to be an in-depth study of both the jurisdictions to see what lessons can we learn from them.

    The system does come with its own challenges but if implemented well, it will help in smoothening the resolution plans while promoting the idea of keeping company as a going concern. This will help in retention of jobs and repayment of dues to the creditors. With the current ongoing crisis, it is safe to assume that it will have far more benefits and yield more fruitful outcomes.

  • One Size Does Not Fit All: Effect of the IBC Ordinance on the Airline Industry

    One Size Does Not Fit All: Effect of the IBC Ordinance on the Airline Industry

    By Vatsalya Pankaj and Likhita Agrawal, third-year students at MNLU, Nagpur

    The COVID-19 outbreak has caused great economic predicament, with many financial institutions and companies on the verge of bankruptcy. With the backdrop of the nationwide lockdown, the Indian government has introduced an ordinance suspending provisions of the Insolvency and Bankruptcy Code (‘IBC‘) to protect the industries from the effect of the pandemic. The airline industry is among those worst hit due to the current situation. Although the ordinance seeks to protect the interest of companies, it may cause an unforeseen impact on the creditors.

    The current condition can be demystified as a no output; still interest, sort of scenario in many cases. The companies have obligations towards their creditors and the prevalent recrudescence makes them unable to meet their financial requirements in terms of the value of money on the credit sanctioned. If this continues, then it could bring the business entity in a state where its liabilities exceed its assets. The same is perilously known as the concept of Insolvency.

    Thus, to provide a cushioning effect for vulnerable industries, the President of India promulgated an ordinance adding Section 10A to the IBC. The section essentially suspends Sections 7, 8, 10 and 14 of the IBC for a period of at least six months (extendable up to a year) from 25 March 2020. Through this ordinance, the Government has provided for a blanket ban of any Corporate Insolvency Resolution Proceedings (‘CIRP’) against any company. It aims to provide some relief to the corporate debtors by preventing the creditors from initiating any form of resolution process against the company. This provides the company with some breathing space to get things back in order which were disturbed because of the pandemic.

    The suspension of CIRP provides for a variety of consequences on the different sectors of the economy, in particular the airline industry. The researches shall be attempting to trace how the finances of the airline industry work and what would be the consequences of the suspension of IBC on this industry.

    The Peculiarities of Airline Industry

    The Aviation Industry is one of the worst affected industries due to the spread of COVID-19 as it has resulted in the grounding of flights both locally and internationally. The Ministry of Civil Aviation had suspended all flight operations on the 24th of March, 2020 to prevent the spread of the epidemic. The Aviation Sector has always been high risk- high return. However, even the most successful airlines are under the threat of bankruptcy. Kingfisher Airlines and Jet Airways serve as examples having gone insolvent, while Air India is struggling to survive. With ever-increasing operational costs coupled with rising fuel prices, there is evidence that operating a consistently profit-making airline is a tough business. Further, reference can be made to an IATA report  (‘Report’) which estimated the losses that the airline industry has suffered globally, due to the COVID-19 pandemic which is expected to be around $84.3 billion in 2020.

    The main assets of airlines are their aircrafts. However, airlines in India are modelled around sale and leaseback transactions. If we analyse the data, airlines in India are rarely ever owned by the airline operator, they are majorly leased from international companies such as Avolon (62), Aircastle (30), BOC Aviation (24) & BBAM (29).

    Lease agreements in the aviation sector work with the principle of “come hell or high water” i.e. the lessee must pay the lessor the charges for the aircraft in all circumstances, without exceptions. It may be argued that in such cases, the defense of force majeure can be claimed to defer the payment of the lease. However as most of the lease agreements are modeled around Common Law, there is no direct assumption of force majeure. To not follow the contract, it must be proven in a court of law, that the situation precluded the performance of the contract. This implies that airlines need to approach a court of law, prove that the current situation provides substantial grounds to them to not follow the lease payment dates and then defer the payment. Thus, it would seem that airlines have no option but to pay the lessors for their aircrafts albeit they may be grounded.

    It is an established principle of aviation law that if the lessee is in possession of the aircraft, the lessee holds the responsibility to pay for it along with the responsibility of maintaining it as per the manufacturing standards and other regulations that may have been set to preserve the airworthiness of the aircraft.[1] Thus, despite no income, the airline would have to pay the dues to the lessors. Additionally, they have to maintain the aircraft up to airworthy standards and incur other expenses to maintain their fleet and crew.

    All of this comes in the backdrop of the fact that most of the airlines had a tough previous financial year with passenger demand decreasing and increasing prices. The pandemic has only worsened the problem. India’s carriers may have to make requests to their respective lessors for deferral of payments till they can make ends meet. However, that is entirely dependent on a host of factors including the airline’s creditworthiness, future business framework, past payment history with the lessor, present financial situation and the competency to pay deferred rentals in the future.

    With the current situation in mind and estimations that air travel demands, would fall significantly in the months succeeding the lockdown airlines undoubtedly, would like to reduce their fleet size. Most lease agreements do provide for the option of invoking “Early Termination Option” or ETO. It means that the lessee will terminate the contract before the due date and return the aircraft to the lessor. However, considering the principles on which lease agreements are made, this option is usually coupled with a hefty fine on the airlines, thereby meaning, that it becomes economically non-viable for the lessee to do so.

    With all the problems culminating into one, the major airlines in the world including those in India are on the verge of bankruptcy. There is the option of bailing out the airline industry. This would require providing economic support to the industry so that it can make ends meet in the short run. This can be done through an economic package which may include tax exemptions, and waiving off landing and parking charges at airports. The Government may also follow the example of the United States and directly infuse cash into the industry. Airline enthusiasts might argue that there is an urgent need to bail out the industry, but keeping in mind Air India’s struggles wherein the Government has already signed off crores in debt, pouring public funds into the already struggling industry would not be advisable or indeed viable.

    The Ramifications of the Suspension of IBC

    The airline industry suffers because of the pandemic and mounting losses makes the situation seems grim for the industry. Further, as most aircrafts are leased from foreign countries, the provisions of the Cape Town Convention govern the lease agreements. The aircrafts which are owned by foreign companies and leased in India, would be deemed to be “International Assets” and India’s international obligations would mandate the return of the aircraft if the lessor demands.[2] The return of aircrafts would render airlines with insufficient aircrafts to operate when air traffic rises again, limiting their chances of recovering losses. This would also lead to excess ground and flight crew and would eventually lead to layoffs in the company. There would be a domino effect and one thing would lead to another, thereby harming the airline industry as a whole.

    In the given scenario restructuring of debts under IBC is required. The ordinance, pose a series of problems to the airline industry as the option of approaching the NCLT for default in payment of lease dues is no longer available.

    Before the IBC came into force, most of resolution and liquidation proceedings were carried out through Sick Industrial Companies (Special Provisions) Act, 1985 and the Companies Act 1956 which were subsequently repealed.[3] Section 230 and 231 of the Companies Act, 2013 (‘Act‘) provides for the arrangements of the companies as an alternative to IBC. However, Section 230 and 231 of the Act does bind all the creditors of the debtor and hence does not serve the purpose.

    The ordinance, however, precludes what would have been best for the airline industry by adding Section 10A to the IBC. It imposes a blanket ban on all Insolvency Proceedings and does not allow creditors to initiate CIRP. While this would have been positive for the national context, but as most lessors are international parties, they would have the right to retake the aircraft. Thus, the airlines would be forced into a situation where the lessors are likely to demand repossession of aircraft which has often been allowed by Indian Courts.[4] This is an unwanted scenario and harms the industry as a whole and it would lead to unintended consequences as discussed above. It is up to the industry to wither the storm and get through this crisis.

    [1] Bunker D H, International Aircraft Financing, Volume 2: Specific Documents (1st edn, IATA 2005) 123.

    [2] Matthias Reuleaux & Morten L. Jakobsen, ‘The De-registration of Aircraft as a Default Remedy in Aircraft Leasing and Financing Transactions’, (2015) 40(6) Air & Space L 377.

    [3] Nithya Narayanan, ‘Aircraft Repossession in India: Turbulence ahead, Buckle up’ (2013) 38 Annals Air & Space L 445.

    [4] Awas 39423 Ireland Ltd. v. Directorate General of Civil Aviation, 2015 SCC OnLine Del 8177; Corporate Aircraft Funding Co. LLC v. Union of India, 2013 SCC OnLine Del 1085.

  • Why Lenders are Withdrawing Applications under the IBC and Opting for One-Time Settlement?

    Why Lenders are Withdrawing Applications under the IBC and Opting for One-Time Settlement?

    By Nitya Jain, a fifth-year student at NLU, Jodhpur

    Introduction

    There has been a rising trend of the corporate debtor and the creditor settling their claims out of court after initiating a formal insolvency proceeding in the National Company Law Tribunal (“NCLT”). This has been made possible due to Section 12A of the Insolvency and Bankruptcy Code, 2016 (“IBC”) which provides for withdrawal of insolvency applications. An aggrieved party first files an insolvency application against the corporate debtor in the NCLT but thereafter realises that a private settlement is more feasible and withdraws the application. In fact, data from Insolvency and Bankruptcy Board of India (“IBBI”) shows that out of the 142 cases closed in the second-half of 2018, 63 had been withdrawn under Section 12A. This is 45 percent of the total insolvency cases closed. Thus, it is relevant to understand the laws governing withdrawal of insolvency applications.

    The withdrawal of the application can be done at various stages of the insolvency proceedings. It can be withdrawn before it’s admission by the tribunal, after its admission, before the setting up of Committee of Creditors (“CoC”) or after the CoC has been set up. It can be withdrawn even after the invitation for expression of interest has been issued and the resolution plan has been made. The laws applicable at each stage differs and the approvals required change. These can be divided into four stages.

    Stage 1: Before the admission of the application

    Before the coming of Section 12A, applicants relied on Rule 8 of the Insolvency & Bankruptcy (Adjudicating Authority) Rules, 2016 to withdraw their insolvency applications. This rule provides for “withdrawal of application on a request made by the applicant before its admission.” The term ‘before its admission’ is of relevance here. In Mother Pride Dairy India v. Portrait Advertising & Marketing , the NCLT acknowledged that a private settlement had been reached between the applicant and the corporate debtor. But it held that the application cannot be withdrawn once it has been admitted by the tribunal. The rationale for the same was that other creditors are entitled to raise their claim after the admission of the application and the proceeding has become in rem. Similarly, in Lokhandwala Kataria Construction v. Nisus Finance and Investment Managers LLP, it was held that irrespective of the settlement between the applicant and the corporate debtor, the matter cannot be closed till the claim of all the creditors is satisfied by the corporate debtor.

    Stage 2: After the admission of the application but before the constitution of CoC

    Section 12A of the IBC was introduced via an amendment to provide a mechanism for withdrawal of application after it has been admitted. In order to protect the interest of all creditors, a safeguard was added in the provision whereby such withdrawal is possible only with the approval of ninety percent voting share of the CoC. Here a doubt arises as to what will happen in a case where the application has been admitted but the CoC has not yet been set up. Can such an application be withdrawn? If yes, how?

    This riddle was solved by the Hon’ble Supreme Court in Swiss Ribbons v. Union of India in January 2019, where it stated that “We make it clear that at any stage where the committee of creditors is not yet constituted, a party can approach the NCLT directly, which Tribunal may, in exercise of its inherent powers under Rule 11 of the NCLT Rules, 2016, allow or disallow an application for withdrawal or settlement…….”

    Consequently, in July 2019, an amendment was made in the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016  (“Regulations”) to accommodate a pre-CoC situation. Accordingly, Regulation 30A (1) (a) of the Regulations provides that before the CoC has been constituted withdrawal may be made by the applicant through the interim resolution professional.

    Stage 3: After the constitution of CoC

    Section 12A will simply apply and the application can be withdrawn provided that such withdrawal is approved by ninety per cent of the CoC. This has to be read with Regulation 30A (1) (b) of the Regulations which states that withdrawal after the constitution of the CoC has to be made by the applicant through the interim resolution professional or the resolution professional, as the case may be.

    Stage 4: After the issue of invitation for expression of interest

    Once the CoC has been set up, the next stage in the insolvency proceeding is invitation for expression of interest. It is an invite to the general public whereby those interested in submitting resolution plans for the corporate debtor can do so. Initially, Regulation 30A of the Regulations did not allow withdrawal of application after issuance of invitation for expression of interest. However, the judiciary still allowed the withdrawal in various cases overlooking the regulation and acting in pragmatic economic terms.

    The Supreme Court in the case of Brilliant Alloys v. Mr. S. Rajagopal  held that the insolvency application for can be withdrawn even after issuance of invitation for expression of interest. The rationale for doing so was that the out of court settlement was more beneficial for all the stakeholders involved. It was considered prudent to ignore the Regulations in this matter to ensure maximum economic benefit to the parties.

    Eventually, the Regulations were amended and the withdrawal of insolvency application was allowed after the issuance of invitation for expression of interest provided there are reasons justifying such withdrawal.

    The judiciary went one step further in the matter of SBM Paper Mills and allowed withdrawal even after the resolution plan was accepted by the CoC. The NCLT acknowledged the value that the one-time settlement was offering the parties which was much better than the resolution plan. However, the tribunal also cautioned against such withdrawals and stated that withdrawal at such a later stage of insolvency proceedings must be discouraged.  Such withdrawals waste the time of the court as well as of the insolvency resolution machinery. Accordingly, the NCLT awarded high costs as a deterrent.

    Conclusion

    Settlement has been sought time and again by creditors in lieu of insolvency proceedings under IBC. Although IBC provides a time limit for resolution of insolvency, it is rarely followed and cases get stretched for more than 500 days which is almost double of the time limit provided in the IBC. In light of this, many lenders opt for withdrawing their application and choose to settle outside court with the debtor. For instance, in January 2020, the Union Bank of India withdrew a couple of insolvency petitions and opted for settlements with the defaulting companies for a much better realisation. The reason for the same was that the bank had not seen any successful resolution for cases referred by it to the NCLT. In a statement the MD and CEO of the United Bank stated that looking at the kind of value that lenders are getting through NCLT and the time taken for resolution, the preferred route is settlement with the corporate debtor. 

    It can be concluded that the judiciary is allowing withdrawal of applications filed under IBC where such withdrawal is economically advantageous to the parties. This practice is in line with the central theme of the IBC i.e. maximization of economic benefit for the lenders. However, it also raises an important question about the effectiveness of IBC in providing maximum fiscal relief.

  • An Inevitable Collision Under The Insolvency Code

    An Inevitable Collision Under The Insolvency Code

    BY PALAK AGRAWAL AND VISHESH JAIN, third-year students at nluo, odisha

    Introduction

    The National Company Law Appellate Tribunal [‘NCLAT’] in its recent decision of SBI v. Metenere held the substitution of Insolvency Resolution Professional [‘IRP’] under the Insolvency Bankruptcy Code 2016 [‘Code’] to be valid. The question dealt with the possibility of unfair and biased Corporate Insolvency Resolution Process [‘CIRP’] since IRP appointed was an ex-employee of the creditor. The author attempts to test the NCLAT judgement against the various provisions of the Code, which is identified as creditor centric, therefore leading to inevitable collision.

    Background of the Case

    In the case of SBI v. Metenere, the Resolution Professional [‘RP’] appointed by the Committee of Creditors [‘CoC’] was an ex-employee of one of the financial creditors i.e., State Bank of India and was also drawing pension from it. M/s Metenere Ltd., the corporate debtor objected to such appointment based on apprehension of bias. The point of deliberation before NCLAT was whether the appointment of an ex-employee of a creditor as RP would render the CIRP process unfair and biased? The NCLAT held that substitution of RP is valid on the basis of apprehended bias. The Adjudicating Authority while dealing with the aforementioned issue acted beyond its jurisdiction and certainly overlooked the literal rule of interpretation.

    Analysis

    • Overstepping of Jurisdiction by the NCLAT

    Entry 8A of the First Schedule of the IBBI Regulation 2016 mandates RP to disclose any association with the financial creditors to the CoC, thereby leaving his appointment on the discretion of the CoC. However, any party to the CIRP aggrieved by the compliance of this provision can approach the Insolvency and Bankruptcy Board of India [‘IBBI’] under Section 217 of the Code. The IBBI is the appropriate authority to take any disciplinary action against the irregular conduct of the RP. A reading of Section 217 elucidates that IBBI shall be the proper authority deciding irregular conduct of the RP, instead of Adjudicating Authority. Therefore, a decision by the Adjudicating Authority on apprehended biasness of the RP, lacks  jurisdiction.

    • Apprehension of Bias

    NCLAT while formulating its decision relied on ‘real danger’ test of apparent bias. The real danger test traces back its origin in the English case of Regina v. Gough, wherein the House of Lords laid the test in term of real danger than likelihood. The court opined that the merits of the case should lead to possibility rather than probability. In the Indian context, the Supreme Court in Kumaon Mandal Vikas Nigam Ltd. v. Girja Shankar Pant also opined, that the surrounding circumstances must be collated and then a conclusion must be drawn, to ascertain that whether there is a mere apprehension of bias or real danger of bias. In the instant case, IRP appointed was merely a pension drawee from the creditor and was not on a panel vested with any decision-making power. Even at a later stage, if the IRP is appointed as the RP, there are certain limitation on the power of RP which require prior approval of the CoC. Therefore, the Adjudicating Authority did not examine the charges of biasness based on any evidence and adopted a lower threshold for determination of biasness.  

    • Disregard to Literal Rule of Interpretation

    Under Regulation 3(1) of IBBI (Insolvency regulation for corporate person) 2016, the IRP shall be eligible to be appointed as RP, if he is independent of the corporate debtor. A bare perusal of Regulation 3(1) shows that it does not prohibit the appointment of RP if related to any party other than the corporate debtor. However, in the present case, NCLAT held the appointment of the RP to be wrong, due to his relationship as ex-employee with the financial creditor. The said finding appears to be inconsistent with the literal rule of interpretation as reiterated by the apex court in Kanai Lal Sur case. In this case, it was held that if the words used were capable of one construction only then it would not be open to the court to adopt any hypothetical construction that is more consistent with the present act. The NCLAT, therefore, on the apprehension of bias took the path inconsistent with the established principle of law and propounded a new judicial principle.

    • IRP/RP as the Custodian of the Corporate Debtor

    IRP/RP acts as a custodian to the corporate persons undergoing CIRP. It has been reiterated by tribunals and courts that the role of IRP/RP is not merely supervisory but also of a negotiator between the creditors and the corporate person to assess and formulate a plan which is best suited for the corporate debtor in keeping his business as a going concern.

    Section 18 of the Code provides for the statutory duties of the IRP which includes carrying every task that is crucial for bringing the insolvency process in motion and collating information on all assets, operations, finance of the corporate person and taking control over the same until the RP is appointed. IRP after assessing the financial position of the corporate person constitutes a CoC under Section 21 of the Code. Once the CoC is constituted, RP under Section 25 of the Code takes over the activities as performed by IRP and carries out further processes involved in a CIRP like preparing information utility and inviting prospective Resolution Applicants. Apart from this, Entries 5 to 9 of the IBBI Regulations provides for the Code of conduct for impartial and independent conduct of the RP.

    Therefore, it is clear from the aforesaid reading, that IRP/RP plays a quintessential role in the whole process of reviving the corporate debtor through CIRP. The IBC scheme and the IBBI Regulation mandates the RP/IRP to be impartial and independent, otherwise it will defeat the very purpose of the Code, which is to balance the interest of all the stakeholders involved in the process.

    • Supervision of CoC over the duties of RP

    During CIRP, the appointment of RP is put-forth before CoC which in its first meeting appoints either the IRP or any other person of their choice as RP by majority ratification of 66%. Apart from this, the CoC is also empowered to change the appointed RP at any point of time during the CIRP process by the majority of 66%. This section makes it significantly clear that the appointment or removal of the RP is directly in the hands of CoC. Putting it differently, if Adjudicating Authority does not endorse the RP as selected by the CoC, then the CoC by the majority vote of 66% can appoint the same person. Therefore, the very independence given to IRP/RP remains to be ambiguous, as its appointment, as well as its removal depends on the CoC. Therefore, the NCLAT’s judgement clearly poses a question on independence of RP.

    Apart from the power of appointment and removal, the CoC oversees and ratifies all the functions undertaken by the RP. Besides, the CoC is called upon to consider the resolution plan vetted and verified by the RP and the RP is not required to express his opinion on matters within the domain of CoC to approve or reject the resolution plan. Therefore, every decision by RP regarding the selection of a resolution plan or liquidation has to be aligned with the commercial wisdom of the CoC. Furthermore, it is a settled principle that RP cannot challenge the commercial wisdom of the CoC unless it is against the very purpose of the Code i.e. it does not balance the interest of all the stakeholders concerned.

    Therefore, it is no harm to mention that a biased action taken by the RP towards CoC at the stage of CIRP has a negligible scope of being checked or corrected. This leads to a bias and may prove to be detrimental towards the corporate debtor. Thus, making RP more dependent on CoC, therefore leading to loss of independence in decision making power.

    Conclusion

    In conclusion, the NCLAT’s decision in Metenere emphasises on the independence of the IRP/RP in order to conduct CIRP in an unbiased and fair manner. But once the Adjudicating Authority assumes the power to adjudicate upon the appointment of IRP/RP, this will open the Pandora box inviting challenges against every appointment and nomination of IRP/RP by the corporate debtor which is against one of the objectives of the Code i.e. the timely completion of the insolvency process.

    Lastly, the author believes that the objective of the Code can be truly achieved when the RP/IRP performs its duties without being influenced by CoC. But it is almost impracticable for the IRP/RP to work independently in the current arrangement of the Code, as the CoC overlooks the appointment as well as functions of the IRP/RP. Therefore, a shift towards institutionalising the appointment of IRP/RP will help break the chain between CoC and IRP/RP and will enable them to work in a more fair and unbiased manner. The aforementioned case has been appealed in Supreme Court and hence, positive changes which align with the Code are awaited.

  • IBC And The Homebuyers’ Debacle: One Step Forward and Two Steps Back

    IBC And The Homebuyers’ Debacle: One Step Forward and Two Steps Back

    BY srihari gopal and vedant malpani, fourth-year students at GNLU, gandhinagar

    In the latter half of the last decade, the Real Estate (Regulation and Development) Act, 2016 (‘RERA’) and the Insolvency Bankruptcy Code, 2016 (‘IBC’) have arguably been the two most revolutionary legislations in India. While IBC replaced a broken system of corporate resolution and restructuring under disparate laws with a comprehensive self-contained code, RERA introduced accountability to the opaque real estate sector, which over the years had gained infamy for its severe delays, irregularities and unfair practices. The legislations also provide for the constitution of two regulatory bodies, i.e. the Insolvency and Bankruptcy Board of India (‘IBBI’) and the Real Estate Regulation Authority respectively to protect the interest of the stakeholders. Over the years, RERA and IBC have come to be recognized as complementary legislations. However, their interplay has resulted in significant overlapping issues which cannot be ignored.

    So far, the biggest issue concerning the two legislations has been the result of a recent amendment to the IBC in March 2020 (‘the Amendment’), which has left the homebuyers nearly remediless. This Amendment takes the homebuyers, who were only recently recognized as creditors under the IBC, a step backwards. The amendment’s constitutional validity has been challenged, and on 15th June 2020, the Supreme Court (‘SC’) has ordered the government to respond to the petitioner’s claims.

    Before delving into the issues with this Amendment and the judgement, it would be relevant to briefly touch upon the status of homebuyers under these legislations over the years.

    Position of homebuyers under the IBC before 2018

    Under Section 2(d) of the RERA, a homebuyer is an allottee who acquires a property through sale, transfer or otherwise but does not include a tenant. Before the enactment of RERA, a homebuyer had no remedy against a real estate developer to receive a monetary compensation in case of default and had to resort to the Consumer Protection Act (‘CPA’). Even after enactment of RERA, there were no provisions for a time-bound resolution, which left homebuyers in dire need of an effective, speedy remedy.

    Prior to the 2018 Amendment to the IBC, homebuyers could not file for insolvency of real estate developers as there was no clarity as to the nature of debt owed to a homebuyer. Since the IBC classified debts as either operational or financial in nature, homebuyers, whose transactions were in the nature of a ‘sale and purchase’, did not fall under either categories.

    The issue of classification of homebuyers under IBC resurged  in decisions like Nikhil Mehta v. AMR Infrastructure, where the NCLT Delhi considered that homebuyers could be brought under the definition of financial creditor due to the nature of their transactions having the ‘commercial effects of a borrowing’. Further, in Chitra Sharma v. Union of India, the Supreme Court   attempted to protect the interest of homebuyers by appointing an Advocate on Record to represent their interest in the Committee of Creditors. Nonetheless, courts could only grant limited protection without a change in legislation.

    Further, it became all the more important to resolve this issue, considering that once an insolvency petition is initiated, a moratorium under Section 14 of the IBC is imposed on all legal proceedings, including those under the RERA (essentially leaving homebuyers out of the process). It was in this light that the IBC Amendments of 2018 and 2020 were introduced.

    Issues with the 2020 Amendment: You can have an apple, but you cannot eat it

    Through the 2018 Amendment to the IBC, homebuyers were recognized as financial creditors, with the amount owed to them coming within the definition of a financial debt having the commercial effects of a borrowing. This came as a huge respite to homebuyers, who often made substantial investments into real estate projects, both in terms of loans and EMIs. The Amendment also survived a constitutional challenge in the decision of Pioneer Urban Land and Infrastructure Ltd. and Anr. v. Union of India and Ors.

    Due to the extraordinary number of appeals brought forth by real estate developers challenging the 2018 Amendment, another amendment was introduced in 2019 through an ordinance, which was later inserted in the IBC by an amendment in March 2020. It introduced a minimum threshold for initiation of insolvency proceedings against a builder, requiring that an application for corporate insolvency resolution process should not be filed by less than 100 or 10 per cent of all homebuyers in a project, whichever was lesser. It was also stated that the threshold limit had to be complied with within 30 days of the promulgation of the ordinance. This was largely unfair to the homebuyers, as before this Amendment even a single homebuyer, with a claim of Rs.1 lakh or more could move to NCLT against the defaulting developer. The Amendment placed homebuyers in a disadvantaged position as compared to other financial creditors who were not subject to such a requirement. The constitutionality of this Amendment was challenged before the Supreme Court in the case of Manish Kumar v. Union of India & Anr. At present, the matter is sub-judice.

    In this case, homebuyers have challenged the Amendment claiming that it has rendered them remediless under the IBC. They further contended that the Amendment is unfair, arbitrary and in violation to Article 14 and 21 of the Indian Constitution due to unequal treatment of similarly placed creditors. Interestingly, the idea of a similar threshold was already rejected by the Supreme Court in the Pioneer case, which makes it all the more confusing as to why the amendment was introduced in the first place. The SC, in this case, stated that the objective of keeping the threshold limit at Rs. 1 lakh was to specifically enable small financial creditors (homebuyers) to trigger the Code just like other similarly placed financial creditors such as banks and financial institutions to whom crores of money may be due.

    The threshold requirement has been subjected to critique in several other instances. Mr. T.K. Rangarajan, a Rajya Sabha MP and a member of the Standing Committee of Finance, had written a letter to the chairman of the Committee citing his concerns with the minimum threshold requirement. In his report, he alleged that (a) the legislature has been influenced by a strong lobby of builders in introducing the Amendment, (b) it is unfair to homebuyers, having individual claims of more than the minimum threshold of Rs. 1 lakh (now Rs. 1 crore), as unlike other operational and financial creditors, they cannot file an proceed against defaulting builders without fulfilling the minimum threshold requirement, (c) it is unreasonable to expect the homebuyers to unite for the purposes of an application when they are unaware of each other in most cases, and (d) there is no such requirement placed on other similarly placed financial Creditors, such as creditors who are a part of a joint lenders scheme.

    The Insolvency Law Committee released a report in February, 2020 in an attempt to justify the threshold. The primary reasons stated were that (i) the threshold was imposed so that an application is filed only in the collective interest of the homebuyers (ii) even if an application under the IBC fails for want of the threshold, alternative remedies under RERA are still available, (iii) undue pressure will be exerted on the corporate debtor for even ‘minor disputes’ without the threshold and (iv) RERA disputes are heavily contentious, and this will be a set-back on the time-bound RERA process.

    None of these reasons justifies the requirement. Undermining claims of single homebuyers as ‘minor issues’ irrespective of the claim they are owed is unfair and arbitrary, considering that homebuyers often invest their life savings or incur significant debt in real estate purchases. In fact, the requirement of the minimum threshold will only make the disputes more contentious, considering that homebuyers, with their limited resources, now have to not only gather information about other homebuyers by themselves but also consolidate their individual claims to file the insolvency application, all within a span of 30 days. Further, as discussed above, though the remedies in RERA and the IBC are concurrent, IBC provides the more time-bound and efficacious solution. Therefore, the mere existence of another remedy is no excuse to limit homebuyers’ rights under the IBC.

    Conclusion

    The ailing real estate sector has been drastically hit due to the pandemic. Many experts from the industry have shown concern about the severe reduction in demand in the housing sector. It is also forecasted that homebuyers are among the ones who are going to be the most affected, as real estate constructions have come to a standstill due to the nationwide lockdown imposed by the Government. With the subsequent costs being expected to exponentially increase, it can be reasonably expected that the number of cases relating to insolvencies in the real estate sector will also rise considerably once the IBC comes back into force. This makes it all the more important to provide expansive protections to homebuyers.

    We believe that the current amendment leaves homebuyers without any effective recourse under the IBC. Corporate debtors are already protected against bogus applications through the new increased thresholds under Section 4 of the IBC. The amendment is therefore nothing but an unnecessary obstacle. However, in case the amendment is found to be constitutional, the RERA should be amended to devise a mechanism for homebuyers to be aware of other homebuyers involved in the project. However, the legislature should primarily consider repealing the amendment completely, considering that the Supreme Court had already struck down the idea of such thresholds before.

  • While IBC Takes a Nap, Could Scheme of Arrangement Rise to the Occasion?

    While IBC Takes a Nap, Could Scheme of Arrangement Rise to the Occasion?

    By Harsh Kumra and Divyanshi SrivastavA, fourth-year students at amity law school, Delhi

    The ongoing pandemic has resulted in a situation that the world has never seen before. While its cause is still unknown to us, its effect is not. Reports suggest that the global economy was undergoing turbulence since 2019, and now, in the wake of COVID-19, the risk of global recession is high.

    To this end, the Indian government has taken a number of policy reforms to limit the economic impact of this pandemic. One of the key reforms has been to put Insolvency and Bankruptcy Code, 2016 (‘IBC’) in abeyance via the IBC (Amendment) Ordinance, 2020, by suspending Sections 7, 9 and 10 for a period of six months to one year. Given such circumstances, it is only obvious that the companies will need an alternative to restructure their debts and make their way out of the distress.

    Debt restructuring laws have been in existence for more than a century now. In this respect, Section 230 of the Companies Act, 2013 (‘Act’) prescribes for a scheme of arrangement (‘SOA’) or compromise between the company and its creditors or between the company and its members. This provision was part of its preceding Acts of 1913 and 1956 as well; however, the process failed to meet the crucial requirements of a rescue mechanism, as it was a protracted procedure, too expensive and complicated to be effective where speed and urgency were required.1

    Resultantly, to address these problems and to change the regime of insolvency laws, IBC was enacted in the year 2016. Although it superseded the debt recovery mechanism under the Companies Act, it is essential to keep in mind that Section 230 still remains an important tool in the hands of companies, its creditors and other members.

    Interplay-Section 230 and IBC

    The primary focus of IBC – a beneficial legislation, since its birth, has been to revive and continue the corporate debtor,2 and therefore, during the suspension of certain provisions of the Code, its alternative mechanisms ought to achieve the same objective.

    The Hon’ble NCLAT, in a number of cases such as S.C. Sekaran v. Amit Gupta, directed the liquidator appointed under the IBC, to take steps in terms of Section 230 of the Act for the revival of the corporate debtor before proceeding with the liquidation of the company.

    Further, in the case of Y. Shivram Prasad v. S. Dhanpal, the Hon’ble NCLAT held that the SOA should be in consonance with the statement and object of IBC. Further, it was highlighted that the Adjudicating Authority can play a dual role, one as an Adjudicating Authority in the matter of liquidation and the other, as a Tribunal for passing orders under Section 230 of the Act.

    Key Differences

    To understand the utility of Section 230 during the suspension of IBC, it is important to understand the key differences between the two mechanisms.  SOA, being one of the oldest and worldly renowned debt recovery mechanisms, has primarily been used in large and complex transactions. It is an important tool at the behest of a company, while on the other hand, IBC is a creditor driven process. Wherein Section 230 can be used both in cases of solvent and insolvent companies, Corporate Insolvency Resolution Process (‘CIRP’) under IBC can be triggered only when there is a debt and subsequently a default of the same.

    Firstly, IBC provides that the Adjudicating Authority shall declare a moratorium after admitting an application under Sections 7, 9 or 10. Where, Section 14 of the IBC highlights moratorium as mandatory, automatic and of wide nature, the structure under Section 230 of the Act, excludes any moratorium provision. Although, under its erstwhile Act of 1956, Section 391(6) provided for a court discretionary moratorium but even so, its ambit was not as wide as that under the IBC. Nevertheless, the NCLT has inherent powers under Rule 11 of the NCLT Rules, 2016 to make such orders as may be necessary for meeting the ends of justice. This means that the NCLT may impose a moratorium to give proper effect to the Section 230 mechanism. In the case of NIU Pulp and Paper Industries Pvt. Ltd. v. M/s. Roxcel Trading GMBH, the Hon’ble NCLAT on the basis of its reasoning that “the Tribunal can make any such order as may be necessary for meeting the ends of justice or to prevent abuse of the process or the Tribunal,” stated that the NCLT has inherent powers to impose moratorium even before the start of CIRP.

    Secondly, under the IBC, Financial Creditors play a significant role throughout the CIRP and in approving the resolution plan. The committee of creditors comprises only of financial creditors and it is only after a resolution plan gets 66% votes that it gets approved.  On the other hand, SOA incorporates a more inclusive approach, where, Section 230(6) requires consent of every class of creditors, wherein each class is required to approve the scheme separately by the requisite majority of 75%.

    Thirdly, as to who can propose the schemes, as per Section 230 of the Act, the liquidator, a creditor, or class of creditors, or a member, or class of members can propose a scheme. Further, once the scheme gets the sanction of the court, it becomes binding on the company and all its members, even those who voted against the scheme (Re: ITW SignodgeIndia Ltd.). Under the IBC on the other hand, a resolution applicant can submit a resolution plan, for the insolvency resolution of the corporate debtor.

    In this respect, Section 29A was introduced by the Insolvency and Bankruptcy Code (Amendment) Act, 2017 to make certain persons ineligible to submit a resolution plan. Consequently, a promoter of the corporate debtor is barred from being a resolution applicant. However there is no such restriction on persons proposing a scheme of compromise or arrangement, resulting to ample amount of debate on the question of applicability of Section 29A of the IBC on SOA.

    Though NCLAT had given two contradicting decisions in respect of applicability of Section 29A to SOA, (R. Anil Bafna v. Madhu Desikan; Jindal Steel and Power Limited v. Arun Kumar Jagatramka) the debate was settled in January, 2020, through the amendment made to Regulation 2B of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016. A proviso was added to the effect that a person ineligible under Section 29A shall not be a party to a compromise or arrangement under Section 230 of the Act.

    Fourthly, where, under the IBC, once a company is liquidated, Section 53 prescribes a ‘waterfall mechanism’ according to which the proceeds from the sale of liquidation assets of the company are distributed in the prescribed order. It must be noted that the same is not applicable to SOA. It follows a different approach in terms of distribution of proceeds. There is no straitjacket formula under the Act for this distribution, however it is upon the court to check if the distribution is fair and equitable and that creditors have been treated on an equal footing (Re: Spartek Ceramics India Ltd.).

    Lastly, Section 31 of the IBC has circumscribed the judicial review by NCLT only to the approved resolution plans. The scope of judicial interference is restricted to the assessment of factors under Section 30(2), which requires the plan to conform to the prescribed criteria. Further, in Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta, the Supreme Court clarified that the commercial decisions taken by the Committee of Creditors are outside the scope of judicial interference. 

    Contrary to this, the NCLT has wide powers in terms of SOA. The scheme can be made binding on the creditors only after it receives the sanction of the court. In the cases of Miheer H. Mafatlal v. Mafatlal Industries Ltd. & Re: Spartek Ceramics India Ltd., it was held that the court has extensive powers to see if the scheme is just and reasonable.

    The way forward

    The Indian judiciary and the legislature have played an important role in appreciating the IBC. If appropriate steps are not taken at this moment, then all the hard work done over the years can go in vain. SOA has been a well-known restructuring instrument globally, and with IBC under suspension, making proper use of Section 230 would undoubtedly be necessary.

    Although, the process of SOA varies from the process given under IBC, with the incorporation of key changes in the provision, it can certainly create an IBC like outcome. This provision within the Act being a more collective process and predicated upon the “debtor-in-possession” regime, would also provide the creditors, the opportunity to work with the already existing management of the company.

    However, the process also being more complicated in terms of creditor approval would require certain relaxations and/ or alterations in that respect. In such a case, an important alteration within the schemes would be the introduction of an automatic interim moratorium, like that under IBC, to provide a relaxation period to the company. This interim moratorium could be further confirmed by the NCLT once the tribunal is satisfied with the schemes brought in.  Moreover, since SOA is by and large a judicially driven process; efforts must be made, to make it more voluntary in nature, as this will help in solving the issues of prolonged delay that has often been witnessed and will also reduce the burden on judiciary.

    Additionally, this is also the right time to introduce some basic tweaks in Section 29A of the IBC, such as adopting a middle ground, wherein, the promoter could be permitted to bid for the corporate debtor but with sufficient safeguards that also protect the interests of the creditors.

    These changes can play a significant role in the debt restructuring mechanism and in the revival of Section 230 of the Act, making it a viable alternative to IBC.