The Corporate & Commercial Law Society Blog, HNLU

Category: Insolvency Law

  • UK Parallel to India: Inspiration for Improvement in Insolvency Laws

    UK Parallel to India: Inspiration for Improvement in Insolvency Laws

    BY Pallavi Mishra, A FOURTH-YEAR STUDENT AT HNLU, RAIPUR

    Amidst the Covid-19 pandemic, companies have been facing an increased threat of undergoing an insolvency resolution process due to the default in repayment of loans as well as failure to abide by other statutory demands for many consecutive months now. In light of this, governments throughout the world have introduced changes in their insolvency laws to relieve companies from the stress of liquidation. The author in this article lays down the key measures taken by the United Kingdom (‘UK’) government, parallel to the status in India. It suggests the need to introduce long-term changes in the Insolvency and Bankruptcy Code which extends beyond the Covid-19 situation.

    UK Regime:

    To overcome the hue and cry surrounding t the UK Government has recently enacted the Corporate Insolvency and Governance Bill as a recovery attempt for the survival of the companies which in turn, directly impacts the employment market. This approach towards a debtor-friendly regime consists of both temporary and permanent measures.

    1. Autonomous moratorium period

    The bill proposes an autonomous moratorium period, which gets triggered not only upon the initiation of the insolvency process but also before such formal commencement. This will provide space for giving effect to the restructuring proposals which a corporate debtor may find feasible for getting new credit influx into the company. The intent behind this is to give a ‘break’ to the company from the continuous piling of monthly loans leading to an increment in the claims of the creditors. As of now, 20 days of initial moratorium has been suggested which may be extended further for another 20 days by the management of the company. The directors shall remain in control of the company during this period. However, similar to an administrator, a qualified insolvency practitioner shall be appointed as the ‘monitor’ to overlook the entire process.  While this provision gives relaxation to the loans incurred prior to the moratorium, the loans incurred during the moratorium shall remain payable after 20 days, or such extension as granted.

    1. Cross-clam down provision

    Further, the bill seeks to introduce cross-class clam down provision. This provision has its origin from Chapter 11 of the US Bankruptcy Code. In the simplest sense, it allows for the implementation of a restructuring plan despite the fact that some creditors may have expressed dissent against the provision. The provision has been meticulously enacted – the proposal for restructuring has to be submitted before the court. The court shall then direct the convening of a meeting of creditors who will vote on the plan. The threshold for approval of the plan has been kept at 75% and binding on both secured and unsecured creditors. The court will assess the alternatives, and the reasons for dissent, and may “clam-down” the dissenting votes if it is seen that the creditors may not be worse-off than if such restructuring plan was not approved. The restructuring plan must provide a “better alternative” than the option of liquidation or insolvency for every class of creditors.

    1. Demands for winding up petitions

    If any petition for winding up of a company was filed between the months of April and June (“relevant period”), pursuant to the non-fulfillment of statutory demands, such petitions shall not be given effect. It will be deemed that the corporate debtor underwent financial stress due to the Covid-19 pandemic, resulting in failure of its obligations under the statute. However, this has not been imposed as a blanket ban; meaning that if a creditor is able to rely on the balance sheets, accounts as well as the prior records to show that the company would have still undergone the insolvency process irrespective of the Covid-19 pandemic, then such winding-up petitions shall be entertained by the court as prescribed. This has been introduced as a temporary measure.

    1. Relaxation on the personal liability of directors

    The threats of personal liability on a director arising from indulgence in any wrongful trading have also been relaxed.  This is a temporary measure curbing the rights of the liquidators to take any action against the directors who continued to trade during the relevant period despite the director’s knowledge of the company’s position with respect to its future prospects. The intent is to reduce the personal liability of the directors if later the company is to face liquidation due to any liability resulting within the relevant period. However, the directors will continue to have a deemed responsibility to act in the best interests of the company. Provisions with respect to fraudulent trading and preferential transactions shall also continue to have an effect.

    Indian Regime

    While the above provisions have been introduced in the UK, parallel to these, India too has enacted an array of amendments including the promulgation of the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020. The main changes include suspension on filing of insolvency proceedings for a year as well as raise in the threshold of default to Rs. 1 Crore. While this announcement has come as a rescue call for the corporate borrowers, the creditors, lenders and guarantors will definitely have to find other solutions to overcome the delay in loan repayment. The author believes that the insolvency regime in India requires long term changes not just limited to the effects of the present circumstances.

    This quest for an alternative is also essential to reduce the backlog of cases and burden upon the Adjudicating Authority once the abeyance of the IBC is over.

    1. Pre-Packaged Insolvency Resolution Process

    To this effect, the author believes that an alternate as well as a complementary  mechanism to the Corporate Insolvency Resolution Process (‘CIRP‘) is a Pre-Packaged Insolvency Resolution Process (‘PPIRP‘) which allows for a similar outcome while leading to the achievement in a much cost-effective, simplified and a shortened manner.

    A unique benefit of the PPIRP is that it allows for a pre-planned arrangement of assets with an objective of relieving stress upon the company much before the default has actually accrued. In fact, in some jurisdictions, the company is allowed to manage its operations throughout this process and even after the default has occurred.

    The implementation of the IBC, though has shown positive results, has not particularly led to a smooth process for approval of the resolution plans. As of January 31, 2020, 3455 cases were admitted under the CIRP. Of these, only 265 could get a resolution plan approved, while 826 of them went into liquidation.  In 2019, the World Bank had put India at 52nd position in resolving insolvency in the Ease of Doing Business rankings and overall 63rd position in the Ease of Doing Business report of 2020. As far as recovery is concerned, India stands at 5%, compared to an average of 20% in the developed economies.

    Within the corporate arena, liquidation poses a major threat to any company but unfortunately is the automatic result arising out of a failure of the CIRP. To combat this issue, the PPIRP provides an additional level of protection to the corporate debtors. It is proposed that the PPIRP be introduced in a manner wherein the creditors are mandated to initiate it first. Only upon its failure should they proceed for filing of the CIRP before the Adjudicating Authority. This will allow for a caveat to introduce important changes to the plan in case it fails to get adequate votes or approval by the Adjudicating Authority at the PPIRP stage. It will also stand as a safeguard against liquidation especially in the Micro, Small and Medium Enterprises (MSMEs) wherein there is an acute paucity of investors and liquidation in fact poses a major concern. Another incentive for the creditors to indulge in a PPIRP rather than the traditional CIRP is to avoid the usual media coverage, defamation and elongated harm which is caused to the reputation of the company in a CIRP.

    A PPIRP is a viable option even through the eyes of company law as it gives a negotiating table for the formulation of lucrative proposals to the creditors and the corporate debtor. Most importantly, this out-of-court mechanism may be considered to be a “peaceful method of settling the dispute.”

    1. Other alternatives to suspension of the IBC

    The Government has inserted Section 10A prohibiting the commencement of CIRP for the defaults made by the company post March 25, 2020 for up to a year. This provision lacks enough criteria to determine which companies have actually defaulted in their payments due to Covid-19. The provision may be misused by willful defaulters in the absence of guidelines to differentiate companies who defaulted during that period but not as a result of the pandemic.

    Conclusion

    By now, it is definitely understood that the effects of the pandemic will have a huge impact on the economy and employment sector. Keeping this in view, the Government should take steps forward to enact permanent measures which will serve as a balanced approach between the creditors and the corporate debtors in the long run. PPIRP, clear categorisation of companies facing financial distress, need to introduce alternatives to suspension of the CIRP are some of the inspiration points from the UK Corporate Insolvency and Governance Bill.

  • Dissecting ‘Dispute’ and ‘Reference to Arbitration’ under Section 7 of IBC

    Dissecting ‘Dispute’ and ‘Reference to Arbitration’ under Section 7 of IBC

    By Shubham Kumar, a Fourth-Year Student at HNLU, Raipur

    In Innoventive Industries Ltd. v/s ICICI Bank the Hon’ble Supreme Court has provided the scheme of Insolvency and Bankruptcy Code, 2016 (“IBC”) with respect to a section 7 application. An application u/s 7 can be filed on the occurrence of a default and ascertainment of the same through records of the information utility or other evidence produced by the corporate debtor. Contrasting the scheme of section 7 with section 9, it was also held that a dispute regarding debt is of no relevance until it is “due”. Therefore, if the Adjudicating Authority is satisfied with the existence of the financial debt and the default, it will admit the application u/s 7(5)(a).

    Thus, a pre-existing dispute between the corporate debtor and financial creditor had no relevance for deciding a Section 7 application until the recent order of the National Company Law Tribunal (“NCLT“) Mumbai in Kotak India Venture Fund-I v/s Indus Biotech Private Limited.

    ‘Dispute’ in terms of section 7 and section 9

    According to section 5(6) of IBC ‘dispute’ includes a suit or arbitration proceedings relating to:

    • the existence of the amount of debt;
    • the quality of goods and services; and
    • the breach of representation or warranty.

    A corporate debtor may bring to the notice of the operational creditor, any pre-existing dispute between the parties. The application u/s 9 can be accepted only in the absence of a pre-existing dispute between the parties prior to the date of demand notice. The dispute can be related to an arbitration award in relation to a pre-existing dispute challenged by the parties or a dispute in relation to the amount claimed pending before an arbitral tribunal etc.

    The Supreme Court in Mobilox Innovations v/s Kirusa Software held that the Adjudicating Authority has to be satisfied only to the extent that there exists a bona fide dispute between the parties. The court is not concerned with the outcome of the dispute.

    However, while adjudicating upon an application u/s 7 the NCLT is not required to look into any pre-existing dispute between the parties. Overturning a decision of the Hon’ble NCLT, Chennai Bench where a section 7 application was dismissed on the grounds of a pre-existing dispute between parties and pendency of civil suit between them, the Hon’ble National Company Law Appellate Tribunal (“NCLAT“) in Vinayaka Exports and another v/s. M/s. Colorhome Developers Pvt. Ltd observed that only if an application is filed by an operational creditor, can the corporate debtor raise the defence of a pre-existing dispute.

    Kotak Case: A Pandora’s box to section 7?

    In the Kotak case, Kotak Private Equity Group (“Financial Creditor“) filed a section 7 application against Indus Biotech Private Limited (“Corporate Debtor”) for the failure to redeem Optionally Convertible Redeemable Preference Shares (“OCRPS“) amounting to Rs. 367,07,50,000 crores. The Corporate Debtor contested the claim of the Financial Creditor questioning its right to redeem such OCRPS when it had participated in the process of conversion of OCRPS into equity shares, including disputes raised regarding the valuation of Financial Creditor’s OCRPS and fixing of the QIPO date. The Corporate Debtor prayed before the Hon’ble NCLT to refer the parties to arbitration pursuant to Article 20.4 of the share subscription and shareholders agreement which contained an arbitration clause for resolving disputes between the parties.

    The Hon’ble NCLT held that since there exists an arbitration clause and the dispute is capable of being arbitrated, the section 7 application cannot be admitted. The said decision of the NCLT raises three-fold concerns: firstly, with regard to the NCLTs’ power to refer a dispute to arbitration in a section 7 application, secondly, the overriding effect of Arbitration and Conciliation Act, 1996 (“Arbitration Act”) over IBC and lastly, the scope for raising a dispute in an application under Section 7.

    • NCLTs’ power to refer to arbitration in a Section 7 application

    In Swiss Ribbon v/s Union of India the Hon’ble Supreme Court held that the Adjudicating Authority under IBC can exercise inherent powers given under Rule 11 of the NCLT Rules, 2016 which states that the NCLT has inherent powers to make such orders as may be necessary for meeting ends of justice or to prevent the abuse of process of the court. The inherent powers under Rule 11 are similar to the inherent power of the Company Law Board (“CLB”) under Regulation 44 which in turn is similar to the powers of the civil court u/s 151 of the Civil Procedure Code, 1909. In Union of India v. Paras Laminates (P.) Ltd. the Supreme Court has categorically held that tribunals function as court and being a judicial body, it has all those incidental and ancillary powers which are necessary to make fully effective the express grant of statutory power.

    Further, the Hon’ble NCLAT in Thota Gurunath Reddy & Ors. v/s. Continental Hospitals Pvt. Ltd. & Ors. has held that: “…it is clear that under Section 420 of the Companies Act, 2013, the National Company Law Tribunal passes an order as a ‘Tribunal’, whereas under the provisions of Section 7 or Section 9 or Section 10 or sub-section (5) of Section 60, the same very Tribunal passes an order as an ‘Adjudicating Authority’ and the same Tribunal in the capacity of ‘judicial authority’ passes order under Section 8 or Section 45 of the Arbitration Act, 1996. As the Tribunal is empowered to pass orders in different capacities under different provisions of the Act…”

    Therefore, while adjudicating upon an application u/s 7 of IBC, the NCLT ought to discharge its duty as a judicial authority, hence a reference to arbitration is not bad in law. While adjudicating an application u/s 7 or 9, the Adjudicating Authority is competent to decide upon a section 8 application under the Arbitration Act.

    • Over-riding effect of Arbitration Act over IBC

    Section 238 of IBC provides overriding effect to IBC compared to any other law for the time being in force. Section 5 of the Arbitration Act also provides for a non-obstante clause. The rules of statutory interpretation state that in case of an inconsistency arising between two special legislations, the latter enacted legislation will have an overriding effect on the previously enacted legislation. However, this is not the rule of thumb. The Hon’ble Supreme Court in Life Insurance Corporation of India and Ors. v/s D.J.Bahadur & Ors. laid down that a statute can be treated as special legislation vis-à-vis one legislation but there may be situations where the special statute will be treated as a general statute vis-à-vis another special statute. The categorisation of special or general depends on the specific problem, the topic for decision and other criteria.

    Providing a blanket overriding effect of IBC over all previous legislative enactments means going against the principles of statutory interpretation. The anatomy of the IBC is such that it does not deal with the determination of disputes and nor does it concern itself with fact-finding. The alpha and omega of IBC is to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time-bound manner for maximization of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders.  In contrast, the Arbitration Act is a complete code for resolution of disputes. The object of the code is to provide speedy resolution of disputes between the parties. Determination of rights and obligations is thus, not within the purview of IBC. Therefore, in an issue related to determination of rights and obligations, the IBC vis-à-vis Arbitration Act, would be considered as a general statute and should have no overriding effect. 

    • Scope for raising a ‘dispute’ in Section 7

    The Innoventive Industries Ltd. case itself leaves scope for raising a dispute under Section 7 of IBC. It states that where the debt is not payable in law or in fact, a section 7 application cannot be admitted. The Hon’ble NCLT in Carnoustie Management (P.) Ltd. v/s CBS International Projects (P.) Ltd. has rightly pointed out that where the loan is itself disputed, the NCLT in a summary proceeding cannot adjudicate upon the existence of the loan, and such questions shall be decided by the competent forum. In other words, the statute mandates the NCLT to ascertain and record satisfaction as to the occurrence of default, and not go into the question of rights of the financial creditor or the corporate debtor.

    Conclusion

    Section 7 of IBC allows NCLT to admit an application on proof of debt and default but it is silent on the aspect where the debt which is being shown as default, is itself disputed. The IBC does not intend to provide a recovery forum to the creditors and should be used only when there exists a debt and default which can be ascertained by the adjudicating authority through summary adjudication. The process should not be used in a manner to threaten corporate debtors and a question of creditors right to claim the amount as debt, when disputed, should be adjudicated upon by a civil court or through arbitration.