Category: Insolvency Law

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 Although it superseded the debt recovery mechanism under the Companies Act, it is essential to keep in mind that Section 230 still remains an important tool in the hands of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.

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.

2. 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.

3. 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.

4. 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 52^nd position in resolving insolvency in the Ease of Doing Business rankings and overall 63^rd 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.”

2. 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.