The Corporate & Commercial Law Society Blog, HNLU

Tag: Insolvency Law

  • NCLT’s Departure: Reviving Time-Barred Claims in Insolvency Proceedings

    NCLT’s Departure: Reviving Time-Barred Claims in Insolvency Proceedings

    By Navya Bassi and Rhythm Goel, fourth-year students at NLU, Odisha

    Introduction

    Recently, the Mumbai bench of National Company Law Tribunal (‘NCLT’) in Gokul Anilkumar v. Shailesh Bhalchandra held that claims that are time-barred can get revived by Corporate Insolvency Resolution Process (‘CIRP’). It laid down that even though remedy is restricted, right cannot be negated. The facts of this case were that CIRP was initiated against Maharashtra Theatres Private Limited, who was the  debtor. A claim was filed by Creditor alleging a financial debt arising out of a term loan facility of Rs. 55 crores.  An application was submitted by the suspended director of the debtor to dismiss the creditor’s claim contending that the debtor’s account was declared as a Non- Performing Asset (‘NPA’) prior to the date of default, rendering the claim to be barred by limitation. The bench addressed two pertinent questions- admissibility of claims that are barred by limitation and ‘one time settlement’ as an acknowledgement of liability to resume the limitation period . The author seeks to analyse whether the bench has gone a bit too far and deviated from well settled position of law.

    Position Prior To This Judgement

    The Report of the Insolvency Law Committee in March 2018 stated that the enforcement of the Insolvency and Bankruptcy Code, 2016 (‘IBC’) was not to suit the interests of the creditors who failed to exercise the available remedies under the pre- existing laws within the prescribed period.

    In 2018, the Supreme Court (‘SC’) in the judgement of B.K. Educational Services Private Limited v. Parag Gupta relied on this report to derive the legislature’s intention of not giving an opportunity to present time- barred claims. It has been made explicitly clear by sections 7 and 9 of the IBC that the creditor can seek CIRP only for debts that have not crossed the limitation period.

    As held by the SC in Andhra Pradesh Power Coordination Committee & Ors v. Lanco Kondapalli Power Limited & Ors., it was not the intention of the legislature to enable a creditor to revive dead claims through the route of the IBC. Section 3 defines debt as “a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt”. This was interpreted by the court as debts that are “due and payable” in law.

    Section 238A of the IBC was inserted through an amendment to explicitly state that for any proceeding before the Adjudicating Authority, the provisions of the Limitation Act, 1963 (‘Limitation Act’) shall be applicable to the proceedings. On the question of retrospective applicability, the SC in Thirmalai Chemicals Limited v. Union of India held that in essence, limitation is procedural and would be applied retrospectively.

    The interpretation of section 18 of the Limitation Act has been a contentious issue. This provision stipulates that if there is a written acknowledgment of liability before the specified period lapses, a new limitation period starts from that acknowledgment. However, the Supreme Court’s ruling in Babulal Vardharji Gurjar v. Veer Gujjar Aluminium held that section 18 would not apply to applications for initiating insolvency proceedings under the IBC. National Company Law Appellate Tribunal (‘NCLAT’) relied upon this contradictory decision for some time until clarity was provided in the case of Laxmi Pat Surana v. Union of India., wherein, the court affirmed that section 18 of the IBC should not be disregarded if circumstances necessitate its application. The court elucidated that if the debt or the responsibility to pay has been acknowledged by the principal borrower or the corporate debtor, new statute of limitations begins from the date of such acknowledgment, as long as it transpires before the expiration of the existing limitation periodTop of Form

    Chaos Ensued

    The order of the NCLT has gone beyond its jurisdiction  to create ambiguity with respect to the limitation period of claim under CIRP.

    To justify its decision, the bench has cited two cases, both being irrelevant in the present context. One of these references was the judgement of the SC in Punjab National Bank and Ors. v Surendra Prasad Sinha.. The court in this case had held that due to limitation, only suit as a remedy is barred. The creditors’ right subsists till the debt is repaid, and thus, he can still exercise his right through an alternative remedy, i.e. balancing the payment through fixed deposit in this case.

    The bench has relied upon this case to hold that claim under CIRP cannot be dismissed on the grounds that it is time constrained. Placing the two cases in juxtaposition, the claims in both are completely dissimilar to each other,  as the Punjab National Bank case pertains to a claim of  criminal breach of trust under the Indian Penal Code, 1860 (‘IPC’) where the issue was of creditor deducting money from the debtor’s bank account outside the limitation period. Even the remedy obtained in this case was not sought through IBC as money was simply deducted from the account after which the validity of the same was challenged before the court. The extract used from this case is “only exception in which the remedy also becomes barred by limitation is that right itself is destroyed.” However, the same judgement also goes on to say that the remedy to enforce the liability stands destroyed after period of limitation lapses. Which, however, is conveniently ignored by the court in the Gokul case.

    Another case that has been referred by the bench is Sunil Kumar Aggarwal v. New Okhla Industrial Development Authority & Ors. by reproducing the part of the order which reads as “The claim cannot be rejected because it is time- barred or claimed by an entity other than the financial creditor.” The bench has read the order in isolation, not being cognizant of the order in entirety which held the claim to be admissible only as it was within the ambit of limitation period. Moreover, the limitation period in question was of twelve years as it pertained to immovable property. This cannot be used as a justification for the present order as the limitation period had not lapsed in the cited case, but it is time-barred in the instant case.

    These cited judgements hold no water as they are not in the context of initiating IBC proceedings outside the limitation period and only add to confusion of the legal fraternity.

    Questions Left Unanswered

    This judgement has encroached upon the already settled questions of law. section 60(6) of the IBC excludes the period of moratorium from the computation of limitation period under the Limitation Act. If the IBC’s intent were to operate in complete alienation of this Act, there would have been no need of incorporating this section in the first place.

    This case particularly had a One Time Settlement (‘OTS’) wherein the debt was acknowledged by the member of the board of directors of the corporate debtor. As per Tejas Khandahar v. Bank of Baroda, OTS proposals come within the ambit of ‘acknowledgement of debt’ in consonance with section 18 of the Limitation Act.

    However, there are certain loopholes in this judgement. Firstly, to what extent is it permissible to assess veracity of the claim when it already fails to meet the criteria provided under the Limitation Act? If this case is to be followed as a precedent by the courts, there will be no point in having an express provision in the first place that bars admissibility of such claims. Secondly, is this judgement phrased this way because of OTS as a recourse, or because the bench necessarily implies evaluating the merits of time-barred claims? An OTS has been repeatedly held as an acknowledgement of liability by the debtor and for the same, a fresh limitation period is permissible under law starting from the date of such an acknowledgement. However, the same is not true for the claims that do not have such a proposal in their agreements. This order fails to distinguish two such scenarios.

    This position was settled by the SC until now. And a departure from the same requires coherent reasoning, which this particular judgement fails to deliver.  

    Conclusion

    Even with the laid down position of law in place, we see that NCLT diverges from the same to lay down its own interpretation of law in the case of Gokul Anilkumar v Shailesh Bhalchadra. NCLT’s decision to revive time-barred debts has led to confusion, citing case law irrelevant to the issues raised in this case. One of the cases cited by the Bench clearly bars the remedy of suit for falling outside of the limitation period, while the other has accepted the claim solely because it falls within the purview of the limitation. So, it is irrational to cite these cases to justify the decision of the bench

    Prior to this order, both the legislative and judiciary seemed clear on the law that claims barred by limitation will not be admissible under the IBC, except in the cases wherein OTS proposals were incorporated. This judgement has the potential to open a pandora’s box of unanswered questions, particularly on assessing the veracity of time-barred claims.

    Until there is further clarification or intervention with respect to this order and the law interpreted therein, the decision stands as a contentious point, leaving room for continued debate and potential future legal challenges.

  • Bharati Airtel & Anr v. V.V. Iyer – Unraveling the Set-Off Saga in Insolvency

    Bharati Airtel & Anr v. V.V. Iyer – Unraveling the Set-Off Saga in Insolvency

    by Pratishtha Agarwal and Prabhav Tripathi, students of third-year at the Institute of Law, Nirma University

    Introduction

    While the Insolvency and Bankruptcy Code, 2016 (“IBC”) serves as a complete code, many a time, the exclusive nature of the Act presents a legal lacuna in the procedure and calls for determining the application of other general laws in such absence of relevant provisions. On a similar note, in the recent case of Bharati Airtel Limited and Anr. v Vijaykumar V. Iyer and Anr., the Supreme Court decided upon the question of the right to claim set-off in the Corporate Insolvency Resolution Process (“CIRP”). In set-off, it is a debtor’s right to settle the smaller claim owed to him against the larger claim payable to his creditor. As there is no statutory provision on setting off the balance amount once the CIRP has been initiated, the Bench comprising Justice Sanjiv Khanna and Justice S.V.N. Bhatti observed the appeal.

    It was held that insolvency set-off and statutory set-off do not apply to CIRP. Though the right to claim of set-off is generally granted under Order VIII Rule 6  of the Civil Procedure Code, 1908 (“CPC”), it is not permitted in the CIRP when the Resolution Professional proceeds to take control and custody of Corporate Debtor’s assets under Section 25(2)(a) of IBC.

    This blog aims to understand the rationale behind the judgement and the exceptions it carved, discuss the arguments presented from both sides and analyse the dissenting stances of foreign jurisdictions on claim of set-off in insolvency proceedings.  

    Facts of the Case 

    In April 2016, eight spectrum trading agreements were executed between Bharti Airtel Limited, Bharti Hexacom Limited, Aircel Limited, and Dishnet Wireless Limited to acquire the usage rights of the spectrum allocated to the latter. Since the agreement was contingent on the approval of the Department of Telecommunications, Government of India, (“DoT”) it had demanded that the Aircel entities submit bank guarantees for Rs 457.73 crores owing to certain licenses and spectrum dues.

    After the Aircel entities filed a challenge with the Telecom Disputes Settlement and Appellate Tribunal (“TDSAT”)regarding DoT’s directive, they were ordered by TDSAT to provide bank guarantees for which they approached the Airtelentities. On the Aircel entities replacing the bank guarantees furnished by the Airtel entities and Airtel entities receiving them from the DoT, Rs. 411.22 crores were payable by the Airtel entities to the Aircel entities.

    Pertinently, the bone of contention arose on 10th January 2019 when the Airtel entities made a payment of Rs 341.80 crores due to Aircel entities after setting-off a balance amount of Rs 145.20 crores on the ground that Aircel entities owed that amount to them. This set-off was contested before the Adjudicating Authority (“AA”) in Mumbai by Airtel wherein an order in favour of the Airtel entities held that they had a right to set off Rs. 112.87 crores from the payment. The Resolution Professional contested the Adjudicating Authority’s order before NCLAT which held ‘set-off to be antithetical to the objective of the IBC.’ 

    Provisions And Principles: No Right To Claim Set-Off In The CIRP

    Relying upon the opening part of the enactment, the Supreme Court judgement addresses IBC as a complete code to consolidate the laws relating to insolvency resolution and reorganization. The intentional omission of statutory set-off or insolvency set-off provisions during CIRP reflects a legislative decision to preclude the assertion of such rights in insolvency proceedings. Additionally, Regulation 29 of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 (“Liquidation Regulations”) which addresses setoff and mutual credits, is confined to Chapter III Part II, specifically about the liquidation process. This posits that if there were a conflicting legislative intent, the law would have encompassed Chapter II Part II of the IBC to allow the application of set-off claims during CIRP.

    Section 238 IBC provides an overriding power wherein notwithstanding anything inconsistent present in any other law for the time being in force, the laws laid down are in effect. This legal position also disarms Regulation 29 from subsuming the CIRP under its scope of insolvency set-off. Further, Order VIII Rule 6 of CPC creates a legal or statutory set-off wherein the defendant has a right to claim set-off against the plaintiff’s demand for an ascertained sum of money that is legally recoverable and is not beyond the pecuniary limits of the court’s jurisdiction. However, this set-off too, is overridden by Section 238 and rendered inapplicable from being exercised during insolvency proceedings, thus maintaining the rigidity and exclusivity of the Code.

    It was further argued that the concept of insolvency set-off, in its entirety, goes against the principle of pari passu. Section 53 of the IBC lays down the priority order of creditors for the distribution of sale proceeds of liquidation assets under the “waterfall mechanism”. Here, set-off offers an overriding effect and primacy to the creditor entitled to claim set-off against the demanded credits of the Corporate Debtor. In the process of dealing with these cross demands by set-off, the assets are depleted in favour of that single creditor with set-off entitlement that was initially available to be settled amongst the general body of creditors. As a consequence, with a decrease in the dividend payable, the same class of creditors are not treated equally and the liquidation hierarchy is also compromised. Thus, if such a claim is permitted in the CIRP, it is bound to go against the waterfall mechanism by keeping the entitled creditor on a higher footing and the other creditors at a disadvantageous position.

    Contradictory Viewpoint on the Applicability of Set-Off to CIRP

    The SC judgment attempts to clear the air on the applicability of set-off to CIRP however it raises pertinent questions on whether the Apex Court has taken an erroneous stance. The judgment moots the contention that Regulation 29 of the Liquidation Regulationsmandates the mutual set-off however the instant regulation only corresponds to liquidation.

    Pertinently, as noted earlier, the judgment of the SC in the case of Swiss Ribbons v. Union of India held that set-off can be considered during CIRP subject to the challenge before the AA. Interestingly, the judgment takes note of the mandatory nature of insolvency set-offs in the United Kingdom as highlighted by the judgment in the case of National Westminster Bank Ltd. v. Halesowen Presswork & Assemblies Ltd.. Therefore, it is vital to highlight that set-off is a widely accepted and practised principle of insolvency law internationally. Notably, Section 553  of the U.S. Code provides for the right of a creditor to offset a mutual debt that arose before the commencement of the case i.e. pre-petition debt. However, per the ratio of In re Shopper’s Paradise,  it was highlighted that a creditor can never offset a post-petition debt against a pre-petition debt. This in line with the distinction drawed upon in the instant judgment in relation to set-off pre and post the initiation of the CIRP. 

    Further, in the matter of Pramod Kumar Sharma Uniworld Sugars Pvt. Ltd. v. ED&F Man Sugar Ltd., NCLT Chandigarh had held that set-off was permissible during CIRP in view of ‘the treatment reflected in the book of accounts of the Corporate Debtor while determining the liability of the parties with regard to the purchase and sale of sugar.’ A case has been made out in detail below for allowing set-off in the context of CIRP. 

    Justifications for Permitting Set-off in the Context of CIRP

    1. Litigation Minimization: Permitting setoffs can aid in the reduction of litigation throughout the CIRP. The presence of set-off may potentially mitigate disputes concerning the validity and magnitude of claims, as it incentivizes the involved parties to negotiate settlements rather than engage in protracted legal disputes.

    2. Encourages Credit Flow: An effectively operating set-off mechanism has the potential to encourage credit flow. If creditors are certain that the quantities owed by the debtor can be offset against their exposure, they may be more inclined to grant credit to financially distressed companies. This would subsequently increase the availability of credit in the market.

    3. Promoting Creditor Engagement: Permitting set-off enables creditors to be more motivated to actively participate in the CIRP. To encourage greater participation in negotiations, contribution to the resolution plan, and support for the company’s revival, creditors might be more inclined to offset their claims against the liabilities of the debtor.

    Conclusion

    However, the Apex Court has carved out two exceptional conditions in Paragraphs 30 and 32 of the judgement, wherein the set-offs are permitted in CIRP in two circumstances. Firstly, a contractual set-off is allowed if its entitlement is effective before or on the date of CIRP initiation.  As the same cannot be precluded, the terms of the contract remain binding besides the moratorium period. Secondly, equitable set-off, wherein the claim and counter-claim are linked by transactions that can be treated as one, was also made an exception by the Bench. Herein, the set-off needs to be “quantifiable, genuine, and established on fact and in law.” Through this judgement, the Supreme Court reiterated the sanctity and exclusivity of IBC and settled the position of law on the applicability of the right to claim set off in the CIRP. In the context of insolvency law, the ratio decidendi is a right step in the way to establish a proper demarcation of claims in CIRP and other laws.

  • Shareholder Intervention in Resolution Proceedings: A Potential Misinterpretation of IBC 2016

    Shareholder Intervention in Resolution Proceedings: A Potential Misinterpretation of IBC 2016

    BY YADU KRISHNA PALLIKKARA, FOURTH-YEAR STUDENT AT SYMBIOSIS LAW SCHOOL, PUNE

    Introduction

    Recently, in Dr. Ravi Shankar Vedan vs. Tiffins Barytes Asbestos (Tiffins), the shareholder of a corporate debtor sought an appeal for two interlocutory orders of the adjudicating authority. First of which was an application seeking a forensic audit of the books of accounts of the corporate debtor and the second regarding approval of resolution application under Section 30 (6) of the Insolvency and Bankruptcy Code (Code). The court dismissed the shareholders’ objections and clarified that shareholders have no locus standi to challenge the resolution plan initiated against the corporate debtor. 

    The post aims to analyse the rationale employed by the court in denying locus standi to the shareholders. It offers a critique of the tribunal’s decision by first, expounding on the concept of shareholders as “persons aggrieved” under Section 61 of the Code . Second, it analyses the interpretation of Section 30(2) of the Code  related to deemed approval and the existing legal position surrounding it. It concludes by advocating for a nuanced approach that protects shareholders’ legitimate concerns while maintaining the effectiveness of the insolvency resolution framework.

    Shareholder as a person aggrieved 

    Herein, the Hon’ble National Company Law Appellate Tribunal (NCLAT) held that the shareholders have no locus standito challenge the resolution plan at any stage, by reasoning that Section 30(2) of the Code provides for deemed approval by shareholders of the corporate debtors, which cannot be taken away by objecting to a resolution plan. 

    Similarly, in Nirej Vadakkedathu Paul & Ors v. Sunstar Hotels and Estates Pvt. Ltd. & Ors  (McDowell Holdings), the NCLAT Chennai denied locus to shareholders who challenged the Corporate Insolvency Resolution Process (CIRP) initiated against the corporate debtor in which they held majority shares.  It forms a part of a catena of judgements, including ICP Investments v. Uppal Housing, Punit Garg vs. Ericsson India Pvt. Ltd., and Anant Kajare vs. Eknath Aher, denying locus standi to shareholders in CIRP proceedings by reasoning that shareholders cannot be aggrieved by initiating CIRP against the corporate debtor, as such interventions in the name of derivative action can render the entire process futile. Accordingly, the contesting parties can only be the financial creditor or the corporate debtor as represented by the Interim Resolution Professional.

    These judgements seemed to altogether overlook the true intention of Section 61 (1) and Section 61 (3) of the Code . While Section 61 (1) provides for “any person aggrieved” by an order of the Adjudicating Authority to prefer an appeal to the NCLAT, Section 61 (3) provides the grounds under which such appeals can be set out, allowing for resolution plan to be challenged for the first time in the appellate stage. While it does specifically identify those who may file an appeal, it sets out that any person aggrieved under Section 61(1) can initiate a proceeding challenging a plan approval order, and shareholders shall come well under this meaning. On a combined reading of both provisions, it is in no way anticipated to exclude shareholders from the meaning of “aggrieved persons,” as that would be a clear injustice and in effect a narrowing of the scope of Section 60 (1).    

    While in McDowell Holdings, the shareholders were denied locus by citing a lack of statutory backing for shareholders ability to challenge a CIRP process and such frequent derivative actions being against the efficiency and purpose of the Code, the court in order to reach its decision had expounded Section 61 (1) of the code. It stated that under Section 61 (1) of the Code, any ‘person aggrieved’ by the order of the Adjudicating Authority may prefer an appeal to the “NCLAT”. The definition of ‘person’ as provided under Section 3(23) of the Code includes ‘individual’, which is a term wide enough to encapsulate ‘shareholders’ within it. This clarifies that while interference from shareholders are generally not preferred, the Code in no manner intends the deprivation of their representative capacity in insolvency proceedings as held in the case of Tiffin’s. 

    In Ashish Gupta v. Delagua Health India Private Limited, the court held that the majority shareholders of a company have the right to challenge the admission of CIRP against the corporate debtor when the admission arose out of collusion among the creditors. It is an example of when courts have considered the specific circumstances demanding intervention by the shareholders and dealt with the same on merits. It proves that shareholder intervention may not always be against the efficiency and purpose of a resolution process under the code and can help in identifying irregularities’ and illegalities in the resolution plan,  aiding in the successful revival of the corporate debtor.

    Also in Tiffins, by interpreting Regulation 2(k) of the Liquidation Regulations 2016, the court held that shareholders who come under the category of ‘stakeholders’ are only recognised in the liquidation process and lack representative capacity in the CIRP. But, according to the same logic, other stakeholders of the corporate debtor such as directors or creditors, can be denied representative capacity by categorizing them as “shareholders” and their consent deemed to be approved, which is totally unwarranted under the code.

    Blurred lines of Deemed Approval and Locus Standi

    Deemed approval of a resolution plan finds no backing in the Code. Under Section 30(2) of the Code, the Resolution Professional (RP) has to ensure that the resolution plan to be submitted meets certain requirements. Under clause (e) of the provision, the RP shall ensure that the plan submitted does not contravene any law in force. The explanation to it provides that the shareholder approval required under the Companies Act, 2013, or other relevant laws for the implementation of the resolution plan is deemed to have been given, provided it is valid and not in contravention of that Act or law. 

    Through Tiffin’s judgement, court has interpreted this explanation of clause (e) as a mechanism of ‘deemed approval’, allowing actions under the resolution plan requiring shareholder approval to have been automatically approved, and more importantly, holding that shareholders have no locus to challenge or object to it. Similar subscription to the deemed approval doctrine can be seen in cases including Jaypee Kensington Boulevard Apartments Welfare Association. vs. NBCC (India) Ltd., DMI Finance Pvt. Ltd. v. Abloom Infotech Pvt. Ltd., Airro Holdings v. Abhilash Lal,  Mr. Keshav Agrawal  Vs. Abhijit Guhathakurta where the courts have rooted their reasoning to the explanation of Section 30 (2) (e) of the Code.

    The courts have overlooked the fact that the explanation was intended solely to facilitate actions that typically need shareholder approval under laws like the Companies Act, such as capital reductions or director appointments, without requiring specific approval for each. It wasn’t meant to cover the entire resolution plan but only those actions needing shareholder consent, and it cannot be used to oust the shareholder’s locus on all matters concerning the CIRP. The MCA notification of 2017 also clarified that the approval mechanism applies only to specific actions required for the implementation of a resolution plan as required under the Companies Act 2013 or any other law in force.

    Shareholders should be allowed to voice concerns about other aspects of the plan, such as illegality, procedural irregularity, or actions harming the company or the public interest, which do not require shareholder approval. [AM7] The same has been clearly set out under Section 60 (5) (c) and Section 61 (3) of the Code, the former of which provides that the Adjudicating authority is empowered to hear any question of law or facts arising in relation to the insolvency resolution of the corporate debtor. The latter provides that any person aggrieved may appeal against an order of the Adjudicating Authority approving a resolution plan, in the circumstance it contravenes the provision of law or if there is material irregularity in the powers exercised by the resolution professional. The provisions can be seen to have been deployed by shareholders to resolve their concerns in various cases including Synergy Technologies vs Parthiv Parikh and Dr. Periasamy Palani Gounder vs Mr. Radhakrishnan Dharmarajan. 

    Conclusion

    In the landmark case of Swiss Ribbons v UOI, the Supreme Court had held that the Code is a beneficial legislation that is aimed at putting the company back on its feet rather than being mere recovery legislation for the creditors. Such an effort to recoup the company requires adequately tending to all the stakeholders involved, including the shareholders of the corporate debtor. While sources such as the Bankruptcy Law Reform Committee Report of 2015 hints that the Code aims at a complete reduction of share capital and the shifting of control to creditors, the mechanism of ‘deemed approval’ of the shareholders and depriving them of representative capacity is not envisaged under the code.

    There is no contention as to the fact that the resolution plan is generally binding on the shareholders post-approval under Section 30(6) and that those shareholders challenging the plan for malicious and vindictive reasons shall not stand strict judicial scrutiny under Section 61(3) of the Code. However, there is no reasonable explanation to prohibit them from challenging the plan for bona fide reasons. 

    Such a blanket decision denying locus to shareholders on all and any matters of Code is unwarranted and can bring in uncertainty considering the concerns that the shareholders can face during a CIRP, including procedural irregularity or illegality in the resolution plan as seen in DHFL’s case  or unfair treatment of shares of the company in the resolution plan as seen in Sintex Industries Case . SEBI had issued a consultation paper in November 2022 proposing protection to minority shareholders of companies undergoing resolution. If the position as laid out in the case of Tiffin’s is maintained, such protections shall be rendered redundant, putting shareholders in a vulnerable position. Given these circumstances, it is imperative that the code does not restrain shareholders from raising their grievances, and the courts may hear the instances and decide on the merits of the case and the degree and reason for such intervention. This will aid in balancing the interests of relevant stakeholders and help in an effective and successful revival of the company. 

  • Financial Creditors As The Super Actors Of CIRP: A Psycho-Analytical Account Of Low Recovery Rates 

    Financial Creditors As The Super Actors Of CIRP: A Psycho-Analytical Account Of Low Recovery Rates 

    BY ROHIT DALAI, A FORTH-YEAR STUDENT AT NLSIU, BANGALORE

    Introduction

    This article argues that the low recovery rates from the Corporate Insolvency Resolution Process (‘CIRP’) under the Insolvency and Bankruptcy Code, 2016 (‘Code’) is a consequence of the vesting of extensive powers with the financial creditors (‘FCs’). This vesting of near plenary control of the CIRPs under the Code provides the FCs with the incentive to make self-interested decisions. The making of the self-interested decision by the FCs is evident in two contexts. First, the interaction of FCs with other actors upon the commencement of CIRP. Second, the decision-making by the FCs as the drivers of CIRP. To this end, the article is divided into three parts. The first part analyses the reasons behind low recovery rates under the Code. In doing so the article uses the social-psychological concept of the ‘discontinuity effect’ to scrutinise the interaction of distinct actors upon the commencement of CIRP. The second part builds on the ‘discontinuity effect’ to study the incentive of the actors and the effect of information asymmetry in a CIRP. In the third part, the article concludes by arguing that the combined effect of the ‘discontinuity effect’, distinct incentives and information asymmetry in the CIRP is the reason for low recovery rates.

     Low Recovery Rates: Discerning the Reasons

    To better appreciate the reasons behind the low recovery rates, it is imperative to delve into the objective of the Code. According to the Preamble, the Code provides for “reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner”. Notably, the Report of the Working Group on Tracking Outcomes under the Insolvency and Bankruptcy Code, 2016 identifies reorganization as the “sole object of the Code” . In the context of the Code’s objective, reorganization rather than liquidation ought to be the mode of closure of the CIRPs. The reorganisation would necessarily entail the  restructuring of the assets and debts thereby ensuring that the business continues with its operations. It is through this objective of keeping the enterprise continuing its operation for the foreseeable future does the Code purport to ensure better returns for ‘creditors of all classes’. In the recent Supreme Court decision in K.N Rajakumar v. Nagaraj and Ors., Justice Gavai through a common judgement and order propounded that under the scheme of the Code, every attempt was to be “first made to revive the concern and make it a going concern, liquidation being the last resort”.[1] Interestingly, empirical evidence points to the fact that creditors of all classes generally get better returns in instances of reorganization vis-à-vis liquidation.[2] However, a scrutiny of the Code in effect evinces the fact that the predominant mode for closure of the CIRPs has been the commencement of liquidation. A perusal of the Quarterly Newsletters released by the Insolvency and Bankruptcy Board of India (‘IBBI’) from 2018-2022 reveals that on average 48% of the CIRPs that were closed, ended up in liquidation. This underlying cause of the mismatch between the purpose and the outcome of the Code can be attributed to the ‘discontinuity effect’. The term ‘discontinuity effect’ is used to refer to the typical phenomenon wherein “groups act more competitively and more selfishly when interacting with other groups than when individuals interact with individuals”. As a corollary to acting selfishly, groups end up engaging in a mode of thinking known as ‘groupthink’.[3] Groupthink is essentially the dominance of intragroup concurrence-seeking and the overriding of “realistic appraisal of alternative course of action”.[4] In the context of CIRP, discontinuity effect and groupthink are evident in the context of the decision making and control over the CIRP by the FCs. It has been observed that the vesting of “near-plenary control of CIRP” in the form of restriction of the voting membership in the Committee of Creditors (‘CoC’) to the FCs, in turn, leads to the FCs to seek a speedy return for themselves. This seeking of speedy returns by the FCs is at the same time a manifestation of the discontinuity effect and groupthink. This manifestation is evident from the frequent prioritisation by the FCs of their monetary payoff over alternative concerns,  “such as fairness or reciprocity” towards other players such as the Operational Creditors (‘OCs’) and the corporate debtor. Moreover, the manifestation is also apparent in opting for liquidation over reorganization even when the recovery rates tend to be low.

    A. Does the Judiciary Mitigate the Discontinuity Effect?

    Pertinently, the Supreme Court (‘SC’) in Swiss Ribbons Pvt. Ltd. and Anr. v. Union of India and Ors.  did charge the FCs who “drive the entire decision making on the CoC” to not ignore the claims of OCs.6 This essentially meant that all creditors were to be equitably treated, even if they have little say in the CIRP. However, a scrutiny of the subsequent judicial pronouncements points towards the adoption of an ‘extreme deferential standard’. Notably, the ruling in Karad Urban Cooperative Bank Ltd. v. Swwapnil Bhingardevay and Ors. and Kalpraj Dharamshi and Anr. v. Kotak Investment Advisors Ltd. and Anr. evinces this extreme deferential standard taken by the SC. The aforementioned cases pertained to allegations of breach of confidentiality while CIRP was underway. The SC in both cases exhibit deference to the commercial wisdom of the CoC. Interestingly, in both aforementioned cases, the SC did not necessarily refer back to the Code while exhibiting deference. This non-reference to the Code points to the fact that the SC failed to take a nuanced view of when the commercial wisdom of the CoC can be deferred to. A nuanced understanding suggests that the CoC’s decision in assessing the feasibility and viability of the Resolution Plan ought to be deferred. In instances where the commercial wisdom of the CoC is deemed to be paramount without the Code being necessarily referred to, the ‘discontinuity effect’ becomes pronounced. This is because in absence of substantial oversight, the FCs as the members of the CoC have ‘unconstrained interaction’ with other actors in the CIRP such as the OCs.7 This unconstrained interactiondoes lead to intergroup competitiveness as groups seek to maximise their benefits.8 In short-run, intergroup competitiveness to maximise outcomes results in a deadlock.9 However, when one of the groups such as the FCs has wider powers and informational asymmetry in its favour, a resultant deadlock is not the consequence. It is this informational asymmetry that further explains the greater liquidation and lower recovery rates.

    Distinct Incentives and Information Asymmetry

    A. Understanding Information Asymmetry Pre-2019

    As has been depicted through the discontinuity effect and groupthink above, distinct actors in CIRP have distinct incentives. It needs to be emphasised that the FCs are driven by the incentive of seeking debt recovery through liquidation. One of the aspects that significantly strengthens the incentive to go for liquidation is the asymmetry of information in CIRP. Pre-2019 the information asymmetry subsisted in the context of taking over of the control and management by the Resolution Professional (‘RP’) and the suspension of the board of directors (‘BoD’) of the company on the commencement of CIRP. Notably, upon suspension, the corporate debtors’ BoD were not allowed access to the resolution plan even though they are given participatory rights -“to be present when required or called for”– in the CoC meeting. This secrecy in the form of non-accessibility of resolution plans produced informational asymmetry. This secrecy with regards to the resolution plan was uncalled for as it was “contrary to the scope, intent and purpose of the Code”. The fact that the erstwhile BoD would know the intangible and tangible value of the assets in addition to them being interested in the value maximisation of the assets of the corporate debtor warranted the supplying of a copy of the resolution plan. Notably, the 2019 decision of the SC in Vijay Kumar Jain v. Standard Chartered Bank held that the erstwhile BoD was to be furnished with the copy of the resolution plan as part of the documents that have to be given in addition to the notices of CoC meetings. While the judgement addresses the problem of information asymmetry to some extent, the problem subsists nonetheless. 

    B. Information Asymmetry and Structural Issues

    The subsisting problem of information asymmetry is also structural when seen in the context of CIRP. While the CoC is entrusted with the task of evaluating the feasibility and viability of the resolution plan in addition to balancing the interest of all stakeholders, it does not necessarily have to deliberate with other stakeholders. For instance, the CoC can benefit from deliberations with OCs to whom the corporate debtor owes more than 10% of the value of its debt. However, the scope for deliberations is foreclosed by the fact that instances, where a single OC is owed such a sum, is likely to be relatively rare. In such circumstances, the CoC does not have to provide the OCs with a forum to put forth their concerns. This non-involvement of the stakeholders such as OCs by the design of the CIRP pronounces the information asymmetry. However, this information asymmetry is distinct in the sense that it works to the detriment of the FCs. Notwithstanding the discontinuity effect and the concomitant self-serving decision-making by the FCs, the free flow of information would allow the FCs to choose reorganisation over liquidation. The fact that FCs go for liquidation even when the probable consequence is low recovery points towards irrationality in decision-making. Put simply, when incomplete information is admitted while making decisions, the decision maker takes decisions that may turn out to be irrational post hoc. Since the CIRP is a “collective process” that intends to bind the corporate debtor’s stakeholders, it is imperative to make provision for effective participation of non-FCs, “whether by giving them an opportunity to vote on the resolution plan, or otherwise”.

    Conclusion

    The low recovery rates under the Code are a combination of two factors. First, the greater control of the FCs over the CIRP. Second, information asymmetry in the process of CIRP. An interplay of the two factors results in liquidation and the concomitant low recovery rates. While the Code seeks to emphasize restructuring, it is the actions of the FCs as the members of CoC that results in the purpose of the Code being defeated. It is only when the loopholes are plugged would the objectives of the Code be realized.

     

     

     

     

  • Regulating The Fees Of Insolvency Professional: A Hit Or A Miss?

    Regulating The Fees Of Insolvency Professional: A Hit Or A Miss?

    BY SANYAM GUPTA, FOURTH YEAR AT NLIU, BHOPAL

    Introduction

    Since the advent of the Insolvency and Bankruptcy Code (“the Code”) in 2016, the Code has been evolving through various dictums given by the judiciary and regulations by the Insolvency and Bankruptcy Board of India (“the Board”) to ensure that it works in tandem with the current economic situation of the nation. These regulators ensure that the main spirit of the Code, i.e., value maximization and speedy resolution in a ‘creditor-in-control model’ is upheld and its scope is enhanced. In order to maximize the payment of the debt to the relevant stakeholders, it becomes incumbent to minimize the Insolvency Resolution Process Cost (“IRPC”). The remuneration of the Insolvency Professional (“IP”) forms a relevant portion of the IRPC; therefore, it must be regulated.

    The IP plays a crucial role in the Corporate Insolvency Resolution Process (“CIRP”). He not only acts as the catalyst facilitating resolution but also runs the Corporate Debtor (“CD”) during the CIRP. It is his expertise that ensures the successful and profitable resolution of the CD. In the case of Essar Steel, the CD reported a profit gain of 5% during the CIRP and reported the highest production as well, under the supervision of the Resolution Professional (“RP”), which further lead to most Financial Creditors realizing 100% of their principal outstanding and 90% of their claim. The credit for this can surely be given to the RP running the CD.

    The Adjudicating Authority (“AA”) has on numerous occasions reiterated that there should be some regulations w.r.t. the remuneration of the IPs.  Starting from the case of Madhucon Projects Limited, wherein the fees of the Interim Resolution Professional (“IRP”) were 5 crores by the first meeting of the Committee of Creditors, while the total amount of debt was 4.45 crores; to the case of Variscon Engineering Services Pvt. Ltd. Vs. Pier-One Constructions Pvt. Ltd. wherein the AA specifically pointed out the need for regulations governing fees of the IPs. There are also instances wherein the IP quotes fewer fees in order to get the CIRP assigned to them, following which they add substantial miscellaneous expenses through advisors/support staff to inflate their dues. All this leads to further unnecessary bleeding of the CD. Thus, regulations and guidelines to regulate the remuneration of the IP become quintessential.

    The Board introduced such regulations and guidelines by uploading a discussion paper titled, “Discussion Paper on Remuneration of an Insolvency Professional” which discusses various aspects of how the Board plans on regulating the remunerations of the IPs. The contents of this paper further went on to amend the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (“IRP Regulations”), to provide incentives to meet the spirit of the code i.e. timely resolution and value maximization in addition to providing for a base pay for IRPs and IPs. The author of this article has criticized this approach of the Board of setting a base pay, while not regulating the extensive expenses charged by IPs that lead to unnecessary bleeding of the CD. The author further goes on to analyze the ‘ratio of cost of the process to recovery rate’ of insolvency proceedings in India, highlights the problems in the amendment, and provides solutions to improve the same.   

    The Regulation

    The Board, vide notification No. IBBI/2022-23/GN/REG091 published the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) (Third Amendment) Regulations, 2022 (“Amendment”) on September 13, 2022. By this notification, the Board has amended IRP Regulations, in order to facilitate the regulation on the remuneration of IRPs and IPs, appointed on or after 1st October 2022.  The Board has followed a two-pronged structure, wherein a minimum/base pay is set up on the basis of the quantum of claims admitted, followed by incentivizing the fees based on performance towards; i) timely resolution and ii) value maximization. The minimum pay scale will be as follows:

    Quantum of Claims AdmittedMinimum Fee (Rs. Lakh) per month
    (i) <= Rs. 50 crore1.50
    (ii) > Rs.50 crore < = Rs.100 crore2.00
    (iii) > Rs.100 crore < = Rs.500 crore2.50
    (iv) > Rs.500 crore < = Rs.1,000 crore3.00
    (v) > Rs.1,000 crore < = Rs.2,500 crore3.50
    (vi) > Rs.2,500 crore < = Rs.10,000 crore5.00
    (vii) > Rs.10,000 crore7.50

    Since time efficiency and value maximizations are the essence of the Code and the IPs play a major role in its realization, the board has added that apart from the minimum or floor fees, the IPs would be incentivized on the basis of i) resolution of CD in the prescribed timelines as given in the Code, and ii) achieving value maximization of CD. Thus, the Amendment provides a performance-linked fee structure for the timely completion of CIRP, wherein a certain percentage of actual realizable value shall be given to the IP as an incentive based on the time taken to resolve the CD. This ranges from 1% for resolution in less than or equal to 180 days to 0% for resolution after 330 days. Furthermore, a variable fee of 1% of the positive difference between the actual realizable value and fair value will be paid as an incentive to IPs who work towards value maximization. These sums must not exceed Rs. 5 crores and must be approved by the CoC. 

    The Amendment in the IRP Regulations ensures that all IPs are paid adequately and are incentivized for following the Code to its essence. While the same is beneficial for the creditors, it is detrimental and might lead to unnecessary bleeding of the CD.

    Critique

    The Bankruptcy Law Reforms Committee in its report mentioned the prodigal nature of any constraint to be imposed on the fees of the RP. It further mentions that due to a competitive market for IPs (where the lowest bidder gets the CIRP), the fees to manage the insolvency resolution process will converge to the fair market value for the size of the entity involved.

    Even though the board has ensured that the IPs be paid a minimum (floor) payment for their services based on the quantum of claims, however, as stated earlier, during the process of appointment of the RP, the IPs quote fewer fees in order to get the CIRP assigned to them, following which they add substantial miscellaneous expenses through advisors/support staff to inflate their dues. Regulation 34 of the IRP Regulations provides for the fees and expenses incurred by the RP which shall be fixed by the CoC and shall be a part of IRPC. While fixing this cost, the RP indicates the approximate estimation of the expenses that would be incurred by them during the CIRP. It shall be assumed that since the RP is a professional, he would quote expenses with a reasonable understanding of the general expenses that would be incurred during CIRP. The RP’s exorbitant expenses should thus be regulated to avoid unnecessary bleeding of the CD and wrongful gains to the RP. The board should fix a maximum criterion (like 250% of the approximate cost stated) in order to ensure that the RP does not get illicit benefits. In cases wherein the RP crosses this statutory limit, they should bear these over-the-top expenses on their own, as a penalty.

    The Board has also failed to address the issue of exorbitant fees charged by the IPs during the CIRP. The following is a list of countries along with their recovery rate during insolvency proceedings (cents on every dollar) as well as their cost of process on the basis of the percentage of the estate of the debtor as per data given in the Doing Business Data published by the World Bank in 2019 :

    Name of the CountryRecovery rate (cents on every dollar)Cost of the process (% of estate)
    India26.59%
    United Kingdom85.36%
    United States of America81.810%
    Norway921%
    Sweden789%
    Slovenia88.74%
    Singapore88.84%

    It is quite evident that India has one of the highest costs of the process as well as one of the lowest recovery rates when it comes to insolvency regimes in the world. Thus, it becomes essential for the Board to regulate the IRPC as well as set a maximum limit on the remunerations filed by the RP, similar to the laws in Canada and the USA. The Board may propose different maximum limits on remuneration for different valuations of claims, similarly as it has done for minimum (floor) pay. Further, these limits can be relaxed for a speedy resolution and value maximization, as has been proposed by the Board.

    The Board has also failed in providing a revision mechanism for these minimum (floor) pay scales as well as for the rate of incentivization. For the same purpose, the board may constitute a committee that may meet on an annual or bi-annual basis. The committee should analyze the prevailing market situation and the fair market value of the fees of IPs for various categories of CIRPs based on the quantum of claims, following which the minimum (floor) pay scales as well as the maximum pay scales of the IPs shall be revised by this committee. 

    Conclusion

    The Amendment is merely a start to regulating the fees of IPs and subsequently the IRPC, but it is a long road ahead. While the IP plays a crucial role in the running of CD during the CIRP, they also have to ensure that the CIRP is completed in a timely manner with the aim of value maximization. The Amendment has tried to ensure that the IPs get a minimum pay as well as an incentivization towards the realization of the core values of IBC. This was done in order to reduce the burden of litigation between parties and on the AA. Yet, the Board should consider practical scenarios which lead to the bleeding of CD and hamper the spirit of the code and its core values and ensure rules and regulations such as regulating the maximum fees charged by the IPs, penalty for charging exorbitant expenses after quoting minimal expenses while getting the CIRP assigned to them, ensuring that these minimum (floor) pay rates and maximum rates are revised in a timely manner to be in tandem with the prevailing market rates are put in place to avoid such scenarios.

  • Vidarbha Industries v Axis Bank: A Slumping Case for Financial Creditors

    Vidarbha Industries v Axis Bank: A Slumping Case for Financial Creditors

    By Neelabh Niket and Nitish Dubey, fourth-year students at HNLU, Raipur

    Introduction

    The Hon’ble Supreme Court (the Court) recently in the case of Vidarbha Industries Power Limited Vs Axis Bank Limited has held that the power of the National Company Law Tribunal (NCLT) to admit an application for initiation of CIRP by a financial creditor under section 7(5) of the Insolvency and Bankruptcy Code, 2016 (IBC) is only directory and not mandatory in nature. This ruling, in simple words, signifies that even if an application is complete under section 7(5)(a), the Adjudicating Authority (AA) in exceptional cases such as where an impending order lies in favour of the Corporate Debtor (CD), may not accept such an application and keep the CIRP in abeyance to protect the entity from being resolved. The Court was of the opinion that the legislature intended section 7(5) to be discretionary in nature as the word ‘may’ has been used in the provision as opposed to the word ‘shall’ used in section 9(5) which postulates a mandatory requirement in the case of operational creditors. The authors through this article intend to revisit the judgement from critical lenses and would lay down the implications of the judgement. 

    Facts

    The Court, in this case, was considering a Special Leave Petition of the Vidarbha Industries Power Limited (VIPL/defaulting Company) which had defaulted on a loan from Axis Bank Limited,, i.e., the financial creditor. The appellant pleaded that the default was on account of a dispute relating to the price of the electricity which was to be settled by the Maharashtra Electricity Regulatory Commission (MERC) and upon which the appellant was expecting to receive a substantial amount which would enable the appellant to pay off the debt. The appellants have gotten a favourable order from the Appellate Tribunal for Electricity (APTEL), however the same has been challenged in the Supreme Court whose order on the issue is awaited. 

    Analysis

    Before we delve into the nuances of the judgement, it is imperative to make it clear that the discretion conferred upon the Adjudicating Authorities to give a breathing space to the CD cannot be asked as a matter of right but can only be granted by the AA when there exist extraordinary circumstances. The authors however will argue that even this step of the Hon’ble Court is unwarranted and will open up Pandora’s box in an otherwise smooth IBC jurisprudence.  The same has been done under four heads which are as follows-

    • Overlooking Past Jurisprudence

    Prior to the instant case, it was well settled through the verdict in E.S. Krishnamurthy vs M/S Bharath Hi Tech Builder judgement that the AA had only two options when an application under section 7(5)(a) came for adjudication: (i) accept it; (ii) reject it. A judgement on similar lines was also expressed impliedly in the landmark case of  Innoventive Industries Ltd vs ICICI Bank wherein the Hon’ble Court held the following, 

    “The moment the adjudicating authority is satisfied that a default has occurred, the application must be admitted unless it is incomplete…” (emphasis supplied)

    However, the present judgement has in effect provided for a third option for the AA— to keep the insolvency proceedings in abeyance. Such an interpretation is not only against the established jurisprudence but also has little backing from the statute itself as neither the IBC nor the rules therein provide the AAs with the power to defer proceedings on account of an external/unrelated event. 

    • Diluting the Cash Flow Insolvency Test

    The Supreme Court’s decision to read discretion into section 7(5)(a) is not simply a simple shift in AA’s routine power but has the potential to disrupt the entire insolvency regime in India. The regime which was built on the solid foundation of a certain and determinable occurrence of a default has been unsettled and may attract bogus excuses by CDs to escape CIRP, causing prolonged litigation. In doing that, the Court has inadvertently dumped the Cash Flow Insolvency Test and allowed facets of the Balance Sheet Test in the Indian insolvency jurisprudence. Before delving into the tests, it becomes imperative to understand their scope and meaning. 

    There exist majorly two tests for determining an entity’s solvent status i) The Cash Flow Insolvency Test and; ii) The Balance Sheet Test. The Cash Flow Insolvency Test concentrates on whether the company can meet current debts from cash and other assets which can be readily realized; if it defaults in such repayment then it is considered insolvent. As long as an entity keeps paying its dues, and does not default no action can be taken against it under this test. Thus, the triggering point in the Cash Insolvency Test is an event of ‘default’. On the other hand, the Balance Sheet Insolvency Test requires the courts to pierce deeper into the company’s balance sheet and gauge its medium to long term liquidity, taking into account the company’s wider circumstances and be satisfied of the company’s insolvency if the company’s assets are less than its liabilities.

    The IBC strictly follows the ‘Cash Insolvency Test’, terming an entity insolvent only when it accounts for defaults. However, the Court via the judgement has digressed from the determination of insolvency from defaults to assessing whether there are other available assets of the company which may be utilized for repayment of debt at a later stage. This approach, as discussed earlier, inclines towards the Balance Sheet Insolvency Test which has not been prescribed or advocated by the IBC. 

    The erstwhile section 433(e) of the Companies Act, 1956 was based on the pretext of Balance Sheet Insolvency as it did not determine insolvency on the basis of defaults but on the entity’s inability to pay dues- a scenario which occurred when the company’s liabilities were greater than its assets.  In simple words, according to this section, an occurrence of default was insufficient in attracting the provisions of insolvency. This was however rejected and replaced by the IBC which ushered significant changes in the Indian Insolvency Regime. Importantly, the Court in Swiss Ribbons Pvt. Ltd. vs Union of India  indirectly approved the Cash Flow Insolvency Test and  noted that in a situation of financial stress, the cause of default is not relevant; and protecting the economic interest of the CD  is more relevant. 

    • Proper Usage of Discretion

    The authors are of the opinion that the usage of ‘may’ in section 7(5)(a) shall be construed to confer discretion to AAs in rejecting a CIRP application only when a mala fide intention is detected and such discretion shall not extend to provide weightage to any extraneous matter which is independent of the loan availed. The discretion in this sense is necessary to curb malicious attempts of financial creditors and CDs in deliberately forcing a Company into insolvency. The same is somewhat prevalent in the IBC jurisprudence and can be traced in few cases. For instance, the NCLAT in the case of Hytone Merchants v. Satabadi Investments Consultants rejected a section 7 application which had fulfilled all pre-requisites on the ground that the debtors and the financial creditors colluded and were acting against the interests of the company. 

    Further, the legislature’s usage of ‘shall’ for operational debt can also be justified on the same premise; the operational creditors are third parties who are not concerned with the entity and hence the chances of such collusion between the CD and operational creditors is very slim and unlikely. The Court has failed to delineate properly the different expressions used in the sections and has wrongly expanded the scope of the word ‘may’ on this premise, which in the authors’ view is wholly unnecessary. 

    • Abridging the Powers of the CoC

    If there is a possibility that the CD may get a favorable order or award, then there is always an option of settlement available with the debtor and the Committee of Creditors(CoC) to settle their claims and withdraw the resolution processunder section 12A of IBC. In any case, it is the Committee of Creditors who after assessing the financial condition of the company, shall decide the best course of action for the Company’s revival. The IBC has not conferred any powers to the NCLT to prima facie decide, at the stage of admitting a petition under section 7, whether a Company is solvent or not. It is counterintuitive to say that  an order or award will operate to save the debtor and confer the NCLT the power to stall the very commencement of the CIRP. 

    Thus, authorizing the NCLT and deferring the initiation of the CIRP on account of an uncertain event in the future may adversely affect the interests of all stakeholders, as with time other assets of the debtor may depreciate for the lack of investment and proper management. 

    Conclusion

    The Insolvency & Bankruptcy Code has been built upon the detection of insolvency upon the occurrence of a default or the Cash Flow Test. The Hon’ble Court via this judgement has diluted this Test and has allowed some element of the redundant Balance Sheet Test to again creep into the regime. The authors herein believe that the broad interpretation of the word ‘may’ in section 7(5)(a) by the Supreme Court will create unnecessary confusion and chaos in the Insolvency scenario in India. One must also not forget that in a commercial setup, there is a chain of transactions which are dependent on each other and a major delay in repayment may culminate in a domino effect, disrupting cash flow across sectors. On an optimistic note, it may however be hoped that such discretion does not become the rule and is only exercised in exceptional cases by the AA. 

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

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

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

    Introduction

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

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

    Background to the dispute

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

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

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

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

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

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

    The CoC accountable for equitable treatment of similar class creditors

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

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

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

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

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

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

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

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

    • Commercial Wisdom of CoC can’t be interfered.

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

    • Equitable Treatment among the creditors is the main objective.

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

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

    Conclusion

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

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

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

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

    Introduction

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

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

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

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

    1.1 Transparency

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

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

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

    1.2 Administration of the CD

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

    1.3 Role of the Courts/Tribunals

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

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

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

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

    2.1 Transparency

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

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

    2.2 Administration of the CD

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

    2.3 Role of the Courts/Tribunals

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

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

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

    Conclusion and Analysis

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

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

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

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

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

     

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

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

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

    [iv] Ibid.

  • Sanctity Of Legal Process Vis-À-Vis Maximisation Of Value Under The IBC: A Watertight Case?

    Sanctity Of Legal Process Vis-À-Vis Maximisation Of Value Under The IBC: A Watertight Case?

    BY DEVASH GARG, THIRD-YEAR STUDENT AT VIVEKANAND INSITUTE OF PROFESSIONAL STUDIES, NEW DELHI

    The Insolvency and Bankruptcy Code, 2016 (hereinafter the “Code”) since its enactment has become a routine subject of exchange in the legal community due to its dynamic character. It has proved to be a milestone of the Indian legislature inasmuch as it has successfully improved the Indian insolvency and bankruptcy laws by simplifying and bringing them under one umbrella.

    The Code mandates the creation of a Committee of Creditors (hereinafter “COC”) for managing the transactions of the corporate debtor during Corporate Insolvency Resolution Process (hereinafter “CIRP”). Be it as it may, the Code places its complete faith in the commercial wisdom of the COC for protecting the commercial interest of the stakeholders and as well as for reviewing and selecting the resolution plans (hereinafter R-Plan) submitted by the rival Resolution Applicants (hereinafter “RA”). Even the Insolvency Law Committee reinstated in its report that one of the primary objectives of the Code is to respect the ‘commercial wisdom’ of the COC. However, it has been observed that under the guise of commercial wisdom, ofttimes COC misuse its wide discretionary powers thereby, abusing the due process laid down by law.

    Therefore recently, on 5th August 2020, the Hon’ble NCLAT passed an elaborate order in the case of Kotak Investment Advisors Ltd. v. Krishna Chamadia, where it observed that, while the COC is indeed fully authorised to exercise its discretionary powers in pursuance of its commercial wisdom, however it doesn’t mean that COC has unfettered powers under the guise of its commercial wisdom to instruct the Resolution Professional (hereinafter “RP”) to adopt an arbitrary or an ab-initio illegal procedure or a procedure which violates the principles of natural justice in the conduct of CIRP. The author attempts to analyse the decision of NCLAT along with its implications in the article.

    I. Constitution of COC- steering body of the CIRP

    Though, unlike Part III (insolvency and bankruptcy for individuals and partnership firms), Part II of the Code doesn’t define the COC for Corporate Persons, but harmonious reading of Code’s provisions would give a fair idea about the purpose, constitution, functions, and powers of the COC. Once all the claims of corporate debtor are collated, under s.21(1) of the Code, the Interim Resolution Professional is required to appoint the COC under s.18(c) of the Code. As a general rule laid down under s.21(2), the COC primarily consists only of financial creditors however, if a corporate debtor doesn’t has any financial creditor, then as per Regulation 16 of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (hereinafter the “CIRP Regulations”), the COC will consist of, 1) operational creditors, and 2) one representative each, elected by workmen and employees.

    The Code helms the COC as one of the steering bodies of the CIRP. As a result, various provisions of the Code acknowledge the significance accorded to the COC at the different stages of the CIRP.

    The RP is obliged to carry out every act in conducting business of the corporate debtor with COC’s prior approval. More specifically, s.28 of the Code lays down certain decisions which can’t be taken without prior clearance from the COC, like raising interim finance or changing capital structure of corporate debtor etc.  

    The COC remains in the saddle even at the very end of the CIRP. According to s.30(4) of the Code, for a valid approval, the R-Plan must be approved by at least 66% members of the COC. Regulation 39(3) of the CIRP Regulations, while further relying upon COC’s commercial wisdom, provides that the approved plan must have been strictly scrutinised and measured by the COC. And, once the COC approves the R-Plan, the RP becomes bound under s.31 of the Code to place it for review before the NCLT.

    Most importantly, the Code doesn’t subject the COC’s decision of approving the R-Plan to per se judicial review as the NCLT i.e. Adjudicating Authority (hereinafter “AA”) is obliged under s.31 of the Code to approve the R-Plan submitted to it by the RP. It may not grant such approval only on the basis of the limited grounds mentioned under s.30(2) of the Code. Similarly, NCLAT can examine appeals from such challenge only on the grounds mentioned under s.61(3) of the Code. On similar lines, the Supreme Court in the case of Committee of Creditors of Essar Steel India Limited Through Authorised Signatory v. Satish Kumar Gupta and Ors., laid down the doctrine of commercial wisdom and crystallised the law on this point by observing that COC exercises its “commercial wisdom” while accepting, rejecting or abstaining the R-Plans submitted by the RAs to it.

    In this manner, the Code has conferred exclusive access to negotiations and the final hand in taking commercial decisions, to the COC.

    II. Commercial wisdom- “Non reviewable”

    Accruing to this statutory backdrop, Courts have adopted a deterrent approach in interfering with the commercial decisions taken by the COC.

    The Supreme Court in Swiss Ribbons Pvt. Ltd. v. Union of India, while interpreting the Code’s preamble held that; as the fundamental aim of the Code is to revive and run the corporate debtor as a going concern, to balance the interests of all stakeholders, and to maximise the value of its assets, thus, CIRP can’t be at odds with the interests of the corporate debtor. And thus, paramount importance must be given during the CIRP to protect corporate debtor’s interests. In this context, the Court upheld the BLRC report which pegged the financial creditors (who constitute the COC) of the corporate debtor as the most qualified persons to manage and revive the said corporate debtor.

    It is pertinent to mention that the Supreme Court in another case, i.e. in K. Shashidhar v. IOB and Ors., observed certain intrinsic assumptions with regards to COC to explain the Code’s rationale for conferring it wide discretionary powers. The Court said that COC possess requisite expertise to analyse and assess the commercial viability of the R-Plans submitted to revive the corporate debtor and that its decisions are outcome of a thorough commercial analysis of the proposed resolutions based upon assessment, deliberations and voting and thus, judicial intervention in commercial decisions of the COC is barred to ensure completion of the CIRP within the timelines prescribed by the Code.

    In a comparatively recent case of Karad Urban Cooperative Bank Ltd. v Swwapnil Bhingardevay, the Apex Court, while saluting the commercial wisdom of the COC, observed that the decisions taken by the COC under its commercial wisdom are non-justiciable. The Court even remarked that as compared to COC, the NCLT has merely a “hand’s-off” role during the entire CIRP.   

    However, above decisions didn’t involve the issue of sanctity of process of law. These decisions are merely binding on the issue of exercise of “commercial wisdom” of the COC, and not whether the COC has the power to go beyond the process envisaged under the Code and mould it according to its whims and fancies under the guise of its “commercial wisdom”.  

    III. NCLAT’s decision in the instant case

    In the present case, the RP invited expressions of interest (EOI) from the interested RAs after initiation of the CIRP of corporate debtor, i.e. Ricoh India Ltd. After receiving EOIs, the RP issued process memorandum with the express approval of the COC to mandate the last date for submission of R-Plans. Two plans were submitted under the said deadline. Both the plans were opened by COC and discussions started within the COC in respect of these plans. However, after initiation of discussion and lapse of considerable time, the RP accepted two R-Plans which were submitted well beyond the last date of submission without issuing a fresh notice calling for EOIs. Most interestingly, one of these two plans, was approved by the COC as a successful plan and the RP moved an application under s.30(6) of the Code for the approval of AA. At this juncture, the unsuccessful RA (who submitted the R-Plan under the prescribed timeframe), filed miscellaneous application with the NCLT challenging the approval of the said plan.

    The AA clubbed both the matters and rejected the miscellaneous application filed by unsuccessful RA thereby, accepting the application filed by RP for approval of the R-Plan. The AA placed its reliance on K. Shashidar (supra), and held that “the commercial decision of the COC for approval of R-Plan is non-justiciable and hence, is required to be sanctioned by the adjudicating authority.” This decision was challenged by the unsuccessful RA before NCLAT in the instant case.

    The main issues before the NCLAT were 1) whether the RP with the approval of COC, was authorized to accept the R-Plans after the expiry of the deadline for submission of the Bid, without extending the timeline for submission of EOI? and 2) whether grant of approval by the COC to the RP, in accepting the R-Plan after the expiry of the deadline was under the commercial wisdom of the COC?

    In consonance with the jurisdictional bounds laid down in Essar Steel (supra), the NCLAT, while answering both of the issues in negative, described the RP’s act of accepting the R-Plan which was submitted beyond the mandated cut-off date, though, with due approval of COC, as “material irregularity” under s.61(3)(ii) of the Code. The NCLAT held that:

    “The act of the Resolution Professional to accept the R-Plan after opening the other bids, which were all submitted within the deadline for submission of R-Plan cannot be justified by any means and is a blatant misuse of the authority invested in the Resolution Professional to conduct CIRP.”

    It also observed that COC in exercise of its commercial wisdom doesn’t possess the power to authorise RP to “adopt a procedure in the conduct of CIRP which is, ab-initio illegal, arbitrary and against the Principles of Natural Justice.”

    The tribunal went on to remark that the RP with the prior approval of COC is fully authorised to call for fresh invitations of EOIs of R-Plans even after the expiry of last date of submission, provided that such timeline for submission of R-Plan can only be extended by publishing a fresh notice in Form ‘G’ under Regulation 36A of the CIRP Regulations. Lastly, NCLAT clarified that COC can’t accept R-Plans from those RAs who haven’t submitted EOI within the prescribed deadline. The NCLAT finally held that COC, under exercise of its commercial wisdom can’t adopt any special procedure for accepting R-Plan after expiration of the deadline otherwise it would tantamount to vitiation of CIRP.

    IV. Conclusion

    The NCLAT grabbed the opportunity with both hands and indisputably flagged the objectives in the preamble to the Code, which reads as “the objective of the IBC is resolution, in a time-bound manner, for maximization of assets”, and successfully established that the objective of maximisation of value doesn’t supersede the sanctity of the process under CIRP. The objective of maximisation of value of assets of the corporate debtor is intrinsically weaved with the sanctity of process and objective of speedy resolution and hence, must not be put upon a higher pedestal.  This submission gains certitude from the decision of the Supreme Court in the case of ArcelorMittal India Private Limited v. Satish Kumar Gupta, wherein R.F. Nariman, J. said that “it is of utmost importance for all authorities concerned to follow…model timelines as closely as possible”. The decision of NCLAT in the instant case was commendable, for it dealt forensically with the meat of the matter, i.e. collision between maximisation of value and sanctity of law. However, it’s submitted that the Courts must further balance the conflict between maximisation of value and sanctity of process to build a water-tight case in near future by declaring the law on the basis of the objectives and provisions of the Code, the regulations and the BLRC report.

  • Afflictions In The Mandatory Filing Of Records With The Information Utility Under IBC

    Afflictions In The Mandatory Filing Of Records With The Information Utility Under IBC

    BY SHREYASHI TIWARI, LEGAL OFFICER AT EXPORT IMPORT BANK OF INDIA AND SHAMBHAVI SRIVASTAVA, FIFTH-YEAR STUDENT AT NUSRL, RANCHI.

    Recently, in  Univalue Projects Pvt. Ltd v. Union of India & Ors., the Hon’ble Calcutta High Court has quashed the order passed by National Company Law Tribunal (“NCLT”), New Delhi whereby it was mandated that financial creditors file a record of default from the Information Utility (“IUs”) when an application for initiation of corporate insolvency resolution process is being filed under section 7 of Insolvency and Bankruptcy Code, 2016 (“IBC”). The article analyses the scope of powers conferred upon NCLT to formulate such laws and further highlights how the provisions of IBC as well as the rules and regulations thereunder clearly showcase existence of no such fixed criteria for establishing the proof of default before an adjudicating authority.

    Background of the case

    The petitions in the present case have been filed against the impugned order passed by the Registrar of NCLT, New Delhi, with the approval of the Hon’ble Acting President of the NCLT, New Delhi dated May 12, 2020 passed by NCLT, New Delhi, whereby it was made  mandatory for the financial creditors at the time of filing an application under Section 7 of the IBC, to submit record of default from IU before the NCLT. Further, the order also allowed for the said provision to be made applicable to the applications which have been pending for admission before the NCLT under Section 7 whereby  it would be mandatory for the financial creditors to submit such information to the IUs  before the next date of hearing in order for their applications to not be dismissed. 

    Concept of Information Utility

    IU  is one of the four essential pillars of the IBC. Section 210 of IBC provides for registration of IUs  for the purpose of providing core services viz. accepting, recording authentication & verification of the financial information submitted by a person (Corporate/Operational Debtor or Insolvency Professional) to persons as may be specified, thus,  IUs act as a catalyst in the CIRP process.  The IUs are regulated vide the IBBI (Information Utility) Regulations, 2017. Despite having an indispensable role, the IU continues to be the least utilised even after a passage of three years since IBC was passed.

    It was in the light of the above that the NCLT passed the order mandating the Financial Creditors who approach the NCLT for CIRP (including the ones already pending before the bench) to mandatorily file ‘default record’ from IU.

    Repercussions that would have followed the NCLT judgment

    IBC defines “core services” under section 213 as all the services which are provided by the IUs. However, there do exist various anomalies in the IBBI (Information Utility) Regulations, 2017 (“IU Regulations”)which would have caused undue impact on the CIRP had the NCLT’s order mandating the filing of records with the IU been upheld. For example, Regulation 19(3) of the IU Regulations states that a user can access information stored with an IU through any IU. It is not unknown that all the companies have potentially sensitive data which may put the company in a vulnerable position if accessed by the general public. The risk of data piracy and data theft mulls over the financial creditors, operational creditors and corporate debtors, considering that the entire database is digital and hence, they might prefer not revealing the information in its full capacity. Similarly, Regulation 20 of the IU Regulation stipulates that the IU should provide an acknowledgment in the light of the data not being mishandled. The draft regulations provided that such acknowledgment shall be coupled with digital signature of the IU.  However, since the IU Regulations do not resonate the same, it may bring in shadow the credibility of the IU in case of any mismanagement with the data.

    Moreover, the IU Regulation 20(1) also states that the information shall be submitted in accordance with ‘Form C’ of the schedule provided in the IU Regulation, much against the framework of IBC which intends the IUs to be an electronic repository of financial information, and not merely one conventional document management system. Even the electronic storing of the data comes with its own repercussions. Yet another issue arises with IU Regulation 25 (2) which provides for the authority to any user to unilaterally mark any data as erroneous. This regulation, hence, provides arbitrary authority to any user to manipulate the data, since the IUs, upon registration, provide a unique identifier under IU Regulation 18, and hence, a user may access the information stored with an IU through any IU Therefore, such access  makes the company vulnerable to unforeseeable risks and damages.

    Merely mandating that the IUs adopt a “Secure system” as per Regulation 20 is not enough to ensure data protection of any company and cannot be used as admissible evidence with already so many loopholes existing.

    More often than not, IUs have been faced with an entry barrier. This is one of the most fundamental reasons as to why till today there exists but one IU (National e-Governance Services Ltd. (NeSL) in India. Regulation 3 of the IU Regulations mandates the IUs to have a net worth of at least Rs. 50 crores, and further prevents foreign control of IUs. Moreover, Regulation 6(2)(e) provides that an IU must pay a fee of fifty lakh rupees to the Board annually. For a financially struggling nation, placing such minimum eligibility criteria has no rationale.  This may lead to monopoly in the market structure.

    Further, the entity, since it would be in possession of such sensitive information, should be in a position to leverage cut tint edge technology. This in turn puts more burden on NeSL to carry out the functions single handedly on such a massive scale.  Hence, the companies do not resort to IUs.

    NCLT’s power to issue such orders

    Needless to mention, the judgment of the NCLT has attempted to implement IBC in its letter and spirit. However, the question arises if the NCLT’s jurisdiction is wide enough to pass such orders?

    This aspect was analysed at length by the Hon’ble Calcutta High Court  taking a  stance that it is outside the ambit of NCLT or the Registrar of NCLT to formulate laws and policies which are not in consonance with the parent acts which in this scenario is the Companies Act, 2013 (“CA, 2013”) as well as the IBC, 2016. The power of tribunals, when it comes to admitting evidence and following the rules of procedure, essentially should not be in In the present case, NCLT’s sudden order would affect the substantive rights of the financial creditors thus creating hindrances in timely recovery of their dues from the debtors, the very purpose of the IBC. In breaking down the limits of the nature of power, while tribunals such as NCLT/NCLAT are vested with incidental powers, such powers can only be exercised when there is no express provision prohibiting such incident or ancillary powers. The Supreme Court has held that incidental and tribunals must be vested with incidental and ancillary powers in order to provide justice to the parties as long as contrary provisions with respect to the same already exists. The Calcutta High Court ruled affirmed the ratio laid down in Union of India v. Paras Laminates that “[T]he powers of the Tribunal are no doubt limited. Its area of jurisdiction is clearly defined, but within the bounds of its jurisdiction, it has all the powers expressly and impliedly granted. The implied grant is, of course, limited by the express grant.” The Calcutta HC cited Section 424(1) of Companies Act, 2013 which mentions ‘natural justice’ as one such express criteria for the orders which are passed by NCLT and found the May 2020 order in violation of the same, thereby NCLT exceeding the scope of ancillary/incidental powers conferred upon it.

    Methods of proving ‘existence of debt’

    As mentioned, the IUs store in the information that helps in ascertaining the existence of a debt of a company. However, IBC also provides for other provisions that assist in concluding the existence of the debt. For example, interpreting Section 7(3)(a) of IBC, it clearly provides that a record of default submitted by an applicant is one of the methods to establish ‘existence of debt’ accrued to a financial creditor. Hence, section 7(3)(a) is disjunctive in nature and in addition to the records submitted to the IU, also enumerates any other record and evidence of default as may be specified as documents that can be submitted by the financial creditor to prove corporate debtor’s debt. The respondents argued that the term ‘as may be specified’ in Section 7(3)(a) be applicable to all the three conditions mentioned therein. The Court refuted their claim by applying the rules of interpretation and principles of litera legis to the said provision, and affirmed the term is applicable to  any of the three categories. The Court also identified that  ‘Part V’ of Form-1 under Rule 4(1) of The Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016 (“AA Rules, 2016”)  read with Regulation 8 of IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 provide more than one category such as a financial contract supported by financial statements, records of withdrawal by corporate debtor, order of court/tribunal adjudicated upon non-payment of debt etc. as other documents that can be attached to application under Section 7 to prove existence of debt.

    Moreover, the Supreme Court has, in the case of Swiss Ribbons (P) Ltd v. Union of India, enumerated eight classes of documents enumerated under Part V- Form 1 of AA Rules, 2016 as ‘other sources which evidence a financial debt.’

    Section 215 is not mandatory in nature

    The word ‘shall’ used in Section 215(b) of IBC makes it mandatory for the financial creditors to submit information to the IUs which is in contradistinction to ‘may’ used in Section 215 (c) for operational creditors.  The Calcutta High Court in Univalue Projects Pvt. Ltd. v. The Union of India & Ors. And Cygnus Investments and Finance Pvt. Ltd. & Anr.v. The Union of India & Ors., refuted the claim made on the grounds of interpretation of the provisions stating that Section 215(1) begins with stating ‘any person who intends to submit financial information’ which implies that the intention of provision is not to make it mandatory to submit financial information to IU and the heading of any provision does not necessarily limit the scope of provisions thereunder. On a harmonious construction of Section 215 with Section 7 of IBC as well as the rules and regulations thereunder would also render the same opinion wherein submitting of any financial information with the IU is not a compulsory precondition for admission of application before the NCLT/NCLAT.

    Conclusion

    The basic aim of IBC as a legislation is not only to minimise the liquidation of corporate entities but also to ensure recovery of dues in a timely manner. The order passed by NCLT Delhi created an unnecessary barrier in the process of financial creditors’ filing of claim under IBC. It attempted to prove redundant the claims of those applications which are pre-existing and have been filed under Section 7 of the IBC, 2016  pending before the various Benches of the NCLT, prior to such final hearing of these applications. This leads to creation of new financial disabilities for the creditors and hence alters the rights available to it.  In the present case, the petitioner Cygnus Investment pressed writ petition citing urgency for initiating insolvency resolution process. Thus, ‘time’ being one of the most important criteria in recovery legislations, the said NCLT Order wrongly interpreted the provisions of IBC (say Section 7(3), Section 215 etc.) and clearly ignored the various methods of submitting records of evidence provided under the various rules and regulations thereunder.  An observation however made by the Court that under Section 215 even IBBI does not carry the power of retrospective rule making is something future discussions over the issue would provide better clarification. This is because the Court highlighted that the current order passed by the NCLT  (a delegate) is as per Section 240 of IBC whereby IBBI can formulate regulations of the nature of ‘delegated legislation’ and even IBBI has not been conferred with the power of retrospective regulation making thus rendering the impugned order promulgated by the NCLT is bad in law.