In the previous two parts (click here[part-1] and here[part-2]), we tried unpacking the broad mechanics of the Insolvency and Bankruptcy Code, 2016 (IBC) and the central actors of the IBC regime. In Part II, we explored IBC’s basic features, concepts such as: information memorandum, liquidation value, moratorium, non-obstante clause, operational creditor and concept preferential transactions. We also tried unraveling some elaborate topics like the scope of judicial review of a Committee of Creditor’s (CoC) decision, the economic philosophy of creative destruction and the vexed issue of the application of the Limitation Act, 1963 to the IBC.
In the third and final part of this series, we go back and dig a little deeper into the roles of some actors and features that have made special appearances in the previous two parts, while introducing you to a few new ones – towards the end. (Here, we deal with terms starting alphabets Q to Z).
Q – Quorum in CoC meetings
Quorum, simply speaking, refers to the minimum number of voting members that must be in attendance at a meeting for the CoC to be able to carry out its proceedings. The IBC, by itself, does not provide any guidance on this. Instead, one has to look towards the Insolvency and Bankruptcy Board of India (IBBI) (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (Regulations of 2016). The Regulation in question is Regulation 22(1) which provides that a meeting of the CoC will be quorate if members representing at least 33% of the voting rights are present. However, this is not cast in stone and the CoC has the discretion to modify the percentage for future meetings. It also dispenses with the requirement of physical presence and allows presence by video conferencing, or other audio and visual means.
While the convening of the meeting, by itself, only requires members representing 33% of the voting rights, all major decisions like the extension of time-limit of completion of corporate insolvency resolution process (CIRP), appointment and replacement of the resolution professional (RP), other actions enumerated in Section 28 of the IBC, approval of the resolution plan and a decision to liquidate the corporate debtor (CD), can only pass muster by a vote of 66% of the voting shares. This voting percentage has replaced the earlier voting threshold of 75%, by way of an amendment in 2018, pursuant to the recommendations of the Insolvency Law Committee. This was due to the onerous nature of the earlier threshold which facilitated liquidation rather than resolution, and which was right in the face of IBC’s basic purpose, i.e to revive and resolve.
R – Resolution Professional
Simply put, a RP is the pivot around which the whole CIRP revolves. Most of the times, the RP initially fulfills several important functions acting in the capacity of an interim RP itself, or in some cases he takes the baton from the interim RP to manage the business of the CD, once he has been appointed by the CoC. Once appointed, the RP steps into the shoes of the CD’s management to conduct its business and help it sail through the CIRP. Section 25 of the IBC lays down several duties of the RP, the foremost of which is to preserve and protect the CD’s assets. Most importantly, the RP has to prepare the information memorandum, invite bids from resolution applicants (RA) and also undertake a limited review of the resolution plans received to check their compliance with statutory requirements.
Also, R – Resolution Applicant
In context of insolvency, a RA is the white knight who comes to the dying company’s aid and channelizes its efforts towards revival. In response to the invitation for bids, the RA submits a resolution plan outlining its ideas and proposals for the CD’s revival. Earlier, Section 5(25) of the IBC defined a RA a bit too simplistically to mean a person who submits a resolution plan to the resolution professional. This meant that the same persons who managed the CD earlier could now don a different hat and bid for it. The revolving doors, thus, allowed promoters or related entities to get their company back with reduced liabilities and to start afresh with a clean slate. This was problematic since it allowed the very people who had led the company to insolvency, to take advantage of their own wrong.
This prompted the Parliament to add Section 29A to the IBC which enumerates several categories of persons who are ineligible to be RAs. This includes both persons who have antecedents which disqualify them and persons who have played a role in causing the CD’s insolvency. Section 29A, however, became a catch-all provision disqualifying a wide variety of persons, who were even remotely connected to an ineligible RA, from bidding. This prompted the Insolvency Law Committee, in its Report in 2018, to suggest amendments to the provision so as to limit its scope. The Parliament did amend Section 29A in 2018, but did not incorporate all the suggestions of the Committee in the amendment.
The provision came into the limelight with the decision of the Supreme Court of India in ArcelorMittal India Private Limited v. Satish Kumar Gupta (ArcelorMittal) where it clarified several aspects of Section 29A. On the factual front, the decision declared both Numetal and ArcelorMittal ineligible to bid for Essar Steel, but allowed them to submit resolution plans on the condition of curing their ineligibility under Section 29A (c). For ArcelorMittal, this required it to clear the dues of two connected companies which were declared non-performing assets. Numetal’s ineligibility, however, was more intractable; since it was ultimately controlled by members of the promoter family of Essar Steel, it now bore the burden of paying off the dues of Essar Steel and of any other companies of the Essar group. This proved to be commercially unviable and led the way for ArcelorMittal to win the bid for Essar Steel (this was also confirmed by the Supreme Court in Committee of Creditors of Essar Steel India Limited Through Authorised Signatory v. Satish Kumar Gupta). The Supreme Court’s decision in Swiss Ribbons v. Union of India has further cemented Section 29A by upholding its constitutionality.
Presently, the question which needs to be addressed is to what extent should the revolving doors be open for RAs who want to bid for the CD. This question gains more prominence in the aftermath of the IBC’s suspension, since one of the concerns that drove the suspension was the inadequacy of finding RA’s who are willing to rescue a CD. The struggle is between two positions which exist at completely opposite ends of the spectrum— should the doors be left wide open so that RAs, even ex-promoters, can bid for the CD at a time when the appetite for reviving CDs is low or should there be limited access so that unscrupulous RAs do not take advantage of the situation to take back their company. Moving forward, striking a balance between these two competing positions should be the objective, though this, by no means, would be easy.
S – Swiss Challenge Method of Bidding
It is often said that a competitive market promotes greater productivity, dynamism and innovation in the goods and services that are produced. A similar logic guides the Swiss Challenge Method of Bidding which has been a prominent feature in awarding Government contracts. As per the method, the Government receives an unsolicited bid to develop a particular project which is then released in the public domain from where counter-bids are invited. If the counter-bids are better than the original bid, the original bidder is given a chance to improve his earlier bid. If he is unable to outdo these counter-bids, the next best counter-bid is accepted. A sense of competition between the bidders ensures that only the best proposal is put forth.
The Swiss Challenge Method has also made its way to the insolvency regime where the CoC, by pitting bidders against one other, is able to command the best price for the CD. For e.g. the RP of Company ‘A’ invites bids from RAs; RA 1 makes a bid of 4000 crores. This bid then becomes the base price for another round of bidding where RA 2 makes a higher bid of 5000 crores. RA 1 is now given an opportunity to reconsider its original bid and improve it to match RA 2’s bid. If RA 1 is unable to do so, RA 2’s bid is accepted. This method increases the amount of money which the creditors receive, and additionally ensures that the more financially well-equipped RA takes control of the CD.
T – Time Value of Money
The concept of time value of money (TVM) proceeds on the premise that an amount of money held today is more valuable than an amount held tomorrow. This is because the possession of money in the present time is certain as opposed to a future possession, and also because presently-held money has the potential to earn interest for its holder, which an amount of money receivable in the future does not. Therefore, a person parting away with money to someone else in the present has to be compensated for the opportunity cost he incurs in delaying the possession of the amount to a later date, as in the case of loans. The payment of interest on the loan, for example, is a recognition of the time-value of money of the lender.
In the context of the IBC, TMV is a crucial feature to identify a financial debt (which is defined under Section 5(8) of the IBC to mean a debt disbursed against the consideration for the TMV) and a person to whom such debt is owed, as a financial creditor. It also helps in distinguishing between financial creditors and operational creditors who render goods and services against a monetary consideration. This amount is given in exchange for goods and services and not against any disbursement of any money, which unlike the case of financial creditors.
While the concept of TMV has figured routinely in many judgments, it became a rather contentious topic in discussions on classifying homebuyers as financial creditors, before they were made so in 2018. The case with which this began was Nikhil Mehta v. AMR Infrastructure where the National Company Law Appellate Tribunal (NCLAT) ruled that a purchaser of real estate, under an ‘assured-returns’ plan, would qualify as a financial creditor for the purposes of the IBC. This entitled the homebuyer to initiate a CIRP against the builder, in case of non-payment of such ‘assured/committed returns’. The NCLAT considered the ‘assured returns’, which was to be paid to the allottees till the date of handing over of possession, as a recognition of the time-value of money.
This was followed by an amendment to the IBC in 2018, which conferred the status of financial creditors on homebuyers by treating the amount raised from such allottees as a financial debt. However, it did not clarify how the element of TMV was present in transactions with homebuyers who do not exactly lend money to real estate developers. This is because, unlike financial transactions where the debtor is obliged to give back the money lent to him, homebuyers do not lend money for a temporary period of time with the promise of its return. This money for money element is replaced by a money for apartment element, which does not qualify it as a financial transaction.
All of these concerns were put to rest by the Supreme Court of India in Pioneer Urban Land and Infrastructure Limited v. Union of India. The Supreme Court held that the absence of a money for money element was not fatal since the real estate developer was always obliged to give back something equivalent of money’s worth—the apartment itself. This lent the transaction a commercial effect of borrowing. Further, it also located the presence of TMV in such transactions by holding that the homebuyers paid a lesser amount for an incomplete flat, since they paid in installments, than they would have had to pay for a complete flat. To the Supreme Court, this difference between the amount paid by way of installments and the price they would have had to pay upfront for a completed flat was the recognition of TMV.
U – Undervalued transactions
Section 45 of the IBC deals with the avoidance of transactions entered into by a CD at an undervalue such as a gift or for a consideration which is significantly lesser than the consideration provided by the CD when it purchased the asset itself. Transacting at an undervalue lends an element of falsehood to the transaction and indicates that it has not been entered into for a legitimate commercial objective. For e.g. Company ‘A’ is going to go under insolvency but its promoters are keen to retain control over some assets which will not be available once the CIRP begins. The promoters sell these properties to related parties for a paltry consideration, in order to lend legitimacy to the transaction. The transaction does result in a transfer to another party, but the assets are still effectively owned by the promoters by virtue of the relation with the transferee (this may even amount to a Benami transaction, but more on that some other day!). The provision treats such transactions as void, since they move the assets out of the control of the creditors who need them the most at the insolvency stage.
Section 46 prescribes the same ‘look-back period’ to review undervalued transactions, that Section 43 prescribes for avoidance of preferential transactions, as we highlighted in the previous part. Section 47 also enables the creditors of the CD to approach the Adjudication Authority (AA) to report an undervalued transaction where such transaction has not been reported by the liquidator or the RP. Apart from passing orders to restore the original position of the CD under Section 48, the AA can require the IBBI to initiate disciplinary proceedings against such errant RPs or liquidator.
Section 49 of the IBC goes a step further in regulating undervalued transactions if they have been deliberately entered to keep the assets beyond the control of the creditors or to adversely affect the interest of such creditors. This provision differs from the main provision in Section 45 in two respects: first, it requires the transaction to have been undertaken with a mala fide intent, and second, it does not prescribe any look-back period for a scrutiny of such transactions. The effect of the second distinction is that every such transaction, irrespective of the time at which it was entered into, will be hit by the provision.
V – Value thereof
For all those scanning the IBC to look for this term, it does not figure anywhere in the bare text of the law. And no, we are not referring to ‘value’ in the hackneyed sense of ‘maximisation of value’ of the CD’s assets. In using this term, we revisit the IBC-Prevention of Money Laundering Act (PMLA) conflict, which we have analysed in the previous part. As noted earlier, under the PMLA, the Enforcement Directorate (ED) is empowered to provisionally attach properties which are the proceeds of crime. PMLA also empowers the ED to attach the value of such property or property of an equivalent value.
Prior to the Insolvency and Bankruptcy Code (Amendment) Act, 2020, this was problematic for an RA who had bid for certain assets which were part of the information memorandum, but which were later sought to be attached by the ED as proceeds of crime. The expansive definition of ‘proceeds of crime’ under PMLA allowed the ED to attach even untainted assets which affected the legitimate expectations of an RA who had bid for the CD on the basis of its assets, which were now being attached. This left an RA a severely damaged CD to tend for and protracted litigation to look forward to.
This problem most prominently manifested itself in the insolvency of Bhushan Steel and Power Limited (BPSL) where its assets were attached under the PMLA, in complete disregard of its bidder, JSW Steel’s interest. Interestingly, after winning the bid, JSW Steel had sought immunity from any prosecution since a forensic audit of BPSL’s accounts had allowed it to anticipate attachment by the ED. JSW Steel was successful in obtaining relief from the NCLAT which had ordered the release of properties attached by the ED, but also stayed the implementation of the resolution plan.
Pending the disposal of the case and prompted by it, the Government amended the IBC, by way of an ordinance in December, 2019, to insert Section 32A (the provision has been permanently added through the amendments to the IBC in March, 2020). The provision immunises the CD from the prosecution for any offence committed prior to the CIRP, once the RP is approved. It also ringfences the CD’s assets against possible attachment in relation to any offence committed prior to the CIRP. Here the term ‘Property’ can be read expansively to include all kinds of property, whether in the nature of proceeds of crime or property of an equivalent value. On the strength of Section 32A, the NCLAT held that BPSL’s assets could not be attached by the ED and paved the way for a successful acquisition by JSW Steel.
The amendment unmistakably intends to provide protection against prosecution and attachment under laws like the PMLA. It seeks to preserve the legitimate expectations of an RA in bidding for a CD and provides the latter with a clean slate beginning. The amendment has rendered the ED almost disabled from proceeding against the CD’s assets, once its resolution plan is accepted but has not stripped it of all its powers. The provision should not be perceived as providing a safety route to unscrupulous promoters since Section 32A itself disallows such immunity and attachment, in cases where the management and control of the CD or its assets pass to a previous promoter of the company or a related party or to anyone who the Investigation Authority may perceive to have abetted the crime or conspired in the commission of the offence. This seems to have been added ex abundanti cautela, since the IBC already contains strong disqualification provisions which prevent a promoter from bidding for his company again by coming in through a revolving door, as we have noted earlier.
Therefore, the provision has struck a delicate balance between protecting the RA’s interest who has bid for the CD’s assets with the assurance of acquiring them and the authority of the ED in bringing offenders to book. The provision will also encourage the ED to go after the assets of the ex-promoters, directors, wrongdoers, especially when PMLA does not limit attachment to just the tainted assets but extends it to property equivalent in value. Also, with no fear of the Damocles Sword of attachment hanging above them, more and more RAs will come forward to place bids for the CD and increase its chances of a turn-around.
W – Waterfall Mechanism
This term is used to refer to the order of priority followed by the IBC in distributing the proceeds from liquidation among the various heads of creditors and is set out in Section 53 of the IBC. At the stage of liquidation, the CoC has no role to determine the distribution of proceeds to the creditors, instead the manner of distribution of the proceeds from sale of the CD’s assets has to be in strict accordance with Section 53 of the Code. But its utility extends even beyond the unfortunate situation of liquidation—as we highlighted in the previous two parts—it helps determine the minimum pay-out (liquidation value or resolution value) to operational creditors under Section 30, it may be used to determine the manner of distribution under a resolution plan and it is also a basis for inquiring into the occurrence of any preferential transactions.
The proceeds from the sale of the CD’s assets flow down the pecking order in the following manner: the first priority is given to defraying the insolvency resolution process and liquidation costs. It is only after this has been paid in full, does the stream flow downwards to other creditors. First in line and standing together are the workmen claiming dues for the period of 24 months preceding the liquidation commencement date, and secured creditors who have relinquished their security in favour of the liquidation. Upon satisfaction of these claims and if there are still some proceeds available for distribution, the provision distributes it in the following order: 12 months’ wages and unpaid dues owed to employees, financial debts owed to unsecured creditors; government dues and unpaid debt to a secured creditor who pursues individual enforcement, equally; remaining debts and dues; and lastly preference and equity shareholders and partners, etc.
Like the workmen’s dues and claims of secured creditors, the IBC requires the government and secured creditors who still have unsatisfied claims after relinquishment to be paid equally. It is interesting to note that secured creditors, who have relinquished their security but who still have an unpaid claim, have been placed all the way down at the bottom when all the water has already dried up. This is to, presumably, encourage them to relinquish their security for the creditors at large, with the benefit of better recovery, rather than pursuing individual claims against the CD and recovering only negligible amounts.
X – (e)xtortionate transactions- Section 50 of the IBC empowers the RP and the liquidator to apply to the AA to avoid extortionate transactions, which is also defined in Regulation 5 of the Regulations of 2016. A collective reading of Section 50 and Regulation 5 reveals that there are three elements of an extortionate transaction: (i) it involves the receipt of financial or operational debt by the CD; (ii) the terms of the transaction requires the CD to make exorbitant payments in respect of the credit provided, and (iii) the terms are unconscionable under the principles of law of contracts. While the first two are conjunctive elements and have to be present together in order to qualify a transaction as an extortionate transaction, the presence of the third element may independently do so. The provision prescribes a look-back period of two years preceding the insolvency commencement date.
Unlike other vulnerable transactions where the CD’s ill-intentioned actions invite scrutiny, in extortionate credit transaction, the CD itself becomes the wronged party. This is because such transactions may require it to pay usurious rates of interest or be a party to a contract which imposes unfair obligations on it. Since these transactions, more often than not, affect the financial viability of the CD and diminish its value, they become liable to be avoided. Section 51 of the IBC enables the AA to pass a variety of orders such as restoring the position as it existed prior to the transaction, setting aside the debt created on account of such transaction or requiring the person to return any amount received under such transaction.
Y – Yield
There could not have been a better placement for the term yield, than here—the final stage of this article. This is because yield, in context of the IBC, can help us take stock of the IBC’s performance and test the prefatory statements we had made about the IBC in the first part. Previously, we have talked about how the IBC has spurred interest in revival and reduced liquidation to a measure of last resort. Let us examine whether this is evidenced in practice.
The most recent research shows that in the 3774 CIRP’s initiated since the commencement of the IBC in 2016, 914 have yielded orders for liquidation and 221 have yielded resolution plans. The average time taken in completion of the CIRP’s yielding resolution is 415 days, including the time taken by the AA. This is a far cry from the time limit envisaged in the IBC, which stipulated a 330-days time limit, including the time taken in legal proceedings. This situation could only worsen with time, as we highlighted in the first part, with the judgment of the Supreme Court of India in ArcelorMittal which has watered down the 330-days time limit.
Although the data reveals an inclination towards liquidation rather than resolution and thus indicates a failure of the IBC, this should not be taken at face value. This is because a majority of the CDs that were pushed to liquidation were entrants from the earlier debt resolution regime or were defunct, and therefore, had little value to offer. Further, creditors still recover their dues in a far better manner than under any other avenues—with the IBC yielding 207% of the realizable value of CDs assets. There is another less noticeable change that the IBC has effected through a change from the debtors in possession to creditors in possession model. The threat of a shift in control has prompted debtors to settle their debt with creditors, something they did not consider doing before the IBC.
Z – Zombie Companies
The Cambridge English Dictionary defines ‘zombie’ as a frightening creature that is a dead person who has been brought back to life, but without human qualities. Add ‘corporate’ before ‘creature’; replace ‘person’ with ‘company’ and ‘human’ with ‘company-like’—you have the definition of a zombie company. Zombie companies, much like undead zombies in a horror movie which refuse to die and don’t let others live, continue to survive off financial aid, either from banks or from governments. As living companies, however, they do very little than just disrupting the natural interplay of demand and supply in the economy.
Since they are mostly subsidized by the Government or survive off lent capital by banks, they have little to worry about generating profits on these investments. This lackadaisical attitude allows them to artificially keep prices low and operate in an uncompetitive manner, to the complete detriment of other players in the market. By keeping prices low, zombie companies force other companies to also lower their prices and operate at a loss, causing them to head towards insolvency. At this stage, the IBC steps in to give such companies a second chance and prevent their corporate death. It plays the dual role of both a zombie company hunter and healer; by targeting them, it kills their zombie instincts and, in the process, breaths fresh life into them.
(2019) 2 SCC 1.
(2019) SCC OnLine SC 1478.
(2019) 4 SCC 17.
(2017) SCC OnLine NCLAT 859.
(2019) 8 SCC 416.