On the process of criminal prosecution for offences under the IBC and the problems created by the NCLAT judgment in Amtek case..
While honour and morality guide the higher man, for everyone else – there is law. Here we examine: what are the consequences of a Resolution Applicant (under the Insolvency and Bankruptcy Code, 2016 (‘IBC’ or ‘Code’)) backing out from a Resolution Plan?
Given the fact, that such a contravention is a penal offence, can a prosecution be initiated straight away, or is there a requirement – under the law – to conduct a preliminary enquiry?
Also, if such a preliminary enquiry is required to be conducted, what role, if any, would the NCLT play in this?
This what we seek to examine in this column.
These questions assume great importance as many resolution applicants (under the IBC) have been accused of backing out from their commitments and not following through with their resolution plans.
To get the basic principles out of the way first, we understand that whether or not to approve a resolution plan is a question left to the commercial wisdom of the Committee of Creditors (‘CoC’).
Once approved by the CoC, the matter comes to the Adjudicating Authority (‘AA’) which, if satisfied that the resolution plan meets the requirements of Section 30(2) of the Code, has to approve the plan, and such a plan is binding on all the stakeholders, including the Resolution Applicant, by virtue of Section 31(1) of the Code.
Once approved, a successful resolution applicant cannot withdraw the resolution plan and is bound by it, and so is everyone else. These are basics.
The NCLAT and its Problematic Ruling
Coming back to the case under discussion (Amtek Auto). In this case, pursuant to a Section 7 application, the Corporate Insolvency Resolution Process (‘CIRP’) of Amtek Auto Ltd was initiated. The CIRP culminated in both the CoC and the AA approving the resolution plan of Liberty House Group Pte Ltd (the successful Resolution Applicant). However, when the question of implementing the plan arose, the Resolution Applicant (Liberty House) backtracked – citing discrepancies and incorrect information in the information memorandum and valuation reports.
The question of liability arose.
As per the scheme of the IBC, if a successful resolution applicant refuses or evades the resolution plan’s implementation, it may amount to an offence under Section 74(3) of the Code.
The rationale behind criminal sanctions against contravention of a resolution plan is to maintain the sanctity of the CIRP, to deter frivolous bidders and to ensure that such applicants are punished for leaving the corporate debtor in a devastated state and sabotaging a CIRP process.
Section 74 of the Code, in this regard, reads:
Section 74. Punishment for contravention of moratorium or the resolution plan.
(1) Where the corporate debtor or any of its officer violates the provisions of section 14, any such officer who knowingly or wilfully committed or authorised or permitted such contravention shall be punishable with imprisonment for a term which shall not be less than three years, but may extend to five years or with fine which shall not be less than one lakh rupees, but may extend to three lakh rupees, or with both.
(2) Where any creditor violates the provisions of section 14, any person who knowingly and wilfully authorised or permitted such contravention by a creditor shall be punishable with imprisonment for a term which shall not be less than one year, but may extend to five years, or with fine which shall not be less than one lakh rupees, but may extend to one crore rupees, or with both.
(3) Where the corporate debtor, any of its officers or creditors or any person on whom the approved resolution plan is binding under section 31, knowingly and wilfully contravenes any of the terms of such resolution plan or abets such contravention, such corporate debtor, officer, creditor or person shall be punishable with imprisonment of not less than one year, but may extend to five years, or with fine which shall not be less than one lakh rupees, but may extend to one crore rupees, or with both. (emphasis supplied)
Going back on one’s commitment under a resolution plan, therefore, is a punishable offence. So far, so good. However, the next question that arises is slightly more complicated. What needs to be examined is :
How is this offence meant to be investigated and prosecuted?
Can a FIR be registered against such a resolution applicant?
Who is to file the complaint before the Court?
Would the NCLT/AA have any role to play in this?
Sub-section (2) of Section 236 of the IBC provides guidance. It reads: “no Court shall take cognisance of any offence punishable under this Act, save on a complaint made by the Board (IBBI) or the Central Government or any person authorised by the Central Government in this behalf”.
This manifests that cognisance of an offence under Section 74 can only be taken on a complaint made by the Insolvency and Bankruptcy Board of India (‘IBBI’ or ‘Board’) or the Central Government. Therefore, an offence u/s 74 of the IBC is not something for which an FIR can be registered at the local police station. It is not a cognizable offence – in that sense.
Further, as per design of the Code, the NCLT also seems to have no role to play in this. Whether to prosecute or not to prosecute, the decision firmly rests with IBBI/Board or the Central Government, appears to be the letter and intent of the Code.
This led to a conundrum; if only the IBBI/Board or the Central Government can file a complaint, how do they get to know whether an offence under Section 74 is committed, given the fact that they are neither parties to a CIRP nor made respondents.
The other issue is whether the IBC envisages any role of the NCLT/AA in this respect.
These were the questions that arose in Amtek Auto case before the NCLAT. This is where NCLAT ended up creating a procedure totally alien not only to the IBC but the first principles of criminal law. Whereas the IBC envisaged only the IBBI or the Central Government to take a decision in this regard, by an interesting process of reasoning, NCLAT envisaged a role to be played by the AA.
Since IBC does not provide for this, the NCLAT chose to place reliance on Section 213 of the Companies Act, 2013 for this, and observed:
Section 213 of the Companies Act, 2013 relates to “Investigation into the company’s affairs in other cases”.
As per clause (b) of Section 213, on an application made to the AA by any other person (say, the ‘Resolution Professional’ or the ‘CoC’) or otherwise (suo moto), the AA has the authority to order that the affairs of the company be investigated by an inspector(s) appointed by the Central Government.
Before passing such an order, the AA needs to provide a reasonable opportunity of being heard to the parties concerned.
Thereafter, suppose the AA is satisfied that circumstances suggest that the company’s business is being conducted with an intent to defraud its creditors, members or any other person (or otherwise for a fraudulent or unlawful purpose) misfeasance or other misconduct towards the company (‘Corporate Debtor’ through ‘Successful Resolution Applicant’), it may pass an order of investigation.
The Central Government shall appoint one or more competent persons as inspectors to investigate the company’s affairs.
While this – indeed – is the procedure when NCLT is investigating into a company’s affairs under the Companies Act, 2013, this process is – in no way – applicable when it comes to a decision to prosecute or not to prosecute a resolution applicant for an offence under the IBC.
The NCLAT made the above process applicable to prosecution of IBC offences. It held:
Therefore, we are of the opinion that before referring any matter to the Insolvency and Bankruptcy Board of India or the Central Government, the Adjudicating Authority/Tribunal is required to provide a reasonable opportunity of hearing to the parties concerned/alleged offenders of provisions of Chapter VII of Part II and if satisfied may request the Central Government to investigate the matter and then to decide on such opinion whether to refer and lodge any case before the Special Judge for trial under Section 236 of the ‘I&B Code’ for an alleged offence under Section 74(3) or any other provision under Chapter VII of Part II of the ‘I&B Code’ and for punishment under Section 447 of the Companies Act, 2013.”
This ruling is problematic for a number of reasons.
Where the NCLAT lost its way
With great respect, the NCLAT while rendering its decision has, unfortunately, neither paid heed to the statutory scheme of the Code nor the difference in civil and criminal proceedings. The NCLAT decision in Amtek Auto suffers from the following anomalies:
The IBC is a complete Code: The usage of Section 213 by the NCLAT was incorrect. By doing so, it has squarely disregarded the Supreme Court’s decision in M/s. Innoventive Industries Ltd v. ICICI Bank [2017 SCC OnLine SC 1025] where the Court held that “there can be no doubt, therefore, that the Code is a parliamentary law that is an exhaustive code on the subject matter of insolvency in relation to corporate entities”. Accordingly, the said provision of the Companies Act, 2013 or for that matter, any other enactment, cannot be imported into the IBC’s scheme since the IBC is a complete code in itself.
IBBI/Board guidelines already provide for a satisfactory procedure: The IBBI guidelines for complaints under Section 236 clearly show how a preliminary determination of the commission of an offence under Section 74 is to be made, and the AA has no role in this process. The guidelines state that:
Every complaint/allegation received by the IBBI complaining/alleging misconduct of a debtor, a creditor, a resolution applicant or any other person other than a service provider shall be forwarded/referred to Prosecution Division in the Administrative Law Wing.
Every misconduct of a debtor, a creditor, a resolution applicant or any other person, as may be noticed by any Division of the IBBI in discharge of its functions, shall be referred to the Prosecution Division.
On receipt of the reference under (a) or (b) above, the Prosecution Division shall assign a number to each such reference.
The Prosecution Division shall gather information from the complainant, operational Division, and the debtor, the creditor the resolution applicants, or the other person, as the case may be, and evidence, if any, regarding the alleged misconduct, within 30 days of the receipt of the complaint.
A DGM level officer of the Prosecution Division shall form an opinion within 45 days of receipt of the complaint if there exists a prima facie case for filing a complaint before the Special Court. If he is of the opinion that there exists a prima facie case, he shall put up the matter to the ED in charge of Prosecution Division who shall decide whether a complaint is to be filed before the Special Court or not. In cases where the ED in charge of Prosecution Division is of the opinion that there exists no prima facie case, he shall close the complaint after recording reasons for the same.
In case where the ED in charge of Prosecution Division is satisfied that a complaint should be filed, he shall cause filing of the complaint under section 236 of the Code to the Special Court having jurisdiction over the matter according to the procedure of Criminal Procedure Code, 1973.
Thereafter, due process of law shall be followed.
Therefore, it is evident that the NCLAT’s concern that a preliminary inquiry is necessary for a complaint to be made has been satisfactorily taken care of in the Board’s guidelines. The AA need not make the preliminary determination here.
Conflicting observations by the NCLAT: It is interesting to note the NCLAT itself has questioned (see para 42) the AA’s jurisdiction to refer the matter to the IBBI/Board or the Central Government under Section 74 of the Code. It also observes (see para 49) that “Section 213 of the Companies Act, 2013 may not apply to the proceeding under the IBC”. Nonetheless, the Hon’ble Appellate Tribunal thought it fit to import the procedure established under Section 213 of the Companies Act, 2013.
Incorrect interpretation of Section 236 of the Code: Another legal folly was to read into Section 236 of the Code what the Legislature did not enact. While placing reliance upon Section 213 of the Companies Act, 2013, the NCLAT failed to appreciate the fact that Section 236 of the Code does not mention the AA (the NCLT) as an authority capable of making reference to the IBBI/Board or the Central Government as opposed to Section 213 of the Companies Act where it is explicitly mentioned.
Furthermore, the NCLAT has also read into Section 236 of the Code, a two-step process before the Special Court can take cognisance. Firstly, an application shall be made before the AA, which shall evaluate whether circumstances exist for referring the matter to the IBBI/Board or the Central Government. Secondly, the IBBI/Board or the Central Government (as the case may be) shall investigate whether an offence is sufficiently made out so that a complaint may be filed before the Special Court. The NCLAT did not make any observation as to whether such reference would be directory or binding.
The AA cannot assume criminal jurisdiction: The NCLAT, through this ruling, has also blurred the line between the civil and criminal process. It is undisputed that the AA is a civil and not a criminal forum, bereft of any jurisdiction of determining a question/ issue of criminal nature. It has essentially made the finding of the AA, a civil forum, a condition precedent for a criminal complaint. The NCLAT, without any legal provision, has allowed the AA to virtually take cognisance of an offence under Section 74 of the Code. This is an encroachment upon the Special Court’s jurisdiction and violative of sub-section (2) of Section 236 of the Code. It is noteworthy that the NCLAT has itself observed (see para 41) that it cannot deliberate whether an offence under Section 74(3) is, prima facie, made out. Therefore, there is no rationale for the show-cause notice when determining the commission of an offence is beyond the NCLAT’s jurisdiction.
An Accused is not entitled to show-cause notice: Furthermore, the issuance of a show-cause notice to the accused is a concept alien to criminal law. An accused has no say at the stage of instituting the criminal complaint. A criminal complaint may be filed without notifying the accused or providing an opportunity to be heard. The issue of principles of natural justice being violated does not arise at this stage.
Whether or not the default on the part of the successful Resolution Applicant was wilful and violative of Section 74(3), is a matter of defence in a trial before the Special Court after cognisance is taken on a complaint made by either the IBBI/Board or the Central Government.
The above, in our humble opinion, renders the NCLAT ruling bad in law.
Currently, the matter is pending in appeal before the Supreme Court in CA No 007567-007569 of 2019. We hope that the Apex Court will remedy this and reinstate the difference between civil and criminal proceedings and restore to the IBBI/Central Government, the powers to initiate prosecutions.
In the previous part (click here), we gave you a general background to the Insolvency and Bankruptcy Code, 2016 (IBC) and tried unpacking some specific concepts crucial to its functioning. We introduced you to the central actors of the IBC regime: Adjudicating Authority (AA), Committee of Creditors (CoC) and financial creditors, including the latest addition to the group—homebuyers. Additionally, we briefly analysed some of the more advanced concepts such as ‘cross-border insolvency’, ‘group insolvency’ and ‘timely resolution’—topics that the IBC (and the country) is still warming up to. We also explained how Courts have interpreted ‘default’ and ‘dispute’, which are important events which can trigger or stall a corporate insolvency resolution process (CIRP).
In the second part, we take a closer look at the IBC’s most fundamental features (terms starting with alphabets I-P).
I – Information Memorandum (IM)
The IM is one of the four important documents in an insolvency process along with the evaluation matrix, request for resolution plans and the resolution plan (RP) itself.
Put simply, the IM is nothing but a document spelling out the details of the corporate debtor (CD) to assist the resolution applicant (RA) in preparing the RP. Section 5(10) of the IBC defines an IM as a memorandum prepared by a resolution professional and then directs the reader to Section 29 which spells out, with greater granularity, what ‘relevant information’ an IM should contain.
This information is intended to provide an all-around picture of the CD and to help stakeholders make informed decisions w.r.t the future of the CD; broadly, it includes information relating to CD’s financial position and disputes by or against it. Insolvency and Bankruptcy Board of India (IBBI) is empowered to lay down what exactly constitutes ‘relevant information.’ The IBBI has done so in Regulation 36 of the IBBI (Insolvency Resolution Process For Corporate Persons) Regulations, 2016 (IBBI Regulations, 2016) where it has added on to the constituents provided in Section 29. These include : the audited financial statements, the list of creditors and the amounts claimed by them, assets and liabilities of the CD, details of guarantees given for the debts of the CD, the number of workers and employees and liabilities towards them, amongst a host of other things.
J – Judicial Review of the decision of the Committee of Creditors
This is a topic worthy of an entire article dedicated to it, but space constraints permit us to only summarize it here. The saga began with the ruling of the National Company Law Appellate Tribunal (NCLAT) in Standard Chartered Bank v. Satish Kumar Gupta, R.P. of Essar Steel Limited which, as we have already highlighted in the previous part of the article, drove coach and horses through the concept of autonomy and commercial wisdom of the CoC in deciding the distribution of proceeds under the RP. Something that was to be left to the CoC was appropriated by the NCLAT. This was problematic since it adversely affected the interests of the most important creditors to the company—secured financial creditors. Secured creditors, for the uninitiated, lend capital to companies at low interest rates because the presence of a security mitigates their risk in the event of a default in repayment. Since the banks’ interests are protected, they are motivated to extend credit to companies. This entire system helps maintain a continuous supply of credit for companies, facilitates greater economic activity, and avoids a chilling effect on lending. In the insolvency resolution process also, it is the CoC, which is composed of financial creditors, that has the capacity and judgement to assess the viability of a Resolution Plan (“RP”). In doing so, the CoC may decide to approve a RP which enables increased recovery by the secured financial creditors, in comparison to other unsecured and operational creditors. As we have noted before, this is only fair since it is only the financial creditors who are willing to take haircuts on their loans and place their claims in a long-term context of the company’s revival, something which operational creditors may not be able to do.
It is in this context that the Supreme Court’s judgment in Committee of Creditors of Essar Steel India Limited Through Authorised Signatory v. Satish Kumar Gupta (Essar Steel) becomes an important precedent. The Supreme Court has rightly held that AAs/ NCLATs cannot make a judicial determination of a commercial decision – which is entirely within the remit of the CoC, composed of financial creditors who are better suited to judge the feasibility and viability of an RP. The decision draws heavily from another decision of the Supreme Court in K. Sashidhar v. Indian Overseas Bankwhere it was held that the commercial wisdom of the CoC was nonjusticiable.
However, judicial review has not been completely ruled out. The AAs/NCLATs have to still ensure that the decision of the CoC reflects a plan to maximise the value of assets and takes into account the interest of all stakeholders, which includes the operational creditors. In providing a narrow scope of scrutiny, the Supreme Court has, therefore, struck a balance. This is important because any company cannot survive merely off financial creditors; it needs a constant supply of goods and services from operational creditors. A complete disregard of their interests can never be in the long-term interests of the company because this may have the effect of handicapping a newly revived company who may rendered a pariah and left with no operational creditors to provide goods and services to it.
Even the 2019 amendment to Section 30 of the IBC, which we have discussed in the previous part, has taken a balanced view by stipulating that the RP has to provide a minimum pay-out to the operational creditors and that the CoC can take into account the hierarchy between creditors in deciding the manner of distribution from an RP. However, a vaguely worded explanation has also been introduced to Section 30 which states that: [f]or the removal of doubts, it is hereby clarified that a distribution in accordance with the provisions of this clause shall be fair and equitable to such creditors.
Before the judgment of the Supreme Court in Essar Steel, there were two possible interpretations of this explanation which rendered it ambiguous. One interpretation was that if the RP provided for the minimum pay-out to the operational creditors, it would be deemed to be a fair and equitable distribution and thereby, eliminate any possibility of judicially review of the ‘fairness’ of the distribution. If it was truly in the character of a deeming provision, that would mean that the Parliament had omitted to insert the words ‘deemed to be.’ Another view was that the explanation had cast a duty on the AAs/NCLATs to determine the‘fairness’ of the distribution to operational creditors and, thus, opened up the floodgates for litigation on the fairness of distribution. However, the latter view brought the IBC back to square-one and defeated the intent of the amendment which is to limit judicial review of distribution under RPs. In Essar Steel, the Supreme Court seems to have endorsed the first interpretation; it clarified that Explanation 1 has been inserted to preclude the AA/NCLAT’s from entering into the merits of the decision of the CoC, once the RP ensures the minimum pay out to operational creditors. This means that the scope of judicial review of the CoC’s decision is circumscribed by the IBC and can no longer be tested on untrammeled subjective notions of just and fair.
A recent decision of the Supreme Court has thrown further light on the issue of commercial wisdom and the limits of judicial review. In Maharasthra Seamless Limited vs. Padmanabhan Venkatesh, the Supreme Court approved a RP where the bid amount was lower than the liquidation value (notional value of assets if the CD was to be liquidated; more on this later). While the NCLAT had ordered the RA to increase the upfront payment to match the liquidation value, the Supreme Court felt that the NCLAT had overstepped its boundaries of judicial review in doing so. It observed that NCLAT’s decision was based on an equitable perception and, was an improper attempt to substitute its own decision for the CoC’s commercial wisdom.
This judgment may come under fire for promoting an unquestionable use of commercial wisdom to defeat any objections against palpably unfair RPs, such as the one in this case, one may argue. However, a close reading of the judgment belies this perception. The Supreme Court itself acknowledged the fact that an RP which provides an amount lesser than the liquidation value appeared inequitable, but also noted that the RA planned to infuse more funds once it began running the company. In other words, the RA’s decision to invest in a staggered manner rather than make a significant upfront payment was based on what the CoC and the RA itself considered to be commercially viable. The judgment reinforces the view that the seemingly impenetrable wall of commercial wisdom is not to enable downright arbitrary RPs to pass muster but is intended to avoid excessive intereference in what are otherwise commercially viable decisions.
K – Kreative Destruction
Yes, creatively spelled. This is at the heart of IBC. The term ‘creative destruction’ was first devised by the economist, Joseph Schumpeter in 1942, in his work titled ‘Capitalism, Socialism, and Democracy.’ He explained it in the following words: “. . . the same process of industrial mutation . . . that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.” To Schumpeter, the process of constant evolution in the kind of technology, products and services people use, undergirds economic growth and productivity. At its heart, creative destruction requires challenging the status quo and introducing reformative ideas and processes to destroy the existing ones, for the better.
Closer to home, we have our very own proponent of creative destruction in the form of Lord Shiva (also known as Lord of Destruction), who destroys and creates the world anew in a more perfect form.
The idea of breaking up old structures to give way to new ones is central to the insolvency process under the IBC. The CIRP involves the removal of the existing management of a CD debtor which is followed by a process aimed at revitalizing it through a RP and to enable it to continue as a going concern. RPs are typically aimed at turning the CD around by infusing fresh capital and helping it chart a new path, all of which is done by a different management, with a better vision than the earlier one. The IBC leaves almost no scope for the earlier management to bid for the CD or regain control of it (something that we will touch upon in the next part). This ensures that a completely new management takes over the CD, uninfluenced by the previous way of functioning and keen to introduce its own ideas. In doing all of this, the IBC paves the path to resolution from destruction for the CD and ends up making use, in its own way, of the theory of ‘creative destruction.’
L – Limitation Act and IBC
As a law which is still plagued by many instances of conflict with other laws, the IBC’s conflict with the Limitation Act, 1963 (Limitation Act) stands resolved by a legislative amendment and reaffirmed by a judgment of the Supreme Court. Like other puzzling questions of law which arise in the implementation of IBC, the question of applicability and the need for judicial and legislative intervention arose from existing jurisprudence which considered the Limitation Act to not apply to claims under the IBC.This reasoning had proceeded on the premise that the IBC is a self-contained code which excluded the application of the Limitation Act. This, however, did not mean that stale claims from even 30 years ago could be admitted since the NCLAT had left it to the AAs to determine limitation on a case-to-case basis, without imposing the requirement to take guidance from the Limitation Act.
Even before any appeals could be made to the Supreme Court, the Parliament added Section 238A to the IBC to apply the Limitation Act to proceedings and appeals under the IBC. The only question, therefore, which fell before the Supreme Court in B.K. Educational Services Private Limited v. Parag Gupta and Associates was whether the Limitation Act would apply retrospectively to applications made on and from the commencement of the IBC on 01.12.2016 till 06.06.2018, the day on which the amendment came into effect.
The Court answered this in the affirmative and held that the definition of ‘due and payable’ under Section 3(12) of the IBC covered only those debts which were not time-barred. This was itself drawn from another ruling of the Supreme Court in Innoventive Industries Ltd. v. ICICI Bank which had held that a debt would not be a due debt if it is not payable in law or in fact. A time-barred debt was not a due debt since it was interdicted by the law of limitation. Not holding so, according to the Supreme Court, would allow anyone, even with a time-barred claim from 1990, to trigger a CIRP even where it is not required and may cause liquidation leading to ‘corporate death.’
Also, L – Liquidation Value
Regulation 2(k) of the IBBI Regulations, 2016defines ‘liquidation value’ as the estimated realizable value of the assets of the CD, if the CD were to be liquidated on the insolvency commencement date. This has to be determined by two registered valuers who have to appointed by the resolution professional within seven days of his appointment. But what exactly is the purpose of determining the liquidation value at a stage when the CD is commencing its journey to recovery, something which is fundamentally opposed to the idea of liquidation.
The answer to this lies in an understanding of the classification of creditors into financial and operational creditors. As we have highlighted in the previous part, the financial creditors in the CoC have wide-ranging powers to take important decisions for the CD like the approval of a RP and deciding the manner of distribution under the plan. Given that operational creditors have no voting rights in the CoC, there is a possibility that the financial creditors may completely disregard their interests. In order to prevent this from happening, the law guarantees the payment of atleast the liquidation value to such operational creditors so that their claims are not completely ignored under a RP. The payment of liquidation value is also guaranteed to ‘dissenting financial creditors’ who do not vote in favour of the RP. This was a result of the first set of amendments to the IBC in 2019, pursuant to which Section 30(2)(b) of the IBC was amended to provide for this payment. In fact, dissenting financial creditors were initially entitled to the payment of liquidation value under Regulation 38 of the IBBI Regulations, 2016, but the provision was struck down by the NCLAT as being ultra vires of the IBC. This necessitated the re-introduction of this provision.
In fact, the first set of amendments in 2019 has amended Section 30(2)(b) to further benefit the operational creditors by mandating the payment of the resolution value, if it is higher than the liquidation value. This is the amount that the operational creditors are entitled to receive if the bid amount is distributed in accordance with the order of priority under Section 53 of the IBC. In simple terms, the amendment has pegged the value of the minimum pay-out in relation to the amount given in RP, rather than the liquidation value, since the former is likely to generate a higher pay out for the operational creditors. However, a persistent difficulty continues to plague both liquidation value and the amount given in the RP: the amount to be paid under the RP will have to be a significant amount for it to be distributed to the operational creditors in the order of priority under Section 53 of the IBC. This is because they are at a lower priority than other categories of persons under the provision and the amount is likely to be exhausted by the time their claims can be satisfied.
A reading of the IBBI Regulations, 2016 reveals another term which accompanies liquidation value : fair value. This is the estimated realizable value of the assets of the CD if they were to be exchanged on the insolvency commencement date between a willing buyer and willing seller in an arm’s length transaction, after proper marketing and with knowledge, prudence, and without compulsion. Note that the italicized terms radically change the circumstances of the hypothetical transactions from the ones that would have to be taken in determining the liquidation value. The determination of fair value is expected to yield a higher valuation than liquidation value, because the former proceeds on the assumption that the CD will continue as a going concern and not be liquidated. The determination of fair value became a requirement only from 2018, when it was added by way of an amendment to the IBBI Regulations, 2016. This change was prompted by low bids being submitted by RA’s, which took liquidation value to be the base for their bids, ignoring the fact that the assets had to be valued in the context of revival and not liquidation.
M – Moratorium
Akin to a ‘closed door’ which does not provide any access to the assets of the CD, the moratorium under Section 14 of the IBC is imposed to keep the CD’s assets together so that the interests of all stakeholders can be addressed, andpiecemeal recoveries through multiple proceedings do not minimize the value of the CD. A seemingly uncontroversial provision has, however, run into trouble in its implementation when it comes to imposing a moratorium on legal proceedings, in the form of suits and arbitrations, by or against the CD.
Although Section 14(1)(a) makes it amply clear that the moratorium applies to all proceedings against the CD, the Supreme Court’s ruling in Alchemist Asset Reconstruction Company Ltd. v. M/s. Hotel Gaudavan Pvt. Ltd.seems to have applied the moratorium to even proceedings by the CD even in absence of an express statutory prohibition in Section 14. In spite of a moratorium on proceedings against the CD, one ruling of the NCLAT in Jharkhand Bijli Vitran Nigam Ltd. v. IVRCL Ltd.and two rulings of the Delhi High Court in Power Grid Corporation of India Ltd. v. Jyoti Structures Ltd.and SSMP Industries Ltd. v. Perkan Food Processors Pvt. Ltd.have allowed proceedings which are against the CD, arguably, in disregard to the statutory prohibition.
In order to overcome the statutory hurdle, these rulings have adopted, what we call, the Impact on Assets theory where all proceedings against the CD are allowed unless they endanger, diminish, dissipate or adversely impact the CD’s assets. This logic interdicts only recovery actions against a CD and allows any other kind of proceedings such as a Section 34 application under the Arbitration and Conciliation Act, 1996 (this was allowed in Power Grid by the Delhi High Court) or even the continuation of an arbitration against the CD till the execution stage. This is because the latter two proceedings do not impact the assets of the CD and accordingly do not hit the moratorium. Supporting this march towards the creative interpretation of law, the NCLAT in Jharkhand BijliVitran Nigam Ltd. allowed thecontinuation of arbitration proceedings against the CD because the adjudication of the CD’s claim depended on the determination of other claims against it. The NCLAT reasoned that if the CD was found liable to pay an amount, the counter-claimant could not recover during the moratorium, thus protecting the CD’s assets. Presently, these rulings which have creatively interpreted Section 14(1)(a) are good law. This is also because the question of their incompatibility with the Supreme Court’s ruling in Alchemist remains unclear due to the language of the SC’s order. This issue, therefore, remains ripe for the Supreme Court’s intervention.
In the interlude between Part I of this article and the current Part, the “proposed suspension of the IBC” has crystallised as law through the IBC (Amendment) Ordinance, 2020, promulgated on June 5, 2020. The Ordinance has notably added Section 10A, which has suspended insolvency filings for defaults arising on and after March 25, 2020 for six months (this period is extendable for up to one year). This may impair the utility of the moratorium in keeping the CD’s assets together. This is because Section 14 of the IBC comes into play only when an application is filed under the IBC, and not otherwise. Therefore, the suspension of filings under IBC has now made it easier to peel off the protective layer over the CD’s assets, both by the CD in transferring its assets and by others in instituting legal proceedings, enforcing security interests or recovering any property occupied by the CD.
N – Non-Obstante clause
The non-obstante clause, as it is understood in its legal sense, seeks to provide an overriding effect to the provision in which it is contained over other inconsistent provisions. The non-obstante clause which gives the IBC an overriding effect is contained in Section 238. The interpretation of Section 238 and the interaction between IBC and other statutes has been the subject of many judgments. Here, we explain two instances which still await resolution.
The first one relates to the conflict with the Securities and Exchange Board of India Act, 1992 (SEBI Act) which is presently pending before the Supreme Court in SEBI v. Rohit Sehgal. The case has arisen from an illegal Collective Investment Scheme floated by HBN Dairies Pvt. Ltd., which was being run in non-compliance with the SEBI Act. In view of this, SEBI ordered the attachment of properties of the company in 2017. Apart from the SEBI taking action, even the investors who had grown impatient with the recovery process, approached the NCLT as financial creditors to initiate the CIRP of the company. The NCLT accepted the application and declared a moratorium under Section 14 of the IBC. Armed with the NCLT order, the RP approached the SEBI for de-attachment of properties which refused to budge, citing the primacy of the SEBI Act. Things ultimately wound up at the NCLT which ordered de-attachment of the property by reason of the overriding effect of IBC over the SEBI Act, which was subsequently affirmed by the NCLAT. This decision has been appealed by SEBI in the Supreme Court which has stayed the order of the NCLT directing SEBI to hand over the title deeds to the RP and ordered SEBI to not create any encumbrance on these properties.
The second unresolved conflict (we say this with the caveat that it remains unresolved from the standpoint of a judicial decision) is between the IBC and the Prevention of Money Laundering Act, 2002 (PMLA). Since the PMLA empowers the Enforcement Directorate (ED) to provisionally attach properties which are the proceeds of crime, it becomes a problem for a RA who has bid on the basis of those assets, with the hope of using them once it takes over the CD. Given the contentious nature of this issue, it was not long before it found its way at the centre of disputes before the Courts. Two decisions of the NCLT, Mumbai and Delhi High Court, at variance with another, hold the ground on this. While the NCLT, Mumbai in SREI Infrastructure Finance Limited v. Sterling SEZ and Infrastructure Limited has held that the IBC prevails over PMLA in view of Section 238 of the IBC and, therefore, no attachment under PMLA can be allowed in derogation of the moratorium. The Delhi High Court, on the other hand, in The Deputy Director Directorate of Enforcement Delhi v. Axis Bankhas taken a different (and a more nuanced) view. It has held that there is no inconsistency between the PMLA and the IBC since both have distinct purposes, text and context which militates against the application of Section 238. In fact, with this judgment, the Delhi High Court has cleared a major misconception surrounding the application of a non-obstante clause. This is because a view seemed to have developed that Section 238 kicks-in each and every time another legislation had to be applied along with IBC and completely barred the application of a co-existent legislation. However, a cardinal principle of interpreting a non-obstante clause is that it only applies in case of an inconsistency with another legislation and this even finds a mention in the provision itself. This is what the Delhi High Court has considered in its judgment while ruling that the laws operate in different spheres.
Coming back to the caveat we had inserted before we began discussing this; the issue of an inconsistency between IBC and PMLA stands resolved, more or less, under the Insolvency and Bankruptcy Code (Amendment) Act, 2020. The Act has added Section 32A to the IBC which provides the CD complete immunity from prosecution for any offence committed prior to the CIRP, once the RP is approved. This amendment will certainly affect attempts to attach properties by the ED under legislations like the PMLA and has impliedly given the IBC an overriding effect over the PMLA, in that sense. However, the NCLAT’s decision, based on the new Section 32A, to disallow the ED from attaching the assets of Bhushan Steel and Power Limited (CD) for which JSW Steel had bid (RA), has been appealed to the Supreme Court. This means that the IBC-PMLA conundrum, inspite of the legislative amendment, is here to stay, atleast till the Supreme Court endorses the NCLAT’s view on this. More on this – in the next part.
O – Operational Creditor
Section 5(20) of the IBC defines an operational creditor as a creditor to whom an operational debt is owed and Section 5(21) of the IBC defines an operational debt as a claim in respect of the provisions of goods or services including employment or debt in respect of the payment of dues, including Government dues. Operational creditors, who are mostly unsecured creditors, as a class, are best understood in juxtaposition with financial creditors who are mostly secured creditors. While financial creditors lend capital on a loan basis which often involves large amounts of money, operational creditors make claims in respect of dues which arise by virtue of the goods and services they have supplied to the CD. For e.g. a wholesale vendor of spare parts who supplies these goods to a car manufacturer is owed the payment of this amount or a lessor who rents out a space to the CD is owed the rent amount; both of these are operational creditors.
The IBC also reflects these differences between the two types of creditors, by allowing only the financial creditors to be in the CoC and to vote on RP’s. Operational creditors are not entitled to vote in the decisions of the CoC but are allowed to attend its meetings, if their aggregate dues are not less than ten percent of the debt. The reason for this exclusion, as clarified in Swiss Ribbons Pvt. Ltd. v. Union of India and later in the Essar Steel decision and in Pioneer Urban Land and Infrastructure Limited v. Union of India, is because the financial creditors are, by their very nature as lenders, well-equipped to assess the commercial viability of the CD and the RP for it, something operational creditors cannot do.
The fact that the operational creditors do not have voting rights in the CoC does not mean the financial creditors can ride roughshod over their interests. As we have noted earlier, the IBC requires that the RP approved by the CoC must provide for higher of the two amounts specified in Section 30(2)(b) of the IBC. This protection has been affirmed by the Supreme Court in the Essar Steel judgment, where it has held that the AA must review the RP to assess whether it has taken the interests of operational creditors into account.
One grouse that operational creditors have always put forth is about the unfair treatment they receive in a CIRP. RPs typically, negotiated by the financial creditors in the CoC, are not geared towards safeguarding the interests of operational creditors. Even the minimum statutory payment of liquidation value (after the 2019 amendment, this is to be considered along with the resolution value provided in Section 30(2)(b)) is often negligible for reasons we have noted above. In fact, this was acknowledged by the Insolvency Law Committee in its 2018 report, which also discussed replacing liquidation value with fair value or resolution value, both of which were eventually discarded for being unsuitable. It also dismissed claims of unfair treatment for lack of empirical evidence.
Meanwhile, attempts by the NCLAT to level the field between financial and operational creditors were thwarted by both the legislature (through the amendment to the IBC in 2019) and the Supreme Court (through the Essar Steel decision). But both the seemingly unpleasant changes contain elements which work to the benefit of the operational creditors. While the Legislature has added the payment of resolution value to the minimum pay out of liquidation value in Section 30(2)(b), the Supreme Court in Essar Steel has tempered the CoC’s commercial wisdom to the condition that it takes into account the interest of all stakeholders, including operational creditors. Even the Insolvency Law Committee’s latest report released in February, 2020 comes as a ray of hope for operational creditors. Noting the need for a fair and just CIRP, the Committee has proposed to confer voting rights on the operational creditors, so that they too have the opportunity to air their grievances against a RP. But the Committee is reluctant about implementing this reform quickly. This is for two reasons: first, the lack of technical and financial capacity in operational creditors to assess the commercial viability of the CD and, second, the impact a larger CoC will have on the efficiency of decision-making. The Committee has, therefore, conditioned the proposal with the need to address these two concerns. The Committee’s proposal has a long way to go before it is reflected in the IBC, but it is still one of the most significant triumphs for the operational creditors since 2016.
With atleast one promising potential change to look forward to, operational creditors have to weather another storm: one brought about by the recently added Section 10A. As noted earlier, Section 10A suspends filings under the IBC by all the three major stakeholders in a CIRP- financial creditors, operational creditors and the CD itself. But it is likely to have a disproportionate impact on the operational creditors. This is because the suspension coincides with the six-month moratorium on repayment of loans being granted by banks, which means that there are no chances of a default occurring, in absence of any obligation to pay on the CD. The financial creditors, therefore, have no reason to file applications under the IBC, atleast during the suspended period. However, operational creditors are perpetually precluded from invoking the IBC for non-payment of amounts due to them. The use of the word perpetually stems from the proviso to Section 10A which bars an insolvency application for a default, in the suspension period, forever. The proviso reads as: . . . Provided that no application shall ever be filed for initiation of corporate insolvency resolution process of a corporate debtor for the said default occurring during the said period. The said period is currently to be counted for six months from March 25th, 2020. With banks expecting repayments (and therefore possible defaults) only after the loan moratorium is lifted, which is likely to coincide with the lapse of Section 10A, it is the operational creditors that stand to bear the major brunt of this. Since the amendment was always intended to benefit the Micro, Small and Medium Enterprises (MSMEs), who are mostly operational creditors, the potential detriment that they may suffer has turned the amendment into a double-edged sword.
However, as alternatives to the IBC, the operational creditors still have two options: (i) They can either approach the civil court for recovery of their dues or they can initiate arbitration if there is a contractual stipulation to that effect; and
(ii) Operational Creditors can also, by virtue of being considered MSMEs, seek protection under the MSME Development Act, 2006. It entitles the operational creditor to receive compound interest if the buyer fails to make the payment and also provides for dispute resolution by the Micro and Small Enterprise Facilitation Council.
P – Preferential Transactions
Normally, a completed transaction between parties is left undisturbed and considered valid, unless it is objected-to by any of the parties to the transaction. However, the IBC empowers the resolution professional and the liquidator to scrutinise certain types of transactions which were entered into in the run-up to an insolvency. Generally referred to as ‘vulnerable transactions,’ they are subjected to an ex-post facto examination by reason of the circumstances under which they are concluded. Preferential transactions are one type of vulnerable transactions, apart from fraudulent (this has been covered in the previous part), undervalued and extortionate transactions, both of which will be discussed in the next part.
As the title itself suggests, preferential transactions are those transactions which are entered into by the CD to give preference to a particular creditor or a surety or guarantor, often to the detriment of other creditors or alike individuals. These transactions are usually entered into in the run-up to an insolvency and with a view to benefit a particular creditor at the cost of other creditors. Such transactions have the effect of disturbing the parri passu distribution intended under Section 53 on liquidation and also reduce the value of the CD to a prospective RA.
Section 43 of the Code explains in detail when a transaction will be deemed to be a preferential transaction by highlighting two situations: (i) when such transaction is for the benefit of a creditor, surety or guarantor for the satisfaction of a debt owed to such person and (ii) when the aforesaid transaction changes the pecking order given inSection 53 in a way that the beneficiary is put in a more beneficial position than it would have been in the event of a distribution being made in accordance with Section 53. To illustrate, for e.g. Company ‘A’ is going to go under insolvency pursuant to which all its assets will become part of a common pool which can be used to satisfy the claims of all creditors, in the event of liquidation. But just before this happens, Company ‘A’ transfers a substantial amount of property in favour of its holding company ‘B’ which is also a creditor of the company. This transfer has the effect of reducing the amount of assets which can be used to satisfy the claims of other creditors and is a transaction which gives an undue preference to Company ‘B’. It further puts Company B in an advantageous position than it would have been under Section 53 as an unsecured creditor.
The provision empowers the liquidator or RP to review any transactions undertaken by the CD in the ‘look back period’ which is a period of two years preceding the date of insolvency for transactions entered into with a related party and a period of one year for transactions with persons other than a related party. Section 44 empowers the AA to pass a variety of orders to restore the position of the CD, it would have been in had the transactions not been entered into. Not all transactions, however, in the ‘look-back’ period are hit by the prohibition: transactions which are made in the ordinary course of business or financial affairs of the CD or the transferee are excluded from avoidance. Similarly, are transactions which create a security interest which secures new value to the CD and transactions which are registered with an information utility on or before thirty days after the CD receives possession of such property.
A recent decision of the Supreme Court in Anuj Jain Interim Resolution Professional for Jaypee Infratech Ltd. v Axis Bank Limitedhas further clarified several aspects related to preferential transactions. The Court was reviewing whether mortgages by a subsidiary company, Jaypee Infratech Limited (CD) in favour of the lenders of its holding company, Jayprakash Associates Limited, could be set aside as preferential transactions. In coming to its conclusion that the transactions were indeed preferential, the Court has described both the conceptual and statutory underpinnings of preferential transactions, in great detail. It has laid down the following interpretative rules for section 43:
So long as both the requirements of Section 43(2) along with the relevant look back period are fulfilled, the transaction will be deemed to be a preferential transaction, irrespective of whether it was, and whether it was intended or anticipated to be;
The look back period can be reckoned from before the commencement of the IBC i.e. even preferential transactions undertaken before 2016 can be scrutinised and doing so will be not be considered a retrospective application of the law.
The word ‘or’ appearing in Section 43(3)(a), which contains the ordinary course of business exception, has to be read as ‘and’. This rule was necessitated by an argument that in order to be excluded from the purview of Section 43, transactions had to be made in the ordinary course of business or financial affairs of only one of the two parties, the CD or the transferee. This would have shifted the focus from the affairs of the CD and saved it of justifying its unusual transactions, so long as they could be justified from the viewpoint of the transferee’s business affairs. Mindful of the disastrous implications of the argument, the Court has held that a transaction has to fulfil the exclusionary requirements of Section 43(3) from both the CD’s and the transferee’s perspectives.
To be continued…..
 Authored by Bharat Chugh, Partner, L&L Partners, Law Offices and Mr. Advaya Hari Singh, 4th-year B.A., LL.B student at National Law University, Nagpur. The views of the authors are personal.
This was first used in Power Grid Corporation of India Ltd. v. Jyoti Structures Ltd (2017) by the Delhi High Court.
Duncans Industries Limited. v. A. J. Agrochem, (2019) 9 SCC 725 [IBC and The Tea Act, 1953]; Forech India Ltd. v. Edelweiss Assets Reconstruction Co. Ltd, (2019) SCC OnLine SC 87 [IBC and The Companies Act, 2013]; Jaipur Metals & Electrical Employees Organization v. Jaipur Metals & Electricals Ltd., (2019) 4 SCC 227 [IBC and The Companies Act, 2013]; K. Kishan v. Vijay Nirman Company Pvt. Ltd. (2018) 17 SCC 662 [IBC and The Arbitration and Conciliation Act, 1996]; Pr. Commissioner of Income Tax v. Monnet Ispat And Energy Ltd., (2018) 18 SCC 786 [IBC and The Income Tax Act, 1961]; Macquarie Bank Ltd. v. Shilpi Cable Technologies Ltd, (2018) 2 SCC 674 [IBC and The Advocates Act, 1961]; Innoventive Industries Ltd. v. ICICI Bank, (2018) 1 SCC 407 [IBC and The Maharashtra Relief Undertakings (Special Provisions) Act, 1958].
Spoiler alert here: the title of this article is misleading. This is, by no means, a complete alpha to omega of the Insolvency and Bankruptcy Code (IBC) and we will merely be skimming at its surface. We call it the ‘A to Z of IBC’ because what we have done here is – arrange the most fundamental principles of IBC law alphabetically, like a dictionary of sorts.
Given the raised threshold to initiate insolvency and the proposed suspension of provisions which empower creditors and the corporate debtor (CD) to do so, it is likely that IBC is going to be on hiatus with no new insolvency resolutions to facilitate and with the pending ones on the back-burner. This gives us the perfect opportunity to take a step back to the basics and analyse the IBC as it was, as it is and as it is likely to be. In trying to do so much in a short series, we are mindful that we will be attracting the wrath of IBC enthusiasts who would complain that we are totally missing nuance and that our analysis is too basic, reductive and simplistic and it does not have enough academic rigor; we’d equally be trashed by those just starting out with IBC of being too convoluted.
Totally mindful of this risk, we march on—trying to unravel the IBC and bring about some method to all this madness, with so much happening with IBC, all the time, and on multiple fronts— legislative, National Company Law Tribunal’s (NCLT) and the Courts.
Through this column, which is the first in a three-part series, we will try to give a brief overview of the primary features and actors in the IBC game and a sneak peek into the new and latest in IBC and the challenges that lie ahead. Since we all love lists, we walk you through these concepts alphabetically. But before we dive deep, here are a few words in the nature of a general preface to this path-breaking piece of legislation called the IBC:
The Indian Economy over the past few decades, to borrow the expression of Arvind Subramanium (the former Chief Economic Advisor), has journeyed “from socialism with limited entry to capitalism without exit.” Over the last few decades, governments have not exactly rolled out red carpets for the setting up of new businesses and industry, and an exit from the Chakravyuha of corporate existence was also ridden with a massive amount of red tape. The legal regime governing winding up prior to the IBC, was, to put it brusquely, as sick as the companies it sought to cure.
The IBC sets out to change all of that. It endeavours to make exit easy and to preserve maximum value for all the stakeholders involved in the winding up of a company. Despite inheriting some very very sick zombie firms from the earlier legal regime, IBC, in a very short span, has shown great results. Debtor’s paradise is now lost, as Justice Nariman beautifully puts it, and decisions in relation to a company under insolvency are taken by expert Resolution Professionals (RP) and Committee of Creditors (CoC), whose primacy has been established recently by way of amendments and progressive judicial decision making.
The shift from ‘debtors in possession’ to ‘creditors in possession’ helps safeguard and preserve a company’s value and prevents mismanagement and asset dissipation, both of which have been endemic in the Indian scenario, especially as a company goes into the twilight zone. We have also witnessed great interest in revival of insolvent companies, and liquidation is gradually being seen, and rightly so, as the very last resort. All in all, the law proves that destruction can be creative and for the larger good. With this general philosophy of this law in mind, let’s get cracking on the specifics:
A – Adjudicating Authority (AA)
This refers to the NCLTs which have replaced Company Law Boards, as the principal adjudication forum for all matters corporate. An NCLT, as the AA, admits and sets the ball rolling on a Corporate Insolvency Resolution Process (CIRP) by appointment of an Interim Resolution Professional and announcing a moratorium, which, for those who arrived late, is an embargo against institution of any suits/proceedings against the CD undergoing a CIRP.
An AA also reviews and approves the decisions taken by the CoC in relation to the revival of the company, acceptance of resolution plans, etc. Currently, there are 16 NCLTs operating as AAs and two National Company Law Appellate Tribunals (NCLAT), one at New Delhi and the other one recently constituted at Chennai. The newly-constituted NCLAT at Chennai will hear appeals from NCLTs which have jurisdiction over Karnataka, Tamil Nadu, Kerala, Andhra Pradesh, Telangana, Lakshadweep and Puducherry. The New Delhi Bench will continue to hear appeals from NCLTs of other remaining jurisdictions. Further appeals from the NCLATs lie to the Supreme Court, provided they involve a question of law.
Generally, on the working of the AAs, as someone wise said, IBC has in a lot of ways been a victim of its own success, due to which NCLTs are extremely overburdened and almost bursting at the seams; we certainly need more of them. In this context, the constitution of a new NCLAT bench at Chennai should go a long way in helping ease the burden on the docket of the NCLAT at New Delhi and further the IBC’s objective of speedy recovery.
B – Bankruptcy
Simply speaking, insolvency is a financial state of being—one that is reached when one is unable to pay off his/her debts on time. Following this is bankruptcy, which, on the other hand, refers to the legal process that serves the purpose of resolving the issue of insolvency. IBC deals with both.
C – Committee of Creditors
The most significant change brought about by the IBC and its central philosophy, is the shift from ‘debtors in possession’ to ‘creditors in control’ in relation to an insolvent company. In other words, when a company defaults on its debt, control of the company shifts from the erstwhile management (who have led the company to where it is) to a CoC. This is for good reason, as creditors have the maximum amount of skin in the game and are the most vital stakeholders in the process. A CoC, therefore, is the primary decision maker of the fate of the company.
Amongst the many functions of CoC, the primary are:
Approving the appointment of a RP;
Approving a Resolution Plan (more on resolution plans a little later);
Approving interim finance for the company, to ensure that its basic needs are met during the process of insolvency and the functioning of the company does not come to a grinding halt.
The question of primacy of CoC’s decisions has been a source of great controversy. This controversy is the most heated in situations where the CoC decides to approve one resolution plan over the other, and especially when it caters to various creditors and stakeholders of the company. Under the scheme of IBC, it is essentially left to the wisdom of the CoC to decide as to which plan best serves the interests of the company. Though it is also correct that eventually it is the AA/NCLT which finally “approves” or “rejects” a resolution plan. This apparent dichotomy has led to a fight for primacy between CoC and NCLT and great controversy on the extent to which the AA/NCLT can second guess the CoC’s decision; a decision which is essentially commercial in nature and not a legal one. We grapple with this question later in the article.
C – Cross Border Insolvency
Picture this, ‘X’ company goes into insolvency with assets spread across the world and pending claims from various lenders. On the company becoming unable to pay off its debts, lenders in country ‘A’ initiate an insolvency process where the Court appoints an administrator to deal with the company’s assets. Simultaneously, lenders of the company in country ‘B’, let’s say India, also initiate an insolvency process where the Court kickstarts the CIRP and appoints an Interim Resolution Professional to begin the process.
This kind of situation gives rise to many questions, none of which are too easy to answer:
Can these two insolvency processes proceed simultaneously?
Which administrator/RP is to take the lead, constitute the CoC and take control of the assets of the CD?
Which law will govern the distribution of the proceeds of a resolution plan?
Is there a way to consolidate these proceedings for an effective and complete resolution?
The IBC, prima facie, does not address these questions comprehensively but instead seeks to promote an ad-hoc framework of cross-border insolvency through Sections 234 and 235, possibly to retain flexibility and since there’s no one size fits all approach possible in such circumstances. These provisions envisage a system to be created through bilateral agreements with foreign countries and provides for an option of sending letters of request to foreign courts for information on the CD’s assets which are located abroad.
The problem with the current position is that it involves lengthy negotiations with individual countries to conclude treaties/agreements which will, more often than not, have different terms and procedures. This position is far from ideal and renders cross-border insolvency processes- agreement-dependent, which comes at the cost of consistency and certainty. It was precisely this position that prompted the Insolvency Law Committee in 2018 to recommend the adoption of the UNCITRAL Model Law on Cross-Border Insolvency, 1997 as a separate part in the IBC. Adoption of the Model Law will enable India to align its insolvency laws with the internationally accepted standards.
Presently, the Government is still considering amendments to the IBC to provide for cross-border insolvency but this gap in the law has not prevented the NCLAT from allowing a cross-border insolvency process for Jet Airways. In an order given in September, 2019, the NCLAT approved a ‘Cross Border Insolvency Protocol’ entered into between the Dutch Administrator of the company and its RP in India. The Protocol aims to promote a coordinated insolvency process for Jet Airways by enabling coordination, communication, information sharing between the CoC, RP and the Dutch Administrator. This makes Jet Airways the first Indian company to undergo a cross-border insolvency treatment. In another decision, NCLT, Mumbai has allowed the inclusion of Videocon’s foreign assets and properties in its CIRP in India, also illustrating the fact that the lack of a legal framework on cross-border insolvency is not deterring the Tribunals from endorsing its principles.
With everyone still celebrating this progressive decision by the NCLAT, a decision of the US Bankruptcy Court for the Delaware District has provided another shot in the arm for the cross-border insolvency regime for Indian companies. On November 4, 2019, a Delaware Court recognised the insolvency case of SBI v. SEL Manufacturing Company Limited as ‘foreign main proceeding.’ As per the UNCITRAL Model Law, on which the US insolvency law is modeled, a ‘foreign main proceeding’ is a proceeding which takes place in the centre of main interest of the debtor which is the place of registration or primary operations of the debtor.
The recognition will result in an automatic stay of any proceedings against the CD in US and bar any transfer of its assets. It will also empower the RP to undertake discovery into the CD’s assets and to manage its estate, including the sale of any assets. This decision, coupled with the recommendations of the Insolvency Law Committee, should prompt the Government of India to move swiftly in introducing a cross-border insolvency legislative framework.
However, it appears that the Government is not rushing into a legal framework without adequately studying the issues involved. In January this year, the Ministry of Corporate Affairs constituted a new committee to study and analyse the recommendations of the Insolvency Law Committee and submit a report within three months. And in February, it expanded the terms of reference for the Committee to include the study of the UNCITRAL Model Law for Enterprise Group Insolvency and to make recommendations for the IBC. Hopefully, such thorough exercises will yield a robust legal framework which is able to cater to all situations which arise in a cross-border insolvency process.
D – Default
A ‘default’ with respect to a debt owed by the CD is a trigger for the initiation of CIRP. The IBC defines ‘default’ in rather uncontroversial terms as : the non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not paid by the corporate debtor. The IBC does, however, distinguish between the ‘default’ in respect of the debt owed to financial creditors and operational creditors. The Supreme Court analysed this distinction in Innoventive Industries Limited v. ICICI Bank(Innoventive Industries)based on Section 7 (initiation of CIRP by financial creditor) and Section 8 (initiation of CIRP by operational creditor) of the IBC. The Court noted that scope of determining a default of a financial debt is limited to the records of the information utility and evidence supplied by the financial creditor. The fact that such a debt is disputed by the CD is inconsequential as long as the debt is due and payable, meaning that it is not interdicted by a law or is payable at a future debt. The CD would be entitled to object to the claim of non-payment on these grounds at the stage of inquiry into the occurrence of ‘default’ under Section 7(5). With the definition of ‘default’ as the only guide for the AA, it has no option but to admit the application filed by a financial creditor if it comes to the conclusion that the debt is due and payable.
In contrast to this, the CD had considerable leeway in disputing the debt owed to an operational creditor, who does not have the luxury of applying directly to the AA without giving notice of the unpaid debt to CD. The CD is then given ten days, from the receipt of such notice, to claim the existence of a dispute on the payment of the debt with the operational creditor. For instance, a defect in and rejection of goods and consequent lack of liability to pay may be a good dispute. The existence of a dispute with respect to a debt can, therefore, prevent the initiation of CIRP.
The reason for allowing the CD to dispute only operational debts is two-fold: first, the debts owed to operational creditors are usually small amounts and a CIRP cannot be allowed to be initiated for paltry amounts, especially when there is room for negotiation with the creditor with regard to the payment of the debt and the capacity of the company to continue as a going concern is not under serious question; second, the chances of raising a dispute with regard to a debt owed to financial creditors is significantly lesser because such debts are generally well-documented and relatively more unimpeachable, especially when registered in information utilities. This leaves very little scope for the CD to dispute its liability and for the AA, which has to only ascertain whether the debt is due and payable.
D – Dispute
The language of the provisions and the Supreme Court’s decision in Innoventive Industries clarifies the distinction between the position of financial and operational creditors and also underlines the fact that the CD may claim the existence of a dispute in respect of an operational debt and avoid a company going under CIRP.
But the question that arises is—what qualifies as a dispute?
Section 8(2)(a) allowed the CD to bring to the notice of the operational creditor – the existence of a dispute and record of the pendency of the suit or arbitration proceedings filed before the invoice was raised by the operational creditor. This could be used to avoid the company going into insolvency. The use of the word ‘and’ ostensibly appeared to suggest that pendency of a suit or arbitration proceeding with respect to a debt was the only indicia of existence of a dispute, and it was only in cases of pendency of a suit or other arbitration proceeding that a CIRP could be avoided. This was problematic for many reasons. This meant that any non-payment (which may be for good reason) and perceived default rendered an entity at the risk of being taken to CIRP. It is only in those cases where a CD was either already defending the demand in a court/arbitration or where it had proactively initiated litigation/arbitration to contest a possible future demand, that it could avoid the CIRP by bringing forth the existence of that suit/arbitration proceeding as evidence of existence of a dispute. This was absurd as it left a CD with no option but to initiate litigation/arbitration against all those who may have an interest in initiating the CIRP against it. Not having done this, the CD had practically no defence and risked being thrown into the CIRP oblivion.
Fortunately, the Supreme Court has cleared the airs on this issue in Mobilox Innovations Private Limited v. Kirusa Software Private Limited, where it has held that the pendency of suit/proceeding is not the only evidence of existence of a valid dispute; in other words, a demand can be considered disputed even without there being a suit/proceeding already pending in a Court or Tribunal. The Court has achieved this by reading the word ‘and’ as ‘or’ in Section 8(2)(a), in line with the objective of the IBC to discourage a full-fledged CIRP based on insignificant amounts owed to operational creditors. In order to avoid the risk of opening the floodgates for blanket denials of liability by the CD, the Supreme Court has given the AA some discretion in ascertaining that the dispute is not a spurious, hypothetical, or illusory dispute, crafted merely with a view to wriggle out of liability. In doing so, the Supreme Court has implicitly imported the ‘bona fide’ standard which appeared in the definition of ‘dispute’ in the earlier Insolvency and Bankruptcy Bill, 2015. The decision allows the CD to claim the existence of a dispute on the notice of payment by the operational creditor, even if it has not actively pursued it before the CIRP, so long as it is able to satisfy the AA of the genuineness of the dispute.
E – Endless Delay, A Persistent Issue?
Timely Resolution and preservation of value in underlying assets is one of the main objectives of IBC. It has always been projected as a law which promotes the timely completion of the insolvency process, well in line with its other objective of maximizing the assets’ value. This desire is also reflected in the provisions of the IBC which originally envisaged the completion of the insolvency process within 180 plus 90 days in Section 12. In practice, however, the insolvency regime is still plagued by endless delay in completion of CIRPs. Many attribute this to the delay which occurs at the adjudication stage, where litigation in most cases causes the CIRP to extend beyond the time limit. This undesirable state of affairs is what prompted the Supreme Court to exclude the time taken in litigation from computing the 270 days limit in ArcelorMittal India Private Limited v. Satish Kumar Gupta.
Worried that the ruling would only exacerbate the situation of delays, the Government, acting with great alacrity, amended the IBC in 2019 to provide for an upper limit of 330 days for completion of the CIRP but clarified that this limit would be inclusive of both the time taken in legal proceedings and any extensions granted by the Adjudication Authorities. The failure to complete the CIRP within this time limit would attract liquidation which was clearly an unfeasible option for all stakeholders involved in the CIRP.
In laying down a non-derogable time limit, the Government was clearly motivated by the desire to preserve the value of assets which naturally depletes if the CIRP goes on indefinitely. But it possibly disregarded the fact that non-compliance with the deadline, even inadvertently, would push the CD towards liquidation which has an equally devastating effect on the CD. This effectively made the remedy worse than the ailment and led to a challenge to the validity of the provision before the Supreme Court in Committee of Creditors of Essar Steel India Limited Through Authorised Signatory v. Satish Kumar Gupta (Essar Steel).
The central argument against the provision was premised on the well-known maxim :actus curiae neminem gravabit— an act of Court shall prejudice no one. Since the time limit brooked no exception for situations where the delay was occasioned by the NCLT/NCLAT’s inability to complete the CIRP without any fault of the litigant, it was considered to be a violation of Article 14 (right against non-arbitrary treatment) and Article 19(1)(g) (right to carry on business). However, instead of striking down the provision in its entirety, the Court chose to strike down only the word ‘mandatorily’ and to read it down as ‘ordinarily.’ This was done to balance both the need for speedy disposal along with the need to promote resolution of the CD in cases where the delay was not attributable to it.
The effect of this judgment is that, ordinarily,a CIRP should be concluded within the 330 days limit. But if any extension has to be granted by the AA, it can only be granted where it is shown that a short period is left for completion of the CIRP and that the time taken in legal proceedings is attributable to the pendency of the action before and/or inefficiency of NCLT/NCLAT itself. While the judgment has the merit of introducing some flexibility in what would otherwise have become an unfair provision in practice, two issues still remain unaddressed: One, the Court has not devoted any discussion to the standard that has to be satisfied in convincing the NCLT/NCLAT that they themselves have occasioned the delay. Second, it has provided little guidance on any limit to the extensions that can be granted beyond the 330 days limit. In absence of any limit, the ruling may end up aiding exactly what the 2019 amendment had set out to tackle.
F – Financial Creditor
One of the most important stakeholders in the CIRP are the ‘Financial Creditors.’ This is because they hold the key to unlocking a new life for the CD. This influential status stems from the primacy that the IBC gives to them as the voting members of the CoC and in priority of their claims. Given that it is only the financial creditors who are capable of assessing the viability of the company and who can place it in a long-term context of revival, the IBC accords them this status. Since the financial creditors have lent capital, on which the company’s existence substantially depends, they have a major say in determining its future course of action. As members of the CoC, they wield significant influence in decisions such as approval of the resolution plan ( it is only when 66% of the CoC has approved a resolution plan, can it move forward to the AA for approval), modification of the capital structure, creation of security interests and undertaking related party transactions.
However, in 2019, a ruling of the NCLAT in Standard Chartered Bank v. Satish Kumar Gupta, R.P. of Essar Steel Limited had threatened this coveted position of financial creditors when it treated the operational and financial creditors at par by holding that the CoC had no role in deciding the distribution of claims from resolution plans and had to only decide the feasibility of bids. This ruling had the effect of diluting the cardinal principle of preference to secured creditors and implied that there was no difference between secured and unsecured creditors in distribution of proceeds from the resolution plan.
This immediately prompted legislative intervention in the form of an amendment in 2019 itself, which restored the primacy of secured financial creditors by enabling the CoC to take into account the order of priority given in Section 53 and the value of a security interest of a secured creditor in the distribution of proceeds, in approving the resolution plan. Further, in order to prevent any disadvantage to operational creditors, the Parliament amended Section 30(2)(b) to state that the resolution plan had to provide the higher of the liquidation value or resolution value to them.
This position was also affirmed by the Supreme Court decision in Essar Steel where it held that it was only the CoC, composed entirely of financial creditors, that could decide the feasibility and viability of resolution plans. This is premised on the reasoning that financial creditors, who are willing to take haircuts on their loans and place their claims in a long-term context of the company’s revival, are better placed than operational creditors to take commercially-sound decisions. However, this commercial wisdom of the CoCis not immune from judicial review and the AA has to still ensure that the decision of the CoC reflects a plan to keep the CD alive as a going concern, maximise the value of its assets and take into account the interest of all stakeholders, even the operational creditors. But as long as a CoCs decision in accepting one resolution plan over the other is motivated by the objective of maximising the value of the company and interests of operational creditors with due regard to its capacity and needs to continue as a going concern, the AA would have its hands off and cannot second guess the commercial decisions taken by the CoC.
In the backdrop of Covid-19, financial creditors face yet another challenge in recovering their dues and one which is unlikely to be solved in the Courts. The Ministry of Finance has recently announced that it plans to suspend fresh insolvency filings under the IBC for a year and exclude Covid-19 related debt from the definition of ‘default.’ With the minimum threshold to initiate an insolvency already raised from one lakh rupees to one crore rupees, these measures indicate the Government’s intention of prioritising the continuity of businesses over resolution under IBC, in already damp market conditions. The combined effect of this on financial creditors would be adverse, to say the least, considering that the measures foreclose the opportunity to seek resolution under the IBC for a significantly long time. Additionally, this may very well serve as an escape route for undeserving debtors who may have had an impending default, even before Covid-19, which has now been given protection from recovery. Some see the proposed suspension of the IBC as a positive measure since the CoC would unlikely to have received any bids for the CD, given the serious financial pressure that companies are under. It is also being considered as a blessing in disguise for strengthening alternatives such as pre-pack insolvencies. While discussions on the need for a pre-pack insolvency regime have predated Covid-19, it is likely to gain more prominence after the suspension ends and there is an upsurge in the number of insolvencies.
Also, F- Fraudulent Transactions
“Three businessmen go for dinner, where each tries to prove his financial worth by offering to pay the bill. One of them says that he should pay as his company had a great financial quarter. Another one says that he has recently got a huge amount as inheritance from a rich aunt that he never knew he had, therefore, being cash rich, he should pay. And the last one, who also happens to be a promoter of a company, replies, tongue-in-cheek, that he should pay since his company is going under insolvency next week!”
With an insolvency on the horizon, unscrupulous promoters sometimes acting in the capacity of directors of the CD may seek to misappropriate assets to the detriment of other creditors. The IBC recognises this possible mischief and seeks to regulate/curb the carrying-on of business which is done with an intent to defraud the creditors of the CD or for any fraudulent purpose. Under Section 66 of the IBC, the RP is empowered to apply to the AA in case it finds the occurrence of any fraudulent transactions. On the application, the AA may direct any persons who were knowingly parties to such transactions to make contributions to the assets of the CD and claw back those monies. The provision goes a step further in enabling the AA to direct the director or the partner of the CD to make contributions to its assets. But to what extent can the RP uncover such antecedent actions of the directors /partners?
Section 66(2)(a) of the IBC spells out what is usually called the ‘Twilight Period,’ which is : the period before the insolvency commencement date, when the directors knew or ought to have known that there is no reasonable prospect of avoiding the commencement of the insolvency process for the CD. The directors/partners are required to exercise due diligence in carrying on the business in the twilight period in order to minimize any potential loss to the creditors. Any failure to do so or any negligent or reckless conduct attracts the application of the provision. It can be argued that the provision imposes additional duties on the directors to ensure that the creditors’ interests are protected now that the company has entered the zone of a possible insolvency.
The reason for this protection is clear—once the company is on the verge of insolvency, it has to cater to the interests of its creditors, who will only benefit if there are enough assets for a prospective resolution applicant to bid for it or are enough for satisfying their claims in case of liquidation. Thus, transactions selling assets at an undervalue or prioritizing the interests of one creditor over the other are some of the transactions which the provision seeks to regulate.
Apart from civil liability under Section 66, fraudulent transactions may also invite criminal liability under Section 69 of the IBC. Like Section 66, where the directors may escape liability by showing that they exercised due diligence in minimizing loss to creditors, Section 69 also allows the officer to show that he had no intent to defraud the creditors at the time of commission of the acts. However, unlike Section 66, the provision has a look-back period of five years before the insolvency commencement date which allows the officer to escape liability for any acts done before this period. On the contrary, the twilight period in Section 66 is not expressed in numerically certain terms and relies on the ‘subjective’ knowledge of a potential CIRP, that a director or partner may have had in the build-up to the CIRP. There is, therefore, little room for disputing the liability to contribute to the assets of the CD under the provision. Many of these fraudulent transactions come up in forensic investigations commissioned by RPs.
G – Group Insolvency
Aristotle once famously said that the whole is more than the sum of its parts. This cannot be more relevant than in the case of group companies where, more often than not, the entire group as a single economic entity is more valuable than the individual companies which make it. A question which arises here is whether this logic can be stretched to apply to the insolvency of companies which make up the group. Theoretically, it can. Group insolvency, as it is called, can be understood as a consolidated insolvency process for related companies which are part of a larger group. Practically, however, the IBC does not address this.
Seen from a jurisprudential standpoint, group insolvency seeks to balance two important imperatives: on one hand, the separate legal personality of even those companies which are closely inter-connected in a group, and on the other hand, recognizing that in spite of this distinct personality, a consolidated insolvency process is advantageous for all stakeholders.
Even though there is no legal framework supporting group insolvency, this has not prevented NCLT benches and the NCLAT from engaging with this issue. In fact, these decisions formed the backdrop to the Report of the Working Group on Insolvency which was released in September, 2019. A breakdown of group insolvency into ‘Procedural Co-ordination’ and ‘Substantive Consolidation’ by the Working Group has guided both its explanation and recommendations. ‘Procedural Co-ordination’ mechanisms aim to coordinate the different insolvency processes of various group companies, without actually disturbing the division of assets and substantive claims of creditors of each of the group companies. This mechanism reduces costs and time associated with different insolvency processes.
In going a step further than mere coordination, ‘Substantive Consolidation’ aims to consolidate the assets and liabilities of group companies so that they can be treated as a single economic unit for the insolvency process. This typically targets those corporate groups where separate personality of group companies is used to escape liability and where the assets and operations of the group companies are otherwise inseparable.
Notwithstanding its benefits, the introduction of a framework for ‘Substantive Consolidation’ may ruffle feathers in the market because it disregards the separate legal personalities of the group companies and combines their asset as part of a single insolvency, sidelining creditor expectations in the process. The Working Group has taken note of this and has therefore recommended a phased implementation of the recommendations with ‘Procedural Co-ordination’ and provisions dealing with perverse behaviour of group companies to be considered in the first phase and ‘Substantive Consolidation’ and Cross-Border Group Insolvency in the second phase. This is a good step especially when the general cross-border insolvency framework is still at a nascent stage. Since the recent amendment to the IBC in 2020 has not dealt with group insolvency at all, it will be interesting to see how the Parliament implements these suggestions in the future.
H – Homebuyers
Home buyers constitute the major source of finance for builders in housing projects. Much of the financial needs of builders are met by the booking amounts/payments made by the homebuyers. With this being the position, homebuyers clearly had an interest in the insolvency process of companies engaged in construction of housing projects. But the IBC posed an initial hurdle: whether such buyers qualified as ‘Operational’ or ‘Financial’ creditors and if they constituted a separate class of creditors, what was the extent of their rights under the IBC. There were judicial attempts to enable homebuyers to stake a claim in the insolvency process. This was also sanctified by an amendment in 2018 which conferred upon them the status of ‘financial creditors’ and treated the amount raised by them as a ‘financial debt.’
Objections against the inclusion of homebuyers as financial creditors were quick to be made; there was no clarity on when a ‘default’ occurred; it was also argued that they could not be treated equally with secured financial creditors. Additionally, real estate developers who were clearly distressed by the amendments challenged them as violative of the Constitution. Fortunately for the homebuyers, the Supreme Court in Pioneer Urban Land and Infrastructure Limited v. Union of India(Pioneer) rejected the challenge and upheld the amendments allowing them to occupy a place in the CoC and to be part of the decision-making process concerning the company’s future.
However, this amendment had an unintended and unseen consequence: it now effectively empowered even a single homebuyer to initiate CIRP and bring an entire project to a grinding halt. This turned the IBC to a mechanism to redress individual grievances which it was never meant to do, especially when such a mechanism already existed under the Real Estate (Regulation and Development) Act, 2016 (RERA).
In light of the above, the Parliament has recently amended the IBC and introduced a minimum numerical threshold of not less than 100 allottees or 10% of the total number of allottees, whichever is less, of a real estate project to initiate insolvency. This move, many homebuyers feel, sets them back and poses an insurmountable burden to look for the requisite number of homebuyers to initiate insolvency. Real estate developers, on the other hand, feel that the amendment will ensure that only bona fide applications are filed and that they are not driven to insolvency only on the basis of individual grievances.
Homebuyers are pulling out all the stops in trying to wish the amendment away. In January this year, they approached the Supreme Court which ordered the AAs to maintain status quo with respect to applications filed before the amendment, till the constitutional validity of the law was decided. They could not, however, register a success before the Standing Committee on Finance which did not recommend dropping the clause from the Bill, despite the dissenting views of three members. All eyes are now on the Supreme Court which is going to adjudicate the constitutional challenge this year and has rich jurisprudence from earlier to borrow upon in deciding the validity of the amendment.
Divided opinions aside, the amendment reinforces the view that the IBC is not meant to redress individual grievances, a remedy for which already exists under RERA. Prescribing a minimum threshold does not in any way dilute the original intent of the IBC which is to provide them a place in the CoC when the real estate company goes under insolvency. Notwithstanding what actually happens in practice, the IBC was never intended to be used as a coercive tool to compel a company to deliver on its promises or to repay the amount taken. There are other remedies for this. As Justice Nariman puts it in the Pioneer verdict, it is only when a homebuyer has completely lost faith in the ability of the current management to complete the project and wants it to be completed by a different developer, should he invoke the remedies under IBC. Seen in this context, a company cannot be thrust into insolvency just because a single homebuyer feels that it should be managed by somebody else. Such a radical decision should be the result of at least a minimum consensus among the homebuyers, especially when the insolvency route also involves the risk of liquidation of the CD . This is precisely what the latest amendment echoes.
Venugopal Dhoot v. State Bank of India, CA- 1022(PB)/2018 (24.10.2018); State Bank of India v. Videocon Industries Ltd., M.A 1306/ 2018 in CP No. 02/2018 (08.08.2019); Edelweiss Asset Reconstruction Company Limited v. Sachet Infrastructure Pvt. Ltd., Company Appeal (AT) (Insolvency) Nos. 377 to 385 of 2019 (20.09.2019); Lavasa Corporation Limited, C.P. 1765/IB/NCLT/MB/2018 (26.02.2020).