20 January, 2020
In the winter of 2015, the Indian Legislature sought to tackle the persistent problem of bad debts affecting Indian financial institutions and trade creditors by enacting the Insolvency and Bankruptcy Code, 2016 (“Code”), which was finally notified in May 2016. The key purpose of the enactment was to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximization of value of assets of such persons / entities.
Since its inception, the Code has been under continuous refinement and has undergone several amendments. The judiciary has also played its significant part in streamlining various provisions of the Code. As 2019 has drawn to an end, we have enumerated below some of the noteworthy changes made in the law by highlighting 15 significant developments in the field of insolvency law in India in the year 2019.
1. Code: Constitutional or Unconstitutional
On 25 January 2019, the Supreme Court in Swiss Ribbons Pvt. Ltd. vs. Union of India upheld the constitutional validity of the Code and inter alia held / observed the following:
i. with respect to discrimination between a financial creditor and operational creditor, since equality is only among equals, no discrimination shall be caused if there exists an intelligible differentia between the said creditors;
ii. that there was no violation of Article 14 of the Constitution with respect to the voting rights of the operational creditors in committee of creditors (“CoC”) because a detailed study has already been undertaken by a financial creditor before sanctioning a loan, and hence they are in a better position to evaluate the contents of a resolution plan as compared to an operational creditor, who only provide goods / services and are involved only in recovering amounts that are paid for such goods / services;
iii. that the CoC did not have the last word about withdrawal of insolvency application and if the CoC arbitrarily rejects a just settlement and / or withdrawal claim, the Adjudicating Authority can always set aside the same;
iv. that the resolution professional has no adjudicating powers under the Code. Also, a resolution professional can be replaced by the CoC in case they are unhappy with his performance. Hence, the resolution professional is really a facilitator of the resolution process, whose administrative functions are overseen by the CoC and by the Adjudicating Authority;
v. that the restrictions laid down under section 29A(c) of the Code is not limited to malfeasance by an erstwhile manager and rejected the argument relating to the fact that somebody merely happens to be a relative of an ineligible person cannot be good enough to oust such person from becoming a resolution applicant, if he is otherwise qualified;
vi. that the ‘distribution waterfall’, as provided under the Code, is not discriminatory and manifestly arbitrary to operational creditors. The Court further held that the repayment of financial debts infuses capital into the economy in as much as banks and financial institutions are able, with the money that has been paid back, to further lend such money to other entrepreneurs for their businesses. This creates an intelligible differentia between financial debts and operational debts, which are unsecured, which is directly related to the object sought to be achieved by the Code.
2. Role of the Adjudicating Authority in approving or rejecting a resolution plan
On 05 February 2019, in K. Sashidhar vs. Indian Overseas Bank and Ors. the Supreme Court held that the “commercial wisdom” of the CoC in approving or rejecting a resolution plan is not open to judicial scrutiny.
The NCLT’s jurisdiction in such cases is to satisfy itself that the statutory requirements specified in Section 30(2) of the Code are met with in the resolution plan approved by the CoC i.e. the resolution plan should contain provisions in relation to (i) priority of payments (as prescribed under the Code); (ii) management of the corporate debtor; (iii) implementation and supervision of resolution plan; and
(iv) compliance with applicable law.
The Supreme Court clarified that where a resolution plan was subject to rejection by the CoC on the grounds listed under Section 30(2) of the Code, including a decision on the eligibility of a resolution applicant under Section 29A of the Code, the said decision would still be subject to judicial review.
3. Corporate Guarantors can be dragged into insolvency
On 11 February 2019, the Supreme Court upheld the order passed by NCLAT in Ferro Alloys Corporation Limited vs. Rural Electrification Corporation Ltd. which held that on a harmonious and purposeful reading of the definitions of corporate person, corporate debtor, debt, claim, financial debt, operational debt, financial creditor and default it can be concluded that as soon as a guarantee is invoked the said guarantee becomes a debt and thereafter a guarantor becomes a 'corporate debtor' as defined under the Code.
In other words, corporate insolvency resolution process under the Code can be initiated against the guarantor who is a ‘corporate person’ and who by operation of law ipso facto becomes a ‘corporate debtor’ by satisfying the ingredients as required for a ‘corporate person’ under the Code.
It further held that without initiating insolvency resolution process against the principal borrower it is always open to a 'financial creditor' to initiate insolvency resolution process under Section 7 of the Code against a 'corporate guarantor' as the creditor is also the 'financial creditor' qua 'corporate guarantor’.
4. Striking down the Reserve Bank of India’s (“RBI”) Circular dated 28 February 2018 (“RBI Circular”)
On 02 April 2019, in Dharani Sugars and Chemicals Ltd vs. Union of India, the Supreme Court set aside the RBI Circular containing the framework for resolution of stressed assets for being ultra vires of Section 35AA of Banking Regulation Act, 1949 (“BR Act”). The RBI Circular mandated banks and financial institutions to initiate resolution against defaulting companies with exposure of more than INR 20 billion (~USD 278.8 million)
The RBI Circular was challenged, inter alia, on the ground that the RBI cannot exercise its power to issue such directions without obtaining authorisation from the Central Government and that further RBI is not empowered under Section 35AA of the BR Act to issue directions for reference to the Code of ‘all cases’ without considering ‘specific defaults’.
The Supreme Court examined in detail the power granted to RBI under Section 35 AA of the BR Act and held that RBI can direct banks and financial institutions to move under the Code only if the following two conditions are satisfied:
i. RBI should obtain authorisation from the Central Government to issue direction; and
ii. it should be in respect of a specific default.
On 7 June 2019, the RBI released the Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions 2019 that provided fresh directions to lenders on the resolution of stressed assets.
5. A tad bit of relief for Home Buyers
On 09 August 2019, in Pioneer Urban Land and Infrastructure Limited vs. Union of India, the challenge on the constitutionality of the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 was rejected by the Supreme Court. Under the new amendment, the ambit of the financial creditor was broadened to include ‘Real estate allottees’ (home buyers) as per Section 2(d) of the Real Estate (Regulation and Development) Act, 2016.
In its findings, the Supreme Court observed that where between the developer and the home buyer a sale agreement exists, it would have the same ‘commercial effect’ as that of a borrowing, so as to mean that the home buyers get back the flats / apartments in lieu of money advanced for temporary use. Further, the Supreme Court clarified that in such a case, both parties have their vested ‘commercial interest’, the real estate developer who derives profit on sale of apartment and the purchaser of such flat/apartment by such sale of the apartment. Thus, the Supreme Court concluded that the amount raised under the real estate agreements from the home buyers aim towards profit and are therefore included within ‘financial debt’ under Section 5(8)(f) of the Code, not even requiring an explanation introduced by the Amendment Act.
6. In an application for insolvency filed by a financial creditor, the existence of default is to be determined in a time bound manner.
On 16 August 2019 an amendment was made to the Code which clarified that an application for insolvency filed by a financial creditor is to be admitted or rejected within the prescribed period of 14 days from the date of receipt of the application. In the event of a failure to do so, the NCLT is required to record the reasons in writing for the delay in determination of default. The 14-day period will only be extended in exceptional cases and not as a matter of routine.
7. Insolvency resolution process must be completed within an overall timeline of 330 days from the insolvency commencement date.
Vide amendment dated 16 August 2019, the overall timeline of 270 days for completing the insolvency resolution process was revised to 330 days. As per the amendment the insolvency resolution process must mandatorily be completed within an overall timeline of 330 days from the insolvency commencement date. The 330 days period includes all or any extensions granted as well as any litigations and related legal proceedings. For an ongoing insolvency resolution process, the amendment provides an additional relaxation of 90 days if the 330-day timeline has already been breached at the time when the amendment came into force.
However, the Supreme Court in Committee of Creditors of Essar Steel India Limited vs. Satish Kumar Gupta & Ors. vide its judgment dated 15 November 2019, struck down the word “mandatorily” as unconstitutional and held that insolvency resolution process should be completed “ordinarily” within 330 days.
8. Appointment of an Authorised Representative
Where there exist a large number of financial creditors the authorised representative of a particular class of financial creditors will vote in the CoC, on behalf of all financial creditors represented by him. Where the financial creditors represented by the authorised representative has taken a decision by a vote of more than 50% of the voting share of the financial creditors of such class, the authorised representative will put his vote as per the decision taken. Such majority vote obtained within a class of creditors will be counted as a 100% vote from that class of creditors in favour or against a voting item.
However, this voting process will not be applicable for taking a decision on the withdrawal of a resolution application and the voting process in such cases will be as originally provided under the Code wherein each individual financial creditor will vote individually.
This was introduced by way of an amendment dated 16 August 2019.
This amendment was introduced in view of cases such as Jaypee Infratech Limited, where the majority of the CoC comprised of thousands of homebuyers and decision-making had been severely hampered on account of creditors not voting on resolutions.
9. Corporate Debtor can be liquidated before preparation of information memorandum
The Code now permits liquidating the corporate debtor post constitution of the CoC and prior to preparing the information memorandum.
This amendment introduced on 16 August 2019 would enable stakeholders to liquidate the corporate debtor if it is found that the corporate debtor does not have assets and the best way of value maximisation is to liquidate the company.
10. Supreme Court on Essar Steel- The End Game
On 15 November 2019, the Supreme Court set aside the order of the NCLAT in Standard Chartered Bank vs. Satish Kumar Gupta, R.P. of Essar Steel Ltd. and Ors. wherein the NCLAT inter alia held that:
i. financial and operational creditors must be given similar treatment (which has been interpreted to mean the same percentage of haircut); and
ii. discrimination amongst financial creditors on the basis of existing priorities or security interest is not permitted in a resolution plan.
The Supreme Court held that ‘equitable treatment’ is accorded to each creditor depending upon the class to which it belongs: secured or unsecured, financial or operational. The equality principle cannot be stretched to the extent of treating unequal as equals.
Accordingly, the Supreme Court allowed the CoC to distinguish between secured financial creditors based on the value of their respective security interests.
11. Code now expanded to NBFC’s
The Ministry of Corporate Affairs in November 2019 had issued two notifications under section 227 of the Code. These notifications prescribe the rules governing the insolvency and liquidation of financial service provider (“FSPs”) and directs the application of these rules and the Code to systematically important Non-Banking Financial Companies (“NBFCs”) (inclusive of the housing finance companies) having an asset size of over INR 5 billions (~USD 69.7 million) as class of FSPs.
The procedure would be governed by The Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019 (“FSP Rules”).
RBI has been notified as the 'Appropriate Regulator' for the NBFCs. On occurrence of a financial default only the Appropriate Regulator of the concerned FSP can file an application. Further, voluntary liquidation process can only be initiated with the approval of the Appropriate Regulator.
The FSP Rules specifically clarify that the moratorium against the FSP will not extend to third party assets or properties which are held in trust by the FSP for such third parties.
12. Provisions relating to personal guarantors under Chapter III of the Code comes into effect from 01 December 2019.
An application for initiation of insolvency against a Personal Guarantor can be made by the debtor (i.e. Guarantor himself); or a creditor either individually or collectively along with other creditors; or through a resolution professional. This process of initiation of insolvency is identical to that of a corporate debtor.
An "interim moratorium" in relation to any debts of the Guarantor will commence as soon as the application for insolvency is filed before the Adjudicating Authority. Within 10 days of appointment of the resolution professional, the resolution professional after examining the application is required to prepare and submit a report to the Adjudicating Authority recommending approval or rejection of the application.
The Adjudicating Authority is required to take into account the recommendations of the resolution professional so appointed, and either admit or reject the application so filed, within 14 days from the date of submission of the report by the resolution professional.
On admission of the application, the interim moratorium ceases to have effect and the period of moratorium commences.
Once the order admitting the application is passed, a public notice inviting claims from the creditors is to be issued by the Adjudicating Authority within 7 days. A claimant will have a right to submit its claims within 21 days of issuance of such public notice. After receiving the claims, a list of creditors will have to be prepared by the resolution professional. In this process the formation of CoC is not required, as the creditors meet and directly vote on the repayment plan. There is no distinction between the nature of creditor under this process.
According to the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) (Third Amendment) Regulations, 2019 , a repayment plan is to be prepared by the debtor in consultation with the resolution professional which should consist of the term of the repayment plan and its implementation schedule as well as the source of funds. Within 21 days from the last day of submission of claims by the creditors, the resolution professional has to submit the repayment plan along with his report to the Adjudicating Authority.
A meeting of creditors has to be convened by the resolution professional on the request made by the creditors having 33% of the voting share (that is in proportion to the debt owed by the personal guarantor to such creditor). Furthermore, any decision taken by the creditors requires approval of more than 50% of voting share of the creditors who vote, unless otherwise specified in the Code.
The debtor and the creditor have the right to file an application for bankruptcy of the debtor on rejection of the repayment plan by the Adjudicating Authority.
13. Insolvency commencement date
The ordinance passed on 28 December 2019 amends the Code to provide that the insolvency commencement date is the date of admission of application for insolvency.
Prior to the ordinance, in case an interim resolution professional was not appointed in the order admitting the insolvency application, the insolvency commencement date was considered to be the date on which such insolvency professional is appointed by the Adjudicating Authority.
14. Immunity provided to corporate debtor and their assets
Vide ordinance dated 28 December 2019, a new section i.e. Section 32(A) is introduced in the Code. This section provides immunity to the corporate debtor and its assets from prosecution for offences committed before the commencement of corporate insolvency resolution process. The immunity is given only to a corporate debtor and not to an individual director or designated partner of an LLP who is being prosecuted for personal vicarious liability. This introduction provides protection to successful bidders from any liabilities or litigation that may arise on account of offences committed by the erstwhile promoters. However, the corporate debtor or the new management will have to provide complete assistance to the investigating team.
15. Minimum threshold for initiating corporate insolvency process for certain class of financial creditors
The ordinance passed on 28 December 2019 amends the code and provides for minimum threshold for initiating corporate insolvency process for certain class of financial creditors. In order to initiate an insolvency process against the Corporate Debtor, where the debt owed is either in form of security/deposits or to a class of creditors, the application should be filed jointly by at least one hundred creditors in the same class or not less than ten percent of creditors of same class; whichever is less. The same threshold applies for allottees under real estate projects.
For further information, please contact:
Souvik Ganguly, Partner, Acuity Law
al@acuitylaw.co.in
