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21 December, 2019
The edifice of the Insolvency and Bankruptcy Code, 2016 (“IBC”) was conceptualised on ideas such as promoting ‘maximisation of value of assets’, ‘a transparent and predictable insolvency law’, ‘avoiding destruction of value of the debtor’ and recognising the difference between ‘malfeasance and business failure’.[1] In the three years since the enactment of the IBC, many areas in the insolvency resolution process have required judicial and legislative interventions to enable the process to achieve the desired results.
Among others, the ongoing investigations against insolvent entities and the risk of cancellation of critical government contracts during the insolvency process, were identified as key impediments to strategic interest in the stressed market. The introduction of the Insolvency and Bankruptcy Code (Second Amendment) Bill, 2019 (“Bill”), by the Government, is a step that will help overcome such ‘critical gaps in the corporate insolvency framework’.[2]
While certain changes introduced by the Bill are in line with international practice, some measures are unprecedented. The Indian insolvency law has evolved to be both modern and unique, This piece will analyse the salient features of the Bill.
Interim Finance Widened
Any effective regime for restructuring offers both sophisticated out-of-court and in-court restructuring tools. With the introduction of the IBC and the June 7 circular[3], India has made progress on both those fronts. However, there was no statutory protection for the superior ranking of priority debt obtained during an out-of-court restructuring. More often than not, the out-of-court subsequently failed, with the debtor ending up in an IBC process. To address this, the Bill proposes to expand the definition of ‘interim finance’ to include, ‘such other debt as may be notified’. The intent of this addition is made clear by the statement of objects and reasons (“SOR”), which suggests that ‘last mile funding’[4] options to ‘prevent insolvency’[5] is likely to be included as interim finance and thereby enjoying highest priority in the insolvency or liquidation process under the IBC. The contours of debts that will qualify for this exemption are to be notified.
Threshold for filing applications
In 2018, home-buyers were categorised as financial creditors for the purpose of IBC. Since then, developers have claimed that this provision has hampered successful completion of various projects as construction was getting stalled due to filing of insolvency applications by home buyers.[6] As per the Insolvency and Bankruptcy Board of India (IBBI) data, since the 2018 amendments till September 2019, 1,821 cases were filed under the IBC by home buyers and in almost all cases, by a single home buyer. Now, the Bill proposes that an insolvency application in relation to a real estate project must be filed by a minimum of 100 allottees or not less than 10% of the total number of allottees, whichever is lesser. In the same vein, the Bill prescribes the same threshold for insolvency applications to be filed by financial creditors holding securities or deposits.
Therefore, if a trustee or agent files an insolvency application, it has to represent the instructions of such minimum number of financial creditors.
Extension of moratorium
To help keep the corporate debtor a ‘going concern’, the Bill extends the scope of moratorium to prohibit the following during the moratorium period:
- suspension or termination of arrangements that involve conferment of rights by any government authority on the ‘grounds of insolvency’, so long as there is no default in the payment of current dues arising out of use of such benefits during the moratorium period; and
- termination of arrangements relating to supply of goods and services that the resolution professional considers critical to, inter alia, protect the value of the corporate debtor.
As regards (a) above, the well-understood policy behind such provisions is that the debtor should not be deprived of a profitable and essential contract during insolvency and that if not restricted, the counterparty may have too much bargaining power to negotiate an out-of-turn payment, ahead of other creditors. While many jurisdictions such as Australia, Canada, Singapore and USA have similar provisions for all contracts, many common law as well as civil law jurisdictions (such as the UK, Hong Kong and Germany) have stayed away from such clauses.
Recognising the expertise brought by insolvency professionals while running a company as a ‘going concern’, the Bill (in (b) above) aims to widen the ambit of essential supplies. Therefore, insolvency professionals will have the flexibility to extend the moratorium to continuance of supply of goods and services that he or she considers essential.
The contours of how the insolvency professionals will deal with this has to be set out in the regulations as well as providing that the costs incurred in lieu of such critical supplies shall form a part of insolvency resolution costs.
Harmonious reading is required of these amendments and the recent Supreme Court decisions holding that the NCLT has no jurisdiction over matters of “public law”, which can include matters relating to allocation of natural resources/Government contracts.[7]
Immunity to successful resolution applicants
The issue of forfeiture of assets by the State and whether such assets should form a part of the bankruptcy estate of an insolvent firm have also been discussed by the US Courts.[8] US laws recognise the principle of “relation back” whereby the property arising or relating to the alleged crime is deemed to vest with the federal authorities from the date of the commission of the offence.[9] In order to avoid failure of insolvent firms by way of alienation and forfeiture of critical assets by the State, it is not uncommon for the stakeholders to enter into “co-ordination agreements” with the federal authorities for an out-of-court settlement.[10]
Forfeiture or attachment of assets of a company due to offences of its erstwhile management, or liability of acquirers and new management of a reconstituted company has received much attention in India as well. Indian courts in the past on grounds of equity have acknowledged that acquirers and their reconstituted targets may not be held liable for the offences of the previous management.[11] The courts have held that it would be “a travesty of justice, of the Company, after its revamp is subjected to persecution”[12] and recognised that continuing litigation of such nature would “discourage entrepreneurs…to undertake the arduous task of resuscitating the discredited companies…”[13]
Section 32-A provides that:
- the liability of the corporate debtor in relation to an offence committed prior to the commencement of insolvency shall cease on approval of a resolution plan in terms of the Code; and
- no action including attachment shall be taken against the property of a corporate debtor in relation to any offence committed prior to the commencement of insolvency on approval of a resolution plan or the sale of such property during liquidation.
The benefit of this immunity applies to acquirers who are not related to the corporate debtor or associated with the commission of the offence.[14] Currently, the provision does not seem to extend to scenarios where the corporate debtor is acquired as a going concern pursuant to liquidation proceedings[15] or by way of a scheme of compromise or arrangement.[16] Further, the Bill whilst protecting the corporate debtor from past liabilities arising from an offence, pins individual liability on persons responsible for commission of such offence in line with UNCITRAL Legislative Guide.[17] Therefore, the provision’s purpose is two pronged, firstly, secure a hassle-free acquisition and simultaneously protect the asset base of the corporate debtor to ensure value maximisation for the creditors.
Financial creditors being exempted from considered as related parties
The UNCITRAL Legislative Guide notes that inclusion of related parties in committee of creditors often raises questions relating to conflict of interest and an insolvency law could specify “…those parties which are not entitled to participate in a creditor committee”.[18] The Code recognises this and prescribes that related parties of the corporate debtor are rendered ineligible from being part of the committee of creditors[19]. However, the Code exempts financial creditors from such ineligibility if such entity is considered a related party ‘solely on account’ of conversion or substitution of debt into equity or convertible instruments.[20] Now, the Bill has clarified that the Central Government may prescribe certain additional transactions that shall not render such financial creditors as ineligible by virtue of being a related party. It appears that the Bill may be seeking to cover situations such as mergers of financial creditors, acquisition of debt, or exercise of rights or entitlements of financial creditors that may result in such financial creditor becoming related parties of the corporate debtor.
CONCLUSION
The Bill continues the pro-active legislative steps being taken to address the live issues in the resolving stressed companies. By providing scope for identification of last mile funding scenarios as interim finance, the Bill aids the rehabilitation of stressed entities in a credible manner. Further, by enlarging the scope of moratorium, the Bill safeguards the sanctity of the rescue operations as envisaged by the IBC. Separately, the immunity granted in terms of proposed Section 32-A will act as an enabler for cleaner acquisitions, thereby incentivising higher bids and promoting an investor-friendly regime.
*The authors were assisted by Ms. Varsha Yogish (Consultant), and thank her for her assistance on this article.
For further information, please contact:
L. Viswanathan, Partner, Cyril Amarchand Mangaldas
l.viswanathan@cyrilshroff.com
[1] Bankruptcy Law Reforms Committee, The report of the Bankruptcy Law Reforms Committee Volume I: Rationale and Design, November 4, 2015, para 3.2.3 and para 3.3.
[2] Statement of Objects and Reasons, The Insolvency and Bankruptcy Code (Second Amendment) Bill, 2019, Bill No. 376 of 2019, (as introduced in the Lok Sabha on December 12, 2019).
[3] Reserve Bank of India, Prudential Framework for Resolution of Stressed Assets, dated June 7, 2019. Available at < https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11580&Mode=0> (Last accessed on December 16, 2019)
[4] Last mile funding refers to financing wherein the borrower is unable to raise further debt for completion of last phase of its project(s).
[5] Supra note 3.
[6] See Livemint, Developers resent buyers filing cases under IBC, November 25, 2019. Available at: <https://www.livemint.com/money/personal-finance/will-homebuyers-remain-creditors-under-ibc-11574661744701.html > (Last accessed on December 13, 2019).
[7] Embassy Property Development Pvt. Ltd. v. State of Karnataka, Civil Appeal No. 9170 0f 2019, judgement dated December 03, 2019. See also Municipal Corporation of Greater Mumbai v. Abhilash Lal & Ors, Civil Appeal No. 6350 of 2019, Supreme Court Order dated November 15, 2019, wherein the Apex Court while determining the validity of a resolution plan held that requirements of other statutes that are issued in public interest are also required to be complied with.
[8] United States v. United States Currency 895 F.2d. 908, 916 (2d Cir. 1990), where it has been clarified that the government’s interest in forfeitable property vests at the time of the offense giving rise to such forfeiture.
In re James 940 F.2d 46, 51 (3d Cir. 1991) (“[w]e conclude that the district court here was correct in holding that a civil forfeiture action proceeding is an exception to the automatic stay “police power” exception of Section 362 (b) (4).”)
[9] Welling, Sarah N. and Hord, Jane Lyle, Friction in Reconciling Criminal Forfeiture and Bankruptcy: The Criminal Forfeiture Part, Golden Gate University Law Review, Law Faculty Scholarly Articles, 2012. Available at <https://uknowledge.uky.edu/law_facpub/553> (Last accessed on December 17, 2019)
[10] Gibbons Bankruptcy And State Forfeiture Laws Collide In Birdsall Services Group Chapter 11 Case. Available at: < https://media.gibbonslaw.com/wp-content/uploads/2019/01/07153528/Bankruptcy-State-Forfeiture.pdf> (Last accessed on December 17, 2019)
[11] Union of India v. Tech Mahindra Limited, Company Appeal Nos. 4 of 2014, Andhra Pradesh High Court order dated June 23, 2014.
[12] Union of India v. Tech Mahindra Limited, Company Appeal Nos. 4 of 2014, Andhra Pradesh High Court order dated June 23, 2014, p. 6.
[13] Union of India v. Tech Mahindra Limited, Company Appeal Nos. 4 of 2014, Andhra Pradesh High Court order dated June 23, 2014, p. 6.
[14] See definition of ‘offence’ as per § 3(38), General Clauses Act, 1897, “’offence’ shall mean any act or omission made punishable by any law for the time being in force.”
[15] Reg. 32(e), Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 (“Liquidation Regulations”).
[16] Reg. 2(B), Liquidation Regulations.
[17] UNCITRAL, Legislative Guide on Insolvency Law, United Nations, New York, 2005, Part 2, III (A)(5) p. 171.
[18] UNCITRAL, Legislative Guide on Insolvency Law, United Nations, New York, 2005, Part 2, III (C)(6) p. 199.
[19] § 21(2) (first proviso), IBC.
[20] § 21(2) (second proviso), § 29A(c) (second proviso) (Explanation I) and § 29A(j) (Explanation I) (second proviso), IBC.
