8 April, 2020
The bankruptcy law framework of India has undergone changes several times since it came into force in the form of the Insolvency and Bankruptcy Code, 2016 ("Code"). Recently, changes have been made in the Code via the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2019 which has now been repealed by the Insolvency and Bankruptcy Code (Amendment) Act 2020.
Further, the Insolvency and Bankruptcy Board of India ("IBBI") also keeps amending the regulations to bring them in line with the provisions of the Code from time to time. The tribunals and courts have also played a tremendous role to settle various contentious issues and given several landmark judgements. Despite all this, the insolvency law is still evolving and requires some more changes in view of the practical issues arising in its implementation.
The Insolvency Law Committee ("Committee") has recommended sweeping changes in the Code in its report1 submitted in the month of February 2020. Some key recommendations of the Committee have been discussed herein below:
Threshold for calculating default
The extant provisions of the Code currently provide for a threshold of default of INR 100,000 for triggering of insolvency resolution proceedings. The Committee is of the view that as a result of low threshold of default, a large number of applications have been filed before the tribunals. This has resulted into an unnecessary burden on the tribunals. The Committee has recommended an increased threshold of INR 5,000,000 for initiating insolvency proceedings.
While the increased threshold of INR 5,000,000 may be considered favourable for corporate debtors, it may be detrimental to the interests of operational creditors. The Committee has, therefore, suggested that a default of INR 500,000 should allow the operational creditors to file applications for insolvency proceedings against corporate debtor.
This is certainly a welcome recommendation from the point of view of medium, small and micro enterprises (MSMEs). At the same time, it may be expected to ease the burden of tribunals.
Further, keeping in view the financial stress and disruption caused by COVID-19, the Government of India has raised the threshold of amount of default to INR 10,000,000. This revised threshold will apply to all companies and not just MSMEs. This appears to be a temporary measure adopted by the Government since on account of the losses resulting from the disruption of business, it might have been difficult for many corporates to make payments to their creditors on a scheduled date.
However, another way to look at this situation is that in case large companies are not paying their vendors, then they will not be able to seek protection under the Code that was available to them prior to the amendment. In this scenario, to this extent, it does not help MSMEs to pursue an efficacious remedy.
Interim moratorium
As per the current provisions of the Code, the tribunals, at the time of admitting applications for the commencement of insolvency proceedings against a corporate debtor, also declare moratorium which prohibits certain actions against the corporate debtor. However, in many cases, the tribunals have taken a longer period (than a fourteen (14) days period as stipulated in the Code) in admitting (or rejecting, as the case may be) the application for initiation of insolvency process. The Committee realised that during this interim period, there is a need to protect the corporate debtor against any action which could be taken by creditors and which could affect the maximisation of value of the corporate debtor.
The Committee, therefore, recommended that there should be introduced, a provision in the Code, to allow 'interim moratorium', after an application for insolvency proceedings has been filed but before the same is admitted, if the tribunals, having regard to the facts and circumstances of the case, consider it necessary in the interest of value maximisation of the corporate debtor.
This is a welcome step as it will preclude other creditors from filing applications against such companies. In any event, if the IRP is finally appointed, such creditors will get a chance to file their proof of debt. By this amendment, their right will not be impaired.
Distribution of profits earned during the CIRP period
Another concern has been in relation to the profits earned by a corporate debtor during the period of corporate insolvency resolution process ("CIRP"). While in some cases, the tribunals had expressed the view that the profits earned by a corporate debtor during the period of CIRP should be passed on to the creditors, the Supreme Court has held that the distribution of profits made during the CIRP should be made according to the terms and conditions of request for resolution plan ("RFRP")2. Accordingly, the Committee of Creditors ("CoC") has a right to decide about the distribution of profits earned during the CIRP of a corporate debtor.
The Committee has recommended that a resolution plan should compulsorily include a proposal on the manner in which such operating profits are to be distributed and that the CIRP Regulations3 may be suitably amended accordingly.
In this context, it may be noted that the RFRP sets out the terms and conditions which need to be taken into account by a prospective resolution applicant while preparing and submitting a resolution plan. It may, therefore, be a prudent practice that the RFRP should set out the terms and conditions related to the distribution of operating profits of a corporate debtor earned during the CIRP. Further, the resolution professional should share (wherever possible) the details of operating profits of the corporate debtor with the resolution applicant(s). This may be helpful for a resolution applicant at the time of finalising the financial proposal for a corporate debtor.
Obtaining statutory approval/regulatory approval
Section 31 of the Code was amended in June 2018 to provide that the resolution applicant will obtain all the required statutory and governmental approvals within a period of one (1) year from the date of approval of the resolution plan or such other time as may be set out in the relevant law (whichever is later). In many resolution plan(s), the tribunals did not give any blanket approval with respect to the compliances/approvals required under any other legislation for the implementation of the resolution plan.
In line with the provisions related to schemes of compromise or arrangement under the Companies Act, 2013, the Committee has recommended that once a resolution plan is approved by the CoC, the resolution applicant should be asked to submit the resolution plan before all the governmental and regulatory authorities whose approvals are necessary for running the business of the corporate debtor.
In case the governmental and regulatory authorities do not raise any objection within a period of forty five (45) days, then, the resolution plan would be submitted before the tribunal for its approval. In case any objections are raised or conditional approval is granted by any governmental or regulatory authority, then the resolution applicant can clear their objections/ meet the conditions either before the plan is submitted before the tribunal or within a period of one (1) year from the approval of the resolution plan.
The recommendation, if implemented, would certainly help a resolution applicant to be aware of the objections raised/conditions imposed by regulatory and governmental authorities before the resolution plan is submitted to the tribunals. In case the resolution applicant is unable to clear the objections or meet the conditions, then he could consider amending or withdrawing the resolution plan and avoid the risk of violation of an approved resolution plan at a later stage.
Issues related to guarantors
As regards the initiation of CIRP against the corporate guarantor, the Committee has recommended that the creditors should not be prevented from initiating CIRP against both, the corporate debtor and its sureties (being the corporate guarantors) under the Code. It may be noted that the appellate authority had not allowed multiple CIRPs for the same set of claims by the same creditors and held that once an application for CIRP had been admitted against a corporate debtor (being the principal borrower or corporate guarantor, as the case may be), then a second application by the same creditor for the same set of claims and defaults could not be admitted against the other corporate debtor (being the principal borrower or corporate guarantor, as the case may be)4.
As regards the filing of claims in the CIRPs of both the corporate debtor and the surety (being the corporate guarantor) for the same set of debts, the appellate authority opined that a financial creditor cannot file claim for the same set of debts in two separate CIRPs. The Committee has recommended that in cases where the principal borrower and the surety (being the corporate guarantor), both, are undergoing CIRP, the creditors should be permitted to file claims in CIRPs of both of them. However, to avoid double dipping, the Committee recommended that in case a creditor recovers any portion of its claim in one CIRP, then the claim amount of such creditor should accordingly be reduced in the other CIRP.
Appointment of Official Liquidator
The Committee has recommended that in case of liquidation of large corporate debtors (say in case of corporate debtors having value of INR 2,000 cr.) and where public interest is involved, the adjudicating authority should be given an option to appoint an official liquidator to carry out the functions of a liquidator under the Code in view of the fact that the experience of private professionals in liquidation is still in the early stages of evolution. However, in such cases, the office of the official liquidator should be subject to the regulation and supervision of the IBBI.
Revival of corporate debtor during liquidation
This is a well settled principle that the primary objective of the Code is the resolution of corporate debtors. The Code does not allow liquidation of a corporate debtor directly but only on failure of the CIRP. The liquidation should be availed of as a last resort only if there is no resolution plan or the resolution plans submitted are not up to the mark.
The Liquidation Regulations5 provide for the sale of a corporate debtor as a going concern as one of the modes for the sale of assets of the corporate debtor undergoing liquidation. However, the Committee has opined that the going concern sale of a corporate debtor is against the scheme of the Code. The liquidator may, though, attempt the sale of business of a corporate debtor on a going concern basis. The Committee, therefore, recommended that the going concern sale mechanism should not be allowed and that the Liquidation Regulations should be amended suitably.
Another mode of revival of the corporate debtor during liquidation is a scheme of compromise or arrangement. Basis the judgement of the appellate authority in several cases, the Liquidation Regulations were amended to provide for the submission of a scheme of compromise or arrangement for the revival of a corporate debtor facing liquidation. Further, in order to prevent any misuse by the defaulting promoters to get back control of a corporate debtor, the IBBI amended Liquidation Regulations to clarify that a person, who is not eligible under the Code to submit a resolution plan for the insolvency resolution of a corporate debtor, shall not be a party in any manner to such compromise or arrangement.
The Committee is of the view that such a scheme of compromise or arrangement is inherently incompatible with the liquidation process since the Code envisages dissolution of corporate debtor once a liquidation order is passed. The Committee has, therefore, recommended that the recourse to section 230 of the Companies Act, 2013, for effecting schemes of arrangement or compromise should not be available during liquidation of the corporate debtor under the Code.
The Committee has, however, proposed that an appropriate process should be devised under the Code to allow the liquidator to effect compromise or settlement with the specific creditors, though, the Committee did not spell out the contours of such proposal.
This amendment will give rise to further interpretational problems since with the notification of the Code, section 230 of the Companies Act, 2013, was also amended to permit a liquidator appointed under the Code to approach the tribunals with the proposals of compromise or arrangement between a company and its members/creditors. In our view, by not allowing a scheme of arrangement post liquidation goes against the very ethos of the Code and is not in consonance with the key objectives of the Code, which are, revival of corporate debtor as a going concern and maximisation of value. Further, the scheme of compromise or arrangement could serve as an effective tool for interested bidders to structure the terms of acquisition of a corporate debtor facing liquidation.
Concluding remarks
It is important to note that the Code has resulted into behavioural changes of many corporate debtors. There have been several cases where many companies settled with the creditors (especially operational creditors) in order to avoid insolvency proceedings. A higher threshold of the default amount, as suggested by the Committee, may reduce the burden of the tribunals. However, the threshold of INR 5,000,000 may have an adverse impact on many creditors. Therefore, it may be prudent to consider a lower threshold (say INR 1,500,000) as against INR 5,000,000.
The recommendation to allow simultaneous filing of claims by creditors against the principal borrower and the surety would definitely protect the interests of creditors (especially financial creditors). Further, the recommendation with respect to obtaining the necessary regulatory or governmental approvals by a resolution applicant before the resolution plan is submitted for approval of the tribunals could help the resolution applicant to avoid the risk of non-implementation, or delay in implementation, of the approved resolution plan.
As regards the appointment of an official liquidator to handle liquidation proceedings of large corporate debtors, there is no doubt that the insolvency professionals may not have technical skills and capacity to handle large liquidation proceedings but at the same time, the legislators should also take into account the success rate of winding up/liquidation proceedings under the Companies Act, 1956 where the official liquidators were given the task of handling the liquidation proceedings.
Further, the proposal to revive a corporate debtor under liquidation was being perceived as a positive development and in some cases, the interested suitors also expressed their interest for the acquisition of the corporate debtor in liquidation proceedings (through scheme of arrangement or sale on going concern basis). Therefore, instead of putting a blanket restriction on schemes of arrangement or going concern sale mechanisms, it should be left to the commercial wisdom of the CoC or the stakeholder’s consultation committee to explore the possibility of revival of the corporate debtor during liquidation in case the business is commercially viable. But in case of commercially unviable businesses, the liquidator, instead of wasting its time and efforts, should directly proceed with the sale of assets and dissolution of the corporate debtor.
For further information, please contact:
Mustafa Motiwala, Partner, Clasis Law
mustafa.motiwala@clasislaw.com
Dinesh Gupta, Clasis Law
dinesh.gupta@clasislaw.com
1 http://www.mca.gov.in/Ministry/pdf/ICLReport_05032020.pdf
2 COC of Essar Steel India Limited through Authorised Signatory vs. Satish Kumar Gupta and Others 2019 SCC OnLine SC 1478
3 The Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016
5 The Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016
