It was started in September, 2002 with
Anup P Shah as its author. He continues to eloquently pen it every month since
then. BCAJ had several features on tax and accounting but very little of Law.
As auditors and advisors, CAs need to have a good working knowledge of laws
which impact business. Each article provided audit steps after covering the
legal aspects. The idea behind the feature is to educate CAs and even
businessmen about laws which impact a business and hence, the name “Laws &
Business”. Anup started writing on different laws and then moved on to
different legal issues. One notable change: When he started he was CA. Anup
Shah and now he is Dr. Anup P Shah.
You are about to read the 196th
contribution. So far the column has covered 82 Laws and 164 legal issues. Two
editions of compilation of Laws and Business have been published by BCAS. When
we asked the author, what keeps him going after sixteen years of monthly
writing: “Writing crystallizes thinking – while readers may benefit from the
Feature, I get a larger benefit since before one can write on a subject, one
must study and analyse it thoroughly. In addition, the desire to learn new
legal issues and a zeal to write keeps the keyboard pounding!” Soon the feature will hit a double century!
Insolvency & Bankruptcy
Code, 2016 – SC’s Booster Shots
Introduction
Rarely has a law witnessed
as many legal challenges in its initial years as the Insolvency &
Bankruptcy Code, 2016 (“Code”) has! Although, the Code is less
than three years old, it has seen numerous battles not just at the NCLT level
but even at the Supreme Court. In addition, the Code itself has been amended
many times to address changing circumstances and in response to Court
decisions. Hence, it has been an evolving legislation. Promoters of companies
under insolvency resolution have tried resorting to judicial forums to prevent
losing control over their companies but Courts have been wary of allowing their
pleas. However, each time the Code has emerged stronger and more robust than
before. In the last few months, the Supreme Court has on three occasions,
delivered landmark decisions, which have helped uphold the validity of the
Code. Let us examine these decisions of the Apex Court in the context of the
Code.
Case-1: Swiss Ribbons (P.) Ltd. vs. UOI,
[2019] 101 taxmann.com 389 (SC)
The Supreme Court by its
Order dated 25th January 2019, upheld the Insolvency and Bankruptcy
Code, 2016 in its entirety with some minor adjustments. This case was not fact
based since it involved a challenge to the Constitutional validity of the Code.
Some of the salient features of this path breaking decision are discussed
below. The main thrust of the petitioner’s argument was that the Code suffered
from various Constitutional infirmities and arbitrariness and hence, deserved
to be struck down. The Court held the primary focus of the legislation was to
ensure revival and continuation of the corporate debtor by protecting the
corporate debtor from its own management and from a corporate death by
liquidation. The Code was thus a beneficial legislation which put the corporate
debtor back on its feet and was not a mere recovery legislation for creditors.
The interests of the corporate debtor had, therefore, been bifurcated and
separated from that of its promoters / those who were in management. Thus, the
Corporate Insolvency Resolution Process (“CIRP”) was not
adversarial to the corporate debtor but, in fact, protective of its interests.
It observed that in the
working of the Code, the flow of financial resource to the commercial sector in
India had increased exponentially as a result of financial debts being repaid.
Approximately 3300 cases were disposed of by the NCLT based on out-of-court
settlements between corporate debtors and creditors which themselves involved
claims amounting to over Rs. 1,20,390 crore. The experiment conducted in
enacting the Code was proving to be largely successful.
Distinction between Operational and Financial
Creditors is Valid
It was argued that the
distinction between operational and financial creditors was Constitutionally
invalid and nowhere in the world was such an artificial bifurcation found. It
was quite likely that since operational creditors were often unsecured (e.g.,
creditors for goods and services) as compared to financial creditors (e.g.,
banks, NBFCs, etc.,) who may be secured, there might not be enough funds left
behind for the operational creditors after paying off the financial creditors.
Further, it was contended that operational creditors had no right to vote as
compared to financial creditors who alone could vote. Moreover, a financial
creditor could trigger a resolution application under the Code merely on a
default taking place. However, in the case of an operational creditor even if a
default takes place and an application is filed before the NCLT, the same would
be rejected if the debtor can prove that a dispute exists with the operational
creditor.
The Court noted that the
reason for differentiating between financial debts, which were secured, and
operational debts, which were unsecured, was in the relative importance of the
two types of debts when it comes to the objects sought to be achieved by the
Code. Giving priority to financial debts owed to banks and lenders would
increase the availability of finance, reduce the cost of capital, promote
entrepreneurship and lead to faster economic growth. The Government also will
be a beneficiary of this process as the economic growth will increase revenues.
Financial creditors from the very beginning are involved with assessing the
viability of the corporate debtor. They can, and therefore do, engage in
restructuring of the loan as well as reorganisation of the corporate debtor’s
business when there is financial stress, which are the things operational
creditors do not and cannot do. Financial creditors help in preserving the
corporate debtor as a going concern, while ensuring maximum recovery for all
creditors being the objective of the Code, and hence, are clearly different
from operational creditors and therefore, there is obviously an intelligible
differentia between the two which has a direct relation to the objects sought
to be achieved by the Code.
Further, the NCLAT has,
while looking into viability and feasibility of resolution plans that are
approved by the committee of creditors, always examined whether operational
creditors are given roughly the same treatment as financial creditors, and if
not, such plans are either rejected or modified so that the operational
creditors’ rights are safeguarded. Moreover, a resolution plan cannot pass
muster u/s. 30(2)(b) read with section 31 unless a minimum payment is made to
operational creditors, being not less than liquidation value.
The Regulations framed under
the Code have been amended to expressly provide that a resolution plan shall
now include a statement as to how it has dealt with the interests of all
stakeholders, including financial creditors and operational creditors, of the
corporate debtor. This further strengthens the rights of operational creditors
by statutorily incorporating the principle of fair and equitable dealing of
operational creditors’ rights, together with priority in payment over financial
creditors.
Hence,
the Court concluded that no discrimination resulted since it was demonstrated
that there was an intelligible differentia which separated the two kinds of
creditors.
Section12A withdrawal of CIRP
In the
past, there have been instances where on account of settlement between the
applicant creditor and the corporate debtor, judicial permission for withdrawal
of the CIRP was required. The Supreme Court, under Article 142 of the
Constitution, passed orders allowing withdrawal of applications after the
creditors’ applications had been admitted by the NCLT. Thus, without
approaching the Supreme Court, it was not possible to withdraw an application
even if both parties consented to the same – Lokhandwala Kataria
Construction P Ltd vs. Nisus Finance and Investment Managers LLP,
CA No. 9279/2017 (SC) and Mothers Pride Dairy P Ltd vs. Portrait
Advertising and Marketing P Ltd, CA No. 9286/2017 (SC).
To remedy this situation,
section 12A was inserted in the Code which allows for the withdrawal of an
insolvency petition filed against a corporate debtor if 90% of the Committee of
Creditors (CoC) approve such a withdrawal. It was argued that this section gave
unbridled and uncanalised power to the CoC to reject legitimate settlements
between creditors and corporate debtors. The Apex Court held that once the CIRP
was triggered, the proceeding became a proceeding in rem, i.e., a collective
proceeding, which could not be terminated by an individual creditor. All
financial creditors have to come together to allow such withdrawal as,
ordinarily, an omnibus settlement involving all creditors ought, ideally, to be
entered into. This explained why 90%, which was substantially all the financial
creditors, have to grant their approval to an individual withdrawal or
settlement. In any case, the figure of 90%, pertained to the domain of
legislative policy. The Court further pointed out that there was an additional
safeguard by way of section 60 of the Code, which provided that if the CoC
arbitrarily rejected a just settlement and/or withdrawal claim, the NCLT, and
thereafter, the NCLAT could always set aside such a decision. Thus, the Court
upheld section 12A of the Code.
Role of RP
The
Court did not find merit in the plea that the resolution professional was given
adjudicating powers under the Code. It held that he was given an administrative
role as opposed to quasi-judicial powers. The Court distinguished between the
role of a resolution professional who had an administrative role versus a
liquidator who had a quasi-judicial role. Thus, the resolution professional was
only a facilitator of the resolution process, whose administrative functions
were overseen by the CoC and ultimately by the NCLT.
Section 29A: Relief to ‘Related Party’
A multi-fold attack was
raised against section 29A which disentitled certain persons to act as
resolution applicants. Firstly, it was stated that the vested rights of
erstwhile promoters to participate in the recovery process of a corporate
debtor were impaired by a retrospective application of section 29A. It was
contended that section 29A was contrary to the object sought to be achieved by
the Code, in particular, speedy resolution process as it would inevitably lead
to challenges before the NCLT and NCLAT, which would slow down and delay the
CIRP. In particular, so far as section 29A(c) was concerned, a blanket ban on
participation of all promoters of corporate debtors, without any mechanism to
weed out those who are unscrupulous and have brought the company to the ground,
as against persons who are efficient managers, but who have not been able to
pay their debts due to various other reasons, would not only be manifestly
arbitrary, but also be treating unequals as equals. Also, maximisation of value
of assets was an important goal to be achieved in the resolution process and section 29A was contrary to such a goal since an
erstwhile promoter, who may outbid all other applicants and may have the best
resolution plan, would be kept, thereby impairing the object of maximisation of
value of assets. Another argument which was made was that under the Code, a
person’s account may be classified as an NPA in accordance with the guidelines
of the RBI, despite him not being a wilful defaulter. Lastly, persons who may
be related parties in the sense that they may be relatives of the erstwhile
promoters were also debarred, despite the fact that they may have no business
connection with the erstwhile promoters who have been rendered ineligible by
section 29A.
The Supreme Court held that
the Code was not retrospective in application and hence, it was clear that no
vested right of the promoters was taken away by the application of section 29A. The Court held that it must be borne in
mind that section 29A had been enacted in the larger public interest and to
facilitate effective corporate governance. The Parliament rectified a loophole
which allowed a back-door entry to erstwhile managements in the CIRP. Hence,
the Court upheld the validity of section 29A. However, it held that the mere
fact that somebody happened to be a relative of an ineligible person was not
good enough to oust such person from becoming a resolution applicant, if he was
otherwise qualified. In the absence of showing that such a person was connected
with the business activity of the ineligible resolution applicant, such a person
could not automatically be disqualified. Hence, the expressions related party
and relative contained in the Code would disqualify only those persons who were
connected with the business activity of the resolution applicant.
Ultimately, the Supreme Court
upheld the validity of the Code in its entirety with a minor tweak for
relatives / related parties!
Case-2: Arcelor Mittal India Private
Limited vs. Satish Kumar Gupta, (2018) 150 SCL 354 (SC)
This decision pertained to
the bid for Essar Steel India Ltd. 29A of the Code contains several
disqualifications for bidders, one of which is that a person would not be
eligible to submit a resolution plan, if such person, or one acting jointly or
in concert with such person was disqualified. In this case, there were two
bidders – the erstwhile promoters and another resolution applicant. It so
happened that both the promoters as well as the resolution applicant were
disqualified by virtue of the various clauses of section 29A. Hence, both of
them modified their shareholding structures and reapproached the NCLT. The
issue finally reached the Supreme Court as to whether both these bidders were
eligible to bid?
The Court adopted a
purposive interpretation of the section and held that the legislative intention
was to rope in all persons who may be acting in concert with the person
submitting a resolution plan. The opening lines of section 29A of the Code
referred to a de facto as opposed to a de jure position of the
persons mentioned therein. This was a typical instance of a “see through
provision”, so that one was able to arrive at persons who were actually in
“control”, whether jointly, or in concert, with other persons. A wooden,
literal, interpretation would obviously not permit a tearing of the corporate
veil when it came to the “person” whose eligibility was to be
considered. However, a purposeful and contextual interpretation was necessary.
While a shareholder is a separate legal entity from the company where he holds
shares, for verifying the resolution plan, it is imperative to lift the
corporate veil and ascertain the constituents who make up the Company. The
Court upheld the doctrine of piercing the corporate veil as enshrined in LIC
of India vs. Escorts Ltd (1986) 1 SCC 264 and distinguished the legal
personality concept of Soloman’s case. It observed that a slew of
judgments has held that where a statute itself lifts the corporate veil, or
where protection of public interest is of paramount importance, or where a
company has been formed to evade obligations imposed by the law, the court will
disregard the corporate veil.
The Court held that seen
from the wide language used in the section, any understanding, even if it is
informal, and even if it is to indirectly cooperate to exercise control over a
target company, is included in the definition of persons acting in concert and
it is not merely restricted to cases of formal joint venture agreements. The
stage at which ineligibility is to be examined is when the resolution plan was
submitted by a resolution applicant. So long as a person or persons acting in
concert, directly or indirectly, can positively influence, in any manner,
management or policy decisions, they could be said to be “in control”. The
expression “control”, in section 29A, denotes only positive control, which
means that the mere power to block special resolutions of a company cannot
amount to control. The Supreme Court also examined the decision of the SAT in the case of Shubhkam Ventures vs. SEBI (Appeal No. 8 of 2009
decided on15.1.2010) which had taken a similar view.
The Court held that since
section 29A is a see-through provision, great care must be taken to ensure that
persons who are in charge of the corporate debtor for whom such resolution plan
is made, do not come back in some other form to regain control of the company
without first paying off its debts. One of the persons mentioned in section 29A
who is ineligible to act as an resolution applicant is a person prohibited by
SEBI from either trading in securities or accessing the securities market. The
Court held that it was clear that it was clear that if a person was prohibited
by a regulator of the securities market in a foreign country from trading in
securities or accessing the securities market, the disability would equally
apply.
Lastly, the court dealt
with the timeline for completing a CIRP. The time limit for completion of the
CIRP as laid down in section 12 of the Code is a period of 180 days from the
date of admission of the application by the NCLT. This is extendable by a
maximum period of 90 days only if 66% of the CoC approve of the same and the
NCLT agrees to the same. If no resolution takes place within such period of 270
days, then the only option is to liquidate the corporate debtor. The Supreme
Court held that the timelines mentioned in the Code are mandatory and cannot be
extended. Nevertheless, the Court also relied on a legal maxim, Actus curiae
neminem gravabit – the act of the Court shall harm no man. Accordingly, it
held that where a resolution plan is upheld by the NCLAT, either by way of
allowing or dismissing an appeal before it, the period of time taken in
litigation ought to be excluded.
Ultimately, the Supreme
Court held that both the applicants were ineligible under the Code but
exercising its special powers under Article 142 it granted one more opportunity
to them to pay off the NPAs of their related parties and then resubmit their
bids.
Case-3: Brilliant Alloys P Ltd vs. S Rajagopal, SLP
No. 31557 / 2018, Order dated 14-12-2018
Section 12A of the Code
allows for the withdrawal of an insolvency petition filed against a corporate
debtor if 90% of the Committee of Creditors (CoC) approve such a withdrawal.
However, Reg. 30A of the Insolvency and Bankruptcy Board of India (Insolvency
Resolution Process for Corporate Persons) Regulations, 2016 provides that an
application for withdrawal u/s. 12A shall be submitted to the resolution
professional before the issue of invitation for expression of interest. Hence,
a question arises as to whether if the debtor and creditor agree to it, can the
petition be withdrawn even after the expression of interest has been issued?
The Supreme Court allowed
the withdrawal and held, that this Regulation has to be read along with the
main provision section 12A which contained no such stipulation. Accordingly,
this stipulation could only be construed as directory depending on the facts of
each case.
Conclusion
The
Supreme Court has time and again stepped in to protect and augment the Code. It
has endeavoured to preserve the basic fabric of the Code and to uphold its
provisions. However, at the same time it has made amendments where it felt a
change was required. The Code is a complicated and intricate legislation dealing
with an extremely complex subject and hence, such an evolution is expected.
However, it is heartening to note that the Apex Court has been up to the
challenge and has done it in a very timely manner. The Supreme Court decisions
have acted as a booster shot in the arm to the Code. The success of the Code
can be best summed up by the Supreme Court’s observations in Swiss Ribbons
(supra), “The defaulter’s paradise is lost. in its place, the economy’s
rightful position has been regained.” 
