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October 2019

THE LATEST AMENDMENTS TO THE INSOLVENCY AND BANKRUPTCY CODE, 2016

By Peshwan Jehangir|Jaideep Singh Khattar
Advocates
Reading Time 23 mins

ONE STEP FORWARD AND TWO STEPS BACKWARD?

 

INTRODUCTION

The Insolvency and Bankruptcy Code has been one of the present government’s landmark legislations and continues to be pursued as a mechanism to improve India’s standing in the rankings for ‘ease of doing business’. The government has been keenly following the judicial developments and has also been very proactive in amending the law in an attempt to iron out any difficulties.

Recently, by a Gazette Notification dated 16th August, 2019 bearing No. S.O. 2953(E), the provisions of the Insolvency and Bankruptcy Code (Amendment) Act, 2019 (Amendment Act) were brought into force. This Amendment Act, in principle, is touted to be an outcome of the decision passed on 4th July, 2019 by the National Company Law Appellate Tribunal (NCLAT) in the case of Standard Chartered Bank vs. Satish Kumar Gupta, R.P. of Essar Steel Ltd.1 and amends the Insolvency and Bankruptcy Code, 2016 (IBC) on certain vital issues.

 

THE ESSAR STEEL CASE

The Essar Steel case related to the insolvency and bankruptcy proceedings of Essar Steel India Limited (ESIL) which were initiated on the basis of an application filed by the State Bank of India and Standard Chartered Bank under the provisions of section 7 of the IBC before the National Company Law Tribunal (NCLT), Ahmedabad. These proceedings were amongst the first few insolvency proceedings initiated pursuant to the RBI press release2  directing banks to take action against 12 large companies that had defaulted on their repayment obligations. The matter has had a chequered history and has been heavily contested by various parties.

Initially, the litigation before the NCLT was related to two resolution applicants, ArcelorMittal India Pvt. Ltd. (AMIPL) and Numetal Limited (Numetal) submitting their respective resolution plans.

The Resolution Professional, however, found both AMIPL and Numetal ineligible to be resolution applicants in view of the amendments brought about by the Insolvency and Bankruptcy Code (Amendment) Act, 2017 and in particular the enactment of section 29A to the IBC which deals with disqualification of applicants.

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1   Company Appeal (AT) (Ins.) No. 242 of 2019

2    https://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=40743

 

While considering the challenge, the NCLT remanded the matter back to the Committee of Creditors (COC) of ESIL, with directions that the comments of the Resolution Professional on the eligibility of the resolution applicants be placed before the COC and the COC should consider the resolution plans submitted by the resolution applicants.

This decision of the NCLT was challenged before the NCLAT. However, while the appeals were pending, the COC rejected the proposals of both the resolution applicants, i.e., Numetal and AMIPL. Eventually, when the appeals were finally heard by NCLAT, it found Numetal to be an eligible resolution applicant as Numetal’s shareholder, Aurora Enterprises Limited (which was a related party and hence violative of section 29A) had divested from Numetal. The NCLAT directed the COC to consider the resolution plan of Numetal. However, insofar as the eligibility of AMIPL was concerned, the NCLAT permitted its resolution plan to be considered by the COC subject to it paying the outstanding dues and interest of KSS Petron Pvt. Ltd. and Uttam Galva Steels Limited (both of which were alleged to be related parties of AIMPL and hence affected by the provisions of section 29A). Both Numetal and AMIPL approached the Supreme Court of India challenging the order passed by the NCLAT.

 

The Supreme Court, vide its judgement of 4th October, 20183 , while dealing with the challenges to section 29A of the IBC, held that both the resolution applicants, AMIPL and Numetal, were in breach of provisions of section 29A; however, exercising its powers under Article 142 of the Constitution of India, it agreed to once again permit the resolution applicants to pay the debts of their respective related corporate debtors and submit the resolution plans for consideration by the COC. Subsequently, only AMIPL paid the debts of its related corporate debtors and the resolution plan submitted by it was considered and ultimately approved by the COC.

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3   Civil Appeal Nos. 9402-9405 of 2018 in ArcelorMittal India Pvt. Ltd. vs. Satish Kumar Gupta and others

 

The second phase of litigation started subsequent to approval of the resolution plan by the Adjudicating Authority where the plan submitted by AMIPL was approved with certain modifications. The order passed by the Adjudicating Authority was challenged before the NCLAT4 by various stakeholders, including the promoter, secured creditors as well as the operational creditors and the COC. The NCLAT dismissed the challenge to the resolution plan but in the process laid down principles which are arguably against well-settled banking principles and distribution of assets.

 

The NCLAT held that the COC is not empowered to decide the manner in which the distribution of the resolution proceeds is required to be made between one or other creditors as the same is within the exclusive domain of the resolution applicant and, if found discriminatory by the NCLT, the resolution plan could be rejected. It further laid down that the COC is merely required to see the viability and feasibility of the resolution plan apart from the other requirements and ineligibility of the resolution applicant but not the distribution of the proceeds.

 

It also held that that under the IBC there was no distinction between secured and unsecured financial creditors and the IBC only had a homogenous class of financial creditors. Further, it also stated that the provisions of section 53 of the IBC will not apply to distribution of amounts amongst stakeholders as proposed by the resolution applicant in the resolution plan. Finally, NCLAT observed that in cases where the NCLT is unable to decide the claim on merit, the parties can raise the issue before the appropriate forum in terms of section 60(6) of the IBC, whereas financial and operational creditors whose claims have been decided by the Adjudicating Authority or by NCLAT, such decision being final, is binding on such financial and operational creditors. Their total claims will be considered to have been satisfied.

 

In addition to the above, NCLAT also held that the claims of financial creditors who were beneficiaries of a guarantee will stand satisfied to the extent of the guarantee and the comparative amount of the guarantee cannot be claimed from the principal borrower.

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4   Supra at 3

 

CONCERNS ARISING SUBSEQUENT TO THE NCLAT DECISION IN STANDARD CHARTERED BANK VS. SATISH KUMAR GUPTA, R.P. OF ESSAR STEEL LTD.5

By laying down that the COC was not required to look into the distribution of the proceeds but merely the viability and feasibility of the resolution plan, the NCLAT has ruled contrary to the report of the Banking Law Reforms Committee of November, 2015 wherein primacy has been given to the COC to evaluate the various possibilities and take a decision. In the words of the Banking Law Reforms Committee, ‘the appropriate disposition of a defaulting firm is a business decision, and only the creditors should make it’.

 

Fittingly, the Supreme Court in K. Shashidhar vs. Indian Overseas Bank6 held that the commercial and business decisions of the financial creditors are not open to any judicial review by the Adjudicating Authority or the appellate authority. Largely, prior to the NCLAT decision in Essar Steel’s case, it was settled that COC will be the imprimatur (meaning authoritative approval) that will guide the resolution process. This, perhaps, also explains the purposive distinction between financial and operational creditors and the consequential waterfall mechanism under the IBC. However, by significantly taking away the power to decide the distribution of the proceeds, the NCLAT had left the door wide open for more companies seeing liquidation proceedings as opposed to insolvency and resolution.

 

Another fundamental distinction made by the NCLAT in Essar Steel’s case was where it has refused to recognise the difference between secured and unsecured financial creditors and decided to treat both at par. This has created grave difficulties for secured creditors where insolvency proceedings are pending and which are yet to commence. As a result, this would also cause the cost of borrowing to go up significantly. An equally important point to note would be that on the kicking in of the moratorium period, the rights of secured creditors would get immediately impacted, and now, with this ruling, secured creditors would expect little in the resolution process. It would, therefore, not be completely incorrect to conclude that more secured creditors may prefer to opt for liquidation as opposed to resolution, as under liquidation at least the sanctity of those secured creditors that chose to realise the security would be maintained. Interestingly, even u/s 31B of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, primacy has been given to provisions of the IBC while recognising the supremacy of secured creditors.

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5   Supra at 3

6  Civil Appeal No. 10673 of 2018 decided on 5th February, 2019

 

Another can of worms had also been opened when the NCLAT held that provisions of section 53 of IBC do not apply to the distribution of amounts received under a resolution plan but only apply in the event of actual liquidation. This not only does violence to the language of the statute, but is also a far cry from the well-established principles of law. Even otherwise, operationally, this would lead to most COCs voting in favour of liquidation as opposed to resolution, given that liquidation would recognise their rights to realise security. Effectively, ‘maximisation of value’ through resolution would arguably have become ‘liquidation’ value.

 

Given the flutter created by the judgement in Essar Steel’s case, the government took prompt steps by amending the IBC. Just how quick the reaction was is borne out from the fact that the judgement in Essar Steel was passed on 4th July, 2019 and the Amendment Act was passed on 24th July, 2019 and after receiving the President’s Assent on 5th August, 2019 it was brought into force with effect from 16th August, 2019.

 

Significantly, the NCLAT decision in the Essar Steel matter has been challenged by the COC forthwith before the Supreme Court7 and the same is pending further adjudication. It is yet to be seen exactly how the same will play out, given that the Amendment Act is now in force.

 

KEY AMENDMENTS UNDER THE AMENDMENT ACT

Some of the key amendments brought about by the Amendment Act are discussed below:

 

Amendment to section 7(4) of IBC

The Amendment Act has amended section 7(4) of the IBC to make it necessary for the Adjudicating Authority to record reasons if, in the case of a financial creditor application, it has not ascertained the existence of default and passed the order within a period of 14 days. This amendment effectively recognises the principle set out in the NCLAT decision in JK Jute Mills Company Limited vs. Surendra Trading Company8 where the NCLAT, while considering whether the timelines under the IBC were mandatory for rectifying the defects in an insolvency application, held that the timeline of seven days was mandatory but the timeline of 14 days to decide on admission of the application was directory. The NCLAT stated that reasons may be recorded where the insolvency application is not disposed of within the time specified under the IBC. Whilst the NCLAT made it discretionary to record reasons, the Amendment Act makes it mandatory to record reasons.

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7   Civil Appeal (Diary Nos.) 24417 of 2019

 

 

 

Amendment to section 12 of IBC

A significant change brought about by the Amendment Act is the mandatory timeline introduced for the completion of the corporate insolvency resolution process (CIRP) by inserting a proviso to section 12(3) of the IBC. The Amendment Act states that the CIRP shall mandatorily be completed within a period of 330 days from the insolvency commencement date, i.e., the date of admission, and shall be inclusive of extensions granted and the time taken in legal proceedings in relation to the resolution process of the corporate debtor. Where CIRP is at present pending, the Amendment Act has made it mandatory for the CIRP to be completed within a period of 90 days from the date of commencement of the Amendment Act, i.e., 16th August, 2019.

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8   Company Appeal (AT) No. 09 of 2017 decided on 1st May, 2017. The NCLAT decision was challenged in the Supreme Court in Civil Appeal No. 8400 of 2017 where the Supreme Court held that the time to remove the defects from an insolvency application was not mandatory but directory, but sufficient cause is required to be shown for the delay in removing the defects

 

 

From the changes made in the Amendment Act, this amendment seems to be the most noteworthy and will have an immediate impact on all CIRPs, pending as well as those admitted to insolvency. The timeline of 330 days, at first blush, seems salutary, but given the mandatory nature of the amendment, appears difficult to achieve in practice.

 

First, the 330-day period is inclusive of all time taken in litigation in relation to the resolution process, which seems difficult to achieve given the pendency of cases as well as delays in the judicial system. Moreover, judicial primacy has already been bestowed to exclude the time during which applications and appeals are pending before the Adjudicating Authority and the appellate authority, keeping firmly in mind the established principle, Actus curiae neminemgravabit – the act of the Court shall harm no man and, to quote the Supreme Court9 , ‘This is only to say that in the event of the NCLT, or the NCLAT, or this Court taking time to decide an application beyond the period of 270days, the time taken in legal proceedings to decide the matter cannot possibly be excluded, as otherwise a good resolution plan may have to be shelved, resulting in corporate death and the consequent displacement of employees and workers.’

 

The NCLAT in the case of Quinn Logistics India Pvt. Ltd. vs. Mack Soft Tech Pvt. Ltd. and Ors.10 has enumerated several other instances beyond the control of the parties, other than pending litigation, which could also delay the CIRP. Instances are also seen where the suspended board of directors and personnel of the corporate debtor have not co-operated with the interim resolution professional leading to delay in formal commencement of the insolvency resolution process. Second, this amendment makes the extension period granted for the CIRP exclusive. This, along with the mandatory language of the amendment, would suggest that in the event the CIRP is not completed within the period of 330 days, there would be no other option before the Adjudicating Authority but to remit the corporate debtor to liquidation under the provisions of section 33 of the IBC. Threateningly, this has been the outcome in the case of S.N. Plumbing Limited11 where the resolution plan was not approved within the period of 270 days under the then prevailing provisions of the IBC, and the NCLAT held that the COC ceased to have any authority after 270 days, resulting in the Adjudicating Authority being mandatorily required to pass an order for liquidation. Needless to say, this would be against the spirit of the IBC which has fostered the idea to maximise valuation and save the debtor from corporate death. Additionally, a one-size-fits-all approach may not work where a CIRP for companies as large as Essar Steel India Limited having a resolution plan worth more than Rs. 40,000 crores is being deliberated upon.

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9   Supra at 5 – This decision was prior to the Amendment Act, where the time period allowed under the IB Code was 270 days inclusive of extension of 90 days

10  Decision dated 8th May, 2018 in Company Appeal (AT) Insolvency No. 185 of 2018

 

Amendment to section 30 of IBC

Another key change has been made by amending the provisions of section 30 of the IBC. This change has primarily been brought about in view of the NCLAT decision in Essar Steel’s case. Essar Steel’s case stated that it would be impermissible for a resolution applicant to discriminate between various classes of creditors, such as secured and unsecured creditors. This led to a position where, even though certain creditors had security, they would recover only such amounts as would an unsecured creditor. This was widely criticised.

 

The amendment to section 30 now provides that a resolution plan should at the very least provide for payments to operational creditors, which shall be the higher of the amount that would be paid to the operational creditor u/s 53 of the IBC on liquidation of the corporate debtor, or the amount that would be paid to the operational creditor, if the corporate debtor was wound up and the resolution proceeds were distributed in accordance with the waterfall set out in section 53(1). The amendment further provides that the resolution plan should provide for the payment to financial creditors who do not vote in favour of the resolution plan and that such payment shall not be less than the amount such creditor would receive u/s 53 if the corporate debtor was being liquidated. As would be apparent, this change has been brought about to emphasise that the distribution of resolution proceeds shall only be in accordance with the statutory waterfall provided u/s 53 of the IBC and to negate the anomaly created in view of the NCLAT’s decision in the Essar Steel case. This, therefore, clarifies that different classes of creditors may continue to be treated differently and the interest of a secured creditor would take priority over that of an unsecured one.

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11  NCLAT decision in Sanjay Kumar Ruia vs. Catholic Syrian Bank Limited decided on 3rd January, 2019

 

 

Under section 53, the priority of claims would be for claims of insolvency resolution professional costs, workmen’s dues, claims of secured creditor where such secured creditor has relinquished his security and is standing in line with the other creditors, wages of employees, financial debts of unsecured creditors, government dues, unsecured debts of secured creditors after adjusting the security value that they have realised on enforcing the security. This means that only after the above claims have been satisfied, the claims of operational creditors are given their due. This is also the reason why operational creditors are normally given a nil value or only Re. 1 as the resolution applicants are uncertain whether any value will remain subsequent to settling the prior claims.

 

Section 30 has also been amended with an explanation to state that the distribution of the resolution proceeds in accordance with section 30 shall be fair and equitable. This change, in the view of the authors, has been brought about in order to cease and desist operational creditors or unsecured financial creditors from claiming that the resolution plan is unfair, inequitable and discriminatory.

 

As an example, if a corporate debtor has overall creditors of say Rs. 1,000 crores (Rs. 500 crores secured and remaining unsecured), is undergoing insolvency and has a liquidation value of about Rs. 300 crores, the code mandates that a resolution applicant pay the creditors a minimum of Rs. 300 crores. Further, the distribution of the Rs. 300 crores must be in a manner so that they pay each class of creditors more money than they would have got if the corporate debtor is wound up and money received is distributed as per the waterfall set out in section 53 of the Code. Based on Essar Steel’s judgement, distribution of amounts received from a resolution applicant (Rs. 300 crores) would have to be paid proportionately to all creditors for it to be approved (irrespective of their place in the waterfall set out in section 53). Interestingly, in a recent judgement12, the NCLAT has considered the amended provisions of section 30 of the IBC and has held that creditors falling under the same class cannot be treated differently, even if they have a dissenting vote. The basis of the judgement seems to be that even though provisions of section 30 have been amended, the provisions of regulation 38 of the CIRP regulations have not been amended. Thus, the CIRP regulations do not permit a successful resolution applicant to discriminate between similarly situated ‘secured financial creditors’ on the ground of dissenting vote.

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12  Company Appeal (AT) Insolvency No. 745 of 2018 decided on 17th September, 2019 – Hero Fincorp Ltd. vs. Rave Scans Pvt. Ltd. and Ors.

 

 

Another explanation added to section 30 clarifies that on and from the commencement date of the Amendment Act, i.e., on and from 16th August, 2019, the amended provisions of section 30 will also apply (a) where the resolution plan is pending approval or has not been rejected by the Adjudicating Authority, (b) where an appeal has been preferred either before the NCLAT or the Supreme Court, or (c) where a legal proceeding has been initiated in any court against the decision of the Adjudicating Authority in respect of the resolution plan.

 

Yet another amendment that has been brought to section 30 in view of the NCLAT’s decision in Essar Steel’s case is that the COC is required to consider not just the ‘feasibility and viability’ of the resolution plan but also ‘the manner of distribution proposed, which may take into account the order of priority amongst creditors as laid down in section 53(1) of the IBC including the priority and value of the security interest of a secured creditor’. A bare reading of this change will make it abundantly clear that this has been brought about only to address the Essar Steel case.

 

By virtue of these changes and the applicability of the amendments to section 30 even to those resolution plans where appeals are pending before the NCLAT and the Supreme Court, it is clear that these amendments may change the eventual distribution of the resolution proceeds in the Essar Steel case.

 

OTHER AMENDMENTS UNDER THE AMENDMENT ACT

Amendment to section 5(26) of IBC

Section 5(26) of the IBC has been amended to clarify that the resolution plan may include provisions for restructuring, including by way of merger, amalgamation and demerger. By permitting restructuring under a resolution plan, the IBC has provided for greater flexibility in the potential revival of a corporate debtor which is in furtherance of the objective of the IBC. By providing even for merger, amalgamation and demerger as potential options in a resolution plan, the Amendment Act has effectively borrowed the principle as laid out in the NCLAT decision in S.C. Sekaran vs. Amit Gupta & Ors.13 wherein it directed the liquidator to take steps u/s 230 of the Companies Act, 2013 and only if there is a failure of revival, should the liquidator then proceed with the sale of the company’s assets wholly, and if that is not possible, then to sell the company in part and in accordance with law.

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13  Company Appeal (AT) (Insolvency) No. 495 & 496 of 2018 decided on 29th January, 2019

 

 

Amendment to section 25A(3) of IBC

The Amendment Act has substituted the provisions of section 25A(3) with the addition of section 3A which provides that the authorised representative under 21(6A), i.e., the authorised representative for security and deposit holders (viz., debenture / bond holders and fixed deposit holders) as well as real estate allottees shall vote at COC meetings in accordance with a majority decision, i.e., 50.01% or more of the financial creditors he represents. Additionally, the amendment also states that where the decision is in respect of section 12A, i.e., withdrawal of the insolvency application, the authorised representative shall vote in accordance with section 25(3) only, i.e., in accordance with the instructions received from each financial creditor, to the extent of such financial creditor’s voting share.

 

This amendment will further enhance the objective to complete the insolvency resolution process in 330 days where large insolvencies involving home buyers and investors holding security receipts are concerned.

 

Amendment to section 31(1) of IBC

Amendment to section 31(1) has crystallised that once the resolution plan has been approved by the Adjudicating Authority, the same shall be binding on all and sundry. The Amendment Act has specifically included Central government, state government and local authority to whom statutory dues are pending in the list of stakeholders on whom the resolution plan shall be binding.

 

As much as this is a much-celebrated amendment as it will lead to increased resolution applicant interest and confidence to bid by staving regulatory litigation, it could also lead to situations where companies being in significant statutory debt could avoid prosecution by simply knocking on the doors of the NCLT.

 

Amendment to section 33(2) of IBC

Provisions for initiation of liquidation as provided u/s 33 have been amended to statutorily recognise the supremacy of the COC to decide on the insolvency process of the corporate debtor. The amendment provides that the COC may take a decision to liquidate the corporate debtor at any time after the constitution of the COC but before confirmation of the resolution plan, including before preparation of the information memorandum.

 

As argued earlier, this again recognises that, after all, it is the COC which is the best judge on taking commercial decisions, including as to whether or not revival of the corporate debtor is possible. If the COC views that resolution is unlikely or not possible, it can now kick-start the process of liquidation immediately and save time. Even before the principle of COC supremacy was recognised by the Supreme Court in K. Shashidhar14, the National Company Law Tribunal, Mumbai in the case of Gupta Coal India Private Limited15 recognised the supremacy of the COC and permitted liquidation of the corporate debtor where it rejected the resolution plan and decided to go for liquidation. The National Company Law Tribunal held that it could not go against the decision of the COC.

 

CONCLUSION

The Amendment Act, in part, is a step in the right direction where it has recast the efficacy of the resolution process by recognising the COC’s supremacy and commercial wisdom in deciding not only on the feasibility and viability of the resolution plan but also the distribution of the resolution proceeds. Another laurel of the Amendment Act is that it has statutorily recognised the applicability of the waterfall mechanism u/s 53 of the IBC regarding liquidation proceedings to even insolvency proceedings. However, despite these advantages the amendment to section 12 where the 330-day deadline has been introduced as a hard stop may be impractical and risks more companies undergoing liquidation rather than resolution. The government must naturally look to augment the number of NCLT benches and improve the infrastructure. There is also a need for improved training being given to stakeholders like resolution professionals and COC members who play a crucial role in the process.

 

Much like amendments to various economic legislations being tested on constitutional principles, even the provisions of the Amendment Act are now subject to the constitutional challenge in the case of Committee of Creditors of Essar Steel India Limited vs. Satish Kumar Gupta & Anr.16. It now remains to be seen whether the changes proposed would have the necessary effect on the corporate insolvency resolution process and yield the desired results.

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14 Supra at 8

15 Decisionin MA 524 in Company Petition No. 31 of 2017 rendered on 1st January, 2018

16 Order dated 7th August, 2019 passed in Civil Appeal (Diary Nos.) 24417 of 2019

 

 

 

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