Category: Corporate And Other Laws

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 16^th
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 4^th 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 4^th
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.

______________________________________

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.

______________

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.

__________________________________

5   Supra at 3

6 
Civil Appeal No. 10673 of 2018 decided on 5^th 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 4^th July, 2019 and the Amendment Act
was passed on 24^th July, 2019 and after receiving the President’s
Assent on 5^th August, 2019 it was brought into force with effect
from 16^th 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.

____________________________

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., 16^th
August, 2019.

__________________________________________

8   Company Appeal (AT) No. 09 of 2017 decided on
1^st 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.

________________________________________

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 8^th 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.

____________________________________________

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

__________________________________

12  Company Appeal (AT) Insolvency No. 745 of 2018
decided on 17^th 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 16^th 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.

_______________________________

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

_________________________________

14
Supra at 8

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

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

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