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Evolution of Corporate Insolvency Resolution Process : journey from start to the pre-pack mechanism

CIRP

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This article is written by Ashutosh Prakash, pursuing a Certificate Course in Insolvency and Bankruptcy Code from LawSikho.

Introduction

As per the traditional company law, a company never dies or ceases to exist unless and until the task for which it was formed has been completed or it is specifically wound up through the procedures. Membership and executives of a company may keep on changing from time to time but that in any way does not affect life of the company. A Company, having no mind of its own, always acts through its stakeholders, each having a unique objective function, with different set of rights, interests depending on the level of engagement with the company. As a consequence, the interest of one stakeholder may conflict with those of another and they may work at cross purposes or even against the interest of the company. Some may leave the company at the earliest sign of its distress. The departure of a major shareholder often orphans the company. Anyway, the insolvency of a particular member does not affect the existence of a company. However, several disruptive forces are killing off older companies at a much faster rate and earlier than decades ago, Irrespective of company’s characteristic of perpetual succession, the average age of companies in recent years has resulted in shortening the lifespan of companies squeezing employees, investors and other stakeholders.

A strict regulatory framework regarding the post process following bankruptcy was always needed. In spite of being a ground requirement for any well-functioning economy, India was lacking in an efficient and strict bankruptcy system. While committees appointed by the Government of India had recommended several changes to the old regime, those recommendations were never implemented in real-time. It was then after the enactment of ‘Insolvency and Bankruptcy Code (IBC) in 2016, this law was being hailed as one of India’s biggest structural reforms in the economic sphere after the independence and it is for sure that as long as it continues to be implemented properly, IBC will have a far-reaching impact on the corporate governance and the availability of credit in India. It has redefined the insolvency resolution framework in India. With this article, I have tried to summarize and put some of the remarkable highlights in bullet points with respect to the major modifications that have happened since the time of the enactment of the principal code with ‘pre and post Covid-19’ legislative amendments and case laws.

Features and developments in the regime

The code provides a mechanism for the insolvency and bankruptcy resolution of debtor companies in a time-bound manner. The common misconception is that this code has provided the process to end a company’s life. Well, it does to a certain extent but it is the last option given to go for in case there’s no other option left. The true spirit of this code lies on the side of revival of companies which are not in such a condition to pay their due debts. The focus is on providing the corporate debtors with an efficient mechanism of Corporate Insolvency Resolution Process (CIRP), so that it could revive itself and continue on with its business further.  The code focuses on maximization of the value of the assets of a company in debt, with a view to promote wealth and business standards. It ensures the availability of credit balancing the interests of all the stakeholders and ultimately, the rescue of companies in a time-bound manner and their rehabilitation in due course. In recent years since the enactment of this mechanism, the National Company Law Tribunals, Debt Recovery Tribunals, the High Courts and the Supreme Court have adjudicated upon several matters under the Code with extraordinary speed, and have provided certainty on the true interpretation of key concepts involved under the code.

The Code establishes a regulatory body the ‘Insolvency and Bankruptcy Board of India (IBBI)’ which also had been extremely responsive in making efficient legislative amendments ensuring the implementation of the true spirit and nature of the code. These developments have enriched the practice of this mechanism in the country and gave its jurisprudence a solid regulation and balance. However, during the implementation of its true spirit, the constitutional validity of various provisions of the code had been challenged before several High Courts, and the Supreme Court. The nationwide lockdown due to the Global Pandemic of Covid-19 has also affected the implementation of this code drastically. In the recent past, the Government of India has taken several steps to control and mitigate the loss caused to the companies due to the pandemic. Although the Corporate Giants were able to manage their profits even in this unprecedented time, The Micro, Small, and Medium Enterprises (MSMEs) struggled a lot to maintain their businesses. From the very year of the enactment of this code to the very recent 2021 amendment focusing on the pre-packaged insolvency resolution process for MSMEs, this law had been in a lot of controversies with respect to its implementation which resulted in numerous changes and clarifications in recent years.

Amendments and Case Laws

This was the very initial change that happened in the code with some clarifications and amendments and the insertion of a few more additional sections in the principal code. The Government of India issued an ordinance in November 2017 making these changes which later on upheld by the parliament as the IBC (Amendment) Act, 2018[2] in the month of January, 2018. Let’s see some important highlights of this modification:

This is a landmark case decided during the initial days of the implementation of this code since the day of enactment challenging and questioning the validity on the ground that the initiation of the CIRP was not consistent with the principles of natural justice. The constitutional validity of Section 7, 8, 9, 14, and 31 of IBC was put in issue on the ground that the provision does not provide the corporate debtor an opportunity to be heard (audi alteram partem), before an application to initiate CIRP under IBC by its creditors is admitted by the adjudicating authority. It was claimed that the provisions of the Code are silent on the right of the corporate debtor to be reasonably heard. Well, relying on the provisions of Section 424 of Companies Act, 2013, it was observed by the Hon’ble High Court of Calcutta that the adjudicating authority is obliged to give reasonable opportunity to be heard to the corporate debtor and must have to adhere to the principle of natural justice while and in doing so the reasons for admission or rejection of application must be recorded in writing.

However, a reasonable point of consideration is that under the principal act, the plan for the resolution and revival of the corporate debtor has to be prepared by the CoC which generally consists of all the financial creditors with voting power and decision making authority in their hands for the approval of the resolution that has to be submitted the Resolution Professional before the adjudicating authority. While the operational creditors are not prohibited from attending the CoC, they weren’t able to take part in the decision making which raised an issue of just and equitable treatment of the operational creditors but the government later on, solved this issue by Amendment Act and by the true interpretation of the code by Judiciary.

This amendment act brought some modifications in support of the true interpretation of the code in the real-time application. With some changes in the substitution of the word words mentioned in the provisions, it also inserted some sections and clauses for clarifications regarding the scope of the definitions and process involved in the CIRP mechanism.

  1. Inserted Clause (5A) in Section 5 of the principal act defining the term ‘Corporate Guarantor’ as a “corporate person who is the surety in a contract of guarantee to the corporate debtor.
  2. Inserted an additional explanation in the sub-clause (f) of clause 8 of Section 5 explaining about the expressions ‘allottee’ and ‘real estate project’ be the same meaning as defined in Real Estate (Regulation and Development) Act, 2016 (RERA).
  3. Inserted another clause 24A in Section 5 defining broadly the term ‘Related Party’ and ‘Relative’ with respect to IBC.

In the present case, the Hon’ble Supreme Court looked at the dispute that arose out of the second amendment act and considered the main issue in hand about the implementation of the newly inserted Section 238A. The question was whether the Limitation Act, 1963 will apply to the CIRP application filed under Section 7 or 9 of the Insolvency and Bankruptcy Code, 2016 which are prior to the date on which the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018[6] came into effect, i.e.- 6th June, 2018. The apex court upheld the applicability of Section 238A to the proceedings of IBC interpreting the intention of the lawmakers of the code to apply the limitation act to the Section 7 and 9 CIRP applications filed by IBC. It was also observed that the application of CIRP against a corporate debtor can only be filed either by a financial creditor or an operational creditor with respect to the debts which have not become time-barred following the default.

It was one of the remarkable amendments in the IBC regime as it brought a major upgrade in the purview of financial creditors in the real estate sector. Also, it brought up some major changes in the voting threshold of the Committee of Creditors in order to boost the CIRP mechanism with more efficacies and in a time-bound manner. Moreover, it was focused on the improvements in effective functioning of the overall process.

Some changes are made with respect to the limitation of time of completion of the process, voting parameters of the authorized representatives and treatment of operational creditors just and fairly. It also clarifies the role of the adjudicating authorities while maintaining proper conduct throughout the whole process.

The Post Pandemic Regime

The unprecedented pandemic of Covid-19 forced governments all over the world to impose lockdown throughout the globe. Prime Minister Narendra Modi also declared a nationwide lockdown from 25th March 2020 to prevent the spread of coronavirus. This led the economy of the nation to hold a pause and just two days after the lockdown, the Union Finance Minister Smt. Nirmala Sitharaman, in a press conference, announced several changes to be taken place in the threshold of default in payment of debts by companies in order to prevent the adverse effects of pandemic on the Indian Economy and following which an ordinance to suspend CIRP was passed with effect from 25th march, 2020.

  1. Insertion of a temporary Section 10A imposing a suspension of filing an application of CIRP for defaults occurring on or after 25th March 2020 for an initial period of six months but not exceeding one year in total.[11]
  2. With another notification by IBBI, the suspension time was extended to its maximum limit of one year i.e. – up to 24th March, 2021.[12]
  3. The threshold amount limit of default for the initiation of CIRP has been increased from Rs. 1 lakh to Rs. 1 Crore.

During the period of this unprecedented time of Covid-19 pandemic, there was suspension of filing CIRP initiation applications with the implementation of the new ordinance. There have been several misunderstandings and confusion with respect to the scope and interpretation of this 2020 Ordinance that gave rise to several disputes with respect to its scope and ambit. However, the Judiciary has played a key role in true interpretation of the amendment and provided clarifications with numerous case laws to clear the confusion with respect to the said provisions of the IBC amendment ordinance, 2020 which was promulgated to combat the adverse effects of lockdown and Corona Virus on the corporate debtors.

This appeal arose in the National Company Law Appellate Tribunal (NCLAT), New Delhi. It was filed against an impugned order of the National Company Law Tribunal (NCLT), Kolkata Bench. The operational creditor Foseco India Limited, filed an application of CIRP under Section 9 which was admitted by NCLT against the Corporate Debtor, ‘Om Boseco Rail Products Limited’. The main issue in the present matter was whether the March 2020 notification of increasing the threshold of default from Rs. 1 Lakh to Rs. 1 crore would apply retrospectively or prospectively. The Hon’ble NCLAT, in this case, held that unless legislation specifically mentioned a provision to be applied retrospectively, it shall be considered to be applied prospectively only. Therefore the march 2020 notification will also apply prospectively to the defaults occurring after 25th March, 2020. Following this, it was also observed that as per Section 4(1) read with Section 6 of the IBC, the right to trigger CIRP against the corporate debtor arises on the date of occurrence of the default from the side of the corporate debtor. Now as per the provisions mentioned in Section 4(1), if the default has occurred before 25th March, 2020, the right to trigger the entire process of initiation of CIRP by Operational Creditor under Section 9 would also have accrued before 25th March, 2020. Now the Notification is prospective in nature, therefore the minimum threshold for all defaults occurring before 25th March, 2020 remains Rs. 1 lakh only, not 1 crore.

This case again brought a landmark judgment in upholding the constitutionality of several provisions of the code. Again the constitutional validity of some provisions of this code was in issue. The petitioners have filed a writ petition in the Hon’ble Supreme Court under Article 32 of the Constitution of India challenging the validity of Sections 3, 4 & 10 of the Insolvency and Bankruptcy Code (Amendment) Act 2020[15] which amended the principal code by addition of three provisos to section 7(1), an additional explanation to section 11, and insertion of section 32A in the IBC. The Apex court upheld their validity by disposing of the writ petition filed and set aside all apprehensions against the IBC (Amendment) Act, 2020[16].

It was a crucial judgment in a so-called case of Arbitration vs. IBC concluded by the Hon’ble Chief Justice of India. The overriding effect of IBC with respect to admission of the CIRP application was the main issue here which was in conflict with the provisions of Arbitration reference in disputes. The Apex Court in this case observed that a situation where an application under Section 7 of IBC is yet to be admitted by the adjudicating authority and simultaneously another petition under Section 8[18] of the Arbitration and Conciliation Act, 1996 is filed, The overriding effect of IBC mentioned under Section 238 will prevail and the adjudicating authority would be duty-bound to first consider the application under Section 7 of IBC while recording a satisfaction if there being any default or not, even in case the application under Section 8[19] of the Arbitration Act for the reference of Arbitration is kept along for consideration. The Apex Court also observed that IBC proceeding is to be considered in rem only after it is admitted following the finding of the default as it would then get itself into having ‘erga omnes‘ effect. However if the Adjudicating Authority is in the opinion that there being no default, it would then leave the field open for the autonomy of parties to secure the appointment of the Arbitral Tribunal.

The Pre-Packaged Insolvency Resolution Process

After a wholesome period of suspension of one year, The Insolvency & Bankruptcy Code, 2016 is back in full force from 25th March 2021. Anyway, the tough task of sustaining momentum starts here, as more Corporate Debtors are anticipated to enter into the CIRP following the outcome of this pandemic. There is obviously a need to prepare the market to support resolutions for the larger number of applications supposed to get filed in upcoming days. The Government of India on 4th April 2021 issued an ordinance in IBC bringing up the ‘pre pack’ insolvency mechanism for the MSMEs in support of the revival of these corporate debtors. It is supposed to tackle the loss that occurred to them due to Covid-19. Moreover it focuses on the mechanism with autonomy of the MSMEs in which the creditors and the corporate debtor with mutual consultation brings out a plan so as to yield faster and better resolution than the CIRP. Here are some remarkable highlights on the new IBC (Amendment) Ordinance, 2021[21] providing a mechanism of ‘pre-packaged insolvency resolution process’ for MSMEs with insertion of chapter- IIIA in the principal code.

Conclusion

Though the IBC has brought a huge relief to the debtors that seek their revivals or the companies that want to exit the market feasibly, it would be a bit tricky to anticipate where the Code will go in coming years. As it is a new and fresh law, a lot has already been modified in just 5 years and a lot more is expected in the upcoming future in order to maintain its true interpretation. The recent feature for the MSME is also expected to revolutionize the resolution process for the debtors of small markets while maintaining their ongoing business as in this Pre Packaged Insolvency Resolution Process, the participation of existing board of directors or promoters of the corporate debtors is largely encouraged. Unlike the CIRP, where there is a long process of appointment of Interim Resolution Professional, then the Resolution Professional and where the affairs of the corporate debtor also controlled by such resolution professional with the guidance from Committee of Creditors, in the pre-pack, the management remains in the control of the promoters or Board of Directors of the MSMEs creating a balance between the creditor in control and debtor in possession.

However, this process can only be initiated by the corporate debtors after obtaining approval from its financial creditors with at least sixty-six percent of the total vote. Hopefully, it will help the MSMEs to enter into consensual restructuring with its creditors and sort out the entire liability pending on its side. A key point to see is whether the MSMEs would be comfortable in opting for this or not but this mechanism is definitely expected to reduce the amount of litigation and yield much faster resolution than the already existing CIRP and also will cut costs occurring in the process. Moreover, this Code has successfully become one of the success stories of recent Indian economic reform and it will continue to get perfect and develop as it gains maturity by the time.

Anyway, the tough task of sustaining momentum will start now, as more debtors are coming into the Indian corporate system. There is obviously a need to prepare the market to support resolutions for the larger number of cases supposed to come in the next few years. Especially following the Covid-19 pandemic, a load full of burden is expected to come in the form of filings for resolution. The insolvency system must also keep evaluating the proper implementation of the already approved resolution plans, so that the true spirit of the code remains alive.

References

  1. https://www.ibbi.gov.in
  2. https://indiankanoon.org

[1] https://ibbi.gov.in//webadmin/pdf/legalframwork/2018/Jan/182066_2018-01-20%2023:35:29.pdf

[2] Ibid

[3] W.P. 7144 (W) OF 2017, https://indiankanoon.org/doc/164560992/

[4]https://ibbi.gov.in//webadmin/pdf/legalframwork/2018/Aug/The%20Insolvency%20and%20Bankruptcy%20Code%20(Second%20Amendment)%20Act,%202018_2018-08-18%2018:40:34.pdf

[5] Civil Appeal No.23988 of 2017, https://indiankanoon.org/doc/105600410/

[6]https://ibbi.gov.in//webadmin/pdf/legalframwork/2018/Aug/The%20Insolvency%20and%20Bankruptcy%20Code%20(Second%20Amendment)%20Act,%202018_2018-08-18%2018:40:34.pdf

[7] https://ibbi.gov.in//webadmin/pdf/legalframwork/2018/Jun/186195_2018-06-06%2021:08:49.pdf

[8] https://ibbi.gov.in//uploads/legalframwork/630af836c9fbbed047c42dbdfd2aca13.pdf

[9] https://ibbi.gov.in/uploads/legalframwork/d36301a7973451881e00492419012542.pdf

[10] https://ibbi.gov.in//uploads/legalframwork/741059f0d8777f311ec76332ced1e9cf.pdf

[11] ibid

[12] https://ibbi.gov.in//uploads/legalframwork/c1d0cde66b213275d9cf357b59bab77b.pdf

[13] Company Appeal (AT) (Insolvency) No. 557 of 2020, https://indiankanoon.org/docfragment/67243565/?formInput=557

[14] WRIT PETITION(C) NO.26 OF 2020, https://indiankanoon.org/doc/54883247/

[15] https://ibbi.gov.in/uploads/legalframwork/d36301a7973451881e00492419012542.pdf

[16] https://ibbi.gov.in/uploads/legalframwork/d36301a7973451881e00492419012542.pdf

[17] ARBITRATION PETITION (CIVIL) NO. 48/2019, https://indiankanoon.org/doc/150558872/#:~:text=Indus%20Biotech%20Private%20Limited%20vs,..%20on%2026%20March%2C%202021&text=1.,granted%20in%20Special%20Leave%20Petition.&text=(a)%20and%2011(12,behalf%20of%20th e%20respond ent%20 Nos

[18] https://indiankanoon.org/doc/1146817/

[19] Ibid

[20] https://ibbi.gov.in//uploads/legalframwork/04af067c22275dd1538ab2b1383b0050.pdf

[21] https://ibbi.gov.in//uploads/legalframwork/04af067c22275dd1538ab2b1383b0050.pdf


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