This article is written by Sumer Karekar, pursuing a Certificate Course in Insolvency and Bankruptcy Code from Lawsikho.com.
Table of Contents
Introduction
After the evident failure of the Sick Industrial Units Act of 1987 (SICA), the Indian bankruptcy regime witnessed an absolute overhaul with the enactment of the Insolvency and Bankruptcy Code (Code) in 2016. With the primary objectives of time-bound resolution of debt, maximization of asset-value and revival of the corporate debtor, the Code emerged as a mechanism for the furtherance of entrepreneurship and availability of credit in the market.
In light of the aforementioned objectives, the Banking Law Reforms Committee (BLRC) has laid special emphasis upon the “rights of creditors” under the Code. In its 2015 Report[i], the BLRC has stated the following;
“… When default takes place, control is supposed to transfer to the creditors; equity owners have no say.”
The BLRC thus recognized the positional weakness of creditors under the prevalent bankruptcy regime, and thus developed a “creditor-in-control” model under the Code. According to this model, the management of the corporate debtor’s affairs shall vest absolutely in the hands of the creditors in the event of financial distress. Likewise, the Hon’ble Supreme Court, in Innoventive Industries v. Union of India[ii], upheld the intention of the BLRC and observed that;
“… the most significant change being, that when a company defaults on its debt, control of the company should shift to creditors rather than the management who was retaining control after the default.”
Therefore, we observe that the rationale provided by the judiciary has been in congruence with the objectives of the Code, thus further empowering the creditors of the corporate debtor; in order to promote effective resolution of debts and ensure the revival of the company.
This article shall further delve into the formation, composition and functioning of the Committee of Creditors, while highlighting the jurisprudence involved and the interpretation adopted by the judiciary to strengthen the Indian bankruptcy regime.
Formation and composition of the committee of creditors
The Committee of Creditors (CoC) is the supreme decision-making body in a Corporate Insolvency Resolution Process (CIRP). Decisions regarding the administration of the corporate debtor are taken at the meetings of the Committee, based on a majority vote of the members.
Section 18 and Section 21 of the Code, obligate the Interim Resolution Professional to constitute the Committee of Creditors, after the collation of the proof of claims. As per sub-section (2) of Section 21, the Committee shall comprise “all financial creditors of the corporate debtor”.
Financial creditors versus operational creditors
The exclusion of operational creditors from the Committee of Creditors has been a key point of discussion. In Akshay Jhunjhunwala and Anr. v. Union of India[iii], the petitioner challenged the constitutional validity of the provisions of the Code, contending that the priority given to financial creditors was unreasonable and therefore, unconstitutional. Rejecting this contention, the High Court of Calcutta concluded that;
“The Bankruptcy Committee gives a rationale to the financial creditors being treated in a particular way vis-à-vis an operational creditor in an insolvency proceeding with regard to a company. The rationale is a plausible view taken for an expeditious resolution of an insolvency issue of a company.”
Subsequently, in Swiss Ribbons v. Union of India[iv], the Supreme Court supported the findings of the BLRC and based its rationale upon the nature of loan agreements, the functioning of financial creditors and the objectives of the Code. Here, R.F. Nariman J. opined as follows;
“… financial creditors are, from the very beginning, involved with assessing the viability of the corporate debtor. They can, and therefore do, engage in restructuring of the loan as well as reorganization of the corporate debtor’s business when there is financial stress, which are things operational creditors do not and cannot do.”
Although the distinction between financial and operational creditors has stirred a controversy, we observe that the design of the Code is aimed at the efficient revival of the corporate debtor, while ensuring maximum recovery to its creditors; thereby justifying the composition of the Committee of Creditors.
Can operational creditors be part of the committee of creditors
As discussed earlier, the BLRC laid heavy emphasis on the exclusion of operational creditors from the CoC. They reasoned that the creditors of the Committee must possess the ability to examine commercial viability, while also being open to restructuring debts to promote the revival of the corporate debtor. Considering that operational creditor would neither want to postpone recovery of the amounts due, nor would they possess the ability to assess viability of the corporate debtor, the Code prioritizes the inclusion of financial creditors to the CoC.
Despite the rationale adopted, Regulation 16 of the Insolvency & Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (CIRP Regulations), provides that operational creditors may form a Committee of Creditors only where the corporate debtor has (i) no financial debt; or (ii) where all financial creditors are related parties.
According to Regulation 16(2), this Committee shall consist of (a) eighteen largest operational creditors by value; (b) one representative of workmen; and (c) one representative of employees of the corporate debtor. Further, Regulation 16(4) vests in this Committee, the same rights, powers, duties and obligations as a committee comprising financial creditors may possess.
Yet, the ability of the operational creditors to effectively manage the affairs of the corporate debtor and to work towards its revival remains a concern. While a Committee of operational creditors would ideally want to recover short-term debts via immediate liquidation, such a scheme may not favour the preservation of the company as a going concern; which is the ultimate objective of the Code.
What decisions does the CoC take
The Insolvency and Bankruptcy Code, 2016 is an economic legislation with the primary motive of rehabilitation of financially distressed corporates, thereby promoting entrepreneurship and availability of credit. In pursuit of these goals, the BLRC, after much deliberation, chose to put the financial creditors of the corporate debtor in the driver’s seat. With this radical shift from the previous regime, the BLRC empowered the CoC to exercise their “commercial wisdom” in order to resurrect the debt-ridden corporate debtor.
Under the Code, the CoC is authorized to decide upon the regular functioning of the corporate debtor during the insolvency resolution process. As per subsection (8) of Section 21, all such decisions taken shall be subject to a minimum majority of 51% of the voting share of the financial creditors.
The CoC conducts regular meetings, wherein it discusses the fate of the corporate debtor. It rules over the working of the Resolution Professional (RP) and possesses the power to approach the Adjudicatory Authority in the event of foul play. Further, it ratifies any administrative decisions taken by the RP.
The CoC facilitates the smooth functioning of the insolvency resolution process. Where it deems fit, the CoCmay decide upon obtaining an extension of time-period in accordance with Section 12 of the Code. Moreover, it determines the viability of the corporate debtor’s business, examines the feasibility of future operations, payments towards CIRP costs and may also resolve to immediately liquidate the corporate debtor, where it finds that the resolution of insolvency is bound to fail.
Committee of creditor vis-ā-vis the adjudicatory authority
The most crucial function performed by the CoCis perhaps the approval/rejection or modification of a resolution plan as per Section 30(4) of the Code. As discussed above, the financial creditors; having previously assessed the business of the corporate debtor and being cognizant about the prevalent market conditions, are required to exercise “commercial wisdom” to select the most favourable approach for the revival of the corporate debtor.
Further, Section 31 states that the resolution plan approved by the CoC must be submitted before the Adjudicatory Authority (“AA”) for its approval. At this stage, the AA may approve the resolution plan if it is satisfied that the plan complies with the requirements provided under Section 30(2) and is not inconsistent with the law.
In light of the above provisions, questions regarding the autonomy of the CoCto approve/reject a resolution plan vis-ā-vis the jurisdiction of the Adjudicatory Authority were raised.
In the case of Vivek Vijay Gupta v. Steel Konnect (India) Private Limited & Others[v], the Ahmedabad Bench of the NLCT propounded as follows;
” The Code, through Section 31 gives the authority to the Adjudicating Authority to approve the plan when approved by CoC and can reject if it does not conform to the requirements referred under Section 30 (2) but not to sit over Judgment on the Resolution Plan approved by the CoC in rejecting the Resolution Plan.”
Similarly, in M/s Bhaskara Agro Agencies v. M/s. Super Agri Seeds Private Limited[vi], the NCLAT recognized the technical expertise of the financial creditors and concluded that;
“So far as the viability or feasibility of ‘Resolution Plan’ is concerned, the AA or the Appellate Tribunal cannot sit in appeal over the decision of the CoC.”
In the landmark case of K. Shashidhar v. Indian Overseas Bank and Others[vii], the Supreme Court clarified that the Code does not empower the Adjudicatory Authority to assess the fairness of the resolution plan approved or rejected by CoC and that the “commercial wisdom” of the CoC shall not be challenged. With regard to judicial intervention, the Supreme Court stated that;
“… the legislature, consciously, has not provided any ground to challenge the “commercial wisdom” of the individual financial creditors or their collective decision before the adjudicating authority”.
Thus, we observe that the decision of the CoCenjoys the highest authority and the judiciary may only intervene where it finds that the resolution plan does not adhere to the provisions of the Code.
Voting power of the committee of creditors
As discussed previously, the Interim Resolution Professional (IRP), under Section 18 of the Code, is tasked with the collation and verification of the submitted proof of claims. The purpose behind this provision is to:
- Assess the existence of debt and default.
- Constitute the Committee of Creditors.
- Determine the voting share of the members of the Committee.
Section 21(2) provides that the voting share of the creditors shall be proportionate to the amount of debt owed to them, in accordance with the submitted claims. The BLRC Report thus stated as follows;
“The voting right of each creditor will be the weight of their liability in the total liability of the entity from financial creditors. The calculation for these weights will need to take into account all the contractual agreements between the creditor and debtor, so that the weight is the net of all these positions.”
As per Section 21(8), the CoC shall take decisions based on a simple majority, with a minimum vote of 51% of the voting share of the financial creditors, unless mentioned otherwise. The exception applies to Section 30(4), which states that the CoCmay approve a resolution plan by a minimum vote of 66% of voting share of the financial creditors; and to Section 27(2), wherein the CoCmay choose to replace the Resolution Professional by a 66% majority. Further, the CoC requires a minimum majority of 90% to rule upon the withdrawal of the insolvency resolution process under Section 12A of the Code.
Calculation of votes: the principle of “present and voting”
In light of these provisions, questions pertaining to the calculation of votes during the meetings of the CoC may arise; particularly when a member of the CoCremains absent from the meeting and fails to cast a vote.
We shall resort to Regulation 25(5) of the CIRP Regulations, which states that – where all the members are not present at a given meeting, the RP shall (i) circulate the Minutes of the Meeting by electronic means within 48 hours of the meeting; and shall (ii) seek a vote on the matters listed for voting, by electronic means, where the system shall remain operational for 24 hours from the circulation of the Minutes.
In the case of K. Shashidhar[viii], the Supreme Court read Regulation 25(5) of the CIRP Regulations and with Section 30(4) of the Code and concluded as follows;
“For that [approval of the resolution plan], the “percent of voting share of the financial creditors” approving vis à vis dissenting is required to be reckoned. It is not on the basis of members present and voting as such. At any rate, the approving votes must fulfil the threshold percent of voting share of the financial creditors.”
Therefore, the Hon’ble Supreme Court has rejected the principle of “present and voting” for the calculation of votes and has interpreted Regulation 25(5) to also cover members who may be absent for a given meeting. Moreover, on a plain reading of Regulation 25(5) of the CIRP Regulations, we observe that where a member remains absent for meeting, he shall nonetheless have the opportunity to review the Minutes of the Meeting and cast his/her vote via electronic means.
Conclusion
With the emergence of the Insolvency and Bankruptcy Code of 2016, the creditors of the corporate debtor have been granted great powers, with even greater responsibilities. The creditors shall take absolute control of the management of the corporate debtor, with the authority to take key decisions and negotiate resolution plans. Nonetheless, they are entrusted with the task of reviving the business of the company and are expected to apply their commercial wisdom for the benefit of the corporate debtor. In the grand scheme of the Code, the impact of the creditor-in-control model of management promises the likelihood of stronger bankruptcy regime.
References
[i] Bankruptcy Law Reforms Committee, Ministry of Corporate Affairs. (2015). The report of the Bankruptcy Law Reforms Committee Volume I: Rationale and Design. https://ibbi.gov.in/BLRCReportVol1_04112015.pdf
[ii] Civil Appeal Nos. 8337 & 8338 of 2017
[iii] Writ Petition No. 672/2017
[iv] Writ Petition (Civil) No. 99 of 2018. Decided on 25.01.2019
[v] Company Petition (IB) No. 05/NCLT/AHM/2017
[vi] Company Appeal (AT) (Insolvency) No. 380 of 2018
[vii] 2019 SCCOnline SC 257
[viii] Ibid
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