This article has been written by Ayushi Jhawar pursuing the Introductory Course: Legal Writing For Blogging, Paid Internships, Knowledge Management, Research and Editing Jobs from LawSikho. This article has been edited by Prashant Baviskar (Associate, Lawsikho).
This article has been published by Oishika Banerji.
Table of Contents
In the Synergies Dooray order, the Court declined to accept the challenge of the NCLT Order, which was based on the fundamental principle that the provision of the Insolvency and Bankruptcy Code, 2016 states that the committee of creditors (“CoC“) of a corporate debtor cannot include a non-related party assignee of related party financial creditor who is going through corporate insolvency resolution process (CIRP).
NCLAT took a different stance from its earlier decision in Fortune Pharma order. As a result of NCLAT’s diverse perspective, that is defended based on the specific facts of the cases, a more fundamental question has arisen. Is there a proper formula that can be applied to determine whether a related party financial creditor of the Corporate Debtor (CD) who’s the assignee and owes a debt to him is subject to the same disqualifications as the related party assignor, or must it be determined more case-by-case, based on the facts?
The above background is relevant in determining whether a related party to whom a debt is owed by a non-related assignee would retain that character and the yardsticks that may be applied to determine that.
Who is a related party?
According to Sections 5(24) and 5(24A) of the IBC, the term related party is exhaustively defined. A related party in the case of a CD is anyone who may act in a managerial or directorial capacity. A related party can own a substantial share of the CD or be able to make decisions for the CD or its subsidiaries, holdings or associate companies. According to the code, a related party can include the following.
- Directors, key personnel, or relatives of the CD.
- Holding, associate or subsidiary of the CD, or a subsidiary of a holding company of which the corporate debtor is a subsidiary.
- Directors, partners, or managers of a private or public company who hold with relatives more than 2% of the paid-up share capital of that company.
- LLP in which one of the CD’s directors, managers, partners, or relatives is a partner.
- Persons holding 20% voting shares in the CD, or the CD holding 20% voting shares in any person.
- A person on whose instructions a director, manager, or partner is accustomed to acting.
- Person controlling the board of director’s composition.
Legal provision on the issue
It is required to constitute a CoC in accordance with Section 21 of the IBC, which states that after the National Company Law Tribunal (NCLT) admits an application on insolvency, the Interim Resolution Professional (IRP), apart from other things, forms the committee of creditors (CoC) on the basis of the claims against the corporate debtor. Members of the committee are all the financial creditors of the corporate debtor, and their voting rights are determined by their debt amounts. A related party owing a financial debt to a corporate debtor does not have any representation rights, participation rights, or voting rights at meetings of the CoC.
A resolution plan must be approved by a majority of members of the CoC. In order for a resolution plan to be approved (or rejected), assignability of debts due to Related Party Creditors must be considered. As per “Rule 28 of Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016”, it is possible to give any person in CIRP to whom debt is due by a creditor to transfer or assign such debt, thus circumventing the restriction of influencing the decision determining of the CoC in assignment or transferring the debt to associates that are not related to such creditor.
Synergies Dooray case
In the case of Synergies Dooray, Synergy Casting Ltd. was the sister company of the Corporate Debtor, therefore, did not have any voting rights. However, Millennium Finance Ltd. received a seat on the CoC for having assigned a large Share of its debt to the company. Edelweiss challenged this assignment, alleging the assignment was made in order to reduce Edelweiss’ voting share. The court found that Synergy Casting had no relationship to Millennium Finance Ltd., and the Applicants claim that the agenda of the CoC would be prejudicial to the CD was not supported since none of the other creditors objected to the assignment. Since the Adjudicating Authority deals with summary proceedings, the CD’s intentions were not considered by the Adjudicating Authority.
Fortune Pharma Case
The NCLT, Mumbai once again considered this issue in Fortune Pharma Private Limited. In this case, an unrelated third party was assigned debts of two related party creditors before admission but after CIRP was filed for. As a result, the voting share of the applicant creditor diminished. The applicant creditor filed a claim that there was an ulterior motive behind the execution of the assignments. The NCLT determined that a simple assignment cannot remove a disqualification that exists at the time of initiation of the CIRP. The Court opined that an assignment is the transfer of one’s debt rights to another person, and the rights of the ‘assignee’ are same as those of the ‘assignor’. Consequently, the assignee cannot change its status from ‘related’ to ‘unrelated’. Therefore, the NCLT, Mumbai held that the assignment of a debt assigned to a related party (who is barred from participation in the proceedings of CoC) will not remove the bar.
Judicial precedents of foreign jurisdictions
Regarding the question of whether the judiciary could disregard the vote of an assignee of Related Party Creditor merely because the claim had been assigned by Related Party Creditor.
The term ‘insider‘ is defined in “Section 101(31)13 of the US Bankruptcy Code”, and individuals or entities that strictly qualify as insiders are called ‘statutory insiders’. In addition, the US bankruptcy courts have recognized a class of insiders that are called ‘non-statutory insiders’. These individuals are not listed in explicit manner u/s “101(31) of the US Bankruptcy Code”, but have sufficiently close ties to the debtor to qualify. It is on the basis of this distinction that the US Bankruptcy courts have handled cases involving transferred claims from statutory insiders to non-insiders in bankruptcy proceedings.
On this point, the judgement by “the United States Court of Appeals, Ninth Circuit in Re The Village at Lakeridge, LLC” on Feb. 2016”, was on the issue that whether for voting on a resolution plan can a transferred claim retain its insider status.
The CD, filed for bankruptcy. The assets of the debtor were being claimed by two creditors. “MBP Equity Partners 1, LLC (“MBP”) held an unsecured claim of $2.76 million and the U.S. Bank National Association (“USBNA”) held a secured claim of $10 million. Dr. Robert Rabkin (“Rabkin”), purchased MBP’s claim against the debtor since he had business and personal relationship with one of MBP’s board members”. Rabkin had no previous connection to MBP or the debtor. “U/s 1129(a)(10) of the US Bankruptcy Code”, a reorganization plan could be confirmed only if at least one class of impaired claims voted to accept it. As per “US Bankruptcy Code Section 1129(a)(10)”: “The plan is impaired if at least one class of claims has accepted the plan, without counting the acceptance of the plan by any insider.”
Rabkin approved the plan despite USBNA’s opposition. The plan had to be approved because both creditors’ claims were impaired.
With regard to his relations with one of the board members of MBPA, USBNA argued Rabkin became a non-statutory insider and cannot be allowed to vote on the plan. As Rabkin had become a non-statutory insider, the bankruptcy court granted USBNA’s motion and disallowed him from voting on the reorganization plan. The “bankruptcy court’s order was reversed by the United States Bankruptcy Appellate Panel for the Ninth Circuit” (“BAP“) that held that Insider status cannot be assigned; it must be determined ”case-by-case” for each individual based on the consideration of various factors.” Consequently, Rabkin was allowed to vote on the reorganization plan since he was not a non-statutory insider.
In a split decision, the Ninth Circuit affirmed the BAP’s ruling and found as follows:
“Obtaining a claim from a statutory insider does not automatically make a person a statutory insider for two reasons. First of all, bankruptcy law differentiates between the status of a claim and of the claimant. A claimant’s insider status is not an attribute of the claim. Since insider status is not a property of a claim, general assignment law – under which an assignee takes a claim subject to its benefits and defects – does not apply. In addition, determining a claim transferee’s insider status is a factual question.”
“Further, if a non-insider acquires a claim from a non-insider, an insider’s claim would retain its insider status when a non-insider acquired the claim from an insider, but would drop its non-insider status when a non-insider acquired a claim from an insider.”
The Ninth Circuit, however, conveniently rejected USBNA’s citation of a precedent in “re The Village at Lakeridge, LLC”, on technical grounds. USBNA had referred a judgment delivered by “the Ninth Circuit in Wake Fores, Inc. v Transamerica Title Ins.” that held that insider status transfers with a claim under general law of assignment. USBNA’s contention, however, was rejected by the Ninth Circuit, which cited a rule stating unpublished cases before 2007 could not be cited in Ninth Circuit courts.
“The Court of Appeal of the Republic of Singapore referenced the Ninth Circuit ruling in SK Engineering & Construction Co Ltd v Conchubar Aromatics Ltd and another” in determination of who is to be treated as a related creditor for confirming a scheme of arrangement. The following were included:
“Although the case is similar “the United States Bankruptcy Code’s” interpretation, the justification in the case is convincing. A creditor acquiring a claim against a scheme company from a related creditor would be absurd if the votes attached to that claim were automatically discounted due to the status of the assignor-creditor, regardless of the relationship between the assignee-creditor and the scheme company. Discounting related creditors’ votes is designed to remove or negate the influence of any bias such creditors may have towards a given voting outcome. This concern does not relate to the claim, but rather to the individual creditor in question. These concerns would not exist if a creditor that acquires its claim against a scheme company from a related creditor had no demonstrable interest in any particular voting outcome outside of its own interests as a creditor.”
This approach is the accurate way to understand if there should be disqualification of an assignee of a Related Party Creditor. It appears that in the Fortune Pharma matter, the holding was not on if the assignee was a non-related party creditor or if an assignee automatically becomes disqualified because the disadvantages applicable to the Related Party will be transferred to the assignee, rather than on whether the circumstances leading to the assignment were non-commercial in nature.
In monitoring the development of jurisprudence in this regard and examining, the NCLTs usually decide to disregard the apparent status of the assignee and add emphasis on the determination of the assignee-creditor’s relation to the corporate debtor and Related Party Creditor when determining the intent of assignments. So, even in the Indian context, it is fascinating to deliberate if ‘non-statutory insider’ could be introduced in order to mitigate the misuse of the essence on debarring of Related Party Creditors.
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