This article is written by Animesh Tiwary.

Introduction

The recent resolution of RattanIndia Power has become one of the first resolutions of stressed power sector outside the IBC mechanism highlighting the significance of such deals to promoters as well as lenders as discussed further. The introduction of Insolvency and Bankruptcy Code (“IBC”), 2016 has brought about a paradigm shift in the sphere of corporate restructuring and debt resolution which has not been witnessed before. One of the most significant effects has been the behavioural change among the promoters. They are now approaching their creditors to address the soaring debt problem before they end up losing the control of their company, which has not been the case earlier. Now, there are two approaches to this problem- going through Corporate Insolvency Resolution Process (“CIRP”) under IBC or making a settlement (pre-admission or post-admission) with the creditors outside of the courts. Both the mechanisms have their own merits and challenges depending upon the interest of various stakeholders.

Need for out-of-court settlements 

Recent research data suggests that out of 21000 cases referred to National Company Law Tribunals (“NCLTs”) since inception of IBC, 10000 of them were settled by Tribunal and close to 8500 cases were withdrawn before admission since dispute was settled outside Tribunal. This highlights that there is a growing trend between the parties to prefer settlement among themselves outside the process rather than going in for CIRP especially when the amount involved is ‘small’ or the case is ‘less complex’. With the current number of 15000 cases pending at various stages in Tribunal overheating the whole system, the lenders are finding it more prudent to find a solution outside of NCLT. 

Advantages of out-of-court settlement vis-à-vis CIRP under IBC 

For creditors 

• • One of the primary objectives of IBC is ‘time-bound’ resolution for which a period of 180-270 days (now 330 days) was mandated under the code. However, the data suggest more than 50% cases have already past the prescribed timeline. Even admission of cases in NCLT is taking longer than 14 days prescribed. Such lengthy timeline discourages lenders to undergo IBC route and drive them towards pre-NCLT settlement.
  • With majority of cases facing the problem of ‘inordinate delay’ in resolution process, the creditors are concerned this may lead to ‘deterioration of assets’ of corporate debtor affecting their economic interest and chance of resolution significantly, driving away the successful resolution applicant as we witnessed in the resolution of Ruchi Soya and now in the case of Jet Airways. The lenders are then left with no other option than to liquidate the assets.
  • Most of these out of court settlements being ‘bilateral’ in nature enhance the chances of resolution due to direct involvement of promoters, unlike in IBC, where promoters have to step down and handover the control of the company. Thus, the lenders can avoid the situation like Essar Steel which dragged in litigation for more than 2 years since promoters were adamant to retain control. 
  • The position of operational creditors under IBC is somewhat disadvantageous than secured or financial creditors. Financial creditors enjoy a preferential treatment compared to operational creditors when it comes to distribution of amount under proposed resolution plan as well as in case of liquidation of debtor as per Section 30 read with Section 53, especially after the recent amendment. The Hon’ble SC in Swiss Ribbons (P) Ltd. v. Union of India taking an averse stand from NCLAT’s Binani case position of equal treatment, has justified such differential treatment under the hierarchy of claims as ‘intelligible differentia’. 

Therefore, operational creditors who are mainly SMEs and small vendors can expect better results from out of court settlements especially when amount of default is small. 

• Corporate debtors engaged in the ‘services’ sector, generally, find it hard to attract bidders since they lack underlying fixed assets considered essential for revival of the firm. Moreover, firms engaged in engineering, procurement and construction (EPC) services tend to lose the value of their assets significantly under the Tribunal. As a result, the creditors end up taking huge haircuts on their dues or debtor ultimately faces liquidation in CIRP under IBC. Pre-admission settlements can provide a way out to them to settle their dues and maximize their recovery.
• This is a widely accepted fact that there is room for improvement in ‘quality of collected data’ under IBC institutions. Especially with respect to assets of distressed firms, access is much better outside the NCLT mechanism.
• Banks can play a vital role in quick resolution of bad debts by entering into inter-creditor agreement (ICA) right at the time of lending before the accounts turn NPA. This mechanism kicks in where the borrower misses the payment and is believed to be in great stress without formally initiating the bankruptcy process. Moreover, restructuring of debt and signing ICA seems more viable to preserve economic value than IBC. 

For promoters 

• It provides an opportunity for promoters to participate in the resolution process unlike IBC where promoters are barred from participating in the CIRP by virtue of Section 29A of the code. Perspective of promoters in the resolution process comes handy in speedy resolution for creditors and enable the former to retain control of the company.

Concerns with out of court settlement 

• Out of court settlement being ‘bilateral’ in nature raises some serious concern regarding interest of other creditors. What about the claims of other lenders? One of the objectives being protection of interest of all stakeholders, the IBC mechanism provides for collation of claims of all creditors unlike out of court settlement where only the creditor entering into agreement with debtor realizes the benefit. 
• It was observed in certain situations that applicants withdrew their applications midway CIRP after entering into a settlement out of court with the promoter. This results in fate of other creditors hanging in balance, ultimately, defeating the objective of the code.

Withdrawal of CIRP application 

Before admission 

Rule 8 of IBBI rules allowed Adjudicating Authority to permit the withdrawal of application on request made before its admission.

After admission 

• Considering the objective of the code, NCLAT in Mother’s Pride Dairy case, was of the view that such withdrawal pursuant to settlement cannot be permitted after admission due to involvement of interest of other creditors. However, Hon’ble SC exercising the inherent power under Article 142 allowed the settlement in that case. After the Lokhandwala Kataria and Uttara Foods & Feeds case having similar facts approaching the apex court, it recommended relevant amendment to be introduced in the code.

Introduction of Section 12A 

• Insolvency Law Committee Report in 2018 suggested that any settlement and consequential withdrawal of CIRP has to be taken collectively by Committee of Creditors (CoC). Thus, Section 12A was introduced providing withdrawal of CIRP permissible with 90% of CoC’s approval, after being admitted. However, it was clarified that such withdrawal was permissible before publication of notice inviting expression of interest (EoI) as per Regulation 30A of IBBI regulations and not after that.
• The constitutional validity of Section 12A was challenged in Swiss Ribbon case where Hon’ble SC, upholding the constitutionality, put forth two scenarios – pre CoC formation stage and post CoC formation stage. In pre-CoC stage, the parties can approach NCLT which may allow or disallow withdrawal or settlement under Rule 11 of IBBI rules. On the other hand, withdrawal in the post-CoC stage is permissible with 90% of CoC vote. Parties are free to approach NCLT under Section 60 in case of dispute.
• Interestingly, the Hon’ble SC has, recently, held that withdrawal may be allowed in ‘exceptional cases’ even after issuing EoI since Regulation 30A is ‘directory’ and not mandatory. However, it may be argued that ‘exceptional cases’ have not been clarified by the apex court which can make this subject to misuse by promoters. 

Looking Ahead 

With deals such as Rattan India Power gaining momentum in IBC sphere, it is empirical to note the importance of foreign capital for ensuring success of any such process especially in the present environment of economic slowdown and liquidity crisis which is where the role of Asset Reconstruction Companies (ARCs) become important. They not only provide the promoters a way out in the form of much needed capital by acquiring debt but also helps in turning around the business. Recent trend suggests that majority of lenders, after forming the CoC, have agreed to such a proposal of settlement when they are offered amount greater than what they would receive through CIRP. This would lead to further growth of the nascent asset reconstruction sector and further the overall objective of debt resolution.

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