This article is written by Madhu Ayachit pursuing Certificate Course in National Company Law Tribunal Litigation from LawSikho.

Introduction

A corporate debtor going through the insolvency resolution process runs low on funds and faces negative cash flows. Since the main objective of the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as “Code” / “IBC”) is the revival of the corporate debtor and to prevent it from going through the process of liquidation, the Code provides for an effective tool of raising “interim finance” which may help the corporate debtor run and function as a going concern during its insolvency resolution process. The concept of interim finance in the Indian context is similar to the concept of “debtor-in-possession financing” under the United States Bankruptcy Code.  

The Interim Resolution Professional (hereinafter referred to as “IRP”), and the Resolution Professional (hereinafter referred to as “RP”) are empowered by the Code to raise the interim finance for the corporate debtor after their appointment in order to meet the corporate debtor’s working capital expenses during the resolution process.  

Since the corporate debtor already has insufficient funds, the creditors might be hesitant to lend their money to raise the finance of the corporate debtor. It might turn out to be a risky investment for them as not only there is uncertainty as to whether the corporate debtor will be able to repay the principal amount as well as the interest accrued on it, there are fair chances that the assets of the corporate debtor might get liquidated if the insolvency resolution process fails. Therefore, the Code addresses the said issues and provides certain safeguards to the creditors in this regard. 

What does interim finance mean?

Interim finance, in an ordinary sense, means raising the funds or money, for a company during its regular course of business, from external sources for a specific purpose for e.g., for a particular project, event, activity, etc., or its daily operations and functions. The interim finance is generally raised to prevent losses. Rather than cancelling or postponing a particular transaction due to unavoidable factors, it is more advantageous for the company to raise funds from external financial institutions and entities. 

What is interim financing under the IBC?

Once the insolvency resolution process of the corporate debtor has been initiated by the Adjudicating Authority, all the operations and daily affairs of the corporate debtor are carried out by the insolvency and resolution professional. The Code has vested the insolvency and resolution professional with the duty to take all the necessary actions that are required to keep the corporate debtor as a going concern during the insolvency resolution process.

As per Section 20(1) of the Code, the IRP has to undertake every endeavour in order to protect and preserve the value of the assets of the corporate debtor as well as manage the operations of the corporate debtor as a going concern. A similar duty of preserving and protecting the assets of the corporate debtor, including continuing the business operations of the corporate debtor, has been vested upon the RP by Section 25(1) of the Code. 

For the purpose of fulfilling the duties mentioned in Section 20(1) and Section 25(1), the IRP and RP are empowered to raise interim finance for the corporate debtor during the resolution process. 

Section 5(15) of the Code defines “interim finance” as any financial debt raised by the resolution professional during the period of the corporate insolvency resolution process (hereinafter referred to as “CIRP”) or the pre-packaged insolvency resolution process (hereinafter referred to as “PPIRP”). 

In simple words, interim finance under the Code can be defined as a “short-term loan” which is raised in order to keep the corporate debtor running as a going concern when it is undergoing the insolvency resolution process. However, in the case of the RP, the action of raising the interim finance needs the approval of the Committee of Creditors (hereinafter referred to as “CoC”) by a vote of sixty-six (66) percent of the voting share as mentioned in Section 28(a) of the Code.

The Hon’ble National Company Law Appellate Tribunal (hereinafter referred to as “NCLAT”) in the case of Sajeve Bhushan Deora v. Axis Bank Ltd. & Ors. (Company Appeal (AT) (Ins) No.741 of 2019), observed that with the approval of the CoC, the RP can raise the interim finance in order to fulfill its duties mentioned in Section 25 of the Code. 

In the case of Edelweiss Asset Reconstruction Company Ltd. v. Sai Regency Power Corporation Private Limited & Other (Company Appeal (AT) (Ins) No. 887 of 2019), the CoC had approved the proposal of the RP of raising non-fund based interim finance for the corporate debtor by a majority of 75%. However, the Appellant who was the dissenting creditor challenged the said action contending that the interim finance was being raised for non-essential services of the corporate debtor and thus, the Appellant cannot be forced to facilitate the same. The Hon’ble NCLAT while acknowledging the duty of the RP to raise interim finance under Section 25, held that the RP is empowered to make the decision if it has been approved by the CoC with at least 66% majority, and thus, the said decision was held to be enforceable. Therefore, in this case, the Hon’ble Tribunal allowed the RP to raise the interim finance for the corporate debtor. 

When does interim finance become effective and attractive under the Code?

When the insolvency resolution process of the corporate debtor is initiated, the corporate debtor is incapable of making any payments to other entities as its cash flows may be very low or have already dried up. Now on top of it, during the insolvency resolution process, apart from the payments to the creditors, the corporate debtor also has to make certain other payments such as CIRP costs, fees of the resolution professionals and valuers, payments to the workmen, etc. The Code has made these payments mandatory irrespective of the financial position of the corporate debtor. 

Therefore, it becomes necessary for the RP to resort to a method that will generate new business for the corporate debtor which in turn will generate some income and enhance the existing financial position of the corporate debtor. The net income generated by the corporate debtor can be used to make the aforementioned payments and also repay the creditors.   

One of the ways provided by the Code to improve the financing position of the corporate debtor is by raising interim finance with the aid and assistance of banks or other financial institutions. Raising interim finance is an effective tool for preventing the corporate debtor from going through the process of liquidation.

For example; project ‘P’ needs an investment of INR 120 crores. The corporate debtor has already invested INR 100 crores. However, just before paying the last installment, the corporate debtor ran out of funds and became incapable of repaying the amounts which it owed to its creditors. In view of the financial position of the corporate debtor, the CIRP has been initiated against it. However, the corporate debtor needs only INR 20 crores for the project ‘P’ and if this amount is given to the corporate debtor, it can generate new business and income, as the market situation is ideal and favourable for the said project and thus, it will aid the corporate debtor in repaying all its dues to the creditors. In such situations, raising interim finance can prove to be an effective tool for improving the cash flows and financial state of the corporate debtor. 

However, the Code is silent as to whether or not interim finance can be raised during the liquidation process. Therefore, interim finance can only be raised during the CIRP or PPIRP.

Safeguards available in respect of raising interim finance

While receiving interim finance from external sources can be beneficial to the corporate debtor, it might prove to be risky for the institutions that are lending the finance due to the following reasons:

(i) Uncertainty of repayment of the principal amount as the corporate debtor is already facing negative cash flows; and

(ii) Uncertainty of receipt of the interest accrued on the principal amount if the insolvency resolution process of the corporate debtor fails and it goes into liquidation.

In order to address the following issues, the Code has provided certain safeguards to the creditors who aid the corporate debtor by raising its finance.

Interest only on unencumbered assets of the corporate debtor

As per Section 20(2) of the Code, the IRP is empowered to raise interim finance, however, during the process, a security interest cannot be created over the encumbered assets of the corporate debtor without the prior consent or approval of the creditors whose debt is secured over such assets.

Therefore, the Code empowers the IRP to raise interim finance only in respect of:

• Unencumbered assets of the corporate debtor; or
• Encumbered assets after taking consent or approval of the secured creditors. 

This is one of the major safeguards that has been provided by the Code to the secured creditors against the unauthorized creation of security interest on the secured assets of the corporate debtor. 

Priority in payment

The Code also safeguards the financial institutions and entities from whom the interim finance has been raised by guaranteeing the repayment of the amount raised, in priority to the other payments. If the corporate debtor goes through the process of liquidation even after the interim finance was raised, the repayment of the interim finance to the financial institutions will be the top priority while liquidating the assets of the corporate debtor. 

As per Section 53(a) of the Code, in distributing the proceeds from the sale of the liquidation of the assets, the full payment of the insolvency resolution process costs and the liquidation costs will be the top priority. 

It is interesting to note that as per Section 5(13) of the Code the term “insolvency resolution process costs” also includes the amount of interim finance and the costs incurred in raising such finance. Moreover, as per Regulation 2(ea)(vi) of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 (hereinafter referred to as “Liquidation Regulations”), the “liquidation cost” also means and includes the interest on interim finance for twelve months or the period from the liquidation commencement date till the repayment of interim finance, whichever is lower. 

Therefore, since the interim finance is a part of insolvency resolution process cost and liquidation cost, it will be realized in full payment before the other payments that the corporate debtor has to make.

Receipt of interest accrued on the interim finance 

Earlier the creditors were hesitant in aiding interim finance to the corporate debtors as there was no certainty of repayment of the principal amount as well as the interest accrued on it by the corporate debtor. However, as mentioned earlier, “liquidation cost” as defined under Regulation 2(ea)(vi) of the Liquidation Regulations, also includes the interest accrued on interim finance up to either twelve months or till the repayment of interim finance, whichever is earlier. 

Therefore, even if the insolvency resolution process and liquidation process of the corporate debtor has been concluded, the creditors can claim the interest accrued on the interim finance.  

This has been proved to be a major relief to the creditors as not only the certainty of repayment of the principal amount of interim finance but also the interest accrued on it is assured by the Code and the Liquidation Regulations. 

Conclusion

While the availability of interim finance aids the corporate debtor in improving its state of affairs to a large extent, there are certain grey areas that have not been addressed yet.

The provisions of raising interim finance of the Code are only applicable to the corporate debtor whose operations are running on the date of the commencement of the insolvency resolution. They do not apply to the corporate debtor whose operations were stopped before the commencement of CIRP or PPIRP. 

Moreover, interim finance also cannot be raised during the liquidation process of the corporate debtor, which means that even if the liquidator feels that the asset value of the corporate debtor is not sufficient to repay its dues, the liquidator cannot raise interim finance. 

References

• http://vinodkothari.com/wp-content/uploads/2019/06/Interim-Finance-Becomes-Effective-Attractive.pdf
• https://indiacorplaw.in/2020/05/super-priority-financing-an opportunity-in-a-crisis.html
• https://www.lexology.com/library/detail.aspx?g=0546f3b6-79ef-4d1b-92af-c0c90df65afd 
• https://www.linkedin.com/pulse/interim-finance-during-cirp-arvind-mangla/?articleId=6676711519981568000 

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