“A Journey into the Heart and Soul of Essar Steel Verdict”
What led to the battle?
Essar Steel was obliged to pay a whopping amount of 54,547 crore to Creditors. State Bank of India and Standard Chartered Bank major financial creditors decided to initiate Corporate Insolvency Resolution Process against Essar Steel (hereinafter called “Corporate Debtor“). Mr. Satish Kumar Gupta was appointed as the Insolvency Professional(IRP) to administer the insolvency proceedings. He plays an important role to keep the existence of corporate debtors alive. After the collision of all claims of financial and operational creditors the said Insolvency professional constituted a committee of creditors to consider pertinent decisions in regard to survival of corporate debtors.
IRP invited applications for resolution plans of the corporate debtor ArcelorMittal, world’s leading steel and mining company won the battle to acquire the Corporate Debtor.
But to the surprise and dismal of CoC NCLT Hyderabad proposed a distribution scheme of 85 % and 15 % respectively to financial and operational creditors. Doubting the correctness of the aforesaid view the case was considered before the National Company Appellate Tribunal. The appellate authority redistributed the debt proceeds, ordered an equal status of distribution to financial and operations creditors and laid a number of principles which were not favourable to CoC.
Thus the matter was placed before the Supreme Court for final determination.
Role of Committee of Creditors
Obviously the Committee of Creditors(CoC) are entrusted with enormous powers to discuss the strategies for the corporate debtor and to address the concerns of all creditors. Here the moot question was whether the committee can play a role in the matter of distribution of debts among creditors.
Bankruptcy Law Reforms Committee which was formed to formulate new laws in bankruptcy has something to say about CoC:
“During the initial discussions the bankruptcy committee considered various possibilities when a company becomes default. Liquidation, sale of companies assets are some of the options. Atlas the committee came to the conclusion that there is only one appropriate forum to discuss such possibilities and it is the creditors committee”.
The learned counsel on behalf of CoC argued that CoC has both power and jurisdiction to deal with all commercial aspects of the resolution plan including distribution of debt proceeds which is made pursuant to the Act. On the contrary there arises a contention from opposite counsel that given the power to committee sometimes it may result in a situation where majority stakeholders override the interests of the minority.
In the case of K Sasidhar vs Indian Overseas Bank on February 5, 2019 appeals were heard against the order of NCLAT which held that the resolution plan for Kamineni Steel & Power Ltd did not attain support of not less than 75 % of voting share of financial creditors in CoC. Thus the resolution plan was rejected. The Supreme court clarified that the legislature has not endowed the Adjudicating authority (NCLAT ) with the jurisdiction or authority to analyse or evaluate the decision of CoC. There are no grounds in which commercial wisdom of the committee could be challenged before the bankruptcy court.
One of the peculiar features of CoC is the approval of resolution plans submitted by resolution applicants. Here the committee has to apply its mind to check whether the plan is feasible and viable. If not, they could suggest modifications which satisfies the interest of all stakeholders. Significantly, the apex court upheld the commercial wisdom of the committee which includes to consider decisions in regard to distribution of payment to creditors. Further it is the duty of committee to harmoniously contemplate interests of creditors in pursuant of the objectives sought to achieve by the Code.
When CoC holds commercial wisdom, the question is where do the lines draw for the Adjudicating Authority?
The pertinent question before the court was whether adjudicating authority could interfere in the commercial wisdom of creditors committee and their power in the resolution plan. According to Section 31 of the Act NCLT can accept the resolution plan submitted by the committee :
- When Insolvency resolution costs and other debts of creditors are specifically provided in the manner prescribed by the Act.
- Distribution of debts to Operational creditors in a fair and legitimate way.
- Management of affairs of Corporate debtors and how the resolution is supervised and implemented.
When the above said conditions are not met adjudication authority can reject the plan.
Now, the grounds under which an order of Adjudicating authority can be challenged before Appellate Authority are:
- When the resolution plan contravenes any provisions of law in force; or
- Irregular exercise of power by Resolution Professional; or
- Creditors or other costs are not properly paid.
Thus Apex Court is of the opinion that the Insolvency and Bankruptcy Code clearly lays down the role of adjudicating authority. It is that their powers are circumscribed within the Act. Legislature has no intention to allocate power to the authority to check and control commercial business decisions of the requisite majority of financial creditors. In a way they could not trespass their powers. Because the hands of Adjudicating authority are tied to the extent provided in the Act.
Learned counsel also brought to the attention of court section 60(5) in the Act. Apart from the powers in Section 31 and 33 which have been explicitly stipulated under the code there is also residual power enjoyed by the adjudicating authority i.e. the NCLT can decide all claims against corporate debtors arisen under the insolvency law. However the power does not result in conflicts with other provisions. The court concluded that residual jurisdiction is not capable of influencing or undermining the powers of tribunal which are already established.
Do the equality norms apply to Financial and Operational Creditors?
NCLAT observed a huge discrimnation towards payment of debt for operational creditors. While the financial creditors were allowed 99 percent of the claims among operational creditors they were treated differently. Thus appellate authority revised distribution of proceeds among the creditors. The argument which favoured the direction was equal treatment of all classes of the corporate debtor.
The Apex Court examined whether creditors can bear the fruits of Article 14 of the Indian Constitution. Court opined that equality is only among equals and no discrimination results if there is intelligible differentia that separates creditors where the object is sought to be achieved by legislation. It had clearly underscored that there is a clear differentiation that places financial and operational creditors in different positions.
As mentioned in Part 1 of my article the underlying factor that marks creditors is the purpose of their credit. Both parties disburse payment for different functions of a business. Even if we compare their relation with debtors the financial creditors would sound a prominent setting. Although the principles of equality have been a dominant character of justice, what is important here is the nature and purpose of each creditor.
First and foremost financial creditors are highly involved in the business of corporate debtors. They give a considerable amount of money and make a good sense of the business. On the other side operational creditors are only involved in the business operations. Their mode of credit and functions are clearly defined. This draws the line of intelligible differentia which separates two categories.
However it doesn’t mean that operational creditors are non essential. Distribution of debts will be different in the case of both classes of creditors. For instance Section 30 (2) of the Act prevails that operational creditors should not be paid less than the amount in the case of liquidation. Also as per recent changes in regulation 38 of IBBI Regulations 2016, they have given priority over financial creditors in the resolution plan. However the latter attains predominancy in Coc and in the matters of debt proceeds. Finally Supreme Court reiterates the legislative idea on insolvency law which makes it clear that equitable treatment is allowed only for similarly situated creditors.
Amending Act, 2019 and Constitutional Validity
Appellate Tribunal’s judgement in April 2019 directed equal treatment of financial and operational creditors. Also delay in the insolvency procedure sought to defeat the objectives proposed by the code. Thus together with other issues arisen around the Act government considered for an amendment and new provisions were incorporated. Changes in Section 12 and 30 were brought to the attention of the Apex Court for determining its constitutional validity.
In Section 12 of the Act a proviso was included to ensure the time bound manner of the insolvency resolution process. ie Corporate Insolvency Resolution Process should be mandatorily completed within a period of 330 days and further if it is pending an extension of 90 days. While in the modification of Section 30 of the Act it recommended minimum payment of debt to be operational and the matter of dissenting financial creditors in the resolution plan was comprehended.
The bone of contention against the amending act was the improper motives of the legislature at the time of amendment. After due consideration, all contentions were rejected by the court and clarified that the rationale to mend Section 12 was to speed up the entire process in adjudication authorities. The adequate reasons could be traced to the old laws and enactments. Because one of the reasons for failure of SICA and other laws was the delay in pending litigation.
Unfortunate delays resulted in problems like low recovery rate, lower valuation value etc. A reference to Para 76 of the judgment where the Honourable Minister presented some facts and figures to explain the reason behind the required acceleration. Notwithstanding anything contained in the section, the Court took the liberty to strike down the word “mandatorily“ as it was found unreasonable and arbitrary.
Considering from the perspective of Operational and dissenting financial creditors the changes in Section 30(2) are quite favourable one. There are instances where their claims are neglected.This would be necessary to assure that the creditors are paid a minimum imperative amount. As regard to Section 53 Court has clarified that it acts as only a watchdog and final decisions are left to the Committee of Creditors.
Personal Guarantors and their Guarantees
Indian Contract Act Section 126 deals with the contract of guarantee. It is a kind of undertaking by a third party when the debtor fails to pay the money back to Creditors. Person who undertakes the obligations is called a guarantor. What forms the crux of the issue here is that one of the promoters of Essar Steel has executed a guarantee deed for the company. NCLAT suggested that once the resolution plan is approved by the committee of creditors guarantors are relieved from their commitments. Learned counsels contended against the extinguishment of rights of creditors against guarantors.
Court expressed views on the status of guarantors under the provisions of the Act. Taking a detailed exposition on Section 31(1) of the Act, Apex Court observed that once a resolution plan is submitted it is binding on all stakeholders including guarantors and they cannot escape their liabilities. It should be noted that despite the fact that committee have commercial wisdom their decisions are also binding on all parties in the plan.
The Insolvency Law Committee was formed by the Ministry of Corporate Affairs to address the issues in corporate insolvency resolution and liquidation. Committee also considered issues related to guarantors. One of the key observations of the committee was the right of the creditor under the contract of guarantee to proceed against the debtor and surety. Further this characteristic of contract is the hallmark of guarantee contract and if there is anything that restrict the right of creditor it defeats the objectives enshrined in the Act.
Court upholds the tenacious feature that principal borrower and surety is jointly and severally liable to the creditor. Since the guarantees are invoked, the Court refused to comment on the matter and set aside the order of appellate tribunal. The Contract Act envisages another set of rights for guarantors called right to subrogation.
Once the guarantors had paid the amount to the creditor they had the right to step in the shoes of the creditor and recover the amount from the debtor. The principle of subrogation rights has been explained by the Court in various circumstances. These are the statutory rights of indemnification of guarantors where they are to be paid back if they had disbursed payment. But the Apex Court rejected the rights of subrogation and held that the deed of guarantee becomes ineffective when the resolution plan is accepted.
Who gets the share of Profits earned by the Corporate Debtor during CIRP?
Insolvency proceedings began in Essar Steel from August 2017 During the Corporate Insolvency Resolution Process till 2019 the company has registered an earning before interest, tax, depreciation and amortisation (EBITDA) of 4,2229 crore. EBITDA is a metric that is used to measure the profits of a company. Certain parameters like interest rate, tax, depreciation, and amortisation are excluded from the calculation of profit.
Learned counsels on behalf of Financial Creditors submitted they have earned interest. So the amount should be distributed to them. On the other side operational creditors contested that they have provided the services and it is their employees who have performed the work during CIRP. NCLAT directed to distribute profits among Financial and Operational creditors according to their shares.
As per the proposal of resolution plan there was no information regarding the distribution of profits. The resolution submitted by the proposed resolution applicant is also accepted by the Creditors Committee. It does not provide payment of profits to any class of the creditors. Apex Court was of the view resolution plan which is consented does not provide distribution of profits toward payments of debts for the Creditors. Thus appellate tribunals sense of judgement was determined as incorrect. Finally it is the commercial wisdom of the committee that determines what amounts to be paid to each class of creditors.
Recently there arose a similar situation in the insolvency of Bhushan Power and Steel Limited. JSW Steel emerged as the resolution applicant. Adjudicating authority directed to distribute profits among financial and operational creditors on a pro rata basis. But NCLAT has directed JSW steel to receive the profits (EBITDA) of 3000 crore during the corporate insolvency resolution process. However the matter is pending before the Supreme Court for final resolution.
Whether provisions in Section 53 can determine distribution in CIRP?
With regard to the distribution of sale proceeds from liquidation estate, Section 53 lays down a proper layout :
- CIRP and Liquidation Costs.
- Workmen dues and Secured Creditors who have relinquished security under Section 52 of the Act.
- Wages and Employee dues other than workmen.
- Unsecured Creditors financial debts.
- Statutory dues like Central and State government dues and Secured Creditors who invoked security.
- Remaining debts sort of operational debt etc.
- Preference Shareholders.
- Equity if any.
The paramount consideration before the court was whether priority distribution could be applied in the case of disbursement of funds for the creditors of Corporate Debtor. The Apex Court did act by ensuring the clear distinction between distribution of debts during CIRP and allocation of claims to all stakeholders in the liquidation process. Add to this, the waterfall mechanism would dilute the decisions of the Creditors Committee or not.
Usually the resolution plan submitted by the resolution applicant identifies only funds which are to be provided to the creditors. It does not mandate that debts should be dispensed as per Section 53 of the Code. Here Section 30(2) comes into the picture to figure out a minimum amount to operational and dissenting financial creditors. These are strongly suggested for the protection of principles of I & B code. The importance is given for fair and equitable treatment of operational creditors by the amendment to Section 30.
Indeed it is the supremacy of CoC decisions that has gained importance. What matters is their decisions regarding the payment and class of creditors to be paid. Section 30 merely acts as a guide to preserve the interests of operational creditors. Thus Section 53 of the Act cannot be considered for the payment under the resolution plan and further it is not possible to hinder the commercial wisdom of the committee.
Sub-Committees formed by Committee of Creditors – Justifiable?
Learned Counsels for Standard Chartered Bank opposed the idea of creation of sub-committees by Committee of Creditors. As per the allegation raised, Sub-Committee secretly entered into negotiations with resolution applicant ArcelorMittal and reduced the upfront payment from Rs. 42,000 Crores to Rs. 39,500 Crores. A substantial question raised before the Supreme Court was whether CoC can delegate any of its functions to Sub-Committees.
Court analysed the powers of the Creditors Committee. Of course it is their commercial wisdom that matters the most. While emphasizing different rights and duties of the Committee, it is very important to recognize their ability to approve a resolution plan. Section 30(4) states that the resolution plan should be approved by majority of not less than sixty-six percent of voting share of financial creditors. That is something which is entirely entrusted with the committee.
In the case the sub committee formed only performed the functions of negotiations with the resolution applicant. Later resolution plans were accepted by the majority of financial creditors. Also in the initial stages Standard Chartered Bank has not raised any objection to the formation of subcommittee. Lookin over the facts, the Court was of the opinion that these duties were purely ministerial in nature and the delegation of power is not contrary to the provisions of the Act.
Thus the major business decisions regarding the resolution of Corporate debtors can be taken by CoC. This cannot be deleted or performed by any authority. Therefore law is abundantly clear that ministerial or administrative functions can be performed by a subcommittee provided that they should act within the purview of decisions of the Creditors Committee.
If you were to ask the significance of the Essar Steel case to some of the experts this is what Managing Director of SBI Mr Arjit basu said “ the judgment delivered by the Supreme Court is not only concerned with the issues in the case. It will also bring finality to the entire IBC processes which had setup in 2016 “. In fact the decision had given a clarity on the number of adjudications that are expected to occur forth. From the prominence of financial creditors the ruling highlights the right of secured creditors then emphasizing on the role of committee of creditors and finally other principles been put forward a fortunate proposal for the matters of Lenders and Bankers.
Here I haven’t really dived into the nitty gritty of the Case. Only an attempt to draw up on the aspects considered by the honourable judges in the verdict. Apart from setting a precedent the Court has also tried to bolster up the objectives in the Insolvency and Bankruptcy Code. In the next part I hope to comment upon the new dimension after the Essar Steel case and my humble thoughts and views.
- Standard Chartered bank and State bank of India Vs. Essar Steel India Limited (NCLT Ahmedabad) C.P (I.B) No. 40/7/NCLT /AHM/2017
- Standard Standard Chartered bank Vs. Satish Kumar upta, R.P. of Essar Steel Ltd & Ors (Company Appeal No. 242 of 2019 )
- Committee of Creditors of Essar Steel India Limited versus Satish Kumar upta % Ors ( CIVIL APPEAL NO. 8766-67 OF 2019 )
- AK Sasidhar vs Indian Overseas Bank (,CIVIL APPEAL NO.10673 OF 2018)
- February 5 2019
- Bankruptcy Law Reforms Committee Part 1 – https://ibbi.gov.in/BLRCReportVol1_04112015.pdf
- https://www.ibbi.gov.in/uploads/legalframwork/630af836c9fbbed047c42dbdfd2aca13.pdf(Amending Act 2019 )
To be continued : Part 3 : Reflections
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