Part 3: “Reflections”
It’s been a year already since the judgment in Essar Steel was pronounced. What made me write about this was the profound content about the Insolvency and Bankruptcy Code and its evolution. It felt like the whole objective of the Act was articulated in the verdict. Part 3 simply tries to explain the impact. The After-effects must have happened but yet I turn to my understanding and assumptions.
Insolvency and Bankruptcy Code, 2016
IBC 2016 was enacted to address various ambiguities of the insolvency regime in India. The Act ensures the priority of reorganization and survival of the Corporate debtor. Also, the Code attributes a comprehensive picture of the roles to be played by different parties in the insolvency procedure. But there is something to worry about the pending number of cases in the bankruptcy code.
As per the data released by the Insolvency and Bankruptcy Board of India 4008 CIRPs have commenced by the end of September 2020. Out of that 1025 ended in liquidation, 473 have been settled, appealed, or reviewed, 291 cases have withdrawn and 277 cases ended in approval of the resolution plan. And the rest of the cases are undergoing CIRP. Sometimes it seems that the purpose of the Act is lost in the middle of nowhere. This is where certain changes could be introduced by understanding the debtor-creditor relationship and upholding the spirit of the law.
One such thing I suggest is about the pre-pack system which is used in the USA and UK. The jurisprudence and economic sense of the countries are incomparable. But if we could implement the real essence of pre-pack aspects it would be a better idea. It is a kind of agreement between the secured creditors and investors before the initiation of insolvency. Provided that the buyer should be able to buy the distressed company ahead of the formal proceedings.
Under the supervision of any statutory authority, the pre-insolvency process should be adopted. Recently MS Sahoo Chairman of IBBI had recommended implementing this system in Indian bankruptcy law. If the government adopts a way without undermining the objectives of the Code and understanding the concerns of all stakeholders then the pre-packaged insolvency would be something new.
How is the Banking Sector Impacted?
The role of the banking sector is significant to an economy. Regulatory authorities need to prevent the situation in which banks run out of cash. It is quite necessary to ensure the free flow of money for the markets. And for the financial institutions, the exponential amount of dues is a nightmare. As I understand, on two aspects the judgment helps to sort out the temporary dilemma faced by banks :
- Liquidity – A liquidity crisis can affect banking affairs and business activities. This raises the interest rate and a high amount of non-performing assets. Around a total amount of 50,000 crores will be infused towards banks after the verdict. To be specific, State Bank of India will receive Rs 10, 239 crores, Canara Bank’s amount of Rs 3639 crore etc. This, in turn, will ensure the liquidity problem and pave the banks back on track. Market reactions have turned positive to the expectations.
- Financial creditors – Appellate Tribunal believed that financial creditors should be considered equal with operational creditors. ie the same amount of debt recovery does not apply to both parties. Financial creditors stand in a more prominent state than operational lenders. Because they contribute to the supreme part of the business of the firm. Apex court has highlighted their paramount nature. This will give a boost to the banks who are financial creditors.
Are there enough shares in the pie for Operational Creditors?
I wondered whether the remedies available in the IBC resolves the problems faced by Operational creditors. They have only restricted rights to receive notice of the creditors meeting and to attend such meetings provided their aggregate dues are at least 10 % of total debt. Though they could express their claims but are left in a position without much power to influence the decision making of CoC. Sometimes this would draw a blank for suppliers who have supplied goods or other parties who fall under the definition of the above-said creditors.
Even in the Essar Steel case, Operational creditors will receive only an amount of 1200 crore against their admitted claims of 4,976 crores, and for a certain category of them, the amount is NIL. And in March 2020 the government increased the threshold limit of default to 1 crore. It will be a devastating blow to the MSME and vendors who desired to claim their dues back. Along with capital accumulation, these creditors are also a significant part of every business concern.
The market sentiment pendulum may swing in favor of financial creditors. But there would be some appropriate alternate forums where operational creditors would raise their concerns and seek the desired results. The Reduction of the default threshold is something the government can consider. These creditors needed better attention and various exit possibilities in the insolvency regime. The reason behind this is pretty simple. One of the ultimate aims of the Code is “to balance the interests of all stakeholders“ and that too includes operational creditors.
Now, what about Guarantors?
Just for the sake of the topic let’s be specific about personal guarantors. Usually, they are the promoters of the companies who stand guarantee for the corporate debtor to avail credit facilities. Section 126 of the Contract Act recognizes the principle of guarantee. But my concern is with the other set of rights for guarantors which is called subrogation. Under this scheme as per Section 140 of the Contract, Act guarantors step into the shoes of the creditor and recover the amount from the borrower.
Unfortunately, IBC has refused to recognize these rights. In Vishnu Kumar Agarwal vs Piramal Enterprise Limited appellate tribunal opined that guarantors cannot enforce the subrogation rights because the object of the Code is the revival of corporate debtors and not a credit recovery mechanism. Thus they cannot proceed with the recovery. Also, the Apex court declined to comment on the issue of guarantors in the Essar Steel case.
The government has notified rules and regulations for the bankruptcy of personal guarantors. As of now, insolvency proceedings can be initiated against the personal guarantor on account of the guarantee executed. This is something that may affect the future credit market. The right of creditors to proceed against the guarantor arises from the basis of the Contract Act. It is under the same Act the rights of personal guarantors are denied. It is the kind of dilemma which exists and there is a need for a clarion call to uphold their rights.
Aftermath on Promoters & Shareholders
“A promoter is the one who undertakes to form a company concerning a given object and sets it going and takes the necessary steps to accomplish that purpose “Justice C. J. Cokburn. The definition underlines the most important aspects of a promoter of companies. Their role is inevitable and it takes some strenuous effort to break the line of duty. Thus it happened in the matter of Essar Steel too. Promoters alleged that their bid amount is much higher than the one proposed by the resolution applicant. Ultimately their last hopes were buried by the adjudication authorities.
The Supreme Court stressed the fundamental nature of S. 29A in the Act. Said section bars all the related parties including promoters from the purview of resolution applicants. Then as per the new amendment in January 2020 promoters who are found ineligible are not capable to be a part of the settlement or compromise under the Companies Act, 2013. These measures could ensure the completion of the insolvency mechanism within the timelines and tighten its grip on promoters to prevent abuse of the legal process.
Now, what happens to the shareholders if the company goes for insolvency particularly small shareholders. On this aspect, I think guarantors and shareholders are on the same page. The resolution plan is binding on all stakeholders including shareholders. They don’t even have the right to vote on the resolution plan. According to Section 53 in the distribution of liquidated assets, the equity shareholders are listed last. They are paid only after the secured and unsecured creditors are paid. Is there a clear exit strategy for minority shareholders? There is every possibility that promoters or buyers try to delist the shares. As part of the changes in the cap structure of the company, there will be a delisting of shares. This is another part where the bankruptcy law is silent.
Does Investor’s mind change?
Apart from the banking system, the verdict can boost investor sentiments. Not only on the domestic side but from International and private equity investors. They would be interested in the bidding of distressed assets of the corporate debtor. The supremacy of financial creditors, established timelines, objectives sought to be achieved by the Code are some of the significant reasons which pave the path for investment. However small investors could find it difficult to share the pie as there is not that much that ensures their rights. In a nutshell, the mechanism of the Insolvency and Bankruptcy Code presents larger opportunities for investment.
Timelines – do they really matter in IBC
Long pending litigation defeats the purpose of bankruptcy law. The Supreme Court has fixed the deadline of 330 days to complete the insolvency proceedings. In exceptional circumstances, the adjudicating authority can grant an extension period of 90 days. This is a good gesture to the business community in our country. Faster recovery rate and time-bound resolution can enhance the prospects of investors and companies. But I doubt how the legal system in India can cope up with the deadline as frivolous litigation is in our blood.
Globally the average timeline of IBC resolution is 1.0 years, 1.2 years…etc. Thus fixing the days to 330 is an additional advantage. Also by striking down the word “mandatorily” in the amendment, the Apex court has upheld the constitutional aspects. In Essar Steel, it has taken over 800 days to resolve the insolvency matter. Even though the time duration was long the case has set a new precedent and principles which could be favorable to future resolutions. Institution of definite timelines can create a positive impact on the resolutions that are expected further.
Who is paramount, Commercial wisdom of CoC or Resolution applicant?
The Supreme Court has reiterated the fact about the commercial wisdom of the creditors’ committee and their decisions. 66% of votes of the committee is required to approve the resolution plan submitted by the resolution applicant. The scope of judicial review is only applicable only when the committee has not considered the interest of all stakeholders. Eventually, CoC is the final word regarding the distribution of assets to creditors.
The surprising thing that occurred to me is the kind of conflict that may happen between the resolution applicant and the committee of creditors. What happens if the Resolution applicant has a better plan than Coc and they do not accept it. In the matter of IMR Metallurgical Resources Ag vs Ferro Alloy Corporation Ltd & Ors, one of the contentions of the appellant was the failure of CoC in its commercial wisdom. That the upfront payment offered by the appellant was six times higher than the resolution applicant accepted by CoC.
The appellate tribunal rejected the contentions of the appellant and cemented the paramount commercial wisdom of Coc. In case of difference of opinion among resolution applicants and CoC, the decisions of the latter are final and their majority is non-justiciable. The adjudicating authority has stated this following the observation in the Essar Steel case. In a way, it is the emphasis on the Creditors committee that has settled the position of law for years.
India is a land of landmark judgments that have protected our fundamental rights and shaped the future. I firmly believe that the decision in the Essar Steel Case holds a valuable place in history. In my three-part case, I have tried to analyze the case from the basics of insolvency and Bankruptcy Code to how it unfolds. Perhaps without a practical sense of the effects, I am particularly proud of this one as it may seek the desired results.
- 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)
- Imr Metallurgical Resources Ag vs Ferro Alloy Corporation Ltd & Ors on 8 June, 2020
- Corporate Insolvency in India and other countries – A comparative Study by Dr Binoy J. kattadiyil and CS. Peer Mehboob.
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