Resolving a Company Vis-À-Vis Resolving Everyone's Interests

Date: October 26, 2019. 

Introduction

It has been only three years since the Insolvency and Bankruptcy Code, 2016 (“IBC”) got enacted and since then the interests of many stakeholders have been met yet many still feel deprived. How could legislation whose one of the primary objective is to balance the interests of all the stakeholders unbalance the interests? Or is it the stakeholders themselves shaking the weigh-scale to create an unbalanced situation? 

In July 2019 the Appellate Authority for companies undergoing Corporate Insolvency Resolution Process (“CIRP”) i.e, National Company Law Appellate Tribunal (“NCLAT”) modified the order passed by the Adjudicating Authority in the case of “Standard Chartered Bank Vs. Satish Kumar Gupta, R.P. of Essar Steel Ltd. & Ors.” (“Essar Steel case”). The NCLAT modified the repayment plan in an attempt to treat identically the Financial Creditors (“FC”) and the Operational Creditors (“OC”) for the purpose of distribution of proceeds. In November 2019 the said order of ‘NCLAT’ was further set aside by the Hon’ble Supreme Court wherein it was held that “neither the adjudicating authority nor the appellate authority has been endowed with the jurisdiction to reverse the commercial wisdom of the Committee of Creditors (“CoC”)”.

Through this article, I made an attempt to describe the rationale behind such ‘commercial wisdom’, the lessons learnt by the stakeholders, and what could be the way forward to such a scenario.

Creditors in ‘IBC’ 

Countries across the globe have seen a number of formal and informal insolvency laws over the past many decades which kept on evolving to give rise to the new ones. Even after the enactment of a large number of laws the underlying issues remain common for many of them.

As per the legislative guide on Insolvency Law by the United Nations Commission on International Trade Laws (“UNCITRAL”) “Insolvency” is, when a debtor is generally unable to pay its debts as they mature or when its liabilities exceed the value of its assets. 

Since there is the presence of a liability it is quite evident that there must be some creditors to whom such liability is owed. Since there are creditors involved there must be certain rights of such creditors and one of them must be rights to recover their debt. Earlier this right was not available to everyone under a consolidated act. In a restructuring arrangement, the ‘FCs’ or banks used to negotiate the affairs on their own with little say of the ‘OCs’. The outcome of such negotiation is optimal when the interests of the corporate debtor and creditors are aligned to maximize the economic value of the enterprise. However, there are several elements in the negotiation that increase the conflict, rather than preventing it between the parties. Not providing fair and equitable rights to creditors is a major reason for conflicts and also one of the lessons we are still learning. 

The term ‘Creditor’ has been defined in section 3 (10) of the ‘IBC’, which reads as: “creditor” means any person to whom a debt is owed and includes a financial creditor, an operational creditor, a secured creditor, an unsecured creditor and a decree-holder. Section 3(30) defines ‘secured creditor’ as “a creditor in favour of whom security interest is created.” 

Section 5(7) defines ‘financial creditor’ as “any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to.” 

Section 5(20) defines ‘operational creditor’ as “a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.” 

‘FC’ primarily is by way of loans and debt contracts and in most cases, they include banks and financial institutions. These creditors have always been part of the economic ecosystem as a business relies on them for their sources of finance.

 ‘OC’ covers a wide array of people, their interest needs to be secured because they can range from a tea vendor to a major supplier without whom the business may shut down completely. They can also range from a peon in the office to a CEO. It also includes Government and regulatory authorities. ‘OC’ also includes workmen, employees, and supplier of utilities. They have always been in books of Corporate Debtor because they support the core activities of the business. As also noted by the Hon’ble NCLAT in “Binani Industries Limited vs. Bank of Baroda & Anr” that, 

“If the Operational Creditors are ignored and provided with liquidation value on the basis of misplaced notion and misreading of Section 30(2)(b) of the I&B Code, then in such case no creditor will supply the goods or render services on credit to any Corporate Debtor.” 

Therefore, unbalancing the interests of ‘OC’ vis-à-vis ‘FC’ could have far-reaching consequences and create a ripple effect of an operational disability in the economy. 

The rationale behind the judgement of the appellate authority Hon’ble NCLAT had, in front of it, questions that were unaddressed and addressing them would mean venturing into unknown territory. Though there were many questions that arose in the proceedings relating to the classification of creditors within a class of ‘FCs’, distribution to secured ‘FCs’, denying the rights of ‘OCs’ and other stakeholders, one of the most significant questions was whether the manner of distribution of funds among various classes of creditors is to be decided by the ‘Resolution Applicant’ or the ‘CoC’?

As we look into the decision of the Appellate Authority, it is imperative to know how distribution was proposed in the order of NCLT. The ‘OCs’ who are workmen and employees, and the ‘OCs’ whose admitted dues is less than Rs. 1 Crore were proposed to be paid 100% of their dues, but the rest of the ‘OCs’ such as IOC, BPCL, GAIL whose claims were admitted at a notional amount of Rs.1/- (Rupees one), had been provided with ‘NIL’ amount i.e. 0% without any basis. The Appellate Authority noted that suggestion of ‘Resolution Applicant’ to distribute the financial package offered by it only to the ‘Secured Financial Creditors’, denying the right of ‘Operational Creditors’ and other stakeholders, is also against the provisions of Section 30 (2) and Regulation 38 (1A), and thereby cannot be upheld. Hon’ble Supreme Court in “Swiss Ribbons Pvt. Ltd. & Anr.” noticed the ‘UNCITRAL Guidelines’ and observed: 

“Quite apart from this, the United Nations Commission on International Trade Law, in its Legislative Guide on Insolvency Law [“UNCITRAL Guidelines”] recognizes the importance of ensuring equitable treatment to similarly placed creditors…...” The Hon’ble Supreme Court further observed that the NCLAT has, while looking into viability and feasibility of resolution plans that are approved by the ‘CoC’, always gone into whether ‘OC’ are given roughly the same treatment as ‘FC’, and if they are not, such plans are either rejected or modified so that the OC’s rights are safeguarded. 

The Hon’ble NCLAT, in the matter of Essar Steel, decided that the Resolution Applicant cannot take advantage of Section 53 for the purpose of determination of the manner in which distribution of the proposed upfront amount is to be made in favour of one or other stakeholders namely— the ‘FC’, ‘OC’ and other creditors. 

The Hon’ble NCLAT came up with an interesting formulae and yet logical rationale behind it which led to the revised distribution wherein the ratio of ‘Total Amount Available for Distribution (X)’ to ‘Total Amount of Claims (Y)’ was 60.7%, and as a result of this magic number, ‘OC’ and ‘FC’ were proposed to be paid 60.7% of their admitted claims except workmen and ‘OC’ having claims less than Rs. 1 Crore which were paid 100%. 

The rationale behind such equitable distribution was derived from section 30(2)(b) read with Section 31 of the ‘IBC’ which provides that the minimum payment made to operational creditors, should not be less than liquidation value. It also does not mean that they should not be provided with the amount more than the amount they could have received in the event of a liquidation which otherwise amounts to discrimination. 

For deciding the power of ‘CoC’ to decide on the distribution to creditors, the Appellate Authority referred to the report of the Bankruptcy Law Reforms Committee (“BLRC”) and held that even this report does not empower the ‘CoC’ to decide the distribution amongst the stakeholders. It took the view of Hon’ble Supreme Court in the matter of “K. Sashidhar v. Indian Overseas Bank and Ors” where the court held that the commercial decision of the ‘CoC’ is non-justiciable and will not be open to scrutiny by the Adjudicating Authority/Appellate Authority. However, it is the duty of the ‘CoC’ to balance responsibilities and duties towards all such stakeholders during the resolution process. The Apex Court in the matter of “Arcelor Mittal India Pvt. Ltd. v Satish Kumar Gupta & Ors.” and “Swiss Ribbons Pvt. Ltd. & Anr. v. Union of India” (supra) laid emphasis on the various responsibilities of the ‘CoC’ including safeguarding interests of other creditors and that resolution plans must provide fair and equitable treatment to ‘OCs’. 

Therefore, the order of the Appellate Authority made it clear that the ‘CoC’ has not been empowered to decide the manner in which the distribution is to be made among various classes of creditors. It is only required to notice the viability and feasibility of the ‘Resolution Plan’. The code and regulations framed thereunder empower the ‘Resolution Applicant’ to decide the manner in which the distribution is to be made.

What the law says? 

While the Code provides a clear system of priorities in liquidation, it is relevant to ascertain the system of priorities under the corporate insolvency resolution process of the Code. 

Section 30(2) of the Code provides the minimum requirements of a resolution plan. A resolution plan must provide for the payment of insolvency resolution process costs in a manner specified by the Board in priority to the payment of other debts of the corporate debtor and the payment of the minimum liquidation value due to ‘OCs’. 

However, Section 30 has been amended vide the Insolvency and Bankruptcy Code (Amendment) Act, 2018 to provide for the payment of debts to the ‘OCs’ which shall not be less than the higher of the following:

 a. The amount payable to the ‘OCs’ in the event of liquidation under section 53; or

 b. The amount that would have been paid to ‘OCs’, if the amount under the resolution plan had been distributed in accordance with the order of priority prescribed under section 53(1); 

The amendment also provides for payment of minimum liquidation value to dissenting ‘FCs’. Further as per amended sub-section (4) of section 30, ‘CoC’ has to approve the plan after considering its feasibility, viability, and the manner of distribution proposed which may take into account the order of priority amongst creditors as laid down in sub-section (1) of section 53, including the priority and value of the security interest of a secured creditor. 

Regulation 38 also provides that the amount due to the ‘OC’ under a resolution plan shall be given priority in payment over ‘FC’ and that a resolution plan shall include a statement as to how it has dealt with the interests of all stakeholders, including financial creditors and operational creditors, of the corporate debtor. 

How does the apex court view this?

In the matter of “Committee of Creditors of Essar Steel India Ltd. Vs Satish Kumar Gupta & Os.” the counsel, on behalf of the ‘CoC’, argued that if secured ‘FC’ are to be treated at par with unsecured creditors, such secured creditors would rather vote for liquidation rather than Corporate Resolution, contrary to the main objective sought to be achieved by the Code. The rationale for only financial creditors handling the affairs of the corporate debtor and resolving them is for reasons that have been deliberated upon by the ‘BLRC’ Report (supra). 

As per regulation 39 , the committee shall evaluate the resolution plans received under sub-regulation (1) strictly as per the evaluation matrix to identify the best resolution plan and may approve it with such modifications as it deems fit. The Hon’ble Supreme Court observed in the instant case that “This Regulation fleshes out Section 30(4) of the Code, making it clear that ultimately it is the commercial wisdom of the ‘CoC’ which operates to approve what is deemed by a majority of such creditors to be the best resolution plan which is finally accepted after negotiation of its terms by such Committee with prospective resolution applicants”. 

In K. Sashidhar’s case (supra), the Hon’ble Supreme Court opined that “the legislature has not endowed the adjudicating authority with the jurisdiction or authority to analyze or evaluate the commercial decision of the ‘CoC’ much less to enquire into the justness of the rejection of the resolution plan by the dissenting financial creditors”. It was further held that what is left to the majority decision of the ‘CoC’ is the “feasibility and viability” of a resolution plan, which obviously takes into account all aspects of the plan, including the manner of distribution of funds among the various classes of creditors. Court also noted that neither the adjudicating authority nor the appellate authority has been endowed with the jurisdiction to reverse the commercial wisdom of the dissenting ‘FCs’. At best, the Adjudicating Authority may cause an enquiry into the approved resolution plan on limited grounds referred to in Section 30(2) read with Section 31(1) of the code and send back the plan to the ‘CoC’ for modification. 

Thus, it is clear that the limited judicial review available, which can in no circumstance trespass upon a business decision of the majority of the ‘CoC’, has to be within the four corners of Section 30(2) of the Code, insofar as the Adjudicating Authority is concerned, and Section 32 read with Section 61(3) of the Code, insofar as the Appellate Tribunal is concerned. The limited judicial review available is to see that the ‘CoC’ has taken into account the fact that the corporate debtor, continues as a going concern during the insolvency resolution process; that it needs to maximize the value of its assets and; that the interests of all stakeholders have been taken care of. 

The Hon'ble Supreme Court in the matter of “Miheer H. Mafatlal vs Mafatlal Industries Ltd” held that: -

“The Court acts like an umpire in a game of cricket who has to see that both the teams play according to the rules and do not overstep the limits. But subject to that how best the game is to be played is left to the players and not to the umpire.” 

As the above case is related to the scheme of compromise and arrangement under the Companies Act, 1956, however, in the context of ‘IBC’ vis-à-vis commercial wisdom of ‘COC’, it can be established that the Adjudicating or Appellate Authority shall not interfere in the commercial wisdom of the ‘CoC’. It is the ‘CoC’, under Section 30(4) read with Regulation 39(3), that is vested with the power to approve resolution plans and make modifications therein as the Committee deems fit. Even under Sections 391 and 392, the High Court cannot act as a court of appeal and sit in judgment over such commercial wisdom. 

Conclusion and the Way Forward

As we saw above that the plans must deal with all creditors in a fair and equitable manner, including those creditors who do not have the right to vote on the resolution plan since they are not ‘FCs’. The plan must also not discriminate against equally situated creditors 

The grievance of the judgement pronounced by Hon’ble ‘NCLAT’ had mainly been to ‘FCs’. But it is also very important to note that the inequitable treatment in the starting stage provided plenty of hopes to the petitioners. Since the plan was not meeting the requirements of law Hon’ble ‘NCLAT’ used it’s wisdom to modify the plan after judicial scrutiny and having a grievance in such a situation is natural. 

On the other hand, having Commercial Wisdom and deciding on fairness and equitableness is also a matter of subjectivity. Therefore, considering the recent order of Supreme Court, I would conclude that the commercial wisdom of the ‘CoC’ shall be subject to the limited judicial review where the ‘CoC’ has failed to fulfil its duties towards the other stakeholder represented by them during the ‘CIRP’ by a means of sending the plan back to the ‘CoC’ to re-submit such plan after satisfying the requirements. 

I hope that the judgement and wisdom of the Hon’ble Supreme Court would prove to be helpful in resolving everyone’s interests. Now the onus lies on the ‘CoC’ to evaluate the plans as per provisions of the act along with regulations, which could further help them in avoiding litigation.

Disclaimer: All views expressed on this page are the author's own as part of his research and do not represent the opinion of any entity with which the author is, or have been associated.