EMERGING LEGAL ISSUES CLOGGING RESOLUTION: There are few major emerging issues which could impact resolutions under IBC (especially in large cases), one of which is shrinking market for resolution. A Corporate Debtor attracts proposals if it has inherent value and technology used by it is not changed (which is very unlikely) and it is viable in its market space. Since, there are...
EMERGING LEGAL ISSUES CLOGGING RESOLUTION:
There are few major emerging issues which could impact resolutions under IBC (especially in large cases), one of which is shrinking market for resolution. A Corporate Debtor attracts proposals if it has inherent value and technology used by it is not changed (which is very unlikely) and it is viable in its market space. Since, there are few takers, the value offered hovers around liquidation value and in many cases substantially below liquidation value. This puts the Committee of Creditors in a dilemma, whether to approve such proposals or take the Company into liquidation.
The second issue which impacts resolution is the role of dissenting creditors who see opportunity to maximize their recovery (at least liquidation value) by dissenting. This position is getting stronger as now they have to be paid in cash, that too in priority to assenting creditors in view of the Supreme Court's judgement in the case of Jaypee Kensington Boulevard Apartments Welfare Association [i]. Thus, one group which see benefit in dissenting to a proposal is getting enriched at the cost of the other which is striving for a resolution and thus are made to pay the cost. This is happening in cases where resolution amount hovers around liquidation value. In such cases if one dissents, he is guaranteed minimum of his share of liquidation value as compared to the assenting group, which gets lesser that that proposed in the Plan. It has created a situation where few Financial Creditors get incentivized by dissenting to even a viable plan thereby putting assenting FCs to a disadvantageous position, as usually the additional amount to be paid to dissenting FC (on account of their share of liquidation value) is taken out of the total amount proposed by a resolution applicant to Financial Creditors.
The third issue which could have wider ramification than mere resolution is "inter se priority of charge holder" during CIRP and at liquidation stage. Lending in India largely derives comfort from the security obtained from the Borrower. It not only works as a risk mitigant, but also as a critical factor influencing cost of funding. Inter-se priority of charge holder is a well established and accepted norm, not only in banking parlance but also in law.
Section 48 of the Transfer of Property Act, 1882 lays down the principle governing the priority which is well recognized under section 30 and 53 of the Code. Supreme Court in its numerous judgements has recognized this principle while deciding the issue of priority in insolvency matters (ICICI Bank Ltd vs Sidco Leathers Ltd. & Ors[ii]).
Prior to this the legal position was settled by way of judgement of Karnataka High Court in State Bank of Mysore v. Official Liquidator & Ors[iii] 1985 (58) Company Cases 609, wherein it was held that ". …. In the result, the bank is entitled to realize that amount on a preferential basis as a secured creditor notwithstanding the fact that it filed the affidavit indicating that it stands within liquidation but subject to the reservation of its security being continued."
However, due to few decisions which have been recently pronounced, courts have taken a divergent view, which has the effect of nullifying this preference and position of a secured creditor in liquidation or CIR Process. This issue could have serious implications, both on flow of credit and on resolution, if the established and well recognized position of law is not restored.
The concept was well accepted and recognized by the Supreme Court in the case of Committee of Creditors of Essar Steel India Limited Versus Satish Kumar Gupta & Ors[iv]. The Supreme Court in its judgement had also explained the rationale behind obtaining security by lenders with the following quote:
Rationale of security - The main purposes and policies of security are: protection of creditors on insolvency; the limitation of cascade or domino insolvencies; security encourages capital, e.g. enterprise finance; security reduces the cost of credit, e.g. margin collateral in markets; he who pays for the asset should have the right to the asset; security encourages the private rescue since the bank feels safer; security is defensive control, especially in the case of project finance; security is a fair exchange for the credit.
With a view to settle the issue, Section 30 of the Code was also amended, by inserting a requirement for CoC to, inter alia, take into account the order of priority amongst creditors u/s 53 (1) including the priority and value of the security interest of a secured creditor, while approving a resolution plan.
Insolvency Law Committee Report of 2020:The issue was also considered by the Insolvency Law Committee Report of 2020, while dealing with the issue of relinquishment of the security under the Code and its effect on inter-se priority among the charge holder. The Committee had observed that this provision could not have been intended to provide secured creditors who relinquish their security interest, priority of repayment over their entire debt regardless of the extent of their security interest, as it would tantamount to respecting a right that has never existed. Further, if the "debts owed to a secured creditor" is not restricted to the extent of the security, there would be broad scope for misuse of the priority granted under Section 52(1)(b), as even creditors who are not secured to the full extent of their debt would rely on the mere fact of holding any form of security, to recover the entire amount of their unpaid dues in priority to all other stakeholders.
The Committee thus recommended that:
7.4. On the basis of the above discussion, the Committee agreed that the priority for recovery to secured creditors under Section 53(1)(b)(ii) should be applicable only to the extent of the value of the security interest that is relinquished by the secured creditor. (unquote)
The sanctity of priority of charge has also been recognized in various other reports:
World Bank Report of 2015 Titled Principles for Effective Insolvency and Creditor/Debtor Regimes states:
"Claims and Claims Resolution Procedures Treatment of Stakeholder Rights and Priorities
C12.1 The rights of creditors and the priorities of claims established prior to insolvency proceedings under commercial or other applicable laws should be upheld in an insolvency proceeding to preserve the legitimate expectations of creditors and encourage greater predictability in commercial relationships. Deviations from this general rule should occur only where necessary to promote other compelling policies, such as the policy supporting reorganization, or to maximize the insolvency estate's value. Rules of priority should enable creditors to manage credit efficiently, consistent with the following additional principles:
C12.2 The priority of secured creditors in their collateral should be upheld and, absent the secured creditor's consent, its interest in the collateral should not be subordinated to other priorities granted in the course of the insolvency proceeding. Distributions to secured creditors should be made as promptly as possible.
C12.3 Following distributions to secured creditors from their collateral and the payment of claims related to the costs and expenses of administration, proceeds available for distribution should be distributed pari passu to the remaining general unsecured creditors, unless there are compelling reasons to justify giving priority status to a particular class of claims. Public interests generally should not be given precedence over private rights. The number of priority classes should be kept to a minimum."
UNCITRAL Legislative Guide
"4. Ensuring equitable treatment of similarly situated creditors.
The objective of equitable treatment is based on the notion that, in collective proceedings, creditors with similar legal rights should be treated fairly, receiving a distribution on their claim in accordance with their relative ranking and interests. This key objective recognizes that all creditors do not need to be treated identically, but in a manner that reflects the different bargains they have struck with the debtor.." (unquote)
Therefore, this important issue needs to be settled to ensure smooth CIR Process under the Code.
PRE-PACKED INSOLVENCY:
In view of the delay happening under the CIRP, the system needed a more effective tool to address insolvency in a cost-effective and timely mechanism. Thus, demand for pre-pack was growing. The Government put in place this mechanism for MSMEs by way of Ordinance dated April 4, 2021 by which section 54A TO 54P were introduced, putting in place the mechanism for Pre-Pack for MSMEs.
However, due to additional stages being introduced (approval by unrelated FC on the base plan and appointment of RP, filing of application, Order on Admission, Insolvency Process, approval of the plan and so on) and inherent constraints and limitation under base plan (which drastically limit scope of base plan), the Pre-Pack for MSME does not offer any better option to MSME as compared to the normal CIRP (where MSME are eligible to submit plan, unless disquieted under section 29A, and there is no limitation on haircuts to FC/OC or to any statutory body).
CONCLUSION:
Thus, while there are challenges mainly on account of delay and haircuts, the legal position is slowly but surely getting clearer. However, a lot is required to be done to ensure timely admission and approval of plans. Delay at these stages is practically defeating the whole object of the Code as delay (at whatever stage) not only diminishes value of the enterprise but also reduces changes of resolution, as it is seen that resolution applicants have moved applications to exit the process whenever there are inordinate delays in approval of plans.
On Personal insolvency front, while the Supreme Court has cleared the way by its judgement in the case of Lalit Kumar Jain vs Union of India[v], still not much progress is noticed on the admission front. Personal insolvency is an opportunity for guarantors as well as lenders to settle the dues within a limited time frame. Of late, Banks have starting using provisions of Section 95 against guarantors as it offers final and conclusive culmination of the process of recovery.
Two areas which remain wanting for more under the insolvency regime are group insolvency and cross border insolvency. It is experienced that when a parent company under a group defaults, it affects the entire group and leads to insolvency of all connected concerns within the group. Business structure of a group is usually such that it works as a single entity and thus needs a common resolution. But so far there are no express provisions to deal with such matters, as NCLTs/NCLAT have tried to find out a solution by clubbing the proceedings, the case under reference being Videocon Industries, however, in the absence of clear provisions it remains at the discretion of the Adjudicating Authority.
In a complex business mechanism where an entity might have assets and business operations spread across many countries and jurisdiction, no single court can resolve the issue unless there is co-ordination and co-operation amongst the courts in different jurisdictions, which could facilitate smooth conduct of the process and its seamless implementation.
Overall, while there remain certain areas of concern, but as discussed earlier, the new regime has tried to address the real issues impacting resolution and default. It has successfully sent a message that one cannot survive, if issue of financial constraints are not addressed timely. There is a clear message to debtors and creditors (as they have suffered substantial haircuts under resolution plans) that there must be serious efforts before planning a project and finance for it. Learnings out of almost five years of experience under the IBC, will lead to strengthening of the financial system in the Country, in the long run.
[i] JAYPEE KENSINGTON BOULEVARD APARTMENTS WELFARE ASSOCIATION & ORS. ……. APPELLANT(S) VERSUS NBCC (INDIA) LTD. & ORS. CIVIL APPEAL NO. 3395 OF 2020 decided on 24.03.2021