Liquidation Value vis a vis Dissenting Financial Creditors: Aftermath Of Maharashtra Seamless And Orchid Pharma

"120. The Insolvency Code is a legislation which deals with economic matters and, in the larger sense, deals with the economy of the country as a whole. Earlier experiments, as we have seen, in terms of legislations having failed, "trial" having led to repeated "errors", ultimately led to the enactment of the Code. The experiment contained in the Code, judged by the generality of its provisions and not by so-called crudities and inequities that have been pointed out by the Petitioners, passes constitutional muster. To stay experimentation in things economic is a grave responsibility, and denial of the right to experiment is fraught with serious consequences to the nation. We have also seen that the working of the Code is being monitored by the Central Government by Expert Committees that have been set up in this behalf. Amendments have been made in the short period in which the Code has operated, both to the Code itself as well as to subordinate legislation made under it. This process is an ongoing process which involves all stakeholders, including the Petitioners."

In the above context, the decisions of the Supreme Court in the cases of MaharashtraSeamless Ltd. vs Padmanabhan Venkatesh and State Bank of India vs Accord Life Spec Pvt. Ltd. (Orchid Pharma Case) assumes great significance, in the evolution of the IBC, especially by reiterating the autonomy and wisdom of the CoC, as held in the case of K. Sashidhar vs Indian Overseas Bank, while also establishing that there is no prohibition in approving a resolution plan which is lesser than the liquidation value. The effect of the said decisions will, therefore, have great implications at the stage of distribution of amounts as per the Resolution Plan to the various stakeholders, especially while considering the same along with the amendments made to the Code on August 2019.

Right of Dissenting Financial Creditors over Liquidation Value

The concept of a dissenting financial creditor was initially introduced as part of the Insolvency & Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 under Regulation 2(1)(f) to mean "a financial creditor who voted against the resolution plan or abstained from voting for the resolution plan, approved by the committee." Further, as per Regulation 38, which deals with the mandatory contents of the resolution plan, it was made clear that the "liquidation value due to dissenting financial creditors and provide that such payment is made before any recoveries are made by the financial creditors who voted in favour of the resolution plan." The determination of the liquidation value is to be carried out as per Regulation 35 of the Corporate Persons Regulations. However, the said definition and introduction under Regulation 38(1) was omitted by Notification dated 5^th October 2018. This was mainly carried out by the IBBI due to the aftermath and as a direct consequence of the decision of the NCLAT in the case of Central Bank of India vs Sirupur Paper Mills Ltd., wherein it had been stated that:

"……the Board has not been delegated with the power under I&B Code including Section 240 of I&B Code to decide as to what amount is to be paid to the 'Financial Creditor' or 'Operational Creditor' including the liquidation value, therefore, they should not pass any mandatory regulation forcing the Resolution Applicant(s) to discriminate between equals."

However, the amendment and the decision of the NCLAT failed to contemplate the recognition of existing rights of financial creditors, whose rights have accrued under the general law, which has been acknowledged internationally as a cardinal principle of corporate insolvency law. By not assuring financial creditors the minimum of liquidation value on their pre-insolvency accrued rights from the resolution proceeds, it thereby works out against their financial interests. For instance, in the event a resolution plan has been approved by the majority of the CoC for an amount lesser than the liquidation value, then even though a secured financial creditor would have received an amount much higher than what would have been received under the resolution plan, the creditor, in such a scenario, would seek to lose significantly. This would thereby go against the very basis of a financial creditor dissenting as against a resolution plan, which is purely a commercial decision, as later validated in the case of K. Sashidar by the Supreme Court. Further, as held in the same case, there is no need for the dissenting financial creditors to record reasons for disapproving or rejecting a resolution plan. Hence, by virtue of the said process, dissenting against a plan would have become a redundant and futile exercise.

In fact, the above amendment was also in stark contrast of the legal position under Chapter 11 of the US Bankruptcy Code and UK's Compulsory Voluntary Arrangements. In particular, the approach of the NCLAT was leaning more towards the horizontal approach of 'fairness' rather than the 'vertical approach' as formulated in the case of Prudential Assurance v PRG Powerhouse. This is further against the approach of the United Nations Commission on International Trade Law, Legislative Guide on Insolvency Law ["UNCITRAL Guidelines"], wherein it has been stated as follows:

"Ensuring equitable treatment of similarly situated creditors

7. 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. This is less relevant as a defining factor where there is no specific debt contract with the debtor, such as in the case of damage claimants (e.g. for environmental damage) and tax authorities. Even though the principle of equitable treatment may be modified by social policy on priorities and give way to the prerogatives pertaining to holders of claims or interests that arise, for example, by operation of law, it retains its significance by 12 UNCITRAL Legislative Guide on Insolvency Law ensuring that the priority accorded to the claims of a similar class affects all members of the class in the same manner………..

(ii) Treatment of dissenting creditors

28. As to the treatment of dissenting creditors, it will be essential to provide a way of imposing a plan agreed by the majority of a class upon the dissenting minority in order to increase the chances of success of the reorganization. It may also be necessary, depending upon the mechanism that is chosen for voting on the plan and whether creditors vote in classes, to consider whether the plan can be made binding upon dissenting classes of creditors and other affected parties.

29. To the extent that a plan can be approved and enforced upon dissenting parties, there will be a need to ensure that the content of the plan provides appropriate protection for those dissenting parties and, in particular, that their rights are not unfairly affected. The law might provide, for example, that dissenting creditors cannot be bound unless assured of certain treatment. As a general principle, that treatment might be that the creditors will receive at least as much under the plan as they would have received in liquidation proceedings. If the creditors are secured, the treatment required may be that the creditor receives payment of the value of its security interest, while in the case of unsecured creditors it may be that any junior interests, including equity holders, receive nothing. To the extent that the approval procedure results in a significant impairment of the claims of creditors and other affected parties without their consent (in particular secured creditors), there is a risk that creditors will be unwilling to provide credit in the future. The mechanism for approval of the plan, and the availability of appropriate safeguards, is therefore of considerable importance to the protection of these interests."

Therefore, as held by the Supreme Court in the case of Swiss Ribbons, the NCLAT, while looking into the viability and feasibility of resolution plans that are approved by the committee of creditors, has always gone into whether operational creditors are given roughly the same treatment as financial creditors, and if they are not, such plans were to either be rejected or modified so that the operational creditors' rights are safeguarded. In fact, equality of treatment, as a reasoning, can only imply equitable treatment of similarly situated creditors and not otherwise.

Nonetheless, the said approach was rectified by introducing an amendment to the Code on 16^th of August 2019, which brought about two significant changes, with respect to the issue of dissenting financial creditors. The first was an amendment carried out to the principal code under Section 30, officially recognizing the right of the financial creditor not voting in favour of a resolution plan. It is, however, interesting to note that the legislature has avoided using the expression "dissenting financial creditor". The second was an amendment made to Regulation 38 of the Corporate Persons Regulations.

"Section 30 – Submission of Resolution Plan:

……..

(2) The resolution professional shall examine each resolution plan received by him to confirm that each resolution plan—

(a) provides 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;

(b) provides for the payment of debts of operational creditors in such manner as may be specified by the Board which shall not be less than-

(i) the amount to be paid to such creditors in the event of a liquidation of the corporate debtor under section 53; or

(ii) the amount that would have been paid to such creditors, if the amount to be distributed under the resolution plan had been distributed in accordance with the order of priority in sub-section (1) of section 53, whichever is higher, and provides for the payment of debts of financial creditors, who do not vote in favour of the resolution plan, in such manner as may be specified by the Board, which shall not be less than the amount to be paid to such creditors in accordance with sub-section (1) of section 53 in the event of a liquidation of the corporate debtor.

Explanation 1. — For removal of doubts, it is hereby clarified that a distribution in accordance with the provisions of this clause shall be fair and equitable to such creditors.

Explanation 2. — For the purpose of this clause, it is hereby declared that on and from the date of commencement of the Insolvency and Bankruptcy Code (Amendment) Act, 2019, the provisions of this clause shall also apply to the corporate insolvency resolution process of a corporate debtor-

(i) where a resolution plan has not been approved or rejected by the Adjudicating Authority;

(ii) where an appeal has been preferred under section 61 or section 62 or such an appeal is not time barred under any provision of law for the time being in force; or

(iii) where a legal proceeding has been initiated in any court against the decision of the Adjudicating Authority in respect of a resolution plan;]"

"38. Mandatory contents of the resolution plan.

(1) The amount payable under a resolution plan - (a) to the operational creditors shall be paid in priority over financial creditors; and (b) to the financial creditors, who have a right to vote under sub-section (2) of section 21 and did not vote in favour of the resolution plan, shall be paid in priority over financial creditors who voted in favour of the plan."

The above Amendment has also drawn strength from the RBI Circular dated 07.06.2019, which has stated to provide protection to lenders who have dissented against a resolution plan with a further direction that the Resolution Professionals shall provide for payment of not less than the liquidation value due to the dissenting lenders. Further, the amendment also drew inspiration from a representation dated 17.07.2019, which was written by the Deputy Secretary General, FICCI to the Secretary, Ministry of Corporate Affairs, pointing out the flaws of the NCLAT judgment in the Essar Case and suggesting that the Government may consider amending the Code to reinstate the law as it was and should be. Therefore, pursuant to the said amendment, it has now become abundantly clear that the financial creditors who have not voted in favor of a resolution plan, shall get the minimum of the liquidated value and further, as per Regulation 38, shall be paid in priority over other financial creditors who have voted in favor of the Resolution Plan.

Retrospective Application to Pending/Challenged Resolution Plans

As part of the amendment to Section 30 of the Code, there have been two explanations that have been inserted. The first explanation deals with the distribution of amounts as per the plan amongst various creditors, which is to be equitable and fair. This insertion is in line with the UNCITRAL guidelines amongst others. Further, as held by the Supreme Court in Committee of Creditors of Essar Steel India Limited vs. Satish Kumar Gupta and Ors.:

"Explanation 1 has only been inserted in order that the Adjudicating Authority and the Appellate Tribunal cannot enter into the merits of a business decision of the requisite majority of the Committee of Creditors. As has also been held in this judgment, there is no residual equity jurisdiction in the Adjudicating Authority or the Appellate Tribunal to interfere in the merits of a business decision taken by the requisite majority of the Committee of Creditors, provided that it is otherwise in conformity with the provisions of the Code and the Regulations, as has been laid down by this judgment."

Additionally, as per the above decision, the expression "equality" cannot mean to imply "equality for all":

"Indeed, if an "equality for all" approach recognising the rights of different classes of creditors as part of an insolvency resolution process is adopted, secured financial creditors will, in many cases, be incentivised to vote for liquidation rather than resolution, as they would have better rights if the corporate debtor was to be liquidated rather than a resolution plan being approved. This would defeat the entire objective of the Code which is to first ensure that resolution of distressed assets takes place and only if the same is not possible should liquidation follow."

The second explanation assumes significance, for the reason being that it has made the application of the amendment retrospective. However, for the amendment to apply retrospectively, the following circumstances mentioned under the Explanation 2 are to be satisfied/met, namely; (i) where a resolution plan has not been approved or rejected by the Adjudicating Authority; (ii) where an appeal has been preferred under section 61 or section 62 or such an appeal is not time barred under any provision of law for the time being in force; or (iii) where a legal proceeding has been initiated in any court against the decision of the Adjudicating Authority in respect of a resolution plan.

The above amendment will have a great impact for those financial creditors not voting in favour of a resolution plan and who fall within the exceptions to Explanation 2 of Section 30. In the case of Orchid Pharma, the Resolution Plan was approved on 25.06.2019 by the NCLT, namely, prior to the amendment to Section 30 in August 2019. Considering that there was a challenge to the resolution plan initially before the NCLAT, which had reversed the Order of NCLT approving the plan and ordered liquidation of the Corporate Debtor and subsequently before the Supreme Court, which had while applying the ratio in Maharashtra Seamless set aside the order of the NCLAT by its order dated 28.02.2020, the requirements under Explanation 2 were satisfied and accordingly, Section 30 would apply retrospectively to the facts of the said case. Therefore, although certain financial creditors did not vote in favour of the resolution plan, which was prior to the amendment in the above case, in view of meeting the requirements of Explanation 2 to the amended Section 30, they would be entitled to claim a minimum of the liquidation value. This would hence, have more significance to the dissenting financial creditors, considering that the resolution plan value, in the said case, was much lesser than the liquidation value.

In fact, the said amendment also came to be tested before the Hon'ble Supreme court in the case of Essar Steel, which has since been subsequently upheld as follows:

" 80. When it comes to the validity of the substitution of Section 30(2) (b) by Section 6 of the Amending Act of 2019, it is clear that the substituted Section 30(2)(b) gives operational creditors something more than was given earlier as it is the higher of the figures mentioned in sub-clauses (i) and (ii) of Sub-clause (b) that is now to be paid as a minimum amount to operational creditors. The same goes for the latter part of Sub-clause (b) which refers to dissentient financial creditors. Mrs. Madhavi Divan is correct in her argument that Section 30(2)(b) is in fact a beneficial provision in favour of operational creditors and dissentient financial creditors as they are now to be paid a certain minimum amount, the minimum in the case of operational creditors being the higher of the two figures calculated under sub-clauses (i) and (ii) of Clause (b), and the minimum in the case of dissentient financial creditor being a minimum amount that was not earlier payable. As a matter of fact, pre-amendment, secured financial creditors may cramdown unsecured financial creditors who are dissentient, the majority vote of 66% voting to give them nothing or next to nothing for their dues. In the earlier regime it may have been possible to have done this but after the amendment such financial creditors are now to be paid the minimum amount mentioned in Sub-section (2). Mrs. Madhavi Divan is also correct in stating that the order of priority of payment of creditors mentioned in Section 53 is not engrafted in Sub-section (2)(b) as amended. Section 53 is only referred to in order that a certain minimum figure be paid to different classes of operational and financial creditors. It is only for this purpose that Section 53(1) is to be looked at as it is clear that it is the commercial wisdom of the Committee of Creditors that is free to determine what amounts be paid to different classes and sub-classes of creditors in accordance with the provisions of the Code and the Regulations made thereunder.

……

82. Equally, Explanation 2 applies the substituted Section to pending proceedings either at the level of the Adjudicating Authority or the Appellate Authority or in a Writ or Civil Court. As has been held in Swiss Ribbons (supra) and ArcelorMittal India (supra) (see paragraph 97 of Swiss Ribbons (supra) and paragraph 82, 84 of ArcelorMittal India (supra)), no vested right inheres in any resolution Applicant to have its plan approved under the Code. Also, the Federal Court in Lachmeshwar Prasad Shukul v. Keshwar Lal Chaudhuri MANU/FE/0002/1940 : AIR 1941 FC 5 and later, this Court in Shiv Shakti Coop. Housing Society, Nagpur v. Swaraj Developers and Ors. MANU/SC/0335/2003: (2003) 6 SCC 659 (at paragraphs 16 and 17) have held that an appellate proceeding is a continuation of an original proceeding. This being so, a change in law can always be applied to an original or appellate proceeding. For this reason also, Explanation 2 is constitutionally valid, not having any retrospective operation so as to impair vested rights."

However, from a reading of the said decision, it has been made clear that the amendment to Section 30 would not be applicable in the event its operation is to impair any vested rights.

In fact, although it has been made clear that Section 30 would operate retrospectively, provided a case meets the requirement of Explanation 2, as in the case of Orchid Pharma, the Supreme Court in Essar could, however, not go into the retrospective application of Regulation 38, which most importantly provides for the priority in distribution of the amounts from the resolution plan amongst the various stakeholders, most importantly, which includes the financial creditors who voted against the plan.

Regulation 38(1), which had been recently amended in November 2019, provides for priority to financial creditors, who have a right as per Section 21 of the Code but who did not vote in favour of the Resolution Plan, over other financial creditors who have voted in favour of the Resolution Plan. However, unlike the proviso to Section 30 of the Amended Act, the gazette notification clearly states that the said amendment to the Regulation shall come in force only with effect from 28.11.2019. As per the previous amendment to Regulation 38(1) in October 2018, it has been stated that the operational creditors shall be paid in priority to other financial creditors, thereby implying that the financial creditors shall be paid pro rata irrespective of whether they assent or dissent to a plan. Nonetheless, having stated the above, when a reference is made to Section 30 of the Amendment, in particular Sub-section (b)(ii), it has been stated that "....and provides for payment of financial creditors, who do not vote in favour of the resolution plan, in such manner as may be specified by the board,......." From an interpretation of the expression "as may be prescribed by the Board" it can also be taken to imply any amendment effected to the IBBI Corporate Persons Regulations, provided it is read conjointly with Sections 3(1), (28) & (32) of the Code. Therefore, once the amended Section 30 becomes applicable to the facts of a case, the application of Regulation 38, although not expressly provided with retrospective application, will by necessary implication have retrospective applicability.

In fact, recently, the NCLAT in the case of DBS Bank Ltd. vs Mr. Shailendra Ajmera, RP of Ruchi Soya Industries Limited, dealt with a challenge by a dissenting financial creditor, who was seeking refuge under Section 30 of the amended act and thereby claiming for the liquidation value. The submission of DBS was as follows:

"4. According to the Appellant as it has voted against the 'Resolution Plan', and in terms of amended sub-Section (2)(b)(ii) of Section 30, it is entitled to minimum amount as payable in the event of 'Liquidation' of the 'Corporate Debtor', which will be close to 90% of its exposure. It is also submitted that distribution has not been made giving priority of payment amongst the creditors in terms of sub-section (1) of Section 53. The 'dissenting secured creditor' has not been provided the amount in terms of sub-Section (2)(b)(ii) of Section 30."

However, the NCLAT negatived the said submission by holding as follows:

"7. In the present case the Appellant has not challenged the approval of the 'Resolution Plan' but has challenged the approval of the distribution made therein. This is also evident from paragraph 6 of the Miscellaneous Application which has preferred by the Appellant – 'DBS Bank, Singapore' before the Adjudicating Authority (National Company Law Tribunal), Mumbai Bench, Mumbai and reads as follows:

"The Applicant is not challenging the resolution plan. The Applicant is only challenging the decision of the CoC as to distribution of the payout under the plan inter-se between the financial creditors of the corporate debtor (pursuant to implementation of the plan). This Hon'ble Tribunal is empowered to review this issue, to determine if it is compliant with law."

As the Appellant is not challenging the 'Resolution Plan', the question of applicability of amended Section 30(2) does not arise."

From a reading of the above decision, it is, however, clear that DBS could not claim retrospective application of Section 30 in view of the challenge being made to the distribution as per the resolution plan in comparison to a direct challenge being made to the resolution plan itself. The said decision has, nonetheless, subsequently been challenged before the Supreme Court and it is to be seen as to how the Court would consider the same. Hence, considering the amendments made to the Code and in light of the decisions in Maharashtra Seamless and Orchid Pharma, there will be a significant impact in the way potential resolution plans are now being formulated and approved/voted upon, including the manner of offering of bids by Resolution Applicants.

 

(Varun Srinivasan is the Principal Associate of the law firm NVS & Associates and the Co-Revising Editor of Tannan's Book on Banking Law & Practice, 25th Edition published by Lexis Nexis. He is also a Member of the Chartered Institute of Arbitrators, London (MCIArb))