IBC - Two Years On - The Game is On

"Curiouser and Curiouser" – Hon'ble Justice R.F. Nariman quotes from "Alice in the Wonderland" to describe the tactics adopted promoter of Essar Steel in the case of Arcelormittal India Private Ltd vs Satish Kumar Gupta.

It has been more than two years now when the path-breaking and drastic law governing insolvency was passed and implemented with great speed and purpose. The speed was necessary as the financial sector was reeling under NPA of more than 10 trillion rupees and the system needed some drastic action to address the perennial issue on account of which sizable number of Banks were put under corrective action plan by the regulator. On account of huge NPA (Non-Performing Assets) of Banks the existing debt recovery mechanism was reeling under tremendous pressure and was found to be inadequate to address the problem. Since, the speed with which the law was put into motion was unparallel, the system, especially banking found itself not prepared to put the things into motion forcing the Government to get into action and issue Ordinance empowering the Reserve Bank of India to direct Banks to file cases under IBC and the journey thus begin to move.

The journey which began with ICICI Bank filing first case in Mumbai NCLT has rolled on and NCLTs are handling more than 2000 cases of CIRP initiated under IBC. Though majority of the cases (about 60%) are still being filed by operational creditors but the core remain the banking/financial default. During its journey of two years the law has evolved by way of amendments (two) and Supreme Court judgments  like Mobilox Innovations Private Limited v. Kirusa Software Private Limited[i] - which in the context of Section 9 of the Code, clarified that the existence of the dispute and/or the suit or arbitration proceeding must be pre-existing – i.e. it must exist before the receipt of the demand notice or invoice, as the case may be.

Surendra Trading Cowmpany v. Juggilal Kamlapat Jute Mills Company Limited and Others[ii] which clarified the issue whether the time limit prescribed for admitting or rejecting a petition for initiation of the insolvency resolution process is mandatory.

Innoventive Industries Ltd. Vs. ICICI Bank & Anr[iii] - Code to override other Laws. Lokhandwala Kataria Construction Pvt. Ltd Vs. Nisus Finance & Investment Manager LLP[iv] - In view of Rule 8 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016, the National Company Law Appellate Tribunal (NCLAT) could not utilise the inherent power recognised by Rule 11 of the National Company Law Appellate Tribunal Rules, 2016.

Alchemist Asset Reconstruction Company Limited v. M/s Hotel Gaudavan Private Limited & Ors[v]  An arbitration proceeding cannot be started after imposition of moratorium.

Black Pearl Hotels Pvt. Ltd. v. Planet M. Retail Ltd[vi] - The duty of determination of an instrument or, to explicate, to determine when there is a contest a particular document to be of specific nature, the adjudication has to be done by the judge after hearing the counsel for the parties. It is a part of judicial function and hence, the same cannot be delegated.

 B.K. Educational Services Private Limited v Parag Gupta And Associates[vii]- Limitation Act, 1963 will apply to applications that are made under s. 7 and s. 9 of the Insolvency and Bankruptcy Code, 2016 on and from the commencement of IBC on 01.12.2016.

Understanding the Law: If one go deeper into the subject, we would realize that though revolving around the basic corporate law governing insolvency of companies, the Committee on IBC and the team working on drafting of the new law had put tremendous efforts to understand the financial and legal system, sickness, issues which brought down the then prevailing system, therefore, was able to set up a realistic system best suited to Indian mindset be it borrowers, lenders, judicial and administrative authorities. Prior to IBC, it was Companies Act which dealt with the provisions relating to winding up, sickness and compromise and arrangements. Independent body (presumably of professional) was overseeing or was supposed to oversee approval of schemes (again prepared by professional agencies under overall "supervision" of operating agency) of rehabilitation and revival through involvement of all the stakeholders be it lenders, state authorities and other claimants. Similarly, under the scheme of arrangements and compromise there was and still is, the requirement of approval by the committee of relevant creditors. Principle of non-interference with the scheme finalized by the Committee (similar to the scheme under IBC) was being followed (German Remedies Ltd. In re (2004) 50 SCL (Bom HC)- Reliance Industries Ltd. In re (2009) 94 SCL 35- Comp Cas 124 (Bom HC). Andhra Pradesh High Court observations in the case of Vadlamudi Rama Rao Vs Asian Coffee Ltd[viii] highlighted the concept by observing that "the fact that its role in according approval to the Scheme of Amalgamation under Section 394 is nothing more than a supervisory role. The role is approximately close to the judicial review of administrative action."

In the case of   Miheer H. Mafatlal vs Mafatlal Industries Ltd[ix]  the Supreme Court highlighted the limit on the power of Company Court to interference with the Scheme placed before it for approval, by laying down that "It is the commercial wisdom of the parties to the scheme who have taken an informed decision about the usefulness and propriety of the scheme by supporting it by the requisite majority vote that has to be kept in view by the Court. The Court certainly would not act as a court of appeal and sit in judgment over the informed view of the concerned parties to the compromise as the same would be in the realm of corporate and commercial wisdom of the concerned parties. The Court has neither the expertise nor the jurisdiction to delve deep into the commercial wisdom exercised by the creditors and members of the company who have ratified the Scheme by the requisite majority. Consequently the Company Court's jurisdiction to that extent is peripheral and supervisory and not appellate. The Court acts like an umpire in a game of cricket who has to see that both the teams play their 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". (Emphasis supplied)

Thus, the scheme of things underlined under IBC too revolves around the same basic principle. However, the things (which are also under threat now) which have made all the difference are- "time bound process" and "debtor not in control". Under SICA/BIFR combine, promoters have free run and free hand to drag the things upto infinity while the Banks were made to struggle and run from pillar to post for remedies under indefinite period of moratorium under Section 22 of the  Sick Industrial Companies Act, 1958 (SICA). IBC too would have gone and met the same fate as that of proceedings under SICA had not the Government stood its ground on the issue of strict time line. Those associated with discussion on the issue during pre IBC period would recall that there were basically three things which were doubted for success – (1) "strict time line for completion of resolution process", (2) capability of IRP (debtor out of control) and (3) judicial over activism (application of PNJ and human rights in financial matters). However, thankfully, Judiciary and Government have stood by the new law giving it the needed shape direction from time to time.

IBC as disruptor: It is said that under the Indian context things do not usually happen unless forced upon. IBC too acted like a disruptor and shook the unaware (be it professionals, financiers, defaulters, claimants). Banks considered it like a recovery mechanism, defaulter thought they would get away with stay and reliefs from Courts, professional (IRPs) took it as one more avenue for work but soon they realize that it was a different cup of tea. Banks were jolted to find out that they are supposed to take quick calls on huge haircuts and that CoC is not a routine debtor creditor meet under CDR/ JLM. Defaulters soon found out that success of stay from Courts were short lived and there was no way out of 'losing control of business' on admission of application. Professionals too realized what it takes to be an IRPs and knowledge of provisions of IBC is of little use when it comes to taking charge/running a huge organization. However, slowly but surely, all the stakeholders have learnt from their experience and trying to evolve.

During last two years of IBC, we have stories of successful resolutions ranging from Bhushan Steel, MBL Infrastructure (recovery reported to be around 63 to 111%) to Zion Steel and Synergies Dooray (recovery around 0.3 to 5%). Consolidation of debt has become the tool, the system is seeing emergence of stronger ARCs and NBFCs who are mastering the art of acquisition, revival and divestment. The systems which was having a handful of experts of the law has seen an emergence of a dedicated field of practice. Of course the media coverage of large value and hot property matters has contributed immensely not only in catching the attention of stakeholders but also young professionals and general public. So much so that it is said that lakhs of crores have been recovered simply by issuance of notice under IBC by supplier MSMs whose money was struck up with large manufacturer. The object of IBC is not in how many cases of default have been resolved but the real success of IBC will come if it succeeds in establishing a system of financial discipline among all the player of the game, be it lenders or debtors. Lending and borrowing is a serious activity of handling public money, therefore, has to be handled with responsibility so that the financial system of the Country continues to function properly. Borrower must realize that default will not be tolerated and it has no room if one is looking for a long inning in the field. Success of TATAs and downfall of Ruias and Mallaya are the cases which prove this rule of the new game called Insolvency and Bankruptcy Code. The systems (SICA) used by defaulters to take refuge has gone with introduction of IBC and with February 2017 Circular of RBI. The message is clear if you want to stay in the game follow the new rules. Amendments brought about in the Prevention of Money Laundering Act and passing of Fugitive Economic Offender Act, 2018 has added teeth in efforts of the system to block escape routes for the defaulters. These powers are in addition to the ever increasing powers of Banks to initiate actions for diversion of money etc under RBI Guidelines and recent circular of Home Ministry empowering PSBs to issue requests of opening of LOCs for wilful defaulters against whom an FIR is yet to be filed.

The future of the new game appears to be bright though few challenges still remain. Inadequate infrastructure and failure of authorities to stick to time line under IBC and cross litigation in the form of numerous applications to NCLT, remain the prime concern. Though infrastructure and failure to adhare to time limit are interconnected to some extent as delay adds to confusion and leads to cross litigation.

Need for an effective Committee of Creditors (CoC) with Bankers at the Core: Understanding of the lending and corporate culture on the one hand and clarity on legal nuances with purpose in approach can not only help in shaping CoC into a matured body capable of understanding and addressing the concern of different stakeholders. An effective CoC will also help Adjudicating Authority (AA) in getting rid of unwanted litigation and avoid delays. There is inherent conflict of interest which plays a critical role in decision making process in CoC. Things get more challenging in single lender forums where decision making burden is practically put on one or at the most two banks (handling small amount of loan). Giving voting powers to a section of operational creditor or including more and more stakeholders in the category of 'financial creditor' is not going to solve the issue as interested operational creditors (especially if it has got a small stake or limited interest/stake) will also be subject to same mind set and thus may not solve the issue. We have to realize that if the things gets challenging for Banks in CoC it will affect lending decisions and cost of funding may go up along with the requirement for more collateral. When banking sector is trying to develop and devise new approach ignoring banks in CoC has the potential of harming the development of new age lending in India.

We should not ignore the fact that it is both the debtors and majority of operational creditors which need support of banking for their existence. We, therefore, need a strong and vibrant financial sector which is willing to finance not only the start ups  but also enterprises and industries, new projects and expansion of existing projects which ultimately generates revenue for the exchequer, opens up business opportunities for the ancillary and associate suppliers and employment for the working class. We also need to realize that it is only the PSU Banks and FIs (with their strong system and practices under overall supervision of a strong regulator) who can remain immune to pressure tactics of defaulting promoters unlike operational creditors like suppliers and workers (who cannot be said to enjoying similar stature or standing), thus capable of taking more equitable and rational decision in CoC.

The issue (demand for voting rights to other creditors) has arisen mainly on account of Corporate Insolvency Resolution Process (CIRP) being turning out be an auction process rather than a revival mechanism where interest of decision making stake holder(s) play a decisive role in approval of the resolution plans. It is not that presence of defaulting promoters (as in the cases of SMEs) has helped the matter. The Supreme Court in the case of Essar Steel has to quote the Quote of  "Curiouser and Curiouser" to describe the amazing tactics adopted by Ruias to retain control of the company while not repaying for defaults. The game being played by a section of promoters is very innovative and challenging for banks and RPs (who have to handle their innovative methods of subverting process). We have to realize that till the system finds its roots, CoC/ decision taking body has to be under financial creditors with suitable representation from the operational creditor. We have to ensure that CoC does not become another chaotic meeting place (like any other conciliatory proceedings before a labour commissioner) where all the members are trying hard bargain thereby going all over, in total disregard to interest of the enterprise and lenders. For the success of IBC we need a responsive and decisive CoC and financial creditor are best suited for that. The need is to set basic norms to be followed by such committees. The system, especially the banking system also needs to ensure that all cases of default need not be treated equally. Business being only a part of larger economic activities, it remains susceptive to prevailing economic conditions and genuine cases needs to be supported and should remain outside IBC.  "Prepack" needs to be given a chance to help out genuine and bonafide cases of default.

The Judgment of the Apex Court in the case of Arcelrmittal India Private Limited will go as the path-breaking judgment in the history of Insolvency of Law in this Country. The Judgement has set the tone for the Court/ NCLT to follow. The case highlights the game defaulting promoter have been and still trying to play and to what extent they can go to subvert the process. The case was a challenge for CoC and Adjudicating Authority on account of gamut of factors and stories, arguments that were built to test the system and its resilience. Thankfully, all authorities struck to basics and adopted the best possible course within realm of IBC. Maze of companies, cross holding, sub-holding created by the promoters was ultimately dissected and the corporate veil was lifted by the Supreme Court to find out ultimate ownership/beneficiary of bid put forth by or on behalf of promoters. The Apex court pointed out that Numetal's initial corporate structure and changes made to it while the resolution process underway were all done with the intent of avoiding the ineligibility criterion under Section 29A(c) of IBC. Supreme Court judgment has clearly highlighted that corporate arrangements - done around the time of submission of a resolution plan that defeat the purpose of ineligibility conditions laid down under Section 29A of the IBC, will be ineligible.

At para 64 of the judgement the Court observed that "The Code was passed after great deliberation and pursuant to various Committee Reports, as has been held in Innoventive Industries Ltd. v. ICICI Bank & Anr. (2018) 1 SCC 407 at paragraph 12. The Statement of Objects and Reasons, which is reproduced in the said paragraph, makes it clear that the existing framework for insolvency and bankruptcy was not only inadequate and ineffective, but resulted in undue delays in resolution. One of the primary objects of the Code, therefore, is to resolve such matters in a time bound manner. This would not only support the development of credit markets and encourage entrepreneurship, but would also improve ease of doing business and facilitate more investment, leading to higher economic growth and development." (Emphasis supplied)

Speed is of essence for the working of the Code: As regards the speed being the essence of the process, the Supreme Court quoted from the report of November, 2015 of the Bankruptcy Law Reforms Committee "Speed is of essence for the working of the bankruptcy code, for two reasons. First, while the "calm period" can help keep an organisation afloat, without the full clarity of ownership and control, significant decisions cannot be made. Without effective leadership, the firm will tend to atrophy and fail. The longer the delay, the more likely it is that liquidation will be the only answer. Second, the liquidation value tends to go down with time as many assets suffer from a high economic rate of depreciation. From the viewpoint of creditors, a good realisation can generally be obtained if the firm is sold as a going concern. Hence, when delays induce liquidation, there is value destruction. Further, even in liquidation, the realisation is lower when there are delays. Hence, delays cause value destruction. Thus, achieving a high recovery rate is primarily about identifying and combating the sources of delay."(emphasis supplied)

The Court has set the tone for all the stakeholder under IBC while observing that "It is settled law that a statute is designed to be workable, and the interpretation thereof should be designed to make it so workable."(emphasis supplied). The Court also quoted from Maxwell on The Interpretation of Statutes, Tenth Edn., pp. 236-237. "A statute is designed", observed Lord Dunedin in Whitney v. Commissioners of Inland Revenue [1925] 10 Tax Cas.88, 110, "to be workable, and the interpretation thereof by a court should be to secure that object, unless crucial omission or clear direction makes that end unattainable".

As regards the right of any of resolution applicant to move applications before NCLT, the Court observed that "Given the timeline referred to above, and given the fact that a resolution applicant has no vested right that his resolution plan be considered, it is clear that no challenge can be preferred to the Adjudicating Authority at this stage. A writ petition under Article 226 filed before a High Court would also be turned down on the ground that no right, much less a fundamental right, is affected at this stage. This is also made clear by the first proviso to Section 30(4), whereby a Resolution Professional may only invite fresh resolution plans if no other resolution plan has passed muster.

On the role of RP, the Court clarified that "A conspectus of all these provisions would show that the Resolution Professional is required to examine that the resolution plan submitted by various applicants is complete in all respects, before submitting it to the Committee of Creditors. The Resolution Professional is not required to take any decision, but merely to ensure that the resolution plans submitted are complete in all respects before they are placed before the Committee of Creditors, who may or may not approve it. The fact that the Resolution Professional is also to confirm that a resolution plan does not contravene any of the provisions of law for the time-being in force, including Section 29A of the Code, only means that his prima facie opinion is to be given to the Committee of Creditors that a law has or has not been contravened. Section 30(2)(e) does not empower the Resolution Professional to "decide" whether the resolution plan does or does not contravene the provisions of law."

On the time line laid down for approval of resolution plan and limit of its jurisdiction, the Court pointed out that Section 64 also makes it clear that the timelines that are to be adhered to by the NCLT and NCLAT are of great importance, and that reasons must be recorded by either the NCLT or NCLAT if the matter is not disposed of within the time limit specified. Section 60(5), when it speaks of the NCLT having jurisdiction to entertain or dispose of any application or proceeding by or against the corporate debtor or corporate person, does not invest the NCLT with the jurisdiction to interfere at an applicant's behest at a stage before the quasi-judicial determination made by the Adjudicating Authority. The non-obstante clause in Section 60(5) is designed for a different purpose: to ensure that the NCLT alone has jurisdiction when it comes to applications and proceedings by or against a corporate debtor covered by the Code, making it clear that no other forum has jurisdiction to entertain or dispose of such applications or proceedings.

The Court also observed that it is also true that the time taken by a Tribunal should not set at naught the time limits within which the corporate insolvency resolution process must take place. However, we cannot forget that the consequence of the chopper falling is corporate death. The only reasonable construction of the Code is the balance to be maintained between timely completion of the corporate insolvency resolution process, and the corporate debtor otherwise being put into liquidation. We must not forget that the corporate debtor consists of several employees and workmen whose daily bread is dependent on the outcome of the corporate insolvency resolution process. If there is a resolution applicant who can continue to run the corporate debtor as a going concern, every effort must be made to try and see that this is made possible. A reasonable and balanced construction of this statute would therefore lead to the result that, where a resolution plan is upheld by the Appellate Authority, either by way of allowing or dismissing an appeal before it, the period of time taken in litigation ought to be excluded. This is not to say that the NCLT and NCLAT will be tardy in decision making. This is only to say that in the event of the NCLT, or the NCLAT, or this Court taking time to decide an application beyond the period of 270 days, the time taken in legal proceedings to decide the matter cannot possibly be excluded, as otherwise a good resolution plan may have to be shelved, resulting in corporate death, and the consequent displacement of employees and workers.

The Apex Court has thus reminded all the stakeholders of their duty which they are expected to adhere to while discharging their functions under the statute. IBC has very effectively laid down the new system of "separation of function" during the CIRP Process which along with time line, constitute fundamental basic structure of IBC and needs to be respected by all stakeholders.

There are few emerging issues which are being shown as grey areas that need more clarity. One such issue is question of interse priority between the lenders on account of priority of their charge and second is the demand for supervision and control over liquidation exercise by the Liquidator on the ground that the law has not developed in this area.

Priority of Charge under IBC: In this context, it needs to be understood that IBC has, while plugging in the loopholes under the then prevailing system of corporate insolvency process, has not changed the basic law. Jurisprudence is well established to take care of all the issue arising out of liquidation process. The principles governing priority of charge forms basic lending norm. Even the new chapter i.e.  Chapter IVA introduced under SARFAESI Act and new section 26B, has only changed the concept of effective date of charge but has not disturbed or removed the concept of priority which is well inscripted under Section 48 of Transfer of Property Act and Sections 47 and 49 of the Registration Act.

The resolution per se does not mean discontinuation of lending process as the enterprise needs to continue its operation and as such there should not be any issue of  inter-se priority between financial creditors and existing arrangements should continue with suitable modifications on account of liquidation of outstanding liability.

In a bid process too the resolution applicant obviously would take into account such issue while proposing his plan to CoC. But, the challenge would arise if "similarly situated creditors" are treated differently. The distribution plan has to take into account the dues and priority of the similarly situated creditor to be equitable and reasonable. This would automatically take care of the issue on hand. Kolkata Bench of NCLT has occasion to deal with the issue in the case of State Bank of India Vs Adhunik Alloys & Power Ltd[x]. While clarifying the issue, the NCLT observed that "creation of class amongst the financial creditors is known to law and being applied in cases in which successful resolution plan was approved. Ld. Senior Counsel for IFCI was unable to bring to my notice any of the provisions of the Code or Regulation so as to enable me to hold that distribution methodology contained for approval is contrary to provisions of the Code or Regulation." NCLT further observed that "It appears to me that in regards balancing the interests of financial creditors, the CoC can take appropriate decision to classify creditors on the strength of the security interest, as it is not contrary to law or against the settled proposition brought to my notice. The AA cannot interfere with the business decision of the CoC who passed the decision with majority vote share in accordance with the provisions of the code. Thus, I am of the considered view that secured creditors' claim are distinct with that of the claim of unsecured creditors." (Emphasis supplied)

IBC has also recognized these principles and has acknowledged claim of secured creditor and workers/employee being different from others. Secured creditors have been given option to enforce their security outside IBC process (in the event of liquidation) and appropriate the proceed (subject to bearing of proportionate cost of liquidation process and sharing proportionate workmen dues). Otherwise also an unsecured financial creditor obviously will not get the same payout (be it CIRP or Liquidation in which case section 53 comes into play) or a partly secured creditor will not suddenly become fully secured creditor or a secured creditor vis-à-vis a specific assets/property will not suddenly become secured creditor vis-à-vis all asset of the Company under IBC. The principle of Secured creditor to the extent of security value is very well built in sub-section (1) clause (b) and (e)(ii) of Section 53 of the Code.

There is suggestion that CoC should also oversee the liquidation instead of liquidator being vested with all functions and directly reporting to NCLT. This suggestion is worth considering and would help in reducing pressure on NCLT besides reducing chances of challenge at every stage of proceedings. Additionally, resolution of issues connected with Information Utility need to be put on fast track to cut short the delay in admission of applications.

The year is ending with recovery of more than 80,000 crores to Banks under IBC. This means the money could be redeployed by banking sector in lending operations and there will be lesser burden on taxpayer for recapitalization of Banks. Next year is going see more of such resolutions/liquidations and much more clarity on some of the issues being contested in pending matters. Further, system should not unnecessarily be worried with failure of CIRP process (if it automatically happen during the process) as the entity could still be saved at liquidation stage (it is of some value) if sold as a going concern (Regulation 32 (c) of IBBI (Liquidation Process) Regulation, 2016 introduced by way of Notification dated March 27, 2018.

[i] Civil Appeal No. 9405 of 2017 decided on 21.9.2017

[ii] Civil Appeal No. 8400 of 2017 decided on September 19, 2017

[iii] CIVIL APPEAL NOs. 8337-8338 OF 2017 decided on August 31, 2017

[iv] CIVIL APPEAL NO. 9279 OF 2017 decided on July 24, 2017

[v] Civil Appeal No. 16929 of 2017, decided on October 23, 2017

[vi] Civil Appeal 2973-2974 of 2017, decided on February 17, 2017

[vii] Civil Appeal No. 23988 of 2017

[viii] 2000 CLC 1356-109 Comp Cas 337 (AP HC DB)

[ix] JT 1996 (8) 205 decided on September 11, 1996

[x]  CA (IB) No. 1086/KB/2018