To Dissent Or Not To Dissent With The Resolution Plan- Predicament Of The Financial Creditors

In order to achieve this objective, the Code has envisaged constitution of Committee of Creditors ("CoC") consisting of financial creditors, and entrusts such CoC with the task of identifying the most feasible and viable plan to revive the business of such distressed entities. The Resolution Professional has been assigned the duty of managing the entire Corporate Insolvency Resolution Process ("CIRP"), assisting the CoC in selecting the most suitable resolution applicants and scrutinizing resolution plans which are submitted by such selected resolution applicants.

The decision regarding approval or rejection of a resolution plan is taken collectively by the members of the CoC after due negotiations and discussions on such resolution plan. The financial creditors are required to consider the feasibility and viability of a resolution plan along with the other requirements as set out in the CIRP Regulations^[1], while exercising their option of approving or disapproving the resolution plan.

Once a resolution plan has been approved by members of the CoC, the minority dissenting financial creditors cannot question the logic or the justness of the opinion expressed by the majority of the financial creditors. The financial creditors are obligated to apply commercial wisdom while reaching to such an opinion. Where a resolution plan fails to garner the requisite voting support of 66%, the decision of the dissenting financial creditors would prevail and the tribunals would be left with no option but to order liquidation of such corporate debtor.

The Insolvency and Bankruptcy Code (Amendment) Act, 2019 ("2019 Amendment Act"), in addition to reaffirming the primacy of the financial creditors over commercial decisions amended section 30(2) of the Code in order to protect the interest of dissenting financial creditors by stipulating the requirement of certain minimum payment to the dissenting financial creditors (in the event the resolution plan has been approved by the requisite majority of financial creditors).

Prior to 5 October 2018, Regulation 38(1)(c) of the CIRP Regulations made it mandatory for a resolution applicant to provide for payment of liquidation value to dissenting financial creditors. However, the National Company Law Appellate Tribunal ("NCLAT") held that due to the absence of any specific provision in the Code, there could be no discrimination amongst the financial creditors as far as the distribution of resolution funds were concerned and that the said Regulation 38(1)(c) of the CIRP Regulations was inconsistent with the provisions of the Code^[2]. Subsequent to this, the CIRP Regulations were amended to do away with the mandatory requirement of payment of liquidation value to the dissenting financial creditors.

Further, while dealing with the issue of providing differential treatment to secured creditors on the basis of value or priority of security interest, the NCLAT had held that all the financial creditors were to be treated in a similar manner if situated similarly and that no distinction was allowed between first charge holders and second charge holders at the CIRP stage^[3].

However, the 2019 Amendment Act, which came into effect on 16 August 2019 (i.e. post NCLAT judgement in Jyoti Structure case), amended section 30(2)(b) of the Code to guarantee to the dissenting financial creditors a payment of at least an amount which such financial creditors would get [in accordance with payment mechanism set out in section 53(1) of the Code ("Waterfall Mechanism")] in the event of a liquidation of such corporate debtor. The Waterfall Mechanism sets out the order in which the proceeds from sale of liquidation assets of a corporate debtor need to be distributed by a liquidator. This amendment bestowed on the financial creditors the freedom to express their dissent with the resolution plan by protecting their rights to receive certain minimum amount.

The 2019 Amendment Act also amended section 30(4) of the Code and clarified that while evaluating a resolution plan, the CoC would have power to look into the manner of distribution of funds (in addition to feasibility and viability of resolution plan) which may (or may not) be based on the order or priority of security interest held by the financial creditors in accordance with the Waterfall Mechanism..

The constitutional validity of the amendments in section 30(2)(b) and section 30(4) of the Code was also upheld by the Supreme Court (in Essar case)^[4]. As a result, the Waterfall Mechanism (which was otherwise applicable at liquidation stage only) can now be applied to the distribution of resolution funds pursuant to the resolution plan.

In the event of liquidation of a corporate debtor, the secured creditors can either (a) enforce and realise their security interest outside the liquidation proceedings (in which case, such secured creditor would be entitled to claim the unrecovered amount as per the Waterfall Mechanism in case of under-recovery), or (b) relinquish their security interest(s) to the liquidation estate and receive proceeds from the sale of assets by the liquidator (in which case the liquidator would sell the assets and distribute the proceeds thereof as per the priority of charges/security interest). However, the amount recovered from sale of the concerned asset (over which the secured creditor holds security interest) has to be first applied to repay the debt of such secured creditor in each case.

Therefore, concerns have been raised that a secured financial creditor may deliberately opt to vote against a resolution plan (even if the resolution plan meets all the parameters of the Code) in anticipation of higher recovery pursuant to the amended provisions of section 30(2)(b), if distribution of funds approved by the CoC is not based on value or priority of security interest over assets of the corporate debtor.

It is pertinent to note that the Code requires a resolution applicant to frame the resolution plan with the primary objective of reviving the corporate debtor as a going concern. Although section 30(2) of the Code and Regulation 38 of the CIRP Regulations set out mandatory contents of a resolution plan, neither the Code nor the CIRP Regulations make it mandatory for the resolution applicant to provide for distribution of funds between the creditors inter-se.

Notably, the Hon'ble Supreme Court (in Essar case) has held that it would be enough if the resolution plan provides for distribution of amount payable towards debt upon a classification of various types of creditors and that though the feasibility and viability of a resolution plan would take into account all aspects of the resolution plan including the manner of distribution of funds among the various classes of creditors, the ultimate discretion in respect of distribution of funds amongst various classes of creditors would be with the CoC only.

In view of the Supreme Court's judgment (in Essar case) and the applicable provisions of the Code and the CIRP Regulations, it appears that a resolution applicant is not bound to provide for the distribution of funds between secured creditors inter-se but it would be enough if the resolution applicant merely specifies the aggregate amount being offered by such resolution applicant to the financial creditors pursuant to the resolution plan. In such case the CoC would have the power to decide the manner of distribution of funds amongst the financial creditors (which distribution, at the discretion of CoC, may be based on priority and value of security interest held by financial creditors). Such a decision of the CoC, being a collective commercial decision would also be binding on the minority dissenting financial creditors.

In view of the above, the scope of dissent of the dissenting financial creditors, as referred in amended section 30(2)(b), seems to be very limited in the sense that the objective of this provision appears to be to protect a financial creditor who has voted against a resolution plan which has failed to pass the test of feasibility and viability in its commercial wisdom. This provision should not be interpreted to incentivize the financial creditors (especially the secured financial creditors) to vote for liquidation of a corporate debtor instead of revival, merely in anticipation of better recovery since such an interpretation would defeat the entire objective of the Code which is, revival of the corporate debtor and not liquidation.

This view is also supported by the judgment of the NCLAT (in DBS Bank case)^[5] wherein the NCLAT has held that the amended section 30(2)(b) of the Code cannot be interpreted in a manner to give advantage to a 'dissenting secured financial creditor' and that where a resolution plan is otherwise feasible and viable, a financial creditor (including a secured financial creditor) cannot dissent with the resolution plan just to take advantage of the amended section 30(2)(b) of the Code and get more amount than other secured creditors. The above-mentioned judgment of the NCLAT (in DBS Bank case) has been challenged before the Supreme Court.

However, there exists a contrary view also as per which, a secured financial creditor should not be denied the benefit of security interest held by such secured financial creditor and that the superior rights of security holders must be honoured in distribution of funds at all stages, whether it is CIRP stage or the liquidation stage.

Until the ambiguity surrounding the scope of amended section 30(2)(b) is cleared by the Supreme Court, the financial creditors (especially the secured financial creditors who do not have enough voting share to block/resist the decisions of CoC) could find themselves in a situation of predicament in deciding as to whether or not they should dissent with the resolution plan (which is otherwise feasible and viable) in case their security interest is not fully protected in the resolution plan.

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Disclaimer: This publication is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to herein. This publication has been prepared for information purposes only and should not be construed as a legal advice. Although reasonable care has been taken to ensure that the information in this publication is true and accurate, such information is provided 'as is', without any warranty, express or implied, as to the accuracy or completeness of any such information. The law set out in this publication is as of 31^st March 2020. Readers should take legal advice before applying the information contained in this publication to specific issues or transactions.

Authors:

Shwetabh Sinha,
Partner, Clasis Law
E: shwetabh.sinha@clasislaw.com

Dinesh Gupta,
Senior Associate, Clasis Law
E: dinesh.gupta@clasislaw.com