Bar & Bench Weekly IBC Diary #5: Related party concept, success fee and more

A roundup of the important decisions rendered by the NCLT and NCLAT on the Insolvency and Bankruptcy Code.
Bar & Bench Weekly IBC Diary #5: Related party concept, success fee and more
Bar & Bench Weekly IBC Diary

The Bar & Bench Weekly IBC Diary aims to report crucial rulings of various courts and tribunals and important updates concerning the Insolvency & Bankruptcy Code (IBC), 2016

1. Telangana State Trade Promotion Corporation v. AP Gems & Jewellery Park Private Limited & Anr (NCLAT, Chennai)

Issue involved:

Whether an authority to appoint nominee director and the power of affirmative vote make the creditor a related party?

Provisions:

Section 5(24), 21, IBC

Key observations in the decision:

The financial creditor’s Managing Director was also a Director of the corporate debtor. Moreover, its nominee director advised the FC in matters relating to the corporate debtor. The Articles of Association pointed out that action relating to significant matters ought to be taken only by affirmative vote of three or more Directors and in the qualified majority, minimum one Director is to be nominated for inclusion. The corporate debtor clearly acts on the advice, direction and instructions of the appellant in its normal business affairs. As such, the appellant squarely comes within the ambit of related party as per Section 5(24)(f) and ought to have been excluded from the composition of the Committee of Creditors (CoC).

Quick Analysis:

This is a welcome decision based on a thorough reading of the Articles of Association as well as the conduct of the management of the corporate debtor. In matters where the resolution professional has to determine the constitution of the CoC in relation to the issue of ‘related party’, it becomes imperative that she analyses the articles as well as inter se management participation agreements of the corporate debtor. The Supreme Court in the case of Arcelor Mittal India Private Limited v. Satish Kumar Gupta held that so long as management or policy decisions can be, or are in fact, taken by virtue of shareholding, management rights, shareholders agreements, voting agreements or otherwise, control can be said to exist. It is also important to read the observations in the case of Phoenix ARC Pvt Ltd v. Spade Financial Services Ltd & Ors.

2. Sai Peace and Prosperity Apartment Buyers Association v. ASK Investment Managers P Ltd & Ors (NCLAT, New Delhi)

Issue involved:

Whether participation of the financial institutions in the management based on an investor agreement categorise them as related parties and hence exclude them from CoC?

Provisions:

Section 5(24), 21

Key observations in the decision:

In order to determine whether a party is a related party in terms of Section 5(24) and Section 21, it is imperative to know the nature of the transactions entered into between the said party and the corporate debtor, and examine the influence and inter-relationship between the parties. The respondent has all the trappings of being a “related party” of the corporate debtor on account of the various provisions of the SSHA, which give its nominee directors on the Board a participatory role in the corporate debtor’s policies.

Quick Analysis:

This is an interesting decision wherein an investment management company was taking part in the management of the corporate debtor on the basis of an investor agreement and in the capacity of an investor. Even though it was a financial institution, the NCLAT rightly held that the protection from exclusion from CoC can only be given to pure play financial institutions who convert their debts into equity. Even if the investor is controlling the board and affirming decisions in the interest of participating investors, it still falls within the category of a related party and hence has to be excluded from the CoC. This decision will surely rattle some feathers in investor-driven asset management/financial institutions.

3. Suspended Management of Jay Polypack Pvt Ltd v. SGV Foils Pvt Ltd & Anr (NCLAT, New Delhi)

Issue involved:

Whether NCLT has the power to set aside an ex parte order of admission after constitution of CoC?

Provisions:

Rule 49, NCLT Rules, 2016

Decision:

Before constitution of the CoC, if the Adjudicating Authority is satisfied that the notice was not duly served on the corporate debtor, it may make an order for setting aside the ex-parte order for initiating the Corporate Insolvency Resolution Process (CIRP) upon such terms as it thinks fit. However, after constitution of the CoC, the Adjudicating Authority cannot set aside even an ex-parte admission order, and in such a situation, the corporate debtor has to file an appeal under Section 61 of the IBC.

Quick Analysis:

It is respectfully submitted that the power of the NCLT under Rule 49 to set aside an ex-parte order is an independent power de-hors the stage of the CIRP. If the aggrieved party satisfies the NCLT that the notice wasn’t served, then the NCLT may set aside the order. Any consideration regarding the stage of CIRP is only a consideration in equity and not in law. The NCLAT has attempted to import the principle of withdrawal proceedings under Section 12A to Rule 49, which is debatable.

3. Keshav Aggarwal v. Abhijit Guhathakurta & Ors (NCLAT, New Delhi)

Issue involved:

Whether a shareholder can object to approval of a resolution plan on the ground that her shareholding has been extinguished in contravention of the allied laws?

Provisions:

Section 30, 31, IBC

Key observations in the decision:

When the promoters’ shareholding is extinguished and cancelled in toto without any consideration, even the nominal exit price of ₹1 crore for minority shareholders cannot be termed as unfair or inequitable. The grievances as suggested by these shareholders cannot be recognised as legal grievances, and do not provide them any cause of action to maintain their objections. Section 30 itself provides that if any approval of the shareholder is required under the Companies Act, 2013 or any other law for the time being in force for the implementation of actions under the resolution plan, such approval shall be deemed to have been given and it shall not be contravention of the Act.

Quick Analysis:

The intent of the IBC is to resolve debts, and hence primacy has been given to resolution of the debts of creditors. In the eventuality the resolution fails, the corporate debtor shall be liquidated. In a heavily indebted company, in the event of liquidation, ordinarily the shareholders are considered at the very last stage of the distribution of proceeds. Hence, by way of extinguishment of their shareholding, they are not put in a situation which is worse than liquidation. Even under the IBC, as per the waterfall mechanism under Section 53, there is a very little chance of the shareholders getting their whole equity back. This view is supported by the Supreme Court’s decision in Jaypee Kensington Boulevard Apartments Welfare Association and Ors v. NBCC (India) Ltd and Ors.

4. Jayesh N Sanghrajka v. The Monitoring Agency (NCLAT, New Delhi)

Issue involved:

Whether a resolution professional can charge a success fee from the CoC and whether such success fee is justiciable?

Key observations in the decision:

If the resolution professional seeks to have a success fee at the initial stage of the CIRP, it would interfere with his independence, which can be at the cost of the corporate debtor. If success fee is claimed when the resolution plan is going through or after it is approved, it would be in the nature of gift or reward. When the fees have to be on the basis of the case and work performed or to be performed, the reasonability or otherwise would be justiciable. ‘Success fees,’ which is more in the nature of contingency and speculative, is not part of the provisions of the IBC and the Regulations and the same is not chargeable.

Quick Analysis:

IBBI has directed the insolvency professional that the fee payable to them should be ‘directly related to and necessary for the CIRP’ and that the same should be determined on an arms’ length basis, in consonance with the requirements of integrity and independence. Many other professionals who are governed by professional conduct and ethics of bodies like ICAI, ICSI, Bar Council of India, expressly prohibit charging a success fee. Any such success fee also eats into the proceeds available for distribution for the benefit of the creditors. The NCLAT has rightly held that the provisions regarding charging of success fee are not commercial decisions of the CoC and can be looked into by the NCLT.

5. In re: Sundaresh Bhat Liquidator of ABG Shipyard Limited (NCLAT, New Delhi)

Issue involved:

Whether a circular by IBBI restricts the applicability of a regulation and amendment in the regulation?

Key observations in the decision:

Perusing the Liquidation Regulations and Clause 12 of Schedule I as was subsequently introduced in 2019, the substituted Regulation which has been brought by way of amendment does not show that the Regulation is to be applied only prospectively. It is an open-ended provision relating to procedural law which in no way states that it will not apply to pending liquidation processes on the date of substitution. Power of the Board under Section 196(1) (p) or (t) to issue guidelines cannot be expanded to interpreting provisions made. A circular cannot substitute existing Regulation in the name of guidelines. The guidelines which are inconsistent with subordinate legislation would not be enforceable.

6. UCO Bank v. Sudip Bhattacharya (NCLAT, New Delhi)

Issue involved:

Whether the corporate debtor has any right with respect to money received from reversal of invocation of a performance bank guarantee (which was paid for by the bank’s own funds) and whether the said refund amount can be construed as an asset belonging to the corporate debtor?

Provisions:

Section 3(31), 14, IBC

Key observations in the decision:

The definition of ‘security interest’ under Section 3(31) includes an interest that has been created in favour of the secured creditor by a transaction which secures payment or performance of an obligation, but it excludes performance-based guarantees from the definition. Further, Section 14(3)(b) of the Code specifies that it does not apply to a surety in a contract of guarantee to a corporate debtor. The amount refunded under the performance bank guarantee is not an asset of the corporate debtor.

Quick Analysis:

NCLAT analysed the definition and moratorium clauses to arrive at the conclusion that the refund from a performance guarantee can be appropriated by the banks, as the same is not subject to the CIRP under the IBC. However, it ought to be noted that the same was in terms of the peculiar facts of this case wherein the initial funds as well as the margin money was transferred by the bank to the beneficiary out of its own funds (not the corporate debtor). Thus, the money was never an asset of the corporate debtor to begin with.

The author is a dually qualified professional. He is a Fellow Chartered Accountant and practices law in the courts of Delhi. He can be reached at mail@deepakjoshi.in

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