The IBC has been a transformational economic legislation which has altered the face of insolvency resolution and liquidation in the country. In the six years of its existence, the legislature has been constantly working towards making it a robust legislation by ironing out the wrinkles through timely interventions. The Ministry of Corporate Affairs has started this year by floating a fascinating discussion paper inviting public comments on further changes being considered. The paper flags over 40 proposed changes to address various concerns identified in the last few years. While many of the suggestions are encouraging, some proposals need a second look. In this piece, we discuss certain key proposals that require a deeper examination.
Information Utilities (IU) have been introduced to serve as a comprehensive and objective repository of financial information regarding the debts of an entity. Currently, it is mandatory for financial creditors to submit financial information with the IUs. In case of a default, the record with the IU can be presented to the NCLT to prove the existence of debt and default. In practice, most financial creditors have started relying on IU records to support their insolvency application.
MCA has now proposed to widen the net and make it mandatory for operational creditors to file relevant financial information with the IUs prior to initiating any insolvency action. It is also suggested that a corporate debtor would be given a reasonable opportunity to respond to the financial information concerning them. MCA is also considering an amendment to provide that the NCLT will only rely on the record of the default available with the IUs to determine if a default has taken place while considering insolvency applications under Sections 7 and 9.
This proposal could spell trouble and inconvenience for operational creditors. Operational creditors are often smaller vendors, employees, etc., who may not have the institutional facilities or discipline of financial creditors. It is far too ambitious to assume that they will be able to regularly update the information with the IUs. Further, it is unlikely that any corporate debtor would admit to a default in response to an authentication request from IUs, thereby making this exercise pointless. It may also not be prudent to be over-reliant on IUs where an operational debt is involved. CIRP has irreversible consequences on a company and its management. To deny the company a chance to make its case before a judicial body altogether would undermine fundamental principles of natural justice and be open to challenge.
MCA has suggested that the Code may be amended to segregate the concept of the resolution plan from the manner of distribution of proceeds. This looks like an attractive idea at first blush. While the amendment would expedite the approval process, it is likely to throw the creditors under the bus as the plan could be implemented before the plan proceeds reach the creditors. This proposal also seems to suggest that the creditors’ vote on the resolution plan could happen earlier in time than the vote on the distribution mechanism. A creditor unaware of its entitlement under the plan may not be able to decide whether it is commercially beneficial to assent or dissent against the resolution plan. This amendment would also result in a multiplicity of proceedings for an already inundated NCLT.
A resolution plan is not meant merely to capture the terms of a bid. It is a holistic solution that creditors arrive at to mutually resolve their debts while reviving an ailing company. The inter-se distribution mechanism is an integral part of this and ought not to be separated.
The paper proposes to introduce an ‘objective formula’ to equitably distribute the plan proceeds. In that, the creditors will receive proceeds up to the corporate debtor’s liquidation value for their claims in the order of priority provided in Section 53. Any surplus over such liquidation value would be rateably distributed amongst all creditors in the ratio of their unsatisfied claims.
First, this suggestion does not address the most teething problem that plagues creditors today – the treatment of security interests and inter-se priorities in a resolution scenario. This issue which needs urgent legislative redressal, has been overlooked. Second, the idea of prescribing a strict distribution mechanism deeply contradicts the settled principles of IBC and may result in a case of over-legislation. This one-size-fits-all mechanism takes away the freedom of the creditors to curate a solution that meets their needs. Third, this suggestion assumes that the resolution amount would always be more than the liquidation value and does not account for cases where the resolution amount is below the liquidation value.
MCA proposes that the CoC should have the ability to request the NCLT to dissolve an entity where it believes that the liquidation process would not be beneficial. Dissolution brings the existence of the company to an end. This seemingly addresses a situation where the corporate debtor has little to no realisable assets and is likely to save substantial time and resources.
The proposal fails to account for certain crucial processes that are undertaken by the resolution professional/liquidator. For instance, the resolution professional/liquidator is statutorily required to evaluate whether the corporate debtor has engaged in improper transactions that should be avoided. Reversal of improper transactions could entail recovery of significant amounts that would ultimately benefit creditors. The creditors applying to the NCLT for direct dissolution may lack the foresight to see beyond the public records of a company and would not be able to unearth the true value of the corporate debtor without a thorough forensic audit.
Interestingly, the option of early dissolution is contemplated in other jurisdictions at the instance of the liquidator. Under the UK insolvency statute, an application for early dissolution can be made by a liquidator only after investigating the affairs of a company. The application can be resisted by stakeholders who believe that further investigation is required. It may be useful for us to draw some lessons from this model.
When a corporate debtor slips into liquidation, the Code contemplates a rehash of several steps already undertaken during the CIRP, such as consolidation, verification, admission/rejection, and valuation of claims. MCA is considering the deletion of these steps to minimise delays. While well-meaning, there ought not be a complete obliteration of these processes. With the passage of significant time, there is a need for updating information gathered during the CIRP. This proposal also fails to account for some nuanced differences between the processes. For instance, unlike a resolution professional, a liquidator has adjudicatory powers in relation to accepting and rejecting claims. Accordingly, the same activities, when conducted again in a liquidation scenario, have different consequences. The legislature would be remiss in treating these as a simpliciter replication.
Some of the big-ticket proposals aim towards streamlining fast-track insolvency and fixing the widely criticised pre-packaged insolvency process. Another such proposal is the possibility of project-specific CIRP in the real estate sector, which is being hailed as a panacea for homebuyers.
Absent specifics, it would be premature to comment on these ideas as the devil lies in the details. However, there appear to be loopholes at first glance. For instance, the suggestion that the NCLT’s role in fast-track insolvency should be minimised to the stage of approval of a resolution plan does not account for the obstacles that an unaccommodating management would pose. Minor changes to the pre-pack insolvency regime fail to address the core issues of an impractical timeline and the inherent lack of trust between promoters and creditors.
Although project-specific CIRP is interesting in theory, this may not work in practice. Often, each project is housed under an SPV, in which case, the benefit of this amendment would not apply. In other cases, developers tend to intermingle resources, funding, etc., and there is barely any real independence between the projects. The workability of the IBC is hinged on specifics, and it would be useful to see the fine print.
There are certain crucial issues, such as cross-border and group insolvency, that do not find any mention in the consultation paper. In any case, the paper leaves one optimistic that the legislature is eager to course correct.
Ashish Bhan, Aayush Mitruka, and Lisa Mishra are lawyers working at Trilegal. Ashish Bhan is a partner, Aayush Mitruka is a Senior Associate, and Lisa Mishra is an associate at the firm.
*Views expressed are personal.