Shaping the Indian bankruptcy regime – one amendment at a time

The new ordinance has much to recommend itself. The tone of the legislation appears to be shifting from suggestive to prescriptive and due to the collaborative process of bringing about the amendments, the prescriptions are largely in line with public comments. However, despite repeated amendments, certain past issues subsist.

On 6 June 2018, the Central Government issued another ordinance amending the Insolvency and Bankruptcy Code, 2016 (IBC). This is the third instance in a little more than half a year, of the IBC being amended to improve it, in response to industry feedback. The new amendments are, for the most part, to implement the recommendations of the Insolvency Committee, formed in December 2017 to analyse public comments and recommend measures to increase efficiency of the IBC process. The consultative process employed for the recent amendments has demonstrated the government’s willingness to cooperate with market participants to devise practical solutions rather than issue edicts from above.
 
Consent threshold 
 
The most significant change in the ordinance is the lowering of consent threshold for approval of a resolution plan from 75 per cent to 66 per cent of the vote share of the creditors’ committee (COC). This is a clear indicator of the legislators’ preference for revival over recovery. This increases deal certainty for bidders. The consent threshold has been reduced across the board with key decisions such as appointment or removal of the resolution professional, business decisions such as alienation of assets, change in capital structure, etc requiring 66 per cent vote and remaining decisions requiring simple majority. This has already had a positive implication with the NCLT, Ahmedabad in the case of Alok Industries instructing the COC to reconsider resolution plans. If you recall, Alok Industries, being one of the first twelve cases referred into bankruptcy upon RBI’s nudge, was referred for liquidation when only circa 70 per cent financial creditors voted to approve the resolution plan.
 
Withdrawal of IBC proceedings
 
One of the next most significant changes is the introduction of the mechanism for withdrawal of insolvency resolution proceedings. Of course, withdrawal is not unprecedented – the Supreme Court in the Lokhandwala Kataraia Construction case  and others, has used its inherent powers to allow such withdrawal. But such withdrawal was dependent on the exercise of the Supreme Court’s discretion on a case-to-case basis and came with attendant costs and uncertainties. The amendment allows withdrawal of insolvency resolution proceedings with the consent of 90 per cent of the COC. It is important to note that it appears that the consent of the applicant is required to withdraw the proceedings. This appears to unduly empower the applicant. For e.g., in the context of an operational creditor applicant, this will mean that the operational creditor can “hold out” even in the face of 90% per cent approval from the financial creditors. Whether this amendment pushes the law to being used more for recovery rather than restructuring, we will only know once we see the detailed regulations which prescribe how the right of withdrawal may be exercised. 
 
Flat buyers as financial creditors
 
Flat buyers have been expressly categorised as financial creditors giving them representation in the COC. Previously, the categorization of a flat buyer as a financial creditor or an operational creditor depended on the nature of his contract with the construction company. The ordinance has also provided for appointment of an authorised representative to represent multiple financial creditors of the same category in COC meetings and vote on their behalf. Many flat buyers have been delivered a raw deal by construction companies. While these measures are meant to protect their interests, it is unclear if the intended objective will be achieved. Under the new regime, the flat buyers will be categorized as unsecured financial creditors and will be protected to the extent of their liquidation value if they dissent. It is possible that in most cases, the liquidation value of the corporate debtor will not be sufficient to make any payment to such flat buyers.  Further, their representation through the authorised representative will provide them the right to vote on the COC matters but it is as yet unclear how they will be able to participate in active discussions within the COC (if at all). This will be particularly difficult where there are large number of flat buyers involved. Also, the interplay with the Real Estate (Regulation and Development) Act, 2016 will also need to evolve. A lot of this is expected to clear up when the IBBI comes out with its regulations (which are expected towards the end of June).
 
Regulatory approvals
 
An aspect of the ordinance not discussed in enough detail is the introduction of the condition on resolution applicant to obtain necessary approvals required under any law within a period of one year from the NCLT approval for the plan or the applicable statutory period, whichever is later. This change is a direct result of the recommendation of the Insolvency Law Committee. However, it may hinder rather than aid the efficient implementation of resolution plans. Necessary approvals would mean approvals required for acquisition of the corporate debtor (such as merger control or foreign exchange approvals) or for implementation of the plan (such as approval for transfer of mining lease). The objective of time-bound insolvency resolution gets defeated if the plan is approved within 270 days and thereafter languishes for a year while the resolution applicant scrambles to get the necessary approvals. Also, if the regulatory authorities choose not to grant the necessary approval after a period of one year, the plan would get defeated, harming the resolution applicant, the corporate debtor and all stakeholders of the corporate debtor. In such situation, the resolution applicant has already made the mandatory payments under the plan and must stand in line as a creditor of the corporate debtor to recover these amounts. The corporate debtor’s value has undoubtedly eroded during this period leading to loss for all stakeholders. Instead of providing for a time period of one year post plan approval, the government’s objectives would have been better served had a mechanism been prescribed for obtaining regulatory approvals prior to or simultaneously with the approval of the plan once COC approval, within the 270-day period, was procured.
 
Guarantors’ rights
 
The ordinance has put to rest the ongoing debate regarding whether the IBC moratorium extends to actions against the guarantors – as per the new amendment, it does not. While this will help lenders utilise their security packages more effectively, the amendment does not go so far as to clarify that the guarantors’ rights vis-à-vis the corporate debtor must stand extinguished after the plan is approved. Without such clarification, it may be possible for the guarantor to claim from the corporate debtor, through its statutory subrogation rights, the debt amount written-off under the resolution plan, if the guarantor pays this amount under its guarantee. Therefore, having such clarification would go a long way in aiding the revival of the corporate debtor since the resolution applicant would not have the guarantor’s sword of Damocles hanging over its head in the future.
 
Section 29A – A work in progress
 
The repercussions of Section 29A, introduced late last year, continue to be felt in nearly every insolvency proceeding. Under the ordinance, specific reliefs have been provided from the Section 29A eligibility criteria for financial entities (such as banks, FPI, investment vehicles and other regulated entities) and acquirers of companies under IBC, certain eligibility criteria have been amended to better clarify and limit their scope, and certain exemptions have been granted in respect of micro, small and medium enterprises. These are all welcome measures but the number of Section 29A challenges may only decrease with time, establishment of jurisprudence and resolution of the larger targets.
 
The new ordinance has much to recommend itself. The tone of the legislation appears to be shifting from suggestive to prescriptive and due to the collaborative process of bringing about the amendments, the prescriptions are largely in line with public comments. However, despite repeated amendments, certain past issues subsist. For instance, the IBC still provides no clarity about the extinguishment of claims not filed within the stipulated time period. Also, potential new issues may arise due to introduction of the new amendments. One thing is clear though – the government is committed to providing an efficient and effective bankruptcy regime and further changes are bound to follow to achieve this goal.

 

About the authors:

Ashwin Bishnoi, Partner, Khaitan & Co and Shruti Singh, Principal Associate, Khaitan & Co.

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