The Insolvency and Bankruptcy (Amendment) Ordinance, 2018: A Practitioner’s Perspective

The Insolvency and Bankruptcy (Amendment) Ordinance, 2018: A Practitioner’s Perspective.

[Mr. Anshul Jain]

The author, Partner at Luthra & Luthra Law Offices in the General Corporate and Regulatory Practice group identifies in this update the key changes and briefly comments wherever appropriate from a practitioner’s perspective.

On 06 June 2018, the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018 (“Ordinance”) was promulgated by the President exercising his powers under Article 123 (1) of the Constitution of India. The need for the Ordinance was felt, as the gazette noted, to “balance the interests of various stakeholders … especially interests of home buyers and micro and small and medium enterprises, promoting resolution over liquidation of corporate debtor by lowering the voting threshold of committee of creditors and streamlining provisions relating to eligibility of resolution applicants”.

  1. Home buyers/ Allottees under a real estate project
  • A “financial creditor” means any person to whim a financial debt is owed. Section 5 (8) of the IBC defines “financial debt”. This includes, per sub-clause (f) of section 5 (8), “any amount raised under any other transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing”.  The Ordinance inserts an explanation to this sub-clause providing that “any amount raised from an allottee under a real estate project shall be deemed to be an amount having the commercial effect of a borrowing”. This is intended to cover home buyers/allottees under a “real estate project” [as defined by the Real Estate (Regulations and Development) Act, 2016].

This amendment does not clarify if the customers of a real estate project will be treated as secured or un-secured creditors. Even if they are provided a voice in the Committee of Creditors (“CoC”), it would hardly provide any benefit to them as they would be one of many creditors sitting in the CoC and their impact would be limited only to the extent of their claim out of the total claim of financial creditors against the company. Depending on the value of their claim, they can easily be voted out by other secured financial creditors. Even if they are heard, the secured creditors can easily assert that they have a higher claim and thus should be paid first and whatever is left after them getting repaid can then be distributed to unsecured creditors.

Furthermore, this amendment does not deal with the means to fully protect their investment in the real estate project. At best, the amendment’s impact would be to provide them some amount of recovery on their claim against the company. What the customers really want is either the money or the homes/units back. This is presently not addressed.

A more effective way to tackle the problem could have been to (i) put the home buyers in the waterfall structure prior to the financial creditors, or (ii) inserting a specific obligation on the incoming resolution applicant to build and deliver the units.

One may also witness situations where no resolution plan is approved and the company goes for liquidation, and in which case the secured creditors can easily use Section 52 of IBC and seek a specific enforcement of their security interest. In a real estate company, the main security interest offered to lenders is the underlying land. So if the secured lenders choose to specifically enforce their security and take away the land from the liquidation waterfall, the customers will be left with nothing to realise from the CIRP.

These concerns will, hopefully, soon be addressed in the impeding CIRP Regulations.

  1. CIRP period
  • Extension: The CIRP period can be extended from initial 180 days by obtaining 66% of voting shares of the CoC (instead of earlier 75% of voting shares)
  • Withdrawal: The Adjudicating Authority may allow the withdrawal of application filed for CIRP by approval of 90% voting share of CoC.

It would be interesting to see if the CIRP regulations define the ‘applicant’ as the one who originally filed the CIRP application or anyone who of 90% votes in the CoC. It would also be interesting to see how, in a case where the CIRP application was filed by him, an operational creditor would be bound by the decision of the CoC unless his claim is been settled.

  • Moratorium: The principle of ‘moratorium’ shall not apply to a surety in a contract of guarantee to a corporate debtor.

This is a huge relief to the lenders who were earlier barred by latest NCLAT order in the matter of SBI v. V. Ramakrishnan and Vessons Energy Systems [Company Appeal (AT) (Insolvency No. 213 of 2017] to invoke guarantee giving by the promoters to secure the loans. With this amendment, the concept of moratorium shall not apply to contracts of guarantee provided to a corporate debtor. This is now in line with the recommendations of Eradi Committee as well.

  • Compliance during CIRP: The IRP/RP shall now be responsible for complying with the requirements under any law for the time being in force on corporate debtor.

This amendment now makes it amply clear that IRP/RP is required to comply with all applicable laws including but not limited to compliances under the Companies Act and the SEBI (Listing Obligations and Disclosure Requirements). A mere plea that the company is under CIRP and thus no compliances are necessary will not be tenable hereon. This is also line with the amendments brought by the SEBI a few days before the Ordinance.

  • Representation in the CoC and related party: A new proviso has been inserted under section 21(2) which exempts the financial creditor, which is regulated by a financial sector regulator, if it is a related party of the corporate debtor solely on account of conversion or substitution of debt into equity shares or instruments convertible into equity shares, prior to insolvency commencement date.

This provides relief to banks, ARCs, NBFCs, etc. who were otherwise considered as related parties due to their shareholding in the corporate debtor.

  • Representation in the CoC—other aspects: A new sub-section 6A has also been inserted u/s 21 to deal with representation of financial creditors in the CoC. It provides:
  1. a) If the financial debt is in the form of securities or deposits and the terms of the financial debt provide for appointment of a trustee or agent to act as authorised representative for all financial creditors then such trustee or agent shall act on behalf of such financial creditors;
  2. b) If the financial debt is owed to a class of creditors exceeding the number as may be specified, then the IRP shall make an application to Adjudicating Authority along with list of all such financial creditors containing the name of an insolvency professional, other than the IRP himself/herself, to act as their authorised representative.
  3. c) If the financial debt is represented by a guardian, executor or administrator, such person shall act as authorised rep on behalf of such financial creditors. Such authorised representative shall attend CoC meetings and shall vote on behalf of each financial creditor to the extent of his voting share. The remuneration of such authorised rep shall be as per the terms of financial debt or relevant documentation or shall be jointly borne by the financial creditors.

It appears that in case of homebuyers, the Insolvency Resolution Professional (“IRP”) has the right to propose the name of insolvency professional that will represent the allottees in the CoC. Since the pool of allottees would generally be large, there appears to be no mechanism as to representation of allottees in recommending the name of the said insolvency professional or his/her appointment. Further, no mechanism is prescribed as to who will be responsible to collect and pay the remuneration of the said insolvency professional. Furthermore, the IRP has to vote on behalf of each and every allottee and, thus, it would be interesting to see how confidential documents like resolution plans, etc would be provided to every single allottee and how each and every allottee would react to the plan. The idea was to safeguard the interest of the allottees but instead, by providing individual votes to each and every allottee (exercised through the IRP, this concept may end up being counter-productive and self-defeating for the allottees.

  • Decision of the CoC:- Section 21(8) is further amended so as to ensure that all the decisions of CoC are taken by 51% of voting share of financial creditors (instead of earlier prescribed 75%)
  • Approval of CoC for certain actions: Actions mentioned under section 28(1) can be taken by the resolution professional with prior approval of 66% of voting shares of the CoC (instead of earlier prescribed 75%).
  1. Persons not eligible to be resolution applicants—Section 29A
  • Three amendments to clause (c):-
    • First, instead of the word ‘has an account’, the words ‘at the time of submission of the resolution plan has an account’ is be substituted.
    • Second, after the words ‘Banking Regulation Act, 1949, the words ‘or guidelines of a financial sector regulator issued under any law for the time being in force’ is inserted.
    • Third, after the first proviso, a new proviso is inserted with two explanations:The proviso states that nothing under clause (c) shall apply to a resolution applicant where such applicant is a financial entity and is not a related party to the corporate debtor.

Explanation 1 provides that for the purpose of the new proviso, the expression ‘related party’ shall not include a financial entity regulated by a financial sector regulator, if it is a financial creditor and is a related party of the corporate debtor solely on account of conversion or substitution of debt into equity shares or instruments convertible into equity shares, prior to insolvency commencement date. This is a welcome relief to NBFCs, ARCs, etc who want to participate in the bidding process.

Explanation 2 provides that if a resolution applicant has an account, or an account of a corporate debtor under the management and control of such person or of whom such person is a promoter, classified as NPA and such account was acquired pursuant to a prior resolution plan approved under IBC, then the provisions of clause (c) shall not apply to such resolution applicant for a period of 3 years from the date of approval of such resolution plan by Adjudicating Authority This would take care of situations of group defaults and would provide ample time to the resolution applicants in resolving the group level default.

  • Conviction for offence: Under clause (d) a laundry list of statutes is prescribed wherein conviction for offence punishable with imprisonment for 2 years or more makes the applicant ineligible; for all other laws, the period prescribed for conviction for offence punishable with imprisonment is 7 years or more. The amended clause (d) further states that this in-eligibility shall not apply to a person after the expiry of period of 2 years from the date of his release from imprisonment. This clause shall also not apply in relation to ‘holding company, subsidiary company, associate company or related party of a person referred to in clause (i) and (ii) of explanation of connected person.With this amendment, frivolous litigations against resolution applicants will become untenable.
  • Disqualified director:-The disqualification prescribed under clause (e) referring to a person disqualified as a director under the Companies Act, 2013, is now not to apply in relation to ‘holding company, subsidiary company, associate company or related party of a person referred to in clause (i) and (ii) of explanation of connected person.
  • Disqualification arising out of being promoter, or in management or control of certain corporate debtors: The disqualification prescribed under clause (g) of the principal Act shall not apply in cases where the preferential, undervalued, extortionate credit transactions or fraudulent transactions took place prior to the acquisition of the corporate debtor by resolution applicant pursuant to a resolution plan approved under the IBC or pursuant to a scheme / plan approved by a financial sector regulator / court and such resolution applicant has not contributed to any such transactions
  • Disqualification qua execution of guarantees:  Under clause (h), instead of restricting the disqualification to ‘enforceable guarantee’, it would now apply to ‘guarantees’; furthermore, it is prescribed that such guarantee has been invoked by the creditor and it remains unpaid in full or part.
  • Disability under foreign jurisdiction:- Clause (i) of the principal Act deals with disability corresponding to section 29A (a) to (h) incurred in a foreign jurisdiction. The expression in clause (i) “has been subject to any disability … under any law in a jurisdiction outside India” has been substituted with ““is subject to any disability …”. This would cover present defaults/situations and not past dealings.
  • Connected person:-Under the ‘explanation’, the old proviso is replaced with a new proviso which states that nothing in clause (iii) shall apply to a resolution applicant where such applicant is a financial entity and is not a related party of the corporate debtor. The expression ‘related party’ shall not include a financial entity regulated by a financial sector regulator, if it is a financial creditor and is a related party of the corporate debtor solely on account of conversion or substitution of debt into equity shares or instruments convertible into equity shares, prior to insolvency commencement date. Furthermore, the definition of ‘financial entity’ is provided which inter-alia means scheduled bank, FII, FVCI, FPI, ARC, AIF, etc.
  1. MSME
  • Application of IBC to MSME:- Section 240 of the principal Act has been amended providing that the provisions of clause (c) and (h) of section 29A shall not apply to the resolution applicant if the corporate debtor is any micro, small and medium enterprise.

This is a welcome relief for MSMEs wherein promoters, if were earlier disqualified under clause (c) and /or (h), can now submit their bids in their companies, thereby resulting in lesser chances of liquidation of such companies.

  1. Approval of resolution plan
  • Required voting:- Section 30 (4) has been amended to the effect that in order to approve a resolution plan, vote of not less than 66% of voting right of CoC (instead of earlier prescribed 75%) shall be required.

The most awaited amendment which will help in securing decisions much more easily and efficiently. This is because the liquidation decision is to be done by 66% of voting right of CoC.

In conclusion—it must be true of any new legislative framework that it becomes more and more effective with time if the legislature and executive respond in a timely fashion to the experience and ideas of all the stakeholders. The Ordinance is an extremely good step. It is time to await the regulations.