[By Arzoo Kedia]
The author is a student of Hidayatullah National Law University.
Introduction
The insolvency regime in India is governed by the Insolvency and Bankruptcy Code (“IBC”) of 2016 and has been at the forefront of innovation. IBC has spurred several novel ideas, such as specifying only one class of financial creditors voting ignoring the security, and having the operational creditors left out during the vote on the resolution plan, all of them otherwise being protected by their rights pre-insolvency. These provisions are considered to be one of the strongest cross-class cramdown provisions in the world. Apart from this, the other distinctive features of IBC include Section 29A (debar the defaulting promoter), Section 32A (immunity from prosecution for past acts), Section 12A (allowing withdrawal of the Corporate Insolvency Resolution Process [CIRP] upon settlement), and the sale of a company as a going concern in liquidation to ensure that the company is rescued.
However, under these new developments, the lengthy time of CIRP has, in most cases, remained a heavy financial drain on the creditors. A recent order by the National Company Law Tribunal (“NCLT”) Hyderabad in the KSK Mahanadi Power Company case, allowing an interim distribution to the creditors before the final resolution plan, is a welcome development in this light. This article examines the evolution of interim distribution in Indian insolvency law, with specific reference to the KSK Mahanadi Judgment, and discusses its broader implications for insolvency proceedings in India.
The article is structured as follows: It first gives an overview of the historical context and legal basis of interim distribution in India and elsewhere, which then leads to an analysis of the absolute priority rule with a focus on its flexibility in the Indian context. Finally, it goes deep into the specific implications of the KSK Mahanadi Judgment and the emerging trends in judicial discretion in the absence of legislative clarity. The conclusion will discuss whether there might be a need for legislation to be rewritten and contrast the approach taken within the UK insolvency systems.
Historical Context and Legal Basis
An interim distribution is a temporary measure that involves distributing a portion of the assets while the case is still ongoing. It can be arranged through mutual agreement between the parties, or either party may request the court to order it. Although quite new in India, interim distribution has its origin in the laws of other jurisdictions, in particular, in the United Kingdom. In the UK, insolvency legislation stipulates that, administrators are allowed to make interim distributions while going through the administration process. This helps manage the cash flow needs of creditors whilst the insolvency process is still on.
The legal basis is strained in India and highly underdeveloped, and the IBC does not expressly provide for it, though the NCLT has occasionally allowed this to ensure that the interests of creditors are protected. The principle was first actually laid down by the National Company Law Appellate Tribunal (“NCLAT”) in the resolution of the IL&FS group. This directive, among several others, was passed by the NCLAT in May 2022, which directed IL&FS to release funds towards public funds, even before the final resolution process of the relevant IL&FS entity. The case of KSK Mahanadi Power Company further made the trend of decisions clear, as in long-drawn insolvency processes, financial relief is almost a rarity. Recently, the NCLT’s Hyderabad bench approved an interim distribution in the case of KSK Mahanadi Power Company, a company that had accumulated a cash balance of over ₹9,000 crores while under the Corporate Insolvency Resolution Process (“CIRP”) for an extended period, surpassing the 270-day timeline. Given the extended duration of the process and the need to protect creditor interests, the NCLT sanctioned the distribution of ₹6,400 crores from the surplus cash among the lenders, even before the resolution plan had been approved.
This decision was driven by the specific circumstances of the Indian market and the extended CIRP timeline. It marks the first instance in which creditors will recover a portion of their dues before the approval of a resolution plan, setting a precedent for future cases. The legal rationale for this decision lies in the necessity of balancing the creditors’ interests with the ongoing operation of the company, ensuring that creditors are not unfairly disadvantaged by delays in the resolution process.
Although the IBC does not explicitly address interim distributions, several provisions implicitly support this practice. Section 53 establishes the order of priority for the distribution of liquidation proceeds, emphasizing that secured and higher-ranking creditors must be paid before unsecured creditors and shareholders. However, this section does not address the treatment of interim distributions, allowing room for judicial interpretation. Section 29A bars delinquent promoters from participating in the resolution process, ensuring that interim distributions are made to credible and eligible parties. Additionally, Section 32A provides immunity to companies and their assets from prosecution for past actions, facilitating smoother interim distributions by removing legal barriers related to the previous management’s conduct. These provisions collectively contribute to a framework where interim distribution can be justified as a means of balancing the interests of all stakeholders, particularly in cases where the insolvency process is expected to be lengthy.
The Absolute Priority Rule and Its Application to India’s Law of Insolvency
The absolute priority rule is a fundamental concept in insolvency law, particularly in countries like the United States, where it is strictly adhered to. This rule requires that senior creditors must be fully paid before any funds are distributed to junior creditors or equity holders during liquidation. It is designed to ensure fairness in the distribution of a debtor’s assets, guaranteeing that those with higher priority claims are not disadvantaged during the insolvency process. However, this rule is not explicitly included in India’s IBC. The IBC’s method for handling creditor payments, particularly during the resolution process, provides a certain level of flexibility. This is because the doctrine established by courts and tribunals has been to entrust decisions regarding the distribution of resolution proceeds to the Committee of Creditors. This approach aims to shield bankruptcy proceedings from excessive judicial interference. This flexibility has been both praised for its practicality and criticized for potentially leading to inconsistent treatment of creditors.
The practice of interim distribution in India, though compliant with the IBC, raises concerns regarding its compatibility with the absolute priority rule. The lack of clear statutory provisions on interim distributions introduces the risk that junior creditors might receive payments before senior creditors are fully satisfied, which could undermine the principle of priority in creditor payments. Proponents of incorporating the absolute priority rule into India’s insolvency framework argue that it would provide clarity and consistency in the distribution process, ensuring that the rights of senior creditors are safeguarded throughout insolvency proceedings. On the other hand, critics argue that the flexibility permitted under the current framework, including the option of interim distributions, is essential for addressing the unique challenges of insolvency in India, where lengthy resolution processes can diminish asset value and harm creditor interests.
It is important to note, however, that interim distributions do not inherently violate the absolute priority rule, as long as the final distribution adheres to the established priority order. In practice, the absolute priority rule is not entirely rigid and can be subject to exceptions, particularly in complex insolvency cases where maintaining the debtor’s operations and ensuring creditor participation are critical. In the case of SEC V. American Trailers Rental Co., the Fifth Circuit held that there should be “fair and equitable” distribution in all stages of bankruptcy proceedings. The circuit then explained that “[t]he words ‘fair and equitable’ are terms of art [in bankruptcy law] – they mean that ‘senior interests are entitled to full priority over junior ones”. In such scenarios, interim distributions can serve as a pragmatic approach to balance the interests of all parties involved, ensuring that creditors receive timely payments while preserving the overall integrity of the insolvency process.
Judicial Discretion and the Need for Legislative Clarity
UK insolvency law, in particular the Insolvency Act 1986 and the recently introduced Corporate Insolvency and Governance Act (CIGA) 2020, have established a clear and easily understandable interim distribution framework for use during insolvency. An effective interim distribution can only be carried out by competent administrators for the creditors if it can be proven that there is a benefit for all the creditors. CIGA introduced other reforms, such as a free-standing moratorium—a company may implement a moratorium to temporally shield itself from the actions of creditors for a defined duration: this gives the company time to negotiate and agree on restructuring plans. It exists independently of other insolvency actions, likening this process to the principle of the pre-ibid resolution stage with more flexibility in processing interim distributions while at the same time preserving the priority of creditor claims.
India’s Insolvency and Bankruptcy Code (IBC) could benefit from similar statutory provisions. By establishing clear guidelines for interim distributions, India could reduce the current reliance on judicial discretion and address concerns related to maintaining creditor priority. The NCLT’s rulings in the IL&FS and KSK Mahanadi cases highlight how important judicial discretion has become in shaping interim distribution practices in India. However, depending too much on court interpretations without clear statutory guidelines, can lead to inconsistencies and legal uncertainty.
To tackle these issues, legislative reform is necessary. By including specific provisions for interim distributions within the IBC, lawmakers can create a clear legal framework that governs such practices. This would reduce the need for judicial discretion and ensure greater consistency across different cases. Drawing inspiration from the UK’s experience with the Insolvency Act and CIGA, Indian lawmakers could introduce statutory guidelines for interim distributions, including criteria for eligibility, rules on priority, and safeguards to prevent misuse. This approach would provide the clarity and stability needed to manage complex insolvency cases effectively.
Conclusion
Interim distribution has been a significant evolution in India’s insolvency regime, prioritizing certain interests over prolonged complications. Although this practice is necessary due to the lack of explicit statutory provisions, it creates legal and practical challenges. Integrating clear interim distribution provisions into the IBC would improve the insolvency framework, providing timely relief to creditors while ensuring fairness and legal integrity. Adopting international best practices, particularly from the UK, could further enhance the effectiveness of the insolvency process and boost creditor confidence in India’s insolvency jurisdiction.
References:
- Insolvency and Bankruptcy Code, 2016
- Insolvency Act, 1986 (UK)
- Corporate Insolvency and Governance Act, 2020 (UK)
- National Company Law Tribunal (NCLT) Hyderabad, KSK Mahanadi Power Company Case Order
- Union of India vs. Infrastructure Leasing and Financial Services Ltd. & Ors. Company Appeal (AT) No. 346 of 2018
- Business Law Review, “The Absolute Priority Rule in Indian Insolvency Law,” Kluwer Law Online, 2024.