[By Vanshika Mathur]
The author is a student of Institute of Law, Nirma University.
Introduction:
In a recent case before the NCLT Bench Mumbai (ICICI Bank Limited vs Supreme Infrastructure India Limited), the issue was whether a section 7 petition under the Insolvency and Bankruptcy Code, could be filed while a scheme of arrangement was pending under Section 230 of the Companies Act. Here, the Corporate Debtor had filed an application before the Tribunal to hold
the meeting with its creditors to discuss a scheme or arrangement under Section 230. A dissenting creditor filed an application before the Tribunal under Section 7 of the IBC on default of the debt. The Corporate Debtor obtained a stay on Section 7 proceedings and an extension under Section 230. The aggrieved creditor filed an Interlocutory Application in the Tribunal in order to modify the order of Stay. The question before the court was whether such a stay can be obtained while a Section 230 application was pending.
Initiation of CIRP proceedings against a Company requires default in payment of debt. Thus, both proceedings may be initiated simultaneously, one by the company and the other by the creditor. This post analyses the overlap between Section 230 of the Companies Act where the companies try to enter into an arrangement with their creditors, and the initiation of CIRP proceedings by the creditor or the company for debt resolution. The post first examines the statutory overlap between Section 230 and CIRP, analyzes key judicial decisions on the matter, and concludes by proposing a practical approach to balance creditor rights and corporate restructuring.
The Law and the Overlap:
Section 230 of the Companies Act allows the creditors or a class of creditors, or members or a class of members to enter into a compromise or arrangement with the Company or its liquidator if the company is being wound up, and make an application to the NCLT to call for a meeting for this purpose. Under sub-section 6, approval of not less than 75% of the creditors or class of creditors is required along with the sanction order by the Tribunal for the compromise or arrangement to be valid on all creditors or class of creditors or members or class of members, the company, and its contributories. Companies often make an application under this section to enter into an arrangement or compromise with their creditors regarding debt restructuring.
Another increasingly popular option is filing an application under the Insolvency and Bankruptcy Code, 2016 which was enacted to provide a unified platform for debt restructuring allowing the Debtor and the Creditors to negotiate terms and revive the Corporate Debtor. The Creditors as well as the Corporate Debtor itself can apply to the Tribunal for initiation of the Corporate Insolvency Resolution Process. The object of the CIRP proceedings is to revive the Corporate Debtor and maximise its assets through a resolution plan. The threshold of default under the CIRP is Rs. 1 Crore making it more readily available for a creditor when compared to the 5% of total outstanding debt requirement under Section 230. CIRP has proven to be fruitful for both creditors as well as the Corporate Debtor as the Code is envisaged to be impartial to all classes of creditors.
Under Section 230 of the Companies Act, an aggrieved creditor can only object to the scheme or arrangement proposed when they have a minimum of 5% outstanding debt of the total outstanding debt. Creditors unable to meet the criteria for objection have the option to resort to initiation of CIRP (as their dues may be more than Rs 1 crore). Therefore, creditors unable to meet the criteria for objection, resort to initiation of CIRP under the Code. A similar situation arose in the abovementioned cases before the Mumbai Bench of NCLT. As such there is no restriction provided in either act where one proceeding cannot be initiated while another is pending. Thus, there is a clear overlap between the two proceedings.
When the IBC was enacted, the lawmakers anticipated potential overlaps with other proceedings. This foresight is evident from the non-obstante clause under Section 238 which grants an overriding effect over conflicting laws. Due to the overriding effect of the Code, the Code is given precedence in cases of legal conflicts. For example, in Principal Commissioner of Income Tax vs. Monnet Ispat & Energy Limited the Apex Court upheld High Court’s ruling, affirming that the IBC overrides any inconsistencies in other enactments, including Income Tax Act. The primary objective of the IBC is to reorganize and resolve corporate entities, firms, and similar bodies in a timely manner, ensuring the maximization of asset value and balancing the interests of all stakeholders, including adjusting the priority of government dues. Courts have repeatedly emphasized that the legislation’s main focus is on the revival and continuation of the corporate debtor, protecting it from liquidation.
Considering the overlap between laws, the non-obstante clause in Section 238 and Section 14, which prohibits the initiation or continuation of pending suits against the Corporate Debtor, are crucial. Therefore, ongoing proceedings under Section 230 of the Companies Act have to be stayed upon the initiation of CIRP proceedings. The Code’s objectives are designed to serve all creditors impartially and to maintain the Company as a going concern.
Where do the courts stand?
The legislative intent behind keeping an objection clause under Section 230 is to protect the interests of the minority. The courts too have been conscious to protect the interests of the dissenting minorities. In the landmark case of Miheer Mafatlal vs Mafatlal Industries Ltd., the Apex Court held that mere approval by a minority shareholder is not enough for the court to sanction a scheme under Section 391 (now, Section 230 of Companies Act, 2013), the court must consider the pros and cons of the scheme to determine whether the scheme is fair, just and reasonable. Mere approval of the majority cannot lead to automatic sanction by the court. Since once approval is given the scheme would be binding on all, including the dissenting shareholders, the court must consider if the scheme is unconscionable or illegal or otherwise unjust to a class of shareholders.
Although the Supreme Court in the aforementioned case emphasized on the rights of the dissenting minority, it has not addressed the threshold required for objecting to the scheme. Therefore, a creditor below the threshold limit cannot object, even if the scheme may affect him unjustly. In Jatinder Singh Ahuja & Ors. vs M/s Tata Steel Limited & Ors., the NCLAT dismissed the appeal stating that it was not maintainable as the creditors and shareholders objecting to the scheme held a very small stake in the company, failing to meet the threshold under Section 230(4). The court clarified that the legislative intent behind a threshold was to prevent a minuscule minority from stalling the scheme that was in the larger interest of all the stakeholders. Where the objections are rejected due to threshold, the creditors find it easier and pragmatic to initiate CIRP proceedings. This overlap between the two proceedings creates confusion and complications for both creditors and the Company.
Keeping this in mind, the Mumbai Bench in the abovementioned case of ICICI Bank Ltd. v. Supreme Infrastructure Ltd. upheld the Section 7 proceedings and removed the stay on the application. The Bench observed that IBC is a complete code with an overriding effect which should not be scuttled or circumvented merely on account of proceedings under the Companies Act. Relying on the landmark case of Arun Kumar Jagatramka vs Jindal Steel and Power Limited & Anr., the court observed that any scheme or compromise under Section 230 during Liquidation of the Corporate Debtor is subject to the provisions of the Code, including Section 29A, and any inconsistency with the Code would render the scheme inapplicable.
Conclusion:
The courts consistently give precedence to the IBC owing to Sections 14 and 238. However, from a practical standpoint, this approach is not always straightforward. When a scheme under Section 230 is nearing finalization, initiating CIRP might cause more harm, particularly if creditors use it as a tactic to obstruct the scheme. Therefore, prioritizing the Code may not be appropriate. In such cases, it is crucial for the court to exercise discretion and carefully determine which proceedings should be stayed. In order to determine this reasonably the courts should keep two factors in mind (a) the financial impact of the stay on the Corporate Debtor and (b) the provisions for the dissenting creditors in the scheme of arrangement. The choice to initiate the CIRP obviously lies with the creditor in case of a default of more than 1 crore. Therefore, in order to keep both sides of the table, we must examine whether the proceedings are arising out of genuine grievance or to merely hinder the scheme of arrangement.