Contemporary Issues

[By Nikshetaa Jain] The author is a 2nd Year student at The National Law University, Odisha. 1. Introduction Corporate groups have grown immensely due to the various legal, tax and business benefits they provide to the owners. However, the structure of corporate groups is very complex, and it is often difficult to make clear distinctions between the ownership and management patterns. This difficulty becomes more pertinent when two or more companies belonging to the same corporate group go into liquidation since there are no provisions in the Indian Bankruptcy Code (hereinafter “IBC”), providing for combined liquidation of such companies. This lacuna in the IBC became more visible during the resolution proceedings of Videocon, Amtek, Adel, Aircel and Jaypee. Thus, there was a need to develop a framework for group insolvency in India. For this purpose, the Working Group on Group Insolvency was constituted, and it submitted its recommendations in the form of a report in 2019. The report suggested several mechanisms which could be used for group insolvency. One of the suggestions of the report was that provisions for substantive consolidation might be developed but at a later stage. However, the Court had applied the doctrine of substantive consolidation in the Videocon case. Since there is no legislative framework in the IBC for applying the doctrine, the courts have a broad discretion to apply the doctrine. Thus, there is a need to develop a framework for the application of this doctrine. While formulating a framework for substantive consolidation, guidance can be taken from foreign jurisdictions as group insolvency is a relatively new concept in India. In this article, the author tries to analyse the doctrine of substantive consolidation in light of the themes discussed in the landmark judgment of Owens Corning. 2. Meaning of Substantive Consolidation Substantive consolidation is a process wherein the assets and liabilities of two companies belonging to the same corporate group are combined so that the companies are treated as a single entity. The results of this process is similar to a merger as creditors of the distinct entities now become the creditors of the consolidated estate of the entire corporate group. 3.  Substantive Consolidation in light of the themes of Owens Corning Case Since there are no provisions for group insolvency in India, reliance is placed on foreign jurisdictions where substantive consolidation has been used commonly in group insolvency cases. In USA, substantive consolidation has been developed due to judicial interpretation. Owens Corning case has majorly contributed to the jurisprudence on substantive consolidation. The themes laid down in the case of Owens Corning are one of the most important principles which govern the application of this doctrine in the USA. In October, 2005 Owens Corning, a corporation and its subsidiaries filed for reorganization under the US Bankruptcy Code and subsequently developed a reorganization plan based on substantive consolidation of all the subsidiaries. The District Court granted a motion for substantive consolidation considering the administrative efficiencies of the doctrine. However, on appeal, the Third Circuit reversed the District Court’s decision and laid down the five themes which must be given due consideration while applying the doctrine of substantive consolidation. The first theme is to respect the rule of entity separateness and to use the doctrine of substantive consolidation only in exceptional cases. Limited liability and entity separateness are the most fundamental principles of corporate law. The structure of corporate groups has become the most preferred due to the fundamental principles of limited liability and separateness of entity, forming the core of the business operations. The principles of limited liability and entity separateness cannot be violated merely because it is difficult to untangle the financial affairs of various companies in the corporate group. The Courts are more reluctant to use this doctrine when a country follows the entity theory. The entity theory presumes that one entity of the corporate group cannot be liable for the debts of the other members of the same group. English laws follow the principle of entity theory,[i] and since most of the Indian laws are based primarily on the English laws, it is safe to assume that India also follows the entity approach. The Working Group also suggests that the doctrine of substantive consolidation, if adopted in the Indian insolvency law, should be applicable in a limited manner. Thus, the first theme can be applied in India as well. The second theme is that substantive consolidation is a remedy for those harms caused by the shareholders who have abused the principles of separateness. The doctrine of substantive consolidation was developed as a remedy for the creditors who had suffered harm due to abuses of the corporate form. Majority of the harms are caused to the creditors due to the fraudulent activities undertaken by an entity under the garb of corporate law principles. If the principles of corporate law would lead to fraud or injustice, then the equitable principle will apply in the form of substantive consolidation. This theme is in consonance with ‘creditor in possession’, an objective of the Indian insolvency law,  as substantive consolidation places the creditors in control of the assets of all the companies of the corporate group in case of abuse of corporate law principles. Substantive consolidation is suitable where an entity completely controls or dominates the corporate group of entities and transfers money between different entities as if the entities are mere departments of the group. The third theme is that mere benefit in the administration of a case cannot be the sole ground for applying the doctrine of substantive consolidation. Substantive consolidation cannot be granted merely on the ground that it is necessary for formation of a reorganization plan. Since any decision to consolidate the assets and liabilities of two or more entities of a corporate group affects the rights of both the debtors and the creditors, substantive consolidation should be applied only after a detailed examination of the rights and interests of the parties involved.[ii] In India, substantive consolidation was used for the first

[By Mayank Bansal & Dev Bansal] The authors are students at the Dr B.R Ambedkar National Law University, Sonepat. Introduction For a successful insolvency regime, the prevention of fraudulent transactions made by the management of the corporate debtor in the hands of certain preferred creditors is crucial to uphold justice. Since these transactions are made prior to the initiation of the Corporate Insolvency Resolution Process (“CIRP”), they reduce the availability of funds for bona fide creditors and other stakeholders to get their dues equitably in the insolvency process. These are called “preferential” or “avoidable” transactions, and The Insolvency and Bankruptcy Code, 2016 (“IBC”) provides for their reversal. Though IBC empowers the Resolution Professional (“RP”) to initiate proceedings against such transfers before the National Company Law Tribunal (“NCLT”), it is silent on their completion period, and more importantly on a situation where the NCLT is not able to adjudicate on these transactions till the completion of CIRP. Recently, the High Court of Delhi (“H.C.”) in Venus Recruiters Private Limited v. Union of India while facing this issue ruled that avoidance proceedings must be adjudicated before or at the time of approval of the resolution plan, i.e., before the completion of CIRP and not after it, on account of limited jurisdiction of NCLT, finite nature of RP, and that no one seemed to be the beneficiary of the recovery.  This article seeks to highlight plausible pathways the HC could have followed in response to the encountered issues and assert that preferential transactions can continue beyond CIRP, for which the NCLT is the appropriate authority and RP should only continue with the proceedings. A distribution mechanism for the subsequent recovery has been propounded, and lastly, the question of litigation cost has also been dealt with. Current Conundrum With Proceedings Avoiding Preferential Transactions The H.C. in the above case quashed the avoidance proceedings post the approval of the resolution plan. This seems absolutely against the principles of justice since the lapse of time shouldn’t be an obstacle in undoing the unjust; the basic essence of such avoidances. As stated in the ICSI’s Statement of Best Practices, the avoidance proceedings aim to restore the unjust amount from the defrauding directors, promoters, and creditors, whereas CIRP relates to the resolution of the corporate debtor, and thus the two should be treated separately. Moreover, the Report of the Insolvency Law Committee (“ILC”) suggested that there shall be no prescriptive timelines for the completion of these proceedings, and they may continue beyond the period of CIRP. These proceedings may involve assessing multiple impugned transactions within the clawback period that may take longer than CIRP, and hence, these proceedings should have been allowed to pursue beyond CIRP. NCLT Should Continue The Adjudication The H.C. held that the NCLT can only adjudicate the avoidance transactions before or at the time of approval of the plan. However, as ILC suggested NCLT for deciding upon other related facets (such as the distribution of the recovery in such cases) even post CIRP, it is apparent that it may also adjudicate these transactions. Besides this, Rule 11 of the NCLT Rules, 2016 empowers the NCLT with “inherent powers” to pass orders as it may deem fit in given facts and circumstances to ensure equity and justice. Although Section 63 of the code bars a civil court to adjudicate any issue for which the NCLT is empowered, the stated judgment concluded in leaving the party to their civil remedies outside the IBC. Transferring jurisdiction to a civil court is blatantly against the provision and spirit of the code. Role Of Resolution Professional On the locus standi of the RP, the court strictly applied the principle laid down in Committee Of Creditors Of Essar and held that the role of RP is finite in nature and he can’t continue as “former RP” after the completion of the plan. However, ILC scrutinizing various alternatives suggested that the RP shall continue with the existing practice and remain the appropriate authority to carry on with the preferential transaction. IBC is a newly enacted code and numerous amendments are undertaken in pursuance of the committees’ recommendations and judicial decisions. Therefore, following the ILC’s recommendations, RP should have continued the proceedings. Distribution Of Recovery The H.C. was of the view that post plan’s approval by the Adjudicating Authority, proceeds from preferential transactions would thereafter neither go to the creditors nor the resolution applicant. However, this seems to be in stark contrast to the ILC’s recommendations on the distribution of the avoidance recovery suggesting the adoption of a flexible approach for the same and to leave to the prudence of the adjudicating authority whom to render the benefits, while explicitly mentioning the creditors and the successful resolution applicant among the beneficiaries and even suggesting a distribution mechanism for the former. At present, there are no concrete provisions on the distribution of such recoveries but recommended to be pursued based on facts and circumstances of the case. Inspired by the U.S. bankruptcy laws, below is an analysis of situations per the ILC’s recommendations. Creditors as Beneficiary The key aim of avoiding these transactions is to avoid unjust enrichment of certain creditors over others, which in effect means that creditors’ welfare is paramount in such situations. The bankruptcy laws of countries like the U.S. also advocate creditors’ benefit, either direct or indirect. While dealing with Section 550 of the U.S. bankruptcy code stating such recoveries to be for the “benefit of the estate”, the Court of Appeals has observed this phrase to articulate the creditors as beneficiary and that they must be ‘meaningfully and measurably benefitted’. In In re Centennial Industries, Inc., the Court of Appeals permitted the debtor to pursue avoidance actions even when the reorganization plan provided for the fixed payments to unsecured creditors over five years, stating that any such recovery will be additional security for the plan’s fulfilment and increase the likelihood of the creditors receiving their future payments.  Hence, the creditors could have been identified by the HC

[By Devansh Rathi] The author is a student at the Dr Ram Manohar Lohiya National Law University, Lucknow Introduction – Since the advent of the Insolvency and Bankruptcy Code of 2016 (“the Code”), the adjudicating and the appellate authority has relied upon and confined itself to the bare text of the Code to interpret the legislature’s intent to disentangle the numerous issues that have arisen. One peculiar concern that has surfaced was whether seeking a refund of an advance given to a corporate debtor would tantamount to an ‘operational debt’ as under Section 5(21) of the Code? The Adjudicating Authorities, in various instances, have answered the same in negative. The issue first arose in SHRM Biotechnologies Pvt. Ltd. v. VAB commercial Pvt. Ltd., where the NCLT held that since the appellant, which invoked section 9 of the Code, was not rendering any goods or services to the debtor, he would not be called an operational creditor. The bench also perused section 5(21) of the Code and carved out three important elements – (i) debt arising out of provision of goods; or (ii) services; or (iii) out of employment. Since the appellant was not falling within the ambit of any of these elements, the bench dismissed the application. Even the NCLT Mumbai in TATA Chemicals Ltd. v. Raj Process Equipments and Systems Pvt. Ltd., while rejecting the application held that the petitioner has not provided any goods/services to the debtor and his claim cannot be called an operational debt. Hence, the Adjudicating Authorities have adhered to the four corners of the definition as inscribed in the Code. However, the NCLAT in Overseas Infrastructure Alliance (India) Pvt. Ltd. v. Kay Bovet engineering Ltd. (“Kay Bovet”) has taken a different approach when perusing the same issue which happens to be the crux of this writing. The author doesn’t aim to criticize the judgement but to highlight the discrepancy and offer a viable reason of the Appellate Authority behind such a discrepancy. The Tripartite Agreement in Kay Bovet – A tripartite agreement was signed between the employer, the contractor (operational creditor/appellant), and the sub-contractor (corporate debtor/respondent). As per the agreement, the Respondent was engaged in designing, engineering, supplying, installing, testing, etc. of factory plant for the employer while Appellant was responsible for all activities pertaining to engineering, procurement and construction as EPC contractor and had to handover the project to the employer upon its completion. In an essence, the contractor was rendering services to the employer while the sub-contractor was rendering the services both to the employer and the contractor, with an objective to fulfil the needs of the employer. In pursuance of the same, the contractor advanced 10% of the contract value to the sub-contractor. However, due to some reason, the tripartite agreement was terminated and the contractor sought a refund of the amount advanced. The bench while looking through the terms of the agreement ruled that the agreement provided for the rendering of services and supply of goods and the contractor’s claim was in such respect. Hence, the contractor’s advance payment to the sub-contractor would make him an operational creditor. The bench also refuted the respondent’s claim of a pre-existing dispute which was sub-judice before the Hon’ble High Court. Analysis – An operational creditor is someone who supplies a good or renders a service, just like a financial creditor who is granting a financial loan. Even the person who is availing the financial loan won’t be a financial creditor even if due to the terms of the contract, further amounts are to be disbursed as the person who is taking the loan is not doing so for the time value of money or interest. The essential ingredient for an operational creditor is that the debt due to them has to have arisen because they have either given goods or rendered some services. Therefore, in ordinary circumstances, a refund of advanced money would not be an operational debt as the buyer is not owed any amount because he has not supplied any goods or services but the debt is actually due, as for some reason the contract could not be concluded. However, the NCLAT in Kay Bovet has taken a different stand but it suffers from certain discrepancies. Here, the sub-contractor was rendering services to the employer and the contractor; however, the contractor was not rendering any services to the sub-contractor but only to the employer. In light of the same, if we examine section 5(21) which says – “a claim in respect of the provision of goods and services….” The term ‘in respect of’ should here mean only pertaining to that particular provision of goods or rendering of services to that party and not to any other third person. But as per the facts, the contractor was not providing any goods or services to the sub-contractor. Here the claim of the contractor was pertaining to the provision of goods and services but those goods and services were rendered by the contractor to the employer and not to the sub-contractor. The stance taken by the NCLAT would have been appropriate if the contractor would have been rendering the services or providing goods to the sub-contractor. The facts of the case are silent on the same as the judgement doesn’t state anything explicitly. To buttress the decision taken by the NCLAT one would have to rely on the implicit logic that the contractor and subcontractor were rendering a service to each other to ultimately fulfil the needs of the employer. The Contractor advanced money to the subcontractor but the Contractor may also have been providing materials, services, etc. The judgment doesn’t reproduce the agreement. Sometimes, in the case of subcontracting, the contract may have provisions such as that certain material to be used for construction will be provided by the main contractor to the subcontractor. In such case, the NCLAT may have felt that the contractor was also to provide goods and services to the subcontractor. Since we don’t have access to the contract