Insolvency Law Archives - Page 13 of 21

Did the NCLAT Through IL&FS Case Rejig the Waterfall Mechanism?

[By Nishita Agrawal and Arth Singhal] The authors are students at the National Law University Odisha. The Companies Act, 2013 [“the Act”] lays down special provisions with respect to prevention of oppression and mismanagement in order to safeguard the interests of the investors, the minority shareholders, and especially the interests of the public under Sections 241 and 242. In September 2018, the Central Government had filed an application under Section 241(2) of the Act against the Infrastructure Leasing & Financial Services Limited [“IL&FS”] a systemically important core investment Non-Banking Financial Company [“NBFC”] & its 169 group entities. The provision allows Central Government to make an application to the Tribunal for relief if it is of the opinion that the affairs of the company have been or are being conducted in a manner prejudicial to the public interest. In case of the service provider and its entities, the Central Government was of the opinion that its managerial persons were negligent and incompetent and its affairs were being conducted in a manner detrimental to the public interest.[i] In order to resolve such matters under Section 241, the tribunal is empowered under section 242(1) to make ‘any order’ as it may think fit to end the matters complained of. Sub-clause (2) further provides for an illustrative list of reliefs along with a residuary clause which confers wide powers on the tribunal to pass orders with regard to any matter which, in its opinion is just and equitable.[ii] This power of the tribunal has been affirmed in the case of Sanjeev Agrawal v. Shri Omkaleshwar Coloniseers Pvt. Ltd.[iii] where the National Company Law Appellate Tribunal [“NCLT”] reiterated the Supreme Court’s [“SC”] decision on the scope of Section 241(2).[iv] The court stated that “the jurisdiction of the Court to grant appropriate relief … indisputably is of wide amplitude” and that “[r]eliefs must be granted having regard to the exigencies of the situation”. When the affairs of the company are conducted in a manner prejudicial to the public interest, the appropriate tribunals can pass orders relating to change of management or debt restructuring so that there is an inflow of money to restore the trust of the public stakeholders.[v] Pursuant to this power, the NCLAT in Union of India v. Infrastructure Leasing & Financial Services Limited[vi] on March 12, 2020, allowed for restructuring of IL&FS and its entities by approving the resolution framework proposed by the Central Government. However, NCLAT in the aforementioned resolution framework refused to follow the waterfall mechanism for distribution of proceeds, as laid down under Section 53 of the Insolvency and Bankruptcy Code 2016 [“the code”]. Section 53 of the Code provides for a detailed hierarchical order of distribution of liquidated assets of the Corporate Debtors [“CD”] between the Operational Creditors [“OC”] and the Financial Creditors [“FC”], in case of liquidation. Further, Section 30(2)(b) of the code required that the payment of debts of the OC were to be made in a manner that the board may specify which shall not be less than the amount to be paid to the OC in the event of a liquidation of the CD under Section 53. In India, the code is still in its nascent stages and faces several issues with respect to its applicability and interpretation. There has been a wide array of disagreement as to whether the NCLAT was within its powers to not follow the waterfall mechanism, or not. With this background, however, it is the authors’ opinion that the NCLAT was right in not following the waterfall mechanism due to reasons discussed hereafter: The code remains inapplicable in the present case due to lack of adequate provisions for resolution of such companies; The principles of code are also not binding on the tribunal under Section 424 of the Act or any other provision; and Even if code or its principles were applicable, it would have been impossible to make the ends of justice meet, as public interest is not an exception to the code. Finally, the IL&FS case has no bearing on the settled principles of code, it is not contrary to the Essar Steel judgment[vii] and the commercial wisdom of the Committee of Creditors [“CoC”] still has supremacy. Non-Applicability of the code When IL&FS defaulted on its debts and was exploring its options, the Code did not pose as a viable solution primarily because, it is a Financial Service Provider [“FSP”] as defined under Section 3(17) of the code, which, until recently,[viii] was excluded from the purview of the code. A financial service provider is a person engaged in the business of providing financial services in terms of authorisation issued or registration granted by a financial sector regulator[ix]; Although, as per Section 227 of the code, the Central Government had the power to notify FSPs which may be conducted under the Code, but failure to do the same, made a remedy under the code impossible. Furthermore, the code lacks a proper framework for the resolution of Group Companies, which discouraged the resolution of IL&FS under the provisions of the code. In this background where India lacked any specific framework for resolution of corporations to the likes of IL&FS, the Financial Resolution and Dispute Insurance Bill first introduced in 2017 could have posed a viable solution to the issues arising in the present case had it not been withdrawn in 2018. Therefore, the code remained inapplicable in the present case, and the tribunal issued the order of resolution under Section 242 of the Act. Non-bindingness of the Principles of code under Section 424 of Companies Act, 2013 Section 424 of the Act lays down the procedure to be followed by the appellate tribunal while deciding any proceedings under the Act. In broad terms, the section lays down the procedure to be followed by the tribunal/appellate tribunal before passing any order.[x] It also confers the tribunal with the power to regulate its own procedure in accordance with principles of natural justice and provisions of the Act or rules framed

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Pre-Package To Rescue Micro, Small And Medium Enterprises: A Step Towards Attaining The SDG 8 Objective?

Leave a Comment / Insolvency Law / CBCL

[By Yasha Goyal and Shreya Ahuja] The authors are students at the Institute of Law, Nirma University. Introduction The Sustainable Development Goal 8 (“the SDG 8”) “is to promote sustained, inclusive, and sustainable economic growth, full and productive environment, and decent work for all”.[i] The target is to achieve these goals by 2030.[ii] The Covid-19 pandemic that hit the world in 2020 has not only affected healthcare but the economy all over the world has collapsed. The businesses are striving to survive and the failure of business results in the unemployment of a large number of people. The poverty and the income disparity between and within the nations are escalating. Income inequality is soaring and the pandemic has turned into a golden opportunity for the ultra-rich to make fortune. The wealth of billionaires in India increased by 35% during the lockdown and by 90% since 2009.[iii] Whereas, the Micro, Small & Medium Enterprises (“MSMEs”) who play a crucial in the economic growth of the country are hard hit by the pandemic, since 2020 more than 75% of SMEs are incurring revenue losses equivalent to or more than 50%, struggling to continue with their operations.[iv] These reports depict that the target of SDG 8 has become even more distant with the advent of this pandemic. Remarked as the ‘Inequality virus’ by Oxfam International[v], this pandemic calls for action from the government to make laws and policies to protect the people to get grips with the declining economic conditions. There is legislation in place for businesses going in distress like the Insolvency & Bankruptcy Code, 2016 (“ the IBC”). Although, the impact of the pandemic requires reform especially to support the small business. Need of IBC to achieve SDG8 The centre of the SDG 8 is the economic growth that results in the employment of all. To attain the targets of SDG 8 the government of India has formulated policies like Skill India, Mahatma Gandhi National Rural Employment Guarantee Act (“MGNREGA”), Make in India, Start-up India.[vi] To attain economic growth it is of paramount importance that the business of the country prospers. Every business in its lifetime passes through a stage of distress, hence it is important to have a policy in place that rescues the business in distress. If the business winds up it is detrimental to the employees working for it, other businesses connected to it, and the overall economy of the country. Since a prospering business contributes towards Gross Domestic Products, increase in exports and the overall economic growth by running constantly. It is imperative to safeguard MSMEs drowning into winding up. It is in this respect, the IBC was formulated to rescue the Corporate Debtors (“CD”) in distress and protect the business. Considering the current pandemic wherein the businesses are struggling to survive and are on the verge of winding up the pre-packs emerge as a fruitful process to achieve the SDG8 goals. As these MSMEs are turning into CDs with the loss in revenue hence it is imperative to provide corporate rescue since they employ 120 million[vii] people contributing a share of 30% towards the GDP[viii]. Introduction of pre-packs under the Indian Insolvency regime Pre-pack is a mechanism globally accepted and implemented. Paving a way for resolution of distressed debts by providing a framework of settlement between CD and stakeholders with a formal abdication of law as per the IBC. The prevalent mechanism to constitute a pre-pack is a negotiation between the debtor and buyer before entering in the appointment of a Resolution Professional, who further assists in the passing of a resolution plan. Unlike other nations pre-pack in India is not only about the out-of-court arrangement but is powered by the laws under the IBC till the extent of the existing NCLT supervised resolution process.[ix] However, under CIRP it was a credit in control model with RP in possession. Under pre-packs to retain flexibility with the MSME, the debtor in possession model is allowed. Wherein, the debtor shall remain in possession of the enterprise and continue to run it until the resolution takes place instead of handling the operation to RP as soon as the admission of insolvency proceedings under CIRP. The option under PIRP provides its inclusive set of laws under section 54C-P of the Code providing a basic structure of the IBC and checks against any forthcoming abuse. The mechanism provides the creditor also an option to choose to proceed by way of CIRP. Further, 66% of approval by creditors is necessary for the resolution process.[x] The duration of the entire proceeding has to be done within a period of 90 + 30 days from the initiation as opposed to the CIRP process granting 330 days from initiation. [xi] The advantage of pre-packs over the existing formal regime of insolvency is that the pre-packs would cause the minimum disruption to the business of the debtor as the CD continues with the existing management unlike in the CRIP proceedings where the management is shifted to the Resolution professional. Further, this is time and cost-efficient as the pre-pack enables the faster resolution that is within 120 days as prescribed in the Ordinance and non-requirement of IP to manage affairs save the cost inclusive of a fee. Moreover, this alternative has the potential to reduce the burden on the courts and tribunals. The advantages of the pre-pack arrangement that rescues the business would help to attain SDG 8 that is stable economic growth and retain the employment of the people. Relevance of Pre Packs The insolvency regime is indeed evolving with multiple amendments coming its way until 2021. The BLRC believes pre-pack is the next step for India towards its natural evolution and need of the hour amongst the pandemic. The creditors were provided rescue under the Insolvency framework of the IBC. However, under the current formal regime of CIRP, the RA is required to rescue a failing company through a resolution plan. In a time when every company is reeling from stress, the possibility of

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Enforcement of Security Interest during Liquidation: Plight of Joint Charge Holders

Leave a Comment / Capital Markets and Securities Law, Company Law, Insolvency Law / CBCL

[By Samyak Jain] The author is a student at NMIMS School of Law, Mumbai. Waterfall mechanism under Insolvency and Bankruptcy Code (IBC or the code) prioritizes secured creditors over other stakeholders when secured creditors don’t enforce the security separately. This acts as an incentive for a lot of them to relinquish their security interest to liquidation estate. However, a situation of deadlock is created when joint charge holders over security are not able to reach a consensus about its treatment during liquidation. Tribunals have been meaning to resolve this based on the type of charge creditors hold over the security. Debtors create interest or lien over their assets to secure repayment of the loan. This leads to the creation of a charge and it is governed as per the contract, the debtors and creditors have entered into. Contracts may allow the creation of further charge over the same security following the procedure prescribed in the contract. The further charge created may be a charge pari passu to the first charge or may hold a different ranking. Creditors often enter into contracts that allow the creation of further charges only on their consent or on the issuance of a No Objection Certificate (NOC). The distinction between both types of charge lies in the priority given to them. Charge on a pari passu basis keeps all the creditors on equal footing, whereas a charge of different ranking gives the highest priority to the first charge holder.[i] Liquidation proceedings pose a challenge for liquidators when joint charge holders are not able to collectively decide about the treatment of their security. Disagreement can exist among charge holders on whether to relinquish their security interest to liquidation estate and enjoy a higher priority in the waterfall mechanism during repayment or separately enforce the security outside the liquidation pool. Tribunals have studied cases of disagreement in both types of charge and have taken diametrically opposite stands. First Charge Holders’ Right Right of first charge holders came to the forefront in the case of JM Financial Asset Reconstruction Company Ltd. v. Finquest Financial Solutions Pvt. Ltd.[ii] (JM Financial case). When Reid & Taylor were undergoing liquidation proceedings, Finquest filed an application u/s 52 of the code seeking leave to sell off the secured asset as they contended exclusive first charge over it. Other secured creditors objected to the contention and claimed a pari passu charge on the asset. Being joint charge holders they demanded relinquishment of security to liquidation estate. They put forth the argument that IBC treats all secured creditors the same and does not distinguish on nature of the charge or on the ranking of respective charge. And therefore, first charge holders are not entitled to special rights. NCLAT perused section 52 of the code to resolve the issue. They emphasized over the process that after setting off the realized amount against the debts due, excess proceeds from the ‘first enforcement’ of security is to be deposited with the liquidator. The wording of the provision allows only single enforcement of the security as per interpretation. Sub-section (4) of the provision[iii] gives power to ‘a secured creditor’ to enforce the security interest through any legal mechanism applicable to it. Based on the reasoning above, NCLAT held that only one secured creditor can enforce security interest to realize its debt and observed that “If one or more ‘Secured Creditors’ have not relinquished the ‘security interest’ and opt to realize their ‘security interest’ against the same very asset, the Liquidator will act in terms of Section 52(3) and find out as to who has the 1st charge”[iv]. NCLAT recognized the right of only first charge holders to enforce the security. An excess amount after recovering the debt of the first charge holder would be required to be deposited in the liquidator’s account. Tribunal denied rights to other secured creditors in case a first charge holder exists. Despite having security to protect their debt, they are treated no different than an unsecured creditor. Also, the decision throws up a challenging question about the treatment of other secured creditors in the waterfall mechanism. What position would other secured creditors enjoy in the waterfall mechanism during distribution is unaddressed by the tribunal. In my opinion, NCLAT has erred in interpreting the provision. It failed to consider the intent of the legislature of prioritizing a secured debt. The statute accords special treatment to secured creditors for obvious reasons that they have security to enforce their debt. If this judgment’s literal interpretation of a provision is enforced, secured creditors other than exclusive charge holders will find their secured debt futile in the IBC regime. Majority Rule among Joint Charge Holders While the above ruling takes away the rights of secured creditors to some extent, NCLAT Delhi has seemingly taken a balanced stand in the issue of pari passu charge in the Mr. Srikanth Dwarkanath vs. Bharat Heavy Electricals Limited[v] (Dwarkanath Case). On the passing of a liquidation order against the corporate debtor, the liquidator filed an application owing to the inability to form the liquidation estate. A liquidator could not commence the liquidation process on account of the deadlock created among secured creditors with respect to relinquishment of security interest. Multiple creditors held charge over the secured asset. Among all, 74% of the secured creditors allowed the secured asset to be a part of liquidation estate. But the liquidator still couldn’t attach the property in his pool on account of refusal from Bharat Heavy Electricals to relinquish the security. Bharat Electricals claimed itself as a superior charge holder. They demanded enforcement of security placing reliance on JM Financial case. However, the court held that the facts of the present case are different from JM Financial owing to the absence of a superior charge over security. With the presence of a charge of equal ranking, NCLAT found it apt to refer to Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (SARFAESI act) to end the deadlock. It specifically

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MORATORIUM UNDER IBC AND CHAPTER XVII OF NIA: A PROLONGED TUSSLE

Leave a Comment / Insolvency Law / CBCL

[By Nimisha Sharma and Uddhav Tiwari] The authors are students at the National Law Institute University, Bhopal. INTRODUCTION Moratorium under Insolvency and Bankruptcy Code, 2016 (“IBC”) has been subjected to multiple legislative amendments and judicial enhancements. Recently, the Hon’ble Supreme Court (“SC”) in P. Mohanraj & Others v. M/s. Shah Brothers Ispat Pvt. Ltd.[i] solved the conundrum about the applicability of moratorium under §14 of IBC to proceedings under §138/141 of Negotiable Instruments Act, 1881 (“NIA”). FACTUAL BACKGROUND The respondent filed two criminal complaints against the corporate debtor (“CD”) and its three directors (appellants) under §138 read with §141 of NIA. Meanwhile, an application under §9 of IBC was allowed by the Adjudicating Authority (“AA”), which resulted in the initiation of the Corporate Insolvency Resolution Process (“CIRP”) and imposition of moratorium upon the CD. The AA stayed further proceedings under the pending criminal complaints. The National Company Law Appellate Tribunal (“NCLAT”) reversed the order of AA and held that §138 of NIA, being a criminal law provision, cannot be held to be a proceeding within the meaning of §14 of IBC. The sole issue that arose in this matter was whether the initiation or continuation of a proceeding under §138/141 of NIA would be covered by the moratorium provision. OBSERVATIONS AND REASONING The analysis given by the court can be summarised under the following heads: Interpretation of Section 14 – Noticeably, the expression “or” occurs twice in the first part of §14(1)(a) – first, between the expressions “institution of suits” and “continuation of pending suits” and second, between the expressions “continuation of pending suits” and “proceedings against the corporate debtor…”. The usage of the word “or” before the word “proceedings” by the legislature makes its intention clear regarding the treatment of “institution of suits or continuation of pending suits” and “proceedings against the corporate debtor” as distinct categories. The word “proceedings” under §14(1)(a) is ‘all-inclusive’ on account of the usage of expressions such as “any judgment, decree or order” and “any court of law, tribunal, arbitration panel, or other authority”. The proceeding under §138 of NIA, being criminal in nature and conducted as per the mandate under §6 of CrPC, is a ‘proceeding’ in a court of law regarding transactions inclusive of debts owed by CD. [ii] The object sought to be achieved by §14 of the IBC is to see that there is no depletion of CD’s assets during the CIRP so that it can be kept running as a going concern during this time, thus maximizing value for all stakeholders.[iii] The same has been reiterated in Swiss Ribbons (P) Ltd. v. Union of India.[iv] Considering this objective, a ‘proceeding’ under §138 of NIA would adversely affect the assets of CD, because the defaulter would have to compensate for the ‘institution, continuation or execution of a decree in a civil suit for recovery of debt or any other liability. Thereby, making the protection granted to CD under §14(1)(a) and (b) futile and affecting the object of §14 which enables the CD to rehabilitate itself as a going concern. Application of the Noscitur A Sociis Rule of Interpretation and ejusdem generis – The Noscitur A Sociis and ejusdem generis, being rules as to the construction of statutes, cannot be applied to restrain the ambit of expressions if they are specifically designed to provide a wide sense. Importantly, in the event where a residuary phrase is used as a catch-all expression to subsume within it the reasonable comprehension of the provision, regard has to be sort to its object and setting. These rules should be used cautiously and should not color an otherwise wide expression, which trammels and frustrate the object of a statutory provision. The objective of Section 14 – Section 14 and other moratorium provisions in IBC – When the language of §81, 85, 96, and 101 of IBC are juxtaposed against the language of §14, it is conspicuous that the scope of §14 is wider. The protection of moratorium through §85 of IBC is only in respect of ‘debts’, whereas the moratorium in §14 is in respect of ‘transactions’, being provided by §14(3)(a). The word “transaction” is a broader concept than “debt”, and inclusive of it. With the exclusion of the word “legal” as a prefix to “proceedings” in §14(1)(a) as used in the moratorium provisions qua individuals and firms, the intention of the legislature is quite clear. §138 is a legal proceeding “in respect of” a debt. “In respect of” is a phrase that is wide and includes anything done directly or indirectly.[v]Thereby, attracting application of §138 of NIA in a legal proceeding regarding any debt and allowing any indirect legal proceeding relating to debt. Also, the moratorium under §14 provides protection to the CD against the transactions mentioned in clauses (a) to (d), inclusive of transactions relating to debts, as are contained in §81, 85, 96, and 101. The interplay between Section 14 and 32A of IBC – Referring to the recent judgment of SC in Manish Kumar v. Union of India[vi] and the ILC Report of February 2020,[vii] the court observed that §32A and 14(1)(a) are independent of each other. §32A primarily aims at extinguishment of criminal liability of the CD, from the date of approval of resolution plan by the AA, in order to give a fresh start to the CD. Declaration of moratorium under §14 just casts a shadow on the proceedings that have already been initiated, which could be resuscitated once the moratorium period comes to an end. It was further observed that the expression “proceedings” under §32A(1) refers to criminal proceedings filed through a First Information Report or complaint filed by investigating authority and not to complaints filed by private persons. If the quasi-criminal proceedings such as those under §138/141 of NIA are initiated against CD, they would defeat the object of imposition of the moratorium and the object of §32A, barring all criminal proceedings against the CD. Nature of proceedings under Section 138/141 of NIA – The court observed

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Insolvency or Arbitration: A Fight Between Special Statutes

Leave a Comment / Arbitration Law, Insolvency Law / CBCL

[By Injila Khan and Utkarsh Mishra] Injila is a student at the Institute of Law, Nirma University, Ahmedabad and Utkarsh is a student at Symbiosis Law School, Noida. The Insolvency and Bankruptcy Code 2016 was enacted to structure and amend laws relating to the reorganization of financial assets and insolvency resolutions relating to corporate persons. Part II of the code deals with Insolvency Resolution and Liquidation for Corporate Persons and accordingly financial creditors, operational creditors, and corporate debtors can initiate Corporate Insolvency Resolution Process.[i]On the other hand, the Arbitration and Conciliation Act, 1996 governs the procedure related to both domestic as well as international arbitration along with their relevant enforcement. However, recently, there has been an ample number of cases where a financial dispute between parties often overlooked arbitration and lead to the process of insolvency of the company that owned the money in the first place. This leads to the failure of the concept of an alternative dispute resolution mechanism as a whole. Moreover, insolvency proceedings create numerous problems for the company who might not be out of funds but simply disputes the existence or quantification of a financial obligation created on the basis of a contractual arrangement. This further leads to insolvency being used as a pressure tactic to strong-arm the debtor organization into unfair payments. Ascertainment of the Term “Debt” under IBC Section 7(5) of IBC states that to initiate Insolvency Proceedings by the Financial Creditor there has to be a judicial determination by the Adjudicating Authority (AA) as to whether there was a ‘default’ by the Financial Debtor. As soon as the AA is satisfied that default has occurred it should accept the application for initiation of CIRP. This was effectively reiterated by the NCLT in the case of Innoventive Industries Limited v. ICICI Bank[ii]which states that claim of default by the financial creditor must be followed by ascertainment of existence of default by the AA. Thus, to start insolvency, the only criteria is debt. Wider Interpretation of the term “financial debt” Sec. 3(12) of IBC defines ‘default’ as non-payment of debt either totally or in part. In the case of SGM Webtech Pvt Ltd. v. Boulevard Projects Pvt Ltd[iii]it was held by the AA that even Fully Converted Debentures (FCCD) are unequivocally treated as a Financial Debt under Sec. 5(8) of IBC and for this reason, FCCDs were considered as financial debt. Also, Sec. 5(8) of IBC mandates debt to be disbursed against the consideration for the time value of money and since interest on debentures increases, therefore, it subscribes to the concept of the time value of money. Therefore, non-payment of any outstanding FCDs will qualify as non-payment of a debt and will be counted as a Default. Thus, debt obligations created by Financial securities are also being considered as financial debt and hence, a chance to invoke insolvency. Arbitration and Section 7 of IBC Disputes falling under Section 7 of the IBC belong to the class of litigations which are deemed non-arbitral.[iv]Therefore even if the agreements entered into by the parties contained an arbitration clause, they hold no relevance as soon as the dispute falls under Section 7 of the Code and there is any debt owed, in part or whole. The Supreme Courtin the case of Booz Allen & Hamilton v. SBI Home Finance Ltd[v]held that “generally and traditionally all disputes relating to ‘rights in personam’ are considered to be amenable to arbitration and all disputes relating to ‘rights in rem’ are required to be adjudicated by courts and tribunals”.Since the applications filed under Sec. 7 of IBC are matters relating to ‘right in rem’,[vi]therefore they are inherently incapable of being arbitrated. The Courts took a similar view in the case of Haryana Telecom v. Sterile Industries[vii]where an application under Sec. 8 of Arbitration and Conciliation Act was not allowed in oppression and management cases under the Companies Act because it was a matter relating to ‘right in rem’. Therefore, it is sufficiently clear that the non-arbitrability of the class of disputes falling under section 7 of IBC makes the application liable to be rejected. Furthermore, in the Booz Allen case[viii], it was specifically listed by the SC that “if the subject matter of a suit involved Insolvency and Winding up matters, then such cases were non-arbitral in totality.” Therefore, any dispute that falls out of the private fora of the two parties and causes a breach even unintentionally shall make arbitration impossible as it classifies as a matter related to right in rem. The current stand of the case-law-based jurisprudence is sufficient to point towards an unstructured and unclear way of classifying a matter into the class of “right in rem” as there is no interpretation of the terms conclusively. The floodgates for divertive tactics in order to prevent arbitration comes from the fact that litigation is generally favourable to the party whose strategy is to prolong the dispute and the courts and tribunals having a huge backlog facilitates the same (A. Ayyasamy v. A. Paramasivam)[ix]. In the Booz Allen case[x], the court opened the floodgates to interpretational litigation when they stated that the subordinate rights related to personam that have arisen from a right in rem can be arbitrated. This comment over the flexibility of the right in rem vis a vis right in personam bifurcation has caused a lot of litigation since the court has to conduct a case-to-case evaluation of the dispute in question. Different interpretations by different High Courts and Supreme Court judges having to distinguish cases has made the questioning of the arbitrability of a dispute a favourable strategy to prevent payment of dues or as a pressure tactic against companies. Furthermore, the application of cases that interpreted the Arbitration Act 1940 such as Natraj Studios (P) Ltd. v. Navrang Studios[xi] has created further ambiguity since the 1996 A & C Act has a remarkable difference from the preceding statute and thus, precedents being used that have adjudicated the 1940 Act has also created huge jurisprudential inconsistencies. Furthermore, IBC and the Arbitration Act are

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Prospective Application of the Notification Increasing IBC Threshold: NCLT’s New Approach

Leave a Comment / Insolvency Law / CBCL

[By Christina D’Souza] The author is a third year student at RMLNLU, Lucknow. It has been almost a year since the Notification dated 24.03.2020([i]) (“Notification”) was notified by the Ministry of Corporate Affairs to increase the amount of default from 1 lakh rupees to 1 crore rupees for filing applications under Part II of the IBC. Even today, an issue is raised before NCLTs regarding the admissibility of claims less than 1 crore rupees where date of default is prior to the date of Notification. In May 2020, in the case of Madhusudan Tantia vs Amit Choraria ([ii]), the NCLAT clarified that the Notification is prospective in nature. It also went on to note that the Notification will not apply to the applications where default occurred prior to the date of Notification. However, in July 2020, the Delhi High Court in the case of Pankaj Agarwal vs Union of India ([iii]), passed an interim stay on the order of NCLT accepting an application for a default of less than 1 crore where default occurred prior to the date of Notification. The Delhi High Court noted that there was an error by the NCLT in accepting the application, as the Notification was clearly applicable. Kerala High Court([iv]) and Madras High Court([v]) have taken similar positions. Recently, in February 2021, the Delhi High Court, in the case of Hari Singh vs Dynamic Aura LLP([vi]), directed the parties to the NCLT to have this issue of admissibility of claims prior to the date of Notification resolved. The NCLT took a divergent approach on this issue. Even after agreeing that the Notification has a prospective application, the NCLT went on to dismiss the application for which the date of default was prior to the date of Notification. NCLT’s Observations in Hari Singh Case Prospective or Retrospective application of the Notification not an issue NCLT accepted that the Notification has a prospective effect, but it went on to note that the issue is not whether the Notification is retrospective or prospective in nature. The issue is whether the right to file an application is a statutory right or a vested right. Right to file an application under IBC Code is a statutory right In this regard, the NCLT went on further to note that monetary jurisdiction is a statutory right, not a vested right. It reasoned on the lines that elements of vested right are altogether different from the statutory right. The Right of filing a case is a statutory right, not a vested right, when statute goes, that right also goes. The jurisdiction under the IBC is one of the remedies the creditor has. If the creditor cannot meet the requirements to initiate insolvency proceedings, then it is always open to the creditor to proceed before the DRT under SARFAESI Act or the Civil Courts under the Civil Procedure Code. Therefore, the parties shall not remain under the notion that it is a vested right to file cases below the threshold limit of one crore, even after that statutory right is not in existence in the statute. Thereby, unless a statutory right is exercised within time, i.e., before 24.3.2020, it cannot be construed as a vested right to file a case. Class Concept for monetary jurisdiction The NCLT recognized a class of creditors for the purpose of the jurisdiction of the Tribunal in light of the Notification. As per the same, the class of creditors who cross the threshold of one crore rupees to file cases, shall be able to invoke the jurisdiction of the Tribunal. The NCLT grouped all kinds of creditors in only one class because the Notification pertained to section 4 of the IBC and section 4 is applicable to all classes of creditors. Thus, the creditor filing an insolvency application shall belong to this class, i.e., must have crossed the threshold of one crore under section 4 of the IBC. The increased threshold applies to non MSME cases as well While interpreting the text of the Notification in a literal sense, the NCLT noted that “if at all the Government intention was only to apply this threshold to MSME cases, Government would mention that specifically”. NCLT further noted that they are required to go by the plain language of the Notification and not otherwise because there is no ambiguity in understanding its language. Nevertheless, even if the Notification was only for providing a relief to MSMEs, the Government at its level cannot create such a classification because that would be a legislative policy work, which cannot be done by the Government alone, without the approval of the Parliament through Legislation. Analysis of the Decision Interestingly, in the Hari Singh case, the Delhi High Court itself directed the NCLT to determine the legal point raised by the petitioners. The position that the Notification is applicable prospectively is more or less settled and the NCLT was right in not delving into the same. What sets this decision apart from all the previous decisions on this issue is the fact that even after accepting that the Notification is applicable prospectively, the NCLT still went on to dismiss the application because the threshold was not met, and the date of default was prior to the date of Notification. To support its decision in this regard, the NCLT did give some strong reasons and at the same time it made the applicants aware of an alternate remedy which they could pursue instead. An interesting question comes up regarding the precedence of Hari Singh case as the NCLAT in Madhusudan Tantia case has given a different observation in this regard. Even though both the Delhi High Court in Pankaj Agarwal case and the NCLT in Hari Singh case have reached a similar conclusion, the NCLT has taken a divergent view while coming to its conclusion, which is evident from the reasoning which is first of its kind. While the Delhi High Court in Pankaj Agarwal case was of the opinion that the objective of bringing

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Supreme Court on Arbitrability of Insolvency Law Disputes: The Case of Indus Biotech

Leave a Comment / Arbitration Law, Insolvency Law / CBCL

[By Akshita Totla] Akshita is a 4th year law student at the Institute of Law, Nirma University. Recently, the Supreme Court in Indus Biotech Private Limited v Kotak India Venture (26 March, 2021) (Indus Biotech),[i] elaborately discussed the arbitrability of the insolvency law disputes in India. The SC in this case categorically held that post the admission of petition under section 7 of the Insolvency and Bankruptcy Code, 2016 (IBC), the dispute would be non-arbitrable. In this article, the author examines the position of law in India and other major jurisdictions on arbitrability of insolvency matters and concludes by providing possible alternatives to the approach adopted by the SC. Factual Background A dispute arose between Kotak and Indus Biotech in relation to the valuation of Optionally Convertible Redeemable Preference Shares (OCPRS) while they were being converted into equity shares. On account of failure of Indus Biotech in redeeming OCRPS within the stipulated time, Kotak triggered the IBC by filing an application for initiation of Corporate Insolvency Resolution Process (CIRP). Before the admission of CIRP application, Indus Biotech filed an application under section 8 of the Arbitration and Conciliation Act, 1996 (Arbitration Act), contending that section 7 IBC petition is not maintainable by virtue of the arbitration clause contained in the agreement. NCLT, Mumbai in 2020 allowed an insolvency dispute to be settled by arbitration by dismissing section 7, IBC application filed by Kotak observing that there is no default. In this backdrop, a Special Leave Petition was filed before the SC. The SC observed that where an application seeking reference to arbitration is filed during pendency of section 7, IBC petition, the adjudicating authority needs to first decide upon the maintainability of CIRP application. And upon admission of section 7 IBC petition, any application under section 8 of the Arbitration Act would thereafter be not maintainable. IBC Proceedings are in rem after CIRP application is admitted The insolvency proceedings are proceedings in rem i.e., having effect on the world at large.[ii] The SC in Booz Allen,[iii] categorically held that insolvency matters are non-arbitrable. To provide more clarity on this issue, the SC in Indus Biotech divided the proceedings into two stages- pre-admission and post-admission stage. In the pre-admission stage, the insolvency proceedings remain in personam. While post the admission of CIRP application, the proceedings become in rem. The SC while referring to Vidya Drolia v Durga Trading Corporation,[iv] noted that on admission of Section 7, IBC petition, third party rights are created in all the creditors, and the proceedings will have erga omnes effect. Thus, it is only upon admission that the matter would become non-arbitrable. In pre-admission stage wherein, the petition is filed by a financial creditor, the NCLT is only required to ascertain the existence of default. The Corporate Debtor (CD) cannot either contend that the petition is used as a tool to bypass arbitration proceedings or there is a dispute regarding the debt amount. This highlights a lacuna in the current framework which disallows CDs to raise bona fide disputes. In circumstances like that of present case, where the dispute was regarding the interpretation of a contractual clause, arbitration can be used as mechanism for quantifying debt. This would rather provide more clarity on the amount of financial debt. Foreign Jurisprudence In the UK, insolvency proceeding does not bar a party to proceed with arbitration. This position was established in Fulham Football Club Ltd v Richards (2011),[v] where the court of appeal ruled in the favor of arbitrability of shareholder unfair prejudice claim. The court of appeal also observed that arbitrability of insolvency law disputes would depend on the whether the dispute involves third party rights or not. For instance, disputes relating to a) order for the payment of debts owed by the insolvent company; b) determination of assets of the estate; or c) determination of schedule of claims, would affect the third-party creditors and would not be arbitrable. Recently, in Riverrock Securities Limited v International Bank of St. Petersburg (2020),[vi] the English High Court held that avoidance claims brought under the Russian insolvency law were contractual in nature and are hence, arbitrable. The court also noted that “the presumption that an arbitration agreement should not extend to claims which only arise on a company’s insolvency” would not arise in English Insolvency cases. This judgment demonstrates the pro-arbitration approach of the English courts, even in cases involving foreign insolvency law. The courts of the United States, emphasize on the policy favoring commercial arbitration than the domestic notions of arbitrability as stated by Justice Blackman in Mitsubishi Motors Corp. v Soler Chrysler-Plymouth Inc. (1985),[vii] In the U.S., the arbitrability depends on whether the matter involves “core” or non-core” issues of insolvency. “Core” bankruptcy proceeding matters are considered non-arbitrable. These proceedings involve determination of rights created by federal bankruptcy law which could only arise in bankruptcy proceedings or a proceeding that could not have existed outside of bankruptcy. On the other hand, in “non-core” matters the court has to compel arbitration. In In re Electric Machinery Enterprises, Inc. (2007),[viii] the eleventh circuit while ordering arbitration held that dispute regarding contractual claim for the money owed was not a “core” proceeding. Furthermore, even if it was a “core” proceeding, there was no evidence indicating that the arbitration proceedings would have conflicted with the object of the Bankruptcy Code. The above-mentioned judgments suggest that the courts of both UK and US have tried to bring coherence in laws and maintain an approach that is consistent with the legislative policy of their respective arbitration laws. The way forward: Is Reconciliation between the IBC and the Arbitration Act Possible? The legislative intent behind the Arbitration Act is to develop arbitration friendly environment in the country. While the IBC aims to rescue corporate debtor within a specified limit by balancing the interest of all the stakeholders involved. Now, the issue here is whether overriding effect of IBC over an arbitration clause based on the consent of the parties, violates the principle of party

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Swiss-Challenge Model under Pre-Packs: The Position of Operational Creditors

Leave a Comment / Insolvency Law / CBCL

[By Damini Chouhan and Vinisha Jain] The authors are fourth-year students at the Institute of Law, Nirma University, Ahmedabad. Introduction The Indian Insolvency Law Committee (hereinafter “ILC”) believes that pre-pack models must be introduced as an alternative to Corporate Insolvency Resolution Process (hereinafter “CIRP”) to ease the insolvency process. ILC formed the Sub-Committee of the Insolvency Law Committee on Pre-packaged Insolvency Resolution Process (hereinafter “sub-committee”). This sub-committee proposed a pre-pack model to the government in October 2020. A pre-packaged insolvency resolution process can be encapsulated as follows. First, it will be available for insolvency resolution as a supplementary method along with CIRP but it shall not run parallel to it. Second, the process commences when the promoters submit a base plan after completion of other formalities. In order to upgrade the value of the Corporate Debtor (hereinafter “CD”), a model of Swiss Challenge has been introduced wherein the base plan submitted by the promoters may or may not be opened to a bid. To begin with, the base plan will have to be necessarily opened to Swiss Challenge if it does not propose to pay the Operational Creditors (hereinafter “OCs”) of the CD in full. On the contrary, if the base plan proposes to pay the OCs in full, the Committee of Creditors (hereinafter “CoC”) is free to decide according to its commercial wisdom whether or not this base plan shall be opened to a Swiss Challenge. Evidently, the optional approaches of the Swiss Challenge are the deciding factors for the outcome of the entire process. These approaches in turn are dependent on the payment proposed to be made to the OCs. Though protection has been imparted to OCs, the protection is hinged upon certain assumptions. This article, therefore, analyzes this provision in light of its probable fallouts and the importance of OCs. The Proposed Swiss-Challenge Model Swiss Challenge is a bidding process where each applicant makes a better offer than the existing one, to secure the contract. It would now be introduced to the insolvency resolution process as well. As mentioned above, the proposed provision which is based on the payment to the OCs presents a binary approach with respect to the Swiss Challenge. The CoC has been made responsible to act in this respect according to the following two situations: first where the base plan proposes to pay the OCs in full and second where the base plan does not propose to make good the entire claim of the OCs. In the first scenario, the CoC has the choice to decide whether or not the base plan will be opened to Swiss Challenge and if CoC feels that it suffices in terms of value, CoC may accept the base plan and not open it to Swiss Challenge. On the other hand, if it feels that the base plan does not give the best value, the CoC applying its commercial wisdom may open it to the Swiss Challenge. Hence, in either case, the entire claim of OCs is protected irrespective of whether the base plan is opened to Swiss Challenge or not. In the second scenario, where the base plan does not propose to make good the entire debt owed to the OCs, the CoC has to mandatorily open the base plan to Swiss Challenge. A single round of bidding would take place and the plan that offers the best value shall proceed further in the process. The promoters shall be given a chance to match their base plan to such a competing plan. It is not necessary that the value escalation in the plan that is finally accepted reaches a stage where the entire claim of OCs is covered. Nevertheless, the OCs have to be paid the minimum liquidation value or no plan will be accepted and the pre-pack would close without consequence. Scope of Improvement In both scenarios, payment of at least the liquidation value to OCs is guaranteed incongruity with the existing CIRP Regulations.[i] Sadly, the liquidation value is generally way too less than what is owed to the OCs. The case of Maharashtra Seamless Limited v. Padmanabhan Venkatesh & Ors is an illustration of such situations where the liquidation value is not even close to the claimed amount. ILC acknowledged this issue in its 2018 Report, but it did not suggest any amendments due to the following reasons. First, even though the liquidation value is the mandate, it was observed that what the OCs actually receive is way above the liquidation value in most cases. Second, when the OCs receive a very less amount, it is in cases where the stress on the CD is extremely high. Third, no representations or evidence that suggest otherwise could be found. Hence, it decided to continue with the status quo, despite the fact that current law provides an inherent scope to the CoC and Resolution Applicants to lawfully leave the OCs with only a meager payout. It seems like ILC is turning a blind eye to a bomb just because it has not exploded. Similarly, just because there is no prima facie evidence of inequitable treatment, does not mean that such treatment is not there. Therefore, even if the faith of ILC in the maturity of CIRP is to be relied upon, the same cannot be said for pre-packs. It would be unwise to continue with the same position of law for the pre-packs regime as well, presuming that pre-packs would work out the same way as CIRP. Moreover, given the role of OCs as suppliers of working capital, in order for a CD to continue as a ‘going concern’, the aim should not just be to protect the OCs but also to incentivize them. Conclusion & Suggestions In both the scenarios of the Swiss Challenge model, the position of the OCs can be further strengthened or they will remain aloof from the value escalation or additional benefits that pre-packs offer. An express provision mandating equitable payouts to all the creditors in cases of abnormal profits or

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Revisiting the Second Proviso to Section 7(1), IBC, 2016: In Re Manish Kumar Ruling

Leave a Comment / Insolvency Law / CBCL

[By Pranav Karwa and Gaurav Karwa] Pranav is a student at the National Law University, Jodhpur and Gaurav is a student at the West Bengal National University of Juridical Sciences. Recently, in the case of Manish Kumar v Union of India (“Manish Kumar Ruling”), the Supreme Court upheld the constitutional validity of all the provisos added to Section 7(1) of the IBC, 2016 (“Code”) via the IBC Amendment Act, 2020 (“the Amendment”). The second proviso to Section 7(1) of the Code introduced a new threshold for filing an application to initiate CIRP by Home-Buyers. As per the proviso, the allottees under a real estate project can apply to initiate the CIRP process only if not less than 100 allottees file it under the same real estate project or one-tenth of the total number of allottees under the same real estate project, whichever is lower. Various writ petitions were filed by real-estate creditors challenging the constitutionality of the Amendment, including the provisos added to Section 7(1) of the Code. The primary allegation in these petitions was that the Second and Third proviso to Section 7(1) violates Article 14 and 19(1) (g) of the Constitution of India. It was also alleged that the impugned provisos are in clear violation of the Supreme Court verdict in Pioneer Urban Land and Infrastructure Ltd. and Anr v. Union of India as in that case, it was observed that Home-Buyers are deemed financial creditors without any restriction imposed on them for initiating CIRP. The authors highlight the key observations by the Supreme Court in Manish Kumar Ruling and in the backdrop of this decision, examine the utility of the Second Proviso to Section 7(1). The authors conclude by suggesting certain better alternatives which comprehensively address the mischief sought to be resolved by the Second Proviso to Section 7(1). Manish Kumar Ruling While setting aside the petitioners’ arguments in the Manish Kumar Ruling, the Supreme Court observed that there is no real discrimination against Home-Buyers. The Court opined that an intelligible differentia exists between Home-Buyers and other financial creditors as there is the heterogeneity, numerosity, and individuality in decision-making in the case of Home-Buyers. In the Court’s view, the Second Proviso to Section 7(1) of the Code acts as a deterrent for individual homebuyers filing frivolous claims before the NCLT. Thus, the Apex Court held that the Second Proviso to Section 7(1) of the Code is constitutionally valid and just because the proviso causes some inconvenience and difficulties to the Home-Buyers is not reason enough to strike it down. Overall, the Manish Kumar Ruling is a major setback for Home-Buyers who want to initiate a CIRP under Section 7(1) of the Code, individually or in small groups. However, on a positive note, the Court has clarified that not all the Home-Buyers, applying under Section 7(1), must have pending dues against real-estate project developers. It will be enough if the total dues satisfy the threshold limit of ₹1 crore. Examining the Utility of Second Proviso to Section 7(1) It is the view of the authors that the Second Proviso to Section 7(1) of the Code was not necessary in light of the already existing safeguards in the Code which prevent initiation of CIRP by frivolous claims Various concerns of the project developers could have been addressed by alternate mechanisms, which were not taken into account by the Court in the Manish Kumar Ruling. There are safeguard mechanisms already existent under the Code to ensure that there is a check on mala fide applications, where a single home buyer intends to change the real estate developer’s management. For instance, penalties ranging from ₹1 lakh to ₹1 crore on fraudulent or malicious initiation of proceedings are provided under Section 65 of the Code. Further, as held in Naveen Raheja v Shilpa Jain & Ors, the NCLT also reserves the power to impose additional costs on such mala fide applications. Moreover, Section 75 of the Code envisages a penalty ranging from ₹1 lakh to ₹1 crore in the scenario where the financial creditor under Section 7(1) omits to disclose any material fact in the application. Thus, merely the fact that a single real estate allottee is filing a complaint does not mean that the Code is being used as a debt recovery mechanism, as there already exist sufficient safeguards to ensure that the NCLT does not entertain the malicious application. Furthermore, an observation by the Supreme Court in Pioneer Urban gives more power and discretion to the NCLT to filter patently frivolous and malicious applications; the Court said that “when a home buyer makes an application, the NCLT’s satisfaction will be with both eyes open – the NCLT will not turn Nelson’s eye to genuine defenses raised by real estate developers.” Moreover, it was also observed by the Supreme Court that as soon as the tribunal admits an application, it becomes a proceeding in rem from a proceeding in persona. Therefore, after the initiation of the proceeding, the entire matter goes out of the individual allottees’ control and becomes a collective action. In this light, the fear that an individual Home-Buyer may use the Code to force the real estate developer’s liquidation is unfounded and without any backing. This is because, after the constitution of the Committee of Creditors, the issue of whether liquidation or corporate restructuring is to take place is decided collectively by voting in the Committee of Creditors. Lastly, the Second Proviso is not an unambiguous provision free of all anomalies. For instance, that the Amendment, introducing the Second Proviso to Section 7(1), does not clarify as to whether the prescribed limit of 100 or 10% of the total number of allottees, whichever is less, is to be satisfied only at the stage of initiation of CIRP or whether it must be maintained throughout the proceedings. The consequence of such ambiguity is that the real-estate developers will take advantage of the same and may strike an out-of-court settlement with one or more allottees, rendering the proceedings infructuous.

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