Insolvency Law

The Supreme Court Revisited the Conundrum of Insolvency Set-off 

[By Prathmesh Agrawal] The author is a student of WBNUJS, Kolkata.   Introduction A Set-off is a concept which basically refers to setting of monetary cross-claims between parties which produces a balance amount. It has wide application in different sections of law. In this article, we will deal with the concept of set-off in an insolvency proceeding and the legality of it, which was discussed by the Supreme Court in a recent case, Bharti Airtel v. Vijaykumar V. Iyer. The Apex Court has dealt with the post-IBC regime, where the courts have in numerous instances earlier, taken the position of disallowing set off in any Corporate Insolvency Resolution Proceedings (“CIRP”) considering section 14 of the Insolvency & Bankruptcy Code (“Code”), which imposes the moratorium. There is an absence of any mandate which upholds the applicability of set-off in a CIRP. Generally, the set off can be given five different meanings, being – 1) statutory set off; 2) common law set off; 3) equitable set off; 4) contractual set off, and 5) insolvency set off. Insolvency Set-off The concept of insolvency set-off, particularly, stands on the premise of ‘mutual credits’ and ‘dealings’, which were undertaken prior to insolvency proceedings. This proposition has also been observed by the House of Lords in the case of Re.: Bank of Credit and Commerce International SA (No. 8)[1]. Let us take an example to understand, where a company A has a debt of Rs 100 towards company B along with list of other companies. And, company B also has a reciprocal (mutual) debt of Rs 50 which is payable to company A. So, applying setting off rules would mean that company A has a balance debt of Rs 50 towards company B. But the problem in case of insolvency arises because company A does not necessarily have the capacity to repay the whole debt to all the creditors (secured or unsecured). So, say company A only has a quantum of Rs 500 to repay all of its creditors, whereas it has a total debt of Rs 1000. Then executing a set-off with company B will imply a repayment to company B, atleast the set-off amount. And, this is being performed before the distribution of any amount to any other creditors, which triggers the contravention of Pari Passu principle. Succinctly, the insolvency set off will mitigate the Doctrine of Pari Passu, which the Indian courts are hesitant to uphold. Although, in a UK case, National Westminster Bank v. Halesowen Presswork & Assemblies[2], the court clearly underscored the mandatory nature of set-off and implicated that right to set-off co-exists with moratorium during administration. Previous and Current Insolvency Regime in India Before the introduction of the Code in 2016, there was an explicit provision for insolvency set-off under section 56 of the Provincial Insolvency Act, 1920 (“1920 Act”), which is now repealed. This specific provision was in consonance with a similar provision in the Insolvency Rules, 2016 of the United Kingdom, which is currently in effect. Additionally, the Apex Court in Official Liquidator of High Court of Karnataka v. Smt. V. Lakshmikutty had also permitted the insolvency set-off applying the aforementioned provision of the 1920 Act. In the present regime, section 36(4) of the Code deals with the exclusion of assets that do not form part of the liquidation estate, which delineates the apportion of assets which could be subject to set-off on account of mutual dealings. This provision is further supplemented by Regulation 29 of the IBBI (Liquidation Regulations), 2016, which provides for consideration of mutual credits and set-off. The problem with the aforestated present legislation is, it only applies to a liquidation proceeding, as under Chapter III Part II and not the CIRP process which is present in Chapter III Part II of the Code. Nevertheless, there is subsistence of a neutral and clear provision for set-off, which has to be provided in the written statement under Order VIII Rule 6 of the Code of Civil Procedure (“CPC”). Ruling of the Case The Supreme court in the instant case categorically repudiated the presence of any legislative intent of including set-off in a CIRP, which was buttressed with the conjoint readings of section 30 and section 53 (which lays down the waterfall mechanism) of the Code. It rejected the applicability of section 36 of the Code or the Regulation 29 on a CIRP. It reasoned those to be solely concerned with the liquidation proceedings and devoid of any role in a CIRP, forcing which might lead to anomalies. Thereafter, it also discarded the ruling of the Supreme Court in Swiss Ribbon, which sustained the exercise of insolvency set-off in a resolution process. Airtel contended the subsistence of clause (ii) of section 30 (2) of the Code, which corresponds the process of distribution followed in a liquidation process to the resolution process. The court rejected this contention and refuses the applicability of Section 36(4) (supra) and Regulation 29 (supra) in a resolution process, which it observed will solely come into play in a liquidation proceeding. The court buttressed its observation by upholding the mandate of section 25, which stipulates the powers of the Resolution Professional to take control of the assets of the insolvent company. The court, although, failed to correctly contemplate, the essence of the Code, and the prejudice the decision will cause to the creditors in a CIRP. Since, a CIRP is conducted to restitute the business of a company, the court should rather promote the concept of setting-off to expedite the process and interest of the stakeholders. The court, has although, forged two exceptions to the norm of non-applicability of the insolvency-set off under aforesaid Regulation 29(supra) or statutory set-off under Order VIII Rule 9 (supra) of the CPC:- Contractual Set-off – It is only applicable where the parties are entitled to the contractual set-off, which is in effect before or on the date of the commencement of CIRP. Transactional Set-off- It is triggered when the claim and counter-claim in the fashion of set-off

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Right to claim set-off in CIRP: A Shift in the Landscape

[By Manisha Soni] The author is a student of Gujarat National Law University.   Introduction Recently, the Supreme Court of India, in the judgment of Bharti Airtel Ltd. vs Vijaykumar V. Iyer, solidified the position of the National Company Law Appellate Tribunal (NCLAT) that the arrears can not be set off when a Corporate Debtor is going through Corporate Insolvency Resolution Proceedings (CIRP), under the Insolvency and Bankruptcy Code, 2016 (IBC).   This provided a crucial clarification of the prevailing legal intricacies and upheld the legislative purpose of the code. Through this article, the author aims to simplify the wisdom inherent in the judgment, considering the legislative intent and the potential ramifications of permitting set-offs in the CIRP. The author proposes that set-offs are not inherently contradictory to insolvency law and can be accommodated within the framework of the IBC.  Factual matrix  Airtel entities were engaged in spectrum trading agreements with Aircel entities to seek the right to use spectrum. Aircel entities faced demands from DoT for bank guarantees related to license and spectrum usage dues. Upon request, Airtel agreed to furnish these guarantees on Aircel’s behalf, deducting the same from consideration payable under spectrum transfer agreements. However, the Telecom Disputes Settlement and Appellate Tribunal (TDSAT) declared DoT’s demand untenable; and the bank guarantees were asked to be returned.  In the meanwhile CIRP was initiated against Aircel entities. Airtel entities, having paid for Aircel entities, submitted a claim to set-off, asserting it as the net amount owed by Aircel entities for operational charges. Adjudication of such claims of Airtel for set-off during CIRP against Aircel created the challenge for insolvency legislation.   The Resolution Professional (RP) asked Airtel to pay Rs. 112 crores to Aircel, who was undergoing CIRP. This was objected to by Airtel entities in NCLT Mumbai.   The Adjudicating Authority in Mumbai initially allowed Airtel entities the right to set off. However, the NCLAT overturned this decision, contending that such a set-off is antithetical to the objective of insolvency legislation.   Analysis of the Judgment   In common language, the term ‘Set-off’ is an instrument that cancels mutual financial obligations between two parties by allowing one party to reduce the amount it owes to a second party by the amount the second party owes.   Arguments by Airtel  Since the United Kingdom’s Insolvency legislation has served as a model for IBC law in India, the Airtel representative relied on Insolvency set-off provisions in the UK. ‘Insolvency set-off’ applies when demands are between the same parties, even when several distinct transactions exist between them.  The pre-requisites of set-off u/s 323 of the UK Insolvency Act 1986, to claim set-off is when mutual credit and debt arise from ‘mutual dealings’ between the parties prior to the commencement of the bankruptcy. Airtel relied on the UK legislation and the case of HC of Kerela, where the judges allowed set-off and held even different, independent, transactions between parties as ‘mutual dealings’ under the Kerela Insolvency Act, 1955.  Airtel argued that the concept of set-off was permissible in India pre-IBC. Section 529 of the Companies Act 1956 and section 325 (now omitted) of the Companies Act 2013 did allow for set-off. Section 44 of the Provincial Insolvency Act 1920, contingent on certain conditions, permitted creditors’ right against the corporate debtors to set-off.  Order VIII Rule 6 of the Code of Civil Procedure, 1908, of India provides statutory set-off. To claim set-off under this rule, the amount should be ascertained.   After the advent of IBC in insolvency legislation, set-offs started to derive legitimacy under section 173 of IBC, where set-offs are allowed in partnership and individual bankruptcies. Apart from that, regulation 29 of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulation, 2016 provides for set-off on account of mutual dealings.    SC Judgment  The SC held that the nature of corporate debtors changes after the commencement of CIRP. Hence, any claim for set-off cannot be raised after CIRP. The Hon’ble Court rejected the applicability of set-off provisions of CPC in CIRP due to the presence of section 238 of IBC, which states that provisions of IBC override all other laws.   Regulation 29 of the Liquidation Regulations provides for mutual dealing and set-off but does not apply to Part II of the IBC, which deals with CIRP.   The court, however, permitted contractual set-off if the date of such set-off was before the CIRP was initiated. A contractual set-off is a mutual agreement to permit set-off and adjustment. The CIRP does not preclude it.   Set-offs are contrary to the common law doctrine of pari passu and anti-deprivation. Though the doctrine of pari passu is not explicitly mentioned in the IBC, an interpretation of the existence of the doctrine can be drawn from section 53 r/w section 52 of the IBC, as these provisions provide for the hierarchy of creditors during the distribution of value arising out of liquidation. This arrangement gives primacy to an operational creditor over a financial creditor should the operational creditor’s claim of set-off be permitted.  Due to the set-off, the liquidation estate’s value gets depleted, consequently affecting the dividend distribution among the rest of the creditors. The doctrine of anti-deprivation discourages this. This doctrine enumerates that a creditor can not obtain a better position than the law explicitly provides during bankruptcy. SC applied the essence of both doctrines in this matter.   The provisions related to CIRP do not provide for insolvency set-off, and the court refuses to extend it through implication. Unlike contractual set-off, Insolvency set-off is not self-executing in nature.  The creditor who wants to exercise set-off can do so from the assets excluded from the liquidation estate to the extent of the set-off value, u/s 36(4) of IBC. Such creditors are often given preferred status in assets statutorily excluded from the liquidation estate.   No new rights are created due to the rejection of rights to claim set-off, and the moratorium will be operative on the corporate debtor’s assets.   Author’s remarks  Set-off is a globally recognised and widely practised concept. Set-off should not be

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Affirmative or Negative: Evaluating Resolution Professional’s role as a Public Servant

[By Rahul Pandey] The author is a student of West Bengal National University of Juridical Sciences.   Introduction Based on a plain reading of provisions of the IBC, 2016, it would not be wrong to assume that the Resolution Professional (“RP”) is supposed to act as the backbone of the entire insolvency resolution process. He is envisaged as an impartial party that acts in the best interest of all involved and upholds the highest standards of professional and moral integrity. However, in the unfortunate situation wherein he is alleged to indulge in mala-fide practices that threaten the whole regime of trust-building the code is supposed to stand for, his position remains unclear. Should he be treated as a “Public Servant” performing a duty that is public in nature under the Prevention of Corruption Act, 1988 (“PC Act”)? Or would it be a better fit to exclude him from the purview of the strict standards of prosecution of said public servants to ensure that the constant threat of being faced with these provisions does not act as a barrier for him in the performance of his duties? This piece shall aim to address this concern and provide a balanced view in light of conflicting judgments delivered in recent months by the Hon’ble High Courts of Jharkhand and Delhi as the matter lies pending before the Hon’ble Supreme Court of India.   The PC Act and its expanded Horizon of Public Servants  Aimed at curbing the evil of corruption across all levels of society, the PC Act provided a wide-ranging definition of the term ‘public servant’ in light of the changing economic order to ensure that its provisions not only apply to those working for the government directly but also those that perform any duty that may be ‘public’ in nature.  A common misconception that arises is that RPs are covered under the term ‘liquidator’ as given by Section 2 (c)(v) of the PC Act and Section 21 of the IPC that define Public Servants. However, the same would be a fallacious conclusion as the liquidators mentioned in these provisions refer to those appointed under S.502 of the old Companies Act, 1956, who were directly appointed by the High Court and drew their pay directly from the government. On the contrary, RPs under the IBC are appointed by the Committee of Creditors (CoC) in coordination with the NCLT under S.22 of the IBC and draw their fee on the basis of assets realised or as deemed appropriate CoC based on their commercial wisdom.   Nature of Appointment   In regard to the nature of appointment of the RP as to bring him within the fold of Section 2 (c)(viii) of the PC Act, conflicting opinions have emerged. The Delhi High Court in its judgement in Arun Mohan v. CBI, 2023 SCC OnLine Del 8080 has emphasised that while only the Interim RP initially is appointed directly by the NCLT, the final Resolution Professional who oversees the CIRP till its conclusion is appointed by the CoC and not the NCLT.   The Jharkhand High Court, on the other hand, in its judgement in Sanjay Kumar Agarwal v. CBI, 2023 SCC OnLine Jhar 394, has held that while the direct role of the NCLT is limited to the appointment of the Interim RP under S.16, IBC, the appointment of the final RP under S.22, IBC, the decision of the CoC has to be communicated to the NCLT. Even in the case of replacement of the RP by the CoC under S.27 (3) and (4), IBC, the committee of creditors shall forward the name of the insolvency professional proposed by them to the adjudicating authority which will forward it to the Board for its confirmation. In light of all these factors, the court has opined that it would be incorrect to conclude that the adjudicating body doesn’t play an active role in the appointment of the RP.  The position taken by the Jharkhand HC is in line with previous decisions of the NCLAT wherein the position of the RPs has been held to be equivalent to that of an officer of the court for the purpose of contempt and thus the nature of the appointment of the RP can be said to be completely within the scope of public nature.   Involvement of Public Duty in role of RP  As has been held by the Supreme Court, the character of “public duty” as performed is the prime factor in determining if the said office was that of a “Public Servant” for the purpose of the operation of the PC Act. The words “Public Duty” can have a very wide range of interpretation. This is somewhat in line with the vision of the introduction of the PC Act which sought to leave open the scope of bringing within its fold offices that gain public function as the dynamics and the functioning of the state machinery changes.   In holding that the RP is not a public servant, the Delhi HC has placed reliance on a paragraph in the SC’s judgement in Ramesh Gelli V. CBI where it has been observed that when an office may hold elements of public duty, without the element of ‘public character’, it may not be considered as that of a public servant. To justify this view, the court has gone on to hold that –  “IP metamorphosizes from an IRP to an RP and thereafter as a Liquidator (as the case may be), and due to such metamorphosis, it would be prudent not to characterize the duties, even if assumed to be “public”, as in the nature of “public character”.”  However, it is respectfully submitted that the change in nature of duties from IRP to RP and to liquidator is not enough to justify that the office of the RP as a whole does not hold an essential public nature. While it may be true that the judgments in Swiss Ribbons and Arcelor Mittal describe the role of the RP as a mere facilitator, his neutrality,

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Limitation under Section 61 of the IBC: End of the Interpretation Saga?

[By Himanshu Gupta & Nandika Seth] The authors are students of NMIMS School of Law, Mumbai.   INTRODUCTION  The concept of limitation provides a timely framework within which an aggrieved can file a suit, appeal or an application in court. It also empowers courts to dismiss any suit, appeal or application filed after the stipulated period has expired. Therefore, limitation plays a vital role in any proceedings as it can serve as a ground for rejecting a suit even if the plaintiff has a cause of action.  However, a conundrum arises as to which date triggers limitation to commence when the matter is conclusively heard on one day and the order is directly uploaded on the website. The Apex Court for the very first time in Sanjay Pandurang Kalate vs Vistra ITCL India Pvt. Ltd.  (“Vistra ITCL”) answered the aforesaid question.  It held that the period to compute limitation to file an appeal under Section 61 of the Insolvency and Bankruptcy Code (“IBC”) from an order of the National Company Law Tribunal (“NCLT”) commences from the date of upload of the order by the Registry. This ruling ensures that the clock of limitation starts clicking once both parties are aware of the content of the order and therefore, they can act accordingly.  FACTUAL MATRIX  The appeal before the Apex Court arose out of an application filed under Section 62 of the IBC against the judgement of the National Company Law Appellate Tribunal (“NCLAT”). The previous appeal was dismissed by NCLAT on the grounds of limitation. Vistra ITCL applied to initiate a Corporate Insolvency Resolution Process under Section 7 of the IBC against the Corporate Debtor.  NCLT heard the application filed by Vistra ITCL on 17th May 2023, however, no order was pronounced on that day. Though the said order bore the date of 17th May 2023, it was uploaded by the Registry on 30th May 2023.    The Tribunal in the present case dismissed the application of Vistra on the ground that the application was frivolous and lacked authorisation of Board of Directors of the Debtor. The appeal was filed before the NCLAT on 10th July 2023. Through the application for condonation of delay filed by Vistra, they contended to have received the certified copy of the order on June 1, 2023 for which the application was made on May 30, 2023 and therefore, time for computation of limitation should start from the 30th May 2023 since it was on that day, they became aware of the content of the order. The NCLAT held that the appeal was barred by limitation as it was instituted beyond the 45 days limitation period as stipulated under Section 61 of the IBC. It opined that the period of limitation was to be computed from the date the order was pronounced. Therefore, an appeal was filed before the Apex Court challenging the order passed by the NCLAT.  OBSERVATIONS OF THE APEX COURT  The Apex Court set aside the impugned order of the NCLAT which dismissed the application for condonation of delay filed by Vistra. It held that no substantive order was pronounced on 17th May 2023. Besides, the cause list stipulated that the case was listed for admission and not for pronouncement.   Further, the Court held that the period of limitation should trigger from May 30, 2023, the date when the order was uploaded. The 30 days’ limitation period in accordance to IBC would end on June 29, 2023, hence the appeal was within the condonable period of 15 days. The Court ruled that the limitation for filing an appeal would trigger from the date when the order was uploaded and not the date on which the Bench heard the matter.  ANALYSIS  The decision in the present case came at the ripe time resolving yet another conundrum in Pandora’s Box of interpreting Section 61 of the IBC wherein the Court clarified the position of law in cases where the matter is conclusively heard but an order is not pronounced.  It has been previously settled in the cases of Prowess International Pvt. Ltd vs Action Ispat & Power Pvt. Ltd and V. Nagarajan v. SKS Ispat and Power Limited & Ors. that the period of limitation begins to run from the date of pronouncement of the order. However, there remained a lacuna as to the situations where the Court decides not to pronounce an order on a given date before the parties but makes it available directly on the Court’s website on a different date.  Previously, in the case of Pr. Director-General of Income Tax v. Spartek Ceramics India Ltd. it was categorically held that the period of limitation runs from the date when the aggrieved party becomes aware of the order. Contrary to this, in the case of Raiyan Hotels and Resorts Pvt. Ltd. Vs. Unrivalled Projects Pvt. Ltd., NCLAT clarified that the period of limitation under Section 61 of the IBC for filing of an appeal does not commence on the date when the appellant became aware of the content, but it shall commence when the order was pronounced.  A harmonious interpretation of these rulings concludes that the only essential to contemplate the period of limitation is the date of pronouncement of the order. In the present case of Vistra ITCL, the NCLT though heard the interlocutory application on 17th May 2023, did not pronounce any order. Vistra became aware of the contents of the order only when it was uploaded on the website, i.e., on 30th May 2023. Hence, the limitation ought to be computed from the latter date which the Supreme Court rightly did.  Furthermore, in Embee Software Pvt. Ltd. v. Solicon Pvt. Ltd., a matter similar to the present case at hand, the aggrieved party was unable to file an appeal owing to the late uploading of the order by the Court, summer vacation of the Court and demise of a family member. The NCLAT taking a lenient, liberal, meaningful and purposeful view satisfied with the reasons ascribed for the delay

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Revisiting CBIRC-II: A Call for a Group Company Insolvency Regime

[By Isha Khurana] The author is a student of Jindal Global Law School.   Introduction   The NCLAT in a January 2023 decision, reiterated the need to lift the corporate veil in matters of group company insolvencies. In doing so, it followed the path laid down in the 2021 CBIRC-II (hereinafter, “CBIRC-II Report”). This subject has been long debated in India and has found itself at the center of various working groups and committee reports. The 2019 working group report was the beginning of India’s recognition of the growing need to incorporate a provision for group company insolvencies, noting the shared control and economic interdependence of corporates. This, at the time, was deemed a win since the only preceding authority was the 2018 report of the insolvency law committee, which placed limitations on the growth of the group insolvency process. The 2018 report limited the scope of group insolvencies in India, by observing that since the insolvency code was only introduced in 2016, it may be “too soon” to introduce such a group company complexity in the statute.    Nevertheless, both the 2019 working group report and the 2021 CBIRC-II report have altered the course for group company insolvencies in India. While previous articles have addressed the nuances of group company insolvency, it is essential to consider the pivotal role played by reports such as the 2019 working group report and the 2021 CBIRC-II report. This article aims to revisit the discussion through the lens of the CBIRC-II decision and the January 2023 decision, to delve into the future of group company insolvencies in India. It attempts to incorporate the family-dominated business environment of India in this discussion, to stress the increased need for a group insolvency procedure. Through this, the article flows into an evaluation of whether the alleged conflict between group insolvencies and the separate legal entity doctrine could hamper the adoption of a group insolvency regime.   Contextualizing Group Companies in India   The 2021 CBIRC-II report fared well in establishing jurisprudence on which corporate groups could be deemed as group companies in India and what factors must exist for the same. A perusal of the committee’s deliberations on the definition of a “group” highlights the importance of shared control, common shareholding, and interdependence among members of a corporate group, for them to be termed as a group company structure. It thus becomes clear that an inclusive definition of “group” must be included in India’s insolvency regime and reliance may be placed on either control or ownership to establish the existence of a group company structure.   It is argued here that the business environment in India will be complemented by this definition. India is known to be home to several family-run businesses, both in the public and private sectors. The existence of such family-run businesses opens the doors for situations wherein holding companies exercise control over their subsidiaries (essentially, a vertical relation) and also for members of the same corporate group (a horizontal or lateral relation) to impact one another, through economic dependence. Thus, the insolvency regime needs to address the same, for promoting equity and fairness, and ensuring the protection of creditors.    The focus on control and ownership factors in the leading elements in establishing group company structures in the Indian context. Owing to the fact that it is commonly observed for common shareholding to be present with corporates exercising control over one another’s activities. Additionally, the deliberations of the working group coupled with the decision in Videocon, also open up the possibility of establishing a group company structure through the presence of common assets, pooling of recourses, interlinked financing, and so on. Thus, judicial decisions and committee reports work well with one another to account for a broad range of scenarios wherein a group company structure may be present.   As India’s corporate environment is dominated by family businesses (arguably, more than any other jurisdiction), it becomes all the more important that an efficient group company insolvency and recovery regime is in place. The same stems from the increased likelihood of corporations exercising control over each other’s operations and decisions. Further, given the operation of businesses in India, where significant control and decision-making power are shared, it becomes easier to pierce the corporate veil, and to allow for the institution of insolvency proceedings against a group of companies that are acting together. However, some may be apprehensive about initiating proceedings against a group of companies, as it may violate the separate legal entity principle, by treating different corporate entities as akin to one another. Thus, an analysis of whether the process of lifting the corporate veil for group insolvencies would contradict the separate legal entity principle must be undertaken, through the lens of judicial decisions.    A Judicial Lens to Piercing the Corporate Veil  Scholars and committee reports have repeatedly noted that insolvency laws are based on the principle of corporations being separate legal entities, following the jurisprudence laid down in Saloman v Saloman. The principle in insolvency law has come to be viewed as one that also distinguishes companies from their subsidiaries or holding companies, advancing from the view that a company is distinct from its members. Thus, binding corporate bodies belonging to the same group of companies was thought of as going against the basic tenets of corporate law.   However, jurisprudence which allows courts to lift/pierce the corporate veil has found its place in insolvency law as well. Practice now allows for the veil to be lifted in situations where associated companies are connected in a manner that they come to be treated as a single concern. The CBIRC-II sheds light on when companies may be treated as a single concern or rather, what links must be present for the same. The most commonly observed would be situations where companies have linked operations or finances when they own shared assets, and engage in related party transactions. In such scenarios, carrying out individual insolvency proceedings for one entity would be fruitless as a creditor would not be able to

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Municipal Bankruptcy: India’s Chapter 9 Moment?

[By Bhaskar Vishwajeet] The author is a student of Jindal Global Law School.   Introduction  Municipal bonds have gathered steam in India. As of when this piece was written, the country has 29 active municipal bonds on the NSE’s IBMX index for municipal bonds. Municipal debt instruments are a great alternative to raising capital for public infrastructure/service works. That said, assuming that the debt obligation is watertight may not be prudent because the issuer is a sovereign. There may be issues with revenue generation and projects being delayed. However, a far more significant threat is the municipal corporation’s bankruptcy.  This article aims to contextualize municipal bonds within India’s bankruptcy regime and assess whether these debt instruments and investors are secured through regulation in case of possible bankruptcy. We shall also refer to the United States to see how the sovereign’s promise of “faith and credit” to back the bond’s health is not always guaranteed.  What are Municipal Bonds?  Municipal bonds are government debt instruments financing public projects and utilities. They attract investors by allowing them to lend money to local government institutions in return for regular interest payments and the return of their principal when the bond matures. The potential tax benefits, such as income tax exemptions on interest income, make municipal bonds appealing, especially to investors in higher tax brackets.  Municipal bonds are of two types: General Obligation (GO) bonds, supporting general development works through revenue from property tax and revenue cess, and Revenue Bonds, funding specific projects like schools and water filtration plants through project-generated revenue. Backed by the respective government’s reliability in repaying debts, municipal bonds receive ‘investment-grade’ ratings from agencies, exemplified by AA+ ratings for New Delhi Municipal Council and Navi Mumbai bonds.  Municipal Bond Health  Municipal Bonds are generally considered safer than other investments in the market for two primary reasons. First, municipal corporations are state instrumentalities. A sovereign pledge supports the bond’s health, and there is a sense of assurance that the state will make good on the interest income and any default whatsoever.  Second, to reinforce investor confidence in the value and health of the bonds, regulators require  municipal issuers to meet certain eligibility requirements. The SEBI (Issue and Listing of Municipal Debt Securities) Regulations 2015 stipulates eligibility requirements in regulation 4 and requires the issuing local government authority or ULB to, inter alia, not have a history of defaulting on debt repayments in the past 365 days of the issuance of a municipal bond and to have at least an investment grade credit rating (BBB- or above) by a SEBI-registered credit rating agency.  The Detroit Case Study and Chapter 9 Protections  Despite their perceived safety, municipal bonds face financial distress, as evidenced by the City of Detroit’s bankruptcy in 2013. Detroit’s case illustrates how legislative protections, such as Chapter 9 of the U.S. Bankruptcy Code (Adjustment of Debts of Municipalities), facilitated a resolution.  Detroit had issued various bonds before its bankruptcy, including GO bonds backed by taxing power and Revenue bonds secured by specific project revenues. Financial problems, stemming from issues like population decline and rising pension costs, led to a severe budget deficit, prompting the city to file for Chapter 9 bankruptcy protection in July 2013. Chapter 9 allows municipalities to restructure debts without asset liquidation, enabling negotiations with creditors under court supervision. This ensures a fair repayment plan while maintaining essential services. Detroit emerged from bankruptcy in 2014 after a federal judge approved a financial restructuring plan.  Does India’s Bankruptcy Regime Protect Municipal Issues?  India’s Insolvency and Bankruptcy Code (IBC) lacks provisions akin to Chapter 9 in the U.S., raising concerns about the protection of municipal bondholders during bankruptcy. Even SEBI offers no guidance on municipal bankruptcies or defaults. Regulators seem to have complete faith in the sovereign pledge of these municipalities and the principle of not interfering with the state’s powers. This logic is akin to the history behind Chapter 9 in the United States, wherein the original municipal bankruptcy legislation from 1934 was held unconstitutional for violating the sovereignty of states. The United States Congress later revised the Act in 1937, which was constitutionally affirmed in United States v. Bekins, and subsequently retained as Chapter 9 through the 1978 Bankruptcy Reform Act.  Chapter 9 is unique because it is tailored for municipal bankruptcies. It includes an automatic stay on any associated claims or litigation against the debtor. The provisions include restrictions on the court’s interference with the municipal debtor’s powers, such as not interfering with the municipality’s borrowing powers and converting the proceeding into a liquidation proceeding. These restrictions are necessary to preserve the constitutional status of Chapter 9 (as the borrower is a sovereign). As a corollary, the municipal debtor must propose a plan to adjust its debt since creditors cannot file plans under Chapter 9. The entire process provides space to negotiate and restructure a debt repayment plan for municipal debt. Indian law does not guarantee such a position.  The problem worsens with the incompatibility of general bankruptcy laws as List I (Central) subjects with List II municipalities. As local governments, municipalities are state subjects in Entry 5 of List II. Multiple states have statutory municipal corporation acts (“Acts”), enabling municipal corporations to raise money by issuing debentures or other instruments (see Section 114A of the Uttar Pradesh Municipalities Act 1916). Almost every Act stipulates the security interests that may be created in a bondholder’s name. These range from municipal taxes, borrowed funds from public financial institutions and even, rarely, immovable property vested in the Corporation. Most municipal corporations/councils must maintain a municipal/sinking fund to ensure an adequate corpus to return the borrowings on debentures/loans. However, many Acts are unclear on whether the sinking fund can be used for other forms of issues, i.e., if the municipality chooses to issue, say – non-debt securities.  There is some guidance concerning the order of payments. Section 151 of the erstwhile Municipal Corporation Act 2000 (Jammu and Kashmir) stated that interest income and loan repayments will be paramount. However, this instance is too remote for broad application. In isolation, these provisions

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Inside IBBI’s Discussion Paper: The Real-Estate Insolvency Panacea?

[By Kaustubh R Kulkarni & Harsh Pandey] The authors are students of National Law University Odisha.   Introduction  The Insolvency and Bankruptcy Code 2016 (Code) was enacted to bring about a framework which would bring down the complexity which was associated with the Insolvency framework for creditors. Be it, the multiplicity of applicable laws or the multiple fora which one had to deal with. With the introduction of the Code this was set to radically change.  However, the real estate sector was not well received by the Code, there were multiple complexities associated with homebuyers and resolution of their problems under the Code. For instance, the conundrum around whether a homebuyer could be considered a Financial Creditor (FC), and issues surrounding whether there has to be a project-wise insolvency resolution process. The Code in this regard has been witness to continuous change by way of amendments or by way of making and amending regulations. The Insolvency and Bankruptcy Board of India (IBBI) to this extent notified a discussion paper on 6 November 2023 proposing several amendments to the existing Corporate Insolvency Resolution Process (CIRP) and Liquidation regulations in the light of real estate-related proposals. The authors argue that the discussion paper proposes a much-needed Project-Wise insolvency regime, but simultaneously dispenses with effectively resolving the convoluted Liquidation Estate tussle.  Project-Wise CIRP: A Judicial Experiment  Homebuyers or allottees have been granted the status of FC in relation to real-estate insolvency through the Insolvency and Bankruptcy (Second Amendment) Act 2018 by amending sub-Section (8) of Section 5, which defines “financial debt”. Further, the validity of the amendment was upheld by the Supreme Court (SC) in Pioneer Urban Land and Infrastructure Limited & Anr. v. Union of India & Ors. Nonetheless, disputes continue to arise between the beneficiaries and other creditors (banks, etc.). It is significant to highlight that there are differences between the types of insolvencies that occur in real estate and other sectors.  It is observed that allottees are usually more interested in obtaining their homes, apartments, or flats back during the insolvency processes than they are in recovering the money they invested in the project. Nonetheless, banks and other lending organizations are more likely to take a cut when they get their invested money back. Furthermore, if one of the Corporate Debtor’s (CD) projects defaulted, the CD’s other projects would also be roped in, leading to unnecessary hassles for the homebuyer.  Introduced in Flat Buyers Associations v. Umang Realtech, project-wise CIRP was deemed to be a potential solution to maximize the value of the assets to balance the rights of different creditors. In this light the Ministry of Corporate Affairs also published a Consultation Paper on 18 January 2023 which specifically highlighted that the Adjudicating Authority shall have the authority to apply CIRP provisions project-wise to only such projects, which have defaulted. Buttressing the same, the SC in IndiaBulls Asset Reconstruction Company Limited v. Ram Kishore Arora and Ors upheld the validity of the NCLAT, New Delhi order allowing project-wise CIRP. Project-wise CIRP is a solution to the substantial problems of both the homebuyers and developers, in as much as it allows them an opportunity to settle their woes quickly and more so for the developers as it prevents stalling the construction of other real-estate projects.  The Proposed Changes  The discussion paper proposes several measures in order to ensure that Homebuyer does not face the brunt of the procedure of the Code. First of them being that the Interim Resolution Professional/Resolution Professional has to ensure that the real estate project be registered with Real Estate Regulatory Authority as a matter of mandate in terms of Section 17(2)(e) of the Code. This will ensure that there is transparency and accountability for a successful resolution. Establishing a separate bank account for each project during the CIRP ensures efficient repayment to homebuyers, thereby heralding project based insolvency as solution to real-estate insolvency disputes.  Secondly, the paper puts forward the execution of registration/sublease deeds with approval of Committee of Creditors (CoC) during the CIRP. This allows the allottees to get their apartments in the case where they have fulfilled all their obligations as against the instrument of transfer. It empowers the homebuyer to obtain the units of the apartment in a “as is where is” basis alongside on the payment of balance amount, if the same is due.  Third and most prominent change, the RP now shall have the power to propose to the CoC to examine and invite separate plans for each project. An amendment hence has been suggested of the CIRP Regulations to insert a clarification right under Regulation 36A(4). This is set to give succor to homebuyers who are usually concerned with a specific project and on the other hand would benefit the developer by ensuring that his other projects are not stalled due to the moratorium if an Insolvency petition is admitted for a single project.   Lastly, the paper proposes exclusion of property in possession of homebuyers from the Liquidation Estate (Estate). This ensures and affords an opportunity to the homebuyer to occupy the units “as is where is” in order for it to not form part of the Estate, which would otherwise entitle the creditors to make a claim and sell the same in order to realize the liquidation value.  Implications and Challenges  The implementation of the discussion paper’s proposals would have far-reaching ramifications and implications for homebuyers and developers. It will affect not only those homebuyers who have their units pending in a particular project (P1) which itself has defaulted but also those homebuyers whose units are pending in other projects, who will be affected by the cascading effects caused by default in P1. By making a provision of taking the possession of the units from the developer in “as is where is”, it gives discretion to either receive a payment with a haircut or to obtain the units even if the construction is incomplete.   The proposed amendment under Section 36 of the Code provides to exclude those

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Understanding Invoice Discounting: Legal Framework, Transaction Dynamics, and Implications under the IBC, 2016

[By Nakshatra Gujrati] The author is a student of National Law University Odisha.   Introduction In the dynamic realm of financial transactions, invoice discounting has emerged as a pivotal tool for businesses seeking to optimize their working capital. Invoice Discounting, also known as Bill Discounting, entails three key participants: the seller, the customer (who is also the debtor to the financier), and the financier, commonly referred to as the factor. The financier provides this short-term relief in exchange for a predetermined commission and discount rate, forming the core dynamics of the transaction.  This article explores the complexities of invoice discounting and its intersection with the Insolvency and Bankruptcy Code, 2016 (“Code”). Governed by the Factoring Regulation Act, 2011, (“Act”) the examination commences by delineating the fundamental process of invoice discounting and elucidating the roles assumed by the seller, customer, and financier. The article examines the dynamics of transactions between the financer and the customer, as well as between the financer and the seller. It scrutinizes the decisions rendered by tribunals, offering insights into the classification of customers as financial debtors and classification of sellers as operational debtors.  What is Invoice Discounting   Invoice Discounting, also known as Bill Discounting in trade circles, is a process where an entity can transfer its invoices (receivables) to a third-party financier, such as a bank or another financial institution. This financial entity, referred to as the “financer”, offers a bank discounting facility, providing short-term assistance in fulfilling the working capital needs of the entity that sold the outstanding bill. In return, the financer levies a designated commission and discount rate for their services.  The Factoring Regulation Act, 2011 (“Act”) regulates the practice of invoice discounting, and businesses engaged in this activity are referred to as “factoring businesses”. This Act aims to validate contracts related to the assignment of receivables. The party to whom the receivable is transferred is known as the assignee, while the entity owning the receivable is termed the assignor.  Invoice discounting typically involves three participants; the seller (sold goods and services to customer), the customer (also debtor of the financer) and the financier (commonly referred to as the factor). In this process the business sells its invoices to the financier, who provides cash. Afterwards when it comes time, for payment the customer pays the amount, to the financier.  Invoice Discounting and Insolvency and Bankruptcy Code, 2016  The section 5(8) of the Insolvency and Bankruptcy Code, 2016 (“Code”) defines financial debt as “debt along with interest, if any, which is disbursed against the consideration for the time value of money”, including “receivables sold or discounted other than any receivables sold on non-recourse basis” as per section 5(8)(e) of the Code.   Nature of transaction between the Financer and the Customer.  The customer enlists the services of a financer to enhance their cash flow, facilitating timely bill payments with reduced risk and increased flexibility, given that such arrangements don’t necessitate collateral. However, a dilemma arises when the customer fails to fulfil payment obligations to the financer. The tribunal is confronted with the inquiry of categorizing the customer as either a financial creditor or an operational creditor of the financer.  In the case of M/s Shree Jaya Laboratories Private Limited,(“Jaya Laboratories”)  it was ruled that “an application under section 7 of the code may be maintained against the customer”.   In the instant case the financer extended its services to the customer on a recourse basis. The Master Direction- Reserve Bank of India (Financial Services provided by Banks) Directions, 2016 classifies the factoring services into three categories. These include (i) non-recourse factoring, where the financer has no recourse against the customer except in cases of fraud, misrepresentation, or failure to fulfill obligations; (ii) recourse factoring, wherein the customer remains liable to the financer; and (iii) limited recourse factoring, allowing the customer and financer to establish conditions for recourse through a contractual agreement. As per section 5(8)(e) of the code, financial debt includes receivables sold or discounted other than non-recourse basis. Hence, the relationship between the financer and customer is of financial creditor and financial debtor and thus an application u/s 7 of the code is maintainable against customer.   Nature of Transaction between the Financer and the Seller  In the recent judgment of NCLAT in Minions Ventures Pvt Ltd vs Tdt Copper Limited (“Minions Ventures”) it was held that “while discounting the invoice of sellers the financers enter into shoes of seller to become operational creditors”. It was observed that in this transaction, no funds were disbursed, let alone for the time value as a financial debt to the seller. Instead, it constituted an operational debt, as the seller provided goods and services to the customer, defining the nature of the debt between the two as operational.   Similarly, this view was taken in Jaya Laboratories while dismissing application of financer against seller under section 7 of the code.  Conclusion  The practice of Invoice Discounting, also known as Bill Discounting, plays a crucial role in facilitating working capital needs for businesses by allowing them to convert their receivables into immediate cash through third-party financiers. The Factoring Regulation Act of 2011 regulates this financial activity, defining the roles of factoring businesses, assignors, and assignees in the process.  Examining the intersection of Invoice Discounting with the Insolvency and Bankruptcy Code of 2016, it becomes evident that the nature of the transaction between the financer and the customer is one of a financial creditor and financial debtor. This is especially true when the services are provided on a recourse basis, as outlined in the Master Direction of the Reserve Bank of India. The application of Section 7 of the Insolvency and Bankruptcy Code against the customer is deemed maintainable under these circumstances.  In the context of the relationship between the financer and the seller, recent judgments, such as the one in Minions Ventures, suggest that when discounting invoices, financers assume the role of operational creditors. In these cases, where no funds are disbursed as financial debt, but rather the transaction revolves

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Ramkrishna Forgings Case – SC Upholds CoC’s Commercial Wisdom

 [By Naman Kasliwal & Vaibhav Kesarwani] The authors are students of Gujarat National Law University.   Introduction In a recent case of Ramkrishna Forgings Limited v Ravindra Loonkar & Anr., the Supreme Court has set aside an order of the NCLT and NCLAT that had put the approval process of a resolution plan on hold. While the judgment has been lauded for its affirmation of the commercial wisdom of the Committee of Creditors (“CoC”) and the limited scope of judicial interference, a critical examination reveals underlying pitfalls that demand our attention. This blog seeks to delve into the intricacies of the judgment, shedding light on inherent drawbacks. By doing so, it aims to provide a comprehensive understanding of potential repercussions that could extend well beyond the immediate case, significantly impacting the landscape of insolvency resolution practices in India.  Background of the Case  ACIL, the Corporate Debtor, underwent the Corporate Insolvency Resolution Process (“CIRP”) under the Insolvency Bankruptcy Code (“IBC”). The CoC approved the Resolution Plan submitted by Ramkrishna Forgings Limited, referred to as the Successful Resolution Applicant (“SRA”). Subsequently, the Resolution Professional submitted an application under Sections 30(6) and 31 of the IBC to the NCLT, seeking approval for the resolution plan.  On September 1, 2021, the NCLT passed an order instructing the revaluation of the Corporate Debtor’s assets. As a result, the application seeking approval of the Resolution Plan was kept in abeyance, and the Official Liquidator was instructed to furnish exact value of assets. Against this order of NCLT, an appeal was filed by the SRA before the NCLAT under section 61 of the IBC. The NCLAT dismissed the appeal while noting the discovery of an avoidance transaction worth approximately Rs. 1000 Crores, justifying intervention due to the involvement of crores of rupees. Aggrieved by the NCLAT order, the SRA filed an appeal to the Supreme Court, arguing that the IBC inherently includes a mechanism for asset valuation of the Corporate Debtor, as outlined in the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016. Thus, the appointment of an Official Liquidator for asset valuation, which is a creation of the Companies Act, 2013, is unnecessary.   Supreme Court’s Ruling  The Supreme Court, in its judgment, addressed the core issue of the extent of the NCLT’s jurisdiction and the role of the CoC in the insolvency resolution process. The Court emphasized that the Adjudicating Authority, in this case, the NCLT, has a limited role, primarily focused on approving resolution plans that align with the requirements of the IBC.  The Court rejected the NCLT’s order for re-valuation, highlighting that there were no objections raised by any party regarding the valuation or the resolution plan. It underscored the importance of the CoC’s commercial decision-making, stating that unless the resolution plan violates the provisions of the IBC, the NCLT should refrain from intervening. The Court referred to previous judgments, such as K Sashidhar v. Indian Overseas Bank, reinforcing the principle that the CoC’s decisions should not be subject to unnecessary judicial scrutiny unless there is a clear violation of statutory provisions, particularly the Sections 30 and 31 of IBC.  In allowing the appeal, the Supreme Court set aside the orders of both the NCLT and the NCLAT, directing the NCLT to pass appropriate orders on the approval application within three weeks. The Court’s ruling essentially upheld the commercial wisdom of the CoC, emphasizing that interference by the NCLT should be limited to cases where statutory provisions are infringed upon.  Harmonizing CoC Autonomy with Stakeholders Rights  Undoubtedly, the court’s emphasis on recognizing the commercial wisdom of the CoC is deeply rooted in the conviction that those with a significant financial stake are inherently best positioned to navigate the complexities of decisions in insolvency resolution processes. This recognition reflects an acknowledgment of the CoC’s intimate understanding of the financial intricacies involved and their vested interest in ensuring a successful resolution.   However, while this emphasis on financial acumen appears logical on the surface, it sparks legitimate concerns about potential biases within the decision-making framework. The considerable influence wielded by financial creditors, if left unchecked, introduces a risk of decisions that prioritize their interests at the expense of other stakeholders, particularly operational creditors or minority shareholders. The autonomy granted to the CoC, if not subject to adequate checks and balances, carries the inadvertent risk of fostering a decision-making culture that might lack the ethical scrutiny necessary to ensure fairness and equity. Striking a delicate balance between financial prudence and ethical considerations becomes paramount in maintaining the integrity of insolvency resolution processes and safeguarding the interests of all stakeholders involved.  The ruling in the Ramkrishna Forgings case appears to adopt a positivist stance on judicial intervention in the CoC’s decision-making process. The court underscores that the resolution plan does not exhibit any of the specific flaws outlined in section 31. However, this approach needs to be assessed in the context of the low recovery rates observed under the IBC. Instances exist where creditors are compelled to walk away with minimal returns, experiencing haircuts as substantial as 99%. Such outcomes might potentially result in non-financial creditors losing faith in the CIRP, as they lack a voice in endorsing resolution plans that entail significant haircuts. This might inadvertently create a chilling effect on challenges to CoC decisions. Stakeholders, including dissenting voices or those with legitimate concerns, may feel discouraged from raising objections if they perceive a reluctance on the part of the judiciary to intervene. This potential deterrence poses a risk to the checks and balances essential for a fair and transparent insolvency resolution process. The fear of facing an uphill battle against entrenched decisions could stifle dissent and hinder the constructive scrutiny that is integral to refining and improving the resolution process.  The potential drawbacks of unquestioningly relying on the commercial wisdom of the CoC have been acknowledged by the Insolvency and Bankruptcy Board of India (IBBI), which has therefore come up with a Code of Conduct and ethical framework for the

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