Interplay Of Schemes Of Arrangement And IBC: A Case Study

[By Sourav Jena & Shivani Pattnaik]

The authors are students at the National Law University, Odisha. 

The insertion of Section 29A in the Insolvency and Bankruptcy Code, 2016 (“IBC”) has been a turning point in the Corporate Insolvency Resolution Process (“CIRP”). Prior to its existence, any individual who submitted a resolution plan could qualify as a resolution applicant. However, this technicality served as a ‘back-door entry’ for individuals who contributed to the default of the corporate debtor to reclaim key managerial control by outbidding other financial institutes. Therefore, Section 29A serves as a ‘restrictive provision’ by narrowing the scope of eligibility of a resolution applicant.

In pursuance of securing the interests of the corporate debtor, the Supreme Court of India (“SC”) in the recent judgment of Arun Kumar Jagatramka v. Jindal Steel and Power Ltd. and Anr. has held that individuals disqualified under Section 29A of IBC would also stand to be disqualified under Section 230 of the Companies Act, 2013(“the Act”). Consequently, individuals shall not make any compromise /arrangement with creditors and members as provided under Section 230 of the Act if they fail to qualify as resolution applicants.

The article seeks to present the facts of the case, and findings of the Court along with a critical analysis of the status quo of corporate insolvency in light of the judgement.

Background

The background of the case spans two separate civil appeals and a writ petition.

Facts of Civil Appeal No. 9664 of 2019

On 07.04.2017, corporate applicant ‘Gujarat NRE Coke Limited’ (“GNCL”) filed an application to initiate the CIRP. One of its promoters namely, Mr. Arun Kumar Jagatramka sought to present a resolution plan before the Committee of Creditors (“CoC”).

Meanwhile, Section 29A was inserted into the IBC wherein Section 29A(g) prohibits a promoter of the corporate debtor to be eligible as a resolution applicant. As a consequence, Mr. Jagatramka failed to qualify, thereby, prompting the National Company Law Tribunal (“NCLT”) to initiate the liquidation of GNCL in the absence of any other resolution plan. Whilst Mr. Jagatramka challenged the NCLT order before the National Company Law Appellate Tribunal (“NCLAT”), he proceeded to present a scheme of compromise and arrangement to which the NCLT directed for a meeting to be conducted to approve the same.

However, an operational creditor viz. Jindal Steel and Power Ltd. (“JSPL”) appealed to the NCLAT against the NCLT order. It was held that as a promoter of the corporate debtor, Mr. Jagatramka was ineligible to become a resolution applicant, thereby, relinquishing the power to propose a scheme of compromise and arrangement for creditors and members.

Facts of Civil Appeal No. 2719 of 2020

On 05.04.2018, the NCLT directed the CIRP of Su-Kam Power Systems Ltd. (“Su-Kam”). Mr. Kunwer Sachdev, one of the promoters, submitted a resolution plan on 15.11.2018. However, with the amendment of the IBC, he became ineligible to qualify as a resolution applicant. Hence, Su-Kam was directed to be liquidated. On the appeal against the appointment of the liquidator, NCLAT not only upheld the decision but also directed the liquidator to invite applications for compromise and arrangement with creditors. Mr. Kunwer, having applied to submit a scheme, was again found ineligible to do so, thereby, giving rise to a slew of appeals.

Writ Petition Civil No. 269 of 2020

Regulation 2B delineates compromise and arrangement under Section 230 of the Act was challenged to be ultra vires the IBC as it was inserted by an amendment notification dated 25.07.2019 under the IBBI (Liquidation Process) Regulation, 2016.

Issues and Contentions

The question of law SC dealt with was whether an ineligible resolution applicant could submit a scheme for compromise during liquidation. The promoters put forth that the ineligibility under Section 29A was applicable only during resolution. This resolution was distinct from proposing a scheme of compromise under Section 230 of the Act, which connotes ‘settlement mechanism.’ Furthermore, Regulation 2B of the Liquidation Regulation was put under the scanner for being violative of  Articles 14, 19, and 21 of the Indian Constitution alleging that it sought to draw a parallel between ineligibility under Section 29A of the IBC to the distinct provision of Section 230 under the Companies Act.

However, the Respondents drew attention to the inherent objective of Section 29A which was to keep individuals, responsible for default of the corporate debtor, away from gaining control of the corporate debtor’s assets. Therefore, the Respondents argued that the resolution process under Section 29A and the liquidation process were shown to be inconsistent by the promoters in order to utilize the loophole.

Findings of the Court

The SC reasoned that liquidation proceedings under the IBC and the proposal of the scheme of compromise under Section 230 lay on the same spectrum. While referring to the Swiss Ribbon v. UOI case, the SC mulled over the intent behind introducing Section 29A and concluded that Section 29A would pervade Section 35(1)(f) of the IBC during the liquidation process. Furthermore, it was observed that courts should be open to interpreting Section 29A in light of Section 230 of the Act in a manner that does not defeat the purpose of their statutory linkage.

In addition, while analyzing the utility of both the Sections, the  SC opined that the legislative intent behind  Section 230 of the Act is to “ensure revival and continuation of the corporate debtor by protecting it from liquidation.” Moreover, the restrictions under Section 35(1)(f) of IBC acts as an extension to that protection and therefore, shall be applicable.

While referring to the Meghal Homes case, the SC contemplated questions raised upon Regulation 2B and stated that the raison d’etre behind the resolution process cannot be distinct from the liquidation process and the same was clear in the regulatory provisions. Therefore, the SC upheld that persons ineligible under Section 29A would also be ineligible to propose a scheme of compromise under Section 230.

 Critical Analysis

The recent judgment of Arun Kumar Jagatramka has partly addressed the issue of the scheme of arrangement in the background of IBC. It has shed away the uncertainty dwelling around the constitutionality of Regulation 2B and decided on the ‘harmonious construction’ between the two regulations. Hereafter, the SC held that there is a nexus between the ineligibility under Section 29A of IBC and Section 230 of the Act. However, some questions arise, including whether there is a need to attach a scheme of arrangement to IBC and whether IBC will be better off without such attachment.

Even the Bankruptcy Law Reforms Committee (“BLRC”), in its 2015 interim report, noted that the insolvency process should be the last option. Only when all the negotiations between the creditors and the debtors fail, the IBC should act as a last resort. This means the creditors and the debtors should have explored the ways of arrangements or amalgamations before resorting to IBC. Hence, BLRC did not suggest any amendments to Section 230 of the Act of 2013. However, even though the SC observed that the introduction of this amalgamation of the Scheme of Arrangement and IBC was an outcome of a series of judicial proceedings, it left certain questions unanswered.

Moreover, the Insolvency Law Committee (“ILC”), in its 2020 report, noted that the scheme under Section 230 does not complement the liquidation process under IBC. However, it highlighted that the scheme may be of some utility to creditors who want to avoid the mandated liquidation proceedings. Hence, the ILC noted that such a scheme of arrangements should not be affected under the Companies Act and the liquidators could be allowed to affect an arrangement or compromise under the IBC code itself.

Lastly, the scheme of arrangements might act as a repeated attempt for revival as there are too many options to do so. Even before the IBC proceedings start, there is an option for resolution under the statutes of the Reserve Bank of India and under Section 230 of the Act. Even if the debtor has to go into liquidation, the inclination is towards the going-concern sales. With all these available methods, opting for schemes in the liquidation process poses more questions than answers. Besides, data as of 2020 shows a poor success rate of IBC liquidation through the process of arrangements and compromise.

Conclusion

The IBC brings upon a comprehensive mechanism for the resolution of corporate insolvency.  In this case, the SC sought to protect the interests of corporate debtors and creditors even while affecting corporate governance. It rightly checked a loophole by extending ineligibilities provided under Section 29A of the IBC to Section 230 of the Act.

Keeping aside the positive considerations of the judgment, it is essential to question whether the added layer of Section 230 of the Act attached with Section 29A of the IBC poses more problems and delays in litigation while undergoing the liquidation process. In the end, there is an increasing need to simplify the prolonged process in order to better the interests of all stakeholders involved, and the recent judgment attempts to steer the discussion in the right direction.

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