Reflecting on the Madras High Court Judgment: Transparency and the Clean Slate Theory in IBC

[By Soniya Raghuwanshi]

The author is a student of Institute of Law, Nirma University.

 

Introduction

The Insolvency and Bankruptcy Code (IBC) of 2016 marked a significant shift from the previous rigid legal frameworks, focusing on a more holistic approach to insolvency. Unlike earlier statutes that concentrated on recovering loans, the IBC emphasizes loan restructuring, aiming to strike a balance between the interests of creditors and corporate debtors. This ensures the survival of the company while also satisfying the creditors’ claims. 

The Clean Slate Theory (CST) posits that once Resolution Plan is approved by Committee of Creditors and subsequently by the approval of Adjudicating Authority then, all claims, whether resolved or unresolved, are extinguished. This doctrine ensures that successful resolution applicant can take over the business without any lingering liabilities. The Committee of Creditors (CoC) play crucial roles in enhancing the effectiveness and integrity of the insolvency process. A recent ruling by Justice N. Seshasayee of the Madras High Court in the case of “The National Sewing Thread Company Limited vs. TANGEDCO highlighted the importance of transparency and full disclosure in the IBC proceedings. The judgment reaffirmed the CST’s application, the CoC’s commercial discretion, fair treatment of creditors, and the need for judicial supervision, ensuring that the principles of the IBC are upheld in practice.  

This article therefore, delves into the implication of Clean Slate Theory and examines substantial questions regarding the validity of claims post-approval of a resolution plan, the equitable treatment of operational creditors, and the extent of judicial oversight in insolvency proceedings for ensuring transparency and fairness This case also underscores critical aspects of the Insolvency and Bankruptcy Code (IBC) in India thus brings to light the critical balance between the CoC’s commercial wisdom and the need for transparent and fair resolution processes under the IBC. 

Analyzing the Implications of IBC Resolution Plans on Creditor Claims and Judicial Oversight

The recent case involving TANGEDCO’s claim for unpaid electricity charges against The National Sewing Thread Co. Ltd. brings to the forefront several critical aspects of the Insolvency and Bankruptcy Code (IBC) and its application. Wherein to determine “TANGEDCO’s Post-Plan Claim Validity under IBC, “The heart of the dispute lies in whether TANGEDCO’s claim for unpaid dues can survive the approval of a resolution plan under the IBC. The petitioner’s stance is that the resolution plan nullifies the claim, while TANGEDCO insists that the resolution plan failed to address its statutory dues. The resolution plan’s binding effect, as per Section 31 of the IBC, suggests that once approved, it should extinguish all prior claims, including those of statutory creditors. 

Furthermore, the question pertaining to the compliance with IBC’s Section 30(2) which mandates fair treatment of operational creditors, ensuring they receive no less than the liquidation value of their claims. The resolution plan’s compliance with this section is pivotal, as it guarantees the minimum entitlement due to operational creditors and prevents their disenfranchisement. The need for the judicial review of Coc’s Commercial Decisions is crucial in determining the fairness. 

The scope of judicial review over the CoC’s decisions is limited. Courts generally defer to the commercial wisdom of the CoC unless there is a glaring non-compliance with the IBC’s statutory requirements. The judiciary’s role is not to reassess the CoC’s business decisions but to ensure that the resolution plan meets the IBC’s provisions. However, the applicability of The Clean Slate Theory(CST) under the IBC posits that an approved resolution plan should wipe the slate clean for the corporate debtor, negating all previous claims and liabilities This principle is crucial for the resolution applicant to commence operations without the burden of past debts, providing a fresh start. 

Therefore, the IBC strives for equitable treatment of all creditors, though it recognizes the distinct roles of financial and operational creditors. The resolution plan must not discriminate unjustly among different classes of creditors, ensuring that each class is treated fairly and equitably within the framework of the IBC 

The Judicial Microscope

The judgment delves into the M.K. Rajagopalan case, drawing parallels to emphasize the supremacy of the Committee of Creditors’ (CoC) commercial wisdom, contingent on the complete disclosure of information. The omission of electricity dues raised eyebrows, suggesting a deliberate act rather than an oversight. 

In M.K. Rajagopalan v. Dr. Periasamy Palani Gounder, the Supreme Court emphasized that the CoC’s commercial decisions must be based on complete and transparent information and must ensure equitable treatment of operational creditors. The ruling highlighted that commercial wisdom of the CoC means a considered decision taken with reference to the commercial interests and the interest of revival of the corporate debtor and maximization of the value of its assets. This decision has introduced a much-needed responsibility to the thought process of the CoC, ensuring that their decisions are made with all relevant information. 

The core Principle of Clean Slate Theory is to provide the Corporate Debtor with a fresh start, free from all the past liabilities and claims which ensures the debtor to be released from obligations and transgressions before the approval of resolution plan. The court emphasized that without complete disclosure of information, the core principle of the Clean Slate Theory is compromised. In the realm of insolvency proceedings, the Supreme Court has reaffirmed the critical importance of the Committee of Creditors’ (CoC) commercial wisdom in the evaluation and approval of resolution plans. This acknowledgment is predicated on the condition that such decisions are in strict alignment with the provisions of Section 30(2) of the Insolvency and Bankruptcy Code (IBC). The CoC, primarily composed of financial creditors, is entrusted with the responsibility to judiciously assess the practicality and sustainability of the proposed resolution plans.  

Simultaneously, the Court has delineated the limited yet pivotal oversight role of the Adjudicating Authority (NCLT) and the Appellate Authority (NCLAT). Their function is to ensure that the resolution plan not only meets the statutory mandates but also dispenses equitable treatment to all classes of creditors, thereby upholding the integrity of the insolvency resolution process.  

Moreover, the principle of equitable treatment of creditors, particularly operational creditors like TANGEDCO, has been underscored as a cornerstone of fair insolvency proceedings. The resolution plan is mandated to guarantee that operational creditors are not short-changed but receive at least the liquidation value of their claims, if not more, depending on the feasibility. The minimal payout offered to operational creditors in the case of The National Sewing Thread Co. Ltd. was deemed insufficient and non-compliant with Section 30(2)(b) of the IBC, which calls for a more balanced approach. 

The Clean Slate Theory in Insolvency Law: Ensuring a Fresh Start for Resolution Applicants

In the landmark case of Ghanashyam Mishra & Sons Private Limited v. Edelweiss Asset Reconstruction Company Limited, the Supreme Court confirmed that once a resolution plan is approved, all debts, including those owed to statutory authorities, are considered settled. This principle, known as the Clean Slate Theory, ensures that the entity taking over is protected from any future claims related to previous obligations 

However, in the case of Rainbow paper, the bench ruled for the resolution to be rejected for not including statutory dues owned by corporate debtors. Therefore, the view stated above is in conflict with the judgement. Moreover, this interpretation contradicts the intended framework of the code. The Court further clarified that sanctioning a resolution plan under the IBC erases all past claims, enabling a fresh start for the new entity. However, this is valid only if the plan meets legal standards and equitably addresses all creditors’ claims.  The Court has underlined that the Clean Slate Theory does not give the entity taking over the right to ignore the valid claims of operational creditors. 

Further elaborating the theory the court  has also referred  the case of Essar Steel India Ltd. v. Satish Kumar Gupta, The Supreme Court highlighted the importance of a clean slate for resolution applicants in insolvency cases. The court stated that with the approval of a resolution plan, all prior claims and liabilities should be considered settled. This is to guarantee that the new management can take over the company without being hindered by previous obligations. The decision supports the principle that once a resolution plan is sanctioned, it should bring about finality and certainty, allowing the resolution applicant to start anew without the burden of unresolved claims. This concept is crucial as it ensures the revival of the business under new management is not complicated by past issues. 

In concurrence with the precedents, Madras High Court emphasized that CST is a judicial concept designed to protect the third-party successful resolution applicant (SRA) from uncertainties of future claims. Therefore, the court gives detail reasoning with respect to CST which does not exist to shield fraud or suppression by the suspended board of the corporate debtor. Irrespective of whether the corporate debtor is an MSME, the suspended board must fully disclose all creditors during the resolution process. But in further explaining, the court held that the theory does not apply to undisclosed creditors due to negligence of the Insolvency Resolution Professional (IRP) or Resolution Professional (RP) or deliberate non-disclosure by the suspended director. 

Therefore, the Clean State Theory aims to safeguard third-party SRAs but does not shield fraudulent actions by the suspended board of the corporate debtor. The case underscores the importance of full creditor disclosure during the resolution process. 

Conclusion

The Supreme Court’s thorough analysis and application of essential legal precedents highlight the necessity to strike a balance between the rights of financial and operational creditors under the Insolvency and Bankruptcy Code. The Court upheld the importance of the Committee of Creditors’ (CoC) business judgment while also ensuring that the resolution plan adheres to legal mandates and treats all creditors fairly. The Clean Slate Theory is vital for drawing in investors, but it must be implemented alongside complete openness and honesty to safeguard the interests of all involved parties. This holistic method upholds the insolvency resolution process’s integrity and effectiveness in India, aiming for an equitable and just resolution for everyone concerned 

Therefore, the court rules in favour of TANGEDCO, stating that the claim for unpaid electricity is justified for the insolvency proceedings hence, the petitioner was required to settle the dues of electricity. 

Leave a Comment

Your email address will not be published. Required fields are marked *

Scroll to Top