The Unresolved Conundrum of Commercial Wisdom of Committee of Creditors

[By Priyanshu Mishra]

The author is a student at National Law School of India University.

 

Introduction

The implementation of the Insolvency and Bankruptcy Code (Hereinafter as “IBC”) was intended to tackle the increasing problem of loan defaults and non-performing assets (Hereinafter as “NPA”). Unlike the previous insolvency law, the IBC focused on reviving companies rather than liquidating them and gave priority to the interests of creditors. Under the IBC, financial creditors played a crucial role as part of the Committee of Creditors (Hereinafter as “CoC”), which held significant decision-making power in the corporate insolvency resolution process (Hereinafter as “CIRP”).

However, in a recent case (MK Rajagopalan v Dr Periasamy Palani Gounder), the Supreme Court ruled that the principle of commercial wisdom cannot be stretched too far to overlook a significant flaw in the functioning of the CoC. This article seeks to explore the implications of this court ruling on the principle of Commercial Wisdom of the CoC. It also questions the absolute authority of the CoC based on the principle of commercial wisdom and suggests the implementation of a Code of Conduct to govern the actions of CoC members.

Legal Precedence: Examining existing jurisprudence on the Principle of Commercial Wisdom of the COC.

In the landmark case of Vallal RCK v M/s Siva Industries, the Supreme Court established that the adjudicatory authority cannot scrutinize the details of a settlement plan approved by the CoC when assessing a resolution application under section 12A. Similarly, in the case of Ashish Saraf v Bhuvan Madan, the Court emphasized that the CoC has the responsibility of making business decisions regarding the approval or rejection of a resolution plan. This includes evaluating its feasibility and viability, and such decisions are considered beyond the scope of judicial review.

Furthermore, in the case of K Shashidhar v Indian Overseas Bank, the Supreme Court concluded that the adjudicating body (NCLT) cannot dispute the autonomy of the CoC, but Judicial Review is limited to the grounds provided in the Act itself, which is a self-contained code. As a result, the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT) cannot overrule CoC rulings. The Court reiterated this stance in the case of Committee of Creditors of Essar Steel India Ltd v Satish Kumar Gupta and Ors, emphasizing that adjudicatory bodies should exercise their jurisdiction as defined in the IBC. They must adhere to the guidelines outlined in Section 30(2) of the IBC and exercise their judicial review power in accordance with Section 32 of the IBC. A similar question arose in the Kalpraj Dharmshi case, where the Court reaffirmed that adjudicatory bodies cannot interfere with the commercial decisions made by the CoC.

Examining the Court’s Role in CoC Decision-Making in the present case: Opening Pandora’s box?

The Courts have generally interpreted the principle of commercial wisdom of the CoC as non-justiciable, granting significant discretion to CoC members, as discussed earlier. However, in this particular case, the Court aimed to limit the broad interpretation of the principle of commercial wisdom while also ensuring limited judicial intervention in insolvency proceedings. The Court found the resolution plan to be in violation of Section 88 of the Trust Act, the IBC Act (specifically Section 29A), and the Companies Act (specifically Section 164(3)), which rendered the resolution applicant ineligible for the insolvency proceedings. The Court clarified that the commercial wisdom of the CoC refers to a well-considered decision made by the CoC in the best interests of both commercial aspects and corporate revival.

In its judgment, the Court sought to define the boundaries of the principle of commercial wisdom within insolvency proceedings, adopting a balanced approach. It also emphasized that judicial intervention should not be disregarded under the pretext of the principle of commercial wisdom of the CoC. The Court recognized that resolving legal conflicts, which are necessary for enforcing the resolution settlement, can only be accomplished through the court’s interpretation of the law. Therefore, the Court stated that limited judicial intervention in the conduct of CoC members is necessary but should focus on matters beyond the scope of the principle of commercial wisdom.

However, while the Court’s approach was commendable, it raised certain unaddressed concerns. By balancing the principle of commercial wisdom of the CoC and the power of judicial review, the Court inadvertently risks increasing never-ending litigation. This outcome is contrary to the legislative intent, which aims to ensure effective and efficient insolvency proceedings for debt-ridden companies. In previous cases such as Essar Steel and Swiss Ribbon, the Court emphasized that the relevance of the commercial wisdom of the CoC is to expedite the resolution process of insolvent companies. Therefore, to align the legislature’s intent with the court’s reasoning on the principle of commercial wisdom of the CoC, it is necessary to establish accountability and transparency within the CoC’s decision-making process. This can be achieved by implementing a structured framework that specifies the conduct and procedures for insolvency proceedings.

However, before implementing such a framework, it is crucial to identify the potential challenges within the insolvency proceedings. In analyzing the current CoC framework, three major problems emerge: procedural delays, difficulties in consensus building, and unreasonable haircuts (reductions in the value of creditors’ claims). These issues primarily stem from the unrestricted authority granted to CoC members, who are shielded from judicial scrutiny under the principle of commercial wisdom.

Procedural Delay:

The Essar Steel case highlighted that the Bankruptcy Law Reform Committee Report of 2015 emphasized the importance of speed in insolvency proceedings in India. However, data from the report indicated that 71% of insolvency cases exceeded the stipulated 180-day timeline. This significant deviation from the intended objective of the code indicates a clear issue with procedural delays.

In the Jindal Saxena Financial Service Pvt Ltd v Mayfair Capital Pvt Ltd, the Court identified that a major cause of delay in insolvency proceedings is the lack of decision-making power given to nominated members of financial institutions within the CoC.[1] This leads to time-consuming internal approval processes within financial institutions. Additionally, members of the CoC may employ delaying tactics such as absenteeism or non-attendance, further contributing to delays. This inefficiency in the current framework hinders the achievement of the legislation’s objectives, necessitating the inclusion of checks on the unfettered discretion of CoC members.

Consensus Building:

Under the current legislative framework, decision-making power within the CoC is vested in financial creditors, while operational creditors are excluded from the process. In the Swiss Ribbon case, the Court upheld the reasonable classification of operational and financial creditors, stating that operational creditors may lack the ability to assess business viability and feasibility. Consequently, operational creditors have no say in the approval of the resolution process. However, subsequent judgments have aimed to ensure equitable treatment of operational creditors through the involvement of financial creditors and the National Company Law Tribunal (Hereinafter as “NCLT”).

Unreasonable Haircuts:

In recent cases, lenders have agreed to significant haircuts, which refer to the reduction in debt amounts. While haircuts are a part of the resolution process, the issue lies in the frequency and substantial reduction of these haircuts.

Historically, haircuts averaged around 55%, but in fiscal year 2021, they increased to over 60%. The Videocon Industry Limited Case witnessed haircuts as high as 95.5%, which the Court criticized but was unable to address due to the principle of commercial wisdom of the CoC. Similarly, in the Siva Industries and Holding case, the CoC agreed to a 93.5% haircut that was later rejected by the NCLT Chennai. These examples exemplify the unrestricted discretion granted to the CoC under the guise of the principle of commercial wisdom, raising concerns regarding the fairness and transparency of CoC decisions.

Promoting Transparency in the Insolvency Resolution Process: Learnings from GLOBAL PRACTICES

To address the lack of accountability and procedural fairness within the functioning of the CoC, it is necessary to establish guiding principles in the form of a code of conduct. Recognizing this need, the 32nd Parliament Standing Committee on Finance emphasized the urgency of implementing a professional code of conduct for the CoC in 2020. Based on the feedback received, the IBBI presented a discussion paper to the Parliament, proposing measures to ensure fairness and transparency in the decision-making process of the CoC. Alongside the code of conduct, structural reforms are required to decentralize power, promote consensus building, and establish an oversight mechanism that enhances accountability and transparency within the CoC’s operations.

Looking at international examples, the UK has a Statement of Insolvency Practice 15 (SIP) that sets out fundamental principles and procedures that Insolvency Practitioners must adhere to during the insolvency process. Deviations from these standards can result in disciplinary action by regulatory authorities. Also, in Singapore, accountability is maintained through court supervision and active involvement in the functions of the Judicial Manager, who performs the role of the Resolution Professional while exercising commercial wisdom. Moreover in the US, the US Trustee, an officer of the Department of Justice, is responsible for monitoring and supervising debtors in possession and the operation of the business within the CoC. In cases of fraud, dishonesty, incompetence, or gross mismanagement by the debtor, the bankruptcy court may appoint an Examiner to investigate the debtor’s affairs. These accountability structures ensure unbiased, objective, and independent conduct of the CoC, serving the interests of stakeholders.

India can draw inspiration from these jurisdictions to implement structural reforms in  insolvency proceedings, ensuring fairness and transparency. Additionally, the judicial interpretation of Commercial Wisdom should be limited to decisions based on relevant information about the company. Furthermore, the court and the resolution professional should be empowered to investigate the conduct of the CoC in cases involving gross mismanagement, corruption, or incompetence.

In conclusion, addressing the issues surrounding the functioning of the CoC requires a comprehensive approach. While the establishment of a code of conduct for CoC members is a positive step towards ensuring transparency and fairness, it is important to acknowledge that procedural fairness alone is not enough. Structural reforms are necessary to foster accountability and transparency within the insolvency process. Therefore, by introducing mechanisms that promote checks and balances, insolvency proceedings can be conducted in a more transparent and accountable manner.

 

[1] 2017 SCCOnLine NCLT 182

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