New IBC amendment: Is it all over now for defaulting promoters?

The Insolvency and Bankruptcy Code (IBC) 2016 in its preamble identifies itself as a law for reorganisation and resolution of companies. This reorganisation and resolution is entirely in control of the creditors as debtors lose the possession of the firm.

Time and again, the IBC has been amended to weed out any attempts by the debtor to regain the control back. The first attempt at it was made in 2017 by insertion of section 29A in the code. Under it, promoters or persons who controlled the insolvent company cannot apply as resolution applicant.

Government’s statement of object behind insertion of this section, says, “Persons who, with their misconduct contributed to defaults of companies, may misuse this situation due to lack of restrictions to participate in the resolution process, and gain/regain control of the corporate debtor… at the expense of the creditors.”

Having shut the door on promoter involvement in the resolution process, the government now glared another challenge -- What if the resolution process fails? The natural outcome of failure of resolution process is liquidation, which could still provide a parachute to promoters through Section 230 of the Companies Act, 2013.

This section empowered the liquidator to make compromises or arrangements with creditors and members upon application. There was no explicit prohibition on defaulting promoters from proposing a compromise or arrangement under Section 230. This could have resulted in such promoters acquiring control of the company.

The new amendment on January 6, 2020, in the liquidation regulations has stitched this loophole. It now clarifies that a defaulting promoter, who is not eligible under the code to submit a resolution plan, shall not be a party to any compromise or arrangement of the company.

Further, a secured creditor cannot sell or transfer an asset to the promoters coming under 29A. Without this amendment, the IBC could have seen promoter-driven attempts of liquidating the company as their own business would now be available for them at a much lower price.

Nonetheless, certain questions still need to stand the test of time. What happens when there is no resolution applicant or a buyer under liquidation, can the promoter come into the picture? Or what happens if the promoter does not want complete control of the company, but only specific assets? Should the sale of such specific assets at competent prices be allowed in the interest of “beneficial liquidation”?

One wonders if this amendment means a dead end for promoters in the IBC. The answer lies in the withdrawal of application through Section 12A (IBC 2016) read with Regulation 30A (Insolvency Resolution Process for Corporate Persons) alongside Swiss Ribbons Judgement (January 2019) of the Supreme Court (SC).

There are three ways to withdraw an application under the IBC. First, when the Committee of Creditors (CoC) approves withdrawal of an application by 90 percent vote share. Second, after giving justifiable reasons to allow application withdrawal once expressions of interest have been invited and the CoC is constituted. Third, before the constitution of the committee of creditors (therefore, without 90 percent voting requirement) when such application is filed through interim resolution professional. Once withdrawn and approved by the NCLT (National Company Law Tribunal), a promoter can regain control of the company.

In the aforesaid case, the Supreme Court has further clarified: “At any stage where the committee of creditors is not yet constituted, a party can approach the NCLT directly, which through its inherent powers allow or disallow an application for withdrawal or settlement.”

The next question that now arises is, what happens when the CoC arbitrary rejects a just settlement and/or withdrawal claim?

To this, the SC interpretively answers in the affirmative. It says, “Under Section 60 of the Code [S 60(5) -- Jurisdiction of NCLT], the CoC does not have the last word on the subject. If the committee of creditors arbitrarily rejects a just settlement and/or withdrawal claim, the NCLT, and thereafter, the NCLAT (National Company Law Tribunal) can always set aside such decision under Section 60 of the Code.”

This leads to a point of legal clarity when the Swiss Ribbons judgment is read with that of Essar Steel (November 2019). In the Essar Steel ruling, the SC emphasises that the objective of the IBC is to respect the commercial wisdom of the CoC when it accepts or rejects a resolution plan.

Furthermore, the NCLT or the NCLAT cannot make an enquiry of this commercial wisdom when they approve a resolution plan. However, in the Swiss Ribbons ruling, the NCLT and the NCLAT are empowered to check into arbitrariness -- hence, the tenets of equality -- when it comes to the CoC’s acceptance or rejection of application for withdrawal or settlement plan with promoter.

Is the Swiss Ribbons judgment an exception to Essar Steel verdict when it comes to undeniable commercial wisdom of the CoC? Or does the commercial wisdom of CoC get exercised only when a resolution plan comes into the picture?

These questions may be subject of further litigation by adamant promoters -- who are still in the process of behaviour change when it comes to debt repayment.

Originally Posted on MoneyControl