Procedural aspects of multiple insolvencies in a group may be consolidated under the Insolvency and Bankruptcy Code but substantial consolidation needs more deliberation, a committee, led by former Securities and Exchange Board of India Chairman UK Sinha, has proposed. The committee was set up by the Insolvency and Bankruptcy Board of India in January this year to propose a regulatory framework for group insolvencies.
This was prompted by insolvency proceedings initiated against several large groups namely Videocon Industries Ltd., Era Infra Engineering Ltd., Lanco Infratech Ltd., Educomp Solutions Ltd., Amtek Auto Ltd., Adel Landmarks Ltd., Jaypee Infratech Ltd., Reliance Communications Ltd., Aircel Ltd. etc. By one estimate, 47 companies—part of different corporate groups—had debt in excess of $70 billion and attempted in-court restructurings last year, the committee has pointed out.
To facilitate revival of such inter-linked companies, the committee has recommended that insolvency resolution procedures of entities within a group could be coordinated while keeping the assets of each entity separate. The 11-member committee has said so even as substantial consolidation has been allowed by the National Company Law Tribunal and the appellate tribunal in the Videocon and Adel Landmarks cases respectively.
Group Insolvency: Committee’s Suggestions
Acknowledging the need for a group insolvency framework in a phased manner, the committee has recommended:
- Procedural co-ordination of insolvency proceedings of domestic corporate groups. This may include holding, subsidiary and associate companies. NCLTs may also allow for inclusion of companies that are so intrinsically linked as to form part of a ‘group’ in commercial understanding but are not covered by the definition of corporate group.
- For such entities, there could be a joint insolvency application, communication, cooperation and information sharing, single insolvency professional and single adjudicating authority, and creation of a group committee of creditors.
- Insolvency process of only those entities under a group may be clubbed who have defaulted on their obligations.
- The regulations should apply only if majority members of the CoC of each entity approve of group coordination.
The committee has rightly proposed that at this stage a regulatory framework for only procedural consolidation must be provided for, Sudipta Routh, partner at IndusLaw, told BloombergQuint.
He said that the entire edifice of corporate law is built on the fact that each company is a separate juridical entity, has separate assets, limited liability and piercing of corporate veil will be allowed in only certain circumstances - that’s the basis on which stakeholders like creditors have dealt with them. If you prescribe consolidation of assets and liabilities of such entities in a group, you will have to turn the entire jurisprudence and commercial understanding on its head, he added.
Substantive Consolidation: Park It For Later
When the assets and liabilities of different entities in a group are pooled together and treated as a single insolvency estate, it’s termed ‘substantive consolidation’. Since substantive consolidation eliminates the benefit of asset partitioning, it has the potential to result in unfair treatment to a certain set of creditors, the committee has pointed out. It may also undermine the licensing, tax and other regulatory reasons due to which the companies are organised as separate group companies.
And so, the committee has recommended that capacity building, creditor and stakeholder coordination must be achieved first, through procedural consolidation, before substantive consolidation is introduced.
The committee’s stance found favor with experts BloombergQuint spoke with.
Very few jurisdictions have codified substantive consolidation of assets and liabilities in their bankruptcy law, Routh pointed out. It’s not like the U.S., U.K., Australia etc. didn’t have the time to mull this but they have chosen to not prescribe it in the law, and it’s the courts that have laid down principles for consolidation of assets and liabilities.
There is a real danger of creditors’ voting rights getting diluted in substantive consolidation. In Videocon, it made commercial sense since all companies were co-obligors for each other—each entity was a primary debtor and not just a guarantor, Suharsh Sinha, partner at AZB & Partners, said.
Besides creditor rights, the other challenge which substantive consolidation poses relates to resolution plans. Can a plan that cherry-picks entities in a group insolvency be entertained or should plans propose resolution on a going concern basis for the whole group?
Currently, the IBC doesn’t allow resolution applicants to pick and choose assets and it would be very difficult to get one bidder to propose resolution for the entire group, Sinha opined. Therefore, we should be cautious of consolidating separate companies into behemoths which become too big to acquire, he said.
But Chander said that after the 2018 amendment, the language of the section that lays down duties of the resolution professional suggests that bidders can propose a plan even for individual entities in a group insolvency.
Section 25(2)(h): A resolution professional shall “… invite prospective resolution applicants, who fulfil such criteria …. to submit a resolution plan or plans.”
Finally, substantive consolidation also disrupts certain bankruptcy-remote financing structures, especially in the real estate and power sectors, Sinha said. Often, a special purpose vehicle is created for a particular project through ring-fencing and lenders lend to this entity without direct exposure to the creditworthiness of the associated companies or promoters, he explained.
Creditors have bankruptcy exposure only to this SPV and aren’t impacted by the economic situation of the parent or other group entities. If you allow consolidation in such cases, the bank that had given X amount on the back of certain security or cash flows of that SPV, his credit appraisal, pricing, rights get mingled with the larger group which could lead to unfair results.Suharsh Sinha, Partner, AZB & Partners
Therefore, consolidation should only be allowed with the consent of the creditors or all companies concerned, he said.
Can Courts Allow Substantive Consolidation?
In India, without a specific regulatory framework, adjudicating authorities will continue to have the discretion to use their inherent power to allow for substantive consolidation if the need arises, Routh said.
And when that need arises, courts may rely on the principles laid down in the Videocon Group and Adel Landmarks cases to allow for substantive consolidation.
In Videocon’s case, combined bankruptcy proceedings against 13 group entities were permitted by the NCLT. Since Adel Landmarks was the principal borrower and was constructing flats and shops in a consortium, insolvency proceedings of five other corporate debtors, all entities connected to Adel, were clubbed with its insolvency resolution.
Three key principles emerge from the Videocon Group and Adel Landmarks’ cases.
- Consolidation could be considered where entities are intricately interlinked to the extent that segregation may result in an unviable solution. The interlinking can be in respect of management, deployment of staff, production of goods, distribution system, arrangement of funds, loan facilities etc. And most importantly, consolidation should prevail if individual entities’ resolution is unlikely to result in maximisation of of assets.
- While considering consolidation for a group, some entities can be segregated- those that are interlinked and are part of the debt agreement, but their assets are identifiable. For such entities within the group, segregation may help in independent survival and potentially result in viable, profitable restructuring proposals. Based on this principle, the NCLT had kept two Videocon Group entities—KAIL Ltd. and Trend Electronics Ltd.—out of the consolidation. These firms have a strong case of functioning and paying back their dues to the lenders independently as they don’t have any operational dependence on the other group entities, the NCLT had noted.
- And finally, consolidation may be necessary to maintain the going concern status of the group. In Adel Landmarks—the principal borrower—lenders had argued that five corporate debtors formed a consortium to develop a township, and consolidation was necessary to hand over the residential and commercial units to the allottees.
Adel Landmarks is a text-book case for substantive group insolvency—one company was owning the land, one was the builder, one was the developer and two companies were guarantors, Harish Chander, executive vice president at Edelweiss Alternative Assets Advisors, said. Edelweiss ARC was the lead financial creditor in Adel’s case.
The principles laid down in Videocon should be applied where the entities in a group are interdependent and substantive consolidation will ensure maximisation of the of assets, said Ajay Shaw, partner at DSK Legal.
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