IBC: Should Promoters Be Permitted To Compromise? The Regulator Wants To Know

No stone must be left unturned in giving a financially distressed company opportunities for survival, seems to be the underlying purpose of India’s insolvency and bankruptcy law. Which is why, even in cases of severe economic erosion and a slim chance of revival, courts have allowed compromise schemes rather than permit liquidation.

But now the government, regulator and courts are in a quandary.

On the one hand they want to give companies every chance to save themselves. On the other, they don’t want the defaulting promoter to be the saviour, even if he is the last man standing.

Soon after enacting the Insolvency and Bankruptcy Code, 2016, Parliament amended it to disallow the promoter of the corporate debtor from participating in the insolvency resolution. Courts have scuppered many an attempted backdoor entry by disgruntled promoters. But if the only option facing the asset is liquidation, then should promoters be denied a last rescue effort?

That’s the question IBBI has now asked stakeholders to weigh in on in a discussion paper seeking feedback.

Promoter Re-Entry Via Schemes?

Once an insolvent company reaches the liquidation stage, section 230 of the Companies Act also applies parallely. This section allows the liquidator - appointed under the IBC - to consider a scheme of compromise or arrangement proposed by any creditor, shareholder or the company itself.

In various cases, the National Company Law Appellate Tribunal has held that such a compromise cannot be entertained if it comes from an entity that doesn’t meet the IBC’s eligibility criteria.

Section 29A of the insolvency code prohibits promoters who are wilful defaulters, have a long-standing non-performing asset account etc, from proposing an insolvency resolution plan. This ineligibility criteria would continue to apply to those proposing a scheme of arrangement as well, the National Company Law Appellate Tribunal has held in Jindal Steel and Power Ltd., Mahendra International Ltd., Senthil Papers and Board Pvt. Ltd., and Gemini Communication Ltd.

Broadly, the NCLAT has done so on two grounds-

One, as per the Supreme Court’s ruling in the Swiss Ribbon case, the IBC’s objective is to ensure a company’s revival by protecting it from its own management and from death by liquidation. This means that a scheme of compromise must be allowed at the liquidation stage, but ineligible promoters must be barred from participating in it.
Two, section 35(f) of the IBC says that a liquidator cannot sell movable, immovable or actionable claims of a bankrupt company to persons barred by section 29A.

But, the IBBI has pointed out that while section 29A will apply during the resolution and liquidation stage, there is no express provision that bars promoter participation in between these two processes i.e. during the compromise and arrangement stage. Yet, the regulator has conceded that allowing promoters to propose a scheme may reward ‘unscrupulous persons at the expense of creditors’.

The same dilemma plagues experts that BloombergQuint spoke to, with other IBC amendments adding to the confusion.

For instance, Section 12A of the IBC allows withdrawal of an insolvency application if 90 percent of committee of creditors (by vote share) approve of it. In Sterling Biotech’s case, the NCLAT has permitted such withdrawal after the CoC accepted a settlement proposal by the company’s promoters.

The approach with respect to promoter participation needs to be consistent, Sunil Srivasatva, former deputy managing director of State Bank of India told BloombergQuint. On the one hand, the IBC allows them to enter into one-time settlement via section 12A but on the other hand shuts the scheme route for them.

That said, if the regulator has taken a call to bar promoters during resolution and liquidation stage, they should be barred from using section 230 route as well, Srivastava added.

Why create this confusion? You can’t say that a promoter has done wrong but allow him to submit a scheme of arrangement. And then if it’s a criminal wrongdoing, he won’t be able to pay up anyway – where is such a promoter getting the money to propose a scheme of arrangement or settlement? If he had the money, why didn’t he settle the dues earlier?

Sunil Srivasatva, Former Deputy MD, SBI

If a promoter is inelgible, why give him a backdoor entry via the scheme route, Srivasatva argued.

There isn’t a straightforward answer to this question, countered Piyush Mishra, partner at AZB & Partners. Logically 29A should be applicable throughout the insolvency process. But if a company is anyway going into liquidation since no resolution plan has been accepted, there is an argument to allow promoter participation via schemes, he said.

Admittedly, Mishra added, there could be concerns with such an approach in cases where fraud, diversion of funds is involved. And so, perhaps, the best approach is to leave it to the commercial wisdom of the creditors’ committee rather than dilute section 29A for the purposes of a scheme of arrangement, he said.

Once resolution fails, there might be some logic in entertaining schemes from promoters. And the creditors can take a call on that. Irrespective of what the regulations say, a system can’t be made to beat all kinds of odds, and there still might be some hard cases.

Piyush Mishra, Partner, AZB & Partners

From the employees and workmen perspective, if a company is going into liquidation, the argument for non-applicability of section 29A (promoter ineligibility) becomes strong, Mishra added.

The Insolvency and Bankruptcy Board of India has given stakeholders time till November 24 to submit their recommendations.