Sign displayed outside a retail store that went belly up. (Photographer: Luke Sharrett/Bloomberg)

IBC’s Liquidation Overhaul: Not Ideal But Enough? 

Barred promoters may soon have legitimate means to regain control of their insolvent assets at the liquidation stage if recent proposals of the Bankruptcy Law Reform Committee are accepted. And while on the face of it this seems contrary to section 29A of the Insolvency and Bankruptcy Code, 2016, experts believe otherwise, pointing out that if no-one else is interested in the asset, it makes little sense to bar promoters as well.

As of March 2019, 378 corporate debtors are facing liquidation, as per IBBI data. To address the various challenges stakeholders are facing during liquidation, the BLRC has proposed the following:

  • Allow promoters to participate at the liquidation stage by proposing scheme of compromise under company law.
  • Give creditors a voice and oversight powers.
  • Allow creditors to propose the mode of sale of the corporate debtor.
  • Introduce a deadline for creditors to make a decision regarding their security interest.
  • Ensure workmen dues are taken care of [even when creditors independently sell assets charged to them].

Promoter Participation, Section 29A No Bar

Presently, a scheme of compromise can be proposed by a member, shareholder or creditor when a company is facing liquidation. This is as per section 230 of the Companies Act, 2013 - under which a scheme of arrangement and compromise between shareholders and/or creditors can be proposed for companies in liquidation. For a scheme of arrangement to be taken to the NCLT, it needs to be approved by 75 percent of the creditors and shareholders.

But the IBC bars the liquidator from selling any movable or immovable assets of the corporate debtor to any entity who is ineligible to propose a resolution plan.

Read together, it would mean, that while on the one hand insolvency law bars promoter participation at the liquidation stage, company law allows the same promoters to participate through the scheme route.

The BLRC has acknowledged this dichotomy but has taken the view that this backdoor entry for promoters should be permitted.

“There will be practical difficulties in implementation of ineligibility for the purposes of Section 230 of the Act. Therefore, it is proposed that the ineligibility norms under Section 29A of the Code may not apply to compromise or arrangement under Section 230 of the Companies Act.”

Also read: IBC: ‘Schemes’ To Help Promoters Make A Backdoor Entry?

Suharsh Sinha, partner at law firm AZB & Partners, pointed out that use of the company law provision won’t require an amendment to section 29A or section 35 of the IBC that prevent sale to ineligible persons during liquidation.

Section 29A sets out eligibility criteria for resolution applicants in an insolvency process (and bars promoters of the corporate defaulter) and section 35 lists the power of the liquidator (and applies same eligibility criteria on buyers in a liquidation process)

Section 35 prevents sale of assets of the company to 29A ineligible persons during liquidation. However strictly speaking, a scheme proposed under the companies act need not entail sale of the company’s assets and an argument can be made for 29A debarred promoters to propose a scheme. But if such a technical view is taken it will defeat the entire spirit and purpose of Section 29A and will incentivise debarred promoters to create further hurdles in the CIRP process aiming to tip the company into liquidation.
Suharsh Sinha, Partner, AZB & Partners 

Agreeing with the view, L Viswanathan, partner at law firm Cyril Amarchand Mangaldas explained that the IBC is premised on the basis of shareholders’ disenfranchisement after a default and that promoters of a company in default should not be handed back management with the creditors taking a write off. Whilst the purpose of a Section 230 scheme in liquidation is to give resolution a further chance, consistent with the object of IBC, it should be not at the cost of other policy considerations such as Section 29A that apply in IBC, he added.

Senior advocate Ramji Srinivasan holds a contrary view. By the time a company is in liquidation, it has already gone through and failed the resolution phase. And if the corporate debtor has not been able to generate any interest in its resolution, then in liquidation, the insolvent company will fetch an even lower value, Srinivasan told to BloombergQuint.

He added that since no one else has shown interest in the insolvent company and every stakeholder is running at a loss, there is no point in arguing that the promoters should still be debarred.

Section 29A was only meant for the purposes of barring a promoter as a resolution applicant, to prevent the defaulting promoter from sweeping in and getting the asset at a cheaper rate. But if no other applicant has shown interest, then I believe there is no point for promoters to still be debarred in liquidation. 
Ramji Srinivasan, Senior Advocate, Supreme Court of India

However, he added, there should be qualifications to promoters applying under section 230. If there has been a serious criminal infraction on account of promoters, for instance if the promoters are guilty of fraud or are ineligible to be directors, they should be barred from proposing scheme of compromise under section 230 as well, Srinivasan added.

Rajkumar Bansal, managing director and chief executive officer at Edelweiss Asset Reconstruction Company Ltd., agreed and said that to allow a promoter barred by section 29A to propose a scheme upon entering liquidation is not per se contrary to the intent of IBC.

Once the corporate insolvency resolution process has failed, the asset cannot be revived and debts cannot otherwise be restructured except through Section 230. In liquidation, the creditors don’t stand to make much. So if there is a proposal from shareholders, the law should allow them to put forth their proposal.
Rajkumar Bansal, MD and CEO, Edelweiss Asset Reconstruction Company

It’s another issue that creditors may not agree to the promoters’ proposal in today’s business scenario. Creditors typically prefer significant upfront payment, which may not be likely in a scheme proposed by the shareholders, Bansal added.

This is an important step to ensure that viable corporate debtors are resolved even at the liquidation stage and for those which are not viable, timely liquidation is done to minimise losses, Kumar Saurabh Singh, partner at law firm Khaitan & Co. said.

Noting that promoters can propose a scheme of compromise, the committee has gone on to suggest that the liquidator or a shareholder or creditor may file an application under section 230 within 10 days of the liquidation order being passed. This process must be completed within 90 days of the order of the liquidation. And if the scheme of compromise isn’t completed within the stipulated time, the liquidation process will start, the committee recommends.

Also read: Is The Liquidation Process Under The IBC Yet Another Pandora’s Box?

Giving Creditors A Voice

The BLRC has also recommended that creditors should have a say in the liquidation process through a stakeholder consultation committee and also be allowed to propose the mode of sale to the liquidator.

Stakeholder Consultation Committee

Creditors have often complained that the liquidation process rules out any involvement of theirs. Currently, the liquidator is the sole toastmaster - he may consult any stakeholder but that view is not binding on him.

The committee has acknowledged this lacuna. It has proposed that creditors be given an oversight of the process through a consultation committee, much like the one under the erstwhile winding up provisions of the Companies Act.

The stakeholder consultation committee (SCC) can comprise of:

  • financial creditors (upto 4 secured financial creditors’ representatives and upto 2 for unsecured creditors),
  • operational creditors (upto 2 representatives),
  • shareholders (upto 1 representative, if eligible under sec 29A),
  • employees (upto 1 representative) and
  • government representatives (upto 1).

The representatives will be selected by majority stakeholders in that respective class, the committee has proposed. The SCC will have access to relevant information and records required for effective deliberation. It will only be able to make recommendations in respect of disposal of business / company. The liquidator will still have the ultimate decision making power.

Wherever the liquidator takes decisions that are contrary to the views expressed by the 66 percent majority of the SCC, he shall record the reasons for such contrary view or action, the discussion paper said.

This suggestion is definitely a step up for creditors who will now have access to the liquidator and his strategy along with relevant information in the liquidation stage, Bansal said.

Though this enables the creditors to be clued in, it still gives the creditors no decision-making power and since the maximum impact of liquidation is on creditors, this proposal is still disappointing to that extent.
Rajkumar Bansal, MD and CEO, Edelweiss Asset Reconstruction Company

Formation of stakeholders committee is a step in the right direction, so that unlike in the corporate insolvency resolution process, other stakeholders like operational creditors have a say from early stage and can be consulted by liquidator before taking critical decisions which can otherwise be prone to litigation, Khaitan’s Singh added.

Preferred Mode Of Sale

Under Regulation 32 of the Liquidation Regulations, the liquidator has various options in the manner of disposal of assets of the company - to sell them individually or collectively or to sell the company as a going concern or even just whole or part of the company’s business.

In its discussion paper, the BLRC stresses on the option to sell whole or part of the business, and not the company, as a going concern. This, it said, could help achieve the end goal of greater realisation.

But Sinha disagrees with this recommendation.

Liquidation as a going concern is an oxymoron. Once the restructuring phase during CIRP fails, it means that the company has no commercial resolution other than being liquidated. The second attempt to artificially resuscitate the company is fraught with legal and practical risks and moral hazard.
Suharsh Sinha, Partner, AZB & Partners 

After a liquidation order is passed, the secured creditors are entitled to enforce their security - which means there may not be any assets left for the liquidator to resolve as a going concern. Secondly, it is not clear if an acquirer in liquidation will also take on the legacy and contingent liabilities of the company. Third, it creates a perverse incentive for all stakeholders to procrastinate resolution via corporate insolvency resolution process in the expectation of a going concern sale in liquidation. Liquidation as a going concern will increase inter creditor conflicts, delay recoveries and lead to further litigation, he adds.

Allowing for more creditor participation, the BLRC suggests that the committee of creditors may, while passing resolution for liquidation, recommend their preferred mode of sale to the liquidator. The CoC must also specify the time within which such sale is to take place.

The liquidator is then required to prioritise CoC’s preferred mode and explore alternatives only if CoC’s proposal fails or the timeline set by CoC expires.

If there is no recommendation from the CoC, the liquidator shall explore all options of sale simultaneously.

Imposing A Time Limit

Under the IBC, the liquidator has at its disposal all assets of the company, barring those in which lenders have created security interest and have not relinquished such interest in favour of the liquidator. Lenders may either sell the assets secured to them on their own or relinquish the security interest and allow the asset to form part of the general estate, which may be disposed as necessary by the liquidator.

The BLRC committee has pointed out that currently, many creditors hold back on the decision to relinquish their security interest, slowing down the liquidation process significantly. And so, it has proposed that a deadline be introduced to avoid this situation.

“Each security holder must inform the liquidator of its decision to relinquish or not relinquish its security interest within 45 days of commencement of liquidation. Non-communication within this period would imply surrender of security interest.”

Further, if the creditors choose to realise their security independently, the workmen recover less or nothing at all, the committee has pointed out. And so, the committee has proposed that if a creditor chooses to realise its security independently, the proceeds from such a sale will first go towards reimbursing the liquidator for the cost of preservation of the asset, and then be shared with workmen.

This provision will apply when the creditors have exclusive security, and to the extent it provides the benefit to workmen and employees, it’s fair, Bansal said.

The Waterfall

There is one critical aspect related to creditors that the committee discussed but chose not to make any recommendation on - whether first ranking charge holders have higher rights than second or inferior ranking charge holders. But the BSLRC has left it up to the Insolvency and Bankruptcy Board of India to decide.

“There is debate as to whether a senior creditor has better rights than a junior creditor in the waterfall under section 53 of the Code. The regulations may clarify the ranking of different charges on the same secured asset.”

In addition to these proposals, minor tweaks have also been proposed, mostly to clarify process. On interim finance, the committee has recommended that if the insolvent entity does not possess any liquid assets, then secured institutional creditors must provide interim finance to run the entity as a going concern or to liquidate it.

A timeline for liquidation - one year from the date it is ordered- has also been proposed, failing which the liquidator will need to apply to the NCLT for extension.