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IBC - Bharati Defence’s Insolvency: The Confusing Message On Creditor-Led Recoveries

Bad facts make bad law. The National Company Law Tribunal’s decision in Bharati Defence and Infrastructure Ltd.’s insolvency case is a textbook example of that.

Bad facts: Conflict of interest between the resolution applicant, financial creditor and resolution professional. Huge fee to the resolution professional. No viable resolution plan. Discriminatory treatment to operational creditors and government dues.

Bad law: Fate of creditor-led recoveries or insolvency resolutions hangs in balance.

What’s The Case About?

In Bharati Defence’s insolvency case, the lead financial creditor, the entity initiating the insolvency process and the successful resolution applicant all happened to be Edelweiss Asset Reconstruction Company.

In 2015, Edelweiss ARC acquired Bharati Defence’s aggregate debt of Rs 6,248 crores through assignment agreements for Rs 1,813 crores. Unable to turnaround the asset, Edelweiss ARC initiated insolvency in June 2017.

Of the five resolution plans that came in for Bharati Defence, the resolution professional rejected four and placed the one presented by Edelweiss ARC before the Committee of Creditors, in which Edelweiss had 82.7 percent vote share. The other four bidders, as noted in the NCLT order, had failed to bring in the minimum earnest money deposit of Rs 10 crore. Additionally, the resolution professional had pointed out that except Edelweiss ARC none of the other resolution applicants had submitted compliant resolution plans with required Know Your Customer details.

Consequently, Edelweiss ARC’s resolution plan was approved by the CoC.

But the Mumbai bench of the NCLT dismissed Edelweiss ARC’s plan on the following grounds:

  • The plan envisages enhancing the company’s value by bringing in professional management and eventually selling it as a going concern. There is no provision of infusing cash. The appellate tribunal has held that a resolution plan cannot just entail sale or auction. And so, acquiring the property, running the company with the sole intention of value addition and finally selling it can’t be treated as a resolution plan.
  • Payment to operational creditors is proposed to be done in a phased manner. The resolution plan expects to pay operational creditors Rs 9 crore, that’s 4.81 percent of their Rs 187 crore dues admitted by the resolution professional.
  • It is proposed that the rights of employees, workmen and consultants will be extinguished and Edelweiss ARC will get immunity from any future claims.
  • The plan proposes to make no payment towards statutory dues. Nil amount proposed to be paid to the government in the resolution plan, is not a genuine proposal, especially when the government departments have paid about Rs 148 crore as advance.
  • The Bharati Defence resolution professional was advised by consulting firm EY. EY is also an adviser to Edelweiss ARC and provided investment banking services to the CoC as well. This creates a conflict of interest. The resolution professional and CoC have failed to ensure appropriate checks and balances and failed to implement ‘Chinese wall’ concept during the insolvency process.

And so, the NCLT rejected Edelweiss ARC’s plan and ordered the liquidation of Bharati Defence on a going concern basis. The tribunal also took umbrage to the payment of Rs 4.27 crore to the resolution professional and his team saying there is no transparency and adequacy of the fees paid to them. Hence, it replaced the resolution professional—Dhinal Shah of EY—with Vijay Iyer of Deloitte.

Precedent For Creditor-Led Recoveries

The insolvency law states that a resolution applicant shall not have a right to vote at CoC meetings unless such resolution applicant is also a financial creditor. This section was relied upon by the resolution professional to argue that the Insolvency and Bankruptcy Code, 2016 doesn’t bar creditors from submitting a resolution plan.

But there is no explicit provision that allows for a bid by a creditor.

For instance, the U.S. bankruptcy law allows a creditor to bid the value of its claim unless the court believes there’s a cause to deny this right. ‘Cause to deny’ has not been defined under U.S. law but courts have denied lenders their right to bid if it’s in the interest of any policy advanced by the bankruptcy code, such as to ensure the success of the reorganisation or to foster a competitive bidding environment.

Globally, if there are no viable bids from external stakeholders, courts allow creditors to take over the company, convert debt into equity, bring-in professionals, prop-up the company and sell it after making it operationally viable, Suharsh Sinha, partner at AZB & Partners, told BloombergQuint. AZB has advised the resolution professional in the case.

In fact ‘credit bids’ are quite commonplace under U.S. Chapter 11 Bankruptcy and in the absence of outside bids, it serves to reduce leverage and improve financial ratios, he said.

Commercially and legally, there is no reason why this plan shouldn’t have been allowed. The NCLT was perfectly entitled to say that it can’t grant certain bespoke waivers such as those relating to exemptions from certain statutory dues. But to invalidate the plan in toto is akin to throwing the baby with the bath water. 
Suharsh Sinha, Partner, AZB & Partners

This is a setback to Indian bankruptcy jurisprudence since it takes away one of the time-tested modes of restructuring which has proved to be financially viable in other jurisdictions, he said.

But Fereshte Sethna, a partner practising insolvency law at DMD Advocates, disagreed. She opined that this is an “excellent verdict” by the NCLT - one which paves the way to protect various stakeholders in financial creditor-driven resolution plans, specifically the interests of the revenue department and also of the corporate debtor’s employees.

The verdict is bound to usher in a new era, where a degree of circumspection in the exercise of potential rights by financial creditors must become the new norm, with high threshold requirements to be fulfilled in all the key areas surrounding formulation of a robust and successful insolvency resolution plan.
Fereshte Sethna, Partner, DMD Advocates

How is liquidation a better outcome than what Edelweiss ARC was proposing, asked H Jayesh, founding partner at law firm Juris Corp. He said the tribunals are failing to understand that nothing in the law prevents the applicability of the waterfall during the resolution stage, that is operational creditors recovering only the liquidation value. Once you recognise the primacy of financial creditors, everything else will fall into place, and so the rejection of the plan on grounds that operational creditors are only getting a fraction of their claims is incorrect, he said.

In Jayesh’s view, what has led to a confusing message is the role of the consultants- resolution professionals, restructuring advisors- who wear multiple hats.

The NCLT has mixed up the two things—the consultants, belonging to the same entity, wearing multiple hats versus the creditor wearing multiple hats. Hopefully, the intent isn’t to dissuade creditor-led recoveries.
H Jayesh, Partner, Juris Corp

But Sinha said the NCLT shouldn’t have have rejected the plan even for the conflict of interest reasons. The grounds for not appointing a resolution professional are laid down specifically under the law and the conflict arises if the resolution professional has worked for the insolvent company in the past. In this case EY was advising Edelweiss ARC—it’s not a conflict of interest; in fact, it’s an alignment of interest, he said.