Photographer: Andrew Harrer/Bloomberg

Does Company Law Envisage The Moratorium IL&FS, Its Group Entities Have Got?

In the span of a weekend IL&FS and its 348 group entities went from facing a litigation whirlwind to getting complete immunity from any lawsuit. But does company law permit such umbrella protection? Legal experts are divided.

Infrastructure Leasing & Financial Services Ltd. was taken over by the government on Oct. 1 after multiple debt defaults sparked a system-wide liquidity crisis. Heeding the government’s petition on grounds of oppression and mismanagement the National Company Law Tribunal permitted a reconstitution of the board with directors selected by the government.

Last week the government approached the NCLT to grant a moratorium to IL&FS and its 348 group entities. The tribunal refused. But on Monday morning, the National Company Law Appellate Tribunal accepted the government’s application.

Why NCLT Refused Immunity

A 3-month immunity was sought by the government for IL&FS and its group entities so that they are not called upon to meet any financial obligation arising from a term loan, commercial paper, fixed deposit, guarantees etc. It had also requested the NCLT to bar continuation or initiation of any suits, arbitration or recovery proceedings against IL&FS and its group entities.

The government used Section 241-242 of the Companies Act, 2013 to make this application. Section 241 deals with oppression and mismanagement cases and allows the government to apply for an order if the affairs of a company are carried out in a manner that is prejudicial to public interest. Section 242 lays down the powers of the Tribunal when such an application is made.

The NCLT dismissed the government’s application, saying:

  • The relief that’s sought by the government is similar to the moratorium under the Insolvency and Bankruptcy Code (IBC) which shields an entity from any recovery or legal action once its admitted for insolvency.
  • But since IL&FS is a financial services provider and IBC doesn’t apply to it a moratorium under that law cannot be granted.
  • The Companies Act, 2013 doesn’t provide for any moratorium when a company is restructuring its debt, as is the case in IL&FS.
  • Since some of the IL&FS group companies are already under IBC-led insolvency resolution, a blanket moratorium cannot be given.
  • And finally, relief under Section 242 has already been granted by allowing the government to take over the board of IL&FS.

NCLAT Relies On Public Interest

On Monday this week, the appellate tribunal ruled otherwise. It allowed the government’s application on grounds of larger public interest, economy of the nation and interest of the company. But the relief has been granted only as an interim measure until the next hearing on November 13. The appellate tribunal has also directed that the five largest creditors be made party to the case.

H Jayesh, founding partner at law firm Juris Corp said that it is a well-settled principle of law that a relief which cannot been granted as a final order, cannot be granted as an interim order. Jayesh is representing some of the creditors of IL&FS’ group companies.

This is worse than robbing Peter to pay Paul
H Jayesh, Founding Partner, Juris Corp

But Vikram Nankani, senior advocate at the Bombay High Court argued that while purists may be right in pointing out that company law does not expressly provide for such a moratorium, it also doesn’t prohibit the NCLT from passing such an order.

Sometimes an extraordinary situation comes up and you need an out-of-the-box answer to it. 
Vikram Nankani, Senior Advocate, Bombay High Court

Watch Nankani and Jayesh discuss the NCLAT decision on BloombergQuint’s weekly law and policy show- The Fineprint.

Edited excerpts transcribed below.

Does section 241 of Companies Act, 2013 envisage the kind of relief that’s been granted by the NCLAT to IL&FS and its group entities?

Jayesh: Section 242 very clearly says that with the view to bringing an end to the matters complained of, the tribunal can make such orders as it thinks fit. While one may harp upon the wide latitude of the term- such order as it thinks fit- it is completely circumscribed by the language - with the view to bring an end to matters complained of.

What has been complained of here? Mismanagement or oppression at best. It is not the case that the creditors are harassing the management and the application is made to bring an end to that harassment. Given that the complaint before the NCLT was that the affairs of IL&FS and its group companies affairs have been conducted in manner prejudicial to public interest, you can pass an order that brings an end to this. That would mean change of management and things related to it and for that, the first step has been taken by allowing the board to be reconstituted.

There is section 244 which allows NCLT to pass interim orders as it deems fit. But it is circumscribed by the further language which says for regulating the conduct of the company’s affairs. That has always been read to mean company’s affairs as between the management and shareholders. To read this now to mean regulating the affairs of a company by limiting the actions of creditors is unprecedented and would lead to expanding the scope of the statute beyond what the parliament intended. We cannot forget that where the parliament wanted either the regulator or forum like NCLT, Company Law Board or the High Court to have moratorium powers, they explicitly stipulated so. If you look at IBC or the erstwhile Sick Industrial Companies Act and even the Banking Regulation Act - they all have explicit words that provide for suspension of legal proceedings.

The Companies Act, 2013 was amended when the IBC came in. The parliament knew that for a creditor-driven winding up under IBC, they need to provide a moratorium. It could be argued that the Financial Resolution and Deposit Insurance Act– which has not come in as yet – would have similar provisions. But even those would apply to the holding company which is IL&FS and not to its subsidiaries - most of which are not NBFCs. So, those group entities which are not NBFCs could’ve been provided a moratorium only under IBC.

That begs a question why is the government avoiding IBC, given that the subsidiaries of IL&FS have defaulted and are not in the financial services business.

Nankani: The purists will say that the conventional theory must be sustained. If you don’t find it expressly in an Act, then you cannot grant that relief. But the point is- is there something which prohibits the NCLT from passing such an order under section 241-242? Is it something so repugnant to the provisions of the law? I understand you have run of the mill cases which normally get covered under section 241 where minority (shareholders) get oppressed by the majority. Or in a few cases, where the majority is being oppressed by the minority. But those are run of the mill cases. Sometimes an extraordinary situation comes up and you need an out of the box answer to it. When government exercised its powers under section 396 of the old Companies Act in relation to NSEL case, eyebrows were raised as nobody had thought about it. People had forgotten about the section until the government exercised its powers of merging the two companies.

Similarly, there is a situation here that demands an out of the box solution. Once you find that there are words in the section itself which says prejudicial to public interest, give it a full and effective meaning. If that means trying to find a solution within the wider interpretation, then merely the lack of an express provision is not a reason to prohibit such a relief.

Also read: IL&FS’ Road Assets Are Not Worth What It Says. Here’s Why…

The NCLAT has only given an interim relief from any legal proceeding, recovery etc. And the creditors will get to make their case in the next hearing. What is the irreparable harm that’s being caused because of the interim directions?

Jayesh: The fundamental question is who are we trying to protect? This is worse than robbing Peter to pay Paul. You have creditors at the holding company level and they did whatever diligence they did. Now you have creditors at the various subsidiary level who gave credit on the basis of the individual companies and not the parent. To protect the creditors of the holding company, you are now penalizing creditors of the subsidiary companies which is unprecedented.

By seeking such a freeze on all the group companies in one go, you are telling the whole world that in India there is nothing like limited liability, restriction on lifting the corporate veil. Whenever we feel like, we will just move the forum and have the corporate veil lifted. Suddenly you’re saying that all these companies are a single balance sheet and therefore need to be treated as a single homogeneous union and please disregard them as separate legal entities. That is one fundamental problem.

The second point is - you already have insolvency proceedings pending against some of these subsidiaries. Their creditors are being told that you will be shut out and you can’t do anything because we the government believe that the parent company needs to be protected. I don’t know if anybody has done this study. I wouldn’t be surprised if it turns out that the class of creditors at the parent company as a homogeneous mass are distinct from the class of creditors of the operating companies. May be that is driving the government to do this. I am just speculating here.

And finally, there is ambiguity in a sense that we are assuming that NCLAT means five largest creditors of each of the entities. If you are saying five largest creditors only of IL&FS, then it proves my point further. Some of the creditors of IL&FS include mutual funds. So, you are suddenly telling a mutual fund that you cannot enforce your rights and do anything and so what that you have to redeem. The issue of sanctity of contracts is being completely ignored.

Also read: Ousted IL&FS Managing Director Hari Sankaran’s Defence