Essar Steel: Supreme Court On Creditor Parity And Rights Of The Creditors’ Committee 
A security guard pulls a gate across the logo of Essar. (Photographer: Abhijit Bhatlekar/Bloomberg News)

Essar Steel: Supreme Court On Creditor Parity And Rights Of The Creditors’ Committee 

The world’s largest steelmaker has finally won a long legal battle to acquire the insolvent Essar Steel Ltd.

The Supreme Court on Friday allowed ArcelorMittal to proceed with the acquisition of of Essar Steel, and overturned the National Company Law Appellate Tribunal’s order that gave secured and unsecured lenders equal right over the proceeds. In doing so, the apex court restored primacy to the committee of creditors—under the Insolvency and Bankruptcy Code, 2016.

“The NCLAT judgment which substitutes its [own] wisdom for the commercial wisdom of the CoC must therefore be set aside,” the apex court said.

The Supreme Court’s judgment addressed moot points around the distinction between financial and operational creditors, the role of the CoC, and the treatment of secured and unsecured creditors.

These questions arose because earlier this year the National Company Law Tribunal had ordered proportionate distribution of ArcelorMittal’s resolution plan among financial and operational creditors, and in doing so had also struck down the power of the CoC to determine such distribution.

The Essar Steel CoC then moved the apex court opposing the NCLAT’s decision of putting the secured, unsecured and operational creditors on the same footing. The dilution of CoC’s powers was also challenged.

Here are the key aspects of the Supreme Court’s order…

Parity Among Financial And Operational Creditors

Among the most controversial points in the NCLAT’s July order was the application of principle of ‘equality for all creditors’ when deciding distribution of claims under the insolvency code. The operational and unsecured creditors of Essar Steel had argued that they were treated inequitably in the distribution of proceeds by Essar Steel’s CoC.

And so, the NCLAT had reversed the payment ratios decided by the CoC and ruled that employees, operational and financial creditors whose claims are less than Rs 1 crore each must be repaid in full, and those whose claims exceed Rs 1 crore must get 60 percent.

The apex court, however, reversed the appellate tribunal’s ruling on the following grounds:

  • The differentiation between financial and operational creditors is inbuilt into the IBC itself.
  • The code achieves this differentiation by vesting the CoC, constituted of financial creditors only, with the discretion of accepting resolution plans.
  • Financial creditors, by their very nature are important to the functioning of a company as they provide capital to a corporate debtor, which in turn is utilised by the company for purchase of assets and expansion.
  • The principle of equitable treatment can only be extended to creditors on an inter se basis if they belong to a same class. It cannot be extended to creditors belonging to different classes.
  • More importantly, the equality principle cannot be stretched to treat “unequals equally”, as such treatment would go against the intention of the code.
  • As the waterfall mechanism under liquidation provides a superior status to the financial creditors, an equality principle would incentivise the secured financial creditors to vote for liquidation instead of a resolution.
  • This in turn would affect the intention behind the code, which is resolution of distressed assets.
  • While regulation 38 mandates the CoC to indicate how it has dealt with interests of operational creditors, it does not, as the NCLAT ruled, envisage a payment of an amount proportionate to the operational creditor’s debt.

Lawyers told Bloomberg Quint that the difference between creditor classes is well established in mature bankruptcy jurisdictions around the world as well as in the IBC.

Indus Law Partner Sudipta Routh told BloombergQuint “the NCLAT judgment had distorted balance envisaged in the code” and that the Supreme Court has restored it.

Role Of Committee Of Creditors

The IBC and the committee report that preceded it, the Bankruptcy Law Review Committee report, both envisaged broad powers for the committee of creditors. The CoC is constituted of financial creditors and while a company is in insolvency proceedings, almost all important decisions, ranging from change in capital structure to change in management, require the CoC’s approval. A resolution plan is accepted only if it receives 66 percent of the voting share of the financial creditors. And while there was no explicit mention in the code, of how the resolution plan proceeds must be distributed between different classes of creditors, the decision was so far being taken by the CoC. That has been the case in the over 150 resolutions so far.

In July, the NCLAT superseded this well-established principle and stripped the CoC of rights to decide on the distribution of proceeds from a resolution plan. It not only directed a proportionate distribution of proceeds under a resolution plan among different class of creditors - financial and operational, but also concluded that the CoC will not have any role in the distribution of claims, and the distribution is to be by done by the resolution professional.

Reading into the scheme of the IBC, the Bankruptcy Law Review Committee’s report and the financial aspects surrounding the primacy to financial creditors, the apex court struck down the NCLAT’s decision on the following grounds:

  • The scheme of the IBC draws a clear distinction between operational and financial creditors.
  • Financial creditors constitute the CoC and all key decisions pertaining to the company are taken by the committee.
  • Even if a resolution professional runs the company on a day-to-day basis, he/she must do so with the approval and supervision of the committee.
  • A resolution plan is considered approved only after requisite approval by the CoC.
What is important is that it is the commercial wisdom of this majority of creditors which is to determine, through negotiation with the prospective resolution applicant, as to how and in what manner the corporate resolution process is to take place.
Supreme Court Order

Hence the Supreme Court concluded that the CoC is in the best position to apply commercial wisdom regarding distribution of proceeds of the resolution plan. The judgment made it clear that tribunals cannot “trespass upon a business decision of the majority of the Committee of Creditors” and the scope for judicial review of such decisions is limited.

These grounds for review are enshrined in the IBC, says Ajay Shaw, partner at law firm DSK Legal.

The judgment makes it clear that disposition of the defaulting corporate debtor is a business decision and hence, only financial creditors should make such decisions. Therefore, tribunals cannot interfere on merits with the commercial decision of the CoC and its ability to interfere is only confined to the grounds enshrined under the IBC.
Ajay Shaw, Partner, DSK Legal

As per the Section 61 (3) of the IBC the appellate tribunal can hear an appeal against the NCLT’s order approving a resolution plan passed by the CoC only if such plan:

  • Contravenes any law;
  • Fails to comply with any criteria specified by the Insolvency and Bankruptcy Board of India;
  • Certain other grounds specified in the code.

Reiterating this, the Supreme Court said the merits of a commercial decision taken by the CoC cannot be interfered with by the NCLAT. But, it added, that the CoC “must reflect the fact that it has taken into account maximising the value of the assets of the corporate debtor and the fact that it has adequately balanced the interests of all stakeholders including operational creditors”.

Secured Vs Unsecured Creditors

Standard Chartered Bank, which was a secured lender to Essar Steel had outstanding admitted dues of Rs 3,487.10 crore, but with a security of just Rs 24.86 crore.

In the distribution of claims, the CoC decided the bank will only get an amount based on its security interest and approved a payment of Rs 60 crore to it under the resolution plan. Miffed by this, Standard Chartered had moved the NCLAT challenging the curtailment. The NCLAT ruled in favor of the Bank and stating that financial creditors must be treadted equally, ordered the CoC to pay Standard Chartered Rs 2,160 crore towards its dues.

Essar Steel’s CoC moved the apex court challenging this modification by the NCLAT. And the Supreme Court ruled in its favour, stating that “ultimately it is the commercial wisdom of the parties to the scheme, reflected in the 75 percent majority vote, which then binds all shareholders and creditors”.

Restating that the CoC’s commercial wisdom cannot be replaced, the court said “it is clear that there is no residual jurisdiction not to approve a resolution plan on the ground that it is unfair or unjust to a class of creditors, so long as the interest of each class has been looked into and taken care of”.

The IBC may not be used to close the inherent gap in the nature of unsecured lending when it comes to the several other unsecured or operational creditors, Vidisha Krishnan, partner at law firm MV Kini & Co., told Bloomberg Quint. The risk was present at inception and even all secured creditors too are taking big haircuts, she said.

In all, the Supreme Court’s judgment brings back on course the interpretation and hence implementation of the IBC, said lawyers.

The most important course correction in this judgment is in the re-establishment of the straight and narrow paths that the tribunals must tread. The judgment re-emphasises the paramount status of the CoC. In a not so subtle message to the tribunals, the judgment makes it clear that the IBC will fail like the SICA (Sick Industrial Companies Act) if tribunals assume non-existent powers to second guess the CoC.
Sudipta Routh, Partner, Indus Law
BQ Install

Bloomberg Quint

Add BloombergQuint App to Home screen.