Five Crucial Cases That Help Decode The Insolvency And Bankruptcy Code
Should the insolvency law prevail over state laws? When can an operational creditor initiate insolvency proceeding? What about the possible gaming of the bankruptcy law by promoters? And is the credit hierarchy sacrosanct? These are some of the questions that courts have had to deal with in the first 10 months of India’s new insolvency regime.
So far, more than 1,500 insolvency applications have been filed, of which around 200 have been admitted by National Company Law Tribunals. BloombergQuint spoke with experts on the top five precedent-setting cases that are shaping India’s insolvency regime.
In the very first case under the new insolvency regime, ICICI Bank Ltd. took Innoventive Industries Ltd. to NCLT for defaulting on its debt. The company challenged the application on grounds that all remedies for enforcement against it were temporarily suspended, owing to a reprieve it had won under the Maharashtra Relief Undertaking (Special Provisions) Act, a state specific labour legislation.
After several rounds of appeal, the matter reached the apex court, which rejected Innoventive’s argument. It concluded that the state law cannot stand in the way of the insolvency code.
But Bahram Vakil, founding partner of law firm AZB & Partners, cautioned against using this ruling to escape compliance under other central laws.
The insolvency code overrides any inconsistency in any other law. But many clients ask us, do we have to abide by competition law, by the Companies Act? Of course, you have to. In fact, there is a clear Section 30 which says that all resolution plans must abide by all applicable laws, but if there is an inconsistency the non-obstante wins.Bahram Vakil, Founding Partner at AZB & Partners
The Innoventive order came with another important observation. The apex court noted that once an interim resolution professional takes control of a company, its erstwhile management loses the right to appeal.
The power to take action on behalf of the company rests with the resolution professional, Veena Sivaramakrishnan, a banking and insolvency law partner at law firm Shardul Amarchand Mangaldas told BloombergQuint.
However, if there is any party, which can include the directors, the shareholders or any other party that can claim that they have been aggrieved by any of the decisions, they can also prefer an appeal. When the board is suspended, none of the erstwhile members of the board can take any action.Veena Sivaramakrishnan, Banking and Insolvency Partner, Shardul Amarchand Mangaldas & Co
But that does not stop any of the members from taking independent action if they can meet the test of being aggrieved, she added.
In another important precedent laid down in the Mobilox case, the apex court deliberated on what qualifies as a ‘dispute’ under the code. The answer to this question is pertinent since the insolvency code bars initiation of insolvency proceedings by an operational creditor if there is a pre-existing dispute between the parties.
The primary issue before the court was whether a ‘dispute’ can exist only if there are pending legal proceedings between the parties or will a rebuttal to a claim by the company also qualify as a ‘dispute’.
The apex court took a liberal interpretation to rule that as long as the company can show that a genuine dispute truly exists in fact and is not spurious, hypothetical or illusory, the NCLT has to reject an operational creditor’s insolvency application.
This ruling has clarified that the requirement of a proceeding being initiated prior to a notice being issued under the insolvency law is not a requirement in case of a bona fide dispute, Kumar Saurabh, finance partner at law firm Khaitan & Co told BloombergQuint.
It’s a very fair position because otherwise operational creditors using it just for debt recovery is not the objective of the insolvency code. And clearly that sort of an approach had to be discouraged.Kumar Saurabh Singh, Finance Partner, Khaitan & Co
The third important case under the insolvency regime is the one that marked the first approval of a resolution plan. The case brought to the fore the possibility of promoters managing voting rights of the committee of creditors.
The insolvency code prohibits inclusion of related parties in the committee of creditors but Synergies Dooray Automotive Ltd.’s affiliate, Synergies Casting, succeeded in indirectly violating this provision by assigning more than 90 percent of its debt to a third party financial institution, Millennium Finance, or so claimed Edelweiss Asset Reconstruction Company – Synergies Dooray’s financial creditor. Consequently, Millennium Finance, by securing approximately 70 percent of voting rights on the creditors committee, approved the resolution plan recommended by Synergies Casting.
Edelweiss went on to challenge the constitution of the committee of creditors, alleging that the assignment of debt by Synergies Casting to Millennium Finance was with the ulterior motive of reducing its voting rights. However, Edelweiss’ argument did not find favour with the NCLT. The tribunal noted that assignment of debt was legally permissible during the pendency of insolvency proceedings and concluded that there was no relationship between Millennium and Synergies Casting.
Aggrieved by NCLT’s decision, Edelweiss has challenged it before the appellate tribunal.
While discussing the alleged motives of the promoters in trying to control the committee of creditors, Vakil said that if what was alleged has indeed happened, it is very unfortunate.
The U.K., Brazil and many other countries did mention that in the first few years you come up with all these difficulties, so the sooner you recognise them the sooner these kinds of shenanigans can be stopped. Because will it happen? For sure, it will happen in every country. The sooner you stamp it out, the IB is going to be extremely cautious in future.Bahram Vakil, Founding Partner, AZB & Partners
Sivaramakrishnan cautioned promoters against indulging in any foul play to evade provisions of the insolvency code.
In my view, the promoters have to be very careful because any transaction entered into to defraud creditors with mala fide intention, and not for good and valuable consideration, can be set aside by the resolution professional.Veena Sivaramakrishnan, Banking and Insolvency Partner, Shardul Amarchand Mangaldas & Co
The Synergies Dooray case has raised another pertinent question on whether the NCLTs, in the process of approving resolution plans, exempt companies from future stamp duty and tax liabilities.
Stamp laws and tax laws relate to prospective or future liabilities of the company and these are not strictly for tribunals to decide during the insolvency process, Saurabh said.
You can decide on retrospective liabilities as part of operational dues, but prospective liabilities in the present scheme of the code does not seem to be strictly covered and that will require clarification. You do it either by amendment or by rules that bring more clarity. I think that will be a better approach instead of tribunals taking this decision independently, that being subjected to challenges before various forums.Kumar Saurabh Singh, Finance Partner, Khaitan & Co
Homebuyers of properties developed by both companies have challenged the constitutionality of the insolvency code on grounds that it denies remedy to creditors that do not squarely fall within the category of ‘financial creditors’ and ‘operational creditors’.
Vakil pointed to an earlier NCLT ruling in the Nikhil Mehta case, where the homebuyers were guaranteed assured returns, and it was concluded that their position was akin to a financial creditor. However, in most cases this would not be the case, Vakil added.
So, a new, if I may call it, a third category has been created saying there is no question – homeowners have to be involved in the process. A new form ‘Form F’ was put up, and they have all lodged their claims.Bahram Vakil, Founding Partner, AZB & Partners
While the issue of constitutionality is still pending, the Supreme Court has issued interim directions to protect the interests of homebuyers in the Jaypee Infratech case.
- It has directed the parent company, Jaiprakash Associates Ltd., to deposit Rs 2,000 crore with the court
- It has allowed representatives of homebuyers to participate in meetings of the committee of creditors
- It has directed the interim resolution professional to present a resolution plan specifically incorporating the interests of homebuyers
The fifth important precedent has seen conflicting views from the National Company Law Appellate Tribunal and the Allahabad High Court. The question that arose both in the Phoenix ARC and the Sanjeev Shriya matter was in relation to the liability of security providers, such as guarantors, under the insolvency code.
As per the law, once an insolvency application against a company has been admitted, all other legal proceedings in relation to the company and its assets stand abated. This period is termed as a moratorium. The appellate tribunal held that the benefits of this moratorium cannot be availed by the guarantors of the company. However, recently the Allahabad High Court took a contrary view and stayed proceedings against the guarantors.
The basic principle, as laid down by the NCLAT, is that a guarantee is an independent obligation and the guarantor can be held liable irrespective of the proceedings against the corporate debtor, Veena pointed out. “The NCLAT was ruling on what is it that the moratorium extends to and it concluded that the moratorium clearly extends only to the assets of the corporate debtor,” she added.
They emphasised on the usage of ‘its assets’ and in that context, they say it is the assets of the corporate debtor in question. But when we look at guarantees today, whether parallel proceedings can lie etc, the Allahabad [High Court] judgement also comes in the picture and our view is that it is necessary to look at the underlying drafting in the guarantee document itself to evaluate what are your rights against the guarantor, which can actually be independent of what can be claimed against the corporate debtor.Veena Sivaramakrishnan, Banking and Insolvency Partner, Shardul Amarchand Mangaldas & Co
Besides these five cases, the Supreme Court has laid down another importance precedent in the Lonkhandwala Kataria case, where it used its inherent powers to allow the parties to settle out of court even after the admission of the insolvency application. Some experts said that in ruling so, the apex court has deviated from the strict letter of the law while others welcomed it, saying the decision will reduce litigation.