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

A curious interpretation of the interplay between company law and the IBC - when the corporate debtor has reached the liquidation stage - may make way for backdoor promoter participation.

The National Company Law Appellate Tribunal, in the case of Gemini Communication Ltd., has said that a scheme of compromise must be considered first at the liquidation stage before the assets of the company can be liquidated. But it hasn’t explicitly stated whether such a scheme can be proposed by promoters, who are barred to participate in the resolution process even at the liquidation stage under the Insolvency and Bankruptcy Code, 2016 (IBC).

Gemini Communication’s Insolvency

In February this year, Gemini Communication’s Committee of Creditors rejected the only resolution plan submitted, on grounds that the offer was too low compared to the outstanding debt of the company and, that the plan discriminated between the different creditors etc. As a result, the Chennai bench of the NCLT directed liquidation of the company.

The promoters then approached the NCLAT and stated that they are willing to offer Rs 30 crore as against the liquidation value of Rs 3 crore. The appellate tribunal rejected this proposal on grounds that section 29A of the IBC bars promoters of a defaulting company from participating in both the insolvency resolution and the liquidation process. Section 29A lays down ineligibility criteria applicable to resolution applicants during the insolvency process and at the time of liquidation.

The Companies Act Twist

Having said so, the NCLAT then considered -

  • The Supreme Court’s ruling in Meghal Homes case, which said that even if a winding up order has been passed against a company, a compromise or arrangement can be proposed under section 391 of Companies Act, 1956. Section 391 allowed the company, any of its members or creditors to make a compromise or arrangement application.
  • This section has been replaced by section 230 of Companies Act, 2013 which also allows for a compromise or arrangement with creditors and members (shareholders). Such a scheme can be proposed if a company is being wound up under the Companies Act, 2013 or under IBC, the NCLAT said.
  • The apex court’s ruling in the Swiss Ribbons case which held that the liquidator can sell the business of the corporate debtor as a going concern.

Relying on all these, the NLCAT held that before the liquidator can be allowed to sell a corporate debtor’s assets, steps laid down under section 230 of the Companies Act, 2013 must be followed. These steps will include considering any application for compromise or arrangement.

For this, the liquidator should be allowed to set up a committee of creditors to determine if the scheme of arrangement is viable, feasible and has appropriate financial matrix, the appellate tribunal said.

“The NCLT will be allowed to approve the arrangement inspite of some irrelevant objections as may be raised by one or other creditor or member keeping in mind the object of IBC, 2016.” - NCLAT 

If this scheme of compromise fails, the liquidator must take steps to sell the corporate debtor as a going concern. Only if that fails, can the assets of the company be liquidated, the NCLAT held.

NCLAT View: Impact

It seems like there is a Hand of God telling NCLTs and NCLAT that take care of the operational creditors, unsecured creditors and avoid liquidation for the corporate debtor, H Jayesh, founding partner at Juris Corp commented. He said that it’s absurd as to how section 230 can be applied to a company in liquidation under IBC.

Once NCLT’s jurisdiction commences under IBC, the Code itself is clear that no other law can prevail. The non-obstante clause clearly says that notwithstanding anything inconsistent under any other law, IBC will prevail. By calling it a scheme under company law, you’re completely bypassing section 29A of the IBC. 
H Jayesh, Founding Partner, Juris Corp

We are going back to the days of SICA where the judiciary believed that liquidation is bad, the company must be revived at all costs and in doing so, you allow unviable assets to continue, you support the crooked; the same thing is happening now, Jayesh added.

The IBC came into force after the Companies Act, 2013 and it expressly bars promoter participation even at the liquidation stage, Sitesh Mukherjee, litigation partner at Trilegal said. But section 230 doesn’t bar promoters from proposing a compromise or arrangement, he added.

Unless a commensurate change is made to the company law, it can be argued that promoters can propose a compromise or arrangement.
Sitesh Mukherjee, Partner, Trilegal

He explained that section 230 needs to be harmonised with section 29A of IBC and it’s a well-settled principle that what is not permitted to be done directly, cannot be allowed indirectly.

‘Section 29A being a later amendment to the IBC, needs to be read into section 230 of Companies Act which permits compromise at the stage of liquidation under the IBC. NCLT will need to keep in mind the bar prescribed by section 29A while applying its discretion in approving a scheme of compromise,’ he added.

The other important aspect is the implementation of the NCLAT direction.

The appellate tribunal has directed that the liquidator be allowed to constitute a CoC- a feature of IBC - while applying section 230 of company law, which mandates a completely different process for approval of schemes of arrangement.

It’s completely uncharted territory, Jayesh pointed out. It’s not clear whether the constitution of this CoC is for steering the process or to vote on the proposed scheme of arrangement, he added.