Sterling Biotech’s Insolvency: Settlement With Promoters Raises Questions Around The Sanctity Of Withdrawal Process

Sterling Biotech’s insolvency proceedings have come full circle. The company was admitted to insolvency resolution by Andhra Bank in June last year and now, the National Company Law Appellate Tribunal has allowed the creditors to withdraw from the insolvency process and settle with Sterling Biotech’s promoters.

The same promoters — Nitin and Chetan Sandesara — who are absconders, facing criminal charges with the Enforcement Directorate and Central Bureau of Investigation looking for them, as the Mumbai bench of the National Company Law Tribunal had noted in its order in May this year. The ED had attached assets worth Rs 4,701 crore of the company in June last year, the investigative agency had said on social media.

And so, Sterling Biotech’s insolvency raises three important questions:

• First, once 90 percent of the lenders approve the withdrawal of the insolvency application, does the NCLT have no say in it?
• Second, should the withdrawal process under the Insolvency and Bankruptcy Code, 2016 be completely insulated from the fact that the offer for settlement has been made by an absconding promoter?
• And three, who will determine that the settlement amount is not ‘proceeds of crime’ — a condition that the NCLAT has laid down while allowing the withdrawal of the insolvency application.

Withdrawal From IBC: NCLT’s Discretion?

In March this year, 90.32 percent of Sterling Biotech’s creditors’ committee by vote share approved withdrawal from the insolvency process. This was done subsequent to a one-time settlement that was offered to the lenders by the promoters. Curiously, the proposal was signed by Farhad Daruwalla on behalf of the Sandesara Group, and it’s unclear whether the promoters had authorised him to make the settlement offer, the tribunal had noted.

So, the NCLT had rejected the withdrawal application for primarily two reasons:

• One, Section 12A of the IBC says the Adjudicating Authority ‘may’ allow for withdrawal once 90 percent of CoC by vote share has approved such an application. The use of the word ‘may’ means that the NCLT has the discretion to accept or reject a withdrawal application.
• Two, if the withdrawal application is allowed, the promoters will regain control and management of the company under the guise of Section 12A. This is contrary to the intent of Section 29A that bars promoters from submitting a resolution plan, the NCLT had pointed out.

The so called one-time settlement scheme is also a type of resolution plan, and the promoters will get the company at a 64 percent discount—Rs 3,110 crore as against a total claim by lenders of Rs 9,053 crore, the NCLT had noted.

On appeal, the NCLT’s order was reversed by the appellate tribunal. The NCLAT held that once the withdrawal application is approved by more than 90 percent of the CoC, it’s not open to rejection by the tribunal and that too on the ground of ineligibility under Section 29A, which is not applicable.

Sections 29A and 12A operate in completely different spheres and are applied in scenarios that are mutually exclusive to one another, Ajay Shaw, partner at DSK Legal, told BloombergQuint. Section 12A was introduced for the very purpose of enabling withdrawal from an ongoing corporate insolvency process and so, the limitation of Section 29A will not apply in such situations, he said.

Senior Counsel AS Chandhiok agreed that ineligibility under Section 29A will not bar an entity from proposing a settlement. But, he said, Section 12A gives the adjudicating authority discretion to disallow a withdrawal application.

This is where the ‘may’ in Section 12A of IBC becomes relevant, Chandhiok said.

Withdrawal Applications: Alleged Criminal Conduct

Under the one-time settlement, Sterling Biotech’s promoters have offered to pay 20 percent of the amount via cash flows from businesses in Nigeria and the remaining raised from interested investors, Andhra Bank had informed the NCLT. The secured lenders have conducted due diligence and are conscious of the fact that there are ongoing criminal investigations against the promoters, it had submitted.

But the NCLT had noted that the amount to be invested by the identified investors, their names, sanction granted by those investors, their financial credibility and strength—none of this information was submitted by Andhra Bank. This casts doubt on the settlement proposal submitted by the promoters, the NCLT had said.

The ED, government and the Ministry of Corporate Affairs had all objected to the settlement proposal but the CoC — majority of which consisted of public sector banks — had approved it.

The NCLAT, however, said if the assets of Sterling Biotech are ‘proceeds of crime’, it is always open to the ED to seize the assets under the prevention of money laundering law. But this will not come in the way of the individual such as promoter, shareholder or director as long as he pays in his individual capacity and not from proceeds of crime.

And so, the NCLAT set aside the tribunal’s order that had rejected the settlement and directed Sterling Biotech’s liquidation.

On the face of it, what the NCLAT has done seems quite stark but at it’s core, they’ve trusted the commercial wisdom of the CoC— in that sense, it’s good that they’ve stuck to this principle that everyone has been stressing upon, Suharsh Sinha, partner at law firm AZB & Partners, said. But on the facts of this case, he said, it may not have been the best outcome.

The way to resolve this conflict is via delegated legislation — specify that in a withdrawal situation, the CoC will ensure that the procedures are complied with, after which it goes to the NCLT for its judicial application of mind, he said.

In this case, it was disconcerting for the NCLT since it wasn’t clear who was making the proposal, whether there was any linkage between this person and the entity from which funds are supposed to come — so the regulator must prescribe guidelines to say that withdrawal applications must be backed by financial statements, details on source of funds, etc., Sinha said.

Settlement Funds Can’t Be Tainted

In allowing Andhra Bank’s withdrawal application, the NCLAT has directed that the settlement amount cannot come from ‘proceeds of crime’.

The anti-money laundering law broadly defines ‘proceeds of crime’ as any property directly or indirectly derived from a criminal activity.

The NCLAT held that there is nothing on the record to suggest that the individual property of the promoter, who has proposed to pay the settlement amount, is subjected to restraint by the ED. At the same time, withdrawal from the insolvency proceedings will not interfere with the ongoing criminal investigations, it concluded.

It’s unclear as to who will ascertain whether the money paid as settlement amount is proceeds of crime or not, Shaw said. To receive any settlement amount from a non performing asset account, lenders are supposed to do due diligence as per Know-Your-Customer anti-money laundering guidelines laid down by the RBI, he said.

The buck should stop with the lenders, Sinha said, but the problem is CoC is a fragmented body—if there are questions around the source of funds, who should be held liable? The practical way to do this is to get a transaction consultant to look at the bonafides of the money trail and rely on that certification, and finally the onus should be on the applicant bank to ensure that the settlement amount is not proceeds of crime, he said.

Watch the video here