Is 29A(c) too rigid?

Section 29A of the IBC disqualifies persons in control of the Corporate Debtor from submitting a resolution plan in the CIRP of the Corporate Debtor. The then Finance Minister while moving the amendment summarized the intent as follows, “you cannot say that I have a NPA. I am not making the account operational. The account will continue to be NPAs and yet I am going to apply for this.” ?In other words, the management of the Corporate Debtor ought not to be able to run the company into insolvency and then turn around and ask his creditors to accept a reduction in their debt.

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29A, in its initial form, was first inserted into the Code by means of an ordinance in November 2017. In 2018, 29A was amended twice. First in January 2018 and finally in August 2018. While 29A sets out several disqualifications for persons interested in submitting a resolution plan, the clearest bar to the ex-management of the Corporate Debtor is contained in sub-clause c of Section 29A. This provision stipulates that if a company under your control has a loan in default (this is called an NPA in the Indian context) then you cannot submit a resolution plan. If your company is undergoing an insolvency process, it defaulted in repaying its loans, this triggers 29A(c). Consequently, merely because your company is insolvent, you cannot submit a plan to rescue it from insolvency.

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I’ve always seen Section 29A as encapsulating a moral objection. Hypothetically, in the absence of Section 29A a promoter could raise debt, default on the debt and then submit a plan that proposes to substantially reduce her repayment obligations. This gives rise to a moral hazard making it likely that promoters will raise unsustainable levels of debt.

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I argue that the rule is too rigid and fails to consider situations where there is a legitimate business failure and no element of malfeasance. Those promoters ought not to be locked out of their own company. I will concede that these promoters would have an opportunity to settle with their creditors outside the IBC, but often that option isn’t as attractive as a plan under IBC which allows a company to undertake substantial reorganization.

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The rigidity of the rule is in a sense acknowledged within the Code itself. Section 240A of the Code exempts medium, small and micro industries from Section 29A(c), meaning that the moral hazard ceases to be a concern when the business is small. There is no reason why this should be the case, an MSME at its higher end includes companies with a turnover of under INR 250Cr, a 250Cr business is a sophisticated business and is likely governed by the same incentives as a larger business.

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Apart from these two reasons, there is a practical problem with Section 29A(c). The Wire reported that there are approximately 7000 firms with a topline of over 200Cr, so the stressed asset market in India isn’t as deep as we’d like it to be. There just may not be enough takers for all the companies undergoing CIRP under the Code. Excluding the ex-management of a Corporate Debtor therefore artificially reduces the number the persons that may be interested in submitting a resolution plan for a particular corporate debtor.

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In view of this, I propose that Section 29A(c) be altered into an opt-in provision. A committee of creditors at any point during the CIRP can choose to enact the Section 29A(c) bar and exclude the ex-management from submitting a resolution plan. At the first level, this allows the COC to account for cases where the insolvency of the company is caused due to factors beyond the control of the ex-management, addressing the issue of rigidity. It would also expand the pool of individuals interested in submitting a resolution plan for the Corporate Debtor. At a second level, I think it creates positive incentives for promoters to cooperate with an RP and the COC during a CIRP. Rather than doing everything they can to scuttle an insolvency process, they would have the incentive to cooperate with the RP at the risk of being excluded from submitting a resolution plan.

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The option to erect the barrier in 29A(c) can be a powerful tool in the hands of financial creditors while negotiating with its debtors. Converting the 29A(c) bar into an opt-in provision could potentially improve CIRP outcomes across the board.