A RESOLUTION OF DEBTS AND DOUBTS

The judgment of 'Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta & Ors.' dated 15.11.2019 passed by the Bench of Hon’ble Justices Nariman, Surya Kant and V. Ramasubramanian was passed in the challenge to the Judgment passed by the Hon’ble National Company Law Appellate Tribunal (“NCLAT”). The question before the NCLAT was to ascertain the legality of the Resolution Plan submitted by Arcellor Mittal, the Resolution Applicant. While I say that the NCLAT was to merely look at the Plan’s legality and adherence to the provisions of the Insolvency and Bankruptcy Code, 2016, (“Code”) the NCLAT’s final Judgment dated 04.07.2019 went against the settled principles of law under the Code and de hors the authority granted to the NCLAT under the Code.

The NCLAT’s judgment in brief held inter alia, that (i) there is no difference between a financial and operational creditor in the payment of dues and therefore operational creditors should deserve equal treatment under a resolution plan, thereby directing a redistribution of the proceeds payable under the approved resolution plan, (ii) security and security interest would be irrelevant at the stage of resolution for the purpose of allocation of payments, (iii) highly belated claims and claims without sufficient proof were admitted, (iv) the Committee of Creditors (“CoC”) is not empowered to decide the manner in which the distribution is to be made between one or other creditors as there would be conflict of interest between the financial and operational creditors, (v) claims against the Corporate Debtor that have not been decided by the Adjudicating Authority or the NCLAT, may be decided by an appropriate forum in terms of Section 60(6) of the Code. This is not all what was held by the NCLAT, however, some of these observations are not only against the judgments prevalent then but also against commercial economic principles of lending in the Indian market.

This article will cover in brief what the Hon’ble Supreme Court held and reiterated vide its Judgment dated 15.11.2019. Some issues that were left unanswered in its previous judgments have been clarified here. However, first and foremost, the systematic manner in which the entire subject of the Code has been tackled in the judgment has to be appreciated. Even without going into the merits and observations of the Hon’ble Supreme Court, the judgment will serve as an excellent primer for someone who wishes to understand the entire process of a resolution of a debtor company, starting from the order of admission against the company, to the duties of the Resolution Professional and the CoC.

COMMERCIAL WISDOM OF COC TO DECIDE RESOLUTION PLAN ABSOLUTE

It may be noted that the NCLAT in its Judgment had directed several changes in the plan approved by the CoC to a significant extent, involving changes in the quantum of payment to be made to the financial and operational creditors. The Hon’ble Supreme Court, while deciding the question considered Section 30(4) of the Code along with Regulation 39 of the Insolvency Resolution Process for Corporate Persons Regulations, 2016 (“Regulations”). The relevant portion of Section 30(4) of the Code is very explicit in that it states as under:

“Section 30(4) - The committee of creditors may approve a resolution plan by a vote of not less than [sixty-six] percent of voting share of the financial creditors, after considering its feasibility and viability, [the manner of distribution proposed, which may take into account the order of priority amongst creditors as laid down in sub-section (1) of section 53, including the priority and value of the security interest of a secured creditor] and such other requirements as may be specified by the Board: ”

The relevant portion of Regulation 39 of the Regulations reads as follows:

 “Regulation 39 – Approval of Resolution Plan:

xxx xxx xxx

(3) The committee shall evaluate the resolution plans received under sub-regulation (1) strictly as per the evaluation matrix to identify the best resolution plan and may approve it with such modifications as it deems fit.”

Notwithstanding the clear language of the provisions, the Hon’ble Supreme Court had already held in K Sashidhar v. Indian Overseas Bank, reported in 2019 SCCOnline SC 257, if the CoC had approved the resolution plan by requisite percentage of voting share, it was imperative for the resolution professional to submit the same to the adjudicating authority. On receipt of such a proposal, the adjudicating authority is required to satisfy itself that the resolution plan as approved by the CoC meets the requirements specified in Section 30(2) of the Code; no more and no less. This is also clear from a reading of Section 31, the relevant portion of which is reproduced herein below:

 “Section 31. Approval of Resolution Plan –

(1) If the Adjudication Authority is satisfied that the resolution plan as approved by the Committee of creditors under sub-section (4) of section 30 meets the requirements as referred to in sub-section (2) of section 30, it shall by order approve the resolution plan which shall be binding on the corporate debtor and its employees, members, creditors, guarantors and other stakeholders involved in the resolution plan”

Thus the legislature has not endowed the adjudicating authority with the jurisdiction or authority to analyze or evaluate the commercial decision of the CoC much less to enquire into the justness of the rejection of the resolution plan by the dissenting financial creditors.

In this light, imagine the process of resolution as the amount in the resolution plan being divided between the financial and operational creditors to clear all debts as far as possible while keeping the debtor company as a going concern. The CoC calls the shots as regards the manner of division and as long as the provisions of law are satisfied, it is up to the majority decision (66%) of the CoC to fix the details. Another aspect that has to be ensured by the CoC is that in its distribution, the plan cannot differentiate between creditors of the same segment even if it distinguishes different classes of creditors for the purpose of distribution.

EXTENT OF NCLT AND NCLAT’S AUTHORITY VIS-à-VIS RESOLUTION PLAN

As stated earlier, the adjudication authority has a very limited role when a plan approved by the CoC comes before it for approval under Section 31 of the Code. The provisions investing jurisdiction and authority in the NCLAT or NCLAT have not made the commercial decision exercised by the CoC justiciable. Undoubtedly, the remedy of appeal under section 61 of the Code, against any order of the NCLT, including the width of jurisdiction of the NCLAT and the grounds of appeal, is a creature of statute. This position is reinforced from the limited grounds of appeal available against a challenge to an order ‘approving a resolution plan’ under Section 31 being, (i) the approved plan is in contravention of the provisions of any law for the time being in force, (ii) there has been a material irregularity in exercise of powers by the RP, (iii) the debts owed to the operational creditors have not been provided for in the resolution plan in the prescribed manner, (iv) the insolvency resolution plan costs have not been provided for repayment in priority, (v) the resolution plan does not comply with the any other criteria specified by the Board. Thus the jurisdiction bestowed upon the NCLAT is also expressly circumscribed, which is limited to matters ‘other than’ enquiry onto the autonomy or commercial wisdom of the CoC or dissenting financial creditors. 

MINIMUM AMOUNT PAYABLE TO OPERATIONAL CREDITORS

The latest amendment to the Code in August, 2019, clarified the minimum payment that is to be guaranteed to the operational creditors, being not less than the amount to be paid to such creditors in the event of a liquidation of the corporate debtor or not less than the amount that would have been paid to such creditors, if the amount to be distributed under the resolution plan had been distributed in accordance with the order of priority, whichever is higher. Even with the amendment it may so happen that nothing is payable to operational creditors, the minimum liquidation value – which in most cases would amount to nil after secured creditors have been paid – would certainly not balance the interest of all stake holders or maximize the value of assets of a corporate debtor if it becomes impossible to run the corporate debtor as a going concern. In such cases, the CoC in its commercial wisdom has to arrive at a business decision to appropriately pay off the dues of certain operational creditors (Eg. electricity). Thus the decision of the CoC must reflect the fact that it has taken into account maximizing 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.

INEQUALITY BETWEEN CREDITORS: DOES NOT MEAN INEQUITY

The NCLAT in its Judgment had applied an equality principle stating that irrespective of whether creditors are secured or unsecured, financial or operational, they all be treated as one group of similarly situated creditors. However, the objective of equitable treatment is based on the notion that, in collective proceedings, creditors with similar legal rights should be treated fairly, receiving a distribution on their claim in accordance with their relative ranking and interests. This key objective recognizes that all creditors do not need to be treated identically, but in a manner that reflects the different bargains they have struck with the debtor.

Thus arises the need for classification of claims. The Code ensures that all creditors who have the capability and the willingness to restructure their liabilities must be part of the negotiation process. This would include the financial creditors of a given debtor, both secured and unsecured, as they would likely comprise the majority of creditors. On the other hand, the liabilities of all creditors who are not part of the negotiation process must also be met in any negotiated situation. These would include all operational and other creditors, who while not part of the CoC, would certainly need to be considered during distribution in a plan, with the end result of keeping the corporate debtor as a going concern. One of the submissions made by Shri Kapil Sibal, on behalf of Standard Chartered Bank (the unsecured financial creditor), was that reorganization is a collective remedy, designed to find the optimum solution for all parties connected with a business and not solely for the business itself and not solely for its creditors. Another variant on this submission was also made being that financial creditors as a majority and forming the CoC, would trample upon the concerns of minority financial creditors and operational creditors. The Hon’ble Supreme Court in this regard held that undoubtedly, protecting all creditors is an important objective and that protecting creditors from each other is also important. However, reorganization in the Bankruptcy Code should not be read so as to imbue creditors with greater rights in a bankruptcy proceeding than they would enjoy under the general law unless it is to serve some bankruptcy purpose. Assuming for a moment all creditors are treated equally under the Code; such a situation would be completely opposite to if creditors proceeded under general law. Under general law, secured financial creditors would necessarily reign supreme in lieu of their securities. The hypothetical situation where all creditors are treated equally would result in unequals being treated equally.

The importance of valuing security interests separately from the interests of creditors who do not have security is well set out. Security interests reduce credit risk by increasing the creditor’s likelihood to be repaid, not only when payment is due, but also in the event of a default by its debtor. This increased likelihood of repayment produces wider economic benefits. First, the availability of credit is enhanced, borrowers obtain credit in cases where they would have otherwise failed in the absence of a security interest. Secondly, credit is also made available on better terms involving lower interest rates and longer maturity rates. Thus secured creditors are high priority creditors on insolvency. Security must stand up on insolvency which is when it is needed most. Security which is valid between the parties but not as against the creditors of the debtor is futile and a law that de-prioritizes security on insolvency destroys what the law created.

The classification of claims of creditors into financial and operational, secured and unsecured, makes it easier to treat the claims of major creditors and even permit a “cramdown” on dissentient creditors if required. A “cramdown” is an override which allows the court to conclude that a rejecting class should be compelled to accept the plan where the class is paid in strict accordance with the relative priority of creditor claims and will receive under the plan a distribution in an amount equal to or greater than such creditors would receive in a liquidation proceeding. The rationale is that these creditors cannot claim “foul” if their recovery is at least as good as they would have received if they had prevailed in having the enterprise liquidated. Indeed, if an ‘equality for all’ approach recognizing the rights of different classes of creditors as part of an insolvency resolution process is adopted, secured financial creditors will, in many cases, be incentivized to vote for liquidation rather than for resolution as they would have better rights if the corporate debtor was to be liquidated rather than a resolution plan being approved. This would defeat the entire purpose of the Code which is to first ensure resolution of distressed assets and only in its failure, liquidation.

Further reasons for having financial creditors as the decision-makers in the CoC, is that financial creditors are in the business of lending money. They earn profit by earning interest on money lent with low margins. They are capital providers for companies, who in turn are able to purchase assets and provide working capital to enable such companies to run their business operations, whereas operational creditors are beneficiaries of amounts lent by financial creditors which are then used as working capital. Operational creditors often get paid for goods and services provided by them to the corporate debtor, out of such working capital. Even the different exit strategies for each type of creditor allow operational creditors to have an immediate exit option in dealings with a potential debtor. Financial creditors may exit on their long term loans, either upon repayment of the full amount or upon default, by recalling the entire loan facility and/or enforcing the security interest which is a time consuming and lengthy process.

Even the Judgment in Swiss Ribbons Private Limited v. Union of India, reported in 2019 SCC Online SC 73, holds that financial creditors, from the very beginning, are involved with assessing the viability of the corporate debtor. They can, and therefore do, engage in a restructuring of the loan as well as reorganization of the corporate debtor’s business when there is financial stress, which are things operational creditors do not and cannot do. Thus, it is the commercial wisdom of the requisite majority of the CoC which is to negotiate and accept a resolution plan, while ensuring maximum recovery for all creditors, while meeting with the provisions of the Code and the Regulations. This may involve differential payment to different classes of creditors together with negotiating with a prospective resolution applicant for better or different terms.

EXTINGUISHMENT OF CLAIMS

The law in this regard is already settled in the judgment of the Hon’ble Supreme Court in State bank of India v. V. Ramakrishnan, reported in 2018 (9) SCALE 597. This judgment held that suits against the personal guarantors of a corporate debtor after moratorium has come about are maintainable. On the contrary, the judgment of the Hon’ble NCLAT had extinguished the rights of creditors against the guarantees that were extended by the promoters/promoter group of the corporate debtor. The NCLAT had further held that claims existing apart from those decided on merits by the Resolution professional could be decided by an appropriate forum

The Hon’ble Supreme Court relied on Section 31(1) of the Code, making it clear that once a resolution plan is approved by the CoC, it shall be binding on all stakeholders, including guarantors. This is for the reason that this provision ensures that the successful resolution applicant starts running the business of the corporate debtor on a fresh slate. Therefore, it was also held that even with regard to the claims that may exist apart from those decided on merits by the resolution professional or claims that were highly belated, it would be extinguished by a successful resolution plan. It was held that a successful resolution applicant cannot be suddenly faced with “undecided” claims after the resolution plan submitted by him has been accepted as this would amount to a hydra head popping up surprising the resolution applicant with claims beyond his bid. All claims have to be submitted to and decided by the resolution professional so that a prospective resolution applicant knows exactly what has to be paid in order that it may then take over and run the business of the corporate debtor.

CONSTITUTIONAL VALIDITY OF SECTION 4 & 6 OF AMENDING ACT – CAN AN AMENDMENT SPECIFICALLY DO AWAY WITH A JUDGMENT?

The timeline of the amending act has to be noted for the challenge to the constitutional validity to make sense. Soon on the heels of the NCLAT judgment which made no differentiation between financial and operational creditors, secured and unsecured creditors, the amending act of 2019 was passed. The Counsel for Standard Chartered Bank, in whose favor the Judgment of the NCLAT had been passed, contended that the Amending Act of 2019 was tailor-made to do away with the judgment of the NCLAT in this very matter. That being so, it was contended that such legislation would be clearly outside the bounds of the legislature as the legislature cannot interfere with a particular judgment and set it aside.

The Hon’ble Supreme Court held that it cannot be said that the legislature has directly set aside the judgment of the NCLAT vide the amendment. It was held that since an appeal against the judgment of the NCLAT lies to the Supreme Court, the legislature was well within its bounds to lay down a general application to all persons affected, bearing in mind what it considers to be curing of a defective reading of the law by an Appellate Tribunal. It is trite law that bad faith, in the sense of improper motives, cannot be ascribed to a legislature making laws.

Coming to the amendments themselves, with regard to Section 4 of the amending Act, the intent had been to do away with the lagging timelines that had been plaguing the legislature ever since SICA was promulgated. More specifically, the Recovery of Debts Act of 1993 and the SARFAESI Act, 2002 all provided for expeditious determination and timely detection of sickness in industrial companies, yet, legal proceedings under the same dragged on for years as a result of which all these statutory measures proved to be abject failures in resolving stressed assets. The Code originally provided a period of 180 + 90 = 270 days for the corporate insolvency resolution process (“CIRP”). The 2019 amendment made it so that the CIRP for a corporate debtor had to be mandatorily finished within 330 days from the insolvency commencement date, the keyword being 'mandatorily'. Even the legal proceedings with regard to the CIRP would not excluded from this time period. At the end of 330 days, the corporate debtor would be put under liquidation. However, relying on the maxim ‘actus curiae neminem gravabit’ meaning ‘no man should suffer because of the fault of the court’, the Hon’ble Supreme Court struck down the word ‘mandatorily’ from the amendment as being manifestly arbitrary. The Hon’ble Supreme Court found that to include the time taken for legal proceedings in the time period for CIRP as prescribed would be excessive interference with a litigant's fundamental rights under Articles 14 and 19(1)(g). The Court did clarify that it is only in exceptional cases that time can be extended, the general rule being that 330 days is the outer limit within which resolution of the stressed assets must take place.

With regard to Section 6 of the Amending Act, where Section 30(2)(b) of the Code was substituted, it is clear from a reading that the new clause gives operational creditors something more than was given earlier as it is the higher of the figures mentioned in sub-clauses (i) and (ii) of sub-clause (b) that is now to be paid as a minimum amount to operational creditors. Even with regard to dissentient financial creditors, the amendment made it so that a minimum payment was guaranteed to them. Of course, depending on the facts of the case, even with the new amendment, an unsecured financial creditor may end up getting nothing but the provision ensuring minimum payment would see that it was a result of following the provisions of law. In fact, pre-amendment, secured financial creditors may cramdown on unsecured financial creditors who are dissentient, the majority vote of 66% voting to give them nothing or next to nothing.

CONCLUSION

To conclude, the Hon’ble Supreme Court succinctly laid down the classification of creditors as necessary because ‘equitable’ does not mean equal distribution; it means distribution which dies justice to every stakeholder involved in the process. A reiteration of the laws laid down in K. Sashidhar and Swiss Ribbons to resolve all doubts and ensure that the Code resolves all debt.