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Closing the backdoor entry to promoters

Closing the backdoor entry to promoters

The Insolvency and Bankruptcy Code, 2016 (IBC) was enacted to expedite and simplify the framework for insolvency and bankruptcy in the country. The notion of ‘creditor in control’ instead of ‘debtor in possession’ is candidly observed by the Code. However, there persisted grey areas in the code and they served as an impediment in achieving the objective of the Code. One of the lacunae was that there existed no specific provision for submitting a resolution plan. Therefore, anyone was eligible for being a resolution applicant including the errant promoters of the corporate debtor who contributed to the downfall of the company.


To cover this gap, section 29A was inserted in the Code in 2017, which restrained defaulting promoters and their related persons from being a resolution applicants. However, the amendment could not resolve the issue in its entirety as there still prevailed a backdoor entry route available to errant promoters upon failure of the resolution process. As a result of the failure of resolution, the process of the liquidation provided a parachute to promoters through section 230 of the Companies Act. Section 230 permits the promoters or any class of creditors of a company to reach a compromise or arrangement with other stakeholders of the company to take control of the company.


Section 29A of IBC and section 230 of the Companies Act were contradictory in spirit.  Therefore, the Insolvency and Bankruptcy Board of India tried to plug in this loophole by amending the Liquidation Process Regulations, 2016. The amendment clarifies that a person, who is not eligible according to the Code to submit a resolution plan for insolvency resolution of the corporate debtor under section 29A, shall not be a party in any manner to a compromise or arrangement of the corporate debtor under section 230 of the Companies Act, 2013. It also clarifies that a secured creditor cannot sell or transfer an asset, which is subject to the security interest, to any person, who is not eligible under the Code to submit a resolution plan for insolvency resolution of the corporate debtor.


Before the amendment, the Adjudicating Authority passed several decisions wherein it observed that there is nothing under section 52 of the Code to preclude the sale of the secured assets to the ex-promoters of the corporate debtor. However, the amendment is an attempt to change the scenario upside down as the errant promoters will not be able to have the driving seat again even under liquidation.


Interestingly, it appears that the amendment failed to take into consideration certain practical intricacies of the procedure. Firstly, it is obscure whether the promoter, who is not intending to take total control of the company, purchase specific assets of the company under liquidation. Secondly, it is also unclear whether the promoter can come into the picture if there are no resolution applications and no buyers during liquidation. Apart from this, section 29A of the Code prohibits the related person of defaulting promoters from submitting a resolution plan. Thus, even a related person that has parted decades back from the promoters and is successfully running an independent business will be barred from entering into any compromise or arrangement for the purchase of assets under liquidation as section 29A disallows it. Such a bar appears to be unjust and it seems that the Section is being stretched too far. Therefore, more clarity is needed on the issue.


Moreover, the amendment has failed to serve the last blow, and the ex-promoters' game is not over yet. It is pertinent here to take into consideration the case of Sterling Biotech wherein the defaulting promoters of the debt-ridden corporate debtor were allowed to take back the control. A one-time settlement offer was proposed by the promoters to the creditors when the CIRP was going on. The offer got a green signal from the committee of creditors. This led to the withdrawal of the application as per section 12A of IBC. The NCLT disallowed withdrawal of application vide order dated 28.08.2019 whereas the Appellate Tribunal reversed the order of NCLT vide its order dated 8.5.2019. However, the ruling of Hon’ble NCLAT was criticized immensely as it failed to take into consideration that the one-time settlement offer was akin to a resolution plan as it exposed creditors to deep haircuts. It allowed the promoters to have the last laugh by gaining control of the company again.


For now, there is no bar for the promoters from proposing any such settlement offer when the CIRP is ongoing. Therefore, it will be interesting to observe the standpoint of Adjudicating Authority in similar cases hereafter.


The Supreme Court has ruled that promoters of insolvent companies, which are barred from bidding for their own companies under section 29A of the Insolvency and Bankruptcy Code (IBC) cannot use any scheme or arrangement to gain control of their company even if it goes into liquidation.


The conundrum on whether section 29A of the IBC, 2016 will apply over the schemes which are mentioned under section 230 of the companies Act, 2013, which has been put to an end by the recent ruling of the Hon'ble Supreme Court in Arun Kumar Jagatramka v. Jindal Steel and Power Limited, REED 2021 SC 03546, has closed the back-door entry of defaulting promoters by using a special provision of compromise or arrangement during the liquidation phase of the insolvency proceeding.


In a case involving the liquidation of Gujarat NRE Coke Limited, the National Company Law Appellate Tribunal (NCLAT) had in 2019 held that any person who was ineligible, under section 29A of IBC, to bid for his company, was also barred from proposing a scheme of compromise and arrangement under section 230 of the Companies Act.


Section 230 of the Companies Act allows promoters or creditors of the company to propose a scheme of arrangement or compromise under which the debt of the company can be restructured.

In its judgment upholding the NCLAT decision, the apex court said that while section 230 would be applicable for promoters and creditors in the normal course of the workings of the company, it would not be applicable if the company is facing liquidation under IBC.


“The company has to be protected from its management and corporate death. It would lead to a manifest absurdity if the very persons who are ineligible for submitting a resolution plan, participating in the sale of assets of the company in liquidation or participating in the sale of the corporate debtor as a ‘going concern’, are somehow permitted to propose a compromise or arrangement under Section 230 of the Act of 2013,” a two-judge Bench of Justices D. Y. Chandrachud and M. R. Shah said.


The matter In a case involving the liquidation of a Limited Company, the National Company Law Appellate Tribunal (NCLAT) in 2019 held that any person who was ineligible, under section 29A of Insolvency and Bankruptcy Code (IBC), to bid for his company, was also barred from proposing a scheme of compromise and arrangement under section 230 of the Companies Act 2013. The Companies Act 2013 is an Indian company law that regulates the incorporation of a company, responsibilities of a company, directors, dissolution of a company. Company means a company incorporated under this Act or any previous Company Law. section 230 of the Companies Act allows promoters or creditors of the company to propose a scheme of arrangement or compromise under which the debt of the company can be restructured. In this matter, the Supreme Court upheld NCLAT’s decision and said that while section 230 would be applicable for promoters and creditors in the normal course of the workings of the company, it would not be applicable if the company is facing liquidation under IB because the company has to be protected from its management and corporate death. It would lead to a manifest absurdity if the very persons who are ineligible for submitting a resolution plan, participating in the sale of assets of the company in liquidation or participating in the sale of the corporate debtor as a ‘going concern’, are somehow permitted to propose a compromise or arrangement under section 230 of Companies Act 2013.


The clarification by the Supreme Court for the participation of promoters in the liquidation process of an insolvent company will speed up the resolution process.


Since the objective of the IBC is to find a suitable buyer for the company and liquidation is ordered only in cases where there are no viable plans submitted, experts believe that a quick liquidation is of utmost importance to maximise the value of assets of the company.


In addition, The National Company Law Tribunal (NCLT), Mumbai Bench has recently provided a new twist to the already labyrinthine insolvency proceedings of the DHFL Group. The NCLT ordered the Committee of Creditors (CoC) to consider the resolution plan submitted by Mr. Kapil Wadhawan, who is the promoter and erstwhile director of the DHFL Group, and to vote on merits. This decision of the NCLT comes at a stage where the CoC, after vetting through multiple resolution plans and manoeuvring through prolonged delays and litigation, has by a majority decided to accept the plan submitted by Piramal Group, the largest bidder. This order has provoked discourse on the applicability of section 29A of IBC even though it has been presently stayed by the NCLAT, till the disposal of the appeal.


Being a non-banking financial company, the DHFL Group was referred to insolvency by the Reserve Bank of India (RBI) under section 227 read with section 239(2)(zk) of the Insolvency and Bankruptcy Code, 2016 (IBC) in 2019. Subsequently, as the corporate insolvency resolution process (CIRP) was initiated, bids were invited from prospective buyers. During this process, Mr. Wadhawan also submitted his bid. However, the CoC rejected it, stating a lack of credibility and evidence that he may not comply with the plan.


The CoC decided to accept the bid of the Piramal Group and present it for authorization of the adjudicating authority. At this subsequent stage, Mr. Wadhawan filed an interim application stating that he is willing to pay all the dues of small and retail investors. Also, his new plan offers to pay substantially higher than the selected bidder, and hence, he asserted that his plan must be considered before the CoC. To substantiate his application, he further stated that he submitted his plan earlier to the resolution professional; however, the plan never reached the desk of CoC for consideration. The adjudicating authority accepted his application and argued that the CoC must consider his plan on the vote on merits. The authority further argued that his plan can be regarded as a “one-time settlement”.


Appositely, a quintessential question that arises for consideration is whether such an order is legal and stands the test of section 29A of IBC? Moreover, should the NCLT have interfered with the commercial wisdom of the CoC at the closing stage of the CIRP? This post aims to analyse these issues and highlight that the order of the NCLT is misplaced.


Jurisprudence and rationale behind section 29A can be understood as Section 29A was inserted in the IBC through an amendment in 2017. The provision lays down the eligibility criteria for a resolution applicant and closes the door for delinquent or derelict applicants who have no intention to abide by the resolution plan they submit. The non-eligibility criteria include wilful defaulters under the directions of the RBI, persons prohibited from participating in the security market or trading in securities by SEBI, undischarged insolvents, persons disqualified to be a director under the Companies Act, 2013, amongst others.


Section 29A, as interpreted by the Supreme Court in Chitra Sharma v. Union of India, REED 2018 SC 08562, was introduced to “ensure that amongst others, persons responsible for the insolvency of the Corporate Debtor do not participate in the resolution process.”  The Supreme Court opined that the provision is in larger public interest with intent to facilitate effective corporate governance and to avoid any backdoor entry of the erstwhile management who has led the corporate entity into its distressed situation and have no intention to revive the company.


Following from this jurisprudence, the NCLT Kolkata in RBL Bank Limited v. MBL Infrastructure Limited, CP(IB) No. 170/KB/2017 rendered a flexible interpretation to the provision. The NCLT noted that the provision does not bar all promoters and directors from filing a resolution plan or participating in CIRP. The aim and objective of the provision are to only prohibit such persons, “who on account of their antecedents may adversely impact the credibility of process under the IB Code.” Thus, the provision does not squarely apply to all promoters of the entity undergoing CIRP.


The NCLAT affirmed this stance in Sreeram E. Techno School Private Limited v. Beans and More Hospitality Private Limited, Company Appeal (AT) (Insolvency) No. 936 of 2019. It observed that the provision does not apply to all promoters. It is pertinent for the adjudicating authority to discern, first, whether the directors or promoters of the company are barred by the conditions mentioned in the provision; secondly, whether the resolution plan submitted by them is under section 30 of the IBC, and; thirdly, whether a majority of the creditors under the IBC agrees with the resolution plan submitted by such person. If all these three conditions are met, the promoter will not be barred by section 29A of the IBC.


However, conversely, in the present case, SEBI has disqualified Mr. Wadhawan from dealing in securities, which is a ground of disqualification in terms of section 29A(f). Thus, he is ineligible to propose a resolution plan. In addition to this, multiple criminal and civil cases are pending against him, although decisions are yet pending. The NCLT’s directions to the CoC to consider and vote on his resolution plan frustrate the objective of the provision, and are in contravention of jurisprudence laid down by the Supreme Court and the NCLAT.


By interjecting at the concluding stage of the CIRP, the NCLT’s stance has led to unwarranted uncertainty. The NCLT has placed excessive faith in the intention of the plan submitted by Mr. Wadhawan instead of weighing it against the law and the decision of the CoC. The judgement not only violates section 29A of the IBC but also contradicts various judicial pronouncements. In light of the same, the order of the NCLAT is misplaced and sets a contentious precedent. It can encourage the promotors and erstwhile directors to take a backdoor entry to regain the control of the corporate entity at the expense of the creditors, which was never the intention of the legislature. Thus, the order violates the basic tenets of the IBC.


In the matter of in Arun Kumar Jagatramka v. Jindal Steel and Power Limited, there were several significances of judgment such as: Firstly, the most important significance of the judgment shall be the speed of the resolution, as the clarification by the Supreme Court for the participation of promoters in the liquidation process of an insolvent company will speed up the corporate insolvency resolution process. Secondly, Since the objective of the IBC is to find a suitable buyer for the company and liquidation is ordered only in cases where there are no viable plans submitted, experts believe that a quick liquidation is of utmost importance to maximise the value of assets of the company. Thirdly, It settles down the conflicting judgments given by different benches of the NCLT, wherein these forums had, to follow the IBC’s principle of the value of asset maximisation, allowed some of the promoters to re-bid for the company or propose some arrangement when it was sent to liquidation.

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