Creditor in Control vs. Debtor in Possession – An Evaluation and Exploration of their Efficiency
Sudhanva Bharadwaj
4th year law student, B.A. LL.B. (Hons.), Jindal Global Law School
Abstract
The debate surrounding whether legal systems of insolvency should be based on the creditor-in-control model or the debtor-in-possession model has been a central part of jurisprudence and academic discussion for decades, and the effects of this debate can be seen in numerous matters of policy even today. With this in mind, this article looks to explore and assess the two systems, focusing largely on India and the USA.
Introduction
Economic failure is a natural and inherent part of business, and it is the state’s responsibility to create a legal system to address such situations. This is where insolvency and bankruptcy laws come into play. Almost all nations will have such a set of rules in place to address such concerns, but the manner they do so will often differ significantly. One of the central bases for distinction between various systems of insolvency laws is whether they implement a creditor-in-control (CiC) model or a debtor-in-possession (DiP) model. The implementation of one model over the other will significantly impact the nature and success of insolvency processes in a country. India has implemented a CiC model with the passing of the Insolvency and Bankruptcy Code, 2016, (IBC). However, many countries, namely the USA, still follow a DiP model. With this in mind, this essay will look to compare the two models and evaluate which of the two seems to be more effective in its approach to insolvency, specifically as it pertains to their implementation in the USA and India.
The CiC Model
The CiC model refers to a model of insolvency in which the management in control of the company at the time of the default is ousted, and in its place, the creditors take over.[1] They generally have the freedom to act in any manner that they deem appropriate to ensure the recovery of any/all debts owed to them. This was likely to give the creditors more power and/or authority over the recovery of the amount due, which will also help prevent any potential delays and largely avoid the creditors being prejudiced against.
India is one of the many nations that has adopted the CiC model. In India, the CiC model manifests itself mainly through the implementation of a Committee of Creditors (CoC) under Section 21 of the IBC, which is simply a group of all the financial creditors of the corporate debtor. The CoC replaces the previous management and they, along with the interim resolution professional, are given control of the company for the duration of the resolution process with the interim resolution professional being given “powers of management of the affairs of the corporate debtor … under sections 17, 18, 20, 23 and 25 of the Code.”[2] However, the appointment of such resolution professional is subject to the approval of the CoC.[3]
Under the IBC, the CoC have been given wide and immense power, including but not limited to those aforementioned. In the landmark case of Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta & Ors.,[4] it was held that the authority and expertise of the CoC in matters pertaining to the Corporate Insolvency Resolution Process (CIRP) are to be considered supreme. The role of the judicial authorities is limited to assessing whether the plan of the CoC is feasible and viable, and to ensure that the law and due process has been complied with. Other cases which have upheld and expanded the same include Edelweiss Asset Reconstruction Company Ltd. v. Mohit Goyal,[5] and Venus India Asset-Finance Pvt. Ltd. v. Suresh Kumar Jain,[6] which held that even the resolution professional is to be approved by the CoC before engaging with his responsibilities.
The DiP Model
The DiP model is, in essence, a system where the debtor still retains control over the company and any/all of its assets and business operations even while it is in default, but under the legal status of a “debtor-in-possession.” India previously followed the DiP model before the IBC was passed but, as discussed earlier, this has now changed to the CiC mode. Currently, one of the most notable examples of a nation which follows the DiP system is the USA.
In the USA, when a default occurs, one of the central remedies is filing for a Chapter 11 bankruptcy under the U.S. Bankruptcy Code.[7] Bankruptcy filed under Chapter 11 involves a reorganization of the company, its debts, and its assets in a manner which may allow it to pay off its dues. Under this chapter, the debtor retains possession of all assets, operations, etc. of the business and continues to be in charge as a “debtor-in-possession.” In essence this DiP will continue to manage the affairs of the business as before. As observed in Commodity Futures Trading Commission v. Weintraub,[8] this power has been given to the DiP on the premise that “the officers and managing employees can be depended upon to carry out the fiduciary responsibilities of a trustee.”[9] However, if it is found that there has been any dishonesty, fraud, or gross incompetence on the part of the DiP will the court put in place a trustee to oversee the company and the insolvency resolution process.
While the DiP does have the power to manage the operations and assets of the business as before, it will need to receive permission/approval from the court for any substantial asset sales.[10] It must also be mentioned that, for the first few months, only the DiP can propose a resolution plan, but after this period the creditors may also do so. Regardless, any/all proposed resolution plans must be approved by a majority of creditors (two-thirds in each class).[11]
Comparison and Analysis
To begin with, one of the main criticisms of the DiP model, and one of the main reasons why it failed in India, is because the DiP model gave too much authority to the existing management, which often meant that the schemes proposed, and the resolution of the insolvency process, was immensely delayed or simply failed. As pointed out in the case of Innoventive Industries Ltd. v. ICICI Bank,[12] the framework for bankruptcy previous to the enactment of the IBC was “inadequate, ineffective” and resulted in “undue delays in resolution,”[13] and one of the major contributing factors to this inefficiency was the fact that the old framework used a DiP system, which meant that debtors could act in a manner which would potentially go against the interests of the creditors while also delaying the process. This issue was largely resolved with the implementation of the CiC model. With the CiC model, the creditors are, in essence, the masters of their own fate, proposing and implementing plans for the resolution of the insolvency process on their own. This is largely reflected by the drastic improvement in the ease of doing business in India between 2015, before the IBC was enacted, and 2020, at which time the IBC had been in effect for a few years. In 2015, India was ranked 142 by the World Bank in their Doing Business reports, but by 2020, this had improved significantly, with India rising to the rank of 63.[14] Clearly, the change in framework had an immense impact, and this is in no small part thanks to the fact that the previous DiP model was replaced with a CiC model, which leads one to the conclusion that the CiC model is clearly more effective than the DiP model in resolving insolvency matters.
However, when one looks at the World Bank’s archives on Doing Business, it can be seen that India, who has a CiC model, still has a significantly lower Resolving Insolvency Score and Recovery Rate than the USA, who follow a DiP model.[15] While India has a Resolving Insolvency Score and Recovery Rate of 62 and 71.6 respectively, the USA has notably higher score in both criteria, boasting a Resolving Insolvency Score of 90.5 and a Recovery Rate of 81.[16] Therefore, clearly the issue which existed with India’s framework prior to the IBC was not solely due to the use of the DiP model, rather it may be more to do with the manner of implementation of the same, as well as the overall framework within which it operated. The USA still uses the DiP model and, based on the statistics aforementioned, it seems to be much more successful. Therefore, it cannot be said that the DiP model is inherently less effective than the CiC model.
This may be explained by looking at the fundamental theoretical basis of the two systems, that is, the two nations’ implementation of the proceduralist and/or traditionalist theories. The proceduralist and traditionalist schools of thought are the two foundational theoretical bases for almost all insolvency systems. Simply put, the proceduralist school of thought takes a strict position on insolvency, saying that in cases of insolvency, only creditors whose credit has become due should be involved in the process. They further believe that, when a company goes insolvent, there is no reason to try and revive or extend the life of the company. As per the proceduralist school, the role of the law should simply be to ensure no premature liquidation takes place, and should not even concern itself with equal distribution. On the other hand, the traditionalist school of thought believes that the main purpose of insolvency should be to revive and rescue the company, and that the reorganization of the company should be done in a manner which is fair and equitable to all stakeholders. While the former school may be condemned for being cold and unfair, the latter may be criticized for being a longer, more drawn out and expensive process.
With this said, while India implements both theories to some degree, the USA takes a largely proceduralist approach. The absolute priority rule, which is heavily favoured by the proceduralist school of thought, is a central facet of American bankruptcy laws, specifically Chapter 11.[17] The aforementioned rule says that, over and above equal distribution, the main objective should be to pay the dues in full to the creditors with the highest priority. This essentially means that secured creditors will be placed much higher in the hierarchy than unsecured creditors, and their dues will be paid in full before the dues of the unsecured creditors are addressed at all.[18] By contrast, India takes a mixed approach. The implementation of the CiC model and the view that the knowledge and expertise of the CiC is to be considered supreme is one which is heavily associated with the proceduralist view, but the overall approach and objective of the India system, that is, trying to save failing businesses, as well as trying to pay employees and other such parties, is one which is purely traditionalist in nature.[19] With this said, the varying approaches in the two nations can be used, to some degree, to explain why the DiP system works so efficiently in the USA, while the CiC system seems less efficient in India.
To begin with, the very fact that the USA’s proceduralist approach does not look to revive companies will make it an inherently faster and more efficient system than that of India. This is reflected by the fact that, as per the World Bank Doing Business archives, India’s resolution process takes generally around 1.6 years, while the USA’s resolution process is usually resolved in 1 year.[20] It takes time to try and come up with a resolution plan which will do justice to all stakeholders while trying to revive the company, making it a much longer and less efficient process than simply liquidating assets and distributing them based on creditors’ priority. This may also be why the recovery rate is much lower, as discussed earlier.[21] However, the trade-off is that the American system is much less equitable, and while it may seem more efficient or effective at first glance, the combination of a DiP and a proceduralist approach under Chapter 11 will make the process more unfair and mechanical, and most stakeholders may potentially end up receiving little or no money which may have been due to them. Therefore, while the numbers may reflect otherwise, it seems that, based on the nature of the two systems, a company and its stakeholders would, by large, benefit more from the Indian system rather than the American one.
Conclusion
To conclude, the question of whether the CiC model or the DiP model is more effective does not have a straightforward or black-and-white answer, it all comes down to the manner in which the model is implemented and utilized. While both models have some inherent disadvantages, if the legal system within which this model is implemented is framed in a manner in which the negative effects arising from the model in question can be nullified or mitigated as far as possible, then it is not necessary that one is inherently more effective than another. This can be seen by the fact that the DiP model was significantly less effective in India prior to the implementation of the IBC, but the DiP model in the USA has seen more success than the CiC model in India. Therefore, it can be said that, rather than one model being more effective than another, it all comes down to how the model is implemented by the nation in question.
References:
[1] Ashwin Bishnoi, Diwakar Maheshwari, and Kumar Saurabh Singh, ‘India Steps into a New Era for Corporate Rescue and Insolvency’ [2017] PL (CL) February 74, 76.
[2] In Re Ajay Gupta (2020) ibclaw.in 05 IBBI
[3] In Re Ajay Gupta (2020) ibclaw.in 05 IBBI
[4] Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta & Ors.(2019) ibclaw.in 07 SC
[5] Edelweiss Asset Reconstruction Company Ltd. v. Mohit Goyal (2022) ibclaw.in 897 NCLAT
[6] Venus India Asset-Finance Pvt. Ltd. v. Suresh Kumar Jain (2023) ibclaw.in 121 NCLAT
[7] United States Code Title 11– BANKRUPTCY 2015
[8] Commodity Futures Trading Commission v. Weintraub [1985] 471 U.S. 343
[9] Commodity Futures Trading Commission v. Weintraub [1985] 471 U.S. 343
[10] Gerard McCormack, ‘Corporate Rescue Law In Singapore and Tha Ppropriateness Of Chapter 11 of The Us Bankruptcy Code As A Model’ [2008] 20 SAcLJ 396, 408-409
[11] Gerard McCormack, ‘Control and Corporate Rescue: An Anglo-American Evaluation’ 56 The International and Comparative Law Quarterly 515, 518
[12] Innoventive Industries Ltd. v. ICICI Bank (2017) ibclaw.in 02 SC
[13] Innoventive Industries Ltd. v. ICICI Bank (2017) ibclaw.in 02 SC
[14] Sparsha Pavan and Sidharth S, ‘Shift in paradigm –Debtor in possession to Creditor in control’ (IBClaw, 28 February 2024)
[15] World Bank Group, ‘Resolving Insolvency’ (World Bank Group Doing Business Archive, May 2019) <https://archive.doingbusiness.org/en/data/exploretopics/resolving-insolvency> Accessed 13 September 2024
[16] World Bank Group, ‘Resolving Insolvency’ (World Bank Group Doing Business Archive, May 2019) <https://archive.doingbusiness.org/en/data/exploretopics/resolving-insolvency> Accessed 13 September 2024
[17] David Polk and Wardwell LLP, ‘In review: insolvency law, policy and procedure in USA’ (Lexology, 4 October 2023) <https://www.lexology.com/library/detail.aspx?g=42bce79e-f32b-4e82-b497-d4ca3d28ff23> Accessed 13 September 2024
[18] David Polk and Wardwell LLP, ‘In review: insolvency law, policy and procedure in USA’ (Lexology, 4 October 2023) <https://www.lexology.com/library/detail.aspx?g=42bce79e-f32b-4e82-b497-d4ca3d28ff23> Accessed 13 September 2024
[19] Medha Shekar and Anuradha Guru, ‘Theoretical Framework of Insolvency Law’ (IBBI, 2020) <https://ibbi.gov.in/uploads/resources/158497d3735f154918648288e56dfebc.pdf> Accessed 13 September 2024
[20] World Bank Group, ‘Resolving Insolvency’ (World Bank Group Doing Business Archive, May 2019) <https://archive.doingbusiness.org/en/data/exploretopics/resolving-insolvency> Accessed September 13 2024
[21] World Bank Group, ‘Resolving Insolvency’ (World Bank Group Doing Business Archive, May 2019) <https://archive.doingbusiness.org/en/data/exploretopics/resolving-insolvency> Accessed September 13 2024
