Grafting the impact on Corporate Governance in the aftermath of CIRP by the application of Insolvency and Bankruptcy Code, 2016 – By Satyaki Paul and Chandril Chattopadhyay 

Grafting the impact on Corporate Governance in the aftermath of CIRP by the application of Insolvency and Bankruptcy Code, 2016

By Satyaki Paul, George School of Law, Konnagar, West Bengal and Chandril Chattopadhyay, University of Burdwan, Burdwan, West Bengal

INTRODUCTION

In today’s world of massively competitive and changing markets, insolvency stands as important pointers for the conduct of business transactions. Just as right to Entry or to start a business, right to Compete or continue the business are important, the right to Exit is a necessary aspect in the business as well. The Insolvency and Bankruptcy Code (IBC) of 2016 created the right exit conditions conducive for the inefficient businesses to vacate the place and create a chance for new businesses, thereby creating a model of greater economic upscaling. But this came with sizable criticisms, often pertaining to the stringent   application on the eligibility criteria   for the Resolution Applicant (RA). This article critically analyses the importance of the Section-29A in IBC and puts an aerial map of the problems faced by the corporate businesses of the country and its impact on corporate governance thereby. The IDBI Bank-C Sivasankaran loan settlement case sets the precedent to the logical failure of Section 29A. Sivasankarsan paid a One Time Settlement amount of Rs.500 crore to the banks against a loan of   Rs 5,000 crore. The promoter’s bid to regain the control of the company has resulted in the failure of Section 29-A as has been told by industry experts. Other cases like Wadhawan-DHFL case also questions such a provision and hence shall be discussed in this article

The English Philosopher Herbert Spencer coined the phrase “Survival of the fittest” [1] based on the “Origin of Species by Means of Natural Selection, or the Preservation of Favoured Races in the Struggle for Life” that was propounded by Charles Darwin. Spencer related his economic theory with this Darwinian concept to bring into force the idea of Social Darwinism. The aspect of economy is simple, the fittest will survive and the weakest will be weeded out. This is exactly what happens in cases of companies and businesses as well.  According to K. Saran, insolvency refers to a state of being insolvent or in a situation of distress [2] which makes a company unable to confront its debts.

JC Holt sees the introduction of the Insolvency Law as the Magna Carta of 1915 which had the clause, “If, for lack of means, the debtor is unable to discharge his debt, his sureties shall be answerable for it. If they so desire, they may have the debtor’s lands and rents until they have received satisfaction for the debt that they paid for him, unless the debtor can show that he has settled his obligations to them.” [3]

SCHOOLS OF INSOLVENCY LAW

There are two operational schools of Corporate Insolvency Law namely the Traditionalist and the Proceduralist perspectives. These two schools of theories were first illustrated by Douglas G. Baird [4] in 1998. In accordance with the Traditionalist principles, the going concern value and the preservation value of the company should be the main concern, hence saving the company from the distressed position is the essential duty of the Insolvency Law. Whereas the Proceduralists say that the life and death of a company should be determined by their market popularity and the law should not work for the already sick company rather it should focus on premature liquidation of the company [5].  

The Insolvency and Bankruptcy code was enacted by the Indian Parliament on May 28, 2016. The code was the brainchild of the then Union Finance Minister and Senior Advocate of the Supreme Court of India, Late Mr. Arun Jaitley. For all the innumerable problems regarding the liquidation and insolvency, this law catered to all the answers under one roof. The objectives behind introduction of IBC are as follows:

1. Ease in doing business.
2. More securities to the Banks and ARC (Assets Reconstruction Company).
3. Make the locked-up Assets free.
4. Growth in the business and investments.
5. Improvement in the Corporate Bond Market.

The Insolvency and Bankruptcy Code (IBC) is the one stop solution for resolving the insolvency cases and giving security to the corporate debtor. The code features a time bound process because the problems orienting with the insolvency are massively complicated and in the past the resolution used to take years and years. IBC is a comprehensive law comprising companies, partnership firms, individuals and many more. The law also promotes entrepreneurship, availability of credit by safeguarding the business environment. It’s a path breaking law which has its effect into resolving financial distress of a company while balancing the interests of all the stakeholders by making sure of generating maximum value to the parties that too in a time bound manner. Prior to IBC there were no laws regarding insolvency.

Section 29A stands as the most talked about part of the IBC. It quickly became the most controversial Section under the law when it was inserted with retrospective effect from November 23, 2017 as it was seen as a solution to the various problems in Corporate Insolvency. The code originally did not have any provisions to prevent defaulting promoters from getting back the corporate debtor, which could occur potentially at steep discounts. Earlier than the 2018 amendment to the code, “any person” was eligible to submit a resolution plan to the resolution professional. This frankly made the code massively vulnerable and opened gates for the defaulting promoters to get a wild card entry back to the top management.

When a company makes huge defaults, makes continuous losses, cannot meet with the expenses, does not have enough resources to pay its employees then the corporate is said to become insolvent and that point of time it demands an experienced and well strategized plan of action to get it out of the probable bankruptcy. To save the corporation from becoming bankrupt and create a safer business environment the Insolvency and Bankruptcy Code was legislated. It made a process which involves restructuring, changing of committees, amalgamations of strategies, amending of goals and challenges, mergers and acquisition, necessary liquidation of assets, getting financial assistance for maximizing the value of assets and saving the financially distressed debtors from the corporate creditors and resolving everything in a time bound manner.

The liquidation of the corporate debtor is to be viewed by using the similar section of Section 35(1) (f) of the IBC. The restrictions here shall be applicable while the Section 230 of the Act will enable the corporate debtor to revive given Section 230 has wider implications. So only the stage of liquidation must be taken into cognizance as has been

Regulation 2B (1) of the Liquidation Regulations must also be viewed in response to Section 29A as it makes the restrictions and disqualifications in Section 29-A available to Section 230, thereby bringing in the answer to why the Section 29-A was anyway introduced in the first place.

A BRIEF INSIGHT INTO CORPORATE DEATHS

It takes a massive amount of time and effort in making a successful corporation. Corporate governance is basically the internal control of the policy and procedures, the strategies and networks which creates the dealings with various stakeholders which in result creates a good relationship between the customers, employees and industry bodies. The main infrastructure associated with running a successful company is what successful corporate governance stands for. It increases and protects the valuation of a company which in turn creates more shareholder interest. When a corporation goes into a state of massive loss, the governance is the main thing which becomes questionable while their efficiency is doubted. One must look at the red flags in failures in governance from beforehand.

Essential lack in proper Corporate Governance Structuring has been recorded in the case where RBI took control over the YES Bank in 2020 due to absence of a credible revival plan [6] in the interest of YES Bank’s creditors. The German automobile manufacturing giant Volkswagen in September of 2015 faced a major crisis [7] known as the “Diesel dupe” associated with their emission test results which lead them into a staggering $18 billion fine as damage and lost its share value by 30 per cent, several studies showed and criticized the highly autocratic style of corporate governance carried on by the company which lead it to bad decision making and lack of transparency in manufacture. [8]

The case of  Bhushan Power and Steel [9]  which was founded in 1970 and became one of the topmost steel manufacturing companies in India. Years of diligence went into failure when massive amounts of money were borrowed for expansion and couldn’t be afforded to repay later. The company became irregular in its payment of interest. The debt of the company rose from 35,710 Crores in 2014 to 46,062 Crores in 2016. Apparently, it was found that the money has been diverted into more than 200 shell companies. Later the result was the company being auctioned and sold to Tata Steel.

THE PROCESS OF RESTRUCTURING

When the corporation falls into a distressed position, it tries to save itself first from the creditors and the lenders. With a lack of revival plans the corporation then fills up the Insolvency and Bankruptcy application under the Insolvency and Bankruptcy Code in the National Company Law Tribunal and goes into a process of restructuring.  A committee of creditors is formed and then starts the due process of restructuring. The time frame for completion of resolution for companies is 180 days (extendable by 90 days as per mutual agreement). In exceptional cases, the time frame may be extended at the discretion of the tribunal to the outer limit of 330 days. The time limit for start-ups or micro-enterprises with revenue of less than Rupees 1 crore is 90 days (extendable by 45 days). Failure to achieve resolution or recovery within the stipulated time limit pushes the defaulter into liquidation. The proceedings are regulated and overseen by the Insolvency and Bankruptcy Board of India (IBBI). The management of assets of the debtors and a suitable decision making is governed by an Insolvency Professional who is appointed by the IBBI. Under IBC both Creditors and debtors submit resolution and this is precisely where Section 29A of the Insolvency and Bankruptcy Code comes in.

Section 29A provides an extensive disqualification criterion for resolution applicants. This is done not to curtail the business but to make the scenario safer for the corporate debtor and the creditor and also to resolve the process quickly. A Resolution Applicant is a person who jointly with any other person or individually submits a resolution plan to a resolution professional upon his/her invitation for the resolution. Before 29A there were no such specified criteria in terms of resolution applicants, hence many times the control fell back to the very people from whom the recovery was to be made. So, the persons due to whose misconduct, fraudulent motive the default took place can regain the control of the company by bidding in massive discounts while banks and financial institutes face massive haircuts. Section 29A provides restrictions to the incumbent management to further work on the recovery of the company. It restricts those people who might have an adverse effect on the entire corporate insolvency resolution process. It not only prevents the promoters or directors but even the people who are related to them.

The ineligibility of the corporate debtor can in basic terms be divided into 4 aspects the first one is,

1. The debtor himself
2. Persons connected with the debtors, the third one consists of
3. Related party to those connected persons and the fourth and final one contains
4. Persons acting with concert to either with the first aspect, second aspect or third aspect; people having a hand in the debtor’s business

So, it can be understood the wide ambit of restriction this code has been able to provide through this particular section. It not only prevented the person ineligible but it went further to prevent the party related, the connected party and everyone associated with that. Persons falling under the given criteria of 29A shall be prevented from submitting a resolution plan. Through the restriction it curtails the future risks which could’ve been caused by the adverse applicants due to whom the company has already made massive default.

EXPLANATION OF SECTION 29-A AND ITS CLAUSES

Clause (c): The point regarding the NPA

This clause contains provisions in accordance with any person or a person acting jointly with such a person who has an account declared and classified as an NPA under Reserve Bank of India itself is ineligible to submit a resolution plan.

Clause (d): Disqualification on account of criminal convictions

This clause contains the disqualification element of an applicant or its connected persons who are imprisoned for more than two years due to a conviction for an offense. But a subsequent amendment added that the imprisonment will only be a bar on the eligibility if the said conviction pertains to the added   XII Schedule to the Insolvency and Bankruptcy Code containing over 25 laws.

Clause (g): Vulnerable transactions

This clause states that if a person has been a promoter or in the management or control of a corporate debtor where a preferential transaction, undervalued transaction, extortionate credit transaction or fraudulent transaction has taken place and the deciding body passed an order within the ambit of the code.

Clause (h): Execution of guarantee by the Guarantor in favour of the Applicant Creditor

Person executing a guarantee in favour of a creditor in respect of a corporate debtor against whom an application of insolvency   resolution has already been made by such creditor under this code.

Clause (j): Connected persons

Person having connection with an already ineligible person. Connected person [10] means:

Clause (i) contains any person who is the

• Promoter or
• Is in the management or
• Control of the resolution applicant

Clause (ii) bans resolution plans which envisage the already ineligible would-be promoters. Clause (iii) contains that the holding, the subsidiary and the associate companies of an ineligible entity are disqualified.

CONCLUSION

29A has largely been controversial for its stringent application. The section has given rise to the Resolution Applicants challenging each other’s eligibility to put forward the resolution plan, due to the decrease in number of third-party bidders for assets during the pandemic the stringent applicability of this section was eased. At this point of time due to the pandemic and still worsening situation, the businesses are still at a recovery phase. Hence, not to give governance to the most experienced promoters in the business sector seemed unjust and against the main motive and identity of IBC.

The initiation of the insolvency process is often not in conformity with the principles of natural justice. The case of Sree Metaliks Ltd. v. Union of India [11], W.P. No. 7144 (W) of 2017 is important to be discussed here as the constitutionality of Section 7 was challenged on the ground that the provision does not provide the opportunity to the corporate debtor to be heard before initiating an insolvency resolution process. The case of Akshay Jhunjhunwala and Anr. v. Union of India [12] , W.P. No. 672 of 2017 where the validity of Sections 7,8 and 9 was challenged. The argument was on the basis of irrationality on the differentiation between the operational and financial creditors. There was significant distinction between how they are treated through the code for the same resolution process. The Calcutta High Court relied on the report of the Bankruptcy Law Reforms Committee, wherein the Committee had stated that, “The Committee reasoned that member of the creditors committee have to be creditors both with the capability to access viability, as well as to be willing to modify terms of existing liabilities in negotiations. Typically, operational creditors are neither able to decide on matters regarding the insolvency of the entity, nor willing to take the risk of postponing payments for better future prospects for the entity. The Committee concluded that, for the process to be rapid and efficient, the Code will provide that the creditors committee should be restricted to only the financial creditors.” The most important case regarding the Constitutional validity of IBC is probably the case of Swiss Ribbons Pvt Ltd. v Union of India [13], W.P. No. 37 of 2019.

Since the enactment of the code, innumerable changes have been made in order to ease the resolution process. The bench of Hon’ble Justices   RF Nariman and Navin Sinha of the Supreme Court in a landmark judgment upheld the Constitutional validity of the code. Especially regarding the eligibility criteria set by the Section- 29A the bench made the remark [14] “If the blind lead the blind, both shall fall into the ditch”.  A person unable to manage his/her owns debt is absolutely ineligible to be a Resolution Applicant (RP) furthermore gets the power to manage the company itself.

If corporate governance is the base of a company, then insolvency and restructuring can be defined as the second chance to a loss-making company. In 2019, MS Sahoo, the then Chairperson of Insolvency and Bankruptcy Board of India (IBBI) stated that the Insolvency and Bankruptcy Code has saved 160 companies from premature deaths [15]. The code has a direct impact on the growth of the Indian economy.

But the times have changed and the recent studies show something very different. Many examples can be seen which create massive doubt on the resolution power of the IBC. According to a report [16], “a total of 4,541 CIRPs (Corporate Insolvency Resolution Process) were initiated till the end of June and out of them, 2,859 were closed. Out of them, 1,349 CIRPs ended in liquidation while 396 ended in approval of resolution plans, as per the latest quarterly newsletter of the Insolvency and Bankruptcy Board of India (IBBI)”.

Thus, following what the Supreme Court had laid down, Section 29A of the IBC must be seen with its immediate purpose. The Management in no way must be allowed to return to the corporate debtor as the resolution applicant and this is where the role of Section 29 A shall come into play.

 One of the biggest reasons behind more liquidation than resolution was the ineligibility criteria under Section- 29A as already mentioned above. Which prevents the most obvious resolution applicants from gaining control of the company. “The number of companies sent for liquidation could have been even higher but for the opportunities being given by the National Company Law Tribunal (NCLT) beyond 330 days to explore revival, as is the ultimate goal of the IBC. The problem is that it will only result in kicking the can down the lane unless some inherent issues are addressed [17], said Sumant Batra, the Managing Partner of the law firm Kesar Dass B. and Associates in an interview with the Mint.

However, the Supreme Court time and again has also specified that the judicial interventions as specified under the powers of NCLT and NCLAT must not be at direct loggerheads with the IBC regulations in India, but the reality is far removed from the advised jurisdictions.

India’s economy has especially been on a downward curve due to the pandemic. While the bigger companies were somewhat sustained, most of the damages were endured by the MSMEs. Inadequate number of buyers, lack of freedom to the resolution professionals to proactively reach out to the potential investors, the overall sick economic condition, lack of viable strategy and many more problems are behind the increasing number of liquidations. Only a foresighted policy formulation can save the industry from the sinking boat. While the stringent nature of the Insolvency and Bankruptcy Code, 2016 has been efficient, it must overcome the procedural barriers and must be seen as the solution provider for even the Tribunals rather than coming in counter narrative stance with them.

References