The Limits of S. 29A: Why Its Scope Shouldn’t Extend Beyond CIRP
Mohak Agarwal&Lavanya Agarwal
5th Year, B.A. LL.B. (Hons.) , National Law University, Jodhpur
Introduction
Section 29A was introduced into the Insolvency and Bankruptcy Code, 2016 [“the Code”] through an ordinance dated November 11, 2017 [“the Ordinance”]. Subsequently, the ordinance was repealed and replaced by the Insolvency and Bankruptcy Code (Amendment) Act, 2017 [“the 2017 amendment”]. Section 29A was designed to render certain categories of individuals, including the promoters of the Corporate Debtor [“CD”], ineligible to submit a resolution plan. Notably, the 2017 amendment also included a proviso to Section 35(1)(f), thereby extending the applicability of Section 29A to liquidation. Subsequently, the applicability of Section 29A was further extended to compromises or arrangements proposed under Section 230 of the Companies Act, 2013 [“Companies Act”], through the insertion of a proviso to Regulation 2B of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 [“Liquidation Regulations”]. While much has been discussed critiquing the broad scope of ineligibility under Section 29A, this article examines the applicability of Section 29A to liquidation and Section 230 of the Companies Act, the legal intent and rationale involved, and how the resulting ineligibility may be counterproductive to the Indian insolvency landscape.
Section 29A: Understanding the legal intent
Prior to the introduction of the Code, the Bankruptcy Law Reforms Committee [“BLRC”] submitted its report [“BLRC Report”] dated November 4, 2015 which laid down the contours of the Code. The BLRC Report stated that the stereotype of ‘rich promoters of defaulting entities’ leading to the idea that all default involves malfeasance is a sign of a weak insolvency regime. As a result, the BLRC report emphasized on drawing a line between default due to malfeasance and that due to business failure and providing a second chance to the honest debtors. In line with these observations, when the Code came into existence, there was no disqualification for the erstwhile promoters of the CD.
However, subsequently, Section 29A was introduced by way of the Ordinance, the objective of which was “to provide for the prohibition of certain persons from submitting a resolution plan who, on account of their antecedents, may adversely impact the credibility of the processes under the Code”. The objective, as evidenced by the Statement of Objects and Reasons of the 2017 amendment which eventually replaced the Ordinance, was to prohibit persons who contributed to the default of the CD or were otherwise undesirable from misusing the provisions to regain control of the CD at the expense of the creditors.
When the 2017 amendment bill was tabled before the Parliament, much emphasis was laid by the then Finance Minister on the fact that without the ineligibilities of Section 29A, the erstwhile promoters of the CD would get an opportunity to get the same enterprise back at a discounted value without discharging the entirety of its obligations. The amendment received presidential assent on January 18, 2018. The 2017 amendment also introduced a proviso to Section 35(1)(f), which extended Section 29A to liquidation proceedings as well.
The introduction of Section 29A and the ensuing ineligibility of promoters from taking part in CIRP has arguably obliterated the distinction between malfeasance and business failure while serving as a denial of second chance to the promoters. While its introduction in CIRP proceedings could still be dismissed as a necessary evil to prevent the misuse of the Code, its extension beyond CIRP seems undesirable and tantamount to using a sledgehammer to crack a nut.
Beyond Resolution: The dynamics of Liquidation
While the primary objective is to rescue the CD and maintain its operations as a going concern, there are instances where this becomes unviable, and liquidation becomes the most feasible option. When all efforts to resolve insolvency through the Corporate Insolvency Resolution Process (CIRP) prove unsuccessful, liquidation is initiated as a last resort. Once liquidation begins, the focus of the Code shifts from sustaining the entity as a going concern to selling off the CD’s assets (or the CD as a whole) and maximizing value recovery. Consequently, the emphasis transitions from resolution to recovery. Despite certain similarities between CIRP and liquidation, they are fundamentally distinct processes due to their differing objectives.
CIRP involves collective negotiations among creditors to evaluate viability, whereas liquidation offers more flexibility for individual recovery. For example, creditors are prohibited from enforcing their security interests during CIRP, but they can do so outside of the Code during liquidation, as outlined in Section 52. Additionally, unlike CIRP, Regulation 29 of the Liquidation Regulations permits set-offs in cases of mutual dealings between the CD and another party. These instances underscore the shift from maintaining the entity as a going concern to maximizing economic value for creditors. They also highlight the inadequacy of a one-size-fits-all approach for CIRP and liquidation, given their distinct aims and objectives. Therefore, policymakers should consider these differences and the primary goal of recovery when extending provisions from CIRP to liquidation.
Section 230: The last resort for survival
Section 230 of the Companies Act enables the CD to enter into compromise or arrangements with the creditors to resolve the debt. While there is no reference to Section 230 under the Code, it derives acceptance by way of judicial pronouncements as well as Regulation 2B of the Liquidation Regulations. Regulation 2B stipulates a 90-day timeframe for completing compromises or arrangements once liquidation is initiated under Section 33 of the Code. Failing to enter into a compromise or arrangement inevitably leads to the CD’s corporate death, except for instances where the CD is sold as a going concern. While there was ambiguity concerning the applicability of Section 29A to compromise or arrangement, the addition of a proviso[1] to Regulation 2B clarified the ineligibility to be attracted. Subsequently, in the case of Arun Kumar Jagatramka v. Jindal Steel and Power Ltd. and Anr.[2], the Supreme Court upheld the ineligibility and held the amendment to Regulation 2B to be clarificatory in nature.
This amendment and subsequent Supreme Court judgment effectively exclude promoters from participating in compromises or arrangements. Consequently, once a CIRP application is admitted, promoters have no opportunity to regain control of the CD unless a 90% majority is achieved for withdrawal under Section 12A. The layout of the Code is such that the management of the CD gets no opportunity to attempt to restructure or resolve the CD’s debt throughout the proceedings. The time-bound nature of the Code requires an application for commencement of CIRP to be admitted within 14 days. Thus, a virtual clock starts running as soon as a CIRP application is filed and the management is only left with 14 days to arrive at a settlement with the creditors. While strict measures are necessary for a robust insolvency regime, the Code’s preference for corporate demise over allowing management to propose schemes for resolution, even after the failure of CIRP, underscores the perceived demonization of promoters by the Code.
A second chance to promoters?: Advocating against the extension of S. 29A
The CIRP Process under the Code heavily relies on the commercial wisdom of the Committee of Creditors [“CoC”]. The CoC enjoys the autonomy to select a resolution plan and determine the manner of insolvency resolution, provided it complies with the basic requirements of the Code. The Apex Court has consistently stressed on the importance of respecting the commercial wisdom of the CoC and refraining from interference in that domain. The Code operates under the assumption that the CoC is best equipped to safeguard its interests.
While it is undeniable that certain categories in Section 29A, such as wilful defaulters, should not be per se allowed to present a resolution plan, an outright denial to the management of the CD to propose a resolution plan where the insolvency could either be due to bad management or business failure is a decision best left for the CoC to decide in an ideal scenario. However, it is valid to argue that this could incentivize complacent or malicious management to enter CIRP, seeking to regain CD at a discounted price rather than fulfilling their debt obligations. This argument holds strong as a justification for the prohibition of erstwhile management from proposing a resolution plan during CIRP proceedings.
The denial of participation in CIRP fares well as a safeguard against malicious or complacent management. However, it is the extension of this very denial to stages beyond CIRP which affects the resolution and recovery of the CD alike.
As far as Section 230 of the Companies Act is concerned, it allows the management of the CD to restructure or resolve the debt when the Code is not triggered, offering a second chance to the promoters of the ailing CD with creditor consent. However, even when the BLRC report supported the idea of a second chance, the Code failed to include this in its landscape. The strict 14-day timeline for insolvency admission leaves the management of the CD with practically no time to propose a scheme to restructure or resolve the debt. The insertion of Section 12A for the withdrawal of CIRP application has been laudable but it essentially means that in order to arrive at a compromise or arrangement under Section 230, a much higher majority requirement of 90% under Section 12A of the Code is required to be satisfied as opposed to a 75% majority requirement under Section 230(6), which often becomes unachievable. In such a scenario, providing a short timeframe to the erstwhile management to propose a scheme under Section 230 seems practicable and fair when all other means of insolvency resolution have failed and corporate death is imminent. With the malfeasance of erstwhile management being checked by its non-inclusion in CIRP and the incompetency being left to be decided by the commercial wisdom of the creditors under Section 12A, it seems prudent to give the erstwhile management a second chance before the Corporate Debtor is met with an otherwise imminent death.
In the event of liquidation, the focus of the Code shifts from resolving insolvency to maximizing recovery. The aim then becomes to recover as much capital as possible by selling off the assets of the CD. Barring sale of CD as a going concern, all other methods of liquidation result in the corporate death of the CD and the liquidation of its assets. Even if it is assumed that the incompetence of erstwhile management led to the CD’s insolvency, barring them from bidding for the CD’s assets seems impractical since the CD would become non-operational nonetheless. Notably, there is no restriction under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 on the erstwhile management from purchasing securities enforced outside the liquidation mechanism under Section 52 of the Code. More often than not, it is the promoters and the erstwhile management of the CD who, due to their familiarity with the CD, are willing to bid for its assets, contributing to increased recovery.
The Code is an economic legislation aimed at maximizing recovery during liquidation. Deviating from this objective based solely on moral arguments and unfounded presumptions that promoter malfeasance contributed to the CD’s insolvency, and therefore barring them from bidding for its assets, is unwarranted. As far as sale of CD as a going concern is concerned, the argument of adequate safeguarding through non-inclusion under CIRP holds valid and aligns with providing promoters a second chance.
The way forward
Entrepreneurship thrives on innovation and risk-taking which are widely viewed as the critical components of the success of any economy. In high power distance countries like India, fostering a culture of risk-taking is crucial for driving innovation and entrepreneurship. However, excessive creditor rights can destroy the incentive for the companies to undertake value-enhancing by risky projects and the promoters might choose unprofitable diversifying investments that reduce the probability of distress. This contradicts the Code’s key objective of promoting entrepreneurship.
The legislature has, time and again, recognized the importance of promoter involvement in insolvency proceedings. This is reflected in the introduction of Section 12A which allows the withdrawal from CIRP proceedings, Section 240A which restricts the applicability of clauses (c) and (h) of Section 29A to micro, small, and medium enterprises, and so on. However, these steps, despite being laudable, fall short due to the wide-ranging applicability of Section 29A right from the admission of the petition till the corporate death of the CD. The legislature should review the application of Section 29A, particularly to Section 230 of the Companies Act and liquidation under the Code, and align them with the objects and purpose of the Code by allowing the erstwhile management to take part in these processes once CIRP has failed.
It is imperative to move away from the stereotypical view of promoters as wrongdoers and embrace an inclusive approach aligned with the Code’s objectives and purposes.
References:
[1] Inserted by IBBI (Liquidation Process) (Amendment) Regulations, 2020 vide Notification No. IBBI/2019-20/GN/REG053 dated 6th January, 2020, w.e.f. 06.01.2020.
