IBC UPDATE | NCLT ALLOWED SUCCESSFUL RESOLUTION APPLICANT TO HANDOVER THE POSSESSION OF THE UNDERTAKING BACK TO COC

In one of the unique cases, National Company Law Tribunal, Mumbai (NCLT) recently passed an order in Mandhana Industries Limited (MIL) – Insolvency Case allowing the successful resolution applicant to handover the control and possession of the company back to the committee of creditors (COC).

Background

Pursuant to an application filed under Section 7 of the Insolvency and Bankruptcy Code, 2016 (IBC), NCLT had allowed the resolution plan and Formation Textiles LLC (Resolution Applicant) was held as a successful resolution applicant. The admitted claim by the Resolution Professional (RP) was of Rs. 1,183 Crores approximately. However, the said resolution plan was later challenged before the NCLT subsequently on following issues:

• First application was filed by the Resolution Applicant on the ground that it had not been provided with the entire information as is necessary for complying with its terms and obligations under the resolution plan;
  
  
• Second application was filed by RP for claiming the Corporate Insolvency Resolution Process (CIRP) costs; and
  
  
• Last application was filed by Bank of Baroda, on behalf of the Consortium, seeking inter alia the possession of the undertaking, which is to be then handed over to a third party, to ensure proper maintenance and that the value of the asset is not depleted.
  

Arguments before NCLT

In the first application filed by the Resolution Applicant, it has been contended that the forensic audit report of the undertaking was not shared with it by the RP. Thus, it had not been provided with essential information which was disclosed in the Report, such as information with regard to the trading business of MIL, which was suspected to be based on sham and bogus sales. Further, it was contended that several financial figures reported were bogus and false.

It was argued that the Applicant’s bid and the resolution plan were based on misrepresentation and concealment of material and relevant facts. Thus, the Resolution Applicant had sought an order quashing and setting aside the Resolution Plan. It was also submitted that the Applicant was willing to handover the possession of the undertaking, without prejudice to its rights and contentions.

During hearings of the applications, the RP and Consortium of Banks suggested that the Resolution Applicant handover the possession of the undertaking in view of its application challenging the Resolution Plan itself. Further, it was contended on behalf of the consortium of Banks that the unit has been handed over to the Successful Applicant on an ‘as is where is’ basis and the said Applicant had defaulted in making the payments as per the resolution plan.

NCLT View:

On the basis of these arguments made on behalf of all the concerned parties, NCLT held that it would be necessary to hear all the applications separately and decide each on its merits, but in the meanwhile, NCLT agreed to give interim relief to the parties. Pending the final disposal and after perusing the material on record, it proceeded to order that the possession of the undertaking be handed over by the Resolution Applicant to the COC, who in turn would hand it over to the erstwhile RP. The erstwhile RP is to continue in the same position and be vested with the rights and duties as provided under Section 14 of the IBC.

Further, such handover would be subsequent to an independent agency / person taking the inventory and examining the status and working condition of the machines of the undertaking. 

MHCO Comment: This is an interesting development under IBC. From this judgment, we can infer that upon any material misrepresentation, a successful resolution applicant could be entitled to terminate the Resolution Plan on approaching the NCLT.

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.comfor any assistance.

LEGAL UPDATE | NBFCs AND OTHER FINANCIAL SERVICE PROVIDERS NOW UNDER IBC

Introduction

Under the Insolvency and Bankruptcy Code, 2016 (IBC), the corporate insolvency resolution process contained in Part II applies to corporate debtors. A corporate debtor is defined as a “corporate person who owes a debt to any person.” Corporate person is defined to exclude financial service providers. A financial service provider is a person engaged in the business of providing financial services in terms of an authorisation granted by, or registration with, a financial sector regulator who is an entity constituted under any law in force to regulate services or transactions in the financial sector.

Under Section 227 of the IBC, the Central Government is empowered in consultation with the financial service regulator to make the provisions of the IBC applicable to financial service providers or certain categories of financial service providers. The financial crises involving IL&FS and Dewan Housing Finance Limited (DHFL) prompted demands to include certain financial service providers (like housing finance companies and other specified non-banking financial companies) under the IBC. This led the Central Government to issue a notification dated 15 November 2019 notifying the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019 (Rules). This update summarises the salient features of the Rules.


Salient Features of the Rules

• The Rules apply to financial service providers or categories of financial service providers, as may be notified by the Central Government under Section 227 of the IBC, from time to time.

• The corporate insolvency resolution process (CIRP) has been made applicable to notified financial service providers. For CIRP to commence, an application must be made by the relevant financial sector regulator to the National Company Law Tribunal (NCLT).

• The aforesaid application must also propose the name of an “Administrator” who substitutes an insolvency professional, interim resolution professional, resolution professional or liquidator, on admission of the application, for the purpose of insolvency and liquidation proceedings of a financial service provider.

• The Rules also contemplate an Advisory Committee appointed by the financial service regulator to assist the Administrator during the insolvency process.

• A moratorium commences from the date of filing the application till its admission or rejection by NCLT. The license or registration granted to the financial service provider continues in force throughout the CIRP.

• The resolution plan must contain a statement of how the resolution applicant satisfies the sectoral requirements of the financial service provider as laid down by the financial service regulator.

• Upon approval of the resolution plan by the committee of creditors, a no objection from the financial service regulator must be obtained on the persons who would take over the control and management of the financial service provider. The no objection (without prejudice to the disqualifications under Section 29-A of the IBC) must be issued by the financial service regulator based on ‘fit and proper criteria’ applicable to the business of the financial service provider. If the financial service regulator does not respond within 45 (forty five) days of the no objection request, the no objection is deemed to have been given.

• The provisions on liquidation including voluntary liquidation under the IBC apply mutatis mutandis to financial service providers.

• The moratorium does not apply to third party assets or properties in the custody or possession of the financial service provider including any funds, securities and other assets required to be held in trust for the benefit of third parties. The Administrator must take control of these assets and deal with them in the manner notified by the Central Government.

• The Rules also prescribe Form 1 for applying under the Rules to commence CIRP against the financial service provider by the financial sector regulator.

On 18 November 2019, the Central Government notified the applicability of the Rules to non-banking finance companies (which include housing finance companies) with asset size of Rs. 500 crore or more as per the last audited balance sheet. A separate notification will be issued on dealing with third-party assets of such companies.

DHFL UPDATE

On 21 November 2019, the Reserve Bank of India (RBI) has, under the provisions of the Reserve Bank of India Act, 1934, superseded the Board of Directors of DHFL owing to governance concerns and defaults by DHFL in meeting various payment obligations and appointed Mr. R. Subramaniakumar, ex-MD and CEO of Indian Overseas Bank as the Administrator. The RBI also intends to commence CIRP against DHFL shortly under the Rules with the Administrator appointed as the resolution professional.

MHCO COMMENT

The Rules are a positive step and will help creditors of financial service providers who are in distress recover a portion of their debt if a suitable resolution plan is in place. This remedy is far more suitable than the process under the relevant laws applicable to a financial service provider since the regulatory bodies have rarely taken steps to resolve the distress of financial service providers who are in default. The IBC is a pro-active legislation and with the finality granted by the Supreme Court in the Essar Steel case, should help reduce the problems faced by creditors in recovering debt from asset-rich corporate debtors / financial service providers in distress.

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.comfor any assistance.

LEGAL UPDATE | LANDMARK JUDGMENT OF THE SUPREME COURT IN ESSAR STEEL

Factual Background

The Corporate Insolvency Resolution Process (CIRP) was commenced against Essar Steel Limited (Essar Steel) under the Insolvency and Bankruptcy Code, 2016 (IBC). Arcelor Mittal was the successful resolution applicant in this process. The resolution plan proposed by Arcelor Mittal involved a payment of approximately Rs. 42,000 crores (Resolution Amount) to the creditors of Essar Steel. The decision on how this amount would be divided between the various financial creditors of Essar Steel was left to be determined by the Committee of Creditors (COC) of Essar Steel. The COC decided that approximately 92% of the loan outstandings of the secured financial creditors would be met out of the Resolution Amount. The operational creditors would, therefore, receive nothing more than the liquidation value of Essar Steel, which was negligible. The National Company Law Tribunal (NCLT) approved the resolution plan with some modifications. This decision was challenged by Standard Chartered Bank and the operational creditors before the National Company Law Appellate Tribunal (NCLAT). NCLAT rejected the claims of the financial creditors and held that both operational and financial creditors must be treated equitably. As a result, from the Resolution Amount, 60.7% of the outstanding dues was payable to each of the creditors, whether financial or operational. The NCLAT also held that the COC cannot determine the distribution of payments pursuant to a resolution plan which must be decided by the resolution applicant. This decision caused considerable heartache to the financial creditors as a class and to the Government who sees the IBC as a major economic reform. To mitigate the impact of the NCLAT order the Government amended the IBC in 2019 to provide that the COC could decide the distribution of amounts pursuant to a resolution plan under the IBC. We have prepared updates on both the NCLAT decision and the IBC Amendment. These can be obtained here and here.

Decision of the Supreme Court

On appeal to the Supreme Court, the Supreme Court overturned most of the decisions of NCLAT in the Essar Steel case. The resolution plan of Arcelor Mittal was approved and the distribution of the Resolution Amount as determined by the COC was upheld. In doing so, the Supreme Court gave finality to a number of issues that had arisen on the interpretation of the IBC. Briefly, the Supreme Court held:

• Corporate resolution under the IBC is ultimately in the hands of the COC. Under the applicable regulations (Regulations), it is clear that it is the commercial wisdom of the COC which operates to approve what is deemed by a majority of such creditors to be the best resolution plan, which is finally accepted after negotiation of its terms by the such COC with prospective resolution applicants.
  
  
• If the COC has approved a resolution plan, the resolution professional must submit such plan to the NCLT for approval. On receipt, NCLT is required to satisfy itself that the resolution plan as approved by the COC meets the requirements of Section 30(2) of the IBC. This includes whether the resolution plan provides for costs of insolvency, payments to operational creditors, management of the corporate debtor and does not contravene any provision of law. This is clearly spelt out in Section 31 of the IBC which provides that the scope of judicial review of the NCLT is limited to determining that such requirements are met. NCLT cannot substitute its opinion on the resolution plan for that of the COC since the commercial wisdom of the COC is the driver for approval of resolution plans. Similarly, the scope of judicial review of NCLAT is limited to the factors mentioned in Section 61(3) of the IBC. These include (i) the resolution plan contravenes law; (ii) there has been material irregularity in the exercise of powers by the resolution professional; (iii) the debts owed to operational creditors have not been provided in the plan in the manner determined by the Insolvency and Bankruptcy Board of India (Board); (iv) the costs of insolvency have not been provided for; and (v) any other requirement laid down by the Board has not been met. Thus, while the relevant adjudicating authority cannot interfere on merits with the commercial decision taken by the COC, the limited judicial review available is to see that the COC has taken into account the fact that the corporate debtor needs to keep going as a going concern during the insolvency resolution process; that it needs to maximise the value of its assets; and that the interests of all stakeholders including the operational creditor have been taken care of. If the adjudicating authority finds, on a given set of facts, that these parameters have not been kept in mind, it may send a resolution plan back to the COC to re-submit such plan after satisfying these parameters.
  
  
• A bankruptcy code should not be read so as to imbue creditors with greater rights in a bankruptcy proceeding than they would enjoy under general law, unless it is to serve some bankruptcy purpose. If an “equality for all” approach recognising the rights of different classes of creditors as part of the insolvency resolution process is adopted, secured financial creditors will, in many cases, be incentivised to vote for liquidation rather than 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 IBC. Equitable treatment is only of similarly situated creditors. Financial and operational creditors cannot be paid the same amounts in any resolution plan before it passes muster. It is the commercial wisdom of the COC that determines the payments to be made to the various creditors in terms of the IBC and this may involve differential payments to financial creditors and operational creditors set out in the resolution plan. Equitable treatment is to be accorded to each creditor depending upon the class to which it belongs: secured or unsecured, financial or operational.
  
  
• Delegation of authority to a sub-committee to negotiate with the resolution applicant is within the power of the COC since the subject matter of delegation is not a core function of the COC.
  
  
• The moratorium under the IBC would not apply to claims under a personal guarantee pursuant to Section 31 of the IBC and the decision of the Supreme Court in State Bank of India v. V. Ramakrishnan (2019). Further, all claims under the IBC are deemed to be settled so that the successful resolution applicant can make a fresh start on a clean slate.
  
  
• The relevant changes brought about by the Amendment Act of 2019 were constitutionally valid.
  
  

MHCO Comment: The judgment of the Supreme Court delivered by Justice Rohinton Nariman has certainly clarified a number of issues that plagued the effective implementation of the IBC. However, at its core the judgment suffers from an infirmity in so much as operational creditors will now be left with little or no money from a distribution of proceeds pursuant to an approved resolution plan that does not cater to this class of creditors. The liquidation value of debt-intensive companies is likely to be negligible or even negative which leaves operational creditors in the lurch. This appears unfair given that the day-to-day functioning of a company depends on providers of goods and services. If such providers face the risk of non-recovery of dues they are likely to suspend the provision of goods and / or services to the company, which would affect its ability to continue as a going concern.

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.comfor any assistance.