Brief analysis of the Working Group on Group InsolvencyNovember 12 2019
The Insolvency and Bankruptcy Board of India has released the report of the working group on group insolvency, proposing reforms in the legal framework to address insolvency and bankruptcy of companies that belong to the same group.
Rationale for the framework of group insolvency in India
Presently, the Insolvency and Bankruptcy Code, 2016 (IBC) does not provide for a consolidated mechanism to (procedurally or substantively) synchronise insolvency proceedings of corporate debtors within the same group. In spite of this, adjudicating authorities under the IBC (the “AAs”) have passed orders taking into consideration corporate debtors and their interconnections with other group companies such as in cases of Sachet Infrastructure, Videocon, Amtek Auto, Jaypee etc.
By way of the background of a few of such instances, in SBI v. Videocon, the AA held that the assets and liabilities of 13 Videocon companies shall be substantively consolidated for the purpose of their corporate insolvency resolution process (“CIRP”). The AA based its decision on factors such as common control, common directors, common assets, interloping of debts, common financial creditors, etc. In the matter of Edelweiss ARC v. Sachet Infrastructure, the AA directed procedural consolidation of insolvency proceedings against 5 companies working as a consortium to develop a residential plotted colony. The court even mandated a single resolution professional to guide the simultaneous CIRPs and complete it in one go with a consolidated resolution plan(s) for total development.
The rationale behind adopting a Framework is multi-fold:
- Companies belonging to the same group are linked either operationally in terms of dependence for the supply of raw material, or financially, in terms of inter-corporate deposits or guarantees. Recognizing these internal linkages is time-consuming and expensive when the insolvency of each group company is dealt with in isolation. Further, the value of assets realized can be maximised if the inter-linked companies are offered for bidding/resolution together.
- There can be a reduction in the asymmetry of information between the different creditors and the promoters. Moreover, the nature of transactions between different groups may have relevance to the insolvency proceeding.
As observed by the working group, codifying a Framework can have advantages such as reduced cost of proceedings, exchange of information, more certainty for stakeholders and maximisation of value.
Scope of the Framework
The Framework proposed by the working group to deal with the insolvency of companies or corporate groups is as follows:
- Applicability: The working group has recommended that the definitions of holding, subsidiary and associate companies in the Companies Act, 2013 take into account both vertical and horizontal integrations between group companies. Given this, a ‘corporate group’, to which the Framework will be applicable, should be defined to include holding, subsidiary, and associate companies. Further, an application may be made to the AA to include other companies if they are so intrinsically linked so as to form part of a ‘group’ in commercial understanding.
- Mechanisms: The issues arising in insolvency of group companies can be tackled by two mechanisms, broadly: (a) the procedural coordination mechanisms (“PCMs”) which are targeted at coordinating procedures of insolvency; and (b) substantive consolidation mechanisms which are targeted at consolidating the assets and liabilities of different group companies so that they are treated as part of a single insolvency estate for the purpose of reorganisation or distribution in liquidation.
- Implementation: The working group has recommended that the Framework should be introduced in a phased manner. Given this, the working group has recommended that, in its first phase, the Framework may cover only domestic entities and the Framework may not include substantive consolidation.
- PCMs: The working group has noted that the key feature of PCMs is that they are aimed at coordinating the administration and conduct of insolvency proceedings, and do not alter the rights and liabilities of the parties. Companies that have not committed default or companies that are not covered under the IBC will not be included under PCMs. Further, the WG has recommended that PCMs (other than co-operation, communication and information sharing) should in-principle be enabled by law, however, flexibility should be granted not to opt for these mechanisms if they do not help maximise the value of assets or lower the costs of proceedings.
- Elements of PCMs: PCMs may involve any or a combination of the following elements:
- co-operation, communication, and information sharing between insolvency professionals (“IPs”), creditors and AAs;
- designation of AAs or single insolvency representative, the formation of a group creditors’ committee and a joint application process; and
- group coordination proceedings.
Working group recommendations
The working group has recommended amending the IBC, the corresponding rules and regulations and other relevant laws to enable its recommendations for the Framework. The key working group recommendations are set out below:
- Co-operation, communication and Information sharing: The IPs, each committee of creditors(“CoC”) and AAs will have to cooperate, communicate and share information with each other, in case of insolvency of group companies.
- Joint application process: A single application to commence CIRP for multiple group companies that have committed defaults can be made. Such a joint application process should be in addition to the mechanism to initiate the CIRP against each group company separately.
- Designation of a single AA: A single AA is required to administer the insolvency proceedings of different companies in a group. This will be the AA that first admits an application to commence the CIRP for any company in the group. However, the CoCs of different companies may, by the required majority, choose the AA as per their convenience. If any CoC opts out of the group insolvency process, the AAs must share information, cooperate and communicate with each other.
- Designation of a single IP: The AA will have to appoint a single IP in the insolvency proceedings of all companies in the corporate group. Multiple IPs can be appointed if a single IP has potential conflicts of interest or insufficient resources to carry out his duties. The different IPs will have to communicate, cooperate and share information with each other.
- Formation of a group creditors’ committee and signing a framework agreement: The group creditors’ committee will be formed at the discretion of the CoCs of each group company. The composition, constitution, and cost of the group creditors’ committee can be decided by an agreement between the CoCs or by a framework agreement.
- Group coordination proceedings: Such coordination proceedings should be enabled by a vote of the majority of each CoC, and governed by the framework agreement. The parties to the framework agreement can appoint an IP as a group coordinator. The group coordinator will be required to propose the actions to be taken by the group. Each CoC can opt-out of the group coordination proceedings if it does not approve of the strategy of the group coordinator. When group coordination proceedings are opened, all AAs should be intimated of the same and all cases should be transferred to a single AA chosen under the framework agreement.
- Extension of CIRP timeframe: The timeframe for proceedings of any company that has opened group co-ordination proceedings may be extended to 420 days (including time taken in litigation) on an application to the AA. (The timeframe presently available for a company to complete CIRP under IBC is 330 days.)
- Rules against perverse behaviour of group companies: While the WG pondered over-rules against perverse behaviour from various jurisdictions which could be incorporated in the Framework, the only amendment that the WG has finally recommended is to allow subordination of intra-group debt in exceptional circumstances of fraud, etc. No other rules against perverse behaviour have been recommended on account of provisions regarding preferential and fraudulent transactions already being covered in the present IBC. Further, the subordination of intragroup claims may be allowed in respect of all group companies, regardless of their solvency.
Each company is a legal person having its own distinct identity and presently, the processes set out in the IBC apply only in respect of the company against whom an application for insolvency resolution has been filed and admitted. While the provisions of the present IBC and the emerging jurisprudence are aimed at revival of every company in distress and maximization of its value, there have been several instances where recovery has been limited or has failed on account of the corporate debtor’s insolvency resolution being dealt with in isolation, to the exclusion of the other entities in the group which form part of intrinsically linked operations or supply chains.
While weighing the recommendations of the working group, utmost consideration should be given to ensure that the Framework is not a subject of abuse, where stakeholders invoke the Framework with the sole intent of extending the CIRP by an additional period of 90 days. To this extent, AAs will have to exercise cautious discretion. The need for this process check can be seen as hugely pertinent in view of the recent instances where the IBC has failed to meet its primary objective of time-bound stress resolution and prevention of asset value erosion.
Nonetheless, the recommendations of the working group, if implemented with caution, will be a definite step towards taking the insolvency reforms forward. The working group report will serve as a guiding principle for the proposed phased implementation of the group insolvency regime for effectively tackling the substantiated issues which have arisen in cases of group insolvency.
Dhwani Shah is currently working as a senior associate at Talwar Thakore & Associates, Mumbai.
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