Foreign Creditors and Insolvency Proceedings in India

Bar & Bench April 6 2018

By Aditya Swarup

The past few months in India have witnessed the admission of insolvency petitions of some high value companies, including Essar Steel and Videocon Industries. Such companies may have assets in jurisdictions outside India and one of the crucial questions that arises is the treatment of these assets.

The problem is attenuated by the nature of the assets in question. A company may operate in a foreign jurisdiction through local subsidiaries or branches/offices. It may also have physical assets in such foreign jurisdiction. In the former case, each subsidiary is a separate legal entity and the winding up/insolvency of the parent does not result in the winding up/insolvency of the subsidiary [See Vodafone v. Union of India, (2012) 6 SCC 613]. However, the shares held by the company in the subsidiary are deemed to be located at the registered office of the subsidiary in accordance with conflict of laws rules.

Let us assume that ABC Ltd. (ABC) is a company incorporated in India and has assets in the form of subsidiary companies and physical assets in the UK. ABC also has some foreign creditors, the relationship with whom is governed by English law. Certain domestic operational creditors of ABC file an insolvency petition against ABC and the petition is admitted and an IRP appointed. The IRP calls a meeting of all the creditors and the Committee of Creditors approves a resolution plan for ABC. However, some of the foreign creditors of ABC do not participate in the resolution process and some foreign creditors participate but do not vote in favour of the resolution plan. What are the options available to such foreign creditors with respect to the enforcement of their debts? Can such creditors independently enforce their debts de hors the insolvency process?

At the outset, it is important to appreciate that such aspects are generally governed by cross-border insolvency laws. In the absence of such laws in India, this post will examine the existing framework from the perspective of Indian and UK law. Furthermore, the Insolvency and Bankruptcy Code, 2016 (Code) does not have extra-territorial effect. The Code also treats foreign and domestic creditors equally with respect to insolvency proceedings under the Code. This was also the position with respect to the winding up of companies in India.

Before the coming into force of the Code and under the Companies Act, 1956, the winding up of an Indian company did not automatically mean that the foreign assets of the company were the subject of a winding up petition. If the assets of such company were situated in UK, the English courts would first have to recognise the winding up order and then had discretion whether or not to give the control of the assets to the foreign liquidator. Further, the UK creditors of the company could independently proceed against the assets of the company located in UK. India and UK both have similar regimes in this regard.

If a UK company had assets and was carrying on business in India, it would be considered an unregistered company in India. If the company was then being wound up in the UK, separate winding up proceedings would have to be instituted in India under Sections 582/584 of the then Companies Act, 1956 and its assets would have to be distributed in accordance with such statute. As a case in point, when the Bank of Credit and Commerce International (BCCI) was being liquidated in Luxemburg, the Cayman Islands and the UK, the RBI instituted separate proceedings in India with respect to the assets of the company in India. Furthermore, common law may recognise a bankruptcy order [Blithman, Re, (1866) LR 2 Eq. 23] but not necessarily bankruptcy proceedings. This post however, deals with a situation before the winding up/liquidation of the company.

As a short answer to the question posed, in the absence of a reciprocal obligation under Section 426 of the UK Insolvency Act, 1986 or the UNCITRAL Model Law on Cross-Border Insolvency (Model Law), English courts will not recognise the sanctity of the Indian resolution process and a foreign creditor whose relationship is governed by English law can independently proceed to enforce its debt in England.

This law arises from the Court of Appeal decision in Gibbs & Sons v. Societe Industrielle Des Metaux, [1890] 2 QBD 399. In that case, the Plaintiff entered into a contract for the sale of copper to the Defendant, a French company. The Defendant defaulted in the contract and went into liquidation. The Plaintiff was given notice of the liquidation and called upon to prove its claim in France. The Plaintiff sent its claim and thereafter began separate proceedings in England to enforce its debt. In the English proceedings, the Defendant contended that by the Plaintiff’s participation in the liquidation proceedings, the Defendant was discharged of its debt to the Plaintiff under French law, i.e. the law governing the liquidation proceedings. Lindley LJ rejected the contention and held that a party to a contract made and performed in England is not discharged from liability under such contract by a discharge in bankruptcy or liquidation under the law of a foreign country.

The decision in Gibbs, though criticized off late, it is still good law in the UK. However, it will only be effective if the company (ABC in this case) has assets in the UK. If not, then such foreign creditor will still have to enforce a decree in India, which decree may not be recognised and enforced under the Code of Civil Procedure, 1908.

The decision in Gibbs is also in consonance with the settled law that a winding up or bankruptcy does not change the creditor’s rights but only the manner in which such rights are enforced. The UK has, in a limited manner sought to over-rule the decision in Gibbs by accepting the EC Insolvency Regulations and the Model Law. Under the EC Regulations, if proceedings are initiated in a EU Member country where the debtor has its Centre of Main Interests (COMI), the laws of that country automatically take priority and have the same effect in all member countries. Similar mechanisms are in place in the Model Law.

Prof. Ian Fletcher has criticized the decision in Gibbs and has called the situation of law in England as unsatisfactory. Moreover, he opines that if a foreign creditor has participated in the insolvency proceedings, he ought to be deemed to have subjected itself to the in personam jurisdiction of the insolvency court and cannot now seek to enforce its claim independently.

The situation highlights a glaring lacunae in the Code and Indian law in general and calls for the urgent need to have a cross-border insolvency regime in India. The need for such a regime was recognised by the High Level Committee on Law Relating to Insolvency headed by Justice Eradi way back in 2000 that called for the urgent adoption of the Model law, in whole or in part for India to have an effective cross-border insolvency regime. The recommendation of the Eradi Committee seems to have fallen on deaf ears. Thereafter, the NL Mitra Committee Report of the Advisory Group on Bankruptcy Laws set out in detail the then prevailing cross-border insolvency regime and once again reiterated the recommendation for the adoption of the Model Law.

The Banking Law Reforms Committee Report, stated to be the report on the basis of which the current Code was formulated, side-stepped the question on cross-border insolvency. The Report noted:

“Some important elements of internationalisation – foreign holders of corporate bonds issued in India, or borrowing abroad by an Indian firm – are dealt with by the present report. However, there are many other elements of cross-border insolvency which are not addressed by this report. Examples of these problems include thousands of Indian firms have become multinationals, and Indian financial investors that lend to overseas persons.

The Committee proposes to take up this work in the next stage of its deliberations.”

In its current form, the Code contains only two provisions that may possibly enable and assist the insolvency process with respect to the assets of a company in a foreign jurisdiction. Section 234 of the Code empowers the Central Government to enter into reciprocal agreements with other countries to enforce the provisions of the Code and Section 235 envisages a “Letter of Request” by the liquidator to the authority of a country with which a reciprocal agreement has been made under Section 234 of the Code for action on the assets of the company situated in such country.

It is important to appreciate that the Code does not envisage the adoption of any law, including the Model law but only reciprocal arrangements with countries. This is perhaps the biggest flaw in the current insolvency regime in India.

Despite deliberations since 2000, no serious efforts have been made by the Government with respect to cross-border insolvency. It is, however believed that the Insolvency and Bankruptcy Board of India (“IBBI”) is deliberating on a framework for cross-border insolvency. In fact, in or around April 1, 2018, the Insolvency Law Committee published a report observing that Sections 234 and 235 of the Code did not provide a comprehensive framework on cross-border insolvency matters and stated that it will attempt to formulate a framework based on the Model Law in a separate report. There is also a rumour of discussions with the United States of America for a reciprocal agreement.

If the ease of doing business and promotion of India as an attractive investment destination are the main objectives of the Code and a series of new commercial laws introduced by the Government, the adoption of a framework for cross-border insolvency is the urgent need of the hour. Without any effective framework, the objectives sought to be achieved by the Code will be rendered nugatory. Till then, foreign creditors may freely enforce their obligations (if not governed by Indian law) against the assets of a debtor company outside India.

Aditya Swarup, B.C.L., M.Phil (Oxon). The views of the author are personal.

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