Quick thoughts on the IBC OrdinanceJune 6 2018
By Deepak Joshi
The Press Information Bureau vide its press release informed that the President today gave assent to promulgate the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018 (Ordinance). It notes that the Ordinance is expected to further strengthen the Insolvency Resolution Framework in the country and produce better outcomes in terms of resolution as opposed to liquidation, time, the cost incurred and recovery rate.
It may be noted that this is the second time that the Insolvency and Bankruptcy Code, 2016 (IBC) has been sought to be amended by means of an ordinance. The only other time an ordinance was promulgated to amend the IBC was in November 2017 which, inter alia, contained the now contentious provision – Section 29A.
Though the copy of the Ordinance is still awaited in the public domain (at the time of writing of this piece), the author has attempted to present some quick thoughts on the 3 major changes brought in by the Ordinance based on the details given in the press release.
Recognition of Home Buyers as “Financial Creditors”
The need for amendment
The home buyers have lobbied long and hard to be recognized as financial creditors. Under the IBC, the home buyers have not been explicitly covered under the definition of either “operational creditors” or “financial creditors”. Their status has been a subject matter of a number of litigations. The NCLT in the case of Col. Vinod Awasthy v. AMR Infrastructure held that a home buyer cannot be characterised as “operational” creditor. However, the NCLAT in a subsequent decision in Nikhil Mehta v. AMR Infrastructure has held that they are financial creditors. This assumes significance because of the following three crucial reasons:
Firstly, Non-recognition of home buyers deprives them of the right to initiate corporate insolvency resolution process under section 7.
Secondly, it also denudes them of an opportunity to be on the committee of creditors (CoC) under section 24.
Thirdly, if the non-recognition subsists, then there is no guarantee of receiving at least the liquidation value under the resolution plan.
The press release states that they have been recognized as financial creditors. This would give them due representation in the Committee of Creditors and make them an integral part of the decision making process. It will also enable the home buyers to invoke Section 7.
The amendments which are expected
Section 5(7) of the IBC defines financial creditor to mean “any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred.” Financial Debt has been defined under Section 5(8) of the IBC. It is pertinent to note that Section 5(8)(f) includes within the definition “any amount raised under any other transaction, including, any forward sale or purchase agreement, having the commercial effect of borrowing”
In view of the author, the funds raised by the builders are used as a means of financing the projects. These projects, for which money is paid up front by the home buyers, are delivered to them at a future date. In that sense, the builder-buyer agreements for a real estate project are to that extent one of the ways to raise finance. Thus, these agreements are for forward sale (possession) of projects for which funds have been borrowed from home buyers in advance. Hence, even commercially speaking, these agreements have the effect of borrowing.
Thus, the author expects an amendment to Section 5(7) and Section 5(8) of the IBC. The Ordinance would do well to just add a clarification under Section 5(8)(f) to include home buyers to avoid complications.
Though the Ordinance will recognize home buyers as financial creditors, it is of utmost importance that they are adequately taken care of as far as the liquidation waterfall under Section 53 is concerned. It is hoped that the home buyers will not be treated at par with the other financial creditors and will be dealt with preferentially since the nature of their dues and the corresponding obligations assumed by the corporate debtor differ significantly from the other financial creditors. The press release is silent on this aspect.
Furthermore, even though the press release mentions about the home buyers forming part of the CoC, the mechanism for the same has not been touched upon. It is interesting to note that in March, the Report of the Insolvency Law Committee recommended that in case of financial creditors like the home buyers, an insolvency professional may be appointed by the NCLT to represent such financial creditors. Though the object seems laudatory, the execution is fraught with impracticalities. It needs to be seen as to how the home buyers would deal with the selection of an authorised representative without considering their say. The role of the authorised representative should be spelt out so that the concerns of the home buyers regarding procedure are allayed. It will also ensure transparency and certainty. It is hoped that the above concerns are addressed in the text of the Ordinance.
Withdrawal of case after the admission of application permitted
There have been instances where after the filing of application for initiation of insolvency proceedings, the corporate debtor arrives at a settlement with the applicant creditor. Having reached a settlement with the perpetrator of the insolvency process, it is in the fitness of things that the application should be withdrawn. However, the judiciary has been struggling to answer a very important question – at what stage should such a settlement be accepted and the withdrawal be permitted?
In so far as the stage before the admission is concerned, Rule 8 of the IB (Application to Adjudicating Authority) Rules, 2016 provide that the NCLT may permit withdrawal of the application on a request by the applicant before its admission. However, there are no rules or provisions governing the stage post admission of application. As a corollary, it follows that once the application has been admitted, NLCT loses its jurisdiction to permit such withdrawal. To make matters more complicated, Rule 11 of the NCLT Rules, 2016 provide an inherent power to the NCLT to make such orders as may be necessary for meeting the ends of justice or to prevent abuse of the process of the Tribunal. Equally important is Rule 10 of the IB (Application to Adjudicating Authority) Rules, 2016 which makes Rules 20-26 of the NCLT Rules, 2016 applicable for the conduct of application under IBC. Notably, Rule 11 which provides for the inherent power of the NCLT to make orders for meeting the ends of justice is not mentioned in the rules made applicable under IBC 2016. This was taken to be the grey area of IBC and it was left to the Hon’ble SC to act under Article 142 and give a judicial validity to such settlement agreements. Being a decision under Article 142, it cannot be treated as a binding precedent.
However, considering the practical and commercial realities, the Ordinance has not provided a way out by stating that withdrawal of application after its admission under IBC shall be permitted only with the approval of the Committee of Creditors with 90 percent of the voting share.
Furthermore, the Ordinance seems to have taken note of the Binani-Dalmia insolvency saga wherein the promoters (along with the initially rejected resolution applicant UltraTech) entered into a settlement with the CoC after the Dalmias were selected as the final resolution applicant whose plan was to be considered by the CoC. They then moved an application for termination of insolvency proceedings. Furthermore UltraTech had raised its bid after having been rejected by the CoC. Hence, to discourage such practices, the Ordinance provides for that such withdrawal will only be permissible before publication of notice inviting Expressions of Interest (EoI). In other words, there can be no withdrawal once the commercial process of EoIs and bids commences.
Streamlining of the timeline and process to avoid delays and achieve objectives of IBC
The need for amendment
One of the objectives as has been stated in the preamble of the IBC is insolvency resolution in a time bound manner. With this objective in mind, the IBC provided for an outer limit of 180 days for the resolution process to get over. An extension of 90 days could be given by the NCLT. Hence, the whole procedure needs to get over in a maximum period of 270 days from the initiation of the insolvency process. If the timeline wasn’t adhered to, the result would be liquidation of the corporate debtor.
However, in practice it is seen that the 270 days timeline is rarely adhered to. The primary reasons for the same are enlisted below:
High voting threshold – all decisions of CoC need to be approved by 75% majority.
The high threshold of 75% of the voting share of financial creditors for decision of the CoC was proving to be a road block in the resolution process. As a result of such a high threshold, blocking of important decisions like acceptance of resolution plan, and other regular decisions was proving to be easier.
Lack of clarity on the status of late bids, negotiations at the fag end of the process.
Experience shows that the promoters may form an “unholy alliance” with an outsider or even an initially rejected resolution applicant and try to enter into negotiations with the applicant creditors or even the CoC. In certain cases, it was seen that a rejected resolution applicant had at the fag end of the process raised its bid and tried to hijack the whole insolvency process. Sometimes, a resolution applicant stakes its claim on the basis of a belated bid. The abovementioned instances and other similar acts lead to litigation which further prolong the insolvency process.
The amendments which are expected
The Ordinance seems to have followed the recommendation of the Report of the Insolvency Law Committee in bringing down the voting threshold from 75% to 66%. The same has been done for all major decisions such as approval of resolution plan, extension of CIRP period, etc. Hence, amendments are expected under the following sections:
Section 30(4) - approval of the resolution plan,
Section 12(2) - extension of the CIRP beyond 180 days,
Sections 22(2) & 27(2) - replacement or appointment of resolution professional
Sections 33(2) - passing a resolution for liquidation
The abovementioned move will promote resolution and discourage liquidation of the corporate debtor.
Furthermore, for approval of the other routine decisions for continuing the corporate debtor as going concern, the voting share threshold has been reduced to 51 percent or more of the voting share of the financial creditors.
In order to preserve and uphold the sanctity of the process, the Ordinance provides that the Regulations will bring in further clarity by laying down mandatory timelines, processes, and procedures for corporate insolvency resolution process. Some of the specific issues that would be addressed include non-entertainment of late bids, no negotiation with the late bidders and a well laid down procedure for maximizing the value of assets.
The maximisation of value while keeping the sanctity of the process intact has been one of the biggest challenges in the implementation of the IBC. This begs the question – what value are we seeking to maximise? Is it the mere monetary value of the assets concerned? Or is it also the economic value of the assets?
The author asks these questions in light of the preamble of the IBC wherein maximisation of value is only one amongst the many other objectives of the IBC. The IBC also seeks to balance the interest of all the stakeholders while keeping the time-bound resolution in mind. It is interesting to note that the Report of Bankruptcy Law Reforms Committee recognises that the erstwhile insolvency laws resulted in deterioration of “economic” value due to the multiplicity of judicial fora and prolonged litigation. It also states that one of the core features of the IBC is that it is a collective mechanism for resolving insolvency to preserve the “economic” value and realise as high an “economic” value as possible.
The author hopes that the procedure for maximisation of value as contained under the Ordinance doesn’t merely focus on the monetary value but also the qualitative aspect of the value of the assets. In the erstwhile regime, it was time and again felt that the value (both in terms of money & otherwise) of the defaulting entity suffered a great amount of loss because of delayed proceedings and non-transparency of the procedure.
The Ordinance should take care of the fact that any attempt of any backdoor entry will hamper the fairness of the process to achieve maximisation of the value. The Report of Bankruptcy Law Reforms Committee notes that the courts must control the process of resolution but not be burdened to make business decisions. Hence, once the procedure has been followed, the Ordinance shouldn’t provide the courts with the power to look into various alternative avenues of maximising the monetary value of the assets or look at the competitive bids or revised bids.
On this point, the Ordinance will be well guided by the decision of the Supreme Court in Vedica Procon Private Limited v. Balleshwar Greens Private Limited, AIR 2015 SC 3103, which held that as long as courts are satisfied with respect to the adequacy of price, they are not required to revisit a concluded sale upon receipt of a subsequent higher bid except on the ground of fraud, which would vitiate any sale including an adequately priced sale.
The Author is a dual qualified professional. He is a 2016 graduate of Campus Law Centre, Faculty of Law, University of Delhi and a 2012 fellow chartered accountant. He currently practices law in the courts of Delhi.
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