The President of India promulgated the Insolvency and Bankruptcy
Code (Amendment) Ordinance 2018 on 6 June 2018 (Ordinance) to amend
the Insolvency and Bankruptcy Code 2016 (IBC). In the short history
of around one and half years since the provisions relating to
corporate insolvency resolution process under IBC came into force
in December 2016, the Ordinance marks the second amendment to
IBC.
The first amendment to IBC (by way of an ordinance in November
2017, which was ratified by the Parliament in January 2018)
primarily dealt with an amendment to introduce Section 29A to IBC
which set out the grounds for ineligibility of the resolution
applicants to submit a resolution plan under IBC.
The second amendment by way of this Ordinance introduces
primarily three changes to IBC, as also stated in one of the
objectives of the Ordinance:
Apart from the changes mentioned as above, the Ordinance also
addresses some of the practical issues as experienced in the
journey of IBC so far.
Amendment |
Particulars |
Khaitan
Viewpoint |
Homebuyers recognised as Financial Creditor |
Definition of
Financial Debt |
- A deeming fiction has been created such that any amount raised
from an allottee under a real estate project is deemed to be having
commercial effect of borrowing.
- Accordingly, the due owed to a homebuyer by the corporate
debtor recognised as financial debt
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This would give right to
homebuyers to initiate insolvency process in case of default as
well as seat in the committee of creditors with other financial
creditors.
Considering the approach of deeming fiction, the clause would be
interpreted strictly. As such, its application will have to be seen
in scenarios where the money is raised from homebuyers in one
entity and the project development is housed in another group
entity.
However, this is an important shift in position on insolvency of
real estate developers and would further strengthen the position of
home buyers after RERA which puts strict obligations on developers
for timely construction of projects. |
Representation
of Homebuyers |
- An authorised representative shall be appointed for a class of
creditors (exceeding such numbers as may be specified)
- Such authorised representative will be appointed by the
Adjudicating Authority (NCLT) upon an application by the interim
resolution professional (IRP)
- Authorised representative is required to be an insolvency
professional
- Appointment shall be prior to the first meeting of the
Committee of Creditors (CoC)
- Such authorised representative shall attend the meetings of CoC
and vote on behalf of such financial creditors (homebuyers) to the
extent of his voting share
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- The finer details will be provided by way of changes to the
Insolvency and Bankruptcy Board of India (Corporate Insolvency
Resolution Process) Regulations 2016 (CIRP Regulations)
- The changes to CIRP Regulations will, inter alia,
provide the number of creditors in a class (including a class of
homebuyer-creditors) that can represent themselves and upon
crossing such prescribed number, an authorised representative will
have to be appointed.
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Manner of voting
in COC by the authorised representative of homebuyers (financial
creditors) |
- Authorised representative shall cast his vote in respect of
each financial creditor in accordance with prior instructions
received from each financial creditor he represents, to the extent
of their respective voting share
- Authorised representative to circulate the agenda and minutes
of the meeting of CoC to the financial creditors he represents
- Authorised representative is duty bound to not act against the
interest of the financial creditor he represents
- If any financial creditor (homebuyer) fails to give prior
instructions to the authorised representative, he shall abstain
from voting on behalf of such financial creditor
- Authorised representative is required to file with CoC any
instructions received by way of physical or electronic means from
the financial creditor he represents – to ensure that the
voting is correctly recorded for such financial creditors.
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- The system of appointing authorised representative for a class
of creditors has been worded generally and is not specific to
homebuyers leaving the flexibility to recognise other classes of
creditors for the purposes of voting and representation in CoC
- The electronic means of procuring prior voting instructions are
expected to be notified as part of CIRP Regulations by the
Insolvency and Bankruptcy Board of India (IBBI).
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Section 29A Amendments: Relaxation in its scope and
applicability |
Related party in
relation to an individual |
- The definition, inter alia, covers relatives leading
up to the fourth generation of an individual (i.e upto sons and
daughters of grandchildren) and maternal side of an individual (i.e
upto grandparents of an individual), including respective spouses
of each such individual
- The definition also provides situations when private companies,
public companies, trustees of a trust, partnerships, LLPs would be
related party of an individual
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- Earlier, the term 'related party' in the definition of
'connected persons' under Section 29A was primarily read to
be in the relation to a 'company' in terms of the
definition under Section 2(76) of the Companies Act 2013 (Companies
Act)
- For related party in relation to individual, the definition of
'relative' under Section 2(77) of Companies Act was
referenced which was narrower than the new definition as introduced
by the Ordinance
- The new definition widens the scope of the 'connected
persons' significantly, thereby making the sweep of
ineligibility wider.
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Disqualification
due to a person being a promoter or in management or control of a
non-performing account (NPA) and one year has lapsed as being
NPA
Clause (c) of Section 29A |
- The opening sentence of the clause has been amended to
specifically provide that a person shall have the NPA account or
shall be promoter or in management or control of an NPA account
'at the time of submission of the resolution
plan'
- Exemptions:
- A financial entity which is not a related party of the
corporate debtor shall not be subjected to this
disqualification
- If a resolution applicant has an NPA account where such account
was acquired pursuant to a resolution plan under IBC – it
shall be exempt from this disqualification for a period of 3
years
- Anyone submitting resolution plan for Micro, small and medium
enterprises (MSMEs), has been exempted from this
disqualification
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- Pursuant to this amendment, a person would now be tested for
ineligibility at the time of submission of resolution plan rather
than at the time of commencement of insolvency.
- The exemption to financial entity is a welcome step as it
addresses their concerns relating to the possibility of them
actually having an NPA account for instance where such financial
entity was already in the business of investing in stressed assets
or the shares were acquired as part of the resolution through a
scheme permitted by RBI, amongst others
- The relaxation for MSMEs comes in the wake of growing
realisation that the market for stressed assets in MSMEs sector has
not matured as it has seen very less bidders. Accordingly, to avoid
liquidation of these MSMEs, not only the promoters of MSMEs (if
they do not suffer from other disqualifications such as being
wilful defaulter) have been allowed to bid for their own companies
even though they had become NPA but also any bidder for MSMEs who
is otherwise disqualified on account of its account being NPA.
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Disqualification
due to being convicted for a criminal offence
Clause (d) of Section 29A |
- Earlier the disqualification attached to a person where he was
convicted for an offence punishable with imprisonment of 2 years or
more
- Now the disqualification attaches where the person is convicted
for an offence publishable with imprisonment of 7 years or more
other than certain prescribed statues in which case the threshold
remains 2 years or more
- The list of prescribed acts includes those relating to economic
offence under securities law, central tax law, environment law,
foreign exchange laws, anti-corruption laws, etc.
- Exemptions:
- Holding company, subsidiary company, associate company and
related parties of the resolution applicant would no longer be
subjected to this disqualification – applicable to the
promoter and persons in management or control of the resolution
applicant
- Disqualification not applicable to a person where 2 years have
lapsed from the date of release of such person.
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- The proposed changes recognise the personal nature of this
disqualification and rightly limits the scope of its applicability
by no longer being applicable to the wider group of 'connected
persons'
- It also clarifies that a person is not disqualified forever due
to a past conviction
- By classification of disqualification thresholds basis the
nature of laws, the provision has been rationalised which helps in
addressing issues around this clause being arbitrary.
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Disqualification
for being disqualified to be appointed as a director under
Companies Act
Clause (e) of Section 29A |
- Exemption: Holding company, subsidiary company, associate
company and related parties of the resolution applicant would no
longer be subjected to this disqualification – applicable to
the promoter and persons in management or control of the resolution
applicant.
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- The amendment recognises the personal nature of this
disqualification which should not attach to all the 'connected
persons'
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Disqualification
due to avoidance transactions
Clause (g) of Section 29A |
- This disqualification is applicable if a person is a promoter
of or in management or control of a corporate debtor where a
preferential transaction, undervalued transaction, extortionate
credit transaction or fraudulent transaction has been found by
NCLT
- Exemption: it has been clarified that where such avoidance
transactions have taken place prior to the acquisition of the
corporate debtor pursuant to IBC or pursuant to a scheme approved
by a financial sector regulator or a court, the acquirer shall not
be subjected to this disqualification.
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- The amendment is in line with the principle that the acquirer
of a corporate debtor pursuant to a resolution plan shall not be
punished for avoidance transactions taken place prior to the
acquisition
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Disqualification
due to being a guarantor to a corporate debtor undergoing
insolvency under IBC
Clause (h) of Section 29A |
- Earlier the disqualification attached merely on the ground of
having provided a guarantee and the beneficiary-creditor of such
guarantee having initiated insolvency against the principal
borrower-corporate debtor
- The amendment also adds a requirement that such guarantee
should have been invoked and remains unpaid in full or part, to
attach this disqualification
- Exemption: Anyone submitting resolution plan for MSMEs has been
exempted from this disqualification.
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- This amendment is in line with the NCLT (Kolkata Bench)
judgment in MBL Infrastructure Limited where NCLT held that merely
because a guarantee has been provided by the promoter of the
corporate debtor he cannot be disqualified, if such guarantee has
not been invoked
- In line with the exemption to MSMEs from NPA related
disqualification, resolution applicants for MSMEs including the
promoters of such MSMEs are also exempted even if they have
provided guarantees that have been invoked by the lenders.
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Scope of
Connected Persons for financial entities |
- Where a financial entity is the resolution applicant –
the holding companies, subsidiary companies, associate companies
and related parties of such financial entity or its promoter, or
persons in management or control would not be put to test under
Section 29A
- Further, financial entity has been defined to include:
- a scheduled bank;
- any entity regulated by a foreign central bank or a securities
market regulator or other financial sector regulator of a
jurisdiction outside India (which is FATF compliant);
- any investment vehicle, registered FII, registered FPI, or a
foreign venture capital investor;
- asset reconstruction companies;
- alternate investment funds;
- such categories as may be notified by the Central
Government
- The exemption available to financial entity to not subject all
its group entities to the test under Section 29A would not be
applicable to those financial entities which are related parties of
the corporate debtor itself
- However, it has further been clarified that a financial entity
which has become related party of the corporate debtor due to
conversion of its debt into equity can avail this exemption.
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- While a financial entity (which is not a related party of the
corporate debtor) has entirely been exempted from the
disqualification due to NPA accounts, this exemption helps narrow
down the list of connected persons of a financial entity which
would be subjected to the test under Section 29A
- Earlier only AIFs, ARCs and scheduled banks in India were able
to avail such exemption.
- The expanded definition of financial entity will enable even
foreign investors to avail this exemption of reduced exposure of
its investments and portfolio companies as they would be exempt
from being put to test under Section 29A.
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Prospective
application of the changes introduced to Section 29A |
- Newly introduced Proviso to section 30(4) specifically provides
that the eligibility criteria in Section 29A as amended by the
Ordinance shall apply to those resolution applicants who have not
submitted resolution plan as on the date of commencement of the
Ordinance, i.e. 6 June 2018
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- Section 29A being a disqualification provision (penal in
nature) cannot be applied retrospectively and thus will be applied
prospectively for resolution plans to be submitted after 6 June
2018.
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Voting Thresholds for Decisions by CoC |
Default voting
requirement of 51% |
- All decisions of the CoC shall be taken by a vote of not less
than 51% of voting share of the financial creditors, except where
otherwise provided elsewhere in IBC
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- Earlier all the decisions of CoC were required to be taken by
75% votes in favour of such decisions
- The items for 51% voting requirement would include residual
items for which the voting threshold has not been provided
specifically under IBC.
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Items that
require 66% voting |
- Approval of a resolution plan;
- Actions under Section 28 of IBC, including raising interim
financing, issuance of additional securities, undertake any related
party transactions, make any change in the management of the
corporate debtor or its subsidiary, etc.;
- Appointment or replacement of resolution professional;
- Decision by CoC to liquidate the corporate debtor.
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- The voting requirement has been reduced from 75% to 66% in view
of the experiences in many cases where the resolution of could not
be achieved due to the requirement of 75% votes.
- The reduced requirement is aimed at promoting resolution over
liquidation.
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Item that
require 90% votes – Withdrawal of insolvency
process |
- NCLT may allow withdrawal of insolvency commencement
application upon application made by the applicant with the
approval of 90% voting share of CoC, in such manner as may be
prescribed
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- This amendment is in view of the challenges faced by NCLT and
NCLAT in setting aside insolvency process even when the applicant
and the corporate debtor have reached a settlement.
- In most of the cases, Supreme Court had to exercise its
inherent powers under Article 142 of the Constitution of India to
set aside insolvency process basis settlement between parties, as
IBC did not have any provision that provided for settlement between
the parties
- While an enabling provision to recognise the settlement with
CoC has been introduced by the Ordinance which may be of
significance for the promoters of corporate debtor in giving them a
second chance to negotiate a settlement with its creditors, the
framework under which settlement can be worked out is awaited as
part of the rules to be notified by the Central Government.
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Moratorium not applicable to Personal or Corporate
Guarantors |
Amendment to
Section 14 (Moratorium Provision) |
- Section 14 has been amended to specifically provide that the
moratorium on instituting any suit against the corporate debtor or
its property is not applicable to 'a surety under a
contract of guarantee to corporate debtor'
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- The last judicial position on this was that the moratorium
provision is also applicable to the guarantors and accordingly, the
guarantees could not be invoked during the insolvency process,
which was under challenge before Supreme Court
- This amendment settles this long-debated question and would
allow initiation of proceedings against guarantors during
insolvency process of the corporate debtor.
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Clubbing of
insolvency proceedings against guarantors |
- Section 60 deals with the jurisdiction of NCLT
- While the chapter relating to bankruptcy of individuals under
IBC i.e. applicable in case of personal guarantees has not yet been
notified, the erstwhile Section 60(2) and (3) provided for
initiation / of bankruptcy proceedings against the personal
guarantor to the NCLT dealing with the insolvency /liquidation of
the corporate debtor
- The amendment to Section 60(2) and (3) now also provides for
insolvency proceedings against the corporate guarantor (in addition
to the personal guarantor) to the corporate debtor to be initiated
with or transferred to the NCLT which is dealing with the
insolvency / liquidation process of the corporate debtor.
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- This is a significant amendment in as much as insolvency
proceedings against the corporate guarantor of a corporate debtor
can be clubbed with the same NCLT.
- This may be a step towards efforts to streamline the resolution
of insolvency of the group
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Amendments to Streamline the Process |
Certain
Clarificatory Amendments |
- Meaning of Dispute: In an application by the operational
creditor to initiate insolvency against the corporate debtor, the
language has been clarified to indicate that dispute regarding the
liability to the operational creditor need not necessarily be
demonstrated by a suit in a court – in line with the judgment
of the Supreme Court in Mobilox Innovations Private Limited vs
Kirusa Software Private Limited
- Waived the requirement to procure certificate from a financial
institution regarding amount due and claimed against the corporate
debtor: The courts faced question in this regard as to whether a
foreign bank certifying non-payment by corporate debtor is in
compliance of this requirement. While the courts did read this
provision liberally and allowed the certificates issued by foreign
banks to also be considered, this amendment waives this as a
mandatory requirement
- Interim resolution professional (IRP) to continue till the
appointment of the resolution professional (RP) and not till the
expiry of 30 days of his appointment
- RP to continue managing the affairs of the corporate debtor
until the resolution plan is approved by NCLT. Earlier, NCLT had to
pass specific orders to vest RP with the powers to manage the
affairs of the corporate debtor pending decision with NCLT
regarding the resolution plan submitted to it by the RP
- Compliance with Laws: IRP/RP responsible for complying with the
requirements under any law for the time being in force on behalf of
the corporate debtor. IBBI had earlier vide its circulars cast a
similar responsibility on the RP
- Shareholder Approval: Any requirement for approval of
shareholders under the Companies Act or any other law for taking
any actions under a resolution plan has been specifically waived.
Earlier, Ministry of Corporate Affairs vide its circular dated 25
October 2017 had waived the requirement of shareholders'
approval for any actions under resolution plan
- Limitation Act to be applicable: Following various conflicting
judgments and views on the applicability of provisions of
Limitation Act to the cases under IBC, the amendment has clarified
that Limitation Act 1963 shall be applicable. This implies that
inter alia a person to whom time-barred debt is owed by
the corporate debtor would not be able to initiate insolvency
proceedings against such corporate debtor.
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- Each of these amendments have been introduced following the
various issues arising in relation to the subject matter of these
amendments.
- While judicial precedents had clarified positions to some
extent, the Ordinance gives legislative certainty in resolution of
these issues.
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Special
Resolution for initiation of insolvency process by corporate debtor
on its own |
- As part of the application by a corporate debtor to initiate
insolvency resolution process for itself under Section 10, an
additional requirement of special resolution by its shareholders or
a resolution by 3/4th of its partners in case of an LLP approving
the initiation of insolvency proceedings for itself has been
added.
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- This amendment is aimed to ensure that the borrowers initiate
insolvency process only with approval of shareholders as Companies
Act does not prescribe this as a separate approval requirement from
shareholders.
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One year period
for implementation of a resolution plan |
- The resolution applicant is required to obtain necessary
approval required under any law within a period of one year from
the date of approval of the resolution plan by NCLT.
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- This amendment reinforces that a resolution plan cannot waive
the requirement to comply with mandatory applicable laws, such as
competition law and other sectoral regulatory laws, as may be
applicable
- Such a provision also begets the question if the resolution
plan may be made conditional to receipt of approvals under
applicable law
- The amendment also creates uncertainty regarding the question
if approval of schemes of merger / demerger, capital reduction,
etc. can be granted by NCLT as part of the resolution plan. Such
schemes otherwise have separate processes under the Companies Act
to be followed before NCLT.
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Central
Government may modify applicability of any provisions to
MSMEs |
- In terms of Section 240A, Central Government has been given
power to exempt MSMEs from the applicability of any of the
provisions under IBC or to apply any of the provisions with such
modifications as it may specify
- Central Government may exercise this power in the public
interest by way of a notification
- A draft of such notification is required to be placed before
Parliament for 30 session days before being issued.
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- This approach gives the Central Government flexibility to
swiftly respond to the changing requirements for MSMEs and to cater
to their specific needs without following the legislative amendment
route.
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With the experience of first 18 months of the working of IBC
where the law was applied in the largest cases of default through
RBI intervention and lot of small and mid-sized borrowers were
pushed into liquidation, the amendments introduced through the
Ordinance is intended to streamline the process of resolution
further. It also pushes a very important objective of IBC i.e.
resolution over liquidation which is expected to guide all the
stakeholders involved in the process of resolution going forward.
The efforts to strengthen the position of homebuyers and permitting
withdrawal of insolvency proceedings post admission are again a
timely response to the challenges faced by the stakeholders in the
initial cases and would provide further maturity and direction to
the insolvency resolution process.