India: Note On Scheme Of Compromise And Arrangement W.R.T Insolvency And Bankruptcy Code, 2016

Question: What will be the status of a scheme of compromise or arrangement initiated under section 230 of the Companies Act, 2013 if the Corporate Insolvency Resolution ("CIR") under the Insolvency and Bankruptcy Code, 2016 ("Code") is triggered during the pendency of such a scheme of compromise or arrangement.

Answer: In order to answer the question above it is necessary to understand the following provisions of the Code in detail:

Moratorium –

Under the Code, the National Company Law Tribunal ("NCLT") is required to declare a moratorium at the time it accepts an application for the CIR process. The moratorium would prohibit:

  • Institution or continuation of suits or proceedings against the company;
  • Any actions for foreclosure, recovery or enforcement of any security interest;
  • Transfer, alienation or disposal by the company of any of its assets or any legal or beneficial interests in the assets;
  • Recovery of any property by an owner or lessee where such property is owned by or in possession of the company;
  • Maintenance of supply of essential goods and services (as may be prescribed) to the company.

The moratorium is required to continue until the completion of the CIR process. The provisions of the Code specifically prohibit institution of any suits or proceedings against the company. In our view a scheme of compromise or arrangement is not a proceeding "against" the company and hence would not be barred. In Commissioner of Income Tax vs. Hindustan Bulk Carriers [(2003) 3 SCC 57] the Hon'ble Supreme Court observed 'If the choice is between two interpretations, the narrower of which would fail to achieve the manifest purpose of the legislation we should avoid a construction which would reduce the legislation to futility, and should rather accept the bolder construction, based on the view that Parliament would legislate only for the purpose of bringing about an affective result'. The intent of the Code is to facilitate rehabilitation of companies wherever feasible and to facilitate efficient liquidation in those cases where resolution of the financial distress of the company is not viable. Keeping in mind the intent of the Code, an interpretation of the provisions which goes against the object sought to be achieved by the Code would not be warranted.

Overriding effect of the Code

Section 238 of the Code provides that the provisions of the Code shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law. The provisions of the Code shall take precedence over any other law which may be inconsistent with the provisions of the Act. While interpreting similar notwithstanding provisions under the Sick Industrial Companies (Special Provisions) Act, 1985 the Hon'ble Bombay High Court in the case titled Re: Pharmaceutical Products of India Ltd. [(2006) 131 CompCas 747 (Bom)] considered the question whether pendency of proceedings before Appellate Authority for Industrial and Financial Reconstruction would exclude jurisdiction of the High Court to entertain petition for compromise or arrangement. The Court after relying on various cases observed that "The legal position is that the provisions of 1985 Act shall prevail over the provisions of the Companies Act 1956 "in case of inconsistency" in a given subject. Besides as is noticed by our High Court the provisions of the two enactments operate in different spheres and the scheme in so far as the power of the High Court to grant sanction to the proposed scheme of arrangement is unaffected".

Similarly the provisions of the Code would interfere and accordingly override the provisions of the Companies Act, 2013 only in the event that the provisions of the Code are inconsistent with the provisions of the Companies Act, 2013 and not otherwise. In the present question, the proceeding for arrangement or compromise is a separate procedure which may not stricto sensu be construed to be inconsistent with the provisions of the Code.

Jurisdiction of Civil Courts excluded

Section 231 of the Code also bars jurisdiction of all other civil courts in respect of any matter in which the Adjudicating Authority is empowered by, or under, the Code to pass any order.

In view of the above, it is opined that although the Companies Act, 2013 and the Code are procedurally different, they are not repugnant to each other. The doctrine of harmonious construction which has been reiterated by the Hon'ble Supreme Court in many cases, clearly states that the statutes have to be construed so as to not reduce the statutes to futility. Giving such harmonious construction to the statutes, we understand that if the CIR process gets triggered during the consideration of a scheme of arrangement or compromise, the scheme shall not abate but shall continue and the Resolution Professional may represent the company in such a meeting for arrangement or compromise.

During the CIR, a scheme maybe passed by the Committee of Creditors mandating the pursuance of a scheme of arrangement or compromise. However, the scheme passed during the CIR process would also require to provide for certain additional matters such as:

  1. Payments of liquidation value to dissenting financial creditors i.e. creditors who do not consent to the resolution plan;
  2. Payments of liquidation value to operational creditors;
  3. Payment of the insolvency resolution process costs.

Once a resolution plan mandating the pursuance of a scheme of arrangement and compromise is passed, the creditors are free to continue their action under section 230 of the Companies Act, 2013 and proceed in accordance therewith.

Important Elements to be considered :

  1. Appointment of Interim Resolution Professional by hostile party – Although the Resolution Professional is under a professional obligation to continue with his operations impartially and is ultimately under the control of the Committee of Creditors, nonetheless in the event where the CIR process is initiated by a hostile party, such a party would be at liberty to appoint an Interim Resolution Professional of his/ her choice. In such an event, the Resolution Professional may not be supportive of the proceedings under section 230 of the Companies Act, 2013 although he has no power to thwart the process under the Companies Act. Under such circumstances, the Financial Creditors (majority) would ideally approach the NCLT and request the NCLT to either replace the Interim Resolution Professional or either instruct him on early constitution of the Committee of Creditors. Once the Committee of Creditors is constituted, it is their prerogative to replace the Resolution Professional as they deem necessary.
  2. Misconduct or stripping away of assets – If during the scenario mentioned in the point above, the creditors apprehend that the assets of the company are likely to be stripped or siphoned off, the remedy available with the creditors is again to approach the NCLT and request for orders for protection of the company's assets in addition to the orders for early constitution of the Committee of Creditors.
  3. Intention of the scheme of compromise and arrangement – The scheme of compromise and arrangement between a company vis-a-vis its creditors or members is basically done for the reorganization of the company's share capital by the consolidation of shares of different classes or by the division of shares into shares of different classes. The intention of the legislature is to reorganize and resolve the issues of the companies through such a scheme which may be brought up by either the company itself, the creditors, members of the company or in case of a company which is being wound up, of the liquidator.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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