The Insolvency and Bankruptcy Code (Amendment) Act, 2019 seeks to address critical gaps and inconsistencies in insolvency resolution timelines, payments received by operational creditors under a resolution plan and manner of voting by an authorised representative on behalf of the class of financial creditors

Background

The Insolvency and Bankruptcy Code, 2016 (Code) is one of the most significant measures undertaken by the Government to address the substantial increase in the level of distressed debt in India. The Code sets out a time-bound insolvency resolution process for defaulting corporate debtors and introduces a creditor-in-possession model whereby a committee of creditors (CoC) is constituted to take decisions regarding the operations of the corporate debtor, including evaluating prospective resolution plans for resolving the corporate debtor's account. The Code was a remarkable step towards resolution of stressed assets, however certain critical inconsistencies and gaps became evident given various legal proceedings initiated in respect of corporate insolvency resolution processes (CIRP).

Additionally, there have been certain judicial pronouncements recently which are being viewed as contrary to the Code's envisioned priority of distribution to financial creditors vis-à-vis operational creditors.

To address some of these issues, the Parliament passed the Insolvency and Bankruptcy Code (Amendment) Act, 2019 (Amendment) which received Presidential assent on 5 August 2019 and will become effective from such date that the Central Government may appoint by notification.

Key Changes

(a) Clarity on allowing comprehensive corporate restructuring through merger, amalgamation and demerger under a resolution plan

Under the Code, it was unclear whether resolution plans could include restructuring provisions such as mergers, demergers or amalgamations. The market practice was to utilize these modes of corporate restructuring in various permutations and combinations. The Amendment clarifies that a 'resolution plan' may include provisions for restructuring by way of merger, amalgamation, and demerger. This clarification can be seen as legitimising existing practices being used to arrive at a commercial resolution.

(b) Time-bound disposal of the resolution application

In order to initiate a CIRP in respect of a corporate debtor, any creditor/corporate debtor may file an application (Resolution Application) before the National Company Law Tribunal (NCLT). The Code provides a period of 14 days for the NCLT to 'ascertain the existence of default' and admit or reject a Resolution Application for initiating insolvency proceedings.

The Supreme Court in the case of J.K. Jute Mills Co. Ltd. v/s Surendra Trading Co. had concurred with the opinion of the National Company Law Appellate Tribunal (NCLAT) that this time limit of 14-days is directory rather than mandatory, and that the NCLT has inherent powers to extend the 14-day period on a case-to-case basis in the interest of fairness and justice. In practice, in many cases, the NCLT would take 3 weeks to a month to ascertain the existence of a default before admitting or rejecting a Resolution Application.

The Amendment introduces judicial discipline in this respect by making it mandatory for the NCLT to pass an order admitting or rejecting a Resolution Application within 14 days from the date of its receipt. In the event of a failure to do so, the NCLT is now required to record the reasons in writing for the delay in determination of default. This amendment therefore seeks to ensure that the 14 day period is only extended in exceptional cases and not as a matter of routine.

(c) Timeline for completion of CIRP increased to an overall limit of 330 days

Prior to the Amendment, the Code required that the CIRP should be concluded within a maximum period of 180 days (with a maximum one-time extension of 90 days) from the insolvency commencement date (the Code denotes this to be the date of appointment of interim resolution professional). However, many CIRPs were exceeding this overall 270-day limit on account of legal proceedings initiated either against the corporate debtor, the CoC or the Resolution Professional.

The Amendment provides that the CIRP must mandatorily be completed within an overall timeline of 330 days from the insolvency commencement date (including all or any extensions granted as well as any litigations and related legal proceedings). Additionally, for an ongoing CIRP, in case the 330-day overall timeline has already been breached at the time the Amendment comes into force, the Amendment provides for an additional relaxation of 90 days as a transitionary measure.

The use of the words 'mandatory' and 'shall be completed' is a further clear indication to complete the CIRP in the specified time frame of 330 days without exception.

(d) Voting by an authorised representative on behalf of certain classes of financial creditors

In order to facilitate decision making in the CoC, the Code provided that if an authorised representative represents several financial creditors, then he shall cast his vote in respect of each financial creditor in accordance with instructions received, to the extent of his voting share.

To simplify this voting process for CIRPs involving a large number of financial creditors (such as homebuyers, beneficiaries of securities or deposits held with a trustee, etc.), the Amendment clarifies that the authorised representative of a particular class of financial creditors will vote in the CoC, on behalf of all financial creditors represented by him as per the decision taken by a vote of more than 50% of the voting share of the financial creditors of such class, who have cast their vote. Such majority vote within a class of creditors will be counted as a 100% vote from that class of creditors in favour or against a voting item. For instance, if out of a class of 100 homebuyers 51 or more homebuyers vote in favour of a resolution plan, then all homebuyers would be considered to have voted in favour of the resolution plan.

This amendment will not only facilitate a simplified voting process for classes of creditors but will help the authorised representative to effectively participate in the CoC proceedings and cast his vote on behalf of the financial creditors he represents. This will smoothen the decision-making process in cases where debenture-holders, homebuyers, depositors or other classes form a significant percentage of the CoC.

Further, it is clarified that the amended voting process will not be applicable for taking a decision on the withdrawal of a Resolution Application and the voting process in such cases will be as originally provided under the Code wherein each individual financial creditor will vote individually.

(e) Distributions under the Resolution Plan

The most important change brought by the Amendment is in terms of the inter-creditor distribution of payments during CIRP. Prior to the Amendment, the Code provided that payment to operational creditors under a resolution plan must not be less than the amount that the operational creditors would have received in a liquidation scenario.

However, the Amendment has included an additional requirement – stating that the payment received by operational creditors must not be less than the higher of:

(i) the amount such operational creditors would have received in the event of a liquidation of the corporate debtor as per section 53 of the Code; or

(ii) the amount such operational creditors would have received if the amount distributed under the resolution plan was distributed in accordance with the priority specified as per the liquidation waterfall under section 53 of the Code.

The Amendment provides that payments to financial creditors who do not vote in favour of a resolution plan will be determined in accordance with regulations framed by the Insolvency and Bankruptcy Board of India; but will not be less than the amount that would have been paid to such creditors in the event of liquidation of the corporate debtor.

Additionally, the Amendment clarifies that such payments made to operational creditors as well as dissenting financial creditors under the resolution plan will be construed as fair and equitable to such creditors, thereby reducing the scope of judicial intervention and litigation at this stage.

The Amendment also provides for retrospective application of the above minimum payments to financial and operational creditors under all pending CIRP proceedings namely, those CIRPs:

(i) where the resolution plan has not been approved or rejected by the NCLT; or

(ii) where an appeal has been preferred before the NCLAT/Supreme Court or such appeal is not time-barred under any provision of law for the time being in force; or

(iii) where a legal proceeding has been initiated in any court against the decision of the NCLT in respect of a resolution plan.

The Amendment clarifies that the manner of distribution of claims must take into account the order of priority amongst creditors as specified under the liquidation waterfall provided under section 53 of the Code, including the priority and value of the security interest of a secured creditor.

These changes are relevant in the context of the recent NCLAT order dated 4 July 2019 in respect of the ongoing CIRP of Essar Steel India Limited (Essar Order). In this order, the NCLAT's views were seen as being widely out of sync with the Code's vision of a creditor-in-control model and primacy of financial creditors. The Essar Order held that one of the benchmarks for assessing the viability and feasibility of a resolution plan is whether operational creditors are given roughly the same treatment as financial creditors and if not, then such resolution plan must be modified or rejected so that the rights of the operational creditors are safeguarded. However, on 22 July 2019, the Supreme Court observed that the NCLAT could not act as a resolution professional and distribute funds. Accordingly, it passed a status quo order and the implementation of the Essar Order was kept on hold. The appeals are currently listed for hearing.

(f) Resolution Plan binding on all Stakeholders

Under the Code, once a resolution plan is approved, it is binding on all stakeholders. The Amendment aims to capture this spirit by specifically providing that a resolution plan will also be binding on the Central Government, State Governments or any local authority to whom a debt in respect of payment of dues is owed. This amendment will reduce delays caused by the government or any local authority raising demands post-approval of a resolution plan and makes it clear that once a resolution plan is approved, it is binding on them as well.

(g) Liquidation by the CoC

The Amendment clarifies that the CoC may take the decision to liquidate the corporate debtor any time after the CoC is constituted and before the confirmation of the resolution plan, including at any time before the preparation of the information memorandum.

This can have a significant impact on stakeholders in the CIRP, as this essentially gives the CoC the power to liquidate the corporate debtor in suitable situations even prior to the information memorandum stage (for instance where the 330-day CIRP period might not result in any credible bidders and may devalue the assets further) and the only mode left for value-maximization of the corporate debtor is liquidation.

(h) Powers of the CoC

In addition to giving new powers to the CoC to liquidate the corporate debtor, the Amendment also clarifies the scope of power of the CoC and its role during the CIRP. The Essar Order had severely curtailed the powers of the CoC vis-à-vis consultation and negotiation with bidders while evaluating any resolution plan. The Essar Order held that the CoC can only approve or reject a resolution plan and cannot negotiate it with a resolution applicant to bargain for better terms (the Essar Order stated that the CoC can only request the resolution applicant to do so).

However, the Amendment seeks to change that and in clear words has empowered the CoC to commercially consider the manner of distribution proposed in the resolution plan while deciding its feasibility and viability. The CoC can evaluate such manner of distribution by taking into account the order of priority amongst creditors as per the liquidation waterfall in section 53 of the Code, including the priority and value of the security interest of a secured creditor.

Key Takeaways

The Amendment is the third round of changes to the Code since its inception. These amendments focus on the revival of a corporate debtor by ensuring timely admission and completion of the resolution process and instilling discipline amongst the stakeholders to avoid inordinate delays. However, the most important and awaited changes brought by the Amendment are to reverse the views taken by the NCLAT in the Essar Order and restore the spirit of the Code by providing important clarifications. To summarise, the key changes brought by the Amendment are:

(a) Vis-à-vis distribution of payments

(i) The Amendment recognizes and restores the order of priority of financial creditors in relation to operational creditors in clear terms;

(ii) The Amendment also recognizes inter-se hierarchy amongst secured and unsecured creditors, a crucial distinction removed by the Essar Order; and

(iii) The new minimum introduced for operational creditors and the order of priority discussed above gives recognition to the practice of using the liquidation waterfall under section 53 of the Code as a yardstick to decide the distributions under the resolution plan.

(b) Vis-à-vis powers of the CoC

(i) The Amendment gives wide powers to the CoC for liquidation of a corporate debtor anytime during a CIRP; and

(ii) The Amendment restores the powers of a CoC to evaluate a resolution plan based on commercial consideration and certain defined parameters which was severely curtailed by the Essar Order.

By enhancing the participation and streamlining the decision-making process of different classes of financial creditors (such as homebuyers, debenture holders, depositors etc.) in the CoC, and introducing comprehensive structuring schemes, the Amendment has sought to keep the Code in sync with changing times and the unique challenges that several cases have posed.

The amendments therefore seek to enhance creditor and investor confidence in the CIRP and ensure that the objective of the Code is not diluted.

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.