Any entity which is undergoing corporate insolvency resolution process (CIRP) faces severe financial distress due to the lack/scarcity or absence of funds in its coffers. The Resolution Professional (RP) has the primary duty of managing the affairs of the company undergoing CIRP and has several primary duties as provided under the Insolvency and Bankruptcy Code of 2016 (IBC). A RP needs finance for operating the entity undergoing CIRP (Corporate Debtor) referred to as Interim Finance. But it is pertinent to note that raising of such interim finance is very arduous for the RP and Corporate Debtors as no individual or corporate entity would be ready to invest in a sinking ship. To resolve this issue, a viable option for funding the Corporate Debtor is through Third Party Funding (TPF). This kind of funding has been used in the field of dispute resolution mechanisms and has the potential to act as a lifeboat in insolvency proceedings too.
Third Party Funding
TPF also referred to as 'Litigation Funding' is a mechanism to facilitate the recovery of claims by individuals and companies, especially those under financial stress, by funding the costs of legal proceedings. A litigation funder finances the cost of the litigation in exchange for a share of any recovery made through the proceedings, rather than the claimant paying the costs of the same. This funding mechanism assists litigants in covering the expenses associated with various forms of dispute resolution, including litigation, arbitration, and mediation. It is popularly referred to as Litigation Funding as the capital herein is leveraged in the ongoing litigation disputes with the aim of levelling the field between the parties in dispute. This type of funding is often on a non-recourse basis, meaning thereby that if the claim cannot be recovered, the claimant is not responsible for repaying the legal costs incurred by the litigation funder. Consequently, the litigation funding agreement typically stipulates that the litigation funder assumes most of the risk, including the risk of losing a claim and any damages that may arise from the litigation related to that claim.
Hence, Third Party Funding helps in covering the legal cost of Litigants such as Lawyer's fees and other related professional fees and out of pocket expenses. It is a viable option for the purposes of funding disputes as it would help the parties in facilitating the whole process at ease. The question that arises here is how such funding could assist a company undergoing CIRP.
The need of Interim Finance
The provision of Interim Finance plays a crucial role in the CIRP process as it helps the RP keep the Corporate Debtor afloat. The Code enlists several duties of the RP, all of which revolve around a singular tenet i.e., the preservation and protection of the assets of the Corporate Debtor.1 The RP, being responsible for the day to day operations of the corporate debtor is responsible for raising of interim finance as provided under the IBC.
To comply with Section 25 and other related provisions of the IBC, interim finance becomes crucial, which has been defined as a financial debt raised by the RP.2 It plays an essential role in the CIRP as it provides resources for carrying on the operations of the Corporate and meet litigations expenditures too. Another essential aspect where interim finance plays a crucial role is in cases of avoidance proceedings wherein the RP has the power to undo all those 'prior' transactions, undertaken for the benefit of any particular creditor or set of creditors harming the interest of other creditors.3 In other words, these provisions of IBC nullify those transactions which lack commercial substance and are solely designed to favour certain creditors or hinder CIRP. This is a safeguard against situations where assets are transferred to deliberately exclude them from the pool available to resolution applicants or creditors during insolvency or liquidation.
To ensure that such claims can be staked, and the rights of all creditors are secured equitably, the RP does need finance. But raising finances for a sinking ship is very arduous for the RPs and face several hurdles in the same. In the case of Edelweiss Asset Reconstruction Co. Ltd. v. Sai Regency Power Corporation (P) Ltd.,4 the court stated that non provision of expeditious interim finance would impede the goal of maximization of the asset value of the Corporate Debtor and would bring the whole process to a grinding halt. This would defeat the spirit and objective of the IBC. Even in the CIRP of Binani Cements, the appointed RP annotated that public sector undertaking banks could not provide for injecting funds due to several provisioning requirements under the RBI guidelines prohibiting such institutions from granting loans to the Corporate Debtor.
Such hurdles are prevalent due to two major aspects:
- No Guarantee on Returns: The expected return on investment is very fragile in such cases and hence creditors become wary and hesitant while injecting funds into such distressed companies.
- Priority Displacement: Once the RP is able to secure interim finance, the IBC states that under the waterfall mechanism, such costs would be in priority to other existing debts.5 Hence, many a times the debt raised by the Corporate Debtor/RP for the purposes of interim finance is disliked by the existing creditors of the corporate debtor because they are reluctant to allow the status of super-priority to such rescue financers which would push them down the waterfall.
Hence, it can be seen that while interim finance acts as a temporary float for any company, there are several hurdles which are faced by the RP/Corporate Debtor to obtain the same, creating a hindrance in rescuing an entity from the clutches of the CIRP and thereby indubitably leading to liquidation.
The Nexus of TPF and Interim Finance
The premise on the basis of which TPF operates is that it is a way of financing which is on non-recourse basis meaning that the funder only recoups their investment if the funded claim is successful and hence the claimant herein is in no obligation to pay back if the claim does not succeed. The risk taken herein is solely of the funder. While the general practice of accessing such funding has been purely only for resolving legal dispute resolutions, TPF can also facilitate a distressed organisation through other ways such as:
- Facilitating Day-to-Day Operations: In insolvency proceedings, maintaining operational continuity is critical for maximizing asset value. TPF provides the necessary liquidity to cover essential operational costs, such as salaries and utility bills, allowing the corporate debtor to function effectively during the CIRP. The absence of immediate cash flow can lead to operational disruptions, which can further diminish the value of the distressed entity. TPF acts as a lifeline, enabling companies to sustain their business activities while navigating the complexities of insolvency.
- Mitigating Financial Constraints: Traditional financing options often become unavailable or too risky for creditors during insolvency. TPF addresses this gap by offering an alternative source of funding that does not require immediate repayment. This arrangement allows RP to pursue necessary legal actions such as avoidance proceedings without the burden of upfront costs.
- Facilitating Legal Proceedings: TPF is particularly beneficial for covering legal expenses associated with pursuing claims against prior fraudulent transactions or preferences made by debtors before insolvency. The ability to secure funding for such litigation is crucial, as these actions often require substantial resources and can be time-consuming. The Supreme Court in A.K. Balaji v. Bar Council of India6 acknowledged that third-party financing for litigation is permissible under Indian law, reinforcing the legitimacy of TPF in supporting legal claims during insolvency proceedings. This support enables RPs to act decisively against wrongdoers and recover assets that might otherwise be lost.
- Enhancing Recovery Potential: By securing interim finance through TPF, RPs can focus on restructuring efforts and maximizing asset recovery without being hindered by financial constraints. The availability of funds allows for strategic actions that can enhance the overall recovery for creditors. This aligns with the objectives of the IBC, which aims to preserve companies as going concerns and maximize their value for stakeholders.
It can be seen that while TPF has become very synonymous to Litigation Funding the ambit of the same can be widened so as to achieve the objectives with which the IBC has been enacted. The same is achieved as it facilitates the access to justice while preserving the going concern status of corporate entity. By providing a viable source of interim finance, TPF supports smoother insolvency proceedings and enhances the chances of successful resolution plans that benefit all stakeholders involved. By tapping into TPF, the prevalent hurdles for accessing interim finance too diminishes up to a certain extent as the same is on a non-recourse basis.
Hence, TPF can act as a viable solution for facilitating interim finance to Corporate Debtors not only in the domain of securing their legal costs and expenses but also to keep the company afloat and maximize the value of assets.
International acceptance of TPF for CIRP
With TPF proving its viability in the field of dispute resolution across the world, it has slowly started gaining acceptance in the domain of insolvency proceedings too.
Australia was one of the first countries in the world to recognise the legitimacy of lawsuit funding in a bankruptcy environment. The Corporations Act of 2001 provides for the statutory requirement of approval of litigation funding agreement agreements from courts ensuring judicial oversight. The courts herein also have the power to invalidate any litigation funding agreement, if it is deemed unfair under the grounds of illegality, unconscionability and public policy under equitable contract. While in Singapore, the implementation of Insolvency, Restructuring and Dissolution Act 2018 (IRDA), authorized liquidators and judicial managers to utilize third-party funding. The funding agreements are subjected to the court's approval particularly in regards to claims in relation to undervalued transactions, unfair preferences, and fraudulent trading. While, there are several countries across the world accessing third party funds for the purposes of litigation, the usage of such funds for the purposes of insolvency has been limited. There are only a handful of countries where the practise of utilising and accessing such pool of funds for the purposes of interim finance has been executed.
In Sum
The utilization of TPF in insolvency proceedings has emerged as a transformative mechanism that addresses the financial challenges faced by distressed entities. By providing essential liquidity, TPF enables corporate debtors to maintain operational continuity, thereby preserving asset value during CIRP. This funding model alleviates traditional financial constraints by offering a non-recourse option, allowing resolution professionals to pursue necessary legal actions without the burden of upfront costs. Furthermore, TPF enhances the recovery potential for creditors by facilitating legal proceedings related to avoidance actions against fraudulent transactions. As jurisdictions worldwide increasingly recognize the benefits of TPF, its integration into insolvency frameworks not only promotes access to justice but also strengthens the overall resolution process, ensuring equitable outcomes for all stakeholders involved. While globally, the purview is only funding for litigation costs even in the aspect of insolvency, the extent of usage of such funding can be increased exponentially. With the Indian laws being lax in pursuance to such kind of funding, the usage of the same can be extended from purely litigation and dispute resolution aspects to financing of a company's day to day operations undergoing insolvency. This evolving landscape underscores TPF's role as a vital resource in navigating the complexities of insolvency, ultimately fostering successful resolution plans and maximizing asset recovery.
Footnotes
1 Section 25 of the Insolvency and Bankruptcy Code, 2016.
2 Section 5(15) of the Insolvency and Bankruptcy Code, 2016.
3 Section 25(2)(j) of the
4 Company Appeal (AT) (Ins) No.887 of 2019.
5 Section 53(1)(a) of the Insolvency and Bankruptcy Code, 2016.
6 AIR 2018 Supreme Court 1382.
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.
