The nuanced issue of "Whether assets of a subsidiary company can be dealt with or treated under the insolvency proceedings of the holding company" has been gaining significance in the ever-evolving insolvency proceedings? Clarifying this issue is essential today, as a concrete segregation of assets is necessary when inter-connected corporate entities are involved in the absence of a legal regime of group insolvency, particularly in cases where subsidiary is having valuable assets with itself.
Legal Framework: Under Companies Act, 2013
Prior to addressing the core issue, it is prudent to look into the definition of a holding and subsidiary company as defined under Section 2 (46)1 and (87)2 of the Companies Act. A holding company is defined as an entity that holds more than 50% of the voting power in another entity, known as a subsidiary. Conversely, a subsidiary is an entity in which the holding company possesses more than 50% of the voting power.
Despite the interplay between these entities due to overlapping shareholding, it is eminent to emphasize that they are independent legal entities. The point of distinction of both companies being separate legal entities is that the holding companies owns shares of the subsidiary company thereby, retaining control over the management of the subsidiary company. This in no way makes the holding company the owner of the subsidiary's assets.
This principle was affirmed by the Hon'ble Supreme Court of India in its landmark judgment of Vodafone International Holdings BV3. The Court clarified that, in the event of a subsidiary's winding up, its assets do not belong to the holding company; instead, they are handed over to the liquidator.
Legal Framework: Insolvency and Bankruptcy Code, 2016
Since 2016, the insolvency regime in India has been governed by the Insolvency and Bankruptcy Code, 2016 (IBC), which functions as a comprehensive legal framework.
- Section 7 allows financial creditors to initiate insolvency proceedings against an entity in case of a debt default.
- Section 14 imposes a moratorium to maintain the status quo regarding the assets and liabilities of the entity undergoing insolvency proceedings.
- The explanation to Section 18(1) explicitly states that an Interim Resolution Professional shall not include the assets of a subsidiary company in the list of assets compiled during the insolvency proceedings of a holding company.
- Section 30 outlines the process for the approval of a resolution plan.
- Section 32A provides the new management which acquires the Company under IBC is given protection in terms of clean slate principle.
- Section 36 explicitly states that the assets of a subsidiary company shall not be included in the liquidation estate of the holding company.
The mandate of the IBC clearly indicates that no assets of a subsidiary company can be subjected to the insolvency proceedings of a holding company. The doctrine of separate legal personality ensures that the insolvency proceedings of the holding company do not impact the assets of the subsidiary.
Judicial trend
Interestingly the present issue has come up for consideration before the Hon'ble Supreme Court of India in judicial pronouncements titled as "Jaypee Kensington Boulevard Apartments v. NBCC (India) Limited & Ors"4 and BRS Ventures Investments Ltd. V. SREI Infrastructure Finance Ltd. & Anr5.
In Jaypee Kensington, the Supreme Court ruled that the resolution plan of the holding company pertains to its shares in the subsidiary as an asset, meaning it does not encompass the subsidiary's assets, which remain separate and distinct. It must be pointed out that keeping in mind the factual matrix in Jaypee Kensington (Supra), where the parties involved, were left on their own accord to arrive at an amicable resolution left a small resolve of rigidity which could be mis-utilised by multiple stakeholders to reinterpret the law in their own manner.
Subsequently in BRS Ventures Investments Ltd. (Supra), the Hon'ble Supreme Court thoroughly examined the complex question of law and reaffirmed that the assets of a subsidiary company cannot be considered part of the holding company's assets. The Court upheld the National Company Law Appellate Tribunal's finding that the resolution plan of the holding company deals with its investments in the subsidiary, not its assets.
Analysis
The Supreme Court's judgment in BRS Ventures Investments Ltd. effectively addressed the treatment of the assets and liabilities of a holding company undergoing insolvency. This decision protects the rights of various stakeholders involved by excluding subsidiary assets from the holding company's proceedings.
By establishing that the assets of a subsidiary company are distinct, the ruling provides clarity for acquirers and financial creditors, reinforcing the idea that all companies operate as separate legal entities. Any attempt to take over the assets of a subsidiary by way of a resolution plan of the holding company cannot be entertained thereafter.
This clarity is crucial, particularly in sectors like real estate, infrastructure, investment companies etc where financial arrangements are often intertwined with the assets and liabilities of the subsidiary.
The decision brings certainty as regards the treatment of assets of subsidiaries particularly for complex insolvency proceedings such as real estate companies and infrastructure companies where the assets are involved in inter-company financial arrangements, which can impede stakeholders from exercising their rights. If the assets of subsidiary companies were made part of the holding company's assets, it could result large-scale deterioration of value for certain "Lenders and Stakeholders" exclusively having exposure in the underlying subsidiary, given that an approved resolution plan allows for a clean slate for the new management, free from past liabilities. The clean slate theory provides all acquirers a fair chance to revive the corporate entity while providing immunity from all past acts and debts.
Such clarity is not merely academic; but also serves practical purposes by protecting the rights of various stakeholders, including creditors, employees, and investors while demarcating the individual corporate entities so as to maintain its integrity.
The judgments promote a healthier business environment by preventing potential misuse of insolvency proceedings and fostering accountability. As corporate structures continue to evolve, the need for clear boundaries in insolvency law remains paramount, ensuring that inter-company relationships do not undermine financial stability or fairness in the marketplace.
Allowing a holding company to incorporate a subsidiary's assets into its resolution plan could lead to significant financial inequities, undermining the rights of the creditors of the subsidiary company and creating an environment ripe for exploitation. The Supreme Court's decisions reinforces the necessity of maintaining strict boundaries in these scenarios, thereby promoting fairness and stability within the corporate sector.
Ultimately, the analysis underscores the need for continued vigilance in preserving the autonomy of subsidiary companies, especially as corporate interconnectivity grows. A robust understanding of these legal delineations is essential for stakeholders to navigate the complexities of insolvency while safeguarding their interests, ensuring that the financial system remains resilient and equitable.
Footnotes
1. (46) "holding company", in relation to one or more other companies, means a company of which such companies are subsidiary companies; [Explanation. -- For the purposes of this clause, the expression "company" includes any body corporate;]
2. (87) "subsidiary company" or
"subsidiary", in relation to any other company (that is
to say the holding company), means a company in which the holding
company--
(i) controls the composition of the Board of Directors; or
(ii) exercises or controls more than one-half of the 23[total
voting power] either at its own or together with one or more of its
subsidiary companies Provided that such class or classes of holding
companies as may be prescribed shall not have layers of
subsidiaries beyond such numbers as may be prescribed
Explanation.--For the purposes of this clause,--
(a) a company shall be deemed to be a subsidiary company of the
holding company even if the control referred to in sub-clause (i)
or sub-clause (ii) is of another subsidiary company of the holding
company;
(b) the composition of a company's Board of Directors shall be
deemed to be controlled by another company if that other company by
exercise of some power exercisable by it at its discretion can
appoint or remove all or a majority of the directors;
(c) the expression company includes any body corporate;
(d) "layer" in relation to a holding company means its
subsidiary or subsidiaries;
3. Civil Appeal No. 733 of 2012.
4. (2022) 1 SCC 401
5. Civil Appeal No. 4565 of 2021
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