India: No More Fleecing – IBBI Puts Insolvency Costs To Strict Scrutiny

Last Updated: 6 July 2018
Article by Chakrapani Misra, Ravitej Chilumuri and Ashwij Ramaiah

Most Read Contributor in India, August 2018

Under the corporate insolvency regime set up by the Insolvency and Bankruptcy Code, 2016 ("Code"), the Insolvency Resolution Professional ("RP") is arguably among the most important individuals concerned with the Corporate Insolvency Resolution Process ("CIRP") of a Corporate Debtor. Under Section 17(1) of the Code, subsequent to the commencement of the CIRP against a Corporate Debtor, the board of directors ("BoD") of the Corporate Debtor stands suspended and the entire management and control of the Corporate Debtor vests with the RP. Under Section 17(2) of the Code, the RP single-handedly enjoys as much powers as otherwise collectively enjoyed by the entire BoD of the Company. In exercise of the aforesaid functions, the RP necessarily has to entail expenses. These expenses incurred by the RP while carrying out his responsibilities as the RP of the Corporate Debtor are termed as 'Insolvency Resolution Process Costs' ("IRP Cost"). However, under the existing insolvency regime, there was scant regulation or oversight on the nature of expenses which could be incurred towards IRP Cost.

The Insolvency and Bankruptcy Board of India ("IBBI") has issued a circular (Ref: IBBI/IP/013/2018) dated 12 June 2018 ("Circular") which aims at laying down an indicative set of guidelines to regulate the fees and other expenses incurred during the CIRP of a Corporate Debtor. In this article we shall examine the guidelines laid down under this circular and the circumstances which necessitated the IBBI to issue the aforesaid Circular.

1. Position of Law Prior to the Circular

It is trite to mention that the IRP Cost is an added financial stress on a Corporate Debtor which is already overburdened with unsustainable debts. Therefore, it is necessary to have well defined guidelines on what heads of expenses can be incurred by the RP and the extent to which they can be incurred. The Code and the regulations made thereunder did lay down certain guidelines to be followed while computing the IRP Cost. These guidelines inter alia are as under:

  1. Under Section 5(13) of the Code, IRP costs include (a) expenses incurred while raising interim finance, (b) fees payable for acting as the RP or any other costs incurred by the RP in managing the affairs of the Corporate Debtor, (c) costs incurred by the RP for generally facilitating the CIRP etc.
  2. Regulation 25 of the IBBI (Insolvency Professionals) Regulations, 2016 ("RP Regulations") stipulates that an RP must provide services for remuneration charged in a transparent manner and is a reasonable reflection of the work which is necessarily and properly undertaken by the RP.
  3. Regulation 27 of the RP Regulations stipulates that an RP shall disclose all costs towards the insolvency resolution process costs, liquidation costs etc to all relevant stakeholders, and must endeavour to ensure that such costs are not unreasonable.
  4. Regulation 31 of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 ("CIRP Regulations") lays down that IRP Cost inter alia shall include amounts due to suppliers of essential goods and services and amounts due to a person whose rights are prejudicially affected on account of the order of moratorium passed under Section 14(1)(d) etc.

It is important to note that the expenses incurred by the RP are not bereft of scrutiny. For instance, under Regulation 31 of the CIRP Regulations, the expenses incurred by the RP as incurred under Section 5(13) of the Code shall be fixed by the Committee of Creditors ("CoC"). Additionally, Regulation 31(e) of the CIRP Regulations lay down that any other costs emanating from the CIRP which otherwise do not constitute amounts due to suppliers of essential goods and services or amounts due to a person whose rights are prejudicially affected by the moratorium, needs to be approved by the CoC. However, it was observed that in reality, the aforesaid statutory provisions were not sufficient to effectively regulate the expenses incurred by the RP during CIRP. This even came to the notice of the adjudicating authorities that a typical CIRP often involved significant IRP Cost which aggravated the already strained financial condition of the Corporate Debtor. Some of the reasons for such exorbitant IRP Costs are elucidated as under:

Absence Of Objective Set Of Guidelines

From the above mentioned statutory provisions, it is evident that the aforesaid statutory provisions lay down very generic and non-exhaustive set of guidelines to determine the nature and quantum of expenses which can be included in the IRP Cost. Although Section 208(2)(a) of the Code obligates the RP to take reasonable care and be diligent while performing his/her functions as an RP including while incurring expenses, there are no objective criteria whatsoever to determine the extent of expenses which can be incurred by the RP towards IRP Cost.

Assured Compensation of Expenses Incurred

Section 30(2)(a) read with Section 31 of the Code ensures that the Resolution Plan submitted by the Resolution Applicant provides for the entire payment of IRP Costs. Further, under Regulation 38(1) of the CIRP Regulations, the IRP Cost shall be paid in priority to any other creditor. Similarly, under Section 53(a) of the Code, RP costs along with liquidation costs rank the highest in the liquidation waterfall while liquidating the assets of the Corporate Debtor. Thus, whether the CIRP succeeds or the Corporate Debtor is liquidated, the expenses incurred by the RP will inevitably be compensated.

The above paragraphs make it clear that the assured reimbursement of all the expenses incurred coupled with the absence of any objective guidelines on the quantum of expense, resulted in RPs to expend prohibitively high IRP Costs with impunity. Such exorbitant IRP Costs often ended up increasing the liabilities of the Corporate Debtor entailing deleterious consequences on all the stakeholders.

2. Express Directions of the Adjudicating Authority

The first landmark order which examined the question of exorbitant IRP costs was the order of the Kolkata Bench of the National Company Law Tribunal ("NCLT Kolkata") in the matter of Binani Cement in C.P (IB) No. 359/KB/2017 ("Binani Cement Order"). In this order, it was observed that the RP had appointed several advisors, legal professionals, facilitators and evaluators and appointed as many as 22 (twenty two) representatives to monitor the affairs of the Corporate Debtor. On account of paying remuneration to all these professionals, the IRP Cost aggregated to an exorbitant figure. On examining the expenses incurred by the RP, the NCLT Kolkata observed the RP had not taken care that the expenses incurred by him were reasonable. Hence the RP squarely violated the provisions of Regulation 27 of the CIRP Regulations. However, it is important to note that the Code does not lay down any consequences whatsoever for the violation of statutory duties stipulated inter alia under Regulation 27 of the CIRP Regulations or Section 208(2)(a) of the Code. In fact, the NCLT Kolkata observed in its order that IBBI should do the needful to renew the Code and regulations thereof to remedy this situation.

As mentioned above, the expenses incurred by the RP is subjected to scrutiny. Admittedly, Regulation 34 of the CIRP Regulations lays down that the budget and the expenses of the RP needs to be approved by the CoC. In fact, Regulation 34 expressly states that the expenses fixed by the CoC shall be inclusive of the remuneration payable to the RP and the other professionals appointed by the RP. However, Regulation 34 does not lay down any guidelines whatsoever on the CoC while approving the expenses incurred towards CIRP Costs. In other words, so long as the CoC keeps on approving the expenses, there is no restriction whatsoever either on the nature or on quantum on the expenses incurred by the RP.

This state of affairs prompted the IBBI to issue the Circular to remedy the situation and attempt to lay down a more objective set of criteria to better regulate the expenses incurred towards the IRP Cost.

3. Position of Law Laid Down By The Circular

It appears that the IBBI has issued the Circular keeping in mind the observations made by the NCLT Kolkata in the Binani Cement Order and laid down an exhaustive set of guidelines on what expenses can be included under IRP Cost. Some of the pertinent clauses in the Circular are elucidated as under.

3.1 Under Clause 6 and 7 of the Circular, an obligation is cast on the RP to inter alia ensure that:-

  • the fee payable to him, the fee payable to the Insolvency Professional Entity, and the fee payable to the Registered Valuers and other Professionals, and other expenses incurred by him during the CIRP are reasonable;
  • the fee or other expenses incurred by him are directly related to and necessary for the CIRP;
  • the fee or other expenses are determined by him on an arms' length basis, in consonance with the requirements of integrity and independence;
  • no fee or expense other than what is permitted under the Code read with the regulations made thereunder is to be included in the IRP Cost;
  • no fee or expense other than the IRP Cost incurred by the RP is borne by the corporate debtor;
  • The IRP Cost to the extent not paid during the CIRP from the internal sources of the Corporate Debtor, shall be met in the manner provided in section 30 or section 53 of the Code, as the case may be.

3.2 In addition to laying down guidelines on expenses, the Code also lays down sufficient safeguards to ensure that the RP acts in a transparent manner while including expenses in the IRP Cost. For instance:

  • Clause 6(d) of the Circular mandates the RP to maintain written contemporaneous records for incurring or agreeing to incur any fee or other expense.
  • Clause 6(e) of the Circular mandates that supporting records of fee and other expenses incurred are maintained for at least three years from the computation of the CIRP; and
  • Clause 6(g) of the Circular provides that all CIRP related fees and other expenses are paid through a proper banking channel.

3.3 Furthermore, the Circular provides further clarity on the various heads of expenses which can be included in the IRP Cost by clarifying the expenses which are expressly excluded from IRP Cost. Clause 8 of the Circular clarifies that the IRP Cost inter alia shall not include:

  • any fee or other expense not directly related to CIRP;
  • any fee or other expense incurred before the commencement of CIRP or to be incurred after the completion of the CIRP;
  • any expense incurred by a creditor, claimant, resolution applicant, promoter or member of the Board of Directors of the corporate debtor in relation to the CIRP;
  • any penalty imposed on the corporate debtor for non-compliance with applicable laws during the CIRP;
  • any expense incurred by a member of CoC or a professional engaged by the CoC;
  • any expense incurred on travel and stay of a member of CoC;
  • any expense incurred by the CoC directly; and
  • any expense not related to CIRP.

Clause 8 of the Circular, along with laying down expenses which are excluded from the IRP Cost, also makes it unequivocally clear that the expenses incurred by the CoC shall not be included in the IRP Cost. This is further buttressed by the explanation to Clause 8 of the Circular. Explanation to Clause 8 of the Circular allows an RP to incur expenses towards obtaining legal opinion on an issue which is relevant for the CIRP. However, if the CoC requires a legal opinion in addition to or in lieu of the opinion obtained or being obtained by the RP, the expense of obtaining such legal opinion shall not be included in IRP Cost.

Thus, it is evident from the aforesaid clauses that the Circular makes an avowed attempt to lay down and delineate the expenses which can be included in the IRP Cost. It also attempts to introduce some objectivity in determining the expenses which can be included and more importantly, which cannot be included towards the IRP Cost.

Conclusion

From the above, it can safely be said that the Circular introduced some much needed clarity into a very crucial practical aspect surrounding the successful CIRP of a Corporate Debtor. In our opinion, the Circular achieves two objectives, first, it clarifies what kind of expenses can be incurred by the RP towards the IRP Cost. Second, it makes it unequivocally clear that only the costs incurred by the RP shall be included in the IRP cost and any expense incurred by the CoC shall be excluded from the ambit of IRP Cost. This ensures that a corporate debtor which is already entangled in a web of unsustainable liabilities is not further over-burdened with exorbitantly high IRP Cost. This also ensures that a prospective Resolution Applicant is not discouraged from bidding for the Corporate Debtor on account of the prohibitively high IRP Cost which increases the cost of acquisition of the Corporate Debtor.

However, having said that, the Circular still stops short of clarifying certain issues. Although the Circular introduces more clarity into the nature of expenses included in the IRP Cost compared to the pre-existing legal position, it still shies away from laying down a completely objective set of rules to determine the heads included under IRP Cost. The text of Clauses 6 and 7 of the Circular still maintain a degree of vagueness. This vagueness in the text of the Circular coupled with the inherent need to examine IRP Cost on a case to case basis still leaves open sufficient room for the RP to incur exorbitant expenses and successfully justify that the expense incurred was reasonable, necessary and directly linked to the CIRP under the circumstances.

Section 208(2)(a) of the Code read with Regulation 27 of the CIRP Regulations imposes fiduciary duties on the RP to be fair and reasonable while incurring expenses towards CIRP. Similarly, Clause 6 of the Circular also lays down that a set of obligations which needs to be complied by the RP to ensure transparency in the expenses incurred. The Circular is silent on what consequences will have to be endured by the RP if the RP violates these fiduciary duties. It is our opinion that IBBI needs to bring forth further clarifications on this issue to better regulate the expenses incurred towards IRP Cost.

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at legalalerts@khaitanco.com

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