This article has been written by Prasad Hegde, a 4th year B.B.A. LL.B. (Hons.) student at Gujarat National law University, Gandhinagar.
Introduction:
The insolvency regime in India is still in its inceptive stage as it has not been too long since the Bankruptcy Law Reforms Committee submitted its the foundation of the Insolvency and Bankruptcy Code, 2016 (Hereinafter “The Code”). The Code was formulated with the primary aim to facilitate and expedite the process of insolvency and bankruptcy and at the same time allow continuous and effective negotiations between the corporate debtor and the corporate creditor in order to come to an effective resolution plan. The enactment of the Code showed the desperateness in India to have a robust system to deal with insolvent companies although there already existed provisions for winding up in the Companies Act, 2013.
The reason why the Indian economy demanded a robust law to deal with insolvent companies was because around 2015-16 Non-Performing Assets in Indian economy were on an all time high and the amount of money which the government was using in revamping Public sector banks were also exorbitant. Hence, this was the reason which led to the formulation of a comprehensive code to revive the stressed and NPA’s. The code was formulated with a dual intention of helping the corporate creditor to recover the loan and at the same time help the stressed corporate debtor in finding a way out through a resolution plan.
IBC Amendment Act, 2017 & Section 29A
Originally when the code was enacted a “Resolution Applicant” was defined as “Any Person who submits a resolution plan to a resolution professional. Hence, a Resolution Applicant could technically be anyone i.e., a creditor, investor etc… Since the Section did not prohibit anyone from filing a resolution plan, it thereby led to promoters and related parties of the corporate debtor also filing a resolution plan. Hence, this shortfall in the law prompted for the insertion of Section 29A by way of an Amendment in 2017.
Since, the introduction of Section 29A, the provision has disqualified persons from being resolution applicants who by their acts have contributed to the financial distress of the corporate debtor or who are undesirable due to various kinds of incapacities or is a “related party to any of the defaulting party. Roughly 10 categories of persons who are falling under the ambit of Section 29A of the code are disqualified in order to prevent them from making a lateral entry and at the same time protecting the interests of the corporate creditor from unscrupulous entities who try to benefit from the Corporate insolvency process thereby undermining the very objective of the code.
2018 Amendment to Section 29A:
The 2018 Amendment to the code, has added more misery to prospective resolution applicants by defining the term “related party”. The definition of related party is very extensive with relation to individuals thereby bringing a large number of persons within the ineligibility criteria (Even spouses of defaulting promoters have been disqualified). Additionally as a welcome move “financial entities” have been excluded from the ineligibility criteria and limited exemptions have been given to “MSME’s” provided they are not wilful defaulters.
Instances of Section 29A hindering the CIRP:
Bhushan Steel’s CIRP: In the famous Bhushan Steel insolvency case the promoters of Bhushan steel contested that Tata Steel UK, a foreign subsidiary of Tata Steel was fined by English Court in February 2018 under UK Act. The charging section [Section 33(1)(a)] had a provision of imprisonment for a term not exceeding twelve months, or a fine, or both. The Promoters tried to equate section 29A (d) of IBC, which deals with eligibility, stipulates has been convicted for any offence punishable with imprisonment for two years or more, with Section 33(1)(a) of the U.K Act. NCLAT held that Tata Steel UK, which is a separate legal entity from that of Tata Steel Ltd, does not attract the disability under Section 29A of the Code and for the said reason, Tata Steel Limited was eligible to file the Resolution Plan.
In the aforementioned case it can be seen that there was no real merit in invoking Section 29A. Perhaps, if Tata Steel was charged with some offence then it would have been a different case altogether. But here, Bhushan steel tried to apply the provision on a foreign entity which was in no way related to the filing of a Resolution plan by Tata Steel. Furthermore, Section 29A (d) prohibits the person who has been convicted and not the associate or subsidiary companies. The very basic Company law rule i.e., “Solomon Rule or the Separate legal entity rule” prohibits associate or subsidiary companies from falling within the ambit of Section 29A (d). Therefore, the action brought by Bhushan steel was merely to stretch the process for no good reason because if Tata Steel’s bid was to be accepted without any delay or litigation then it would have been better for Bhushan steel to come out of such a stressful position quickly.
Electrosteel’s CIRP: In the Electrosteels case, Vedanta’s (which was one of the bidder) resolution plan was challenged on the ground that one of Vedanta’s affiliates in Zambia which was a unit of Vedanta’s UK-based parent Vedanta Resources Plc had been found guilty of violating certain environmental laws, punishable with two or more years in jail. This contention was later rejected by the NCLT and it approved Vedanta’s Rs 53.20 billion resolution plan.
As seen in the case of Bhushan Steel, here Renaissance Steel (Another bidder of Electrosteel) failed to see that under Section 29A (d) of the Code, it had to be seen if a “Natural Person” was punished or not. But in the present case none of the Directors of Vedanta Ltd. or Vedanta Resources Plc were punished. Hence, even here it was a clear case where Renaissance Steel tried to stall the CIRP for no good reason despite already having a precedent in the form of “Bhushan Steel” which had cleared the air with regard to Section 29A (d).
The UK Approach
The Graham Review into Pre-pack Administration (Report) in 2014 recommended the introduction of pre-pack pools. Under the Pre-Pack Pool system the assets of the corporate debtor/insolvent company would be purchased by the promoters or connected parties of the corporate debtor/insolvent company in secrecy. As the word ‘pre’ suggests, the ground work for preparing the resolution plan is carried out well before formal administration of the plan and carries with it certain limited benefit, such as preservation of jobs. This scheme would also increase transparency and ensure accountability when the assets of the corporate debtor are sought to be purchased by the defaulters themselves.
Conclusion
With regard to the Procedural aspects as seen in the above instances the invocation of section 29A makes the CIRP more complex, cumbersome and lengthy due to additional responsibilities vested on the RP to determine eligibility of applicants. This will have a material economic impact and will affect the recovery mechanism of the financial creditors by bringing down the ultimate financial and economic value of the plan.
With regard to the substantive aspects, this provision has the potential to hinder innocent applicants who may be declared ineligible. In several instances when this provision was invoked liquidation was merely reduced to a probability. Hence, this provision impacts the very heart and soul of the code by having a negative impact on the CIRP because at the end of the day it is important to have a solution to both the stressed debtor as well as the creditor, so if there is anything which hinders such solution then such a provision of law has to be closely scrutinized. Even SBI Chairman Rajnish Kumar went on to say that Section 29A has been stretched too far and most of the litigation is because of this provision.
Further it is an accepted principal that all failures in business firms do not happen because of mismanagement or fraud and it can never be assumed that always it is the promoters or the top management who are involved in the business failure. There are certain external environmental factors which contribute to failure of business. Thus, it is essential to differentiate between wilful defaulters and those who have only defaulted because of certain circumstances which were not within their control. Therefore, there is an urgent need to bring necessary changes for the betterment of the CIRP.
ENDNOTES
[i] Section 5(25) of The Insolvency and Bankruptcy Code, 2016, http://www.mca.gov.in/Ministry/pdf/TheInsolvencyandBankruptcyofIndia.pdf.
[iii] State Bank of India v. Electrosteel Steel Limited, CP No. (IB) 361 NCLT Kolkata (2017), http://164.100.158.181/interim_orders/kolkata/21.07.2017/1.pdf.
[iv] Insolvency under Section 29A: Pre-Pack Pools and Independent review of Connected Party Sales, IndiaCorpLaw (April 3rd, 2018), https://indiacorplaw.in/2018/04/insolvency-section-29a-pre-pack-pools-independent-review-connected-party-sales.html
[v] Dr Sandra Frisby, ‘A preliminary analysis of pre-packaged administrations’ 44 Nottingham University Law Review 1, 31 (2007), https://www.iiiglobal.org/sites/default/files/sandrafrisbyprelim.pdf
[vi] IBC Section 29A needs more clarity, says SBI’s Rajnish Kumar, Livemint (Jan. 20, 2019), https://www.livemint.com/Companies/k26KgtfptaJImEdVZCx13L/SBI-chairman-says-interpretation-of-Section-29A-of-IBC-stret.html
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