Insolvency Liquidation Process: Secured Creditors cannot sell assets to entities ineligible for Insolvency Plan.

“Higher realization and shorter resolution period was the USP of IBC 2016; but in actuality it has been marred by litigations & delays caused by loopholes & ambiguities in the Code!”
– Kritika Chabbra (Market Analyst, MUDS Management Pvt. Ltd.)

IBC 2016: An Effective Tool for Insolvency

Insolvency and Bankruptcy Code, 2016 (IBC) has been hailed as the biggest and most ambitious piece of economic legislation of the NDA government which is undoubtedly a well-intentioned step towards economic reforms. Understandably, IBC has been welcomed by all stakeholders and as a consequence, it has witnessed great popularity in its short journey of 3 years.

Framed with an intention to provide an effective, time-bound solution to financially stressed corporates, IBC basically lays stress on working on an effective resolution plan but if it does not turn out to be feasible, then the insolvent company goes for liquidation.

270 days is the maximum time period mandated by the IBC to resolve the insolvent entity’s assets but in case, a buyer is not found within the stipulated period or the committee of creditors is unhappy with the resolution bids, then the assets of the insolvent company shall be liquidated under the guidance of the resolution professional.

Gaps in the IBC Ecosystem

IBC, which is still in its infancy, has been facing roadblocks as the ambiguities and vagueness in the Code are being exploited by unscrupulous elements. The gaps, loopholes and discrepancies have led to litigations leading to delays, thus, eroding the very essence of the law.

One such flaw was related to the resolution applicant. A resolution applicant was originally defined under the Code as any person who submits a resolution plan to the resolution professional and hence, had a very wide category. 

As there was no specific criteria or qualification defined under the Code as to who would be eligible to submit a resolution plan, a resolution applicant, thus, could be any person like a creditor, promoter, prospective investor etc.

This loophole in the law provided an opportunity to defaulting promoters to submit a resolution plan which would give them an opportunity to make a backdoor entry helping them to acquire assets of the corporate debtor at a discounted price.

“This lacuna or loophole has worked against the very essence of the IBC and defeated its purpose.”
— Anuskha (Company Secretary, MUDS Management Pvt. Ltd.)

Insolvency and Bankruptcy Code (Amendment) Bill 2017

The Insolvency and Bankruptcy Board of India (IBBI) became aware of this major gap in the procedure of resolution and liquidation and put in sincere efforts to plug in the loophole and provide complete clarity. Thus, Insolvency and Bankruptcy Code (Amendment) Bill 2017, was introduced and section 29A was included in the code.

29A mandates that any person/s who have contributed to the defaults of the corporate debtor or are undesirable due to incapacities as specified in the section or even are a ’related party’ to another defaulting party, will be ineligible to submit a resolution plan under the Code.

Thus, putting such a provision meant that all such people, who took control of the distressed company in a clandestine manner, are prevented from gaining control of the corporate debtor.

Although the amendment was well-intentioned and it did actually cover a few gaps yet, it did not bring in the desired effect as clarity was lacking at various levels. The ambit of ineligibility and disqualification was very wide and naturally caused more hurdles than relief.

Thus, the need for IBBI to rework on it arose leading to another amendment.

“Changes and amendments are inevitable to keep the Code most relevant tool of insolvency and bankruptcy.”
— Isha Malik (Company Secretary, MUDS Management Pvt. Ltd.)

Insolvency and Bankruptcy Code (Second Amendment) Bill 2018

An official release published recently said that the Insolvency and Bankruptcy Board of India (IBBI) has notified changes to liquidation process regulations in the Insolvency and Bankruptcy Code. These regulations have come to effect from January 6, 2020.

IBC provides time-bound and market-linked resolution process for stressed corporate but in case a resolution process does not seem feasible, then the entity goes for liquidation.

From time to time, IBC has been amended in order to smoothen the process and making the Code an effective tool for insolvency and liquidation.

This latest amendment also provides a process for a stakeholder to seek withdrawal from the corporate liquidation account.

In addition, the amendment also clarifies that a secured creditor is required to pay the excess of realised value of the asset over the amount of its claims admitted, within 180 days of the start of liquidation.

Elaborating on the specific provisions of the amendments, Mehul Bheda, partner, Dhruva Advisors LLP, says, “The amendments are introduced to bring liquidation on par with the resolution process. The restrictions placed on the promoters under Section 29A of the code are now equally applicable to liquidation. This means that no promoter, who is barred from the resolution process, can make a backdoor entry by buying the assets of the company under liquidation or even participating in a scheme of arrangement under Section 230.”

“The amendment clarifies that a person, who is not eligible under the code to submit a resolution plan for insolvency resolution of the corporate debtor, shall not be a party in any manner to a compromise or arrangement of the corporate debtor under section 230 of the Companies Act, 2013.”

L. Viswanathan, partner Cyril Amarchand Mangaldas, explains the provision of the latest amendment as such, “The amendment to apply Section 29A to a scheme in liquidation is in line with the objective of the IBC to disallow persons who are disqualified from submitting a resolution plan from reacquiring the company through the mechanism of a scheme or in enforcement of security interests by secured creditors.”

Ineligible Creditors  Restrained

The biggest outcome of the amended regulations is that it has provided more teeth to IBC and strengthened the Code, bringing more clarity and transparency. This move shall stop the backdoor entry of those creditors who are barred from submitting an insolvency resolution plan and will restrict them from regaining control of their insolvent firms during liquidation proceedings.

This amendment lays down that a secured creditor has to contribute its share of the insolvency resolution process cost, liquidation process cost and workmen’s dues, within 90 days of the liquidation commencement date.

  (Source: Economic Times)

In addition, the secured creditor within 180 days of the liquidation commencement date has to pay excess of realised value of the asset, which is subject to security interest, over the amount of its claims admitted.

The release further states that the assets should become part of the Liquidation Estate in case the secured creditor is unable to pay the amount to the liquidator within 90 days or 180 days,    

Among other things, the amendment mandates that before an application for dissolution is submitted, the liquidator is required to deposit the amount of unclaimed dividends and undistributed proceeds in a liquidation process and also any income earned into the corporate liquidation account.

“By debarring those individuals who have defaulted on debt obligations, Section 29A of the IBC has ushered in transparency and morality in the entire insolvency process!”
— Isha Malik (Company Secretary, MUDS Management Pvt. Ltd.)

Conclusion

As with everything else, this amendment also has its pros and cons.

The intention of the frame workers is undoubtedly sincere and righteous as they want IBC to be true to its spirit and be hailed as an outstanding piece of legislation for insolvency and bankruptcy of corporate entities.

Talking about these amendments, the Supreme Court has described insertion of section 29A as “a ‘plugging loophole’ and has ruled that strict adherence to Section 29A is mandatory and that willful defaulters shall not be permitted to participate in the corporate insolvency resolution process.”

But on the other hand, the experts point out that although the move is aimed at weeding out defaulting promoters from regaining control of their companies at the liquidation stage, it may adversely impact the recovery chances.

The multiple layered, comprehensive standard of disqualification will surely mar the chances of some genuine resolution applicants as it covers a wide range.

Stressing that this move may lead to lower recoveries for creditors, Manoj Kumar, partner at law firm Corporate Professionals, says, “In many cases promoters have tried to get their companies back by proposing scheme of arrangements in the liquidation stage under Section 230 of the Companies Act,”

While weighing both sides, one can definitely point out that the pros outweigh the cons but the need of the hour is that decision should be taken by the courts on a case to case basis as the ultimate need is maximizing the objectives of the IBC and safeguarding the rights of all the stakeholders.

“By framing these amendments, IBBI has sought to root out this particular fallacy in the Code; hopefully this will help to expedite the process of insolvency resolution and liquidation.” 
-Shweta Gupta, Founder and CEO, MUDS

By | 2020-02-05T15:42:48+00:00 February 5th, 2020|Insolvency Education Series|0 Comments

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