Dissenting Financial Creditors and Resolution Process under IBC

The resolution plan shall provide for the payment of debts of financial creditors, who do not vote in favour of the resolution plan, in such manner as may be specified by the Board, which shall not be less than the amount to be paid to such creditors in accordance with sub-section (1) of section 53 in the event of a liquidation of the corporate debtor – Section 30(2)(b) as amended by Insolvency and Bankruptcy Code (Amendment) Act, 2019, w.e.f. 16-8-2019.

Section 53(1) provides that notwithstanding anything to the contrary contained in any law enacted by the Parliament or any State Legislature for the time being in force, the proceeds from the sale of the liquidation assets shall be distributed in the following order of priority and within such period and in such manner as may be specified, namely :—

(a) the insolvency resolution process costs and the liquidation costs paid in full;

(b) the following debts which shall rank equally between and among the following :—

(i) workmen’s dues for the period of twenty-four months preceding the liquidation commencement date; and

(ii)  debts owed to a secured creditor in the event such secured creditor has relinquished security in the manner set out in section 52;

(c) wages and any unpaid dues owed to employees other than workmen for the period of twelve months preceding the liquidation commencement date;

(d) financial debts owed to unsecured creditors;

(e)  the following dues shall rank equally between and among the following :—

(i) any amount due to the Central Government and the State Government including the amount to be received on account of the Consolidated Fund of India and the Consolidated Fund of a State, if any, in respect of the whole or any part of the period of two years preceding the liquidation commencement date;

(ii) debts owed to a secured creditor for any amount unpaid following the enforcement of security interest;

(f) any remaining debts and dues;

(g)  preference shareholders, if any; and

(h) equity shareholders or partners, as the case may be.

 Though not written explicitly, the above envisaged payment shall be dependent upon the either of following two assumptions w.r.t. his security interest:

1. Whether such secured dissenting financial creditor would had been relinquishing his security interest to the liquidation estate; or

2. Whether such secured dissenting financial creditor would not had been relinquishing his security interest to the liquidation estate.

The resolution process under the Code rests on a well-defined plan called “resolution plan”. It is a well-established principle that while resolving an entity, the creditors of that entity shall not be put in a situation worse than what would have been in case the entity were to be liquidated (or else, there would be no point in resolving the entity). This principle is referred to as “vertical comparison”. The objective of vertical comparison is to determine the minimum level of returns which a particular stakeholder will have in the event of liquidation of the entity. This minimum level has been referred to as “liquidation value” under the recently notified Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (“the regulations”).

The words “which shall not be less than the amount to be paid to such creditors in accordance with sub-section (1) of section 53 in the event of a liquidation of the corporate debtor” used in section 30(2)(b) call for vertical comparison of a creditor’s entitlement in these two scenarios – resolution and liquidation.

Vertical comparison means a comparison between a creditor’s entitlement in the resolution plan and in a hypothetical liquidation. The rule of vertical comparison was emphasised in T & N Ltd., In re [2004] EWHC 2361 (Ch), by David Richards J, who states,

“While I am wary of laying down in advance of a hearing on the merits of any scheme or company voluntary arrangement (CVA) any particular rule, there is one element which can be mentioned at this stage. I find it very difficult to envisage a case where the court would sanction a scheme of arrangement, or not interfere with a CVA, which was an alternative to a winding up but which was likely to result in creditors, or some of them, receiving less than they would in a winding up of a the company, assuming that the return in a winding up would in reality be achieved and within an acceptable time-scale”

One of the important parameters on which a voluntary arrangement is to be tested is “vertical comparison”, that is, the situation that would have prevailed, had the debtor been allowed to go into liquidation. This brings us to an important tenet based on which all resolution plans must be constructed. A resolution plan is, after all, a mutually convenient alternative to liquidation. To liquidate the entity will unfairly affect several stakeholders – that is why the stakeholders decide to resolve the situation. The essential premise, therefore, is that the priorities and proportionalities that will obtain in case of liquidation will by and large be maintained in a voluntary arrangement as well.

Interpretation to be considered while drafting resolution plan:

1. Those who do not vote in favour of the resolution plan implicitly signify that they would had liked not to relinquish their security interest as stipulated in section 53 and would had liked to enforce, realise, settle, compromise or deal with the secured assets in accordance with such law as applicable to the security interest being realised and to the secured creditor and apply the proceeds to recover the debts due to it.

2. Since they would not had been relinquishing security interest they would had been enforcing the security interest on their own and hence if such own enforcement by them yields an amount by way of proceeds which is in excess of the debts due to the secured creditor, the secured creditor shall account for such surplus and tender to the IP any surplus funds received from the enforcement of such secured asset.

By: CA Kamal Garg