Somasekhar Sundaresan*

When Code is not meant to be a legislation that nudges conduct of corporates towards good conduct, away from misconduct. It is meant to be a procedure-based legislation that applies uniformly to all corporates. However, that it has come to affect corporate conduct cannot be missed. This article is a short contemplation on the effect of the Code as an economics legislation, taking just five facets into account.hen one considers the introduction and evolution of the Insolvency and Bankruptcy Code, 2016 (Code) three years after its introduction, one cannot but notice that although the legislation is meant to be purely one that governs process and procedure in the journey of an insolvent company from potentially terminal sickness to death, like with most matters mortal, it indeed has a fallout for corporate conduct during healthy life.


In its journey, the first economic conduct that got nudged, even if unintentionally, was that the corporate debtor (CD) must have a proper record of its disputes with operational creditors (OCs). While prior disputes with financial creditors (FCs) is no bar to the initiation of insolvency proceedings (section 7 of the Code), the Adjudicating Authority (AA) overseeing insolvency proceedings is not meant to bless the commencement of insolvency proceedings in the case of an OC (section 9 of the Code). Initially the judicial declaration of the law on the subject was that pre-existing dispute over the amount claimed to be due between the CD and the OC could only be evidenced by litigation pending in a court of law. Eventually, the law got declared, and indeed amended to make it clearer, that pre-existence of a dispute may be borne out from the material on record, and not necessarily only by initiation of actual litigation filed and pending in courts.

Since the existence of a dispute would necessarily be a mixed question of fact and law, the effect on behavioural conduct of companies is that CDs necessarily need to maintain proper record of disputes and differences with OCs. If a dispute is worthy of litigation, a company would actually litigate. If there indeed exists a dispute, but the circumstances do not warrant the filing of actual litigation, adequate evidence of having assessed why pursuit of litigation is not advised despite the existence of a dispute, would now be maintained.


A somewhat connected behavioural change is the gaming by parties who have rights and obligations under the Code. An OC of a financial loan-free company would stand on a footing totally different from an OC of a company that routinely takes financial assistance. It is foolhardy for an OC to invoke the Code with a view to actually get a resolution of a CD. After the insolvency process is initiated, the voice of the OC may be totally drowned out by the size of the FCs. From being a coercive wielder of a weapon with a finger on the trigger of the insolvency process, the OC would become a supplicant before the committee of creditors (CoC), with hardly any chance of a realistic recovery.

Therefore, the Code as a coercive tool of recovery would have limited utility for an OC-only CDs who would fear the trigger of the resolution process (with the resultant moratorium leading to the CD being treated as a pariah in the business community) would feel the fear of the Code to pay up. A company that is actually insolvent and may in fact be contemplating initiating the insolvency process would not perceive the Code as a coercive threat to pay up. The Code is not even meant to be a coercive recovery tool, but does enable an opportunity for coercive recovery to this limited extent. In the initial months of the Code, the legislation was a far stronger tool of coercive recovery for OCs than it is now.

On the contrary, once the resolution process is initiated, the scope for the OC to be relegated to the unimportant is quite wide. Likewise, the perception that OCs get a raw deal, and that the AA must have regard to fairness to the OC is already subject matter of intense litigation, winding its way in the last stages of a brutal fight now pending adjudication in the Supreme Court (SC). The National Company Law Appellate Tribunal (NCLAT) took the view that OCs got a raw deal and provided its own methodology of computing the size of the hair-cut to be administered to OCs and the FCs.

The conflicts between these two classes of creditors are unlikely to settle down and much may come to depend on a case-by-case assessment of fairness in a resolution plan. Yet, it must be remembered that getting a fraction in a resolution would still give an OC more than what liquidation upon failure of resolution may yield. Likewise, unless a company is truly insolvent, the Code is not meant to be used at all. It would be the usage of a sledgehammer to swat a mosquito. Indeed, this was the position under the old company law where anyone who would seek recovery would serve a winding up notice, but the Code has evolved into a really serious process for real resolution leading to liquidation, and therefore, creditor behaviour will indeed be impacted.


The introduction of section 29A to disqualify any and every person ‘connected’ to an insolvent from resolving any other insolvent came up for close constitutional scrutiny. The SC indeed upheld the constitutional validity of this provision, ruling that the provision, although crude, would not be rendered unconstitutional. Crude, it indeed is – what with a blanket ban across the board for anyone who is a related party to any party related to an insolvent. Many types of disqualifications in the provision are objectively clear and justifiable but indeed the restriction on every related party is dangerously expansive and wide.

There has indeed been a behavioural impact due to this provision. Connections are fast being shed. And where connections are not easy to shed, debts are unexpectedly being repaid. Either the connection with the insolvent is being severed, or the insolvency is being cured. This provision can be regarded as an expected source of a bonanza for some of the lenders who had taken into account the connections with powerful business houses, which for purposes of credit appraisal were regarded as providing comfort and standing behind the credit of the CD. Faced with a total disqualification from authoring any resolution plan for any other company, this provision has forced many a powerful hand to pay up dues of companies they are connected to, even if for the record, they protested the inference of the connection.

The urge to disconnect has led to provisions in other legislation to come into sharp focus. Securities regulations stipulate in detail how someone who has been historically regarded as a promoter may cease to be a promoter. Compliance requirements for reclassification of a person who was a promoter but whose shareholding has come down to below 10 per cent are stipulated. The impact of the Code has sharpened the focus on enforcement of regulations governing listing obligations and disclosure requirements. In fact, an externality of this behavioural change has led to stock exchanges get so conservative that even a promoter whose holding has been totally wiped out is pushed to go through the process for reclassification.


An interesting economic impact of the Code is the manner in which a completely controversial policy choice was made about the usage of the legislation by those outside the administration of the legislation. The framework for ‘prompt corrective action’ formulated by the Reserve Bank of India led to the choice provided by the Code being converted into a mandatory use of the choice under law governing banking regulation. The decision to invoke the Code and initiate an insolvency process, leading up to potential liquidation was a matter of a right of the bank. Forcing the bank to actually exercise that right, by issue of an edict that the banks must use this process, led to a very piquant and nuanced challenge to the policy of the central bank from the standpoint of arbitrariness.

The SC ruled that the blanket forced usage of the Code across the board, regardless of the industry, regardless of the company in an industry and regardless of facts, was an arbitrary policy choice. Each of the actions to initiate the Code process taken by each of the banks under this framework would have been fully valid had these actions been taken voluntarily as a matter of choice and as a matter of case-specific assessment of facts warranting such action. However, the same actions taken, not by application of mind, but by forced mandatory usage of a power made available under the Code, rendered the same actions to be set aside.


The same policy also led to another interesting facet of the behavioural impact of the operation of the Code coming to the fore. When the law confers a right and thereby a protection, and that too as a matter of choice, taking away the choice and the discretion and making it mandatory for banks to exercise a particular choice was a new dimension hitherto unheard of. It led to many other nuances and facets of behavioural economics come to the fore.

The central bank, which is the regulator, placed itself in the shoes of the regulated, taking decisions that they ought to take. Such a policy change led to undermining the sovereignty of the governance mechanisms of the bank – with the supervisor and regulator taking the decisions for the supervised and the regulated. The actions were still those of the bank, but the actual decision was being taken outside the bank. Lessons in regulation of conduct have been learnt and this has presented a great opportunity to learn about the core difference between choice and force – the former always being more resilient, truthful and apt for a democratic system like ours.

Finally, there is still one question that remains at large – does the Code have any preference between liquidation and resolution? Many legal and judicial minds tend to take an approach that liquidation is avoidable and that one must do the most to make resolution work. There is nothing in the Code to make any expression of such a preference. The choice between resolution and liquidation is a sovereign right of the CoC. They can choose in their wisdom to liquidate a company once they form a view that the CD is a basket case. The SC has upheld such sovereignty of the CoC.

However, in cases where the resolution plan does go through, obviating liquidation, when there is a challenge to the terms of the resolution, the question rears its head again. The SC would now decide whether one can at all second-guess the CoC and its choice of the nature and scale of haircut to be given to individual creditors and classes of creditors. The SC would also need to decide on whether the discretion and sovereignty of the CoC is absolutely sovereign without being attended with the need to be fair and be seen to be fair. Whether the obligation to accord equitable treatment of stakeholders, a mandate for fiduciary role of directors under company law, would need to be imported to treatment meted out by the CoC is the question to ask. The jury is out on this one.


To summarise, while the Code is purely a legislation that codifies the run of the rule of law governing insolvency and bankruptcy proceedings in relation to companies (insolvency of individuals is yet to be brought under the ambit of this law), its sheer operation in the ecosystem has led to various consequences on behaviour of parties involved and persons affected by it. A continuous study of these developments, backed by empirical data and statistical analysis of its impact would hold the key to regulatory impact assessment of the Code. The legislation is still young, and presents a rich opportunity for study. This space has to be keenly watched.


*(Mr. Somasekhar Sundaresan is a Counsel practising in litigation in the field of economics and administrative law.)

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December 2020