The Insolvency and Bankruptcy Code (“IBC 2016” or “Code”), 2016 introduced on 28 May, 2016, was brought in to consolidate and amend the laws relating to insolvency and bankruptcy. Within the framework envisaged in the Code, there were plethora of cases admitted for corporate insolvency resolution, including 12 large stressed companies such as Essar Steels Limited, Bhushan Steels Limited, Amtek Auto Limited, etc. While the Code is being utilised widely, several operational and interpretational issues have surfaced during its implementation. Although some intermediate amendments were made in the Code, the government deemed it fit to constitute a formal committee to study the major issues in the corporate insolvency process systematically. Based on recommendations made by the committee under the chairmanship of Mr Injeti Srinivas, various reforms have made their way through the IBC (Amendment) Ordinance 2018 (Ordinance), which has been notified with effect from 06 June, 2018. This Ordinance makes some interesting refinements in the Code.
Homebuyers as Financial Creditors
One such reform is recognition of “home-buyer” status as a financial creditor for initiating the Corporate Insolvency Resolution Process (CIRP) against fraudulent/ defaulting real estate developers. As per the Code, only a financial creditor can initiate CIRP. Financial creditor has been defined under the Code. The definition is not very clear as to whether a “home-buyer” is part of it. This led to issues in insolvency proceedings against Jaypee Infratech Ltd and the Amrapali Group. In case of Jaypee Infratech, the amount paid by home buyers amounted to INR 14000 crores, whereas that of financial creditors was ~INR 9800 crores, i.e., the stake of home owners was 1.4 higher than the stake of financial creditors of the company. However, in the resolution plan, the financial creditors were given 1.6 times higher weightage than customers, leaving hundreds of home buyers in the lurch.
This reform now equates an “allottee” of a “real estate project” to be a person having a commercial effect of borrowing, enabling home buyers to represent themselves in the Committee of Creditors (CoC). This provides them a fair chance of receiving repayment of their investment from proceeds of the liquidation sale.
However, as the CoC would now include both home buyers and other financial creditors such as banks, considering that their decision making powers and the time taken for drawing conclusions vary significantly, it may delay the CIRP process. In addition, if the outstanding value of home buyers exceed the value of other financial creditors, they would enjoy a majority stake, and thus, greater voting power.
Here, one may want to think whether this reform is really beneficial for home buyers? As owners of the property would now be treated as creditors, their rightful property would form part of common pool of assets with the other assets of the company. Therefore, property that earlier belonged to a particular individual, would now belong to a common pool of creditors and its proceeds would be shared by other creditors also.
Relief to Promoters of MSMEs
Another reform introduced under the Ordinance pertains to promoters of Micro, Small and Medium Enterprises (MSMEs). It was observed that MSMEs did not attract much attention from other resolution applicants, and thus, have to undergo liquidation. To overcome this, the Ordinance provides relief to Promoters of MSMEs to bid for their business by submitting resolution plans, provided they are not wilful defaulters and do not attract other disqualifications related to default. This is a welcome change, as it will give an opportunity to promoters of MSMEs to turn them around faster, providing an impetus to one of the largest employment-providing sectors. The Ordinance also empowers the Centre to allow further exemptions or modifications in the MSMEs sector, if required, in public interest. This amendment would help in promptly responding to the changing needs of MSMEs without having to amend the law further.
Amendment to persons ineligible to be resolution applicant
Section 29A of the Code provides for persons ineligible to be resolution applicants. Earlier, it defined “related party” only in the context of a corporate debtor; however, it was silent on related party and relatives in context of individual/ promoters, giving rise to ambiguities and litigations, such as in the case of Essar Steel. In this case, Rewant Ruia, son of the company’s co-promoter Ravi Ruia, was alleged to be one of the end beneficiaries and a shareholder of Numetal Limited who had bid for the stressed steel firm. This led to controversies on his eligibility to bid. To rest this confusion, the Ordinance has now defined “relatives” and “related party” in relation to individuals who have run a stressed business and these identified persons would now be barred from bidding for the stressed business. The amendment covers relatives leading up to the fourth generation of an individual, which has widened the scope of persons falling under the ineligibility criteria.
Section 29A also disqualified certain genuine persons having Non-Performing Assets (NPAs), including a financial entity from being a resolution applicant. Financial entities include ARCs, Scheduled Banks, Alternative Investment Funds, verseas Financial Institutions, and registered Foreign Portfolio Investors. These entities are likely to be related to companies that are classified as NPA, causing unintended exclusion from the list of resolution applicants. To streamline it, only those who contributed to defaults of the company, or are otherwise undesirable are to be rendered ineligible. Accordingly, a carve-out for pure play financial entities has been made. Relaxations have been given to a person having acquired NPA during prior bid under the Insolvency Code with a cooling period of three years.
Withdrawal of Application
The Ordinance, being an outcome of challenges faced in the implementation of IBC, 2016, has tried to address one of the issues faced in Binani Cement Ltd, a case under the IBC. In this case, UltraTech Cement Ltd struck a deal outside the IBC framework with Binani Industries Ltd, the parent of Binani Cement, to buy its 98.43% stake in the cement unit and applied to terminate the insolvency proceeding. The Code itself did not have a procedure laid down for terminating the insolvency proceeding.
To plug this lacuna, the Ordinance now permits withdrawal of the insolvency applications if it is approved by 90% of the CoC, but only before publication of notice inviting Expressions of Interest.
Threshold reduced for making decisions
To encourage resolution versus liquidation and speed up the process, the Ordinance has brought down the CoC voting threshold to 66% from 75% for all major decisions, such as extension of the insolvency period, appointment/ replacement of resolution professionals, approval and submission of resolution plan, making any change in the management of the corporate debtor or its subsidiary, etc. However, 51% voting share is required for the remaining routine decisions of the CoC. The voting requirements were brought down, as there were cases in the past where resolution could not be achieved because of the high threshold limits.
Besides the above amendments, in order to further strengthen the Insolvency Resolution Framework in the country and produce better outcomes, the Ordinance has brought in more clarity by laying down mandatory timelines, processes and procedures for CIRP. It addresses some issues, such as non-entertainment of late bids, no negotiation with late bidders, and a well laid down procedure for maximising the value of assets. The Ordinance also provides for a mechanism to allow participation of security holders, deposit holders and all other classes of financial creditors that exceed a certain number in meetings of the CoC through authorised representation.
Further, it provides successful resolution applicants a minimum one-year grace period to fulfil various statutory obligations under competition law and other sectoral regulatory laws, as may be applicable. This has been introduced to facilitate the implementation of the resolution plan by successful bidders. This raises a question whether the resolution plan can be made conditional upon receipt of approvals under these acts. In addition, it creates ambiguity whether the approval of arrangements such as mergers, demergers, etc., form part of the resolution plan without having to follow distinct processes under the Companies Act.
While the above changes are welcome and may aid in implementing the Code in its true spirit, it still needs to be evaluated periodically to address the ever-emerging challenges in its implementation.
The views expressed in this article are personal. The article includes input from Dhwani Sanghavi, Associate, M&A Tax, PwC India