INTRODUCTION
Fair and equitable treatment of the operational creditors (‘OC’) has been a much-debated issue in the realm of insolvency and bankruptcy law, many jurists and writers have criticized the Section 53 of the Insolvency and Bankruptcy Code (‘IBC’) and even called it an “unjust act” mainly owing to the inherent inequality based on which it operates.
The recent introduction of the Pre-Pack Insolvency Resolution Plan by the ordinance dated April 4, 2021 has opened up a pandoras box for the operational creditors, this article tries to analyse the position of operational creditors in light of the Pre-Pack Insolvency Resolution Plan and provides a plausible solution to strengthen their position.
BACKGROUND
The introduction of the Pre-Pack Insolvency Resolution Plan (‘PIRP’) provides a much-needed relief to the cash-strapped Micro, Medium and Small Enterprises (‘MSME’s), but it seems like it yet again fails to resolve the woes of the operational creditors which also forms a major part of the MSME sector in India.
The power dynamics in the PIRP has shifted from a pre-dominantly creditor-in-control model to a debtor-in-control model, under PIRP the corporate debtor has the power to submit its own resolution plan to the NCLT, and once it is accepted by the court it can continue to operate as a going concern without having to change the management of the company, as a result placing the control in the hands of the corporate debtor.
STATE OF OPERATIONAL CREDITORS
The inequality faced by the operational creditors is laid bare in the section 54k of the amendment act which vests the power to approve the resolution plan solely in the hands of the Committee of Creditors (‘COC’), section 54k must be read in consonance with section 21(2) of the IBC act which recognizes only financial creditors as members of the COC, this essentially leaves the OC’s with little to no bargaining power.
Although section 54k says that “the COC may approve the base plan if it does not impair the dues of the operational creditors”, it has been historically seen that the financial creditors have always looked for maximizing their recovery of dues, regardless of it being detrimental to the operational creditors.
Moreover, this can be further seen in the case of Café D Lake Private Limited wherein HDFC bank being the sole financial creditor passed a resolution withdrawing the CIRP even if it was detrimental to the other class of creditors.
It is worth noting that in the case of Rajputana Properties v/s Ultratech Cement Ltd & Ors. The Hon’ble Supreme Court held that “the dues of operational creditors must get at least similar treatment as compared to the dues of financial creditors, if not same”. Hence, it is very imperative that the dues of the operational creditors must be given an equal treatment with that of the financial creditors, especially in the debtor-in-control model of PIRP.
Under the section 54k of the PIRP, there are two scenarios which arise in the base resolution plan, 1) where the operational creditors are getting their complete due, 2) or where the operational creditors are not getting their complete dues, in the first scenario it is optional for the COC to go for a Swiss challenge i.e., inviting third party resolution applicants similar to CIRP proceedings but in case of the 2nd scenario the COC has to compulsorily go for a Swiss Challenge.
It would not be a far-fetched assumption to say that most of the times the operational creditor has never recovered their complete dues, this is mainly because of 3 factors –:
1) Most of the times the correct valuation of the company is not arrived at because of faulty and dubious methods.
2) The corporate debtors who are the most badly hit are not able to recover anything due to depreciation and amortization of the assets.
3) According to IBC operational creditors are paid only after the secured and unsecured financial creditors, workmen expenses etc., hence more often than not they are left with little to nothing.
This begs a question as to what is the minimum value which the operational creditors must be paid in a CIRP, here the section 30 it is clear that the resolution professional must make sure that according to the resolution plan the operational creditors must get a minimum of liquidation value.
Liquidation value as a threshold for measuring the minimum payment to the operational creditors creates an inequitable ground for the operational creditors as the liquidation value of the corporate debtors is way less and ultimately the operational creditors are left with nothing.
USING FAIR VALUE AHEAD OF LIQUIDATION VALUE
Liquidation value according to the Insolvency And Bankruptcy Board Of India (Insolvency Resolution Process For Corporate Persons) Regulations, 2016 is defined as “liquidation value means the estimated realizable value of the assets of the corporate debtor, if the corporate debtor were to be liquidated on the insolvency commencement date”.
From the above definition it is clear that the basic assumption behind calculating the liquidation value is that the corporate debtor would be dissolved on the insolvency commencement date but that is not true in case of a PIRP as the Corporate Debtor would continue to operate as a going concern without being dissolved, while also retaining control over the company.
The usage of Liquidation value also suffers from a number of problems and inefficiencies, some of which are as follows-:
- No definite way of calculating – The responsibility of deciding the liquidation value is on the valuers appointed by the Interim Resolution Professional (‘IRP’), and there has been no established formula to calculate and derive the liquidation value of the assets of a corporate debtor till date, hence it can easily vary depending upon the valuation techniques used by the valuers.
- Collusion between the Resolution Applicants and valuers – There have been numerous incidents where the valuers have undervalued the assets of the corporate debtor for instance, in the recent case of Videocon bankruptcy proceedings all the resolution applicants quoted the same value as the liquidation value decided by the valuers and the IRP, this was unprecedented as the liquidation value is always revealed after the resolution applicants quote their offer.
Videocon bankruptcy is not the only instance of collusion between the Resolution Applicants and valuers and surely not the last one, the lack of ethical integrity and calculating methods in valuation makes the usage of liquidation value ineffective, as a result it is the operational creditors who suffer the most as they end up getting little to nothing out of the liquidation value.
Keeping in mind the inefficiencies of using the liquidation value and the inherent privileges that the current PIRP offers to the corporate debtors, the current scheme of PIRP proceedings must at least use fair value as the minimum value of the resolution plan of the corporate debtor without which the resolution plan would not be approved.
According to the CIRP regulations “fair value means the estimated realizable value of the assets of the corporate debtor, if they were to be exchanged on the insolvency commencement date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had acted knowledgeably, prudently and without compulsion”.
The basic assumption based on which fair value operates fits the purpose of the PIRP process as it assumes that the company would continue as a going concern and would continue to operate and earn revenue which would also raise the value of its assets, hence the inherent privilege enjoyed by the corporate debtor in a PIRP must be in sync with the concerns of the operational creditors, as a result it is imperative that fair value must be used instead of the liquidation value when calculating the minimum amount which the OC’s shall get under PIRP.
Although the process of calculating the fair value of the assets is a time-consuming process which would involve active marketing, an alternative can be used wherein the corporate debtors expected discounted cashflows after approval of the PIRP plan would be calculated, and accordingly a value should be attached to the assets after based on its future value.
Moreover, such methods of accounting must be standardized and included in the draft valuation professionals bill as the current scheme of valuers must be properly equipped to use such methods of valuation concerning PIRP proceedings.
CONCLUSION – A FRESH START FOR THE OPERATIONAL CREDITORS
The current scheme of proceedings under the IBC presents a very grim picture of the state of the operational creditors, in line with this the PIRP must at the very least provide some respite to the operational creditors by considering “Fair Value” in place of “Liquidation value” in its proceedings, this would help restore their faith in the IBC and would provide them a much needed incentive to carry out their businesses with freedom as they form a very important part of the economy too, therefore, such measures would help ensure fair and equitable treatment of the operational creditors under the IBC.
This article is written by Aayush Akar, student, National Law University Odisha & Rohan Kalita, Student, Gujarat National Law University.
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