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Resolution vs. Liquidation: The Real Spirit of Insolvency and Bankruptcy Code, 2016

Revival of the stressed company may be the primary objective of the Code, but official data show that more companies have gone for liquidation in the new regime so far than the resolution as lenders have failed to endorse any viable plan for their revival. According to the data available on the IBBI website, till the end of June 2018, total 1547 applications for the Insolvency Resolution were filed out of which 977 applications had been admitted into resolution process and of which 91 were closed on appeal or review. Data further reveals that till 30th June 2018, total 136 companies yielded liquidations while only 34 companies achieved resolution.

Companies are generally incorporated with the motive of profit earning but many times, due to some financial constraint or other reasons, situations may arise where surviving of entity becomes difficult. Rescuing such sinking companies or exiting ruined businesses has been a pain for investors for decades. To resolve the problem of such corporate distress, Government of India has enacted the Insolvency and Bankruptcy Code, 2016 (IBC), which is the most significant pieces of legislation in the bankruptcy law of India. IBC has created a lot of excitement and anxiety in the industry, as it throws both opportunity as well as challenges.

Insolvency, in respect to the Company, is a situation when a Company becomes incapable of recompensing its debts in the  ordinary  course  of  business,  or  it  becomes incapable of  disbursing  his  debts  as  they  become due. Any creditor can approach before the tribunal (National Company Law Tribunal, NCLT) with the appropriate application against such company. Bankruptcy is a concept which is like a voluntary surrender.[1] In this case, the company voluntarily goes to the Court and officially declares that it is unable to pay any further debts.

The IBC has changed the regime from ‘Debtor-in-Possession’ to ‘Creditor-in-Control’.[2] Under the IBC, any creditor, being a financial creditor, an operational creditor or a corporate debtor through Corporate applicant or any authorized member, a person who has the controlling capacity over the financial affairs of the corporate debtor, who owed Rs100,000/- or more can file an insolvency petition against a defaulting company.[3] According to the latest amendment the home buyers can also initiate Corporate Insolvency Process against builder or developer as they have been included in definition of ‘financial debt’.[4] A ten days demand notice has to be given to the corporate debtor by such creditors before approaching the NCLT. However, an operational creditor can directly approach the NCLT if the corporate debtor does not repay the outstanding dues or fails to show any existing difference. If this is accepted by the tribunal, moratorium will be declared and the corporate insolvency resolution process (CIRP) will start.

The spirit of IBC: Resolution or Liquidation?

When a company is in state of insolvency, its creditors will have two options i.e. either recovery or resolution. In other words, when insolvency proceedings commence against a company, there are two possible outcomes i.e. the sale of the existing business as a going concern (known as Insolvency Resolution) or the sale of the assets of the company (Known as Liquidation). The IBC is a single consolidated law which provides provisions for both; insolvency resolution and liquidation.

Before putting step towards resolution or liquidation, one question needs to be answered:  whether it would be possible for a revived company to earn enough in future to pay off all its creditors? If the answer is affirmative, then creditors should opt for resolution and not for liquidation. According to the Chairperson of Insolvency and Bankruptcy Board of India (IBBI), M. S. Sahoo, the soul of the Code is to keep the firm alive by balancing the interest of all stakeholders for which a successful resolution is needed. [5]

The general motto is- “Law should provide a reasonable opportunity for rehabilitation of a business before a decision is taken to liquidate it so that it can be restored to productivity and become competitive”.

Thus the Insolvency and Bankruptcy Code was enacted to strike a balance between Resolution and liquidation. Creditors of a sinking company should first explore the option to revive the potentially viable company. Where revival or resolution is not feasible, then they should go for liquidation. In case, a business attains resolution, the creditors will have the option to recover their dues from future earning of the company. In the contrary, liquidation is the drastic solution. Liquidation brings the life of a firm to an end. It destroys organizational capital and renders resources idle till their reallocation to alternate uses. Further, it is inequitable as it considers the claims of a set of stakeholders only if there is any surplus left after satisfying the claims of a prior set of stakeholders fully. The code therefore does not allow liquidation of a firm directly. It allows liquidation only after the process fails to yield resolution.[6]

Revival of the stressed company may be the primary objective of the Code, but official data show that more companies have gone for liquidation in the new regime so far than the resolution as lenders have failed to endorse any viable plan for their revival. According to the data available on the IBBI website, till the end of June 2018, total 1547 applications for the Insolvency Resolution were filed out of which 977 applications had been admitted into resolution process and of which 91 were closed on appeal or review. Data further reveals that till 30th June 2018, total 136 companies yielded liquidations while only 34 companies achieved resolution.[7]

Liquidation in the first meeting of CoC:

It is observed that many companies have been struggling for survival for years, even much before the implementation of IBC. These companies are almost ‘dead’ and the chances of revival are very rare. In such cases liquidation is the only way to recover the money. Here an important question which arises is that “Can the Creditors decide to liquidate the company in the first meeting of CoC?

Answer to the above question is in affirmative. In highly stressed business, if it appears that the company will not be able to achieve any resolution in 180 days or the extended 270 days, liquidation can be only option to realise the money trapped. According to Section 33, where the resolution professional at any time during the CIRP but before confirmation of a resolution plan, submits to the tribunal the decision of the committee of creditors to liquidate the company by the requisite majority, the tribunal may pass a liquidation order against such company.[8] The tribunal has passed liquidation order at initial stage in many cases such as VIP Finvest Consultancy Private Limited v. Bhupen Electronics[9], Chivas Trading Private Limited v. Abhayam Trading Limited[10], C.A. Rajendra K. Bhuta v. Best Deal TV Pvt. Ltd[11] etc., on the ground that there was no hope for revival, and the creditors were not willing to spend their hard earned money to recover the drowned money.

Permission for withdrawal of Application even after Admission:

The adjudicating authorities witnessed many cases where parties arrived at any compromise or settlement after the admission of the resolution application. Therefore, in order to meet out the motive of the Code, legislature introduced a new provision to enable the Corporate Debtor to settle the claim even after admission of application and revive itself.

Now the adjudicating authority may allow to withdraw the application admitted under section 7 or section 9 or section 10, if the 90% of voting share of Committee of creditors give consent for withdrawal.[12] This also indicates the intention of the legislature to give chance to rehabilitate the corporate debtor. Before this amendment, application could be withdrawn only before admission and not after the admission.[13] The same was held by the National Company Law Appellate Tribunal (NCLAT) in the case of Sabari Inn Vs. Rameesh Associated P. Ltd[14], Prowess International vs Parker Hannifin India P. Ltd[15], Lokhandwala Kataria Construction Pvt Ltd vs Nisus Finance[16]. Interestingly, in the case of Kapil Gupta vs. Indiabulls Housing Finance Ltd.,[17]NCLAT held that application cannot be withdrawn after admission, even if settlement has been reached between the parties.

Reduction in voting share for approval of Resolution Plan:

In furtherance to maximizing the possibility of resolution, maximizing the value of assets locked up in NPAs and protecting the interest of various Creditors, legislature has reduced the share of votes required for approving a resolution plan by the committee of creditors from 75% to 66 %. Now Committee of Creditors may approve any feasible or viable resolution plan by a vote of not less than 66% of voting share of the financial creditors. This reduction in voting share will make it easier for the CoC to go ahead with a plan even if there is a difference of opinion among bankers.

Section 29A: Contradicting the Spirit  

Section 29A lays down some ineligibility criteria for resolution applicant. According to this Section, persons who had contributed to the downfall of the corporate debtor or were unsuitable to run the company because of their antecedents whether directly or indirectly are ineligible to submit resolution plan.[18] By introduction of this provision, the procedure has become more complex as the resolution professional or the liquidator is given the additional responsibility to determine the eligibility of the applicants.[19]

In addition to the procedural obstacles, it is imperative to note that the disqualifications enshrined in this section have the potential to hinder several innocent applicants who may be deemed ineligible due to mere technicalities and trivialities. The ambit of the section is so wide that ineligibilities have become common, making liquidation not merely a possibility but also a probability.[20]

The intention behind insertion of Section 29A has been made clear by the legislature[21] stating that the person who with his misconduct, contributed to defaults of corporate or are undesirable may misuse this situation due to lack of prohibition or restrictions to participate in the resolution or liquidation process, and gain or regain the control of the Corporate Debtor. It means, legislature intended to checkmate sly, unscrupulous promoters who are trying to buy back their assets paying a fraction of what they originally owed lenders. All they have to do is to place relatively higher bids (than other bidders) for their assets. And if they bid successfully, they regain control of their assets, and also get all debt waived off.

The provision is no doubt with good intention, but it is on the basis of basic assumption that the Corporate Debtor has defaulted because of the misappropriation and diversion of funds by management. Legislature probably has in mind the defaulters like. Vijay Malya, Neerav Modi or the cases like Satyam,  Kingfisher, Sahara etc. where the promoters or directors were in default but surely there may not be same situation in all the cases.[22]  In a market driven economy, failure of business can be for various external factors like change in market conditions, change in technology, economic meltdown, poor demand, scarcity of funds, bona fide management decisions and many others; misappropriation is only one of them.

For example, introduction of mobile phone has wiped out the business of wrist watch, alarm clock and camera industry and has affected many other sectors adversely, for no fault of theirs. Failure of company like Nokia cannot be attributed to misappropriation at all. Many industries had to be closed down because of orders of Supreme Court due to environment and other concerns. All these cannot be attributed to misappropriation alone. Many Public Sector Undertakings, including BSNL, MTNL, Air India, are incurring huge losses. It can never be considered that losses are due to misappropriation or diversion of funds.

It is justified to exclude where there was misappropriation of funds or where management is clearly incompetent, in other cases, the Corporate Debtor himself is the best judge to decide the policy to revive or rehabilitate the company, as they know all ins and outs of the company. It is not expected from an outsider to have through knowledge of the issues and challenges faced by the company.

The Code was designed to find the best possible way out for an ailing entity. It was meant to be more inclusive in approach and there was definitely no intention to avoid promoters from submitting resolution plans. It appears that the consequence of this section extends way beyond what it originally intended to accomplish. Thus, blanket ban on the existing promoters to participate in resolution plan is not at all correct. Issues of each Corporate Debtor have to be considered on case to case basis and then to decide whether or not to allow the Corporate Debtor in the insolvency resolution process.

Conclusion:

The Insolvency and Bankruptcy Code, 2016 is enacted with the intention to revive the sinking companies and this Code shall make a definite difference in the overall ease of doing business in the country. The Code also aims at giving the power to the creditor in case of default by the debtor which is exactly opposite to the earlier acts and laws. This Code is still evolving and various new provisions have been inserted by way of amendment. The amendments are expected to further strengthen the insolvency Resolution framework and produce better outcomes in terms of resolution as opposed to liquidation. However, there are some provisions which are contrary to the spirit of the Code and blanket application of such provisions may defeat the very purpose of the Code.

[1] Abhinav Pandey, The Insolvency And Bankruptcy Process In India, Available at https://blog.ipleaders.in/insolvency-bankruptcy-process-india/

[2] Shivam Goel,  The Insolvency and Bankruptcy Code, 2016: Problems & Challenges, Imperial Journal of Interdisciplinary Research (IJIR) Vol-3, Issue-5, 2017 ISSN: 2454-1362,

[3] Section 4 of the Insolvency and Bankruptcy Code, 2016 

[4] Explanation to Section 5(8)(c) of the Insolvency and Bankruptcy Code, 2016

[5]  Indronil Roychowdhury, Insolvency & bankruptcy: Focus on resolution and not liquidation, says IBBI chief MS Sahoo, Financial Express, Avaialble at https://www.financialexpress.com/industry/banking-finance/insolvency-bankruptcy-focus-on-resolution-and-not-liquidation-says-ibbi-chief-ms-sahoo/1200219/

[6] Resolution: The soul of IBC, Mr. M.S. Sahoo, Available at http://www.ibbi.gov.in/Article%20Resolution%20The%20Soul%20of%20IBC%20in%20IBBI%20Newsletter%20October-December%202017.pdf

[7] The Quarterly Newsletter of the Insolvency and Bankruptcy Board of India, Available at http://www.ibbi.gov.in/Newsletter_IBBI_April_jun2018.pdf

[8] Section 33 (2)

[9] MANU/NC/0042/2017

[10] MANU/NC/1673/2017

[11] MANU/NC/2275/2018

[12] Section 12 A

[13] Rule 8 of Insolvency and Bankruptcy( Application to Adjudicating Authority) Rules, 2016

[14] (2018) 91 taxmann.com 70 (NCLAT)

[15] (2017) 85 taxmann.com 187 (NCLAT)

[16] (2018) 91 taxmann.com 207 (NCLAT)

[17] (2018) 145 SCL 167

[18] Richa Saraf & Sikha Bansal, Ineligibility Criteria U/S 29A Of IBC: A Net Too Wide, Available at https://www.livelaw.in/ineligibility-criteria-u-s-29a-ibc-net-wide/

[19] Varun Khandelwal, Section 29A of the Insolvency Code: A Critique of its Impact & Recent Developments, India Corp Law, Available at https://indiacorplaw.in/2018/05/section-29a-insolvency-code-critique-impact-recent-developments.html

[20] Ibid

[21] Para 2 of statement of objects and Reasons appended to Amendment Bill 2017

[22] Taxmann’s Insolvency and Bankruptcy Code 2016, June 2018`

Categories: Corporate Law

View Comments (2)

  • I recently passed the limited insolvency exam which has become very difficult. I am also involved with many proposals dealing with insolvency. Our experience says that the act has helped many operational creditors to get their dues recovered. Yes, some banks do not like it since they do not like any change and have failed to understand modern banking. Bankruptcy is part of industrial cycle. A study of USA has shown tremendous failure and success of industries. Just compare housing bubble, the major failure of banks and millions of bankruptcy of individuals in 2008. But it leads the world with the best industrial growth today. Please actually involve in handling the cases and help India achieve its goals. Yes, allow the industry to run successfully or bankrupt it. No in between. But it is too early to judge the case. I am with ICSIIIP. as a member.

  • i agree with your statement that "allow the industry to run successfully or bankrupt it.No in between" but my concern is that section 29A should not be allowed to be applied blindly. it should be applied on the case to case basis. It is very much possible that company is not going into loss because of some external factors on which it does not have any control. Another thing is that IBC was enacted to revive the business not to benefit the COC. it has been appear in many cases where resolution plan was not accepted by the COC because they were getting more money in liquidation. If this is the situation, what will happen to the employees of the company? COC may get good money out of liquidation but the company will no longer exist and the workers of the company will be unemployed.

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