Proposed Monetary Penalty Circular : A Matter of Perception, Uniformity and Clarity

The recent circular of the Insolvency and Bankruptcy Regulator (IBBI) on imposition of monetary penalties on the erring Insolvency Professionals has stirred the hornet’s nest. The IP fraternity is flustered and disquiet is discernible. The circular mandates IPA’s to amend their bye-laws and incorporate 14-point cause and effect to discipline the IP’s. The circular is a graded step after the amendment of Model Bye-Laws Regulations requiring these penalties to be deposited in an internal Fund created to meet establishment bill and other expenses of IBBI.

Effect of Circular

Let’s understand the effect of the circular:

  1. The circular attempts to reduce discretion of Disciplinary Committees of IPA’s in imposition of monetary penalty by bringing in uniformity and consistency.
  2. The monetary penalty is to be imposed on erring IP’s upon issue of show-cause notice, which may be sub-moto or on the basis of complaint or information, or directions from MCA/NCLT.
  3. Show-cause notice will necessarily provide opportunity to the IP to explain followed by a personal hearing.
  4. The Disciplinary Committee will then have to decide about the due diligence of the concerned IP.
  5. If the Disciplinary Committee decides to hold the IP guilty, it may proceed to take action as envisaged in the Bye-laws.
  6. The monetary penalty will be imposed if the Disciplinary Committee decides to invoke this penalty clause.

The process of imposition of penalty has to follow the principles of natural justice. The compliant IP need not worry about the monetary penalties. Fixation of quantum of penalties works two ways – first, it minimizes the discretion of the Disciplinary Committee and second, it brings in certainty. Let us understand it this way. Even today, the Disciplinary Committee has the power to impose monetary penalty on erring IP’s after following the due process but there is no limit on their powers. Unbridled power or controlled discretion – which one is better?

On a positive note, the penalty schedule works as a checklist of what should not be done by an IP.

Clarity Needed

Regardless of arguments for and against the monetary penalty circular, it calls for clarity on following aspects:

a. Whether it will apply retrospectively or prospectively? In other words, whether it can apply to completed or ongoing assignments or will it apply to assignments to be undertaken on or after the amendment in bye-laws.

b. The meaning of fee is not clear. Whether it would be considered on accrual basis or receipt basis? If the action is taken while the assignment is ongoing, whether the fee up to the date of imposition of penalty would alone be considered?

c. The maximum penalty goes upto 25% of the fee in each of the 14-point non-compliances. If the IP is held guilty of 5 offenses and the Disciplinary Committee decides to impose maximum of 25% of the fee in each case, would the penalty go beyond the 100% fee?

d. How the amount will be recovered from an IP upon imposition of penalty?

e. What are the consequences of failure of an IP to make payment of penalty?

f. What would be the time frame within which the penalty id to be deposited?

g. Will deposit of penalty be a pre-condition for filing appeal against such an order?

h. Should the discretion of Disciplinary Committee in imposition of minimum penalty be restricted?

Conclusion

No work of any professional can go unchecked. The circular has the objective of controlling the discretion of the Disciplinary Committee while imposing monetary penalties. Without a doubt, more clarity is expected and the Governing Boards of IPA’s will do a favor if they can bring out FAQ’s on the subject and hold wide consultations before bringing this into their bye-laws.

Deciphering IBC Ordinance, 2020 – COVID Period Defaults cannot be a Trigger for Corporate Insolvency Resolution Process

Time Stops for COVID Period Defaults

Ashish Makhija, Insolvency Professional
FCA, FCMA, LLM (India), LLM (USA)
Managing Attorney, AMC Law Firm
ashish@amclawfirm.com

Much awaited Ordinance suspending actionable sections of Corporate Insolvency Resolution Process was promulgated on 5th June, 2020. 

Reasons for Promulgation of Ordinance

  1. COVID-19 Pandemic has created uncertainty and stress for business for reasons beyond their control.
  2. India was under lockdown from 25th March, 2020 to combat COVID-19 and this added to disruption of normal business operation
  3. It is difficult to find adequate number of resolution applicants to rescue corporate persons who may default in discharge of their debt obligation.
  4. Distress is around due to unprecedented situation and corporate persons are being pushed into insolvency proceedings under the Code.
  5. Defaults arising on account of unprecedented situation to be excluded for the purposes of insolvency proceedings under the Code.

Here is the low down of the Ordinance:

  1. Section 10 A has been inserted in the Code suspending initiation of CIRP under sections 7, 9 and 10 for COVID Period Defaults.
  2. No application under sections 7, 9 and 10 can be filed for defaults arising on or after 25th March, 2020for a period of 6 months (COVID Period), that is, upto 24th September, 2020 (‘COVID Period Defaults’). 
  3. 3Central Government has retained power to extend COVID Period upto one year i.e. 24th March, 2021.
  4. The Ordinance provides permanent protection to corporate debtors for COVID Period Defaults. For such defaults, no application for initiation of CIRP can ever be filed by any creditor.   
  5. Initiation of CIRP on the basis of defaults that occurred prior to 25th March, 2020 is allowed.
  6. By the same analogy, the defaults arising after the COVID Period will entitle the creditors and corporate debtors to initiate CIRP.
  7. A question arises whether the application can be filed for initiation of CIRP if the COVID Period Default continues beyond COVID Period? Conjunct reading of Section 10A, proviso to Section 10A and Explanation manifests that COVID Period Default has to be expunged. Such a default cannot be a cause to trigger CIRP at any time. Logically, therefore, the quantum of COVID Period default has to be excluded as it is non-est in the eyes of law.  Put Simply, COVID Period Default = No Default. For initiating CIRP after the COVID Period, there should be a fresh default of minimum amount of Rs. 1 Crore. Nonetheless, the amount of default after COVID Period can be combined with default arising before 25th March, 2020.  
  8. The creditors and corporate debtors will have to spend their time in proving the exact date of occurrence of default as Adjudicating Authority will be bound to identify the timeline of occurrence of default.
  9. Another amendment in Section 66 protects the parties carrying on the business of the corporate debtor from order of contribution as COVID period default will not fall under the category fraudulent trading or wrongful trading. 

 

THIRD AMENDMENT IN CIRP REGULATIONS – A CASE OF OVERSTEPPING BY IBBI

Since its introduction, the Insolvency and Bankruptcy Code, 2016 (Code) has ruffled feathers amongst the Indian corporate sector. Original Code has been amended few times and every amendment has been a classic case of discussion amongst the insolvency practitioners, who are front runners for their implementation. The recent amendment of corporate insolvency resolution process regulations by the Insolvency and Bankruptcy Board of India (IBBI) is no different. IBBI has exceeded its authority under the Code besides stoking confusion. The genesis of the Third Amendment in corporate insolvency resolution process regulations lies in the Insolvency and Bankruptcy (Amendment) Ordinance, 2018 (6 of 2018) which was promulgated by the President of India on 6 June 2018. The Amendment Ordinance, in turn, owes its existence to the Report of the Insolvency Law Committee submitted in March 2018.The need to amend the CIRP Regulations arose because of the Amendment Ordinance 2018.

Gap between Date of Ordinance and Amended Regulations

The gap between the date of commencement of the Ordinance and the date of amended Regulations was avoidable. The purpose of issuing Ordinance is to legislate urgent matters while the Parliament is not in session. Without the amended regulations, some of the amendments brought in by the Ordinance remained on paper and this has defeated the very purpose of promulgating the Ordinance. It was incumbent upon the Regulator to be prepared and issue the Regulations soon after the Ordinance for faster and effective implementation of the amendments.

Applicability of Third Amendment CIRP Regulations

The applicability clause of the Third Amendment has become a cause of concern. On plain reading, it sounds good, but a deeper analysis shows that clause 1(2) has been drafted without much thought. Clause (1) reads as under:

“1(1) These regulations may be called the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) (Third Amendment) Regulations, 2018.

(2) They shall come into force on the date of their publicationin the Official Gazette and shall apply to corporate insolvencyresolution processes commencing on or after the said date.”

The enforcement date states that the amended regulations come into force from the date of their publication (i.e.3 July 2018) but applicabilityis restricted to corporate insolvency resolution processes commencing on or after 3 July 2018. This has come from nowhere, effectively nullifying the immediate applicability of the provisions amended by Insolvency and Bankruptcy (Amendment) Ordinance, 2018 (6 of 2018). It may be recalled that Amendment Ordinance 2018 came into force from 6 June 2018 and it is applicable for all corporate insolvency resolution processes regardless of their commencement date. In other words, any pending action under pending corporate insolvency resolution process or corporate insolvency resolution process commencing on or after 6 June 2018 requires compliance of amended provisions. It does not make a distinction between pending corporate insolvency resolution process or the corporate insolvency resolution process which commences on or after the date of enforcement of the Ordinance.

With no such express or implied intent in Ordinance, the Third Amendment in CIRP Regulations still distinguishes between the corporate insolvency resolution processes on the basis of their commencement date. The amended Regulations apply to corporate insolvency resolution processes commencing on or after 3rdJuly 2018. For example, Regulation 6 provides for public announcement. It has been amended to provide that the public announcement must state additional matters as per newly inserted clauses (ba) and (bb). Applying the applicability clause of the regulation, it applies to corporate insolvency resolution process that commence on or after 3 July 2018. In a case where application for initiation of corporate insolvency resolution process was admitted on 2 July 2018 and the public announcement was yet to be made, the additional matters are not required to be stated in the public announcement. In that sense, two sets of regulations will exist simultaneously and the Interim Resolution Professionals, resolution professionals, corporate debtors, committee of creditors, resolution applicants and adjudicating authority will have to keep in mind the two sets of regulations. It is a sure shot recipe for confusion and chaos.

The following tabular presentation assesses the difficulty that may arise in implementing some of the provisions of the Code which have become applicable from 6 June 2018:

 

Regulation  Number

Subject Matter

Analysis

3(1A) Consent to be obtained from Interim Resolution Professional or Resolution professional replacing Interim Resolution Professional in Form AA In pending corporate insolvency resolution process cases, this need not be followed as per applicability clause whereas the Code mandates that w.e.f 6 June 2018, written consent of Interim Resolution Professional and resolution professional replacing Interim Resolution Professional must be obtained.
4A Choice of Authorised Representative The Ordinance amended the Code treating property buyers as financial creditors w.e.f 6.6.2018. Hence, a right vests in such financial creditors to be a part of committee of creditors through authorized representative from that date. However, such a right has been negated in cases of corporate insolvency resolution processes pending as on 3.7.2018 since regulations relating to class of creditors are applicable for corporate insolvency resolution process commencing on or after 3 July 2018.
12(2) Late Submission of claims Prior to amendment, the claims could be filed with the Interim Resolution Professional or resolution professional before the approval of resolution plan. This has been changed to restrict late filing of claim up to ninety days from the insolvency commencement date.

Distinguishing between pending corporate insolvency resolution processes and fresh corporate insolvency resolution process on or after 3 July 2018 seems discretionary and there is no rational relation to the objective sought to be achieved.

30A Withdrawal of Application The Code has inserted a section for withdrawal of applications. Restricting it to cases of corporate insolvency resolution process commencing on or after 3 July 2018 defies reasoning. The Code does not state that this provision is applicable to future corporate insolvency resolution processes.

 

 

 

 

Regulation 30A relating to withdrawal of admitted application under section 12A is non-est

The insertion of Regulation 30A prescribing the manner of withdrawal of applications under section 12A cannot be a case of simple oversight. Section 12A of the Code reads as under:

“12A. Withdrawal of application admitted under section 7, 9 or 10.

The Adjudicating Authority may allow the withdrawal of application admitted under section 7 or section 9 or section 10, on an application made by the applicant with the approval of ninety per cent. voting share of the committee of creditors, in such manner as may be prescribed.”

The presence of the words ‘as may be prescribed’ in section 12A means that a corresponding Rule will be prescribed by the Central Government. This intent runs throughout the Code. This view is fortified if we consider clause (fa) inserted in Section 239(2), which reads as under:

“239. Power to make rules. –

(1) The Central Government may, by notification, make rules for carrying out the provisions of this Code.

(2) Without prejudice to the generality of the provisions of sub-section (1), the Central Government may make rules for any of the following matters, namely: –

 xxxx

 (fa) the manner of withdrawal of application under section 12A;

 xxxx”

Clause (fa) has been inserted by Insolvency and Bankruptcy (Amendment) Ordinance, 2018 (6 of 2018) as a consequence of insertion of section 12A. Conjunct reading of section 12A and 239(2)(fa) underlines the fact that rules have to be made for the subject matter provided in section 12A and such rules can only be made by the Central Government. IBBI enjoys no power under section 12A or section 240 of the Code to make Regulations in respect of withdrawal of applications as provided under section 12A. The exercise of power by IBBI by inserting Regulation 30A exceeds authority. The Regulation 30 is a nullity in the eyes of law.

The exercise of ‘super authority’ by IBBI has created an avoidable confusion and chaos. Interestingly, the provisions of making the application under section 7,9 and 10 for initiating corporate insolvency resolution process are provided in the Rules framed by the Central Government but the manner of withdrawal of such an application is provided in the Regulations. This mistaken assumption of power by IBBI in prescribing the manner of withdrawal of application needs to be addressed immediately.

Resolution Professional to make Application for Withdrawal

Regulation 30A(1) provides that Interim Resolution Professional shall make an application for withdrawal of application under section 12A in Form FA, after obtaining the consent of the committee of creditors by ninety percent voting share. The application is required to be made before issue of invitation of expression of interest under Regulation 6A. Section 12A does not restrict the time for making an application for withdrawal of application. However, the Regulation 30A prescribes the outer limit within which the application for withdrawal is to be made. This seems to be contrary to the scheme of the Code.

Further, the use of the word ‘applicant’ in section 12A refers to the applicant creditor and not the resolution professional. Sub-regulation (3) of Regulation 30A provides that the application for withdrawal is to be made by the resolution professional to the committee of creditors. Significantly, the Code provides that the application is to be made to the Tribunal.

Bank Guarantee to accompany the application

Regulation 30A(2) also provides that application for withdrawal shall be accompanied by a bank guarantee towards estimated cost incurred for purposes of clauses (c) and (d) of regulation 31 till the date of application. This provision is an additional requirement not envisaged under the Code. It is also not clear as to who will provide the bank guarantee – resolution professional or applicant creditor or corporate debtor or promoters/directors of the corporate debtor.

Committee of creditors to consider application within seven days

Regulation 30A(3) provides that the committee of creditors shall consider the application made by the resolution professional within seven days of its constitution or seven days of receipt of the application, whichever is later. The committee of creditors, in turn, has to approve the decision of withdrawal with ninety percent vote for withdrawal to be effective. There is no provision in the Code for making application to committee of creditors in section 12A.

Application to be forwarded to the Tribunal

Regulation 30A(4) also provides that ince the application is approved by the committee with ninety percent voting share, the resolution professional shall submit the application under sub-regulation (1) to the Adjudicating Authority on behalf of the applicant, within three days of such approval. The use of the word ‘on behalf of the applicant’ is surprising. The resolution professional, while making the application has to submit an affidavit verifying the application. Here, resolution professional becomes an applicant on behalf of the applicant. Such an intent is also missing in the Code.

Conclusion

IBBI has exceeded its authority while framing the Regulation 30A. In terms of section 240, the Regulations framed by IBBI cannot be inconsistent with the provisions of the Code and the Rules framed thereunder. The Amended Regulations is a typical example of inconsistency between the Code and Regulations. IBBI has clearly overstepped its authority and the power delegated to it under the Code. IBBI owes its existence to the Code and is not expected to transgress the threshold set for it.

© Ashish Makhija: ashish@ashishmakhija.com

Disclaimer: The views expressed here are views based on my personal interpretation for academic purposes alone and should not be deemed as legal or professional advise on the subject. If relied upon, the author does not take any responsibility for any liability or non-compliance.

More Hits than Misses – Critical Analysis of India’s Insolvency & Bankruptcy Ordinance, 2018

Second Ordinance in Six Months

The Indian Insolvency law is shedding its infancy sooner than expected. In a span of little over six months, the President has promulgated the second Ordinance brining sweeping changes in the Insolvency and Bankruptcy Code, 2016 (Code). It can be argued that the Government is responsive to the needs of the time, but some look at it as a result of poor drafting in the original law. Regardless of the reason, it looks like the Government is taking the emerging misperceptions seriously. The upshot of the Code is that the limited liability business entities are forced to make sweeping changes in their business dealings with the creditors. They can no longer afford to ignore their timely payments. Financial discipline is here to stay. The second Ordinance has its roots in Insolvency Law Committee Report, 2018.

Immediate Commencement of the Provisions

As expected of any Ordinance, this one also comes into force immediately, that is, from 6thJune, 2018. But the question that begs answer is whether the Government and the Regulator are ready with the consequent amendments in Rules and Regulations? The most likely answer is ‘No’. The Insolvency and Bankruptcy Board of India (Board or Regulator) and the Central Government would work on the Regulations after the promulgation of the Ordinance as they are not supposed to know its contents beforehand.  This means that it will be some time before we see amended rules or regulations to be notified. Practically speaking, the provisions requiring amendment in Rules and Regulations would remain on paper unless supported by the Rules or Regulations.

Home buyers are Financial Creditors

Bringing home buyers under the umbrella of financial creditor was a long-standing demand of the society. In few cases, the debt owed to them forms a majority, yet they were relegated to the fringe by the Code. To strike a balance, they are now considered as a financial creditor under S. 5(8)(f); the amount paid by a home buyer is now deemed as the amount having the commercial effect of borrowing. The impact of this amendment is far reaching and the home buyers now, being a financial creditor, get a right to be a part of committee of creditors albeit through a representative who will be the insolvency professional appointed by the NCLT. How many of us know that proposal to include home buyers in financial creditor was dissented to by three committee members of Insolvency Law Committee? Like home buyers, there are many creditors who are neither operational creditors nor financial creditors. Ordinance has not offered any solutions for them. Amending the definition of operational creditors to mean “creditors other than financial creditors” would solve the problem. This, it seems, has to wait.

Assets of Personal and Corporate Guarantors are outside Moratorium

 Conflicting judgments of NCLT Benches, NCLAT and Allahabad High Court have been set to rest and rightly so by an amendment placing the assets of personal and corporate guarantors outside the purview of moratorium. Corporate insolvency resolution process cannot be allowed to disturb the contractual arrangement between the lender and the surety. The personal and corporate guarantors need to fend themselves without taking a shelter of moratorium under the Code.

Related Party and Relatives

The Ordinance now defines ‘related party in relation to an individual’for the purposes of corporate insolvency resolution process. It is extensive and is meant to control the conflict of interest of individuals associated with corporate insolvency resolution process. Surprisingly, the definition contains the phrase ‘spouse’ but does not define it. Interestingly, Companies Amendment Bill 2008 also contained this phrase in the definition of relative but was omitted from the next version of Bill. The Explanation defines relative for the purposes of ‘related party in relation to an individual’. This may confound the confusion as relative is defined for the purposes of newly added clause (24A) in S. 5 but the term relative for the purposes of clause (24) – related party in relation to a corporate debtor has no definition. Having not been defined, one will rely on its definition in the Companies Act, 2013 by virtue of S. 3(37). This may lead to a dichotomous situation – same phrase having two different meanings under the Code. This calls for super amendment now.

Correcting the Drafting errors

The Ordinance corrects many drafting errors in the Code. Supreme Court laid down the law that in S. 8, the word ‘and’ should be read as ‘or’ for the corporate debtor to bring to the notice of the operational creditor the existence of dispute or record of pendency of suit or arbitration proceedings in response to demand notice. The Ordinance seeks to correct this error. Similarly, the Ordinance corrects the situation by making a bank certificate optional for filing of application by an operational creditor.

Special Resolution made mandatory for initiation of corporate insolvency resolution process by Corporate Debtor

No longer corporate debtors would be permitted to file for their corporate insolvency resolution process on the basis of board resolution. Filing of such application now requires a special resolution by a company or three-fourth of the total number of partners of LLP. While adding this requirement, the Government missed an opportunity to correct drafting error in clause (b) of S. 10(3) which reads as “the information relating to the resolution professional proposed to be appointed as an interim resolution professional”. It should actually read as “the information relating to the insolvency professional proposed to be appointed as an interim resolution professional”.

 Lowering of the Decision-Making Threshold in Committee of Creditors

In the Code, the decisions of the committee of creditors were to be made by a majority of 75%. It stands changed as follows:

 

Decision Voting Percentage in Committee of creditors Prior to the amendment Voting Percentage in Committee of creditors after the amendment
Extension of period of corporate insolvency resolution process 75 66
Withdrawal of application for corporate insolvency resolution process It was not allowed 90
Replacement of Resolution Professional 75 66
Actions under section 28 75 66
Approval of Resolution Plan 75 66
Decision of the Committee of creditors to liquidate 75 66
All other decisions 75 51

Lower threshold limit means the critical decisions such as approval of resolution plan, change of resolution professional, will now have a greater chance of getting through the committee of creditors. This may have been done to hear more success stories under the Code.

Interim Resolution Professional to continue after 30 days

 The Interim Resolution Professional will now hold office until the date of appointment of the resolution professional under section 22 and not until 30 days from the date of his appointment as per the provisions of Code. Similarly, the resolution professional shall continue to manage the operations of the corporate debtor after the expiry of corporate insolvency resolution process until an order is passed by NCLT approving or rejecting the resolution plan, provide the resolution plan has been submitted. These provisions correct the situation of uncertainty prevailing under the Code.

Interim Resolution Professional is responsible for all statutory compliances

A reigning doubt in the minds of the Interim Resolution Professionals has been set to rest by the Ordinance clearly mandating that the Interim Resolution Professional shall be responsible for complying with the requirements under any law on behalf of the corporate debtor.

Banks or FI’s holding shares in corporate debtor are no longer excluded from representation etc in committee of creditors

Banks or Financial Institutions, even though they were financial creditors, had no right of representation, participation and voting in the committee of creditors if they held more than twenty percent of voting rights. This led to an anomalous situation, which has now been corrected with the addition of a proviso in S. 21(2) providing that financial creditors regulated by a financial sector regulator shall not be excluded from representation, participation and voting in the committee of creditors merely because of the fact that their debt was converted into equity prior to insolvency commencement date.

Unwilling Interim Resolution Professional not to be continued as Resolution professional

The Interim Resolution Professional, if not willing, cannot be forced to continue as a Resolution Professional now as the Ordinance makes it mandatory to have the consent of Interim Resolution Professional before being appointed as resolution professional. Infact, consent of insolvency professionals to act as Interim Resolution Professional, Resolution professional or liquidator is a mandatory condition under the Code.

Implementation of Resolution Plan

 The Code had a gaping hole as to implementation of a resolution plan. The Ordinance makes it mandatory for NCLT to satisfy itself as to the provisions in the resolution plan for effective implementation. The onus to approve necessary approvals under any law has been fixed on the resolution applicant. These approvals will have to be obtained within a period of one year from the date of approval of the resolution plan by NCLT.

Accepted Claims can also be Appealed

The Ordinance has sorted out another anomaly in the Code by providing that claims accepted by the Liquidator can also be appealed. Earlier, only rejected claims could be appealed. This amendment was not really necessary as acceptance of lower amount of claim by liquidator was in fact a ‘rejection’ of the remaining amount and an appeal could lie for the partial rejection.

NCLT to exercise Jurisdiction in cases of Insolvency Resolution or Liquidation of Corporate Guarantors to a corporate debtor

In addition to the personal guarantors, the Ordinance now mandates that the insolvency resolution process or liquidation of a corporate guarantor to a corporate debtor shall be dealt by the bench of NCLT where the corporate insolvency resolution process or liquidation of the corporate debtor is under process. This is regardless of the location of the registered office of the corporate guarantor. Ordinarily, under the Code, the jurisdiction of NCLT Bench is decided by the situation of registered office of the corporate person but in case of corporate guarantor, it will be subject to the jurisdiction of the NCLT Bench dealing with the corporate insolvency resolution process or liquidation of the corporate debtor. Here, corporate guarantor means a corporate personwho is the surety in a contract of guarantee to a corporate debtor. Corporate guarantor will include company as well as limited liability partnership. The change also indicates that if the corporate insolvency resolution process or liquidation proceedings of a corporate guarantor is in process, having commenced prior in time to that of corporate debtor, such cases shall stand transferred to the NCLT bench dealing with corporate insolvency resolution process or liquidation of the corporate debtor.

Bar on Jurisdiction of Civil Courts

The Ordinance has extended the bar on jurisdiction of civil courts over the action taken in pursuance of orders passed by the Boardunder the Code. The Board is empowered to pass orders under several circumstances under the Code. Now, no such order can be questioned in a civil court. Earlier only orders of adjudicating authority were covered.

Limitation Act applies to the Code

 The Ordinance settles the dust over the applicability of law of limitation. Henceforth, no creditor with time barred debts can approach NCLT for initiating the corporate insolvency resolution process against the corporate person. This effectively nullifies the judgments of NCLAT which first held that law of limitation cannot apply to proceedings before modifying it to a substantial extent in a later judgment, which is under a stay by the Supreme Court. Now that case becomes infructuous.

Relief to Micro, Small and Medium Enterprises

 The Central Government has been delegated the power to determine the applicability of the provisions of the Code to micro, small and medium enterprises. The big relief also comes into the form of removing disqualification to act as a resolution applicant in two circumstances, namely, clause (c) and (g) of Section 29A. Further, if a person was convicted for any offence punishable with imprisonment for two years or more, he was not eligible to be a resolution applicant. Offences were not restricted to specific laws. The Ordinance has now added the Twelfth Schedule giving a list of 25 Acts, the offences of which shall make a person ineligible to act as a resolution applicant.

Transfer of Winding-up proceedings to the Tribunal

 Interestingly a proviso has been added in section 434 of the Companies Act, 2013 to provide that proceedings relating to winding-up of companies pending before High Court or any other Court prior to commencement of the Code can be directed to be transferred by such Court to the NCLT on an application made by any party to the proceedings. Such transferred proceedings shall be treated as an application for corporate insolvency resolution process under the Code. This provision may trigger transfer of winding-up cases from High Courts to NCLT.

The language employed is, however, confusing and may lead to unintended results. Firstly, it is not clear whether the intent is to transfer applications pending consideration of the Court whether to pass winding-up order or not, or to all cases including those where winding-up has been ordered or provisional liquidator has been appointed. The language suggests all cases including where winding-up is under process can be transferred.

Secondly, all such transferred cases will assume the status of application for initiation of corporate insolvency resolution process. It is not clear how the cases where winding-up is under process and substantially advanced be treated as application for initiation of corporate insolvency resolution process.

Thirdly, winding-up under the Companies Act, 1956 and 2013 was possible on many grounds including inability to pay debts. The Code has omitted only ‘inability to pay debts’ as a ground of winding-up from the Companies Act but not others. Inability to pay dents has been included in the Code broadly classifying it as ‘default’. The corporate insolvency resolution process is triggered on occurrence of default and not on any other ground. If a winding-up was pending before the High Court due to ‘other ground’ on the date of commencement of the Code, its transfer to the NCLT and treating it as a case of corporate insolvency resolution process defies reasoning and logic.

The confusion, it seems will be settled by the Courts. The agony of poor drafting, however, continues. Intriguingly, the Insolvency Law Committee did not deal with this aspect. It only suggested to amend section 434 of the Companies Act, 2013 by amending paragraph 34 of schedule XI of the Code to state that if a petition for winding up on the grounds of inability to pay debts is pending and an order for winding up of the company has been made or a provisional liquidator has been appointed, the leave of the court hearing the winding up proceeding must be obtained, if applicable, for initiation of the CIRP proceedings against such corporate debtor under the Code. The intent and content seem to be at variance. Law will take its own interpretational course.

Conclusion

The Ordinance was the need of the hour and irons out the blunt edges of the Code, which caused confusion amongst insolvency professionals and legal fraternity. The benches of NCLT, NCLAT and Supreme Courts were also at variance with each other, passing diametrically opposite judgments on some aspects. Making similar conceptual changes in Part III can be regarded as a missed opportunity. The experience of corporate insolvency resolution process is here and that could have been applied to the provisions of individual and partnership insolvency resolution and bankruptcy. It seems we will see another Ordinance after the commencement of Part III of the Code. But like it or hate it, insolvency law is here to stay. The full colour of the provisions of the Code is yet to be seen by the corporate persons, promoters, directors and insolvency professionals. One thing is clear, ignorance of this law will hit the debtors very hard.

© Ashish Makhija

Disclaimer: The views expressed here are views based on my personal interpretation for academic purposes alone and should not be deemed as legal or professional advise on the subject. If relied upon, the author does not take any responsibility for any liability or non-compliance.

Status of Personal Guarantor After Discharging debt of Corporate Debtor under IBC?

Personal Gurantors to corporate debtors are in the limelight now-a-days thanks to Insolvency and Bankruptcy Code, 2016 (Code). The personal guarantors are a worried lot as the lenders, particularly the financial creditors under the Code, are invoking guarantees calling upon them to pay the debts of debtors for which they stood surety regardless of pending corporate insolvency resolution process of the corporate debtor against which the surety stood. The law on liability of the surety is perspicuous in India after the Apex Court had held that “the creditor is not bound to exhaust his remedy against the principal Debtor before suing the surety, and a suit may be maintained against the surety though the principal has not been sued.” (State Bank of India v. Indesport Registered, AIR 1992 SC 1740). Also, there is no quarrel in the position that liability of the surety is co-extensive with that of the Principal Debtor unless the contract provides otherwise (S. 128 of the Indian Contract Act, 1872).

Let us analyse the position of the surety once the creditor or lender recovers the amount of the debt from the surety. A Surety, upon payment of debts due by a debtor to the creditor, steps into the shoes of the creditor. A question, however, arises is whether the surety becomes a financial creditor under section 5(7) of the Code upon payment debts of the corporate debtor? Section 5(7) of the Code defines the financial creditor as “any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to”. The definition of financial creditor goes into the definition of financial debt, which has been defined in S.5(8) of the Code. It has a meaning and an inclusive part. The meaning part defines it as “a debt alongwith interest, if any, which is disbursed against the consideration for the time value of money”. The inclusive part contains nine instances which are construed as a financial debt.

Typically, a personal guarantor is entitled to recover the amount from the principal debtor any amount paid on his behalf. This position prevails under the general law of contracts and the surety gets the benefit of every security to which the creditor was entitled to (S. 141 of the Indian Contract Act). To this extent, the position is undisputed. The surety is also invested with all the rights which the creditor had against the principal debtor when the guaranteed debt has been paid by the surety (S. 140 of the Indian Contract Act). Whether the rights collected by the surety against the principal debtor also include the right to be called as a financial creditor under the IBC?

The definition of financial debt, as noted earlier, has two parts and one point of view suggests that to be considered as a financial creditor, the debt now owed to the personal guarantor should satisfy the ingredients of financial debt. The question hinges on satisfaction of element of ‘time value of money’ in the debt. On closer examination of the effect of section 140 and 141 of the Indian Contract Act, one may notice that the surety gets all rights that the creditor had against the principal debtor besides getting benefit of every security. The benefit of security assumes significance in the context of recovery but acquisition of “all rights of the creditor” has wider connotation. It would definitely include the right to be termed as financial creditor and exercise all rights that would have accrued to original creditor.  Subrogation of all the rights of creditor against Principal debtor includes access to securities and right to legal remedies which a creditor was entitled to. Subrogation is “an equitable doctrine holding that when a third party pays a creditor or obligee the third party succeeds to the creditor’s rights against the debtor or obligor”[“Subrogation.” Merriam-Webster.com. Merriam-Webster, n.d. Web. 8 Apr. 2018] and legal right is “the aggregate of the capacities, powers, liberties, and privileges by which a claim is secured” [“Legal Right.” Merriam-Webster.com. Merriam-Webster, n.d. Web. 8 Apr. 2018]. The amalgam of reasonings and meanings stated above leads to the conclusion that surety gets the right to be called as a financial creditor under the Code and gets all powers of financial creditor vested therein.

The result of the above discussion is that a claim can be filed by the surety as a financial creditor in corporate insolvency resolution process or liquidation process under the Code. Surety, therefore, steps into the shoes in every literal sense and the shoes does not pinch in the absence of any express provision debarring the surety to be considered as a financial creditor. Whether the surety will be a part of the committee of creditors is a different matter which hinges upon the related party concept as defined in the Code?

Conclusion : The proposition of surety attaining the status of a financial creditor upon discharge of debts on behalf of the principal debtor sounds logical and reasonable from legal perspective as well as equitable considerations.

© Ashish Makhija: ashish@ashishmakhija.com

Disclaimer: The views expressed here are views based on my personal interpretation for academic purposes alone and should not be deemed as legal or professional advise on the subject. If relied upon, the author does not take any responsibility for any liability or non-compliance.

Key Issues under IBC – Should IRP/RP consider interest while verifying and admitting the claims of creditors?

As regards financial creditors, the IRP/RP should take into account the interest claimed as per the terms of the loan agreement including penal interest, if any upto the insolvency commencement date.

For operational creditors, ordinarily the interest is not considered unless it is claimed by the operational creditor or other creditor and it is stated in purchase or work order. In other words, claim will be admitted to the extent there was agreement between the parties to charge and pay interest. If there is no agreement, merely the fact that it is mentioned in the invoice does not entitle the operational creditor to that interest. Interest has to be taken into account excluding the credit period as per the agreement or customary practice of the trade or usage having the force of law.

To conclude, no thumb rule can be established for providing and calculating the interest in claims by operational and other creditors; it depends on the facts and circumstances of each case.

Disclaimer: The views expressed here are views based on my personal interpretation for academic purposes alone and should not be deemed as legal or professional advise on the subject. If relied upon, the author does not take any responsibility for any liability or non-compliance.