IBC: Why ineligibility norms concerning defaulting promoters should be relooked for MSMEs

November 10, 2019 11:42 AM

Lack of clarity within IBC provisions regarding the applicability of ineligibility norms to a transaction to save the corporate debtor from the ultimate liquidation seems to have driven the thought process of IBBI releasing the Discussion Paper.

Insolvency, E marketplace, toxic assets, delay in resolution, IBBI, e marketplace solution, e marketplace insolvency, insolvency and bankruptcy codeThe discussion paper was released on November 3, 2019, by the Insolvency and Bankruptcy Board of India (IBBI), on the Corporate Liquidation Process.
  • By Harish Kumar

The recent discussion paper dated November 3, 2019, released by the Insolvency and Bankruptcy Board of India (IBBI), on the Corporate Liquidation Process (Discussion Paper), seems to have yet again set into motion the unceasing debate concerning ineligibility of the defaulting promoters from indirectly gaining control over the corporate debtor. As understood, the ineligibility norms set out under Section 29A of the Insolvency and Bankruptcy Code, 2016 (IBC) are applicable not only during the Corporate Insolvency Resolution Process (CIRP) but made extended to disposing of assets/properties of the corporate debtor during the liquidation stage as codified under Section 35(1)(f) of the IBC.

However, lack of clarity (within IBC provisions) regarding the applicability of such ineligibility norms to a transaction (such as a scheme of compromise/arrangement potentially to save the corporate debtor from the ultimate liquidation) contemplated during an interim period (being a stage between the CIRP and liquidation process) seems to have driven this thought process of IBBI releasing the Discussion Paper. This seeks public comments on, inter alia, the applicability of Section 29A of IBC to a scheme of compromise/arrangement as proposed during such interim period.

Perceivably, although not included in the Discussion Paper, a relevant contributing factor which may need to be assessed is the introduction of Section 12A under the IBC which has allowed for withdrawal of IBC application post-admission to CIRP subject to receipt of 90 per cent voting share of the committee of creditors. Within the contours of the provisions of Section 12A, a promoter (who is otherwise debarred vide Section 29A from participating in a resolution plan during CIRP) is given yet another opportunity that too during CIRP, to gain control over the corporate debtor upon making payment to the lenders/creditors.

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Undoubtedly, the moralistic argument favouring the applicability of Section 29A is well supported with the rationale that the company should not go back in the hands of the same persons (promoters) whose conduct has brought the company into insolvency stage. However, the same may be rebutted with demonstrated reasons/facts that a particular default triggering unintended insolvency proceedings would have occurred for various reasons (such as change in regulatory framework, long gestation period particularly in power and infrastructure sectors, etc.) beyond promoter’s control, thus, has nothing to do with any ‘willful wrongdoing’ on the part of the promoters.

As commonly recognized, a promoter being traditionally in control of the company would be in a better position to understand the nuances of the business and its dynamics. Moreover, from business perspective, it may fairly be expected that the promoter (who has built-up the company) is willing to take up the company back into its previous healthy shape (without performing any additional tasks such as due-diligence) rather than a new investor who, for obvious commercial reasons, would not only put-forth various pre-conditions in the resolution plan but also eye upon benefiting from acquiring the stressed asset at possible discounted value.

It is also understood that Section 240A of IBC (dispensing with the applicability of clause (c) and (h) of Section 29A on the MSME) has been introduced considering that enough resolution applicants may not have come forward given the nature of the business of MSMEs. On the same pretext, shouldn’t the present scope of Section 29A be relooked at for considering creating suitable carve-outs for such sectors where the cost of running a company is so high that no resolution applicant is coming forward? Even if there is any, the expected hair-cuts are so steep that the lenders (if permitted) would be more willing to open the bid for the promoters, who in fear of losing control over the corporate debtor, would likely to put-forth highest numbers, which might turn out to be a win-win situation for all the stakeholders matching the underlying objective of IBC viz. ‘every possible resolution with maximization of value, prior to last resort of dissolution’.

(Harish Kumar is the Partner at L&L Partners. Views expressed are the author’s own.)

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