Insolvency and Bankruptcy Code paints all promoters with same brush

Published: December 1, 2017 5:08:53 AM

The ordinance paints all promoters with the same brush, without taking into account why the default happened.

Insolvency and Bankruptcy Code, Insolvency and Bankruptcy Code paints, bankruptcy process stakeholders, Constitution of IndiaThe ordinance paints all promoters with the same brush, without taking into account why the default happened. (Image: Reuters)

By Abir Roy

The recently promulgated ordinance relating to the Insolvency and Bankruptcy Code (IBC) has generated a lot of buzz, and has evoked mixed responses from bankruptcy process stakeholders. The prevalent notion so far was that there are/were sick companies, but there are no sick promoters. This ordinance, coupled by the press release of IBBI on November 7, 2017, seeks to put at rest this notion and, in effect, bars defaulting promoters. The Supreme Court, in the Innoventive case, had observed that entrenched management should not be allowed to continue in management if they cannot pay their debts. The ordinance, however, seeks to go one step beyond, and notes that the said management cannot even come back to management if they cannot settle their debt and are errant defaulters. There has always been an apprehension that the erstwhile promoters may use the IBC process to get the assets at a haircut and come back to management. There have been legislative and regulatory measures to ensure that there is no gaming of the process, like not allowing related parties to be on the Committee of Creditors (CoC), or doing away with the requirement of a shareholder’s resolution for actions contemplated under an approved resolution plan by way of an MCA clarification. The latest, the death knell, was spelt out in the ordinance. Before we get into the nitty-gritty of the ordinance, it must be noted however that the ordinance needs to be sanctified by Parliament in the winter session, otherwise it will lapse, as per Article 123 of the Constitution of India.

The avowed objective of the ordinance is to strengthen further the insolvency resolution process; it has been considered necessary to provide for prohibition of certain persons from submitting a resolution plan who, on account of their antecedents, may adversely impact the credibility of the processes under the Code. ‘Antecedents’ is the key word and, thus, the primary objective of the ordinance was to ensure that such persons should not impact the credibility of the Code. While the intent of the same is laudable, by disallowing certain categories of persons—connected persons who are undischarged insolvents, wilful defaulters (in accordance with the RBI guidelines), legal offenders, disqualified as a director, whose accounts have been classified as NPA for a period of one year and have failed to make the payment of all overdue amounts with interest thereon, and face charges relating to non-performing assets before submission of the resolution plan—the ordinance may create certain new issues, if one reads the fine print of the law.

The first is that the promoter whose account has been classified as NPA has to get finance to make her/his/its account standard before she/he/it can bid in the resolution process. Thus, it may be a practical issue for a promoter to get an external financer to finance her/his/its debt and also what is owed to the corporate debtor in order for her/him/it to give a viable and efficient resolution plan. The IRP fraternity has been fretting that they are not able to get interim finance as no financer wants to invest in a company under the insolvency resolution process. So, expanding that logic, the promoter may have difficulty in getting a white knight investor to bail her/his/its account and also invest with the promoter. The biggest hurdle, in my opinion, is that the ordinance bars most of the promoters, if not all, since it prohibits a person who has executed an enforceable guarantee in favour of a creditor in respect of the debtor from bidding.

Most of the promoters would have given either personal or corporate guarantee to the banks or other creditors to secure the loan; and barring such promoters, who may have been honest, may have been a step too far, considering the objective of the ordinance. Further, such promoters in the negative list are barred from acquiring properties of the debtor in the liquidation process. Thus, if we look at the wordings of the ordinance vis-à-vis the objective, it seems like the ordinance has painted all promoters with the same brush and does not take into account why the default happened. One must be careful in comparing all cases of default with malfeasance. Thus, the ordinance requires greater clarity for nuanced interpretation, and this should be brought about by the Parliament.

The ordinance also imposes a fiduciary duty on the CoC in the entire resolution process—from inviting bids to approving plans—since it has to take into account the complexity and scale of the business operations and also feasibility and viability of the plan so proposed. Also, since one of the categories of people who are prohibited includes such person who have indulged in preferential transaction or undervalued transaction or fraudulent transaction, it is now the duty of the RP to look into such transactions and, coupled with the IBBI press release earlier this month, forensics audit may be a practical necessity. The CoC may have no option but to approve the said expense.

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