Vol V CPSLR, NUALS NUALS IBC E-NEWSLETTER [1] NUALS IBC E-NEWSLETTER Vol. 5, March-April, 2019 * All views expressed are those of the authors. The Newsletter is for private circulation and not for sale. CONTENTS KEY HIGHLIGHTS……………………………………………………………………………..4 SPECIAL INTERVIEW With Mr. Rajeev Vidhani.…………………………………………………………………………….9 QUASHING OF THE RBI’S FEB 12 CIRCULAR: WHAT LIES AHEAD By- Saurav Roy……………………………………………………………………………………...12 THE PERPLEXMENT IN ASCERTAINMENT AND INCLUSION OF CONTINGENT LIABILITY IN THE RESOLUTION PROCESS By- Rupal Gupta & Nehreen Mehra………………………………………………………………….14 PRE-PACKAGED INSOLVENCY: QUICK RESCUE PROCESS OR A FUTILE EXERCISE? By- Rahul Kanoujia and Dhruv Thakur……………………………………………………………….18 CASE UPDATES……………………………………………………………………………….21 IBBI RULES……………………………………………………………………………………32 AN INITIATIVE OF CENTRE FOR PARLIAMENTARY STUDIES AND LAW REFORMS, NUALS (KOCHI)
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Vol V CPSLR, NUALS
NUALS IBC E-NEWSLETTER [1]
NUALS IBC E-NEWSLETTER
Vol. 5, March-April, 2019
* All views expressed are those of the authors. The Newsletter is for private circulation and not
for sale.
CONTENTS
KEY HIGHLIGHTS……………………………………………………………………………..4
SPECIAL INTERVIEW
With Mr. Rajeev Vidhani.…………………………………………………………………………….9
QUASHING OF THE RBI’S FEB 12 CIRCULAR: WHAT LIES AHEAD
1 Brilliant Allow Pvt. Ltd. v. Mr. S. Rajagopal & Ors., Petition(s) for Special Leave to Appeal (C) No(s). 31557/2018.
the ongoing CIRP. It does not make S. 29A
redundant or create a backdoor entry because
the withdrawal process is completely
dependent on the consent of the original
Applicant and approval of the withdrawal
application by the Financial Creditors with at
least a 90% vote share. Thus, if the FCs ascribe
the failure of the CD on willful act or
incompetence of the promoters, they can very
well refuse to provide consent for withdrawal.
However, in a resolution plan bidding process,
as long as a Resolution Applicant is eligible
under Section 29A, the FCs, cannot bar such
Applicant from submitting a resolution. The
two provisions work harmoniously. In fact,
recently, the SC in the case of Brilliant Alloys
Private Limited1 held that Regulation 30A of
CIRP Regulations which bars withdrawal
under S. 12A after issuance of an EoI, is
directory and not mandatory.
2. Due to the advantage of liquidation
over resolution in terms of higher value
recovery, the trend has shifted to
liquidation being the preferred mode. Will
this be a hindrance in the viability and
popularity of the IBC process?
Off late, the process of liquidation has gained
prominence in India and foreign jurisdictions
especially with respect to creditors whose debts
enjoy a decent security cover over recoverable
assets. The statement holds significance but
cannot be generalized, for instance, for non-
brick and mortar companies, such as EPC
(Engineering, Procurement, and Construction)
companies, recovery is low for liquidation due
to lack of existence of hard assets. Thus,
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liquidation can be preferred only in case of
asset-heavy companies or companies where
approvals can be easily transferred or obtained
post asset acquisition and where the lenders
reasonably believe that the recovery shall be
higher in case of liquidation or that the
company has lost all viability for any potential
recovery. Additionally, the first preference of
the lenders should always be insolvency
resolution. Liquidation should be resorted to
only when no potential bidders are offering a
value higher than liquidation value or where all
timelines have been exhausted. The legislative
intent of reducing the voting percentage from
75 to 66 is proof in itself, that insolvency
resolution is to be given an impetus. Thus, the
norm is resolution and liquidation is only an
option of last resort as reiterated by the
Courts/ Tribunals through various judicial
pronouncements (such as, in the case of Arcelor
Mittal).2
3. The SC in K. Sashidhar’s case has
clearly mentioned that CoC decisions are
commercial decisions and are not to be
interfered with. But contrast can be seen in
the recent case of Essar Steel v. Arcelor
Mittal, in which NCLT has made some
observations for giving the OCs a 15%
stake instead of lesser. In your opinion,
how far is it correct on part of NCLT to
review a commercial decision made by the
CoC, and does this essentially amount to
judicial review of commercial decisions?
The observation made by NCLT Ahmedabad
is only a recommendation and not a direction
per se. The decision in K. Sashidhar’s3 case only
2 Arcelor Mittal India Private Limited v. Satish Kumar Gupta and Ors., 2018 TaxPub (CL) 1116 (SC).
reiterated that the commercial wisdom of the
CoC should not be questioned with respect to
the approval of a Resolution Plan unless it is
wholly arbitrary. However, the observation by
the NCLT is only with regard to certain aspects
such as the distribution of resolution proceeds,
wherein the Tribunal has recommended a
change in proportion to ensure reasonable
parity amongst Financial and Operational
Creditors. There is a difference between
NCLT/ NCLAT interfering with the
approval/ rejection of a resolution plan and it
recommending a change in distribution of
proceeds of an approved resolution plan. The
present recommendation is only for modifying
the distribution as well as clarifying the
position of similarly and dissimilarly placed
creditors.
4. It can be seen that even after a
decision has been taken by the CoC, bids
are still being submitted. Do you think a
cut-off date is required for this as well?
How will such a time frame be managed?
In exceptional cases, Courts have allowed the
bids to be submitted even after the bid
submission date. It has been held and reiterated
by NCLAT on several occasions that the
objective of the IBC is commercial insolvency
resolution and not completion of a bid process.
The objective of the Code is value
maximization, whereby the Company/ CD
should be able to end its financial misery and
continue as a going-concern along with
creditors recovering the highest possible value.
This sole objective should not be allowed to be
defeated on a technicality. Hence, submission
3 K. Sashidhar v. Indian Overseas Bank and Ors, 2019 SCCOnLine SC 257.
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post the cut-off date has been allowed to
ensure maximum recovery for the benefit of all
stakeholders rather than turning CIRPs into
mere bid processes, allowing the highest bidder
to walk away with the company, without due
regard to the interest of all stakeholders and
business continuity.
5. A significant concern has been
expressed in certain CIRP cases that
Insolvency Professionals in India are
charging high fees that may not be
reasonable and commensurate with the
work being handled by them. There have
also been instances of abnormally low fees
charged by an IP, such as ₹1, to act as an
Insolvency Resolution Professional.
Should this disparity be a cause of concern
and, if yes, how can this be addressed?
There are no set guidelines but attempts have
been made in the form of general guidelines.
Other developed jurisdictions have fee
schedules attached to the insolvency
regulations. Thus, a standardized fee structure
should be adopted in India as well. As far as
lesser payments are concerned, there might be
other considerations involved in the current
processes.
6. Contingent liabilities, the debts
which are not dealt with in the resolution
plan, might not get due consideration at
the time of crystallization of debts when
compared to a similarly placed creditor
even though both the causes of action
arose at the same time, i.e., before the
insolvency commencement date. How can
this disparity, which is detrimental to both
the contingent debtor as well as the bidder,
be resolved?
Presently, the placement and treatment of
contingent liabilities is dealt with in the manner
set out in the Resolution plan, with provisions
limiting liability of Resolution Applicant to the
total amount provided for the respective class
of creditors in the resolution plan and
realignment of distribution inter-se the class
upon crystallization of contingent liabilities
pertaining to that class or providing for
settlement at NIL value due to non-availability
of sufficient liquidation value. If it is felt that
sufficient funds will not be available for
Secured Creditors or Operational Creditors,
limited recourse may be provided for
contingent liability (though there exists no
other reason to treat them differently).
Another alternative can be holding money in
an escrow for contingent liabilities.
7. In your view, what are the grey
areas that persist in IBC?
Firstly, the concept of third-party contracts
does not find a place in the Code. The question
arises as to whether the court has jurisdiction
to adjudicate upon their rights, including
termination of third-party contracts. Secondly,
the finality of claims itself is still a problem
area. There is no express provision in the Code
which deals with the acceptance or
extinguishment of claims submitted after a
particular date. This is expected to be settled in
due course, once claims are received post
completion of substantial CIRPs. Thirdly, the
position for distribution of resolution proceeds
can be made based on the ranking of charges
as well as between secured and unsecured
creditors. The position is under deliberation
before Hon'ble NCLAT in some prominent
matters such as Essar Steel.
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QUASHING OF THE RBI’S FEB 12
CIRCULAR: WHAT LIES AHEAD
By Saurav Roy4
INTRODUCTION
The SC, via its order in Dharani Sugars and
Chemicals Ltd. v. Union of India,5 struck down the
circular dated February 12, 2019, and declared
it entirely ultra vires, in relation to powers that
are delegated to the RBI under Ss. 35AA and
35AB of the BR Act. The Feb 12 Circular had
initially revolutionized the restructuring regime
for banks and financial institutions by repealing
a host of RBI Circulars on debt restructuring;
such as CDR, JLF, and many others. These
schemes, commonly referred to as the
‘alphabet soup', were replaced in favor of an
entirely new regime governed by the Feb 12
Circular.
In layman terms, the Feb 12 Circular inter alia
provided that:
Lenders ought to put in place a policy for
stressed assets;
In the case of default (SMA-0, SMA-1,
SMA-2), identification of a resolution plan
is necessary;6
Independent credit evaluation must be
conducted for accounts of ₹1 billion; and
Compulsory reference is to be made to IBC
proceedings for accounts over ₹20 billion
in case of unachieved resolution from 180
days starting March 1, 2018.
4 Saurav Roy, 5th Year Student, ILS Law College, Pune. 5 Dharani Sugars and Chemicals Ltd. v. Union of India, (2019) 5 SC ALE 629. 6 SMAs, or Special Mention Accounts, are classifications used by the RBI to better manage the bad loans. When
FINDINGS OF THE APEX COURT
The operative and most pertinent parts of the
SC order are as under:
The SC reasoned that the Feb 12 Circular
ought to be struck down as it exceeded the
power granted to RBI under the Relevant
Sections of the BR Act. Moreover, the
basic tenor of the Relevant Sections led the
SC to hold that the RBI ought to issue
directions only in cases where the Central
Government mandates or provides
instructions. Any generalized directions
issued by the RBI without Central
Government authorization would be ultra
vires of the BR Act.
The SC upheld the arguments of
petitioners from the power production
sector, who argued that a general circular
(such as the Feb 12 Circular) quantifying
INR 20 billion as the threshold for default,
could not be applied to individual cases
without a case by case analysis. Credence
was given to the nature of business
undertaken by power production
companies, and the long gestation periods
involved in the same.
The SC held that there was no evidence to
show that Section 45L (3)7 of the Reserve
Bank of India Act, 1934 had been satisfied
by the issuance of the Feb 12 Circular. The
SC unequivocally stated that all cases under
IBC which were under the auspices of the
Feb 12 Circular would be Non-Est, and
thus struck down. However, it becomes
principal and interest are outstanding for 30 days, it falls under the SMA-0 category. Similarly, 30-60 days of default is SMA-1, and 61-90 days falls under SMA-2. 7 Reserve Bank of India Act, 1934, §45L.
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important to iterate that notwithstanding
the merits of the case, the SC has not
curtailed any lenders’ statutory rights under
the IBC to initiate insolvency proceedings
as a financial creditor under Section 7 of
the IBC.8
IMPLICATIONS OF THE ORDER
The invalidation of the Feb 12 Circular has
technically left a gaping hole in the distressed
assets space, with clarity on the RBI’s stance
expected post general elections of 2019.9 That
being said, it is pertinent to analyze the
pedantic approach taken by the SC and its
implications on the commercial sector. A few
key observations and considerations are
delineated below:
Given that cases restructured under the
ambit of the Feb 12 Circular are now
technically bad in law, banks ought to
revisit benefits of asset classification and
provisioning taken under the Feb 12
Circular, and the effect it would have on
their balance sheets.
It is logical to presume that cases that have
been initiated solely on grounds under the
Feb 12 Circular would now be withdrawn
under Section 12A of the IBC, after
concurrence of the CoC. This could also
lead to filings on the part of the debtor to
take itself out of the insolvency process,
and the interplay between these filings and
IBC will certainly lead to innovation on the
part of the legal fraternity.
8 Insolvency and Bankruptcy Code, 2016, §7. 9 RBI's revised debt resolution rules likely post-election, Economic Times Markets,
The timelines envisaged under the Feb 12
Circular had forced promoters to hurriedly
arrange funds in order to enable a ‘one-
time settlement' with banks or rush to find
new investors into equity. Various offshore
debt funds began acquiring loans from
banks, predicting a speedy resolution. The
invalidation of the Feb 12 Circular can
prove to be a blow to the liquidity in the
distressed assets market.
The negation of the Feb 12 Circular has
exposed the market to uncertainty,
especially in relation to negotiations
between bankers and promoters.
Previously, the security of fixed timelines
and predictability of outcomes enabled
smooth market liquidity. With these
timelines no longer in place, lengthier time
periods could affect the consistency and
efficacy of resolutions.
THE WAY FORWARD
Given that the SC has rejected the generalized
approach adopted by the RBI in terms of
directions and mandates, it is the author’s belief
10 Rupal Gupta & Nehreen Mehra, 3rd-year Students, Amity Law School Delhi, affiliated to G.G.S.I.P University. 11 Property, Black's Law Dictionary (2nd ed. 1910). 12 Insolvency and Bankruptcy Board of India, Minutes of the 3rd meeting of the Advisory Committee on
Given that the statutory rights under IBC
continue to exist for banks, it is worrying that
they often need to be prodded or even
compelled to exercise these rights. It is high
time that the banks chased their bad loans
themselves, without the interference of other
agencies.
THE PERPLEXMENT IN
ASCERTAINMENT AND INCLUSION
OF CONTINGENT LIABILITY IN
THE RESOLUTION PROCESS
By Rupal Gupta & Nehreen Mehra10
MEANING
Contingent liability in the literal sense can be
defined as a liability that depends on an event
to happen to become a liability. Funds are set
aside to handle the loss.11 It is a probable
liability. For example, if a company has given a
guarantee for some other entity's debt,
statutory dues, penal interests, late fees, etc.
The IBC is silent on contingent liabilities
however, the definition of claim u/S. 3(6) &
that of financial debt u/S. 5(8) implies that it
can be treated as a claim as suggested by the
Advisory Committee on Corporate Insolvency
& Liquidation.12
Similarly, in the US, it is clear that under the
Bankruptcy Code of the US, ‘property’
encompasses both contingent & disputed
assets.13 U/S. 101(12) of the Bankruptcy Code,
‘debt’ is defined as “liability on a claim,” &
‘claim’ is defined u/S. 101(5) of the Bankruptcy
Corporate Insolvency & Liquidation held on 10-11th February, 2018 https://ibbi.gov.in/Agenda_04C_150318.pdf. 13 In re Hall, 304 F.3d 743 (7th Cir. 2002).
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Code as a “right to payment, whether or not
such right is reduced to judgment, liquidated,
unliquidated, fixed, contingent, matured,
unmatured, disputed, equitable, secured, or
unsecured.”14
Hence, there is no specific definition of a
contingent liability in the IBC, however, its
essence is present.
RELEVANT PROVISIONS UNDER IBC
& THE CIRP REGULATIONS, 2016
Under the CIRP, once the application for the
initiation of the resolution process is admitted
by the NCLT, the creditors are supposed to
submit all their claims against the CD.
However, Chapter II of the IBC provides that
such an application can only be filed when a
default is made by the CD. Thus in this
scenario, the main question that arises is
whether certain contingent liabilities can be
submitted as a claim by a creditor? Even
though the IBC does not directly address this
issue, inference regarding the admissibility of
contingent liabilities can be drawn from the
following-
1. The term ‘claim’ as defined u/S. 3(6) of the
IBC, includes any right to payment,
irrespective of whether it is matured or not.
2. Regulation 14(1) of the CIRP Regulations
provide-
14. Determination of amount of claim.
(1) Where the amount claimed by a creditor is not precise
due to any contingency or other reason, the interim resolution
professional or the resolution professional, as the case may be,
14 United States Bankruptcy Code, 11 U.S.C. § 101(5). 15 Export Import Bank of India. v. Resolution Professional JEKPL Pvt. Ltd, [2018] 146 CLA 246.
shall make the best estimate of the amount of the claim based
on the information available with him.
This implies that liabilities which have not yet
become debt i.e., they are contingent or
unmatured can be included in the total
liabilities of a CD. The valuation of contingent
liabilities will be done by the insolvency
professional.
APPROACH OF THE NCLT & THE
NCLAT
The main concern regarding the treatment of
contingent liability is that its occurrence is not
confirmed and when it is treated as a claim
under the CIRP, no reliable estimation of its
value can be made.
Till now, the issue about the treatment of un-
invoked corporate guarantee, which is
contingent at the date of commencement of
the CIRP has been decided by the Hon’ble
NCLAT in Export Import Bank of India. v.
Resolution Professional JEKPL Private Limited15. In
this case, the orders of the NCLT in Axis Bank
Limited v. Edu Smart Services Private Limited16 &
Export-Import Bank of India v. JEKPL Private
Limited17 were set aside which held that un-
invoked corporate guarantee cannot constitute
a ‘claim’ as first, it had not crystallized as a ‘debt’
at the commencement of CIRP; second,
enforcement of such contingent liability would
result in enforcing of ‘security interest’ leading
to violation of the moratorium imposed u/S.
14(1)(c) of the IBC. The Hon’ble NCLAT
rejected the plea that right to claim any debt
16 Axis Bank Limited v. Edu Smart Services Private Limited, CP (IB)-102(PB)/2017; Braj Bhusandas Binani v. Vijaykumar V. Iyer, [2018] 146 CLA 114. 17 Export-Import Bank of India v. JEKPL Private Limited, CA No. 159/2017.
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arises only when the Creditor's debt is due &
payable & referring to the definition of default
u/S. 3(12) held-
"It is clear that the default of debt has nothing to do
with the claim of a person, whether secured or
unsecured."
Moreover, it was observed that the duty of the
resolution professional to maintain an updated
list of all the claims u/S. 25 (2) (e), was also
indicative of the fact that even unmatured
liabilities could be treated as a claim.
Thus, this decision is welcome as it has given
much clarity regarding the admissibility of
contingent liabilities. This aligns with the
intention of the Legislature, which can be
inferred from the provisions of the IBC
discussed above.
OUTLOOK OF FORUMS OUTSIDE
INDIA
Contingent liability has been recognized as a
claim under Bankruptcy proceeding
worldwide.
As per UNCITRAL Legislative Guide to
Insolvency Law,18 the recommendation is that:
“The Insolvency Law should specify the claims
that may be submitted to include all rights for
payment that arise from acts or omissions of
the debtor prior to commencement of the
insolvency proceedings, whether mature or
18 10, Legislative Guide on Insolvency Law 14 (5th ed. 2005), https://www.uncitral.org/pdf/english/texts/insolven/05-80722_Ebook.pdf. 19 Official Trustee in Bankruptcy v. C S & G J Handby Pty Ltd, (1989) 21 FCR 19.
not, whether liquidated or unliquidated,
whether fixed or contingent. The law should
identify claims that will not be affected by the
insolvency proceedings.”
Full Federal Court in Official Trustee in
Bankruptcy v. C S & G J Handby Pty Ltd19
observed that the Bankruptcy Code is quite
wide. It opined that “every possible demand, every
possible claim, every possible liability, except for
personal torts, is to be the subject of proof in
bankruptcy.”
“Future & contingent creditors are just as much
entitled to a ranking as present creditors, in a different
way… In the case of contingent creditors, a sum is set
apart to meet their claim, should the condition upon
which it depends become purified.”20
Although contingent liability is recognized
however, its inclusion in calculation is always in
question, as the contingency makes the
valuation of the claim impossible, even though
liability has been fastened.21
The Seventh Circuit’s decision in In re Xonics
Photochemical, Inc22 recognized contingent
liabilities and even gave the formula to
evaluate. It stated that a contingent liability
should neither be added on the balance sheet
at its full face amount nor should it be shown
as zero. Instead, the Court explained that "to
value the contingent liability it is necessary to discount
it by the probability that the contingency will occur and
the liability becomes real." This is referred to as
the ‘probability discount rule.’ The Seventh
20 Thomas M Burton, Liquidator of the Ben Line Steamers Ltd, [2011] S.L.T. 535, Order dated December 24, 2010. 21 Riggin v. Magwire, 15 Wall. 549, 21 L. Ed. 232. 22 Xonics Photochemical, Inc. v. Mitsui & Co. (In re Xonics Photochemical, Inc.), 841 F.2d 198 (7th Cir. 1988).
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Circuit23 refined the ‘formula’ later. It was
observed that the formula given in Xonics was
from the creditor’s point of view & the
Bankruptcy Code required to think from the
debtor’s point of view.
The Court in Mellon Bank, N.A. v. Official
Committee of Unsecured Creditors of R.M.L., Inc.24
& in Advanced Telecommunication Network Inc. v.
Allen25 have followed the Xonics rule.26
The other method of evaluation is ‘Hindsight’,
in which an expert is asked to give a solvency
plan or a plan for valuation. Although it is
considered as inaccurate, since an expert
cannot give a plan for unknown liabilities, there
have been cases in which this valuation method
has been preferred such as in W.R. Grace & Co.
v. Sealed Air Corp.27 However, the Bankruptcy
Court in Diamond Power International Inc. v.
Babcock & Wilcox Co.28 observed that the
hindsight method was incorrect.
Another method is the ‘Monte Carlo Method’
which is probabilistic and uses statistical
random sampling techniques that reproduces
various sources of uncertainty. It calculates an
average or expected value over a large range of
resultant outcomes.29 This method has proved
to be quite successful in many cases such as In
re, Tronox30.
23 Covey v. Commercial National Bank of Peoria, 960 F.2d 657, 660 (7th Cir. 1992). 24 Mellon Bank, N.A. v. Official Committee of Unsecured Creditors of R.M.L., Inc. (In re R.M.L., Inc.), 92 F.3d 139 (3d Cir. 1996). 25 Advanced Telecommunication Network Inc. v. Allen (In re Advanced Telecommunication Network Inc.)490 F.3d 1325 (11th Cir. 2007). 26 In re Hoffinger Indus. Inc., 313 B.R. 812 (Bankr. E.D. Ark. 2004); In re Merry-Go-Round Enters., Inc., 229 B.R. 337 (Bankr. D. Md. 1999).
CONCLUSION
Even though the decision of the NCLAT dealt
with a certain type of contingent liability, it has
settled the uncertainty surrounding its
treatment under the resolution plan. It is
believed that there is one more reason why
contingent liabilities should be considered a
claim under the CIRP. It will be unfair for a
creditor if he is not allowed to participate in the
process because of the contingency of its claim.
Moreover, once the company liquidates, such a
claim will never be recovered. The NCLAT
decision will help in avoiding such injustice to
any creditor.
However, the issue regarding the reliable
estimation of such claims still exist. It cannot
be denied that the power given to the
resolution professional under Regulation 14
will be subjectively applied. "No single valuation
method is universally applicable to all appraisal
purposes. The context in which the appraisal is to be
used is a critical factor.”31 Thus, it is suggested that
some guidelines be laid down in this regard
which shall provide the basis for estimation.
This will ultimately help in bringing uniformity
in the calculation of such claims. For this
purpose, assistance can be taken from the
methods laid down in the foreign cases
discussed above. The inclusion of contingent
liability & its correct estimation is also essential
27 W.R. Grace & Co. v. Sealed Air Corp. (In re Sealed Air Corp.), 3 281 B.R. 852 (Bankr. D. Del. 2002). 28 Diamond Power International Inc. v. Babcock & Wilcox Co. (In re Babcock & Wilcox) 274 B.R. 230, 262 (Bankr. E.D. La. 2002). 29 In Lyondell Chemical Co. v. Occidental Chemical Corp., 608 F.3d 284 (5th Cir. 2010). 30 In re Tronox, No. 09-01198-alg (Bankr. S.D.N.Y. Nov. 20, 2012) ECF No. 591. 31 In re Commercial Fin. Servs., Inc., 350 B.R. 520, 532 (2005).
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as the financial creditors who have contingent
claims will also be part of the CoC which may
affect the resolution plan.
PRE-PACKAGED INSOLVENCY:
QUICK RESCUE PROCESS OR A
FUTILE EXERCISE?
By Rahul Kanoujia & Dhruv Thakur32
The Government is contemplating inception
of a quick rescue process i.e. pre-packaged
bankruptcy for corporate entities which will
unfold preferably in boardrooms than
courtrooms. Pre-packaged insolvency scheme
is a concept where bankruptcy courts are
approached with a pre-negotiated
reorganization plan by the creditors and
shareholders. Pre-packaged bankruptcy is a
plan for the financial reorganization of
distressed firms and is a popular corporate
restructuring exercise prevalent in the US and
UK. This plan is prepared with co-operation of
the creditors and the underlying objective is to
simplify the bankruptcy process to save the
firm’s money in accounting and litigation fees.
After filing a plan for reorganization, a
confirmation hearing can be scheduled quickly,
due to advance negotiation with creditors
leading to a quick exit from bankruptcy. To
illustrate, in 2017, Vodka Maker Roust Corp,
filed, initiated insolvency process under
Chapter 11 of the US Bankruptcy Code, and
it took just four business days to get a plan
approved. The company was hit by the steep
32 Rahul Kanoujia & Dhruv Thakur, 2nd year Students, Gandhinagar National Law University, Gandhinagar (Gujarat). 33 REUTERS, https://www.reuters.com/article/us-usa-bankruptcy/ever-shorter-u-s-bankruptcies-have-creditors-scrambling-idUSKBN15G5FO, (last visited December 29, 2018).
fall in Russian Ruble in 2016 and spent nine
months forging out a pre-packaged bankruptcy
plan with note-holders to cut 462 million
dollars in debt.33 Hence, pre-packaged
insolvency allows a company to engage in a
compact bankruptcy process, as almost all the
restructuring negotiations have taken place
before filing for bankruptcy.
ADVANTAGES OF OPTING FOR A
PRE-PACKAGED INSOLVENCY
The most significant advantage of pre-
packaged insolvency is the conservation of
money and time as the mechanism of CIRP is
smoother with lenders on board with a
restructuring plan beforehand.34 Credit goes to
expedited schedule, fees and costs associated
with monthly reports, attorneys, other
professionals, and creditor committees are
minimized.
Further, negative publicity that may have been
incurred with creditors fighting for their claims
in a long bankruptcy process, can be avoided.
Hence, goodwill of the company stays intact
which results in a higher price being achieved
than what otherwise would have been
realized.35
For a CD, instead of facing the CIRP, which is
disruptive to customers, suppliers, and
employees, it will have the opportunity to
broadcast a strong positive message to its
constituencies, by initiating pre-packaged
insolvency process. This will indicate that the
34 Kasee Sparks Heisterhagen, Pros, and Cons of the Pre-Pack Bankruptcy, Lexology (December 26, 2018), https://www.lexology.com/library/detail.aspx?g=f927e4b4-ef28-4714-9a04-0a49bb327f80. 35 Jose M. Garrido, Out-of-Court Debt Restructuring 09, (World Bank 2012) [hereinafter referd as ‘Garrido’].
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CD is more competitive in the business
because it will have a more manageable capital
structure in the immediate future.36 Under
Chapter 11 of the US Bankruptcy Code, which is
also a potential point of reference to introduce
the concept of pre-packaged insolvency in
India, a debtor can obtain Bankruptcy Court's
approval of a disclosure statement because
solicitation is not required for a pre-packaged
bankruptcy as it is done outside of the
bankruptcy process.37 Also, if the debtor is
interested in continuing to run its business as a
new company, but needs help in dealing with
on-going financial problems, then the pre-pack
administration could be the best solution
available.38
About the employees of the insolvent
company, the pre-packaged bankruptcy
process provides relief through the swift
transfer of a business to the acquirer without
any delay and job loss.39 Furthermore,
Indentures and credit agreements outside of
bankruptcy process require the unanimous
written agreement of note-holders or lenders
to implement a transaction that affects the
fundamental economics of a deal, for ex.,
maturity, principal and other economic terms.
Because all holders must approve these
changes, holdouts or else unresponsive parties
can vitiate the process.40 On the flip side, in a
planned process if the affected class of
36 Alexandra Kastrinou and Stef Vullings, ‘No Evil is
Without Good: A Comparative Analysis of Pre‐pack Sales in the UK and the Netherlands’, 27 International Insolvency Review 320, 320-339 (2018). 37 Raza Khan, UK: Pre-Packaged Insolvency, Mondaq (December 26, 2018), http://www.mondaq.com/uk/x/665912/Insolvency+Bankruptcy/PrePackaged+Insolvency. 38 Garrido, supra note 5, at 8. 39 Admin, The 5 Biggest Advantages of Pre-Pack Administration, HJS Recovery (December 26, 2018),
creditors accepts the proposed treatment by
two-thirds in dollar value and one-half in
number of creditors, voting can make binding
changes In Chapter 11 of the US Bankruptcy Code,
plan process, the Bankruptcy Code allows for
a class of creditors to make binding changes to
all aspects of an indenture or credit
agreement.41
ON THE CONTRARY, PRE-
PACKAGED BANKRUPTCY IS A
CONTROVERSIAL TOOL WHICH HAS
SOME POTENTIAL DISADVANTAGES
There exist various risk factors associated with
pre-packaged bankruptcy, which need to be
taken into consideration before adopting a
suitable framework in India. Firstly, a creditor,
whether financial or operational, if aware that
a bankruptcy filing is anticipated might take an
aggressive stance in collecting its dues from the
company. 42
Secondly, there is a perceived lack of
transparency concerning marketing and
evaluation of the claims, which can give rise to
an impression that full value may not be
obtained particularly in the case of sale to a
related party connected to the directors of the
CD.43
https://www.hjsrecovery.co.uk/the-5-biggest-advantages-of-pre-pack-administration/. 40 Garrido, supra note 35, at 10. 41 US Bankruptcy Code, Chapter 11. 42 Id. 43 Alexandra Kastrinou and Stef Vullings, ‘No Evil is
Without Good: A Comparative Analysis of Pre‐Pack Sales in the UK and the Netherlands’, 27 International Insolvency Review 320, 320-336 (2018).
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Thirdly, in many legal systems, creditors could
face liability if it is found that through the
implementation of the workout they were de-
facto running the debtor’s business (shadow
directors). They may also face lender’s liability
for the concession of abusive credit.44 But in
the Indian insolvency scenario, those risks do
not exist, because new finance typically
requires the consent of creditors and/or
authorization of the AA.
HOW PRE-PACKAGED BANKRUPTCY
WORKS IN US & UK
UK (pre-packaged bankruptcy has become
popular since the Enterprise Act 2002) and
the US (pre-packaged insolvency provisions
are often found in Chapter 11) have
historically been perceived as leading
jurisdictions in the development of
restructuring and insolvency law – to the extent
that dozens of local insolvency regimes around
the world have been modeled on some
combinations of their processes. Hence to
ascertain accurate feasibility of Pre-Packaged
Insolvency it is significant to understand how
it functions in these nations where pre-
packaged insolvency marks its inception.
a) UNITED KINGDOM
In the UK, directors must pass a resolution
stating they have considered the financial
position of the Company. That resolution
includes appointing an advisor known as an
Insolvency Practitioner (IP). The IP shall
review the CD’s financial position, its
performance and accordingly advise on
options available, namely: ‘Carry on the
business'; Company Voluntary Arrangement,
Administration (Including consideration of a
44 Garrido, supra note 35, at 13.
pre-pack sale); and Creditors Voluntary
Winding-up.
Where a pre-packaged bankruptcy
administration is deemed appropriate, the IP
shall try to identify buyers. Ensuring
Compliance via the Statement of Insolvency
Practice 16, it provides direction to IPs
concerning any proposed pre-pack sale. IP
shall through independent valuers, evaluate the
value of the company.
The Directors are obliged to prepare a
Statement of Affairs. If a connected party is
leading in these talks to acquire the business,
they are required to consult with the pre-pack
pool of creditors. IP will then be appointed as
an Administrator to affect the sale of the
business and or assets of the company. After
the sale, an Administrator should provide
creditors with a detailed narrative explanation
and justification (the SIP 16 statement) of
why a pre-packaged sale was undertaken and all
alternatives considered.
b) UNITED STATES OF AMERICA
In the US, unlike the UK, a CD negotiates the
terms of a Chapter 11 restructuring plan and
solicits votes on it prior to the bankruptcy filing
and Court approvals.
Pre-packaged Bankruptcy in the US allows a
company to quickly implement a balance sheet
restructuring without the consent of 100% of
its creditors (restructuring debt outside
bankruptcy often requires unanimous consent
from financial creditors). Further, in the US a
pre-pack requires the support of creditors that
hold two-thirds in amount and more than one-
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half in the number of claims voting in a class
under the bankruptcy plan.
Pre-packaged Insolvency in the United States
can be completed within thirty to ninety days.
By minimizing a debtor's time in bankruptcy,
pre-pack limits the administrative costs that a
debtor would otherwise incur during formal
insolvency proceedings.
THE ROAD AHEAD FOR PRE-
PACKAGED INSOLVENCY IN INDIA
At present, the Govt. of India is evaluating the
idea of adopting a suitable framework for pre-
packaged insolvency in India, based on past
experiences with the UK and US. The primary
objective for such discussion is to make the
pre-negotiation method amongst various
stakeholders, very clear. The IBBI is probably
going to be entrusted with this exercise. It's
expected that IBBI might come back up with a
discussion paper, inter alia, inviting suggestions
on key objectives. However, solely time can tell
that whether the pre-packaged insolvency
process, which is common in developed
insolvency jurisdictions, can be able to work its
way in India where the insolvency practice is
still at a growing stage.
CASE UPDATES
[SUPREME COURT]
April 30, 2019
JK Jute Mill Mazdoor Morcha v. Juggilal
Kamlapat Jute Mills Co. Ltd. through its
Director & Ors, Civil Appeal No. 20978 of
2017.
The case before the SC was primarily to analyze
whether a Trade Union could be an OC under
the IBC. The factual matrix of the case was that
the Trade Union issued a demand notice on
behalf of the workers under S. 8 of the Code,
to the CD. The Respondent approached the
NCLT which dismissed the claims of the Trade
Union as an OC, holding workers alone could
file an individual application before NCLT.
NCLAT on appeal upheld the NCLT’s order.
The SC analyzed the meaning of OC under the
S. 5(20) of the Code and traced it to be a
‘person’ to whom an operational debt is owed.
A careful reading of the term ‘person’ was also
done by the Court under S. 3 of the Code
which includes “any other entity established
under a statute”. Court read in the scope of
Trade Unions Act, 1926 into this clause of S. 3
of the Code.
Court gave a purposeful interpretation to the
provisions of the Trade Unions Act, stating
that a registered Trade Union being a body
corporate, has a general fund built through
contributions of the Workmen. This fund of
the Trade Union could certainly be used for the
initiation of a legal proceeding to which the
trade union is a party and for protecting the
rights of the workmen.
The Court held the orders of NCLAT to be
burdensome as each Workmen would have to
pay the CIRP cost, valuation cost, and
incidental costs, etc. Therefore, SC set aside the