The operational creditors cited the NCLAT’s decision on July 4, 2019, in Standard Chartered Bank vs Satish Kumar Gupta, R P of Essar Steel
Often, courts step in to lend direction when new statues lack clarity or are inconsistently interpreted. In other cases, the legislature steps in to remedy errors that find their genesis in judicial errors and shortcomings lending an interpretation inconsistent with objects of the statute. Two such recent amendments to the Insolvency and Bankruptcy Code (IBC) fall into the latter category.
The first is to Section 12 of the IBC. Despite the Supreme Court stressing the importance of statutory timelines (in its October 2018 judgment in the Arcelor Mittal case), including model timelines under Regulation 40A, it observed elsewhere in the same decision that “where a resolution plan is upheld by the appellate authority, either by way of allowing or dismissing an appeal before it, time taken in litigation ought to be excluded”. This observation diluted the apex Court’s earlier emphasis on avoidance of undue delays. This error has now been corrected through the introduction of two provisos to Section 12(3). First, by providing that resolution processes will “mandatorily be completed” within 330 days from the “insolvency commencement date” and, second, it clarified this would include time taken in legal proceedings. Last, for all pending proceedings which have extended beyond 330 days, a maximum period of 90 days is provided to conclude the process. The consequence of non-adherence to these timelines set out in Section 33 will be liquidation, which shall apply mandatorily. The amendment would need to go hand-in-hand with systemic and infrastructural changes to ensure that the “rescue culture” under the code is not diluted by liquidations flowing from the tribunals’ inability to handle cases, due to capacity constraints.
The second set of amendments is course-correction in the wake of judicial errors by way of changes to Section 30. To understand these errors, it is necessary to provide some context.
The amendment was passed by the Lok Sabha on August 1, 2019, with the Rajya Sabha approving it two days earlier. Presidential assent came on August 5. Three days later, on August 8, these amendments came up before the Supreme Court in the Essar Steel operational creditors case.
The operational creditors cited the NCLAT’s decision on July 4, 2019, in Standard Chartered Bank vs Satish Kumar Gupta, R P of Essar Steel (i.e. the NCLAT Order dealing with Essar Steel’s insolvency and ArcelorMittal’s resolution plan). The NCLAT sought to interfere with the approval accorded to the ArcelorMittal resolution plan by the NCLT.
Two glaring errors crept into the decision. First, it held that the committee of creditors (CoC) has no role in the distribution of upfront payment by the resolution applicant as part of the resolution plan, despite this exercise would necessarily involve considering “feasibility and viability” (emphasis under Section 30(4)). Second, it held that Section 53, providing a “waterfall mechanism” of the IBC could not be applied in distributing the upfront payment among the stakeholders.
Logically, the “waterfall mechanism “provides guidance for distribution, prioritising secured creditors over unsecured creditors. In the absence of a guiding principle at the resolution stage prior to liquidation, there should ordinarily be no reason for a court to interfere. The NCLAT, however, held that Section 53 is inapplicable while considering a resolution plan, and its mechanism is only relevant at the point of liquidation. Instead, it emphasised an imagined parity between operational and financial creditors that was divorced from the statutory text, ignoring that the “waterfall mechanism” is predicated on the importance of underlying security arrangements which forms the bedrock of modern banking system.
The amendment stresses the importance of the “waterfall mechanism” by stating that operational creditors would, at a minimum, receive liquidation value or the value they would have received if the upfront payment under the resolution plan had been distributed, whichever is higher. In doing so, the legislation takes care of the principle of “fair and equitable dealing of operational creditors’ rights” emphasised by the Supreme Court, in the Swiss Ribbons case.
Finally, the amendment clarifies that the CoC approval to the resolution plan shall be after considering “the manner of distribution proposed, taking into account the order of priority amongst class of creditors including the priority and value of the security interest of a secured creditor”. This change kills two birds with one stone. It not only brings the focus back on the commercial principles and the “waterfall mechanism”, but also clarifies that the CoC’s active role in deciding the manner of distribution.
The amendments meet hostility from operational creditors (who do not have a seat in the CoC), as observed by the Supreme Court in the Essar operational creditors case, we believe that the changes are positive developments for the banking sector, underlying philosophy that underpinned the Code.
The author is a Managing Partner BMR Legal, and an independent advocate and Karan Lahiri is a practicing advocate. Views are personal