Insolvency under Section 29A: Pre-Pack Pools & Independent Review of Connected Party Sales

[Rudresh Mandal and Hardik Subedi are 3rd year students of NALSAR University of Law, Hyderabad]

While the Insolvency and Bankruptcy Code, 2016 (“IBC”) in section 5(25) initially allowed ‘any person‘ to submit a resolution plan, the moral hazard posed by defaulting promoters buying back the assets of the corporate debtor at steep discounts soon prompted the Government to bar certain persons and entities from participating in insolvency proceedings. To this end, the introduction of section 29A by the IBC (Amendment) Act, 2017, insolvency proceedings involving inter alia promoters of the corporate debtor (and connected persons), willful defaulters (section 29A(b)), persons involved in the management of a company whose assets have been classified as anon-performing asset (section 29A(c)), and parties connected or related to themwho seek to buy-back the assets of the corporate debtor, have been caught in a legal logjam.

The ongoing Essar Steel insolvency matter has given rise to a number of interesting legal questions necessitating a refinement of the contours of section 29A. That section 29A is over-inclusive and could often prevent promoters buying back the assets of the corporate debtor in good faith (strategies akin to phoenixing) with adequate pay-outs to the creditors has been recognized by the Government, which through the Amendment sought to restrict the reach of section 29A and has been discussed earlier on this blog here. In the context of section 29A(h), the National Company Law Tribunal (“NCLT”) in RBL Bank Ltd. v. MBL Infrastructures Ltd noted that the object of 29A was not render promoters as a class, ineligible. While the Code strives to promote a rescue culture and competition for insolvent companies, section 29A could potentially be counter-productive.

One of the issues which the Essar Steel controversy brought to light was the issue of ‘related parties’ and ‘connected persons’. Briefly put, the Ruia family, promoters of the insolvent Essar Steel are minority shareholders of Numetal, a consortium with the Russian VTB Bank seeking to bid for the assets of Essar Steel. While prima facie, Numetal’s bid did not seem to be problematic since Rewant Ruia was neither Numetal’s promoter, nor was he in its management or control(section 29A(j)), the outcome of this specific controversy is not relevant for the purposes of this post. Nonetheless, in more recent developments, to overcome any possible challenge under section 29A, the Ruias’ stake was recently bought out by two of Numetal’s existing investors, Tyazh Prom Exports and Indo International.

What assumes significance is the larger issue of how India can possibly navigate the complexities of business arrangements orchestrated by promoters of the corporate debtor who attempt to purchase the assets of the debtor at discounted rates, to the detriment of its creditors. Given the nascent stage of Indian insolvency jurisprudence, how then can the Government qualitatively refine resolution proceedings when sales to promoters and connected parties are involved?

Recourse to English law may help us in this regard. The Graham Review into Pre-pack Administration in 2014 recommended the introduction of pre-pack pools to increase transparency and ensure accountability when the assets of the corporate debtor are sought to be bought by the promoter or by connected parties. Briefly, apre-pack essentially entails the resolution professional selling the assets and business of the insolvent company, usually to promoters and connected parties in secrecy. As the word ‘pre’ suggests, the ground work for preparing the resolution plan is carried out well before formal administration and does have certain limited benefit, such as preservation of jobs. However, such a proposal would never gain traction in the Indian political climate which is vehemently against promoter (and connected party) buy-back of businesses, especially secrecy in a pre-pack. The lack of transparency in a pre-pack administration does not seemingly take into account the interests of creditors.

In light of the above, the Insolvency Resolution Professional (“IRP”) must be tasked with the duty of ensuring that sales to promoters and connected parties are transparent, as is the intent of the English Statement of Insolvency Practice 16 (“SIP 16”).Though the Insolvency and Bankruptcy Board of India (“IBBI”) recently promulgated the Insolvency And Bankruptcy Board Of India (Insolvency Resolution Process For Corporate Persons) (Third Amendment) Regulations, 2017 striving to disclose the details of connected party sales, Indian law could benefit from an ex post independent review of the sale of assets to promoters/connected parties (like the pre-pack pool).

With mature jurisdictions like the United Kingdom debating on the propriety of pre-pack administration, India is certainly not ready for the introduction of such a radical concept. However, what India could benefit from is the establishment of a body like the pre-pack pool, which is engaged in independent review of connected party sales.The underlying rationale for this is simply that promoter or connected party buy-back may sometimes offer the creditors the best deal, and the individual or entity ought to be presented with a chance to outline its bid to the pool of experienced businessmen established by the IBBI to ensure independent scrutiny of promoter or connected party purchases. While approaching the pool ought to be voluntary, a refusal to do so must be brought to the notice of the resolution professional. After scrutiny, a negative statement (English SIP 16) issued by a member of the pool should not render the bid ineligible, but the same should be communicated to the IRP, who could then disqualify the connected party. Similarly, a positive statement could establish the bona fide of the promoter or connected party. Such positive or negative statements would assist the IRP in adjudging the eligibility of the bidder and prevent legal logjams like the Essar insolvency proceeding.

While section 29A is indeed well-intentioned, its consequences may be wider than anticipated with a large number of bidders being declared ineligible often due to trivial issues and technicalities, thereby reducing the bid amounts ultimately the returns to creditors.A blanket ban on promoters as a class will ultimately discourage entrepreneurship. Credit and default are two sides of the same coin and often business pursuits culminate in failure. The edifice of insolvency laws across jurisdictions lies in allowing the honest, but unlucky promoter to restart its business. Herein, a pool of independent business practitioners can step in to decide the commercial bona fide of the promoter or connected party, thereby streamlining the insolvency proceeding. Given the fledgling phase of insolvency jurisprudence in India, independent scrutiny of connected party sales can only help in ironing out the wrinkles that often obstruct resolution proceedings.  In this corporate climate, where the Government is fine-tuning the IBC in response to cases like Essar and Electrosteel, a body like the pre-pack pool would help in negotiating this turbulent, transitory phase to a mature jurisprudence.

– Rudresh Mandal & Hardik Subedi

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