Section 29A of the Insolvency Code: A Critique of its Impact & Recent Developments

[Varun Khandelwal is a Third Year B.A., LL.B. (Hons.)student at The W. B. National University of Juridical Sciences (NUJS)]

Introduction

The insolvency regime in India is still in its nascent stage and it has not been too long since the Bankruptcy Law Reforms Committee submitted its report, which laid the foundation of the Insolvency and Bankruptcy Code, 2016(the “Code”). Initially, theCode permitted any person to be a ‘resolution applicant’ under section 5(25). However, an Ordinance was promulgated, which was later incorporated into an Amendment Act (differences between the Ordinance and the Amendment Act have been discussed earlier on this blog here) with the intention ofproscribingunscrupulous promoters from buying back their assets at substantially discounted rates. Section 29A sets forth a wide array of disqualification criteria, which could render a person ineligible;it was indeed the most fundamental addition to the Code under the aforementioned amendment. This section has incontrovertibly witnessed the greatest limelight and remains the most contentious provision of the Code. It has complicated and arguably derailed the resolution process in several cases, as parties have resorted to extensive litigation, thus creating an impediment for successful time-bound resolutions.

Impact

The invocation of section 29A not only significantly influences the procedure of resolution but also engenders a material economic impact. The procedure has become more complex as the resolutionprofessional or the liquidator is given the additional responsibility to determine the eligibility of the applicants. Moreover, this obligation to determine the eligibility of an applicant also dampens the prospect of completing the resolution process within the prescribed time period of 180 (or 270) days.

In addition to the procedural obstacles, it is imperative to note that the disqualifications enshrined in this section have the potential to hinder several innocent applicants who may be deemed ineligible due to mere technicalities and trivialities. The diminution in the number of applicants inhibits the necessary competition in the bidding process, which in turn pares down the ultimate financial value of the resolution plan. Moreover, the ambit of the section is so wide that ineligibilities have become common, making liquidation not merely a possibility but also a probability. Liquidation must be avoided at all costs as it is not only detrimental to the creditors, compelling them to take inordinate haircuts,but also obliterates the organisation capital of firms. This negatively impacts both corporate sentiments and jobs, affecting the growth of the economy. Thus, it is evident that the consequence of this section extends way beyond what it originally intended to accomplish.

Moreover, this section fails to appreciate one of the most sacrosanct principles behind the formulation of the Code. This principle envisages the fact that all forms of business failures cannot be deemed to be a result of a fraud or mismanagement on the part of the promoter. There may be several extraneous reasons why a business may not succeed such as economic shocks and other factors beyond the control of the promoter. This can be evinced by a perusal of cases like Essar Steel and Bhushan Steel as previously observed by this article. Thus, it is essential to differentiate between promoters who engage in malfeasance and those who have only defaulted the creditors due to the prevalence of unpropitious circumstances.

Report of the Insolvency Law Committee

On 26March 2018, the Insolvency Law Committee submitteda report addressing various pressing issues in relation to the Code. One of the key recommendations of this report was to streamline the application of section 29A in order to prohibit only those who have contributed to the defaults and have consequently run the company aground,or are otherwise undesirable, from participating in the insolvency resolution process.

The recommendations in relation to this section include the deletion of “if such person, or any other person acting jointly or in concert with such person” from the first line of the provision. This aims at preventing the interpretation of the phrase “person acting jointly or in concert”in accordance with the definition provided in the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011. This is a commendable step as such an interpretation was proving to be counter productive owing to the wide range of individuals who stood disqualified from the resolution process due to wide-ranging scope of the definition.

Other positive recommendations include the exclusion of pure play financialentities from the ambit of clause (c) of section 29A, as the Committee rightly observed that it is highly probable for them to be related to companies that are categorised as non-performing assets (NPA). Another pragmatic suggestion in relation to this clause is the addition of a provisostating that the sectionwill not apply if the NPA is held solely due to the acquisition of a corporate debtor under the process prescribed by the Codefor a period of three years from the date of approval of the previous resolution.

Further, the suggestions to narrow down clause (d), which relates to conviction for offences punishable with imprisonment of two years or more and clause (e), which deals with disqualification to act as director under the Companies Act 2013, are indeed laudable steps towards a more progressive application of this section. The Committee observed that these two clauses are personal in nature and need not be extended to the related parties of the resolution applicant. Moreover, clause (d) might be further narrowed down by incorporating a schedule of offences to exclude those offenceswhich have absolutely no connection with the ability of an applicant to successfully manage a corporate debtor. Lastly, the ambit of this clause may also be tapered down if the Government agrees to the suggestion that it will not be applicable if an appeal has been preferred against the concerned order within the prescribed statutory period.

Clause (g) of the section also has been constricted in its application. This provides the necessary safeguard for applicants who have acquired corporate debtors, who have previously engaged in a preferential, undervalue, fraudulent or extortionate credit transaction. Furthermore, the Committee has provided for the necessary change in phrasing of clause (f) in order to ensure it is in consonance with the decision of the NCLT.

However, while addressing the issue of compliance withsection 29A being too onerous and self-defeating as it prolonged the resolution process indefinitely, the Committee merely stated that applicants would be required to submit an affidavit confirming their eligibility under this provision. Additionally, it was of the opinion that the presence of section 30(2)(e) which mandates the resolution plan to be in consonance with the law, would ensure compliance with section 29A. Lastly, it clarified that this section would be prospective in its application to prevent any sort of hindrances in cases, which are already at an advanced stage.

The way forward

Even though prospective application is both desirable and creditable, the Committee has failed to address the larger question of how it seeks to increase the inclusion of innocent promoters, minimise the adverse economic impact caused by inordinate delays, restrict the involvement of the adjudicating authorities and prevent unnecessary risks posed by frivolous litigation. The submission of an affidavit confirming eligibility is not viable as competing parties can always unearth some minor technicality disqualifying their competitor by virtue of the sheer dimensions of the section.

The Cabinet has approved a new Ordinance based on the report submitted by the Committee. Hopefully, the Ordinance has incorporated the aforementioned alterations and modifications. However, more importantly, the Government needs to answer the question of the conundrum created by the legal interpretation in the Bhushan Steel case that litigations are not to be included within the time frame of 270 days established by the Code. This defeats the very purpose of having a deadline for the resolution process and must be addressed in the subsequent Amendment Act, if not in the Ordinance.

Moreover, to differentiate between innocent and unscrupulous promoters, a body like the pre-pack pool in the United Kingdom could be established as discussed on this blog earlier. This would essentially entail the establishment of a body of experienced businesspersonsappointed by the Insolvency and Bankruptcy Board of India who could independently review promoter or connected party purchases. Promoter inclusion is also imperative because their complete exclusion dissuades them from cooperating with the resolutionprofessional who requires relevant information from them to invite bidders. Lastly, exclusion is dangerous by virtue of the possibility of the promoter indulging in asset stripping and other high-risk behaviour if the company is undergoing recurring losses and is on the brink of insolvency. Thus, promoters who have not indulged in any malfeasance must be given the opportunity to bid for their own companies.

In conclusion, section 29A has till date created more problems than it has solved. Instead of barring defaulting promoters, it has created a gateway to obstruct any resolution process by way of litigation. While the procedural and economic impact may be beyond the control of the Government, the need to streamline the application of this provision is imminent. Therefore, as the Code is on the verge of being overhauled, it is incumbent on the Government to incorporate the necessary modifications to transform the fledgling insolvency regime in India into a more advanced legal mechanism.

– Varun Khandelwal