Entity versus Enterprise: Dealing with Insolvency of Corporate Groups

[Vinod Kothari and Sikha Bansal are with Vinod Kothari & Company. The can be reached at [email protected]]

Present-day businesses sweep across multiple entities, such that the “enterprise” consisting of multiple entities, often in multiple jurisdictions, is referred to as a “group”. While accounting standards and securities market regulators have moved on to the concept of “business groups”, the ghost of the 19^th century ruling in  Salomon v. Salomon & Co continues to hover over corporate laws and, consequentially, over insolvency laws too.

Insolvency laws have not been accommodative of “group concerns” – the insolvent entity is treated as a separate and focused subject matter altogether, and the group entities remain insulated, irrespective of the extent of intermingled structures and shared resources. The relevance of the enterprise approach may be seen from two perspectives – the objective of insolvency or liquidation proceedings, and the complex, inter-connected nature of legal entities in corporate groups of the present day. Given the primary objective of insolvency laws to rescue an entity, a mostly entity-focused approach may fail to do justice to the needs of an ailing enterprise, where resources, operations and assets may be scattered across entities. In liquidation too, where the intent is to liquidate assets, if the assets are entangled across entities and jurisdictions, no meaningful liquidation may be achieved. In any case, due to the entangled nature of the entities, whereby picking up one of the group entities and seeing the same in isolation may not be meaningful at all, the group approach becomes unarguable.

As Sir Goode[1] laments,

“Business, entity or group enterprise?

The subject of insolvency proceedings has always been, and continues to be, the particular corporate entity that has become insolvent, and this focus is accentuated by the reluctance of English law to pierce the corporate veil. What insolvency law here and overseas has so far singularly failed to accommodate is the management of enterprise groups where one or more, or possibly all, members of the group have become insolvent. Whereas the preparation and filing of group accounts has long been required, when it comes to insolvency the distinct legal personality of each individual company within the group is respected, with separate proceedings for each company, yet the insolvency of one member of a group may threaten the viability of previously solvent members and where the group activity is integrated a coordination of the management of the group as a whole may be highly desirable. This is particularly the case as regards multinational group of companies, where the complexity is exacerbated by the variety of corporate structures and the possibility of concurrent proceedings in different jurisdictions governed by different laws, . . .”

[emphasis supplied]

While India is pondering over developing a framework under the Insolvency and Bankruptcy Code for group-based insolvency, a lot of work has already been done across the globe – UNCITRAL had constituted a working group, Working Group V, to deal with insolvency law, and through its various sessions, the Working Group has been advancing its work on insolvency of enterprise groups. The UNCITRAL Legislative Guide to Insolvency Law has dedicated a complete part, viz., Part 3, dealing with insolvency of enterprise groups. The EU Insolvency Regulation also applies in cases where there are insolvency proceedings in two or more EU member states.

When it comes to approaches, a group-focused approach may involve looking in multiple directions – as in “looking up”, “looking down” and “looking laterally”. As it suggests, looking up would mean looking at the holding or controlling entities, looking down would mean looking at the subsidiary level, and looking laterally would require looking at fellow subsidiaries, or entities equally controlled by holding entities. The UNCITRAL work discusses several approaches – extension of liability and contribution orders, equitable subordination, avoidance applications, procedural consolidation, and substantive consolidation – last two being major and extensive ones.

Procedural consolidation is where the proceedings of insolvency of different entities are coordinated, even if before different judicial or adjudicating authorities. On the other hand, substantive consolidation disregards the separation of entities and pools the assets and liabilities of various entities into a common hotchpot. This extreme remedy is rarely used, even though UNCITRAL has been aggressively working on developing the principles for the same. Basically, substantive consolidation is ordered by courts where pooling of assets and liabilities is to the larger benefit of different creditors, and generally not prejudicial to any. Mostly, this is done under circumstances similar to those inviting “lifting or piercing the corporate veil”; even substantive consolidation is different from veil lifting or piercing. US courts have well developed jurisprudence around substantive consolidation, though the remedy has been considered to be one which should be “sparingly used”, particularly after the ruling in Owens Corning. Recourse to the remedy will depend upon several factors, majorly, interests of creditors of the entire group.

India does not seem to have any trail of winding up case law on substantive consolidation, though “lifting of corporate veil” has been a well-known recourse in several judicial precedents. While, under the Insolvency and Bankruptcy Code, a subsidiary’s assets cannot form a part of an insolvent holding company, it is felt that the very idea of substantive consolidation is based on a substantive, equitable power of the adjudicating bodies. The remedy is applied in cases where the separation of legal entities is either artificial, or it is observed that dealing with the insolvency of one of the several entities, without disturbing the others, will be self-frustrating approach. Therefore, it is futile to search for legal provisions to permit approaches such as substantive consolidation. It is felt that insolvency laws have equity at their core: therefore, irrespective of the provisions explicitly providing for exclusion of the assets of a subsidiary from those of the holding entity, the National Company Law Tribunal has the equitable power to order substantive consolidation, wherever deemed appropriate and in the ends of justice.

In the Paper titled Entity versus Enterprise: Dealing with Insolvency of Corporate Groups, posted on SSRN, the authors have delved deeper into the discussions and have made an effort to identify ways for making group insolvency work from global and Indian perspective.

– Vinod Kothari & Sikha Bansal

[1] Goode on Principles of Corporate Insolvency Law, Fifth Edition, by Kristin Van Zwieten, pg. 29-30.