[Vinod Kothari is an insolvency practitioner at Vinod Kothari & Co and can be reached at [email protected]]
The attention that reforms in liquidation regulations has received, relative to what has gone into the case of resolution, is far lesser than deserved, given the percentage of the resolution cases that slip into liquidation. Most of the major liquidations initiated 12 to 18 months ago are either making very tardy progress, or are stuck into dead-ends. There were several changes needed in the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016, and it is heartening to see the Insolvency and Bankruptcy Board of India (IBBI) announce certain amendments by way of the Insolvency and Bankruptcy Board of India (Liquidation Process) (Amendment) Regulations, 2019, concluding a consultation process that began almost 8-9 months ago. The best part is that the amendments have incorporated most of the useful suggestions that were made either in the roundtable meetings held across the country, several comments and write-ups,[1] or subsequently in a response to the Discussion Paper.
The amendments impose far stricter timelines on the liquidators but, at the same time, smoothen the processes, particularly by relying less on periodic valuations and removing the cap on the reduction of the reserve prices. The peculiar concept of going concern sale in liquidation has also been enabled by making clearer rules, by a creditor-driven process of defining the bundle of assets and liabilities that are to be transferred by way of a going concern. The concept of schemes of arrangement during liquidation has defined time limits now. Relinquishment of security interest too has a definitive timeline. The process of consultation by liquidators is also quite well defined. On the whole, attempts have been made to resolve most of the difficulties that were being encountered in the ongoing liquidation matters.
The major highlights of the amendments are as follows:
Liquidation costs on financial institutions
One of the major concerns in ongoing liquidations is lack of liquidity. The liquidator finds that the liquidation estate is either completely dry, or may get some cash flows, but the same may come after protracted time. In such cases, how does the liquidator meet the running expenses of the liquidation proceedings?
First of all, the word “liquidation costs” is now much better defined, with several inclusions. While, some of the inclusions in the definition may continue to raise questions – for example, “costs incurred….for preserving and protecting the assets, properties, effects and actionable claims, including secured assets, of the corporate debtor”, one must appreciate that the definition is now far more comprehensive than it was. This, however, shall not include the costs incurred towards a scheme of compromise or arrangement under the Companies Act, 2013, if applicable. The same has been dealt with further in the post. The amendment has to be read in synchronization with the newly inserted regulation 39B of the IBBI (Insolvency Process for Corporate Persons) (Amendment) Regulations, 2019. Further, the newly inserted provision in regulation 2A states that where the liquidation costs are estimated by the liquidator to exceed the realisations, the liquidator may call up “financial institutions” to contribute to the same, in proportion to their share in the “financial debts”. “Financial institutions” is defined in section 3(14) of the Insolvency and Bankruptcy Code, 2016 to include banks, non-banking finance companies and public financial institutions.
The shortfall may be claimed by the liquidator on the basis of an estimate, within 7 days of the passing of the liquidation order. The timeline of 7 days seems impractical for several reasons – first, within 7 days of the passing of the liquidation order, it will be impossible for the liquidator to get an estimate of the recurring costs, more so when he may not have been a resolution professional. Secondly, since the contributions are to be made in proportion to financial debts, the process of filing and admitting claims may not have begun at all at this time. Also, the applicability of this provision to existing liquidation matters will remain unclear. Further, while a demarcation on the basis of secured and unsecured financial creditors (read: institutions) remains unclear, it must also be noted that such contributions cannot be used for costs incurred in relation to compromise or arrangement under section 230 of the Companies Act, 2013
This contribution by the financial institutions is akin to an interim financing during liquidation, as this contribution remains escrowed, and has a first claim on the liquidation waterfall, as a part of “liquidation costs”. However, inclusion of this financing as a part of liquidation costs results into a circular logic – the contribution itself is to fund liquidation costs, and it is a part of liquidation costs itself. That brings a complicated question of prioritisation within a particular clause of section 53(1) of the Code – in this case, clause (a).
The strange and almost untenable conclusion of this is that whereas as shareholders have a limited liability and use default and liquidation as the option, so that they pay nothing over and above their equity in the company, lenders may run the prospect of having to lose all their debt, and yet end up paying for liquidation costs. Hopefully, lenders will realise the need for taking hard decisions, including, potentially, an action of striking off the name of the company after giving up their security interests and claims.
Resolution during liquidation – compromise and arrangement
The National Company Law Appellate Tribunal in S.C. Sekaran v. Amit Gupta, referring to the order of the Supreme Court in Meghal Homes (P) Ltd. v. Shree Niwas Girni K.K. Samiti, has highlighted that liquidators may try to see if schemes of compromise or arrangement are feasible even during liquidation. Notably, section 230 of the Companies Act, and the corresponding provisions of the Companies Act, 1956 and the UK Companies Act, 1948, have always enabled presentation of schemes of arrangement during liquidation by the liquidator.
The newly inserted regulation 2B now provides that where a scheme of compromise or arrangement is proposed under section 230, “it shall be completed within ninety days of the order of liquidation”. It is unclear as to what is to be completed within 90 days. As is well known, there are several sequential steps in a scheme under section 230: making of the scheme by the person seeking to present it, presentation of the scheme before the National Company Law Tribunal (NCLT), ordering of meetings by the NCLT of members as well as creditors, if applicable, filing of report of the meeting of members and creditors with the NCLT, the NCLT holding a hearing on the application after obtaining feedback from the regulatory authorities and, finally, passing orders. In the present circumstances, the end-to-end time between filing of the first application until orders may be anywhere between 6 months or longer. Logically, the reference to the timeline above is for filing of a scheme of compromise or arrangement, since the rest of the process is under the supervision of the NCLT.
Note that a scheme of compromise or arrangement involves sanction of both shareholders and creditors by stipulated majority under the Companies Act. Additionally, settled principles over decades require separate meetings of every class of creditors to approve the scheme. A resolution proceeding itself was a scheme of arrangement – that having failed, whether schemes of arrangement will provide the ability to a company to rise like a phoenix from its ashes remains to be seen.
Presumptive relinquishment of security interests
The earlier law did not clarify the point of time when the secured creditor has to make up its mind on whether to use the process of self-help sale of assets outside liquidation under section 52 of the Code, or to be a part of the liquidation proceedings by relinquishing its security interest and claiming a priority as provided by section 53(1)(b).
The insertion of regulation 21A now makes it clear that the secured creditor shall decide its options while filing the claim. If, within 30 days of the commencement of liquidation proceedings, the secured creditor does not intimate the option of selling the asset under section 52, the assets covered under security interest shall be presumed to be part of the liquidation estate.
Consultative process
Unlike during resolution, the settled principle in case of compulsory liquidation is that the proceedings are almost completely under the control of the liquidator, who works as an officer of the court. Section 35(2) of the Code allows the liquidator to consult stakeholders but, in the same breath, it also says that the consultations shall not be binding on the liquidator. Under the past practice of winding up under the Companies Act, creditors’ intervention in compulsory liquidation came in form of an advisory committee. In case of liquidation under the Code as well, while consultation was not mandated by law, in practice most major liquidations had a consultation committee.
The insertion of regulation 31A now provides harmony to this so-far-arbitrary process of consultation committees.
– First, the regulation mandatorily requires the liquidator to have a consultation committee, even though whether any or what matters will be put up for consultation is still largely governed by the provisions of section 35(2).
– Secondly, the composition of the multi-stakeholder consultation committee is now well-defined. This is markedly different from the present practice where most consultation committees were replicas of the committee of creditors during a corporate insolvency resolution process (CIRP). The consultation committee will have representatives from secured creditors, unsecured financial creditors, employees and workmen, operational creditors, government and shareholders. Quite obviously, the references to each of these classes is based on the claims filed by each class of stakeholders. For instance, the government will be there in the stakeholders’ list if the government’s claim is admitted.
Ideally, committees should consist of an odd number of members, to avoid matters striking a tie. Based on the table given in the regulation, in most cases, secured financial creditors will have more than 50% of the total claims – hence, there will be four representatives from secured financial creditors, and one each from unsecured financial creditors, employees and workmen, operational creditors, government and the shareholders. The selection of the representatives of each class may be done by mutual consensus of the stakeholders in each class but, failing any such consensus, the highest claimants in the class shall be invited upon the committee.
– Thirdly, the consultations in the committee will be decided upon by a vote of 50% of members present and voting. There are two important points to note – the voting is not by value, but by head count. Secondly, and thankfully, the voting rule is here to count only those present and voting. Therefore, no one can frustrate decision-making either by not coming to the meeting, or by not voting.
– Fourth, while the consultations in the meeting are not binding on the liquidator, the liquidator has to state in writing the reasons for not agreeing with the advice given in the meeting.
Going concern sale
The insertion of regulation 32A addresses several of concerns relating to a going concern sale in liquidation. First, and very important, there is a hard timeline of 90 days for deciding whether to go for a going-concern sale. The 90-day period starts running from the commencement of liquidation. Therefore, the applicability of this provision to existing liquidation proceedings becomes a challenge – particularly where there are ongoing attempts to cause a going concern sale. The stance of the Regulations is to have definitive timelines, so that indefinite time is not lost in recursive processes – first, seeing a going concern sale fail, and then opt for the other modes of sale, thereby elongating the time. Therefore, fairly speaking, this amendment should be applicable to existing liquidations with the 90 days’ timeline running from the date of the amendment.
Second, the confusion that prevailed with the version of the amendment circulated with the Discussion Paper – that liabilities will be transferred with the assets – has now been removed. The grouping of assets and liabilities that will form part of the going concern sale will be determined by the Consultation Committee, or by the liquidator.
Repetitive valuations and discretion to reduce reserve prices
There are several helpful amendments pertaining to valuations. First, valuation in liquidation is not mandatory, as the regulations now permit and do not force the liquidator to have a valuation done during liquidation. The liquidator may either rely on the valuation done during CIRP, or opt for a fresh valuation. This will obviate the starting point to be the CIRP valuation, which has, in any case, been unsuccessful.
Secondly, the liquidator now has the discretion to keep reducing reserve prices for the auction – starting with 25% for the first failed auction, and then 10% thereafter. Going by the spirit of the Code, the subsequent reductions in value, if any, shall be by written down value method.
Impact on on-going matters
Since the amendments are effective from the date of their publication in the Official Gazette, it seems that all amendments will impact ongoing liquidation matters as well, except in cases where specific carve-out has been given,[2] or in cases where it is impractical to apply the amendment.[3] In their application to existing matters, the timelines laid in the Regulations may have to be read with reference to the date of the notification, rather than the commencement of liquidation, etc.
It will counter-purposive to take a stand that the amendments do not apply to existing liquidations – it should be noted that much of the move to amend the Regulations itself arose from the experienced difficulties in existing liquidations. New liquidations could not have been the subject matter of the Amendments, leaving existing liquidations unattended. However, as earlier mentioned, some of the timelines will have to be read as referring to the date of the amendment, rather than the date of commencement of liquidation.
– Vinod Kothari
[1] Many of the concerns expressed by the author, e.g., on computation of liquidation fee, relinquishment of security, the transfer of liabilities as a part of going concern sale, etc., have been addressed.
[2] For example, in relation to the liquidator’s fees, the Amendment Regulations shall not be applicable in relation to the liquidation processes already commenced before the coming into force of the said Amendment Regulations.
[3] For example, the timeline of one year cannot be applied to matters which are more than a year into liquidation.
