[Harshit Agrawal is a B.A. LL.B. (Hons.) student at Dr. Ram Manohar Lohiya National Law University, Lucknow]
Some of the biggest challenges faced by the Insolvency and Bankruptcy Code, 2016 (IBC) in India are to get a fair value for the stressed industries as a going concern keeping in mind the interest of the creditors. The problem becomes more aggravated in the ‘group company’ situation where a corporate facade is created. The creditors extend monies to such corporate groups relying upon the group as a single entity. The heavy interdependence of such entities over each other preclude them from attracting appropriate resolution plans and this usually ends up in liquidation with little or no recovery. One solution to this problem developed in the major jurisdictions is the doctrine of substantial consolidation. This doctrine enables the adjudicating authority to merge the assets and liabilities of all such individual entities in a common pool which can then go into a common corporate insolvency resolution process (CIRP). This also enables the elimination of cross-debts, by maximising the asset value of the insolvent group. The Mumbai bench of the National Company Law Tribunal (NCLT) in State Bank of India v Videocon Industries Limited recognised the doctrine of substantial consolidation and allowed the consolidation of 13 of the 15 Videocon group companies.
The Background
The consortium of banks led by the State Bank of India (SBI) moved an application for substantial consolidation for the 15 companies belonging to the ‘Videocon Group’, where the consortium was the common creditor. A separate CIRP petition was admitted against all the entities, but it failed to obtain any attractive bid because of the lack of collateral assets and their inability to survive individually. In the absence of any prevailing provision in the legislature, using its equity jurisdiction, the tribunal analysed bankruptcy jurisprudence in the US and the UK and decided in favour of the consortium.
Test for Consolidation
The NCLT bench offered a two-step test to consolidate the assets and liabilities of the corporate debtor. For prima facie enquiry the tribunal emphasised on the so called ‘check list’ approach from the US to provide for 14 touchstone factors like common control, common directors, common assets, common liabilities, inter-dependence, inter-lacing of finance, pooling of resources, co-existence for survival, intricate link of subsidiaries, inter-twined accounts, inter-looping of debts, singleness of economic units, common financial creditors and common group of corporate debtors.
The tribunal further provided for looking into individual entities and segregating them into categories based on the above factors as parameters. The first category comprises entities whose assets and liabilities are so intermingled that, if segregated, the possibility of maximisation of asset value is too bleak. Whereas the second category comprises of units, which even if segregated, have the possibility of viable profitable restructuring proposals. Taking a cue from the US bankruptcy regime, the tribunal stressed upon balancing the equity between consolidation and maintaining corporate separateness. The bench held that “if an entity is self-serving, self-dependent and self-sustainable, a view can be taken for not granting consolidation”. Applying the above principle, the tribunal consolidated 13 out of 15 companies into one entity while deciding to have separate CIRP for the remaining two.
Analysis
The doctrine strikes at the basic principle of corporate law of limited liability and corporate separateness established in Salomon v A. Salomon & Ltd, [1896] UKHL 1, and is usually connected with the remedy of ‘piercing the corporate veil’. But substantial consolidation has over the years established itself to be different remedy from ‘piercing the corporate veil’, both in applicability and application. In substantial consolidation, the subsidiaries are merged horizontally whereas while piercing the corporate veil subsidiaries are merged vertically with their holding company, although the genesis of both lies in remedying the fraudulent behaviour of the corporate group. In case of substantial consolidation, fraud is usually that the financial or operational creditors were made to believe through the debtor’s action that they are dealing with the group rather than the individual entity. The first ‘check list’ approach of the tribunal developed in this case points towards identifying this fraud. This approach is close to what is known as ‘modern’ or ‘liberal trend’ in the US bankruptcy regime. The criterion will end up being satisfied in a majority of cases as most of the factors get an affirmative vote owing to the corporate structures to evade tax liabilities. Therefore, it attracts much criticism as well for availing of the otherwise rare remedy too generally.
Substantial consolidation as a remedy should always be treated as an exception rather than the rule. This is because, firstly, it does not always benefit all the creditors but ends up detrimental to some. The consolidation goes against those creditors who extended monies to the company as individual entity rather than the group and forced to take larger haircuts in the common resolution plan from a common pool. For example, the consolidation of A and B (A’s asset value is more than B’s) would be a windfall for creditors of B and harmful for the creditors of A. Secondly, such creditors also face a reduction in their voting shares in the committee of creditors (CoC) because of proportionate reduction in the debt owed to them; more so that some operational creditors may also end up losing their right to be present in the meetings of CoC.
Sensing the same, the tribunal allowed the creditors to object to a consolidation through the second-step test based upon balancing the equity between consolidation and maintaining corporate separateness. The independence of the entity from the other group companies emerged as the touchstone of this test while segregating the entities into two categories. This approach of the tribunal will ensure that stakeholders do not suffer from the first problem stated above. Thus, the entity will only be consolidated with other group companies if the preliminary enquiry suggests that it will end up into liquidation, if taken for separate CIRP. But, this does not address the second problem brought by consolidation or rather the tribunal specifically refuted the reduction in share of the financial creditor as a ground to vote against consolidation.
Thus, this approach may be problematic for future references. There may be situations where though the target entity is independent of other group companies the case is not so vice-versa. The adjudicating authority, following this test, may end up making a large pool of insolvent entities lacking any glimmer to attract investment while segregating comparatively better entities to go individually. This goes against the goals set to be achieved through the whole exercise of substantive consolidation. Moreover, this is also antithetical to the argument that creditors, while extending the credit, must have relied upon the overall assets of the group rather than the entity. The rationale behind the consolidation is to benefit all the creditors by maximising the asset value of the insolvent group, which is the objective of IBC.
Independence of accounts, including assets and liabilities, as a criterion rather than the independence of businesses while balancing the benefits and harms endured by creditors may bring results closure to the objectives of the IBC. While applying the final test for consolidation, a case-by-case enquiry should be made in comparison of loses to the stakeholders in both the situations. Procedural benefits should also considered while concentrating on the losses to the stakeholders. In the author’s opinion, the emphasis should be on the question whether consolidation brings benefits overcoming the losses if not consolidated? The decision should be in favour of consolidation if it brings better results even though the entity is found self-serving, self-dependent and self-sustainable in the second test.
Concluding Remarks
The insolvency and bankruptcy jurisprudence is still in its nascent stages in India. This is the reason the Report of Insolvency Law Committee in 2018 considered it to be too soon to bring the doctrine of ‘group insolvency’ in the legislature. But the urgency due to the complex corporate structures forced the tribunal to bring in the same through its equity jurisdiction. The tribunal formulated the otherwise complicated remedy in the simplest way possible so as to fit in the current requirements of the IBC keeping in mind the legislative intent and objectives to be achieved. The move will benefit recoveries in other large group company insolvency cases. The adjudicating authority should ensure that this remedy is used only in such rare cases while applying the broader principle of balancing the equity between consolidation and maintaining corporate separateness established though this case.
– Harshit Agrawal