Safeguarding Promoters’ Interest in Insolvent Companies: Recent Judgments of the NCLAT

[Soham Chakraborty is a II year, BA LLB (Hons.) student at NALSAR University of Law, Hyderabad]

A series of judgments of the National Company Law Appellate Tribunal (“NCLAT”), as discussed herein, have led to some important developments regarding the rights of promoters when it comes to regaining control of their company under the Insolvency and Bankruptcy Code, 2016 (“the Code”). These judgments relate to sections 12A and 29A of the Code and section 230 of the Companies Act, 2013 (“Companies Act”). Section 29A of the Code was introduced by way of the Insolvency and Bankruptcy Code (Amendment) Act, 2017. The statutory provision bars certain entities and individuals from submitting resolution plans if such person, either singly or jointly along with others, suffers from any of the infirmities specified in clauses (a) to (i) of the section 29A. Section 29A(c), which came into effect on 6 June 2018, imposes a blanket ban on the erstwhile promoters and directors of the debtor company from submitting any resolution plans. The ban is imposed not only on persons mentioned in clauses (a) to (i), but also on any parties related to those disqualified. Such a blanket ban fails to make any distinction between the genuine and the unscrupulous, and thus it ends up punishing even those who, without any fault of theirs, were the victims of causes beyond their control. This post intends to examine the ways in which the NCLAT judgments affect the position of erstwhile promoters and also suggests steps which can be taken to prevent honest promoters from being forced to lose control of their companies.

Procedure for invoking proceedings under sections 7 and 9

The Code stipulates that once a corporate debtor defaults on obligations exceeding rupees one lakh, the financial creditors and operational creditors of the debtor can make an insolvency application under section 7 and section 9 of the Code respectively. Once an application is admitted by the National Company Law Tribunal (“NCLT”) an interim resolution professional (“IRP”) will be appointed who will replace the board of directors of the debtor company. The responsibility of managing the daily affairs of the corporate debtor will then fall on the IRP and later on the resolution professional (“RP”) upon the confirmation of the IRP as the RP or on appointment of a new person as the RP. Subsequent to this, a committee of creditors (“CoC”) will be formed consisting of all the financial creditors of the debtor, and invitations will sent out to submit resolution plans for the insolvency resolution of the debtor company. It is at this instance that section 29A finds its application in preventing the erstwhile promoters and directors from submitting any resolution plans and thus regaining control of the company at a discount after forcing the creditors to take a haircut on the obligations owed to them.

The inspiration behind inserting section 29A to the Code is to prevent such a reoccurrence of default and to instill fear among the promoters of losing control of their companies upon failure in payment to creditors. However, it fails insulate them against external factors like market recessions, credit squeeze in the market, poor agricultural output because of natural climatic conditions, energy crises arising from shortage in coal or oil due to various national and international circumstances. With the looming fear of losing control of their companies, the promoters are discouraged from taking any risks in business thus hampering strategies that may be critical to survive and compete with their rivals.

Promoters’ avenue under section 12A to regain control of the company

With the introduction of section 12A to the Code through the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, the erstwhile promoters were given the opportunity to regain control over the company even after the admission of the insolvency application. This is possible through an application made to the adjudicating authority by the resolution applicant followed by a vote in favor such an application by  at least 90% of the CoC compared to just 66% needed for the approval of any resolution plan. Later, regulation 30A was inserted into the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate person), 2016 (“Insolvency Regulations”) which required that such an application for withdrawal must be made only before the expression of interest (“EoI”) under regulation 36A of the Insolvency Regulations. Thus, once the process of bidding has commenced, no withdrawal application can be made to the adjudicating authority by the applicant.  

However, the Supreme Court in Brilliant Alloys Private Limited v. S. Rajagopal held that regulation 30A is directory in nature and that withdrawal applications may be allowed in “exceptional cases” even after the issuance of invitation for EoIs. That being said, the Court did not devise any definitive tests that needed to be satisfied in order to enable such withdrawals to take place even after the EoI and, resultantly, it is obscure as to which cases would qualify under ‘exceptional cases’.  In the subsequent case of Swiss Ribbons Private Limited v. Union of India, the Supreme Court endorsed its judgment in Brilliant Alloys.

In a favourable decision for the promoters, the NCLAT in Andhra Bank v. Sterling Biotech Limited held that section 29A is not applicable to section 12A of the Code. The NCLT had rejected the withdrawal application under section 12A subsequent to the one time settlement plan offered by the promoters to the CoC, as the same would be a violation of section 29A of the Code, which disqualified promoters from submitting resolution plans. By setting aside the NCLT’s liquidation order, the NCLAT allowed Andhra Bank to withdraw its application and the promoters were able to regain the control of the company, which would otherwise have been liquidated had the NCLT decision been upheld.

Promoters’ avenue under section 230 of the Companies Act, 2013 to regain control of the company

Section 230 of the Companies Act the deals with the power to compromise or make arrangements with creditors and members. Such compromise or arrangements can include mergers, demergers, and amalgamations of companies or even corporate debt restructuring. When a corporate debtor under the Code goes into liquidation, the adjudicating authority may direct the liquidator to consider provisions under section 230 of Companies Act as the last attempt to keep the company as a going concern.

The NCLAT in S.C. Sekaran v. Amit Gupta  directed the liquidator, appointed under the Code, to  “take steps in terms of Section 230” for the revival of the corporate debtor before undertaking the sale of its assets. After this judgment, it was unclear as to whether the erstwhile directors of the company can also propose such schemes of arrangements and retain the control of the company. This ambiguity was cleared in the NCLAT’s recent judgment of Jindal Steel and Power Limited v. Gujarat NRE Coke Limited wherein it was held that those disqualified by section 29A from submitting resolution applications are also disqualified from proposing any scheme of arrangement during liquidation of the company. The NCLAT held that “even during the period of liquidation, the corporate Debtor is to be saved from its own management”. Thus, the NCLAT effectively made it impossible for promoters to use this route from regaining control over the company.

Suggestions and conclusion

Under the current scenario, the only way for promoters to regain control over their company is through section 12A of the Code. However, the uncertainty created by the Brilliant Alloys decision has still not been resolved, and it remains to be seen in which ‘exceptional cases’ the adjudicating authority will allow for the withdrawal even after the EoI. It is pertinent to mention that even the report  of the Bankruptcy Law Reform Committee (“BLRC”) draws a line between business failure and malfeasance, with the latter being defined as “illegitimate transfer of wealth out of companies by controlling shareholders.” The report points out further: “If default is equated to malfeasance, then this can hamper risk taking by the firm.” Furthermore, it states: “Bankruptcy law must enshrine business failure as normal and legitimate part of the working of the market economy.” Hence, section 29A, by failing to differentiate between malfeasance and honest business failures, puts honest promoters at a serious disadvantage by forcing them to part with the control of their company.

It is necessary to realize that once the NCLT admits a section 7 or a section 9 application against a debtor, the promoters of the debtor company have few opportunities for regaining control of their companies. Under these circumstances, the author recommends that there should be a system to recognize and differentiate between business failures and malfeasance. Towards this end, as mentioned in an earlier post on this Blog, a committee of independent businesspersons can be set up by the Insolvency and Bankruptcy Board of India, which will scrutinize the bona fide of the promoters or the connected parties. The decision arrived at by this committee should be communicated to the IRP or the RP, as the case maybe. For the smooth functioning of such a process:

  • Section 29A can be amended to disqualify only those promoters accused of conduct amounting to malfeasance resulting in losses to its creditors.
  • An amendment can be made allowing the withdrawal of cases of genuine business failures even after the issue of EoI, provided it meets the criteria set out in section 12A of the Code. This would also help in clearing the ambiguity created by the Brilliant Alloys
  • In cases of genuine business failures, promoters can be allowed to propose schemes of arrangements under section 230 of the Companies Act to prevent the company from going into liquidation.
  • Steps can be taken to introduce pre-packaged insolvency resolution scheme under the Code and also to ensure that section 29A, as it stands right now, is not applicable to it. That the Government is looking at such a measure is evident from its invitation to comment on such a proposal, a welcome step in this direction.
  • At a legislative level, an increase in the limit of rupees one lakh in default for invoking the Code can reduce instances of genuine business failures causing loss of control of companies.

Furthermore, the promulgation of the recent Insolvency and Bankruptcy Code (Amendment) Ordinance, 2019 making it mandatory for certain classes of financial creditors to have either a minimum of 100 applicants or 10% of the total number of applicants, whichever is lower, for invoking the Code is a welcome step. In order to protect the interests of honest promoters, more such steps towards relaxing the stringent scheme of the Code are the need of the hour, especially in light of the impending economic slowdown.

Soham Chakraborty

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