The (Active) Involvement of Directors during Insolvency Proceedings

[Kushagra Srivastava is a 3rd year B.A.L.L.B. (Hons.) student at National Law Institute University, Bhopal]

Section 17(1)(a) of the Insolvency and Bankruptcy Code, 2016 (the “Code”) vests the management of the affairs of a corporate debtor in the interim resolution professional (“IRP”) on the insolvency commencement date in accordance with section 16 of the Code. This implies the imposition of corresponding duties on the IRP. In a circular dated 3 March 2018, the Insolvency and Bankruptcy Board of India directed that, while acting as an IRP for a corporate person under the Code, reasonable care and diligence shall be exercised to ensure corporate debtor’s compliance with the applicable laws, failing which liability would be imposed on the IRP. This is unlike what would have been the case under section 166(3) of the Companies Act, 2013 where consequences of violation of such a duty would be borne by the directors.

Additionally, clause (b) of section 17(1) of the Code suspends the powers of the board of directors by giving the right of their exercise to the IRP, thus restricting the scope of the acts of directors. The functions of the directors are merely limited to providing mandatory assistance and cooperation to the IRP in the management of affairs of the corporate debtor, as evidenced by section 19(1) of the Code. Therefore, the question arises whether the IRP is acting solely during an insolvency resolution process or the directors have some role to play with corresponding duties.

Recent Stand of the England and Wales High Court

The Chancery Division of the High Court of England and Wales on 21 January 2020 rendered a significant verdict in System Building Services Group Limited, clarifying the duties of the directors of a company that has become insolvent. Rejecting the contention that the silence of authorities on this subject hints at non-survival of directors’ duties after company’s entry into administration or voluntary liquidation, the Court held that the general duties of directors under sections 171 to 177 of the UK Companies Act, 2006 continue independent of, and run parallel to, the duties owed by an administrator or liquidator. It was noted that the law expects, in an insolvency situation, for more than one actor to play their part, and that the fiduciary duties of the directors are an important part of the protection afforded to the company and its creditors under English law.

Insufficiency of the IRP to Comply with All the Duties as a Sole Actor

In Golden Jubilee Hotels Limited (2018), the Andhra Pradesh High Court observed that the various duties of an IRP enumerated under section 18 of the Code clearly manifest that one individual cannot undertake all of them. The Court added that, in light of section 19 of the Code, which mandates personnel of the corporate debtor to extend all assistance and cooperation to the IRP in management of affairs, the argument that the IRP cannot delegate some of his duties and functions to such personnel has to be rejected.

In 2019, the landmark judgment of the Supreme Court of India (SC) in Swiss Ribbons Pvt. Ltd. v. Union of India, which upheld the constitutional validity of whole of the Code, also laid down that the resolution professional is really a facilitator of the resolution process, whose administrative functions are overseen by the committee of creditors and the adjudicating authority. Thus, even though all the management is vested in the hands of a single person by the Code, yet the independence of the resolution professional’s actions is certainly subject to question.

Rendering Validity to the Actions of Directors

In Assam Company India Ltd. (2019), before the initiation of insolvency proceedings, the company had been declared as a ‘shell company’ by the Securities and Exchange Board of India. The managing director, acting in accordance with a resolution passed by the board of directors authorizing him to file a petition on behalf of the company, approached the Gauhati High Court against the declaration. But, this was done only after the company had become the subject of insolvency proceedings. Hence, the defendants argued that the directors had no locus standi,as it was the IRP who was responsible to file actions on behalf of the company, and that the board of directors acted illegally. The Court, however, held that it is the directors of the company who are directly affected by such a declaration and thus, even though section 17(1)(b) of the Code suspends the board of directors, yet the Court held the authorization by the same to the managing director to represent the company as valid.

In Innoventive Industries Limited v. ICICI Bank (2017), when the application filed by a financial creditor for initiating corporate insolvency resolution process was admitted, an appeal was filed by the corporate debtor, through its directors, before the National Company Law Appellate Tribunal (NCLAT), which was however dismissed. In that context the Supreme Court held that an appeal at the behest of the erstwhile directors of the corporate debtor cannot be maintainable. However, in Assam Company, the High Court pointed out that the same was not the case before them. The challenge did not relate to the corporate insolvency resolution process, but to the branding of the company as a shell company, and thus the directors had rightly filed the petition. Moreover, in Subasri Realty Pvt. Ltd. v. N. Subramanian (2018), the NCLAT put it specifically that the suspension of the board of directors does not amount to a suspension of the managing director or any of the directors of the corporate debtor. Thus, denial of locus standi to a director in a matter affecting him directly would not find any strength.

Suggestions

It has become clear that the provisions of suspension of the board of directors and vesting of all the managerial functions in the IRP should not be given a strict interpretation. It is impracticable to suggest that an IRP can act on his own. Consequently, there is a lot more to the functions of the directors during insolvency proceedings than providing mere cooperation and assistance to the IRP.

In System Building Services, section 172(3) of the UK Companies Act, 2006, which provides for a director’s duty to have regard to the interests of the creditors as a whole, was observed as the foremost duty of a director in an insolvency context. It is imminent that an equivalent provision in the Companies Act, with a simultaneous subjection of the Code to the same, is considered at this stage.

The England and Wales High Court in the aforesaid case had noted that the UK Insolvency Act, 1986 makes it clear that a company’s entry into administration or voluntary liquidation does not, of itself, result in the removal of directors from office. Interestingly, the holding of NCLAT in Subasri Realty case also went along the same lines. But, with the survival of directors following insolvency, it also becomes necessary to note that there is an active survival of their functions and duties as well, rather than merely carrying out a supporting role. To achieve this, recognition of general duties of the directors under the Companies Act is certainly a minimum requirement, independent of the Code.

Kushagra Srivastava

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