Application of Section 29A of the IBC to Schemes of Arrangement

[Nipuna Varman is a student at the NALSAR University of Law, Hyderabad and Lalitha Nandula a student at the Gujarat National Law University, Gandhinagar]

The Insolvency and Bankruptcy Code 2016 (IBC) focuses on two aspects, i.e., the corporate insolvency resolution process (CIRP) and the liquidation process. The CIRP is prescribed for the revival of the corporate debtor. Under the IBC, the focal point is to ensure revival and continuation of the corporate debtor. In situations where the CIRP fails, it would end up in liquidation of the corporate debtor.

In recent times, the adjudicating authorities have been providing opportunities to the liquidator for restructuring through a scheme of compromise or arrangement under section 230 of the Companies Act 2013 (Act). A scheme of compromise or arrangement is one between a company and its creditors or members or any class of them. Historically, schemes of arrangement have been provided under the Companies Act 1956. However, the same has been replicated in the Act. Under section 230 of the Act, a proposal for compromise or arrangement can be initiated by any member, creditor or the liquidator by filing an application to the appropriate National Company Law Tribunal. This post analyses the applicability of section 29A of the IBC to a scheme and the effect of the amendment on the participation of the promoters of the corporate debtor in it.  

Judicial Trends of Section 230 of the Act

For the first time, the National Company Law Appellate Tribunal (NCLAT) in S.C Sekaran v. Amit Gupta passed an order stating that the liquidator is directed to take steps under section 230 of the Act before proceeding with the liquidation of the company. The NCLAT relied on Meghal Homes Pvt. Ltd. v. Shree Niwas Girni K.K. Samiti where, during the pendency of liquidation process, a scheme was proposed under section 391 of the Companies Act 1956. The NCLAT held that only in case of failure through the scheme will the liquidator go ahead for the sale of the assets of the corporate debtor, partly or as a whole.

Further, in Y. Shivram Prasad v. Dhanapal, the NCLAT stated that the scheme must be in accordance with the objectives of the IBC. Additionally, when any member or creditor or class of creditors applies for a scheme through the liquidator, such liquidator must make an application on behalf of the company under section 230 of the Act. In the most recent case of Jindal Steel and Power Limited v. Arun Kumar Jagatramka, the NCLAT referred to Meghal Homes, Swiss Ribbons Pvt. Ltd. v. Union of India and S.C Sekaran and reiterated that the liquidator must make all efforts to revive the corporate debtor under section 230 of the Act. During the process of liquidation, in order to protect the corporate debtor from its former management and death due to liquidation, it is necessary to revive the corporate debtor.

Applicability of Section 29A of IBC to the Scheme

Section 29A of the IBC, which was introduced through the Insolvency and Bankruptcy Code (Amendment) Act, 2017, restricts certain persons from submitting a resolution plan during CIRP. An undischarged insolvent, wilful defaulter, or promoter of a company among others are restricted from becoming a resolution applicant and submitting a resolution plan. The intention behind section 29A of the IBC is to oust the previous management from taking control over the corporate debtor again. However, until January 2020, there was nothing mandated by the law, which prohibited ineligible persons under section 29A to make an application for a scheme under section 230 of the Act. As discussed by the Insolvency and Bankruptcy Board of India (IBBI), there are several practical difficulties in the implementation of section 29A for the purposes of section 230 of the Act.

Under section 29A of the IBC, a promoter is not eligible to submit a resolution plan. However, reading into section 230 of the Act, there is no express bar on promoters to submit a scheme, essentially allowing the promoters or the management of the corporate debtor to regain control over it. The intent of the IBC is to allow the corporate debtor to avoid liquidation and rebuild the business to make it profitable again. However, allowing the previous management to regain control over the corporate debtor would mean that the management that drove the corporate debtor to insolvency and possible liquidation would again be put in a position of power in the company.

The conundrum of whether a person ineligible under section 29A of the IBC could propose a scheme under section 230 of the Act has been discussed in various decisions. The NCLAT, in Shivram Prasad, held that if any member or creditor of the corporate debtor proposes a scheme through the liquidator, such liquidator must make an application on behalf of the company under section 230 of the Act, even if such member or creditor is otherwise prohibited under section 29A of the IBC. Relying on the above decision, the NCLAT in R. Anil Bafna v. Madhu Desikan held that the promoter and director of the corporate debtor can propose a scheme of arrangement with the consultation of the liquidator under section 230 of the Act.

However, a conflicting approach was taken by the NCLAT, in Jindal Steel. It was held that the corporate debtor must be saved from its own management, even for the purpose of section 230 of the Act. This implies that promoters who are ineligible under section 29A of the IBC are also prohibited from making an application under section 230 of the Act.

Effect of the Amendment to IBC Regulations

On 6 January 2020 the IBBI amended the Insolvency Bankruptcy Board of India (Liquidation Process) Regulations, 2016 and added a proviso to regulation 2B. This regulation provides for the rules binding the compromise or arrangement proposed under section 230 of the Act. The proviso excludes the person ineligible under section 29A of the IBC from being a party in any manner to such compromise or arrangement. It must be noted that this amendment has been introduced to plug the loophole that existed in the insolvency law, and it also must be looked at as an attempt to preserve the true purpose of the IBC.

A pertinent question that arises in this regard is whether this amendment also means that the ineligible persons shall not be allowed to vote on the scheme in question. The answer to this question is in the negative; it is evident from the proviso that the ineligible person is prevented to partake in the compromise in any manner. Therefore, the amendment undoubtedly aims to prevent the promoters of the corporate debtor from taking back the reins of the company through schemes and through voting for such compromise. This means that the restrictions put in place under section 29A of IBC will now be equally applicable to the process of liquidation.

Another question that must be considered is whether, if the scheme requires the control of the corporate debtor to be reinstated to the promoters and such scheme is passed during the vote, then the IBC allows restoration of control. It must be noted that the amendment to the Regulations includes regulation 37(8) which states that a secured creditor should not sell or transfer a secured asset to any person held ineligible under section 29A. It is evident that the legislative intent behind these amendments is to prevent the transfer of control to the ex-promoters of the corporate debtor. The spirit of IBC is to ensure the continuity of the corporate debtor. However, giving control to the management that already failed to rescue the corporate debtor from insolvency seems counterproductive. Even though there is no overt reference that the scheme of arrangement requiring reinstatement of the promoters is not maintainable, it evidently goes against the objective of the legislation. However, this line of argument does hold some merit and one must question whether the IBC through its provisions can exercise pervasive control over the will of the secured creditors, independent directors, and other stakeholders.

Conclusion

The amendment has been introduced to fill in the gaps in the insolvency law in India. It clarifies the position of the promoters and management of the corporate debtor in the process of insolvency and liquidation. It removes the contradiction between IBC and the Act. Further, the amendment strengthens the NCLAT decision in Jindal Steel and upholds the focus of the IBC, which is to protect the corporate debtor from its management.

– Nipuna Varman & Lalitha Nandula