[Apoorva Upadhyay and Parthsarthi Srivastava are 3rd year BBA.LL.B students at National Law University Odisha]
As the economic conditions continue to deteriorate, several corporations will likely turn to file for bankruptcy protection in the near future. One of the most sought after alternatives for such distressed companies would be access to capital to ensure minimum liquidity and continuation of operations during the revival period with the aid and assistance of banks and other financial institutions. At first blush, it may seem counterintuitive that financial institutions would lend large amounts of money to struggling companies, which are almost on the verge of bankruptcy. However, as it turns out, financial institutions often lend for a variety of reasons such as safeguarding an existing loan position or taking an opportunity to secure considerable, safe returns as a new lender. This post analyses the role of interim or last-mile financing as a panacea for financially distressed companies.
Super Priority Finance: Lessons from Uncle Sam
In the Indian context, last mile or rescue financing is fairly new. However, one can turn to established jurisdictions such as the United States, which provide for robust financing mechanisms. The experience from established jurisdictions suggests granting super-priority status for rescue financing, either through express legislative provisions or judicial interpretation. For instance, the US Bankruptcy Code under chapter 11 provides for various benefits, including super priority status to a creditor who provides financial aid to a company undergoing reorganization, through a mechanism known as debtor-in-possession financing.
The primary concern that arises in lending money to a distressed company is whether any influx of fresh capital to aid the working needs and initiate the recovery of the company will be entirely utilised towards payments to existing financial obligations. To address this concern, the US Code provides for “super priority” status to creditors who provide finance to companies in distress. This ensures that such lenders will rank ahead of all existing creditors and that any cash flow generated as a consequence of such financing will first go toward the debtor-in-possession financiers and not the existing creditors, thereby steering clear of the debt overhang problem. This mechanism has proven to be reasonably sturdy in practice in the US and some of the landmark bankruptcies in the past such as those of Chrysler and General Motors included this mechanism within their restructuring framework.
Super Priority Finance: The Asian Experience
In an attempt to establish itself as the hub for debt restructuring in Asia, Singapore has introduced several changes to its insolvency regime. The Singapore regime is primarily inspired by the US Code and includes concepts analogous to debtor-in-possession financing. In May 2017, Singapore amended its Companies Act and introduced super priority financing via section 211E which confers on courts the authority to grant the super priority status. The first landmark decision that discussed the new additions was Re Attilan Group Ltd where the applicant sought to obtain rescue financing through subscription of additional shares. The applicant, citing section 211E, asked the Court to grant priority status to the “rescue financing”. The Court opined that in order to grant priority status under section 211E, three prerequisites must be satisfied. First, the proposed financing must be “rescue financing” according to section 211E (9); secondly, the conditions stipulated under section 211E (1), i.e., the financing was the last resort available to the company in the circumstances, must be satisfied; and, lastly, that the Court must exercise its discretion to grant priority status. The Court further observed that under the new legislative framework, super priority status should not be granted unless it was absolutely necessary. The rationale is that “it is only where there is some evidence that the company cannot otherwise get financing that it would be fair and reasonable to reorder the priorities on winding up, giving the rescue financier the ability to get ahead in the queue for assets.” Therefore, the applicant must prove to the court that “reasonable attempts at trying to secure financing” were made in order to seek super priority status. In the absence of the same, the Court considered the subscription of shares as “rescue financing” but did not grant “priority status” to it.
Interim Finance: Experience from the IBC
Under the Indian landscape, similar to its international counterparts, the Insolvency and Bankruptcy Code, 2016 (IBC) was envisioned with an intention of reviving distressed companies and ensuring that they remain a ‘going concern entity’. Interim financing lies at the heart of such protectionist measures. Similar to the ‘super-priority’ position in the US and Singapore, the IBC under section 5(13)(a) categorises interim finance within insolvency resolution process costs (IRPC). Therefore, according to section 5(13)(a) read with section 53(1)(a) of the IBC, it is accorded highest priority during liquidation, and also during corporate insolvency resolution process (CIRP) through section 5(13)(a) read with section 30(2)(a). Unlike Singapore, the priority status is not accorded later by the discretion of the adjudicating authority. If the committee of creditors (CoC), exercising its commercial wisdom, decides to raise interim finance, it is automatically granted priority as an IRPC.
The legislative framework in India
The latest version of section 5(15) of the IBC defines interim finance asany financial or other notified debt raised by the insolvency resolution professional during the CIRP. The legislative importance conferred to this process is reflected by the fact that the IBC, within section 20(2)(c), not only empowers the resolution professional to raise interim finance, but under section 25(2)(c) it also imposes a duty upon him to do so if it is required to maintain the corporate debtor as a going concern. Such finance can be raised by interim resolution professional in terms of section 20(2)(c) before the formation of the CoC or by a resolution professional according to section 28(1)(a) after the formation of the CoC.
Judicial Analysis: Lessons from the Edelweiss Case
One of the first crucial cases that dealt with interim finance in India is Edelweiss Asset reconstruction Company v. Sai Regency Power Corporation Pvt. Ltd. decided by the National Company Law Appellate Tribunal (NCLAT) in December 2019. In this case, an argument raised by Edelweiss (noted in paragraph 4 of the judgement) brought an important issue for consideration before NCLAT. That was whether, through a strict interpretation of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, interim finance can be availed for supply of essential goods and direct costs only and to exclude the manufacturing input costs. The NCLAT reasoned that the ‘value of a going concern is much more than a non-functional plant or concern.’; therefore, deeming it unwise to let such an entity come to a ‘grinding halt’, it allowed interim finance to be raise for input costs too.
Although the reasoning is progressive, the order lacks the desired clarity. The NCLAT could have utilized this opportunity to take a purposive interpretation of IBC and categorically ease regulations 31 and 32. Additionally, due to the lack of an authoritative interpretation in this regard, these regulations are still incongruent with section 14(2a) of the IBC. Notably, regulation 32 creates strict categories to define ‘essential goods’, and both the regulations preclude input costs and manufacturing expenses. However, section 14(2A) grants the determining discretion to the resolution professional and the CoC.
Legislative Endeavours And The Road Ahead
The above discussions reflect that super priority financing is an established concept in foreign jurisdictions and operates within a realm of distinctly developed legal frameworks. In India, it is relatively underdeveloped. Therefore, to bridge this gap, there have been various encouraging legislative endeavours. For instance, to prevent lenders from losing ad interim interest benefits, the Insolvency and Bankruptcy Board of India (IBBI) in March 2018 provided that interest incurred until 12 months of commencement of liquidation or until repayment of the loan (whichever is earlier) will be included in IRPC. Similarly, the Reserve Bank of India (RBI) in June 2019 in its Prudential Framework for Resolution of Stressed Assets made a significant advance by declaring that interim finance should be treated as standard asset within its asset classification norms. In December 2019, an amendment ordinance was introduced that allowed the legislature to widen the scope of interim finance that can be raised by the resolution professional. These are welcome changes towards developing a robust insolvency regime in India.
While India has been progressing, albeit slowly, to incentivise interim finance, there has been much uncertainty, particularly regarding the acknowledgment of various forms of finances disbursed by banks and non-banking finance companies as interim finance. In today’s uncertain economy, a task is to maintain the liquidity of banks while extending interim finance to companies that may slump the path of insolvency in times to come. This is an area where collaborative efforts are needed from the RBI and IBBI. Further, the discussion of the Edelweiss case reflects a need for tribunals and courts to adopt an analytical approach and proactively settle interpretative challenges that may arise due to interrelated laws. These efforts will ensure that interim finance lives up to its legislative intent of reviving distressed companies.
It is time India endeavoured to match the pace of the US and Singapore in creating robust distress financing norms. Singapore’s early strides towards converting itself into debt restructuring hub will benefit its economy in today’s uncertain times. We must take cues from these advanced jurisdictions to enhance our interim finance framework and, if the importance to priority financing accorded by Europe and UNCITRAL is anything to go by, then it would be prudent to take a leaf from their book.
– Apoorva Upadhyay & Parthsarthi Srivastava