[Sikander Hyaat and Sara Jain are 5th year B.A., LL.B. (Hons.) students at MNLU Mumbai]
The outbreak of the coronavirus pandemic has caused substantial market disruptions and deterioration of consumption. Recently, the Fitch Ratings has reduced India’s GDP growth forecast from 5.1% to 2%, making it the slowest growth rate over the past 30 years. Consequently, businesses are facing severe financial distress. They are defaulting on their payment obligations because of the demand disruptions caused by the pandemic.
In the context of the Insolvency and Bankruptcy Code, 2016 (IBC), resolution applicants are finding it increasingly difficult to abide by the resolution plans submitted by them owing to the uncertainty in viability and valuation of businesses. Considering the drastic change of situation, they may seek to either reduce the size of their investment or withdraw themselves from the insolvency resolution process. In fact, just last week, Ramkrishna Forgings, who is the winning bidder of Acil Ltd, an insolvent automotive components maker, has demanded renegotiations.
Disruptive impact on the corporate insolvency resolution process
Under the corporate insolvency resolution process (CIRP), the resolution plan has to undergo three phases in order to become final. The first stage comprises the resolution applicant submitting the resolution plan to the resolution professional for consideration. Thereafter, in the second stage, the resolution plan is required to be approved by 66% of voting share of the financial creditors in a meeting of the committee of creditors (CoC). Lastly, in the final stage, the plan shall be placed before the National Company Law Tribunal (NCLT) for approval, after which it would be implemented.
In the current scenario, if the resolution plan is in the first stage, the resolution applicants may be permitted to withdraw or modify their application as the same has not been examined or approved by the CoC. The CoC has not applied its mind to the resolution plan and, therefore, withdrawing or modifying at that stage can be permitted by providing reasonable grounds. On the other hand, if the resolution plan is in the final stage and has been approved by the NCLT, it becomes binding on all the stakeholders involved in the plan according to section 31 of the IBC. In Maharashtra Seamless Limited v. Padmanabhan Venkatesh (22 January 2020), the Supreme Court held that a resolution plan approved by the NCLT cannot be withdrawn by the resolution applicant.
However, if the resolution plan is in the second stage, i.e., it has been approved by the CoC but not the NCLT, a question arises whether renegotiations or withdrawal of the resolution plan ought to be permitted. The question of withdrawal of resolution plan in this stage has been dealt in two decisions of the NCLT Mumbai. In Satyanarayan Malu v. SBM Paper Mills Ltd (2018), two applications were filed before the NCLT, one for withdrawal of the insolvency application filed under section 10 utilizing the provisions of section 12A and, second, for the withdrawal of the resolution plan by the successful resolution applicant. In the said case, the NCLT permitted withdrawal of insolvency application under section 12A and, therefore, held that any determination on the second application would be futile. Nevertheless, it went on to reprimand the resolution applicant for attempting to withdraw the resolution plan without any reasons, given the far-reaching impact it would have on the process. The NCLT stated that such a practice should be discouraged, as it adversely affects the rights of the other resolution applicants and the corporate debtor, and thereby “thwarting” the CIRP process. The NCLT ordered that only half the earnest money deposited by the resolution applicant would be returned.
In Deccan Value Investors L.P v. Deutsche Bank (2019), the NCLT Mumbai permitted the withdrawal of resolution plan after approval by the CoC because the information supplied to the resolution applicant was found to be incorrect and misleading. It stated that “the IBC neither confers the power or jurisdiction on the Adjudicating Authority to compel specific performance of a plan by an unwilling resolution applicant” and that “the letter and spirit of the I&B Code mandate the acceptance of only a viable and lawful resolution plan being implemented at the hands of a willing resolution applicant.”
At first blush, the aforementioned lines may seem to indicate that withdrawal of approved resolution plans should be allowed. However, when read in the context of the case, it denotes that withdrawal should be permitted in reasonable circumstances when the resolution applicant is not at fault.
In essence, permitting resolution applicants to modify or withdraw their resolution plan after approval of the resolution plan by CoC, when they have not suffered a ‘material adverse effect”, is unfeasible and unviable. It results in a substantial wastage of time, money and effort, and is unfair to other resolution applicants who were deprived of participating in the CIRP of the corporate debtor.
Force majeure and MAE clauses: A matter of wordings
Resolution plans, like general commercial agreements, contain force majeure or material adverse effect clauses (MAE), which may be exploited by entities to terminate or renegotiate the plan. Such clauses are case-specific, as they vary depending on the specific language drafted in the plan. Traditionally, however, a market standard MAE is defined as an event or circumstance that has had, or is reasonably expected to have, a material adverse effect on the target’s business, assets, liabilities or results of operations.
This definition provides a possibility of two potential standards of a MAE. They may require an event to have had a material adverse effect or reasonably expect it to have a material adverse effect. By implication of language, the former requires that a quantifiable material adverse effect has taken place, while the latter leaves scope for a speculative effect based on a reasonable expectation. There may be clauses with a broader ambit that cover both standards. In some cases, there may even be ambiguity in drafting.
For the sake of argument, a resolution applicant is likely to argue in favor of a broader interpretation that takes into account expected possibilities and not just damage that has occurred, while a committee of creditors will argue in favor of a narrower interpretation. An adjudicating forum will have to, in pursuance of the principles of natural justice, entertain and address both strands of argument. While it is accepted that an outcome is contingent upon the wordings of the clause, it is appropriate to address how the law should broadly operate in making such a determination.
The Supreme Court has held in Satyabrata Ghose v. Mugneeram Bangur (1953) that the law of discharge is to be governed solely under the terms of the Contract Act, 1872. Therefore, parties may be absolved from the further performance of an obligation if the whole purpose or basis of a contract was frustrated by the intrusion or occurrence of an unexpected event or change of circumstances, which was beyond what was contemplated by the parties at the time when they entered into the agreement. More recently, the Court in Energy Watchdog v. Central Electricity Regulatory Commission has pointed out that for an event to be force majeure it has to actually render performance of the agreement impossible or illegal.
Placing a force majeure or MAE clause in the context of the pandemic, applicants may prima facie have a valid basis in law to terminate or renegotiate a submitted plan. In fact, in February 2020, the Ministry of Finance declared that Covid-19 can be treated as a natural calamity and hence a force majeure. However, it must be noted that the Supreme Court has also clarified in Energy Watchdog that courts do not have the general power to absolve a party from the performance of its part of the contract merely because its performance has become onerous on account of an unforeseen turn of events. It must be shown that they never agreed to be bound in a fundamentally different situation which had unexpectedly emerged.
Two recent American cases provide more context. In context of a merger, it was held in Akorn, Inc. v. Fresenius Kabi AG, Quercus Acquisition, Inc. (2018) and Channel Medsystems, Inc. v. Boston Scientific Corporation and NXT Merger Corp. (2019) that “[a] buyer faces a heavy burden when it attempts to invoke a material adverse change clause in order to avoid its obligation to close” and that “a detailed facts and circumstances determination is required”. An important observation made, which somewhat justifies this requirement of a higher burden of proof, was that “…….in the negotiation context, counter-balancing the buyer’s high burden of proof is the buyer’s significant leverage created in calling an MAE, forcing the seller to consider the risk of a failed transaction on its business and the cost of the all or nothing litigation that may follow”.
Drawing an inference from these cases, a very high burden of proof must be imposed on an applicant to establish the presence of such facts. This applies more in the context of a resolution plan under the IBC because of the months-long previous negotiations, denial of other applicants and reduction in value of the target’s assets (which is already insolvent), the opportunity cost of a resolution plan approved by the committee of creditors is very high for an approved applicant to conveniently back out of it. Applicants must not be allowed to escape fulfilling their obligations under the approved plan merely on the basis of a ‘speculation’ that the pandemic will make the performance impossible, but prove the destruction of value or material or quantifiable impact because of the pandemic. Moreover, it is an established common law principle that the findings of a court must be made in order to uphold the sanctity of a contract. In light of this principle, if the adjudicatory body finds itself in a position where words of the clause do not provide an explicit basis for discharge, it ought to direct a renegotiation of the terms and see termination only as a last resort.
– Sikander Hyaat & Sara Jain