[Aastha Agarwalla is a final year law student at Campus Law Centre. Faculty of Law, University of Delhi]
The United Kingdom (UK) recently enacted a much-awaited economic legislation, the Corporate Insolvency and Governance Act 2020 (CIGA). The CIGA introduces sweeping reforms, including a cross-class cramdown provision (CCDP), in the restructuring legal framework. The cramdown mechanism, inspired by Chapter 11 bankruptcies in the United States (US), limits the ability of the creditors to block a viable restructuring proposal that has the overwhelming support of those creditors who retain an economic interest in the business. Specifically, cross-class cramdown occurs when a reorganization plan proposed in relation to a debtor is implemented even though an entire class of creditors votes against the plan.
Intriguingly, the enactment of CCDP in the UK has spurred various debates around the world, especially India, on comprehending such jurisprudential development in their respective jurisdictions. Upon a careful study, one may undisputedly note that the concept of CCDP is not alien to the Indian corporate restructuring regime. In this post, the author examines the contours of CCDP, and argues why such provision should be incorporated in the pre-insolvency restructuring mechanisms.
Scope of Cross-class Cramdown
A corporate entity can restructure its debt by espousing to any of the three methods, viz. (i) resolution mechanism in Insolvency and Bankruptcy Code 2016 (Code), (ii) scheme of arrangement under sections 230 to 232 of the Companies Act 2013 (the Act, 2013);and (iii) Prudential Framework for Resolution of Stressed Asset prescribed by the Reserve Bank of India (RBI).
Notably, the most potent statutory underpinning of CCDP is envisaged in the Code. For the purposes of the corporate insolvency resolution process (CIRP), the Code classifies creditors into financial and operational creditors. Section 21 of the Code sets out the procedure of formation of the Committee of Creditors (CoC), the decision making body of CIRP of the corporate debtor. It is pertinent to note that the CoC comprises only of financial creditors (secured and unsecured) and, in doing so, operational creditors do not obtain any representation in the CoC. That means, whilst obtaining the approval a resolution plan from the CoC (as per the appropriate majority of all financial creditors), the interest of operational creditors and dissenting financial creditors do not find direct representation. Thus, the Code inherently recognises a cramdown across a whole class of operational creditors. The Supreme Court in Swiss Ribbons v. Union of India upheld such a cramdown situation, provided operational creditors are accorded equitable treatment.
On the contrary, the CCDPs are absent from the other two restructuring methods. The ‘Prudential Framework for Resolution of Stressed Asset’ promulgated by the RBI in 2018 does not postulate any mechanism for CCDP. Similarly, restructuring implemented through a scheme of compromise or arrangement under section 230-232 of the Act, 2013 does not allow CCDP. According to section 230(6) of the Act 2013, the scheme must be approved by every ‘class of creditors’. Since class-wise approval is an innate feature of the scheme of arrangement, it is not possible to cram down one or more classes as whole. However, it is certainly possible to cramdown the dissenting minorities forming part of each class. Therefore, what follows from the foregoing discussion is that any pre-insolvency attempt to restructure in India will have to be undertaken without the benefits of the CCDP.
On the flipside, CCDP has been introduced (or proposed) in several jurisdictions across the globe in recent years. Very recently, the UK pioneered cross-class cramdown mechanism in its restructuring regime. It allows dissenting classes of creditors to be crammed down, subject to meeting two conditions. First, the court is satisfied that none of the dissenting class(es) would be any worse off under the plan than they would be in the event of ‘relevant alternative’. Specifically, the relevant alternative is whatever the court considers would be most likely to occur if the restructuring plan was not sanctioned. Second, at least one class of creditors who have a genuine economic interest in the company, in the event of relevant alternative, has voted in favour. Further, Europe also lately recognized the need of including a CCDP as one of the minimum standards which EU member states will be required to incorporate into their national restructuring laws in order to comply with the recently approved Directive on Restructuring and Insolvency. Similarly, in 2017, Singapore enacted Companies (Amendment) Act 2017, a restructuring reform to establish itself as a global restructuring hub. It introduced the CCDP in order to make creditors’ scheme of arrangement a more attractive debt restructuring tool in Singapore.
Thus, the question that looms large is whether India should also jump on the bandwagon by tweaking the extant procedural norms on schemes of arrangement.
Absence of Cross-Class Cramdown in Restructuring Scheme: A Dampener?
To address such issues, there is always a need to balance between flexibility to the company, and the concerns of various stakeholders. The schemes of arrangements are often criticized for being slow and cumbersome. One of the issues that present difficulties for using schemes for restructuring is the requirement to compose separate classes of creditors. Historically, schemes have been frustrated by creditors in hopes of a better deal and, as a result, a major difficulty of ‘hold-up’ arises. If, depending on the nature and extent of classification required, nearly all creditors have to approve the restructuring, it potentially allows even very small creditors to derail the process while bargaining for additional advantages. Consequently, restructuring becomes far more onerous to execute due to hold-up. However, the introduction of CCDP can largely overcome this problem by circumventing dissenting class of creditors from derailing an equitable scheme, making creditors’ schemes a more efficient restructuring tool.
This is seemingly attractive from the company’s perspective as the company can exercise flexibility in a restructuring scheme. But, advocating for the introduction of CCDP in Indian law, it is recognized that the rights of those crammed down also need consideration and need to be treated fairly. The cramdown will bring with it the possibility of minority oppression and a legal system will therefore need to consider how to respond appropriately to this need for minority protection, and how to weigh that protection against the interests of the majority in rehabilitating the company or its business.
But, taking cue from the example set by advanced jurisdictions, a CCDP can be introduced with appropriate safeguards. One such protection can be in form of ‘compulsory sanction of the scheme by a court’. Courts would be in a position to ensure that the plan is fair and equitable at this stage of the process, and can provide a level of protection to a dissenting class of creditors. Basically, the CCDP should only be available by the court’s order, not by the mere majority vote of the creditors. Even if this is not considered to be sufficient protection, provisions requiring valuation exercises to be carried out, and for dissenting creditors ‘not to be worse off’ under the scheme than they would be in a liquidation (assuming that is the alternative to a scheme), could be considered.
More importantly, India has traditionally been a very creditor-friendly jurisdiction; creditors have tremendous rights of enforcement. This can be seen as a way to redress the balance slightly more in favour of what is becoming the status quo around the world and giving the board of directors more opportunity to try and rescue their company.
Indubitably, the success of the Code is attributable in no small measure to the decision-making being confined to the financial creditors as a single class. In my opinion, it is time to replicate the successful features of the IBC and novel restructuring reforms in overseas jurisdictions, in order to create an alternative resolution mechanism that is equally effective. It should also be noted that insolvency proceedings generally carry a stigma of failure, which reduces creditor confidence in the potential to save the business through a formal restructuring. Thus, it is very important to reform the archaic pre-insolvency restructuring mechanisms, if India wants to remain a preferred destination for debt restructuring. The CCDPs will be an efficacious addition to the scheme of arrangement procedure as it will provide a calibrated framework for Indian entities to restructure their debts and, concomitantly, to avoid the torrent of insolvencies that may occur after the period for which the Code is suspended comes to an end.
– Aastha Agarwalla