[Sikha Bansal is a Partner at Vinod Kothari & Company]
The concerns around schemes of arrangement under section 230 of the Companies Act, 2013 in the background of insolvency proceedings under the Insolvency and Bankruptcy Code, 2016 (IBC) have been partly addressed with the ruling of Supreme Court (SC) in Arun Kumar Jagatramka v. Jindal Steel and Power Ltd. The SC has held that the prohibition contained in section 29A of the IBC should also attach itself to a scheme of compromise or arrangement under section 230 of the Companies Act, when the company is undergoing liquidation under the IBC. The reasons is that proposing a scheme of compromise or arrangement under section 230 of the Companies Act while the company is undergoing liquidation under the provisions of the IBC lies in a similar continuum.
Earlier, there were several rulings of the National Company Law Appellate Tribunal (NCLAT) which allowed schemes of arrangement during liquidation (see, e.g., S.C. Sekaran and Y. Shivram Prasad). After such rulings, the IBBI (Liquidation Process) Regulations were amended to include regulation 2B, which states that “a person, who is not eligible under the Code to submit a resolution plan for insolvency resolution of the corporate debtor, shall not be a party in any manner to such compromise or arrangement.”
Interestingly, a broader issue which SC noted (in para 89) states: “Since the efficacy of this arrangement is not challenged before us in this case, we cannot comment on its merits.” With this ruling, and also given various other concerns associated with schemes of arrangement under the IBC, we may need to consider if at all the amalgam of schemes of arrangement and the IBC was a necessity. Could one contemplate that the IBC regime would be better off without section 230 schemes? This post seeks to develop an answer.
Was this an ‘original’ idea?
The applicability of section 230 schemes under IBC arises out of amendments made to section 230 of the Companies Act by way of section 255 of the IBC read with the 11th schedule thereto. Section 230 was amended to include references to a liquidator appointed under the IBC, thereby making all the difference.
Evidently, the Bankruptcy Law Reforms Committee (BLRC) did not deliberate in its report or in its interim report (2015) on the possibility of ‘schemes of arrangement’ in liquidation proceedings, although it did discuss the feasibility of schemes for debt restructuring (see Interim Report, pages 78-79). The BLRC explicitly noted that schemes of arrangements for debt restructuring “have not had many takers in India. This may be partially attributable to the perception that court driven processes necessarily involve delays and significant costs. Additionally, there have been problems of holdouts by creditors”. However, such schemes have been relatively successful for schemes between shareholders. Also, schemes can also facilitate ‘pre-packaged rescues’.
In fact, it would be interesting to note some of the important extracts of the 2015 Report wherein the BLRC observed that insolvency proceedings should be the proceedings as a last resort. That is, the IBC should come into the picture after all negotiations between the debtor and the creditors to resolve the conflict fail. The extract is reproduced below:
“The proposed Code assumes that, under situations of stress in the entity, the debtor and creditors have already have gone through negotiations to reach a solution to keep the entity as a going concern. The IRP is considered as a last course effort to resolve conflicts in the negotiations. Then triggering the IRP can be assumed to be a considered step, after deliberation and preparation.” [emphasis added]
This indicates that the BLRC proceeded on the assumption that insolvency proceedings under the IBC would be chosen by the initiating party after all other efforts to resolve debtor-creditor conflict have been explored and there are no more doors open for resolution. Therefore, one can say that the debtor and creditors should have already explored the option of a possible scheme of compromise or arrangement before seeking recourse to the IBC.
Therefore, in the draft of the IBC prepared by the BLRC, no amendments were proposed to section 230 of the Companies Act. Such amendments in section 230 was actually proposed by the Joint Parliamentary Committee (in page 70 of its report). Seemingly, the Committee did not cite any reason or explanation for the same.
While the SC, in its ruling (see, para 89), has noted “the explicit recognition of the schemes under Section 230 into the liquidation process under the IBC was through the judicial intervention of the NCLAT in Y Shivram Prasad”, the author submits that the legislature itself allowed section 230 schemes under the IBC, even before the NCLAT ruling, as discussed above. The NCLAT ruling too has taken note of amended section 230 of the Companies Act.
Hence, it appears that the introduction of this alloy of schemes of arrangement and the IBC was not an outcome of a designed thought process. Nevertheless, the idea was endorsed by the judiciary in a series of rulings (as pointed above) in order to accentuate the chances of revival of the business entities. However, as already pointed out, various questions and concerns remain in relation to schemes of arrangement undertaken in the IBC liquidation processes, which has also been raised by Insolvency Law Committee (ILC) in its report (2020).
It may be noted that earlier the Insolvency and Bankruptcy Board of India (IBBI) had come out with a Discussion Paper (2019) on liquidation process where the regulator sought public opinion on applicability of section 230 schemes during liquidation proceedings. Later, the ILC, in its report (2020), also highlighted the incompatibility of section 230 schemes with the liquidation proceedings under IBC. The ILC recommended that “recourse to Section 230 of the Companies Act, 2013 for effecting schemes of arrangement or compromise should not be available during liquidation of the corporate debtor under the Code”.
However, the Committee noted that such schemes may have utility in liquidation, e.g. in cases where “creditors may find it useful to avoid certain mandatory requirements of the liquidation process – such as to enable settlement of outstanding, contingent claims, or where such compromises may be used to avoid certain mandatory set-offs, or modify rights vis-à-vis third parties”. The ILC, therefore, viewed that “such a process for compromise or settlement need not be effected only through the schemes mechanism under the Companies Act, 2013,” and felt that “the liquidator could be given the power to effect a compromise or settlement with specific creditors with respect to their claims against the corporate debtor under the Code”. Therefore, the ILC was not in favour of section 230 schemes being combined with the IBC, but recommended some sort of schemes within IBC itself. Paragraph 86 of the SC ruling clearly brings out this view.
Repeated attempts for revival – an unnecessary exercise?
A general argument which can support the applicability of section 230 schemes in IBC liquidation is – if a scheme can be undertaken in liquidations happening outside the IBC, then why not under the IBC? That takes us to the very obvious question as to how a liquidation under the IBC is different from a general liquidation. The answer is obvious: liquidation under the IBC is (mandatorily) preceded by resolution proceedings, which is arguably another incarnation of schemes of arrangement.
Schemes would generally entail a compromise by creditors, merger or demerger of the company, or other forms of corporate or capital restructuring, which are also the possible routes of resolution. It is just that, when it comes to the IBC, this ‘settlement mechanism’ has to be in alignment with the ‘resolution mechanism’.
In fact, schemes of arrangement have been seen as effective means of resolving insolvency over years – see rulings Miheer N Mafatlal v. Mafatlal Industries Ltd., Forbes and Company v. Official Liquidator and Rasiklal S. Mardia v. Amar Dye Chem Ltd, notwithstanding the fact that such schemes are also used by financially healthy companies for restructuring purposes. In rulings such as Swiss Ribbons, the courts have held that “liquidation should be seen as a matter of last resort”. Allowing schemes of arrangement even after liquidation is actually counter-intuitive to this idea, as it allows for a never-ending cycle towards resolving an entity.
There are already too many options. Before the IBC proceedings begin, the parties can go for resolution under the framework of the Reserve Bank of India or under a general scheme of arrangement or compromise under section 230. Note that we are already envisaging a pre-pack rescue mechanism. Once IBC proceedings begin, the corporate insolvency resolution process (CIRP) is for resolution and revival of the entity only – there are chances of withdrawal of proceedings too. Even if the corporate debtor slips into liquidation, preference has to be given to going-concern sales. Despite all these available mechanisms, we are still looking for schemes in liquidation where one might end up having more questions than solutions. The idea of a scheme of arrangement, in itself, is almost like trying for a fresh beginning, where the ruins are all the liquidator is left with.
Also, data suggests that the success rate of such schemes in IBC liquidations might actually be very low. As on September, 2020, only one case of liquidation was closed by way of compromise or arrangement.
One of the greatest barriers to business restructuring can be a framework which makes it virtually impossible to liquidate and wind up a viable entity. Over-emphasizing revival and neglecting the fact that liquidation, in some cases, is the best way to maximise value, might actually lead to value destruction. In fact, some committee reports such as the Report of the Committee on Industrial Sickness and Corporate Restructuring, popularly known as Goswami Committee report (1993), have advocated the sale of dismantled assets over going-concern sales in liquidation. In the author’s view, an entity under the auspices of IBC gets multiple chances of proving its viability. A viable business, in all possibilities, should emerge successful from CIRP proceedings. Thus, the insistence on another opportunity in the form of a ‘scheme’ might actually be futile.
– Sikha Bansal