“Clean Slate Theory” under the Insolvency & Bankruptcy Code: An Analysis

[Aditya Saraswat is a 5th year student at National Law University, Jodhpur]

One of the foremost objectives of the Insolvency and Bankruptcy Code, 2016 (the “Code”) is to ensure timely resolution and revival of corporate debtors. For this purpose, various resolution plans are invited and deliberated upon before a final plan is selected. However, what if certain liabilities are imposed by the Government or local authorities on the corporate debtor after the approval of a resolution plan? What if these liabilities arose due to negligence of the resolution professional? Will the successful resolution applicant be bound to bear those liabilities? This post analyzes a recent judgment of the Supreme Court in this regard.

Supreme Court’s Observations on the “Clean Slate Theory”

On April 13, 2021, the Supreme Court observed in Ghanashyam Mishra and Sons v. Edelweiss Asset Reconstruction Company (“Edelweiss”) that if additional liabilities are allowed to be imposed on the successful resolution applicant after the approval of the plan, the entire plan would become unworkable. The Court said that such surprise debts cannot be sprung upon the resolution applicant, which were not laid down in its resolution plan. If that is allowed, the very calculations on which the resolution applicants rely to submit their resolution plans would go awry. The Court emphasized that a successful resolution applicant should start with a clean slate on the basis of its approved plan.

The Court further discussed that this clean slate theory is evident from section 31 of the Code, according to which an approved resolution plan is binding on all the stakeholders involved in the resolution plan. This provision was amended by the Insolvency and Bankruptcy Code (Amendment) Act, 2019 to make the successful resolution plan binding on “Central Government, any State Government or any Local authority”. The Court found this particular amendment to be clarificatory in nature and, hence, retrospective in operation. Therefore, any claim, even if it pertains to a date prior to the effective date of this amendment, would not be entertained after the resolution plan is approved. The Supreme Court went ahead to explain that this amendment was not even required in the first place. This is because a successful resolution plan is already binding on “creditors” in terms of section 31. The Court said that Central Government, State Governments and local authorities are already covered within the term “creditor”, as they can be recognized as operational creditors. Even if that is not the case, they can easily come within “other stakeholders” in section 31. Hence, the Court observed that there was no need for this amendment, as the successful resolution plan is already binding on these authorities according to the provisions of the Code.

Significance of the Edelweiss Judgment

The Edelweiss judgment holds a lot of importance as it furthers the entire purpose and mechanism set out under the Code. It is important to note that an opportunity is already given to creditors under section 15 of the Code to submit their claims against the corporate debtor when a public announcement is made for initiating corporate insolvency resolution process (“CIRP”). Hence, giving another opportunity to them to raise their claims after the approval of resolution plan is against the interests of successful resolution applicants. Moreover, it is the duty of resolution professional to maintain an updated list of claims [section 25] and prepare an information memorandum [section 29]. According to Regulation 36 of     Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (the “CIRP Regulations”), this information memorandum is necessarily required to include a list of creditors with the amounts claimed by them. The details of all material litigation or proceedings initiated by the Government and statutory authorities are also required to be mentioned.  Thus, this information memorandum helps the resolution applicants in forming legitimate expectations regarding the assets and liabilities of corporate debtors. If claims are allowed to be raised after the approval of resolution plan, these legitimate expectations will definitely be vitiated.

Also, under regulation 37 of the CIRP Regulations, a resolution applicant can provide for the settlement of debt at a reduced value and extinguish the unsatisfied part of claim. The Code has not expressly provided for the treatment of such unsatisfied claims, but the logic behind such a provision is to maximize the value of corporate debtor’s assets. Therefore, it can be deduced that the legislature seeks to completely extinguish such claims after a resolution plan is approved. Otherwise, even these creditors will come forward to file their claims, which is not the intention of Code.

The “clean slate theory” is also evident from section 32A in the Code which was inserted through the  Insolvency and Bankruptcy Code (Amendment) Act, 2020 and provided that once a resolution plan is approved, a corporate debtor cannot be made liable for any offence committed prior to the commencement of CIRP. Recently, in Manish Kumar v. Union of India, the Supreme Court upheld the constitutionality of this section and emphasized on the need for a successful resolution applicant “to make a clean break with the past and start on a clean slate”.  Thus, the Edelweiss judgment is of immense significance in the light of increasing instances where creditors raised their claims after the approval of a resolution plan. This decision will certainly help in protecting the interest of successful resolution applicants.

Possible Departure from the Judgment

However, the author believes that there are still a few situations which may not fall within the scope of this judgment. For instance, the above observations are made by the Supreme Court by heavily relying on the language of the resolution plan which clearly provided for the extinguishment of all claims outside its scope after the approval. It is still unclear what will happen when the resolution plan itself has not expressly provided for extinguishment of such claims. The scheme of the Code and relevant regulations as explained above are in favor of not accepting these claims even in that situation. But it will be interesting to see how authorities react when such an issue comes up for adjudication. In the meantime, it is important for resolution applicants to take utmost care while drafting their resolution plans and expressly provide for such clauses.

Further, it is important to note that a successful resolution plan is binding only on those entities which are “involved” in the CIRP process [see section 31]. Those creditors who have not received the opportunity to raise claims will certainly not be included here. In terms of regulation 6 of the CIRP Regulations, a notice regarding the initiation of CIRP process must be published where the registered office and principal office of the corporate debtor is situated or where the corporate debtor conducts material business operations. In Electrosteel Steels Limited v. The State of Jharkhand, since the resolution professional had not complied with this requirement, the creditors were deprived from making their claims. Accordingly, the claims raised by such creditors even after the approval of resolution plan were accepted and the resolution plan was held not to be binding on them.  However, the Supreme Court in the Edelweiss judgment quashed and set aside this case on finding that the resolution professional did actually comply with the requirement of publishing notice under regulation 6 of the CIRP Regulations in the prescribed manner.

But, it is quite evident from this case that the success of “clean state theory” depends a lot on the due compliance of certain important responsibilities by the resolution professional.  Some error or negligence on part of resolution professional should not lead to the creation of liabilities on the successful resolution applicants. For this purpose, the author believes it is important to provide for further scrutiny of the role of resolution professional. This could be accomplished by obligating the committee of creditors (“CoC”) under section 30(4) of the Code to countercheck whether the public announcement is made by the resolution professional in the prescribed manner. This would be reasonable because a resolution professional already performs most of his or her functions under the guidance of the CoC [section 28] and is a mere facilitator in the CIRP process. However, it is surprising to note that the resolution professional’s function of publishing a notice under section 15, which is of great importance in calling out the creditors and subsequently determining the financial position of corporate debtor, is not double checked by CoC. That can certainly help in ensuring that all creditors of the corporate debtor are “involved” in the CIRP process, thereby minimizing claims by them after the approval of resolution plan.

Concluding Remarks

It can be said that the Edelweiss judgment is significant in achieving the prime objective of the Code, i.e., the revival of corporate debtors. If the binding effect of resolution plans are affected, this objective will be hard to achieve as it will discourage the resolution applicants to take control of corporate debtors. However, in order to effectively enforce this judgment, it is necessary to deal with above situations which may fall outside its scope.

Aditya Saraswat

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