Fallacy in Extending Section 29A of IBC to Liquidation

[Amay Bahri is a final year student at National Law University, Delhi]

Section 29A of the Insolvency and Bankruptcy Code, 2016 (“IBC”) is one of the most contentious and debated provisions under the legislation. It creates a statutory bar on certain persons (being promoters or management of corporate debtors) as well as persons connected to, related to, and working jointly with such persons from submitting a resolution plan or acquiring assets of the corporate debtor (“CD”). This provision was not originally present in the IBC, but due to increased instances where the management of the CD would bid and regain control of the CD after insolvency process, the legislature introduced this provision to prevent promoters and management from getting back the ownership of CD. Observing the enormous influence and similarity of US and UK Insolvency Laws with that of the IBC, the provision marks a drastic shift by adopting an automatic disqualification of certain persons from the insolvency process. None of the Insolvency Laws under any jurisdiction across the globe, including US and UK, provides for such a de facto disqualification.

Due to the dynamic nature of the provision, it was expected that the provision will evolve and the legislature will have to continually amend the provision; however that has not been the case. Section 35 of the IBC applies the bar under section 29A to the liquidation procedure. This piece will analyse the concerns arising from this extension under section 35(1)(f), and will also highlight how the pandemic has further necessitated a change in the status quo.

Concerns from Extension of Disqualification

Explanation to section 35(1)(f) of the IBC provides that the liquidator shall not sell any asset of the corporate debtor to anyone who is ineligible to present resolution plan. This ineligibility also extends to compromise under section 230 of the Companies Act 2013, and sale as a going concern under IBC; thereby closing all routes for the promoters of the corporate debtor to be involved in the resolution of the corporate debtor. The author argues that this extension of disqualification under section 29A to liquidation by sale of individual assets is inconsistent with the intention and scheme of the IBC, and has no nexus with the objective of section 29A.

Intention and Scheme of the IBC

It is often argued that the primary aim of the IBC is to promote resolution and entrepreneurship, and not merely to get maximum value for creditors. Further, there are numerous Supreme Court decisions that have clarified that revival of the CD is the primary aim of the IBC. It is correct that the intention of the IBC is to promote resolution and revival of the CD, and not merely to get higher returns to the creditors; however, the objective of the IBC changes once the resolution process has failed and the company reaches the stage of liquidation by sale of individual assets. At this stage, it is clear that there is no way for the company to continue as a going concern and that the death of the CD is inevitable. Hence, the aim shifts to providing the creditors and the stakeholders the maximum value possible. Once the scope of restoration or resolution is dead, then the only interest is that of the creditors who wish to recover as much amount that they can; however, barring people from participating in liquidation reduces the chances of getting higher value.

No nexus to situation envisioned under 29A

Section 29A was introduced in the IBC to prevent the promoters and the management, who led to failure of the CD, from regaining control over the CD. Extending the bar to the scheme of compromise under the Companies Act and sale as going concern is still in consonance with the intention behind introducing section 29A because such arrangements result in revival and continuance of the CD. However, there is no nexus in extending the disqualification to stage of liquidation by sale of individual asset.

Liquidation by individual sale is the final stage in the insolvency process and marks the death of the CD. It signifies that there is no future for the business as a going concern and the most effective alternative is to sell whatever can be sold to recover the most amount of money. This is very different from resolution under IBC, scheme of arrangement under the Companies Act, and sale as a going concern because the resolution or arrangement allows the CD to continue as going concern; however, liquidation by selling of individual assets does not. At this stage it is not possible for the CD to be sold as a complete entity; hence there is no possibility of promoters of CD gaining back control of the CD. Thus, the extension of disqualification under section 29A to the liquidation stage is inconsistent with the objective of the IBC and the 2017 amendment that introduced section 29A.

Relaxations because of the Pandemic

Apart from the general policy concerns around the application of disqualification under section 29A to the liquidation by sale of individual assets, the pandemic has necessitated relaxing the disqualification during the liquidation process. The COVID-19 pandemic has brought numerous challenges for business, with many small businesses being in a comparatively greater stress. Government sensing this plight of small businesses introduced a pre-pack insolvency mechanism for micro-small and medium enterprises (which relaxes the disqualification under section 29A) so that these enterprises can restructure and move forward. Over the course of the pandemic, the number of liquidations has also increased. The IBBI quarterly newsletters of Oct-Dec 2020 and Jan-March 2021 highlight that the number of liquidation cases are almost thrice that of resolution. Further, the newsletters also show that less than 5% of total liquidation cases are resolved through compromise or sale as a going concern. Hence, the majority of the cases under the IBC end up being liquidated by sale of individual assets. At this stage where there is no chance for revival of the company, the focus of the process is to be on value maximisation of assets. Section 29A being a dynamic provision has to change with the prevailing situation. Due to the effects of the pandemic the number of liquidations by sale of individual assets has gone up. In such a situation applying 29A to the liquidation process is further depleting the value that creditors can get from liquidation of CD. Hence, in light of the effects of COVID-19, certain relaxation on applying section 29A to liquidation process is necessary.

Conclusion

The explanation to section 35(1)(f) of the IBC provides that the persons barred under section 29A cannot  participate in the liquidation procedure. Once a CD reaches the stage of liquidation by sale of individual assets, there is no hope for restructuring or resolution of the company and it is clear that the company will not continue as a going concern. The IBC’s primary goal was to ensure that the company continues as a going concern. However, once it is clear that it will be liquidated, the primary aim then becomes getting as much value as possible from the liquidation process. Extending the bar under section 29A to the liquidation process thus contradicts the value maximization objective of the IBC, and runs against the intention behind section 29A. The application of this provision becomes all the more absurd in the current situation of pandemic where businesses are facing insolvency due to the drastic effects of the pandemic. The ability of other businesses to participate in the resolution process has also decreased, leading to a fewer applicants willing to participate in the insolvency process. In this backdrop, disqualifying promoters (who arguably have the most skin in the business) because of something that is beyond their control would be unjust, disproportional, and against the intent of section 29A itself.

– Amay Bahri