Commercial Wisdom of the Committee of Creditors: An End to Excessive Deference?

[Mathanki Narayanan is a 4th year B.A. L.L.B. (Hons.) student at Jindal Global Law School]

The conceptualization of the Insolvency and Bankruptcy Code, 2016 (IBC) was underpinned by the need to preserve economic value through expediency. However, its implementation has revealed asymmetries of power amongst the creditors. The Committee of Creditors (CoC) spearheads the Corporate Insolvency Resolution Process (CIRP), effectively taking over the reins from the erstwhile Board of Directors of the debtor-company. Comprised entirely of financial creditors, the CoC’s decisions in respect of the fate of the corporate debtor have consistently been upheld by Adjudicating Authorities in the guise of upholding its “commercial wisdom”. This post attempts to briefly examine the growth of this deference and scope for change in light of the recent judgment in the case of M.K. Rajagopalan v. Dr. Periasamy Palani Gounder.

Tasked with the responsibility of helping the corporate debtor get back on its feet, the CoC may either seek profitable resolutions from the market (with or without a haircut on claims of any or all of the stakeholders) or, as a last resort, proceed with liquidation. The decision as to whether or not the corporate debtor is to be eased back into business or liquidated is left to the COC- as a fundamentally “business” decision. There is little doubt that upholding commercial wisdom will hasten the CIRP/liquidation process. However, the question to be asked here is- at what cost?

The CoC comprises only financial creditors; operational creditors are consequently relegated to a position that leaves them ill-equipped to claim their dues or even adequately participate in the processes which might otherwise allow them to do so. Although the Supreme Court (SC) in Essar Steel India v. Satish Kumar Gupta emphasized that the CoC must account for the interests of all stakeholders while finalizing a resolution plan, the absence of any concrete delimitation of the CoC’s powers puts those classes of creditors who are not part of the CoC at a disadvantage. The increasing prevalence and magnitude of haircuts (albeit an improvement from pre-IBC days) could lead to more difficulties for creditors, particularly operational creditors. For instance, in the insolvency proceedings of Videocon Industries Ltd., the claims of the secured financial creditors took a haircut of approximately 96%, while the claims of operational creditors took a haircut of around 99%. Furthermore, because the IBC is a relatively new legislation, judicial interpretation and innovation play an important role. In this context, judicial deference in the form of an unquestioning commitment towards upholding the commercial wisdom of the CoC is dangerous not just vis-à-vis the corporate debtor itself but also in terms of its implications for the wider economy.

An array of judgements, from K Sashidhar v. Indian Overseas Bank to Gail India v. Ajay Joshi, have consistently upheld the substantial powers bestowed upon the CoC. Although it can be said that judicial scrutiny inhibits the unbridled use of these powers, the fact remains that there is not much in the way of a comprehensive judicial review to hold the CoC accountable for its oversight. The case of Kalpraj Dharamshi v. Kotak Investment Advisors is particularly important in this regard, as it addressed the issue of conflict between the CoC and the Adjudicating Authority vis-à-vis approval of resolution plans. The SC stated that such commercial wisdom is not to be interfered with except in accordance with the grounds delineated in sections 30 and 61 of the IBC. According to these sections, a resolution plan may be challenged for contravening any law, not conforming to the Board’s requirements, having material irregularity in the exercise of the resolution professional’s powers, etc. The SC also upheld the primacy of the CoC, stating that it is the best judge of the feasibility of a resolution plan by virtue of its commercial wisdom. On 3 June 2023, the SC even approved a 93.5% haircut in the settlement amount by quashing the NCLAT’s order for liquidation in the case of Vallal Rck v. Siva Industries and Holdings.

However, the SC has taken a small but encouraging step in the right direction by limiting the freedom of the CoC in Rajagopalan. Since the submission of the resolution plan was in contravention of Section 88 of the Indian Trusts Act, the SC held unequivocally that the commercial wisdom of the CoC should not be “over-expanded to brush aside a significant shortcoming in the decision making of CoC when it had not duly taken note of the operation of any provision of law for the time being in force.” In this case, the commercial wisdom of the CoC was questioned with respect to multiple aspects of the insolvency process (such as the ineligibility of the resolution applicant, as well as the failure to place the resolution plan before the CoC). However, the Court held the CoC accountable in a very constrained manner. While factors such as the ineligibility of the Resolution Plan (given its contravention of Section 88) did not necessarily form part of the CoC’s consideration, the SC also held that the status of the CoC would not be a sufficient reason to ignore such shortcomings. Furthermore, commercial wisdom is accorded a status of primacy in the CIRP- subject to the condition that every aspect of the Resolution Plan is made available for the CoC’s deliberation.  Given that the IBC itself has been designed in such a way that the claims of financial creditors take precedence over the claims of operational creditors, the limited grounds for challenging commercial wisdom as enshrined in Sections 30 and 61 are woefully inadequate to do anything beyond curbing obvious excesses of power and ensuring legal compliance.

Perhaps this form of excessive reliance on the CoC’s decision will fulfill- in a myopic sense- the goals of the IBC, i.e., speedy resolution of insolvency. But as time passes, careful heed must be paid to how the IBC truly commits to collective involvement and equal rights of all creditors. The SC, instead of enumerating a broader framework to challenge the liberties of the CoC, has effectively upheld its commercial wisdom yet again, but this time with the important caveat that it cannot be used as an excuse to turn a blind eye to its shortcomings. Commercial wisdom is affirmed subject to the fulfillment of certain conditions, such as thorough consideration of the final resolution plan, the availability of relevant information, and so on. Therefore, despite this judgment marking a turn in the trend of simply relying on the CoC, it is limited. This post argues that the actions of the CoC must be evaluated against a standard laid down in a comprehensive code of ethics and not merely the limited grounds mentioned in the IBC itself. While the IBBI has acknowledged the need for formulating a draft Code of Conduct, authorities would be well-advised to bear in mind the economic and legal implications of granting unrestrained powers to the CoC. It also remains to be seen whether this judgement will inspire a judicial trend of decreasing deference to the commercial wisdom of the CoC.

Mathanki Narayanan

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  • Do not agree with your argument. You acknowledge that IBC was designed in such a way as to give primacy to financial creditors. So, let them take primacy! “Commercial wisdom” — might be hard to detect in some cases, but I would rather the CoC is let alone, rather than crooked promoters and other vested interests questioning the deference of the courts to CoC, thereby creating an opening for endless litigation. IBC would then become as sick as the erstwhile SICA.

    • The Preamble of the IBC clearly states that it was enacted to promote the maximization of asset value through insolvency resolution, while balancing “the interests of all the stakeholders.” Your concerns regarding unwarranted interference with the mechanisms of the IBC are legitimate; however, it is also important to pay heed to the manner in which the goals of the IBC are achieved. The primacy accorded to financial creditors is essentially a means to an end- if these means are not reflective of an equitable balancing of interests, then the question of sustainability arises. Furthermore, I am not arguing that commercial wisdom is unnecessary- I am merely trying to demonstrate that this principle should not be wrongfully invoked to sidestep the interests of operational creditors. In this light, a carefully drafted code of ethics will promote equitable treatment of all creditors, while also preventing (like you pointed out) the IBC from becoming as sick as its predecessors.

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