[Paras Khetan is a 3rd year BA.LLB (Hons.) student at the National Law School of India University in Bangalore]
Recently, the National Company Law Appellate Tribunal (NCLAT) in Vijay Saini v. Devender Singh had the opportunity to interpret section 25A(3A) of the Insolvency and Bankruptcy Code, 2016 (IBC) in the context of a withdrawal application under section 12A of IBC. The NCLAT applied different voting mechanisms for authorised representatives representing the homebuyers in case of a section 12A application as opposed to other applications under section 28 of the IBC.
While the NCLAT correctly applied section 25A(3A) based on a textualist interpretation, this post seeks to critique section 25A(3A) itself for providing a different voting mechanism for different applications for authorised representatives. It would do so by, first, highlighting the inconsistency in the voting mechanism for authorised representatives and, second, arguing for the need for a uniform individualised voting mechanism for the authorised representatives before finally concluding the post.
Inconsistency in the Voting Mechanism for Authorised Representatives
The appointment of an “authorised representative” is necessary where a “class of creditors” includes at least 10 members. Section 25A(3A) of the IBC mandates that the authorised representative must vote in accordance with the decision taken by more than 50% of the voting share of the financial creditors he represents. The NCLAT in Vijay Sainihas clarified that this decision would be deemed to have been taken on behalf of the entire “class of creditors” (i.e. 100% of the class) that the authorised representative represents. On the other hand, the proviso to section 25A(3A) mandates that in case of an application under section 12A, the authorised representative must vote in accordance with section 25A(3), which mandates that the voting has to be done in accordance with the voting share of each financial creditor individually. This has been clarified in Vijay Saini.
It would be useful to illustrate this disparate voting mechanisms with a hypothetical factual matrix. Let us assume a committee of creditors (CoC) has two members – an authorised representative of homebuyers with 90% of the voting share and a bank with 10% voting share. Further, 51% of the homebuyers have voted in favour of the concerned application and the bank has voted against the application. Now, if the application relates to approval of the resolution plan, then according to section 25A(3A), the resolution plan would be approved as 90% of the CoC is deemed to be considered to have approved the resolution plan. However, if the application relates to withdrawal under section 12A, then the same would not be deemed to be approved (despite achieving the threshold of 90%) as only 45% of the CoC (i.e. 51% of 90%) would be deemed to have voted in favour of the application in terms of the proviso to section 25A(3A).
This indicates an inherent arbitrariness in the voting mechanism for authorised representatives, which can have important ramifications for the approval or non-approval of resolution plans and section 12A applications. This is evidenced by the judgment in Vijay Saini where the different voting mechanism for a section 12A application led to the non-approval of the same, which would have otherwise witnessed a different outcome.
The constitutionality of sections 25A and 25A(3A) has been upheld in Pioneer Urban and Manish Kumar respectively. However, the differences in the voting mechanisms under section 25A(3A) for section 12A applications and for other applications was never challenged in Manish Kumar. Therefore, this leaves section 25A(3A) open to a constitutional challenge under Article 14 of the Constitution of India. A possible rationale for the different voting mechanism in case of a section 12A application has been hinted in Vijay Saini. Apart from the textualist interpretation of section 25A(3A), the NCLAT also emphasizes that the separate mechanism is in furtherance of the rigorous threshold of 90% voting share, as the proviso makes it difficult to achieve the requisite 90% threshold. However, this high threshold under section 12A cannot be used to treat a “class of creditors” differently for different purposes.
Need for Uniform Individualised Voting for Homebuyers
The disparity in the voting mechanisms for authorised representatives necessitates an enquiry into the desirability of the same. This is particularly important in the case of homebuyers who are necessarily mandated to appoint an authorised representative. This post argues for the need for a uniform voting mechanism wherein the authorised representatives vote based on the individual voting share of the creditors as opposed to voting based on the majority of the class of creditors.
The rationale behind the insertion of section 25A(3A), i.e. voting based on the majority of the class of the creditors, is to “facilitate decision making in the committee of creditors, especially when financial creditors are large and heterogeneous group”. This heterogeneity of interest has been the primary basis for upholding the constitutionality of this provision in Pioneer Urban and Manish Kumar. However, the Supreme Court has never explained what constitutes the heterogenous interest of the homebuyers that may force them to vote differently when compared to other financial creditors. To the contrary, the Supreme Court (see Pioneer Urban) as well as the legislature (see para 4.7 of Report of the Insolvency Law Committee) have held that the common interest of homebuyers (just like that of financial creditors) is in the financial health of the corporate debtor. Further, the fact that the above provisions do not apply in case the homebuyers are less than 10 in number indicates that the legislature is primarily concerned with the large number of the homebuyers as opposed to their heterogenous interests. Therefore, there is no rationale for diluting the voting power of the homebuyers to that of a class as opposed to their individual voting share. The disparate voting mechanism is also against the UNCITRAL Legislative Guide on Insolvency Law (UNCITRAL Guide).
The requirement that the authorised representative must vote based on the majority of the class of creditors has led to unfavourable implications for homebuyers. First, it has led to a dilution of their individual voting power. A 51% majority of the homebuyers can bind the 49% minority of the homebuyers to any application tabled before them. This is in stark contrast to the general rule that only a 66% majority of the CoC can bind the rest 34% minority under section 28(3) of IBC. This disempowers the homebuyers and goes against the general trend of empowering homebuyers by the legislature.
Second, the most severe implication of this voting mechanism is that the dissenting homebuyers are not considered as dissenting financial creditors. The Supreme Court in Jaypee Kensington used the voting mechanism in section 25A(3A) to hold that the dissenting homebuyers cannot be considered as dissenting financial creditors, as the authorised representative votes for the entire class as a whole. Section 30(2)(b) provides that the dissenting financial creditors have the right to a minimum liquidation value under section 53 and are to be paid in priority under regulation 38(1) of the CIRP Regulations. This has been further interpreted in Jaypee Kensington to include a right to direct payment by cash or a right to enforcement of security interest (if there is any). These essential rights of dissenting financial creditors would not be available to the homebuyers due to the different voting mechanisms for them. This would also be violative of the UNCITRAL Guide. Further, the Court in Jaypee Kensington stretched the “class-based” voting mechanism for homebuyers to deny dissenting homebuyers of a right to appeal against the approval of the resolution plan. This again has serious ramifications for the rights of homebuyers as they are deprived of any recourse against the approved resolution plan.
Therefore, the different voting mechanisms have been used by the Court in Jaypee Kensington to deny dissenting homebuyers substantive rights that are otherwise available to dissenting financial creditors. Even though Jaypee Kensington’s correctness has been recently doubted in DBS Bank Ltd, the ratio regarding dissenting homebuyers not forming dissenting financial creditors has not been challenged. Further, regarding the rights of dissenting financial creditors which has been challenged, the rights relating to minimum liquidation value and priority over payment cannot be challenged as they are statutorily guaranteed.
Thus, there is a need to do away with the “class-based” voting for homebuyers and instead use a uniform individualised voting mechanism. This is particularly important since homebuyers are unsecured creditors and fall relatively low in the waterfall mechanism under section 53.
Conclusion
This post has highlighted the disparate voting mechanisms for different applications in the case of authorised representatives. It has argued for a uniform voting mechanism that is based on the individual voting share of the creditor as opposed to a majority of the “class of creditors”. The latter has immense negative consequences for homebuyers in terms of dilution of their voting share as well as depriving them of the benefits of dissenting financial creditors. The legislature needs to amend the relevant provisions to ensure that the above is rectified and homebuyers’ interests are adequately protected.
– Paras Khetan