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October 22, 2019/0 Comments/in Companies Act 2013, Insolvency and Bankruptcy
Code /by Staff Publication
-Sikha Bansal
(resolution@vinodkothari.com)
After Sick Industrial Companies (Special Provisions) Act, 1985 (‘SICA’) was enacted,
it was not possible to invoke the provisions relating to the schemes of
compromise/arrangement for companies under BIFR[1]. However, the Insolvency
and Bankruptcy Code, 2016 (‘Code’) made amendments[2] in section 230 of the
Companies Act, 2013 so as to include a liquidator appointed under the Code as
eligible to propose a scheme under that section. Later, the Insolvency and
Bankruptcy Board of India (Liquidation Process) Regulations, 2016 (‘Regulations’)
were amended[3] to facilitate schemes under section 230 of the Companies Act, 2013.
Given that the company gets a fair chance of resolution under the Code before being
pushed to liquidation, the window for completion of scheme has been provided only
for the initial duration of 90 days from the liquidation order.
As the Code makes references to section 230, for operative provisions, one has to
refer to related provisions of the Companies Act, 2013. There might be
inconsistencies in between the two laws – as to timelines, eligibility as to being a
proposer of scheme, etc. As such, it would be important to harmonise the provisions
under both the laws; consequentially, mechanics of a scheme framed under the Code
read with the Companies Act, 2013 might be slightly different from a scheme framed
only under the Companies Act, 2013.
Also, given that the scheme will have to pass the sanction of the National Company
Law Tribunal (‘NCLT’), the scheme has to adhere to the principles which the
courts/NCLTs had been following while approving/rejecting the scheme.
The expression “liable to be wound up”, at one point of time, was a conundrum as the
court would consider only such company “liable to be wound up” for which winding
up was actually pending. As such, the schemes of arrangement were substitute or
alternative to the winding up or bankruptcy which was actually pending, that is, the
scheme was considered to be an alternative mode of winding up in the sense that it
averts the winding up. See the ruling of P&H High Court in Sm. Bhagwanti v. New
Bank of India Ltd., Amritsar, AIR 1950 EP 111.
Subsequently, the law evolved through rulings like Seksaria Cotton Mills Ltd. v. A.E.
Naik And Ors., 1967 37 Comp Cas 656 Bom, and then Re: Khandelwal Udyog Ltd.,
1977 47 Comp Cas 503 Bom – while in the former case, the court held that the
schemes were possible for all companies except those financially sound; in the latter
case, the court held that the that the expression “liable to be wound up” means all
companies, including a normally functioning company, to which the provisions
relating to winding up apply.
While resolution plan during CIRP, going concern sale in liquidation and schemes of
arrangement are fundamentally intended to save ailing but viable businesses and may
have commonalities (for instance, a merger/demerger, transfer of assets, may be
common methods in all these cases); however these processes differ in mechanics and
effects.
The liquidation
process, in such case,
can take additional
90 days.
Later, in Meghal Homes Pvt. Ltd v. Shree Niwas Girni K.K.Samiti & Ors., (2007) 7
SCC 753, the SC dealt specifically with the interplay between the provisions of
sections 391 to 394A and section 466[6] of the Companies Act, 1956 with respect to a
company in liquidation, and acknowledged not-so-exhaustive application of Mihir H.
Mafatlal (supra) to companies in liquidation, and held –
“22. When a Company is ordered to be wound up, the assets of it, are put in
possession of the Official Liquidator. The assets become custodia legis. The follow up,
in the absence of a revival of the Company, is the realization of the assets of the
company by the Official Liquidator and distribution of the proceeds to the creditors,
workers, and contributories of the company ultimately resulting in the death of the
company by an order under Section 481 of the Act, being passed. But, nothing stands
in the way of the Company Court, before the ultimate step is taken or before the
assets are disposed of, to accept a scheme or proposal for revival of the Company. In
that context, the Court has necessarily to see whether the Scheme
contemplates revival of the business of the company, makes provisions
for paying off creditors or for satisfying their claims as agreed to by
them and for meeting the liability of the workers in terms of Section
529 and Section 529A of the Act. Of course, the Court has to see to the
bona fides of the scheme and to ensure that what is put forward is not a
ruse to dispose of the assets of the Company in liquidation.
. . . We are therefore satisfied that the Company Court was bound to consider
whether the liquidation was liable to be stayed for a period or
permanently while adverting to the question whether the scheme is one
for revival of the company or that part of the business of the company
which it is permissible to revive under the relevant laws or whether it is
a ruse to dispose of the assets of the company by a private arrangement.
If it comes to the latter conclusion, then it is the duty of the court in which the
properties are vested on liquidation, to dispose of the properties, realize the assets
and distribute the same in accordance with law.”
Similar observations have been made, even before the SC ruling in Meghal Homes
(supra), by High Courts. For instance, see Kashinath Dikshit And Anr. v. Surgicals
and Pharmaceuticals, ILR 2002 KAR 5191, wherein Karnataka HC rejected a
scheme for want of bona fides as the shareholder coming forth was “only an
intermediary in assisting the second petitioner to purchase the assets of the company
in liquidation”. It was the noted “before a scheme of arrangement is sanctioned, the
Court has to satisfy itself whether the compromise or the scheme of arrangement is
real compromise or arrangement for revival of the company in liquidation in
the interest of the members and its creditors”. The second petitioner, that is the
propounder of the scheme was neither member nor a creditor of the company. He
had no interest in the affairs of the company, and had only intended to purchase
the assets and liabilities of the company in liquidation by filing an
application styled as a scheme of arrangement. See also, K. Sudhakar Gupta
v. Electro Thermics (Pvt) Limited, 2004 122 CompCas 625 AP.
(i) whether the direct object of the scheme is revival of the business of the company
and the scheme is in the best interests of the members and creditors;
(ii) whether the statutory provisions have been complied with or not;
(iv) whether the arrangement is such that a man of business would reasonable
approve;
(v) whether the scheme is fair and reasonable and based on correct information as to
the company;
(vi) whether the object of the scheme is bona fide and there is no malicious intent
involved, for instance, covering up of the misdeeds of the directors, making a back
door attempt at buying the assets through the scheme, etc.
Also note that in case of schemes, the requirement is ‘class consent’ and thus, the
approach is inclusive as opposed to corporate insolvency resolution process where
decision-making is with financial creditors only.
The view finds support in a Singapore ruling, Hitachi Plant Engineering &
Construction Co Ltd and Another v Eltraco International Pte Ltd and Another,
[2003] SGCA 38 which includes extensive discussions on how a scheme of
arrangement and liquidation are fundamentally different, and that a scheme of
arrangement is nothing more than a contractual arrangement between the company
and its creditors to arrive at a compromise arrangement which satisfactory to the
parties. In the case, the Singapore Court took a pragmatic approach as follows –
“81 Further, one has to remember that a scheme of arrangement is a corporate rescue
mechanism. As with other corporate rescue mechanisms, such as judicial
management, it seeks to rehabilitate the company and achieve a better realisation of
assets than possible on liquidation: see, generally, Woon, Company Law, (2 ed, 1997)
at p 627 and Chapter 17. Such a rescue mechanism may need, in order to be effective,
to discriminate amongst creditors for example by repaying bigger creditors
proportionately less than small creditors are repaid. Dictating that the assets should
be distributed in a pari passu manner would not only decrease the flexibility now
available to planners of schemes but it may also put a dampener on what the
scheme of arrangement could achieve and spell the death knell of the company
prematurely.” [emphasis supplied].
The Singapore Court relied on English rulings like Re Bank of Credit and Commerce
International SA (No 3) [1993] BCLC 1490, and Re Anglo American Insurance Ltd
[2001] BCLC 755, and observed that the courts have sanctioned schemes of
arrangement which potentially infringe the pari passu rule even in instances where
the company is insolvent or is facing liquidation. Looking for a rationale to apply or
not to apply ‘pari passu’ principle in schemes, the Singapore Court stated,
“86. It seems to us that whether the pari passu principle should apply outside
liquidation really depends on whether the creditors to be affected by a proposed
scheme of arrangement require the additional protection of this principle. Our view is
that they do not. The statutory regime already sufficiently safeguards the interests of
such creditors . . . every creditor is entitled to challenge the scheme before the courts
and to point out why it should not be sanctioned. Such objections can be based on the
failure of the scheme to embody the pari passu principle or be made for other
reasons. Where the objection is that the scheme does not provide for pari passu
distribution, the court will be able to decide whether in the particular circumstances,
this objection is an insuperable barrier to implementation of the scheme. The
statutory regime therefore enables each case to be considered on its own particular
facts and this is a far better approach than the rigid application of the pari passu
rule would be.”
One of the additional challenges for schemes proposed for companies in insolvent
winding up is to reconcile the conflicting provisions of section 29A of the Code and
section 230 of the Companies Act, 2013.
A member proposing a scheme under section 230 may be disqualified, most possibly
in clause (c) of section 29A, to be a resolution applicant or to purchase the assets of a
company in liquidation. Notably, the SC has upheld the validity of section 29A; as
such allowing an ineligible person to propose a scheme under section 230 would go
on to violate section 29A of the Code.
Another view is that there is no equivalent of section 29A with respect to section 230
of the Companies Act, 2013. Further, the scheme would need approval of each class of
creditors (unlike resolution plans) as well as shareholders. Hence, the scheme will not
be hit by section 29A.
At present, there is a lack of clarity as to how the two provisions will be reconciled.
Anyway, the NCLT, following the principles above, will have to see through the intent
and purpose of the scheme to prevent abuse of the scheme by the promoters to make
a back-gate entry or to delay or obstruct liquidation proceedings.
In State Bank of India v. Alstom Power Boilers Ltd., 2003 116 CompCas 1 Bom, the
Bombay HC laid down factors which would generally be taken into consideration by
the court in identifying ‘class’ (see para 20). Several UK rulings include extensive
discussions on the scope of the word “class”[8].
Following the principle as above, in case of a scheme under the Code, the following
classes (of creditors/members) may be identified keeping parity with section 53 – (a)
secured creditors (financial/operational), (b) workmen, (c) employees, (d) unsecured
financial creditors, (e) statutory creditors, (f) other creditors, (g) preference
shareholders, (h) equity shareholders. Alternatively, the classes as identified for the
purpose of stakeholders’ consultation committee should be sufficient, namely, (i)
secured creditors who have relinquished security interest, (ii) unsecured financial
creditors, (iii) workmen and employees, (iv) government creditors, (v) operational
creditors (other than workmen/employees/government), and (vi) shareholders.
There is nothing in the law providing for moratorium on creditor action, etc. (akin to
section 14/33 of the Code) for the period during which the schemes are formulated,
discussed, put to meetings, tabled before the NCLT and then implemented[9].
Given the wide-ranging powers of NCLT[10], it is opined that NCLT may impose
moratorium during formulation and till approval of the scheme, while the
implementation stage will be guided broadly by the scheme itself. Besides, NCLT shall
have power to supervise the implementation of the scheme – section 231(1).
In terms of section 231 of the Companies Act, 2013, if the scheme fails, the NCLT may
make an order for winding up the company and such an order shall be deemed
to be an order made under section 273[11]. The Code is silent on this.
Regulation 2B of the Liquidation Regulations says that the time taken on
compromise/arrangement, not exceeding 90 days, shall not be included in the
liquidation period but does not provide for contingencies where the scheme fails
during the implementation phase.
9. POWERS OF NCLT
While adjudicating on the scheme, the NCLT will be exercising powers both under the
Companies Act, 2013 as well as the Code. The NCLT will have powers to supervise the
implementation of the compromise or arrangement, and it may give directions in
regard to any matter or make such modifications in the compromise or arrangement
as it may consider necessary for the proper implementation of the compromise or
arrangement.
[1] The Supreme Court (SC) in Tata Motors Ltd. v. Pharmaceutical Products of India
Ltd, 2003 (7) SCC 619, held that SICA is a special statute and a self-contained code,
due to which its provisions will prevail over the provisions of the Companies Act, 1956
and that it was not possible to harmonise the provisions of sections 391 to 394 of the
latter with schemes of arrangement with the provisions of SICA.
[2] Reference, clause 6A of the Eleventh Schedule to the Code. Notably, para 6A was
not included in the draft proposed by the Bankruptcy Law Review Committee;
however was inserted pursuant to observations of the Joint Parliamentary Committee
(JPC). JPC inserted the clause as ‘drafting improvement’, and no further explanation
has been provided in JPC’s report for the same.
[3] Regulation 2B, inserted vide Insolvency and Bankruptcy Board of India
(Liquidation Process) (Amendment) Regulations, 2019; Notification No.
IBBI/2019-20/GN/REG047 dated 25.07.2019
[5] The language of regulation 2B of the IBBI (Liquidation Process) Regulations, 2016
suggests that the compromise/arrangement shall be completed within 90 days of
the order of liquidation. As such, there is nothing which debars a proposer to come
forward with a scheme before the liquidation order is passed. It might be thus,
possible that a scheme of arrangement can be proposed during the resolution period
too. In that case, while the scheme would need a supermajority approval, the
withdrawal of insolvency proceedings will need approval of 90% of the CoC.
http://vinodkothari.com/wp-content/uploads/2017/02
/Guide_to_Liquidation_Valuation_for_Insolvency_Resolution_under_the_Code.pdf
[8] In the context of the question “with whom is the compromise or arrangement is
made”, the answer will depend upon the analysis of – (i) the rights which are to be
released or varied under the scheme, and (ii) the new rights (if any) which the scheme
gives, by way of compromise or arrangement, to those whose rights are to be released
or varied. See Re Hawk Insurance Company Ltd. [2001]2 BCLC 480. The Court
relied on the test formulated in Sovereign Life Assurance Company v. Dodd [1892] 2
QB 573 that a class “must be confined to those persons whose rights are not so
dissimilar as to make it impossible for them to consult together with a view to their
common interest” and held that the test be applied in the light of the analysis above,
and that it is also important to ensure that those whose rights are sufficiently similar
to the rights of others that they can properly consult together should be required to
do so. See also, In Re Sovereign Marine & General Insurance Company Ltd. & Ors.
[2006] EWHC 1335 (Ch).
[9] In Singapore, there are provisions empowering the court to restrain proceedings
where no winding up order has been passed, and enhanced moratorium provisions
have been included, according to which where a company proposes, or intends to
propose, a scheme of arrangement, the court may, on the application of the scheme
company, grant a moratorium order. Such an application, however, can only be made
where no order has been made and no resolution has been passed for the winding up
of the company. The moratorium is broad and it may restrain winding up resolutions,
legal proceedings against the company, execution against property, etc. Notably,
moratorium orders may also be granted with respect to a holding or subsidiary of the
subject company, where necessary conditions exist.
[10] The NCLAT in NUI Pulp and Paper Industries Pvt Ltd v Roxcel Trading GmbH,
Company Appeal (AT) (Insolvency) No 664 of 2019, held that NCLT has inherent
powers under Rule 11 of the National Company Law Tribunal Rules 2016 to make
such orders as may be necessary for meeting the ends of justice or to prevent abuse of
the process of the Tribunal. The order pertained to pre-CIRP moratorium once an
application for CIRP is filed.
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