Resurrecting the Dead- A discussion around schemes of arrangement in liquidation

-Sikha Bansal

(resolution@vinodkothari.com)

In India, the provisions for schemes of compromises/arrangements have formed a part of the Indian Companies Act, 1913 and then the successors – the Companies Act, 1956/2013 following the English law.

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 article discusses the aspects as follows.

1. SCHEMES AS ALTERNATIVE TO WINDING UP

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.

Notwithstanding, the concept of schemes of arrangement was originally designed as a way-out for companies already in winding up or at the brink of winding up. Schemes of arrangement have been sanctioned and winding up has been stayed/cancelled in a number of rulings for the purpose of revival of the company – Vasant Investment Corporation v. Official Liquidator, Colaba Land and Mill Co. Ltd., 1981 51 Comp Cas 20 Bom, Miss Richa Jain v. Registrar Of Companies and Ors., 1990 69 Comp Cas 248 Raj, Shree Niwas Girni Kamgar Kruti v. Rangnath Basudev Somani, 2005 127 Comp Cas 752 Bom, Dinesh Kapadia v. Silk Mill Workers Union[4], etc.

2. HOW ARE SCHEMES, IN ESSENCE, DIFFERENT FROM GOING CONCERN SALE AND RESOLUTION PLAN?

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.

A point-wise comparative, as is understood in general sense, is drawn below.

S. No. Points of comparison Resolution plan Going Concern Sale (GCS)

 

Schemes of arrangement
1. Stage

 

During CIRP During liquidation Anytime[5].
2. Who proposes?

 

Resolution applicant Liquidator, in consultation with stakeholders’ consultation committee

 

Member/creditor/liquidator
3. Creditor involvement Only financial creditors in CoC – therefore, single class dominance. Where the CoC recommends while deciding to liquidate the corporate debtor; the liquidator shall endeavour to make a GCS.

 

Class-wise consensus required – hence, no particular creditor class dominates.
4. Shareholder involvement None. The plan is binding on the shareholders though. None. Shareholders are merely stakeholders, entitled to distribution in accordance with section 53.

 

Members are eligible to propose a scheme. Members’ sanction is also required for sanctioning the scheme. Here, the AA may examine interplay of the provisions with section 29A of the Code.

 

5. Who facilitates the process? Resolution professional Liquidator Will depend. AA may direct the liquidator to oversee and supervise.

 

6. What happens to the management of corporate debtor?

 

The board of directors remains in animated suspension – the powers cease and get vested with resolution professional.

 

In general, GCS may or may not provide for reorganisation of management.  However, in liquidation, the officers/employees cease to be so once the liquidation order is passed. Though, the liquidator can retain employees to the extent required for beneficial liquidation.

 

In general, schemes of arrangement may or may not provide for reorganisation of management.  However, in liquidation, the officers/employees cease to be so once the liquidation order is passed. Though, the liquidator can retain employees to the extent required for beneficial liquidation.

 

7. Priorities of creditors Principles of section 53 applicable to the amount distributed under resolution plan.

 

Section 53. To be fair and equitable; application of section 53 is neither mandatory nor may yield desired results – see discussion below.
8. Binding nature Provided under section 31 of the Code. This is a mode of sale prescribed under Regulations, and not a contract sanctioned by AA.

 

Provided under section 230(6) of the Companies Act, 2013
9. Timelines 270 days (including extension), 330 days (including litigation) Where the liquidator is unable to sell on going concern basis, within 90 days from the liquidation commencement date, he may proceed to sell the asset in any other manner under the Regulations.

The liquidation process, in such case, can take additional 90 days.

 

To be completed within 90 days of the order of liquidation. The period of 90 days is not to be included in the liquidation period.

3. PRINCIPLES FOR SANCTIONING SCHEMES FOR A COMPANY IN LIQUIDATION

The law under section 230 of the Companies Act, 2013 or that under the predecessor do not explicitly deal with the principles which the court should follow in sanctioning a tabled scheme.  The principles, however, have evolved over time by judicial interpretations and perspectives.

In Miheer H. Mafatlal v. Mafatlal Industries Ltd., (1997) 1 SCC 579, the SC propounded fundamental parameters for sanctioning a scheme, though not specific to a company in liquidation; not being discussed here for the sake of brevity.  Once the broad parameters are met, the Court will have no further jurisdiction to sit in appeal over the commercial wisdom of the majority even if in the view of the Court there can be a better scheme for the company and its members or creditors for whom the scheme is framed. The Court has only supervisory jurisdiction over the scheme and not appellate jurisdiction.

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.

Similarly, in Rajeev S Mardia v. Official Liquidator of Mardia Steel Ltd. (in Liquidation), the Gujarat HC remarked, “It is important to bear in mind that today in the guise of sponsoring Revival Scheme, many promoters seek possession of the assets. Revival Scheme is an alternative to winding up. It is welcome. However Courts have to be circumspect. They must check the financial viability of the sponsor to revive.”

The courts have also drawn a distinction between revival of corporate existence and revival of business activity. While an order of stay on winding up would necessarily result in the revival of the corporate existence, the same, by itself, is not sufficient for the exercise of discretion by the courts to order such stay. See, Meghal Homes (supra) and Forbes & Company Ltd. & Anr v. The Official Liquidator of the Hon’ble Bombay High Court & Anr.

Therefore, as can be seen, while considering schemes with respect to a company in liquidation, the courts have gone into the following aspects –

(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;

(iii) whether the class(es) have been fairly represented 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.

The courts have also provided for purchase of minority/dissenting shareholding by the majority shareholders. See Vasant Investment Corporation (supra).

4.   APPLICABILITY OF SECTION 53 IN SCHEMES

Besides, another interesting question would be the question as to priorities, as to whether section 53 would apply and the vertical comparison approach[7] shall be followed in schemes of arrangement. While the resolution plan shall follow vertical comparison approach, as explicit from the provisions of section 30 of the Code, the law does not call for application of section 53 on schemes of arrangement.

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.

Practically, no creditor/member will vote in favour of a proposal which puts them in a situation worse than in liquidation; however, where it is in the best interests of the company for its revival and the same is commercially viable, the priority accorded to a particular class, with the majority consent of that class, may be curtailed. Hence, it may be opined that the priorities under section 53 are not strictly applicable to schemes of arrangement.

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.”

5.   RECONCILIATION BETWEEN SECTION 29A AND SECTION 230

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.

6.   IDENTIFICATION OF CLASS FOR APPROVAL OF SCHEME

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].

In Rajeev S Mardia (supra), the court specifically considering the creditor classification in the framework under the Companies Act, 1956 (especially, section 530) as to companies in liquidation, held that reference to “class” would “include the classes of the creditors as known to law”. Therefore, in case of a company in liquidation, the four categories of the creditors may be identified as (i) secured creditors, (ii) workmen (iii) preferential creditors (statutory creditors) and (iv) unsecured creditors. Here, the court distinguished the case of a scheme proposed for an ongoing company since under that case some creditors’ rights (say, statutory creditors) for separate classification u/s 530 would have not accrued on account of no winding up order.

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.

7.   MORATORIUM DURING THE FORMULATION AND IMPLEMENTATION PERIOD

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).

8.  FAILURE/PRE-MATURE TERMINATION OF SCHEME

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.

However, it is viewed that the proceedings in respect of the corporate debtor originated under the Code, and recourse to section 230 of the Companies Act, 2013 has been provided by way of an external remedy. If the remedy fails, the corporate debtor will still be under the premises of the Code and will thus be liquidated in terms of the Code only and the timeline of 1 year for completion of liquidation should be applicable from the date on which the scheme is declared to have failed.

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.

10. WAY AHEAD

The interface of the Code with section 230 is new and the law as well the mechanics are expected to evolve with time. The law-makers and regulators may endeavour to bring more clarity to the provisions – for instance, as to moratorium, (in)applicability of section 29A/section 53, and pre-mature termination/failure of the scheme and provide for various possibilities/contingencies. Meanwhile, the judiciary has to face the challenge of harmonising the provisions.


[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

[4] 2015, https://indiankanoon.org/doc/104788583/

[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.

[6] Dealt with power of the court to stay winding up

[7] Read the article “Guide to Liquidation Valuation for Insolvency Resolution under the Insolvency Code” wherein the concept of vertical comparison as followed with respect to company voluntary arrangements in UK has been explained, here:

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.

[11] Section 273 provides for winding up by the NCLT.

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