Sikha Bansal, Partner
The Article below has also been published on the IndiaCorplaw Blog, see here
The concerns around section 230 schemes in the background of insolvency proceedings under the Insolvency and Bankruptcy Code, 2016 (IBC) have been partly addressed with the ruling of Supreme Court (SC) in Arun Kumar Jagatramka v. Jindal Steel and Power Ltd. The SC has held that the prohibition contained in section 29A should also attach itself to a scheme of compromise or arrangement under section 230 of the Companies Act, when the company is undergoing liquidation under the auspices of IBC. Reason being: proposing a scheme of compromise or arrangement under section 230 of the Companies Act, while the company is undergoing liquidation under the provisions of the IBC, lies in a similar continuum.
Earlier, there were several rulings of NCLAT which allowed schemes of arrangement during liquidation – for instance, see S.C. Sekaran, Y. Shivram Prasad, etc. After such rulings, the IBBI (Liquidation Process) Regulations were amended to include Regulation 2B, which also state that “a person, who is not eligible under the Code to submit a resolution plan for insolvency resolution of the corporate debtor, shall not be a party in any manner to such compromise or arrangement.”
Interestingly, a broader issue which SC noted in the ruling is in para 89, which says, ““Since the efficacy of this arrangement is not challenged before us in this case, we cannot comment on its merits.” With this ruling, and also, given various other concerns associated with schemes of arrangement under the premises of IBC, we may need to consider if at all the amalgam of schemes of arrangement and IBC was a necessity. Can we say that the IBC regime would be better off without section 230 schemes? This post tries finding an answer.
Was this an ‘original’ idea?
The applicability of section 230 schemes under IBC arises out of amendments made in section 230 of the Companies Act, vide section 255 of IBC read with the 11th Schedule thereto. Section 230 was amended so as to include references to a liquidator appointed under IBC and that is what made all the difference.
Evidently, the BLRC, in its report or in its interim report (2015) did not deliberate on the possibility of ‘schemes of arrangement’ in liquidation proceedings. Although, the BLRC definitely discussed the feasibility of schemes for debt restructuring. The BLRC explicitly noted that schemes of arrangements for debt restructuring have not had many takers in India. This may be partially attributable to the perception that court driven processes necessarily involve delays and significant costs. Additionally, there have been problems of holdouts by creditors. However, such schemes have been relatively successful for schemes between shareholders. Also, schemes can also facilitate ‘pre-packaged rescues’.
In fact, it would be interesting to note some of the important extracts of the 2015 Report, where BLRC observed that insolvency proceedings should be the proceedings as a last resort. That is, IBC should come into picture after all negotiations between the debtor and the creditors, to resolve the conflict, fail. The extract is reproduced below –
“The proposed Code assumes that, under situations of stress in the entity, the debtor and creditors have already have gone through negotiations to reach a solution to keep the entity as a going concern. The IRP is considered as a last course effort to resolve conflicts in the negotiations. Then triggering the IRP can be assumed to be a considered step, after deliberation and preparation.”
This indicates that BLRC proceeded on an assumption that insolvency proceedings under IBC would be chosen by the initiating party after all other efforts to resolve debtor-creditor conflict have been explored and there are no more doors to resolution. Therefore, one can say that the debtor and creditors should have already explored the option of a possible scheme of compromise/arrangement before seeking recourse to IBC.
Therefore, in the draft of IBC prepared by BLRC, no amendments were proposed to section 230 of the Companies Act. Such amendments in section 230 was actually proposed by the Joint Parliamentary Committee. Seemingly, the JPC did not cite any reason or explanation for the same.
While the SC, in its ruling (see, para 89), has noted “the explicit recognition of the schemes under Section 230 into the liquidation process under the IBC was through the judicial intervention of the NCLAT in Y Shivram Prasad”; however, the author humbly submits that the legislature itself allowed section 230 schemes under IBC, even before the NCLAT ruling, as discussed above. The NCLAT ruling too, has taken note of amended section 230 of the Companies Act.
Hence, it seems, at least in the understanding of the author, that the introduction of this alloy of schemes of arrangement and IBC was not an outcome of a designed thought process. Nevertheless, in humble views of the author, the idea was endorsed by the judiciary in a series of rulings (as pointed above) in order to accentuate the chances of survival/revival of business entities. However, the author has already pointed out various questions/concerns pertaining to schemes of arrangement undertaken in IBC liquidation processes, which has also been raised by Insolvency Law Committee in report (2020).
It may be noted that earlier, IBBI had come out with a Discussion Paper (2019) on liquidation process where the regulator sought public opinion on applicability of section 230 schemes during liquidation proceedings.
Later, the Insolvency Law Committee, in its report (2020), also highlighted the incompatibility of section 230 schemes with the liquidation proceedings under IBC. The ILC recommended that “recourse to Section 230 of the Companies Act, 2013 for effecting schemes of arrangement or compromise should not be available during liquidation of the corporate debtor under the Code”. However, the Committee noted that such schemes may have utility in liquidation, e.g. in cases where “creditors may find it useful to avoid certain mandatory requirements of the liquidation process – such as to enable settlement of outstanding, contingent claims, or where such compromises may be used to avoid certain mandatory set-offs, or modify rights vis-à-vis third parties”. The Committee, therefore, viewed that “such a process for compromise or settlement need not be effected only through the schemes mechanism under the Companies Act, 2013,” and felt that “the liquidator could be given the power to effect a compromise or settlement with specific creditors with respect to their claims against the corporate debtor under the Code”.
Therefore, the ILC was not in favour of section 230 schemes being amalgamated with IBC; but recommended some sort of schemes under the premises of IBC itself. Para 86 of the SC ruling clearly brings out this view.
Repeated attempts for revival – an unnecessary exercise?
A general argument which can support the applicability of s. 230 schemes in IBC liquidation is – if a scheme can be undertaken in liquidations happening outside IBC, then why not under IBC? That takes us to the very obvious question as in how a liquidation under IBC is different from a general liquidation. The answer is obvious – liquidation under IBC is (mandatorily) preceded by resolution proceedings, which is nothing but another avatar of schemes of arrangement.
Schemes of arrangement would generally entail compromise by creditors, merger/demerger of the company, etc. which are also the possible routes of resolution – see also reg. 37 of CIRP regulations. Just that, when it comes to IBC, this ‘settlement mechanism’ has to be in alignment with the ‘resolution mechanism’.
In fact, schemes of arrangement have been seen as effective means of resolving insolvency over years – see rulings Miheer N Mafatlal v. Mafatlal Industries Ltd., Forbes and Company and another v. Official Liquidator, Rasiklal S. Mardia v. Amar Dye Chem Ltd. etc., notwithstanding the fact that such schemes are also used by healthy companies for restructuring purposes.
In rulings such as Swiss Ribbons, the courts have held that liquidation should be seen as a matter of last resort. Allowing schemes of arrangement even after liquidation, is actually counter-intuitive to this idea – as in, it allows a never-ending run towards resolving an entity.
There are already too many options. Before IBC proceedings begin, the parties can go for resolution under RBI framework or under a general scheme of arrangement/compromise under section 230. Note that, we are already envisaging a pre-pack rescue mechanism. Once IBC proceedings begin, CIRP is for resolution and revival of the entity only – there are chances of withdrawal of proceedings too. Even if the corporate debtor slips into liquidation, preference has to be given to going concern sales. All these, and we are still looking for schemes in liquidation, where one might end up having more questions than solutions. The idea of a scheme of arrangement, in itself, is almost like trying for a fresh beginning, where the ruins are all the liquidator is left with.
Also, data suggests that the success rate of such schemes in IBC liquidations might actually be very low. As on September, 2020, only 1 case of liquidation was closed by way of compromise/arrangement.
One of the greatest barriers to business restructuring can be a framework which makes it virtually impossible to liquidate and wind up a viable entity. Over-emphasizing revival and neglecting the fact that liquidation, in some cases, is the best way to maximise value, might actually lead to value destruction. In fact, some committee reports have advocated sale of dismantled assets over going concern sales in liquidation. In view of the author, an entity under the auspices of IBC, gets multiple chances of proving its viability. A viable business, in all possibilities, should emerge successful from CIRP proceedings and thus, insistence on another opportunity in the form of a ‘scheme’ might actually be futile.
 Interim Report of BLRC, pg. 78-79.
 See page 70 of the JPC Report.
 See Report of the Committee on Industrial Sickness and Corporate Restructuring, popularly known as Goswami Committee report (1993).