The Contingencies associated with Contingent Claims under IBC

– Sameer Gahlot | Assistant Manager | finserv@vinodkothari.com

The Insolvency and Bankruptcy Code, 2016 (‘Code’/ ‘IBC’) provides for a collective resolution mechanism – claims of multiple creditors of different nature are collated by the resolution professional or liquidator, as the case may be, which are then repaid from the recoveries made, either pursuant to a resolution plan or by way of realisation under the liquidation process. Thus, in either case, to be able to recover their dues from the corporate debtor, it is pivotal that such party qualifies as a ‘creditor’ with a legitimate ‘claim’ as per the Code.

That being said, while crystallized claims can be easily accounted for, the problem lies where claims are either contingent or unascertainable. Though there have been various judicial developments in this domain, the laws are still not settled and uncertainty looms over the following questions:

1. Whether the term ‘claim’ as defined under section 3(6) of the Code includes within its purview contingent claims (e.g. bank guarantees, letter of credit or other unfunded exposures) (collectively called “Unfunded Exposures”)?
2. If yes, what would be the relevant factors for assigning value to these claims?
3. Whether the concerned creditor should form part of the Committee of Creditors (‘CoC’)?

It must be appreciated that the ramifications of the above, ranging from the manner of valuation of the claim to inclusion of the creditor in the CoC, and consequently voting rights, are cardinal for achieving the underlying objective of the Code. In this article, we have broadly covered various aspects related to this issue, the ongoing discussions and a possible solution to clear the air surrounding this issue to the extent possible.

Contours of a ‘Claim’

The expression ‘claim’ as defined under section 3(6) of the Code has two parts – (i) right to payment; and (ii) right to remedy for breach of contract if such breach gives rise to a right to payment. Right to payment, irrespective of its nature, can be fixed, disputed, undisputed, legal, equitable, secured or unsecured. Other side of the coin is ‘debt’ as defined in section 3(11) of the Code. While ‘claim’ involves a ‘right to payment’, ‘debt’ involves a ‘liability’ or an ‘obligation’ to make a payment which is ‘due’.

Unfunded Exposures do not involve any current outlay of funds on the part of the financial creditors. It must be noted that the stress under Section 5(8) dealing with “financial debt” is on the amount disbursed and not on an obligation or undertaking to disburse. Hence, there is no ‘debt’. However, there is an ongoing ‘commitment’, which if fructifies, will entail right of recovery on the creditor. Therefore, in a given scenario, the right to payment may not be ‘existing’ or ‘immediate’, but rather ‘contingent’. As such, the debt is a contingent one – does such contingent debt give rise to a ‘claim’?

As discussed below, authorities and laws across recognize ‘contingent claims’ as a part of the bankruptcy process.

In “Law relating to Insolvency and Bankruptcy Code, 2016”, the authors^[1] discussed that, in general, the intent of bankruptcy laws is that debts of all description are provable. The intent of a very wide sweep of the definition of provable debt was explained in Joint Administrators of LB Holdings Intermediate 2 UK Limited v. Anthony Victor Lomas, (2015) EWCA Civ 485, citing Nortel GmbH (2013) UKSC 52, (2014) AC 209, that the scheme of insolvency laws is all potential liabilities should be capable of being proved, so as to allow equitable opportunity to all creditors to claim their debt, even if the debt be contingent upto the date of bankruptcy.

UNCITRAL’s definition of ‘claim’ in the Legislative Guide includes ‘contingent claim’. The Guide talks about provisional admission of claims – refer page 259 of the Guide, that, “Claims may also be conditional, contingent and not mature at the time of commencement”. Further, “Where the amount of the claim cannot be, or has not been, determined at the time the claim is to be submitted, many insolvency laws allow a claim to be admitted provisionally, subject to giving it a notional value. Determining a value for such claims raises a number of issues such as the time at which the value is to be determined and whether it must be liquidated (in which case it will need to be considered by a court) or estimated (which might be undertaken by the insolvency representative, the court or some other appointed person).” Reason being, “An important reason for permitting provisional admission is to allow creditors holding those claims to participate in the proceedings and, in particular, to vote on key issues, such as on approval of the reorganization plan or on other issues requiring a decision by creditors.” Also, “Provisional admission of a claim will generally entitle the creditor to participate in the proceedings to the same extent as other creditors, except that they may not be entitled to participate in distributions until the value of the claim is finally fixed and the claim admitted. Where, however, the claim is ultimately not fully admitted, any previous votes by the creditor in the proceedings may be discounted in proportion to the admitted claim.”

In the United States, the term ‘claim’, under section 101(5) of the United States Bankruptcy Code, provides an extensive definition and uses ‘contingent claims’ consistently in the US Code. In Epstein v. Official Committee of Unsecured Creditors, a striking balance was provided between the present and future claimants through the Piper test. Under this test, all claims (present and contingent) standing in near relation to a company are assigned best estimated value so as to safeguard the position of future claimants thereby providing a suitable resolution plan considering the interest of all the creditors. The legislative history of US Code shows that the word ‘claim’ was intended to be given the widest possible meaning, so that all legal obligations of the debtor, no matter how remote or contingent, will be able to be dealt with in the bankruptcy case. See rulings like Danzig Claimants v. Grynberg (In re Grynberg), 113 B.R. 709 (Bankr. D. Colo. 1990).

​​Similar provisions are there under UK Insolvency Act, 1986 read with UK Insolvency Rules, 2016. Section 382(3) states that all claims are treated as debt or liability whether they are in present or future, certain or contingent, fixed or liquidated. As per rule 14.2 (under Part 14, Chapter 2), all claims by creditors, except as provided in this rule, are provable as debts against the company or bankrupt, whether they are present or future, certain or contingent, ascertained or sounding only in damages.

Even the erstwhile laws, namely Presidency Towns Insolvency Act, 1909 (“PTIA”), called for recognition of contingent debts, for instance, section 46(4) of PTIA, provided that an estimate shall be made by the official assignee of the value of any debt or liability provable as aforesaid which by reason of its being subject to any contingency or contingencies, or for any other reason, did not bear a certain value and section 33 of the Provincial Insolvency Act, 1920 (“PIA”) stated that if, in the opinion of the court, the value of any debt is incapable of being fairly estimated, the court may make an order to that effect, and thereupon (as per section 34) the debts shall not be included in the schedule and shall not be provable under the said Act.

Even now, section 41 of the Code requires the liquidator to determine the value of claims admitted under section 40 in such manner as may be specified by the Board. As such, regulation 14 of IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, regulation 25 of IBBI (Liquidation Process) Regulations 2016 requires IRP/RP/Liquidator, as the case may be, to make the best estimate of the amount of the claim, which cannot be ascertained due to any contingency or any other reason, based on the information available with him.

Hence, while it may be argued that there is no specific reference to the words like ‘contingent claims’ in the definition of claim under the Code (unlike that in US Code); however, given the established principles of bankruptcy laws, and the discussion above,  it may be inferred that such claims or debt are not to be excluded. Although, such claims cannot be a basis for filing insolvency applications under sections 7, 9, 10; yet should be provable and should form part of overall claims against the debtor.

Judicial Precedents in India

Over the years, there have been several case laws on the issue of treatment of the Unfunded Exposures, pronounced by the National Company Law Tribunal (‘NCLT’), the National Company Law Appellate Tribunal (‘NCLAT’), and the Supreme Courts (‘SC’). Some of the case laws are discussed below in brief:

• In the case of Bank of Baroda v. Binani Cements Ltd. [C.P. (IB) No. 359/ KB/ 2017], before the Hon’ble National Company Law Tribunal, Kolkata Bench.
• In JEKPL Ltd. v. Exim Bank [C.P. No. (IB) 24/ALD/2017 and C.A. No. 159/ 2017], before the Hon’ble National Company Law Tribunal, Allahabad Bench.
• In Axis Bank Ltd. & Ors. v. Edu Smart Services Private Limited [(IB)- 102 (PB)/ 2017], before the National Company Law Tribunal, Principal Bench, New Delhi, order dated 27/10/2017.

Thereafter, vide a joint order dated 14th August, 2018, in the matter of JEKPL as well as Axis Bank (supra) the Hon’ble NCLAT, held that claims under non-invoked corporate guarantee have to be admitted under the Code, as contingent claims. NCLAT, in para 56 of Order dated 14th August, 2018 says, “we hold that maturity of claim or default of claim or invocation of guarantee for claiming the amount has no nexus with filing of claim pursuant to public announcement made under Section 13(1)(b) r/w Section 15(1)(c) or for collating the claim under Section 18(1)(b) or for updating claim under Section 25(2)(e). For the purpose of collating information relating to assets, finances and operations of Corporate Debtor or financial position of the Corporate Debtor, including the liabilities as on the date of initiation of the Resolution Process as per Section 18(1), it is the duty of the Resolution Professional to collate all the claims and to verify the same from the records of assets and liabilities maintained by the Corporate Debtor.”

However, with respect to this case, in view of the order of the Hon’ble Supreme Court, dated 13th April, 2021, in the matter of, Ghanshyam Mishra & Sons v. Edelweiss Asset Reconstruction Company, the order of the Hon’ble NCLAT in the aforementioned matter does not seem to be settled.

Also, the Hon’ble SC in the matter of Committee of Creditors of Essar Steel India Limited vs Satish Kumar Gupta & Ors. [Civil Appeal No. 8766-67 OF 2019] pointed out, “A successful resolution applicant cannot suddenly be faced with “undecided” claims after the resolution plan submitted by him has been accepted as this would amount to a hydra head popping up which would throw into uncertainty amounts payable by a prospective resolution applicant who successfully take over the business of the corporate debtor. All claims must be submitted to and decided by the resolution professional so that a prospective resolution applicant knows exactly what has to be paid in order that it may then take over and run the business of the corporate debtor. This the successful resolution applicant does on a fresh slate”.

Hence, not adequately recognising contingent claims during the resolution process would work against the rationale explained by SC in Essar Steel. The idea, as discussed above, is to take stock of ‘all possible claims’ which the acquirer may come across, so that suitable provisions may be made in the resolution plan. Same principles apply in case of liquidation. Although liabilities are not transferred in a liquidation sale, but are extinguished under section 53; however, if any contingent debt fructifies during the process itself, the same should be released in accordance with the priority under section 53.

Valuation

Once the claims have been admitted, the next question is that of valuation. Where the amount of the claim cannot be determined at the time of submitting the claim, laws in various jurisdictions like UK and US allow a claim to be admitted provisionally subject to giving it a notional value. As valuation of unliquidated claims have far-reaching impact, determining a value for such claims raises a number of issues, such as the time at which the value is to be determined and whether it must be liquidated or estimated.

The provisions correspond to sub-sections (3) & (4) of section 322 of the UK Insolvency Act. A bankruptcy debt may not have a certain value owing to a contingency or contingencies or any other reason. On similar lines, rule 14.14.1 (under Part 14, Chapter 2) of the Insolvency Rules, 2016 rule 4.86 of the UK Insolvency Rules require the liquidator to estimate the value of any debt which, by reason of its being subject to any contingency or for any other reason, does not bear a certain value. Though, in accordance with the supplementary powers conferred under section 168 of the UK Insolvency Act, the liquidator may apply to the court (in the prescribed manner) for directions in relation to any particular matter arising in the winding up (therefore, including valuation matters).

In the Indian context, it is the responsibility of an Interim Resolution Professional/Resolution Professional/Liquidator to ascertain and assess the unfunded exposures and to assign the best estimated value. Regulation 14 of the IBBI (Insolvency Resolution Process for Corporate Persons) (‘CIRP’) Regulations, 2016 state that “Where the amount claimed by a creditor is not precise due to any contingency or other reason, the interim resolution professional or the resolution professional, as the case may be, shall make the best estimate of the amount of the claim based on the information available with him.” Also, sub-section (5) of section 171 requires that the bankruptcy trustee shall estimate the value of any bankruptcy debt which does not have a specific value. According to sub-section (6), the value assigned by the bankruptcy trustee under sub-section (5) shall be the amount provable by the concerned creditor. Further, as and when there are any developments having material impact on the claim, the same shall be considered and the value modified accordingly.

As to the basis on which contingent claims shall be valued, there is little guidance available. For example, the Technical Manual of the Insolvency Service, UK suggests – “It may save protracted correspondence if the official receiver as chairman of the meeting, liquidator or trustee seeks to have the creditor provide his/her own calculation of the claim, together with supporting evidence, and this calculation can then be assessed by the official receiver.” In Danka Business Systems Plc (In Members’ Voluntary Liquidation), or Ricoh Europe Holdings BV v. Spratt [2013] EWCA Civ 92^[2], it was held that, while valuing a contingent claim, a liquidator is not obliged to apply the “worst case scenario”, but can make a reasonable assessment of the likelihood of the contingency coming to pass . .”

The authors in “Law Relating to Insolvency and Bankruptcy Code, 2016” state, “The value of a liability is the present value of the cash payments, or economic sacrifices that would be required to satisfy or transfer the obligation, discounted at a rate of return that reflects the risk of that liability. In addition to the concept of present value, a contingent liability also incorporates additional uncertainty regarding the likelihood or probability that the event that would give rise to the liability may not in fact take place. This additional uncertainty must also be taken into consideration in determining the liability’s value.”

Closing Remarks

From the discussion above, the following principles may be concluded in respect of claims filed by creditors with respect to Unfunded Exposures:

1. Amount of the Unfunded Exposures, to the extent the same remains outstanding, will be admitted as contingent claim. As and when, during the conduct of the CIRP/liquidation process, the Unfunded Exposures expire or are no longer payable by the financial creditor, the amount thereof shall be reduced from such Unfunded Exposures.
2. In case, during the conduct of the CIRP/liquidation process, an Unfunded Exposure devolves or is converted into a funded exposure, the same shall be immediately recognised as an ordinary claim, at par as if it was funded at the commencement of insolvency/liquidation proceedings.

Accordingly, the treatment during CIRP shall be as follows –

1. If during the course of CIRP, the exposure becomes funded, for instance, on account of invocation of the guarantee, then IRP/ RP/ Liquidator shall modify the committee of creditors/ list of stakeholders, as the case may be, thereby including the funded exposure as a part of the claim.
2. The details of the contingent claim, so admitted, should obviously form part of the information memorandum.
3. The rights of that creditor shall be determined accordingly. In our view, the concerned creditor may be included in the CoC to the extent of ‘estimated value’ of the contingent debt. Where the contingent claim fructifies during the insolvency process, payment to creditor under the resolution plan will be proportional in accordance with the plan. If the contingent claim does not result in a debt, there is no question of any payment.

And, treatment during Liquidation shall be as follows –

1. The Liquidator has to make distributions based on the amount of claims admitted – there is no question of making a distribution to a financial creditor, even where the financial creditor has not actually incurred an exposure in respect of the Unfunded Exposure.  The Unfunded Exposures in many cases are in the nature of performance guarantees which have defined expiry periods.  The likelihood of the Unfunded Exposure expiring without any claim is substantially higher than that of the Unfunded Exposure being devolved and encashed by the beneficiary.
2. Therefore, only non-contingent claims shall be entitled to distribution.
3. If, at any time before final distribution is to be done, an Unfunded Exposure still remains alive, the Liquidator shall assess its value in view of the contingency of the exposure being converted into a funded exposure, over the-then remaining effective tenure of the contingent exposure

Necessary clarifications may be required from the law-makers/regulator to settle the discussion around contingent claims.

^[1] Vinod Kothari and Sikha Bansal, Taxmann

^[2] Source: http://www.bailii.org/ew/cases/EWCA/Civ/2013/92.html; pg. last visited on 7th July, 2016.