Reversibility of Liquidation Order?

By Richa Saraf (resolution@vinodkothari.com)

Insolvency and Bankruptcy Code was framed with the object to provide opportunity for revival to an insolvent company, however, since the rising number of liquidation cases, as against resolution, is a cause of worry.

“After more than a year of the Insolvency and Bankruptcy Code proceedings, there have been more liquidation cases than resolution of the non-performing assets accounts. According to a data from the Insolvency and Bankruptcy Board of India, in the National Company Law Tribunal, around 78 companies got liquidation orders since February 2017[1].”- quoted in an article in Business Standard.

“An analysis of companies that have completed the Corporate Insolvency Resolution Process (CIRP) till December reveals that liquidation orders were passed for as many as 30 companies. This is three times the number of 10 cases for which resolution was approved at the culmination of the CIRP, as per latest data available with the Insolvency and Bankruptcy Board of India.[2] quoted in an article in Indian Express. Read more

Financial Creditors & Committee of Creditors: What, Why and How?

By Megha Mittal (resolution@vinodkothari.com)

IBBI issues clarification w.r.t. voting powers of CoC

Brief Background:

Pursuant to the Insolvency and Bankruptcy (Amendment) Code, 2018, the crucial reduction of voting threshold from 75% to 66% for critical matters like approval of Resolution Plan, Extension of CIRP, and all matters of section 28 of the Insolvency and Bankruptcy Code, 2016 (Code), came into effect.

However, there still prevailed ambiguity as to how to determine this threshold of 66%. What shall be the fate of those financial creditors who abstained from voting?

In this background, the Insolvency and Bankruptcy Board of India (IBBI/ Board) has issued a clarification w.r.t. voting in the Committee of Creditors.

Constitution of Committee of Creditors- What, why and how?

Committee of Creditors” (Committee) is a committee consisting of the financial creditors of the Corporate Debtor. This Committee eventually forms the decision making body of the various routine tasks involved in Corporate Insolvency Resolution Process (CIRP), responsible for giving approval to the IRP/ RP to carry out actions that might affect the CIRP.

A major chunk of the dues of the Corporate Debtor is that of Financial Creditors and thus, to recognize their substantial interest, the Committee is formed. The power to ratify the managerial decisions taken by the RP vests upon the Committee; It is this Committee that approves/ rejects the Resolution Plan, extension of CIRP, decides upon liquidation of the Corporate Debtor, ratifies expenses borne by the RP etc. In short, all decisions having an impact on the Corporate Debtor shall first be approved by the Committee.

As per section 18 of the Code, it is the duty of the Interim Resolution Profession to constitute the Committee upon collation of all claims received against the corporate debtor and determination of the financial position of the corporate debtor. It shall consist all those financial creditors whose claims have been received within the time period stipulated in the public announcement.

Voting power of the Members

In the event of passing any resolution by the Committee, a minimum threshold of assent is required to be obtained. However, in light of these facts, the following questions arise w.r.t. fate of creditors who submit delayed claims or the determining the voting power of the members of the Committee

  • What happens when a financial creditor submits claims after the stipulated date as per public announcement?

Where a financial creditor submits its claim after expiry of the last date for submission, it shall form a part of the Committee for purposes after such submission. No decision taken prior to its inclusion in the Committee can be questioned later on.

  • How is it to be determined whether the requisite threshold is met?

While determining the percentage of votes received in favour, only those creditors then forming part of the Committee shall be considered as the total value of creditors and the votes of those creditors who abstain from voting shall be deemed to be dissenting votes.

These provisions can be better understood with the help of an illustration:

Illustration:

A corporate debtor, X Ltd. has 6 financial creditors having dues to the tune of Rs. 600 crores. By the time the last day for submission of claim expires, the claims of only 3 financial creditors being A, B and C having dues of Rs. 50 Crores, Rs. 75 crores and Rs. 125 crores, respectively have been submitted.

Thus, the IRP constitutes a committee of these 3 creditors.

After the last day for submission of claims expires, another financial creditor, D, having dues of Rs. 100 crores submits its claims. After the claim is verified, such financial creditor shall also form part of the Committee.

D, opposes a certain decision taken by the Committee prior to its inclusion. Such contention placed by D is non-maintainable as the previous resolutions passed by the Committee shall be held good because they were duly passed with requisite majority.

After D is admitted as a member of the Committee, there are a total of 4 members having total dues of Rs. 350 crores. Now, for a resolution requiring minimum 66% of the votes to be passed, members of the Committee having dues of atleast Rs. 231 crores must vote in favour of such resolution.

Assuming a situation where out of the 4 creditors, A chose to abstain from voting, A shall be deemed to be a dissenting creditor. Thus, even on such abstention, votes in favour of minimum 66% of Rs. 350 crores i.e. Rs. 231 crores shall be required and not that of Rs. 300 Crores.

Another point to be noticed is that dues of creditors not forming part of the Committee shall not be taken into account while determining the requisite percentage. In the illustration above, the remaining creditors of Rs. 250 crores shall not be taken into consideration while passing of resolutions.

Conclusion:

Considering the above, the following can be concluded:

  1. Financial creditors not forming part of the Committee shall not have any voting power w.r.t. decisions taken by the Committee unless they become a part of the Committee.
  2. Creditors abstaining from voting shall be deemed to be dissenting shareholders.

LOOK- BACK PERIOD VIS-À-VIS FRAUDULENT TRANSACTIONS

By Richa Saraf  (richa@vinodkothari.com)

Sections 45, 49, 66, 69 of the Insolvency and Bankruptcy Code, 2016 requires and empowers the Liquidator to apply to the Adjudicating Authority for appropriate orders in case of any vulnerable transactions that the Liquidator comes across during the process of liquidation. Such transactions may either be with respect to breach of applicable law, or deleterious to the interests of creditors or stakeholders, or otherwise, not transactions designed to be in good faith. The transactions, whether being undervalued or fraudulent shall be considered vulnerable to the interest of the stakeholders of the Company.

The article hinges on the crucial question of applicability of the limitation to the aforementioned sections. In this regard, we shall discuss how the provisions were imbibed in the Code, despite there being no equivalent in the Companies Act, 2013 or previous Companies Act. The general notion is that limitation should be applicable to all transactions, including fraudulent transactions referred to in Section 49 of the Code. However, the article will explain as to how undervalued transaction, done deliberately without due compliance, partakes the nature of a fraudulent transaction, and since fraud is a nullity forever, in case of such transactions, as covered by Section 49, there is no question of any look- back period at all.

Deciphering the intent of incorporation of provisions relating to vulnerable transactions:

The concept of “fraudulent preference” existed both in Companies Act, 1956 and 2013, however, the provision pertaining to undervalued and fraudulent transaction is a unique incorporation in the Code, adopted from the UK Insolvency Act, 1986. The Bankruptcy Law Reform Committee, referring to Section 243 of UK Insolvency Act, 1986, recommended that a provision voiding transactions defrauding creditors should be included. It is further, pertinent to note that the Committee, while discussing the intent behind insertion of this provision in the statute, observed that the provision for fraudulent transactions should not have any time- bar. The relevant extract from Interim Report (page 98-99) of the Committee is reproduced below:

“In the UK, Section 423 of the IA 1986 voids transactions at undervalue if such transactions have been entered into with the intention of putting the assets beyond the reach of, or otherwise prejudicing the interests of a person who is making or may make a claim against the company. While the scope of this provision is similar to that of the provision avoiding transactions at undervalue (Section 238, IA 1986), Section 423 actions differ in that they do not have any time limit for the challenged transactions, and is available in and outside formal insolvency proceedings. The inclusion of such a provision in the CA 2013 would reinforce the protection given to creditors under avoidance law by permitting the liquidator to set aside transactions entered into prior to the one year period ending in the company’s insolvency. This is necessary to guard against the siphoning away of corporate assets by managers who have knowledge of the company’s financial affairs in cases where a long period of financial trouble, extending over a year, ends in insolvency.

**

A provision invalidating transactions defrauding creditors similar to Section 423 of the IA 1986 should be inserted in CA 2013. Such provision would apply without any time limits and should be available in and outside formal insolvency proceedings.

It is clear that the analogous provision in the UK law does not have any limitation period, and also, there is no limitation period with reference to Sections 49 and 66 in the language of the law itself. Here, it is relevant to cite Report of Insolvency Law Committee (March, 2018), by virtue of which an amendment was made to exclude time limit from Section 69 of the Code:

“24.1. Section 69 of the Code provides for punishment for transactions defrauding creditors by the corporate debtor or its officers “on or after the insolvency commencement date”. However, as per sub-section (a), if the transaction results in a gift or transfer or creation of a charge or the accused has caused or connived in execution of a decree or order against the property of the corporate debtor, the accused shall not be punishable if such act was committed five years before the insolvency commencement date or if she proves that she had not intended to defraud the creditors. In this respect, the pre-fixing of the offence with “on or after the insolvency commencement date” is erroneous. Further, pre-fixing the same phrase in sub-section (b) is also erroneous, as the transaction involves concealment or removal of any property within two months from the date of any unsatisfied judgement or order for payment of money. Thus, the Committee decided that the phrase “on or after the insolvency commencement date” be deleted from section 69.”

Additionally, vulnerable transactions are generally considered to be transactions of a continuing nature, having their adverse and prejudicial impact on the ongoing financial position of the Company, which has already slipped into distress, and therefore, the concept of any look-back period or claw-back period shall not be applicable, since it cannot be contended that a transaction, done with a deliberate, culpable design, becomes washed of its gullibility merely because the liquidation proceedings are initiated certain number of years after the date of commission of the relevant transaction.

Distinction between Section 45 and Section 49:

Both Sections 45 and 49 pertains to avoidance of undervalued transactions, the only difference being that Section 49 deals with undervalued transactions undertaken with malafide or wrongful intent, while for Section 45; the presence of any motive is not required. The reference in Section 49 to transactions covered by section 45 is merely for the factual ambit of transactions covered by the section, and the additional element of intent marks the crucial difference between the two sections.

Moreover, while a look- back period has been provided for undervalued transactions under Section 46, there is no limitation period for fraudulent transactions covered under Sections 49 and 66 of the Code. The intent being “once a fraud, always a fraud”, a time- honored doctrine clearly applies. The maxim “fraud vitiates every transaction into which it enters applies to judgments as well as to contracts and other transactions” is a part of common law jurisprudence, largely based upon equitable doctrines and has been has been upheld by courts repeatedly in several cases such as The People of the State of Illinois v. Fred E. Sterling, 357 Ill. 354; 192 N.E. 229 (1934), Allen F. Moore v. Stanley F. Sievers, 336 Ill. 316; 168 N.E. 259 (1929), and further, In re Village of Willow brook, 37 Ill.App.2d 393 (1962), wherein it  was observed “It is axiomatic that fraud vitiates everything.”.

Fraud destroys the validity of everything into which it enters, and that it vitiates the most solemn contracts, documents, and even judgments, is well settled, and has been time and again reiterated in various judgments in broad and sweeping language. If both the sections were to encompass a time-limit then it would defy the whole purpose, and the reason for incorporating two separate provisions in the Code would fail. The basic essence is that any person who has done any wilful act should not be allowed to get away by citing reasons such as lapse of time.

In light of the aforesaid, it can be concluded that while an undervalued transaction is a matter of fact, for which intention does not matter, however, when the intention to cause a prejudice to the creditors is embedded in such undervalued transaction, the transaction comes within the offence of Section 49. If a transaction, so imbibed with malafide intent, was subject to the same fate and the same limitation as a transaction mentioned in Section 45, then Section 49 would not have any relevance at all. On the contrary, it can be pointed out that Section 49 was inserted specifically for the so-called willful defaulters, for which the limitation of time, mentioned in Section 45, cannot be relevant at all. Thus, it will not be correct to say that there is any claw-back for willfully undervalued transactions under Section 49 and fraudulent conduct of business under Section 66.

IBBI lays down procedure for Resolution Plans -Third set of amendment in IRP-CP Regulations

By Shreya Routh (resolution@vinodkothari.com)

“Tough times do not define you, they rather refine you”- is perhaps the quote which the Insolvency and Bankruptcy Code, 2016 seeks to achieve. The Insolvency and Bankruptcy Code, 2016 (“Code”) tries to refine the tough times which the corporate debtor goes though during the corporate insolvency resolution process. With an objective of bringing more clarity in the process of resolution, IBBI has come out with yet another amendment in the form of Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) (Third Amendment) Regulations, 2018, (“Amended Regulations”).

Following major amendments have been brought:

  1. Report certifying constitution of the committee of creditors
  2. Notice and voting at the meeting of the committee of creditors
  3. Invitation of Resolution Plan and Request for Resolution Plan
  4. Withdrawal of the CIRP Applications
  5. Regulations with respect to class of creditors
  6. Regulations with respect to authorised representatives of resl-estate buyers

This write up deals with the points 1 to 3.

To read about the other topics covered under the Amendment Regulations, please refer to the article,” CIRP Amendment lays focus on Class of Creditors” by my colleague Ms. Megha Mittal. Read more

The Curious Case of Home-Buyers: All is Well?

By Sikha Bansal, (sikha@vinodkothari.com) (resolution@vinodkothari.com)

 

All the hullabaloo surrounding the inclusion of “home-buyers” in the category of financial creditors was put to rest by the promulgation of the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018 (“the Ordinance”). The Ordinance amends the definition of “financial debt” u/s 5 (8) of the Insolvency and Bankruptcy Code, 2016 (“IBC”) so as to include in clause (f):

“any amount raised from an allottee under a real estate project shall be deemed to be an amount having the commercial effect of a borrowing

The Ministry of Corporate Affairs, in a statement released in respect of the Ordinance, stated:

“The Ordinance provides significant relief to home buyers by recognizing their status as financial creditors. This would give them due representation in the Committee of Creditors and make them an integral part of the decision making process. It will also enable home buyers to invoke Section 7 of the Insolvency and Bankruptcy Code (IBC), 2016 against errant developers.”

At the outset, it might be interesting to note that the amounts raised from the allottees, in every case, might not be classifiable as financial debts in substance. For instance, where allotment/contract is cancelled by the home-buyer and there is a claim of return of principal sum with interest, the NCLT in Pawan Dubey & Another v. M/s J. B. K Developers Private Limited held that such an amount cannot be claimed as a financial debt. The Ordinance makes no distinction for these cases and creates a “deeming” provision, by using the words “deemed to be an amount having the commercial effect of a borrowing”.

Is this happy ending? A pensive thought refuses accepting that all is well.

What about the priority?

Been accorded the status of “financial creditors”, the home-buyers will get a seat on the CoC. As such, they can exercise their voting rights to decide on resolution or liquidation of the entity.

However, being a financial creditor and being a secured one, are two different things. The Code, while introducing the differentia as to operational and financial creditors has retained the conventional classification of secured and unsecured creditors too. The same is evident from the definition of “financial debt” and “secured debt” and also priority enlisted under section 53 of the Code. As such, a financial creditor need not be a secured creditor.

While the Ordinance postulates home buyers as financial creditors, there has been no clarification as to such creditors being secured or unsecured. No changes have been made in section 53 to allot a specific priority to the home-buyers. As such, the monies of home-buyers will fall under clause (d), i.e. financial debts to unsecured creditors.

A secured creditor, irrespective of whether financial or operational, occupies second priority at par with workmen’s dues. However, financial debts owed to unsecured financial creditors rank after the dues of secured creditors, workmen, employees [for specified periods].

Therefore, the benevolent Ordinance seems to have performed the job partly. The home-buyers might still be left in a dry.

Home, Sweet home?

The entire exercise will very much depend upon whether the home-buyers are keener to get their flats ready or just get refund of their money. Say, if the objective of home-buyers is to get their flats ready, the recourse under the Code will not be of much help. The only feeble way in which they can ensure this is to utilize their voting rights to stall liquidation and get the corporate debtor in resolution mode, so that their flats can be completed and handed over to them.

On the other hand, if the objective of the home-buyers is to get their money back, as stated earlier, they do not seem to be at an advantageous position. The liquidation value ascribable to them would be very low in view of their sub-ordinated priority in the waterfall. As such, whether resolution or liquidation, there are fragile chances of home-buyers regaining their hard-earned money.

Why not RERA?

Section 18 read with section 19 (4) of the Real Estate (Regulation and Development) Act, 2016 already provides for refund of amount of allottees if the promoter fails to complete or is unable to give possession of the property. Several provisions of RERA stipulate adjudication of compensation and penalty for non-compliances by promoters.

In situations where the promoter fails to deliver the flats as well as refund the said amounts, and for some reasons also goes into insolvency before NCLT; there seems no benefit for the home-buyers to be a part of CoC, for reasons cited above. That is, in any case, the monies they would get would be limited to the extent of “liquidation value”.

Hence, the home-buyers are in no better situation, so far as return of their own money is concerned.

In search of a better deal . . .

For reasons as above, it seems that IBC is not a holistic shelter for the home-buyers.

Instead of awarding the status of financial creditor to the home-buyers, a better solution would have been to define the priority of home-buyers such that they could get their refunds alongside the dues of secured creditors and workmen.

There would have been another probable solution: RERA provides for maintaining a separate account for depositing the amounts realized for the real estate project from the allottees, from time to time, to cover the cost of construction and the land cost. Such a provision, in a manner, implies that the moneys so obtained by the promoters would be in the nature of money held in trust. Applying the analogy, if the money taken from home-buyers is accorded the status of “money held in trust”, the corpus will not be a part of the “assets” or “liquidation estate” of the promoter entity, and therefore would be out of the purview of section 53.

However, for the time being, the possible solution before home-buyers is either RERA or the amendment brought in by the Ordinance. The efficacy of this amendment will be pronounced only in times to come.

Overview of Insolvency and Bankruptcy (Amendment) Ordinance, 2018

By Sikha Bansal,(sikha@vinodkothari.com) (resolution@vinodkothari.com)

 

Post the Insolvency Law Committee’s Report recommending an overhaul in the Insolvency and Bankruptcy Code, 2016, the Government has passed the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018, vide Notification dated 6th June, 2018, in an attempt to set things right. No doubt, IBC has triggered positive vibes in the lending market, yet being an evolving law, it has its own drawbacks.

The Ordinanceis the second ordinance in respect of this legislation; which, among several other amendments, seeks to provide first-aid for the burns given by the first ordinance passed 6 months ago in November, 2017 [later enacted as IBC (Amendment) Act, 2018, with modifications] in the form of section 29A. Read more