INVITATION FOR EXPRESSION OF INTEREST FOR ACQUISITION OF ASSETS OF “NICCO CORPORATION LIMITED –IN LIQUIDATION”ON “GOING CONCERN BASIS”

Ineligibility criteria u/s 29A of IBC: A net too wide!

-By Richa Saraf & Sikha Bansal (resolution@vinodkothari.com)

 

Resolution plan is designated to be the “way-out” for insolvent entities coming under the Insolvency and Bankruptcy Code, 2016. The resolution professional appointed by the adjudicating authority constitutes a committee of creditors, invites resolution plans from prospective resolution applicants, and places the resolution plans before the committee of creditors. The resolution plan which is approved by the committee of creditors is submitted to the adjudicating authority for sanction. A resolution applicant, as defined under section 5(25) of the Code, earlier referred to mean any person who submits a resolution plan to the resolution professional. Hence, a resolution applicant might have been any person- a creditor, a promoter, a prospective investor, an employee, or any other person. The Code had not gone into the basis and criteria for selection of the resolution applicant. This became a fatal loophole in the law which allowed back-door entry to defaulting promoters at substantially discounted rates for the assets of the corporate debtor.

To curb the illicit ways, several amendments were made in the Code, first by way of Insolvency and Bankruptcy Code (Amendment) Ordinance, 2017[1] dated 23rd November, 2017, then by Insolvency and Bankruptcy Code (Amendment) Act, 2018[2] dated 19th January, 2018 (“Amendment Act”). Of all the amendments, the one which has become a riddle for all is section 29A. The section specifies persons not eligible to be resolution applicant, and has ten parts (i.e. clauses), the tenth part is further divided into three sub-parts, of which the third part has its own descendants. These layers of section 29A are more in the nature of elimination rounds. The write-up below digs deeper into the section.

Resolution Applicant – Who and Who Not?

Vide the Amendment Act, the definition of “resolution applicant” was amended so as to mean a person, who individually or jointly, submits a resolution plan to the resolution professional pursuant to the invitation made under section 25(2)(h).

Section 25(2)(h) requires the resolution professional to invite resolution plans from prospective resolution applicants who fulfill criteria as laid down by the resolution professional with the approval of committee of creditors, having regard to the complexity and scale of operations of the business of the corporate debtor and such other conditions as may be specified by the Board.

Section 29A is a restrictive provision- any person falling in the negative list is not eligible to submit a resolution plan.

Therefore, a person in order to be eligible to submit a resolution plan –

  • shall fulfill the criteria laid down by the resolution professional with the approval of the committee of creditors; and
  • shall not suffer from any disqualification mentioned under section 29A.

Section 29A – A Pandora Box

According to Section 29A, a person suffering from the disqualifications as mentioned hereunder shall not be eligible to submit a resolution plan. Further, any other person acting jointly or in concert with the prospective resolution applicant shall not be covered under the following disqualifications –

  • (i) the person is an undischarged insolvent;
  • (ii) the person is a wilful defaulter in terms of the RBI Guidelines issued under the Banking Regulation Act, 1949;
  • (iii) the person has an account, or an account of a corporate debtor under the management or control of such person or of whom such person is a promoter, classified as non-performing asset in accordance with RBI Guidelines issued under the Banking Regulation Act, 1949 and at least a period of 1 (One) year has lapsed from the date of such classification till the date of commencement of the corporate insolvency resolution process of the corporate debtor: Provided that the person shall be eligible to submit a resolution plan if such person makes payment of all overdue amounts with interest thereon and charges relating to non-performing asset accounts before submission of resolution plan;
  • (iv) the person has been convicted for any offence punishable with imprisonment for 2 (Two) years or more;
  • (v) the person is disqualified to act as a director under the Companies Act, 2013;
  • (vi) the person is prohibited by SEBI from trading in securities or accessing the securities markets;
  • (vii) the person has been a promoter or in the management or control of a corporate debtor in which a preferential transaction, undervalued transaction, extortionate credit transaction or fraudulent transaction has taken place and an order has been made by the adjudicating authority under the provisions of the Code;
  • (viii) a person who has executed an enforceable guarantee in favour of a creditor, in respect of a corporate debtor against which an application for insolvency resolution made by such creditor has been admitted under the Code;
  • (ix) a person who has been subject to the above listed disabilities under any law in a jurisdiction outside India;
  • (x) connected persons, i.e. persons connected to the person disqualified under any of the aforementioned points, such as those who are promoters or in management of control of the resolution applicant, or will be promoters or in management of control of the business of the corporate debtor during the implementation of the resolution plan, the holding company, subsidiary company, associate company or related party of the above referred persons – exception has been carved out for scheduled banks, asset reconstruction companies registered with RBI under Section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, and alternative investment funds registered with SEBI.

Major aspects of the provision have been analysed as below-

Layers of Ineligibility

An assiduous analysis of Section 29A reveals that the section imposes four layers of ineligibility, as mentioned below-

  • First layer ineligibility, where the person itself is ineligible;
  • Second layer ineligibility, i.e. where a “connected person” is ineligible;
  • Third layer ineligibility, i.e. being a “related party” of connected persons; and
  • Fourth layer ineligibility, where a person acting jointly/in concert with a person suffering from first layer/second layer/third layer ineligibility, becomes ineligible.

 

 

Clause (c): The NPA Criterion

Clause (c) of Section 29A debars a person or a person acting jointly or in concert with such person who-

  • has an account classified as NPA;
  • is a promoter of a corporate debtor the account of which has been classified as NPA;
  • is in the management of a corporate debtor the account of which has been classified as NPA;
  • is in control of a corporate debtor the account of which has been classified as NPA.

At least a period of 1 (One) year should have elapsed from the date of classification till the insolvency commencement date. Therefore, any company (including the promoters/persons in the management of or control of such company) which has its account classified as NPA for last 1 (One) year will not be able to file a resolution plan however, the Code provides for a carve out that such person shall be eligible to submit the resolution plan if such person makes payment of all overdue amounts with interest thereon and charges relating to non-performing asset accounts before submission of resolution plan. See also, clause (j) of Section 29A.

Clause (g): Vulnerable Transactions

According to clause (g) of Section 29A, a promoter/person in the management of or control of a corporate debtor in which a preferential transaction (Section 43), undervalued transaction (Section 45), extortionate credit transaction (Section 50), or fraudulent transaction (Section 49) have taken place and the adjudicating authority has passed an order under the Code. The provision is qualified to the extent it uses the term “corporate debtor”, and that the adjudicating authority should have passed an order under the Code itself.

Clause (h): Guarantor executing guarantee in favour of the applicant creditor

The negative list includes persons who might have guaranteed the obligations of the corporate debtor which is currently in insolvency. As the provision goes, a person who has executed enforceable guarantee in favour of a creditor in respect of a corporate debtor against which an application for insolvency resolution made by such creditor has been admitted under the Code. Going by the construction of the clause, it appears that the guarantee should be in favour of that creditor who has applied for insolvency resolution of the corporate debtor.

The provision came up for discussion in RBL Bank Ltd. v. MBL Infrastructures Ltd. [CA(IB) No. 543/KB/2017; order dated 18.12.2017], where NCLT took a view that there was no intent of the Government to debar all the promoters, only for the reason for issuing a guarantee which is enforceable, unless such guarantee has been invoked and not paid for, or the guarantor suffers from any other antecedent listed in section 29A. The resolution applicants stated that by purporting to disqualify the entire class of guarantors under the said clause would be violative of the valuable rights of the applicant. If the guarantee is not invoked and demand is not made on the guarantor, the debt payable by him is not crystallized and the guarantor cannot be therefore said to be in default for breach of the guarantee and be penalized merely because a legal and binding contract of guarantee exists, which is otherwise impossible but is subject to its invocation in accordance with the terms of the guarantee. The NCLT agreed to the view observing that the guarantors in respect of whom, a creditor has not invoked the guarantee or made a demand under guarantee should not be prohibited. Therefore, no default in the payment of dues by the guarantor has occurred, cannot be covered under clause (h) of Section 29(A). It cannot be the intent of clause (h) to penalize those guarantors who have not been offered an opportunity to pay by calling upon them to pay the dues, by invoking the guarantee. Therefore, the words “enforceable guarantee” appearing in clause (h) are not to be understood by their ordinary meaning or in the context of enforceability of the guarantee as a legal and binding contract, but in the context of the objectives of the Code and Ordinance in general and clause (h) in particular.

Clause (j): Connected persons

The word “connected persons” appear in clause (j) of section 29A. A person who is connected to the persons as defined under the Explanation, shall be disqualified if the other person suffers disability under clause (a) to (i) of section 29A.

“Connected persons” have been defined so as to include three categories –

Explanation.— For the purposes of this clause, the expression “connected person” means-

(i) any person who is the promoter or in the management or control of the resolution applicant; or

(ii) any person who shall be the promoter or in management or control of the business of the corporate debtor during the implementation of the resolution plan; or

(iii) the holding company, subsidiary company, associate company or related party of a person referred to in clauses (i) and (ii):

The definition can be analysed as follows-

  1. Clause (i) includes:
    1. promoter;
    2. person in the management; and
    3. person in control

of an ineligible resolution applicant.

Further, in accordance with clause (iii),

  • where (a) or (b) or (c) is a company, the holding, the subsidiary, and the associate companies or “related party” of (a), (b), (c) (as the case may be), shall also be disqualified.
  • where (a) or (b) or (c) is a natural person, any “related party” of such person shall also be disqualified.

 

  1. Clause (ii) basically seeks to debar persons from submitting resolution plans in which persons suffering from disabilities mentioned under Section 29A are proposed as promoters or in the management of or in the control of the corporate debtor during implementation of the resolution plan. It includes-
    1. would-be promoter;
    2. person, would-be in the management; and
    3. person, would-be in control

of the corporate debtor, who suffer from disqualification under section 29A.

For example, A wants to submit resolution plan for B Ltd. A proposes that C shall be in the management of B Ltd. during the implementation of the resolution plan. However, C is a person suffering disability under Section 29A. A, therefore becomes ineligible to submit resolution plan.

Further, in accordance with clause (iii),

  • where (a) or (b) or (c) is a company, the holding, the subsidiary, and the associate companies or “related party” of (a), (b), (c) (as the case may be), shall also be disqualified.
  • where (a) or (b) or (c) is a natural person, any “related party” of such person shall also be disqualified.

For scope of the term “related party”, see below.

Note that from the scope of “holding company, subsidiary company, and associate company”, the following have been excluded, i.e. the following can proceed to submit the resolution plan-

  • a scheduled bank; or
  • an ARC registered with RBI under section 3 of the SARFAESI Act, 2002; or
  • an AIF registered with SEBI.

Related party

“Related party” has been defined in Section 5 (24); however, the definition is specific to corporate debtor, i.e. the definition specifies the persons who shall be treated as “related party’ of the corporate debtor. Hence, where the persons referred to in clauses (i) and (ii) of the Explanation are persons other than the corporate debtor, the definition under section 5(24) becomes irrelevant, and the following may be noted-

  • Where one of the person is a company, “related party” shall be interpreted in terms of section 2(76) of the Companies Act, 2013;
  • Where none of the persons is a company, the definition of the term “related party” has been left open. In the context of natural persons, generally the term “relative” is used.

Associate Company

For the purpose of determining whether a company is an associate of the other, the definition as under Section 2(6) of the Companies Act, 2013 shall be referred, wherein “Associate company”, in relation to another company, means a company in which that other company has a significant influence, but which is not a subsidiary company of the company having such influence and includes a joint venture company.

For the purpose of the said definition, “significant influence” means control of at least 20% (twenty per cent) of total share capital, or of business decisions under an agreement.

For example- “Company X” holds 20% of total share capital of Company “Y”, then Company X will be deemed to be an associate company of Company Y.

Relevant time- whether lookback allowed?

A relevant question would be regarding the point of time at which the ineligibility has to be ascertained. The language of the section suggests that only present status of the resolution applicant has to be seen. No lookback period has been prescribed. However, the authors opine that it would be upon the committee of creditors to decide on whether any past event shall be weighed upon while making the final decision.

More of a Diktat?

The Code has been designed to find the best possible way out for an ailing entity- it was meant to be more inclusive in approach. However, the reach of Section 29A extends to four layers (as explained above), and may lead to exactly opposite results. The intent of the Code was not to restrict genuine applicants, but only to exclude participation from habitual miscreants or applicants who might themselves be sick, however, Section 29A may result in elimination of persons who might be interested in buying stakes in the entity.

See RBL Bank Ltd. v. MBL Infrastructures Ltd. [CA(IB) No. 543/KB/2017; order dated 18.12.2017], where the NCLT, considering the objective of the Ordinance, 2017, opined that clause (h) of section 29A is not to disqualify the promoters as a class for submitting a resolution plan. The intent is to exclude such class of persons from offering a resolution plan, who on account of their antecedents, may adversely impact the credibility of the processes under the Code. The case is, for the time being, pending with NCLAT[3].

The Code was designed to find the best possible way out for an ailing entity- it was meant to be more inclusive in approach and there was definitely no intention to avoid promoters from submitting resolution plans. However, the reach of Section 29A extends to four layers (as explained above), and may lead to exactly opposite results. It is quintessential to ensure that the citadel of insolvency resolution does not have holes into it but at the same time, it is also important to ensure that the citadel is not inaccessible, with no steps, doors or windows.

The intent of Section 29A will be counter- productive if it results into a whole lot of intending resolution applicants being disentitled, because the recursive definitions of related party, connected persons etc are cast wide enough, intertwining all the entities promoted by an entity.


[1] http://ibbi.gov.in/webadmin/pdf/legalframwork/2017/Nov/180404_2017-11-24%2007:16:09.pdf

[2] http://ibbi.gov.in/webadmin/pdf/legalframwork/2018/Jan/182066_2018-01-20%2023:35:29.pdf

[3] Last update as on 10.02.2018.

An Insight on Direct Selling Guidelines, 2016 Pyramid Schemes vis-a-vis MLM

By Saloni Mathur (finserv@vinodkothari.com)

Introduction

There has been a shift in the paradigm of the performance of the direct selling agents. The role and responsibilities of the direct selling agents have witnessed a revolution, where they are required to comply with certain codes as prescribed by the government from time to time, and follow certain practises while discharging their responsibilities. The RBI’s master directions[1]on the outsourcing norms have put stringent compliances on the service providers while discharging their functions, and increased responsibility and monitoring on the part of the non-banking financial companies. The question that arises here is whether those non- banking companies complying with the outsourcing guidelines, fall under the ambit of the direct selling guidelines also and if they, then what is the nature of the applicability of these direct selling guidelines on them.

According to a report on the Indian direct selling industry published by FICCI and KPMG, the direct selling market in India has grown at a CAGR of 16 per cent over the past five years to reach INR75 billion today.[2] Due to this unprecedented rise in direct selling industry and the growth of a large distribution base, major scams have been witnessed over the years in reputed companies owing to the nature of marketing methods adopted by them.

The Government of India, Ministry of consumer affairs, food and public distribution, department of consumer affairs, vide its notification number F.No.21/18/2014-IT (vol II) dated 09th September, 2016 modelled certain guidelines on the direct selling regulating the business of direct selling and the multi-level marketing.

This article is an attempt to envisage the rationale behind these guidelines and the applicability of these guidelines on the direct selling agents and the various compliances that are required to be made by the direct selling entities and the direct sellers.[3] Further this article also takes into account the concept of Multi-level marketing and the pyramid schemes with reference to the applicability on the direct selling agents.

Rationale behind the launch of the Scheme

The direct selling industry has brought about with itself a huge reservoir of marketing, selling and distribution base for the goods and services, which has given rise to various fraudulent practises in the marketing and the distribution system. Instances can be drawn from the famous Amway and the Qnet case where entire money in the chain was earned only through the recruitment of new members and adding more participants to the channels of distribution, rather than the actual sale of the goods and services. Though the Amway was convicted of “illegal pyramid scheme” it could finally escape all criticism under the umbrella of the “the Amway safeguard rules”. However, the case has left strong marks of scepticism in the validity of the direct selling business.

The companies which were engaged in multi-level marketing were carrying out various frauds through the recruitment of large number of participants in the system. Thus, a need was felt where a robust system of direct selling guidelines was required to protect the interest of the consumers.

Defining the Pyramid and the MLM schemes

Defining the Pyramid Scheme

“Pyramid Scheme” as defined in the guidelines mean a multi layered network of subscribers to a scheme formed by subscribers enrolling one or more subscribers in order to receive any benefit, directly or indirectly, as a result of enrolment, action or performance of additional subscribers to the scheme. The subscribers enrolling further subscriber(s) occupy higher position and the enrolled subscriber(s) lower position, thus, with successive enrolments, they form multi-layered network of subscribers.

The key feature of the pyramid is that as the entrants in the last layer of the pyramid continue to get more and more participants who pay money. By way of this a hierarchy is created and the sponsor who holds the top most position is the recipient of the highest commission. The Amway case is the perfect example of the “illegal Pyramid scheme” where the purpose of the scheme was to make money through recruiting more distributors at various levels.

The pyramid scheme is illegal in India under the Prize chits and Money Circulation Schemes (banning) act, 1978. Hence there is a non-applicability of this scheme.

Following are some of the key constituents of the Pyramid Schemes

High registration fees

The basic quality of a pyramid scheme is that there is a high registration and entry fees upfront that the participants in the scheme have to pay. The entry fee is so high that the participants holding top position get a very high commission fees.

Goods sold at a price higher than the fair value and a higher quantity that is generally sold in the market

The goods and services under the pyramid schemes are not sold at the fair value. Fair value means the price at which the goods and services are generally available in the market. If the goods are sold to the consumers at a price higher than what is a general fair market price, it is a pyramid scheme.  Similarly, if the goods are sold at a quantity higher than what is expected to be consumed by, or sold, resold to consumers, it will constitute to be a pyramid scheme. The price of the goods and services have a higher component of commission cost rather than the actual product price. The price of the product generally has 70% commission cost and remaining 30% cost of the product.

The level of unsold inventory

Under the pyramid schemes the unsold inventories of the participants is not generally brought back by the distributor.

Emphasis on the recruitment of more members

There is a greater emphasis on the recruitment of more members rather than promoting and distributing the product. The purpose here is to fetch higher commissions for the sponsors at the top most level.

No material contract between the direct selling entity and the direct seller

There is no material agreement entered between the direct selling entity and the direct seller on buy back, refund, repurchase policy of the unsold inventory.

No cooling off period

There is no cooling off period given to the direct sellers up to which they can cancel the contract.

Defining the Multi-level Marketing (MLM) scheme

In an MLM structure, multi-level marketing or the network marketing are used to sell the products directly to the consumers in which the salesmen are compensated not only for the work done by them but also for the sales of the people who have joined the company through them.[4]

The main purpose of the MLM scheme is to ensure wide distribution of the products or services and the intent is to sell the product through a network of wide range of distributors. Thus, it is just a marketing strategy unlike a fraudulent pyramid scheme where there are tangible distribution of the goods and services.

Comparing the MLM and the ‘Pyramid’

The big difference between multilevel marketing and a pyramid scheme is in the way the business operates. The entire purpose of a pyramid scheme is to get distributors’ money and then use it to recruit other distributors. The entire purpose of MLM is to move the product and ultimately achieve the sales of the product. The theory behind MLM is that the larger the network of distributors in a chain, the more products the business will be able to sell. Therefore, whether it is a pyramid scheme or an MLM approach depends upon the legality of the schemes and the purpose behind their operation as the Pyramid scheme is illegal.

Defining key concepts under the ‘direct selling guidelines 2016’

‘Direct selling’ has been clearly defined in regulation 6 which means marketing, distribution and the sale of the goods or providing of any services as a part of network of direct selling other than under a pyramid scheme.

Thus, what constitutes to be a direct selling is based on four conditions i.e direct selling has to be marketing, distribution, and selling of the goods and services as a part of network of direct selling. Thus all the four conditions need to be qualified simultaneously for determining direct selling. Thus, a direct selling agent, if restricts its services only to marketing of products and not to selling and distribution would not be required to comply with these guidelines.

Similarly, the network is defined as an arrangement of intersecting horizontal and vertical lines. To be a network it is therefore necessary that there is a hierarchy of a direct selling agents such that there is a superior subordinate relationship at all levels of distribution

The ‘network of direct selling’ means a network of direct sellers at different levels of distribution who may recruit or sponsor further levels of the direct sellers, who they then support. “Network of direct selling” shall mean any system of distribution or marketing adopted by a direct selling entity to undertake direct selling business and shall include the multi-level marketing method of distribution.

This network of direct sellers also includes the multi-level marketing method of distribution.

Thus, network of direct selling shall be hierarchical. Single level of distribution would not constitute any network.

Comparing the network, the Pyramid and the MLM

The network may be at a horizontal level also. For example, if there is one direct selling entity selling goods and services through a single level of the direct sellers, all at the same level shall constitute a network. However, Pyramid necessarily has to be a vertical hierarchy such that there should a superior subordinate relationship. Multi-level marketing shall have to a be a legal marketing strategy and not a fraudulent scheme.

Understanding the applicability of the scheme

The applicability of the above guidelines on the direct and selling agents have to be checked from the following facts:

This scheme is applicable on the following companies.

  1. Companies engaged in marketing as well as selling and distributing the products simultaneously under the network of direct selling.
  2. All the multi-level marketing schemes such that there are different levels of distribution and the participants are at different distribution levels. Here the participants at the same level of distribution shall not be required to comply with the scheme.
  3. Company carrying its operations through a hierarchical multi-level system.
  4. Companies appointing the direct selling agents in such a way, such that they are sponsoring or carrying out recruitment further so that a large network of distribution is created
  5. Companies that have relevant clauses in the outsourcing agreement and which specifically reflect the outsourcing or subcontracting of the service to the third parties.
  6. Companies requiring direct selling agents to pay high membership fees and greater entry costs.

Non-Applicability of the guidelines to Pyramid schemes and companies having only one level of distribution

The guidelines shall not be applicable to the pyramid scheme. This is because these schemes are generally money-making schemes and not any legal marketing strategy. This comes from the fact that pyramid schemes are generally created not to market the products, but to create a distributor base for earning large money through promotion. Thus, the direct selling guidelines take a legal view and apply to only legal MLM schemes and direct selling.

Further the companies having only a horizontal distribution base such that they are not recruiting or sponsoring further levels in the chain shall be kept out of the purview of these guidelines.

Quick compliance checklist for direct selling guidelines 2016

  1. All direct selling companies in India shall submit an undertaking to the department of the consumer affairs within 90 days from 12th September 2016.
  2. Direct seller cannot receive remuneration or incentive for the recruitment/enrolment of the new participants.
  3. Direct sellers can only receive remuneration derived from the sale of goods or services
  4. Direct seller shall carry its identity card and not visit the customers premises without prior intimation/approval.
  5. Direct selling company cannot force its direct sellers to purchase more goods or service than they can expect to consume or sell.
  6. Direct selling company cannot demand any entry fee/registration fee.
  7. Company must provide every participant written contracts describing the material terms (buy back, re-purchase policy, cooling period, warranty and refund policy.
  8. Mandatory orientation session with accurate information for the newly recruited direct selling agents
  9. There shall be prohibition of the pyramid scheme and the money circulation scheme.
  10. There shall be a monitoring authority to deal with the issues related to the direct selling.

Conclusion

There is no scepticism regarding the benefits of the direct selling guidelines on the interest of the consumers in prevention of the frauds against them, however comprehending the applicability of these directions is a hard nut to crack for various entities who are in a dilemma to comply with these guidelines. The guidelines do not specifically state the extent of the applicability; however, they do give certain apparent indications to the entities to whom these guidelines shall be applicable.

Thus, any company desirous of increasing their distribution base for selling wide range of products or services and who intend to do it by creating a hierarchical distribution that requires further outsourcing and recruitment shall be required to comply with the guidelines. Further the outsourcing agreement between the DSA and the service provider shall clearly state the provisions regarding contracting and the sub-contracting, subsequent to which only a network of distributors could be created.


[1] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/NT87_091117658624E4F2D041A699F73068D55BF6C5.PDF

[2] https://www.souravghosh.com/blog/direct-selling-guidelines-2016/

[3] http://consumeraffairs.nic.in/writereaddata/Direct%20Selling%20guidelines.pdf

[4] https://www.icsi.edu/WebModules/LinksOfWeeks/JuneCS_2014.pdf