Summary of Important Supreme Court Judgements on IBC

Team Resolution | resolution@vinodkothari.com

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Group Insolvency: Relevance of Substantive Consolidation in Indian Context

– Vinod Kothari and Sikha Bansal[1] | resolution@vinodkothari.com

Introduction

Insolvency law has always to be aligned to economic realities; when it comes to solving the problem of corporate insolvencies, an economy cannot disregard the prevalent corporate structures. The design which corporates adopt to conduct business must, in fact, be one of the most critical factors while designing the insolvency laws.  Thus, if group assets, contracts, technological assets, investments or intellectual or other business rights remain scattered across a complicated group of intertwined entities, an insolvency law framework that remains constrained by the bounds of “legal entity” is unlikely to achieve the objective of ensuring preservation and, in case of liquidation, equitable distribution of corporate value for the benefit of stakeholders.

Propagation of group structures in India

Therefore, the key question to start is: do Indian businesses have complex group structures, involving layers of entities, whether legally structured as subsidiaries or not? An OECD report, prepared  with significant inputs from SEBI[2], citing data collected from 4100 listed companies as of December 2020, says that there are on an average 50 subsidiaries for listed companies forming part of NIFTY-50, a number which has tripled over the last 15 years. It goes further to say that there are 15 listed companies which have more than 100 subsidiaries, whereas there are some which have over 200. Further, out of the 100 largest listed companies by market capitalization, approximately 40 India listed companies had three or more layers of subsidiaries/step-down subsidiaries, surpassed only by Singapore and Malaysia among OECD countries.

If the numbers stated in the above survey are surprising, it must be submitted that these numbers do not incorporate (a) number of layers on the top of the listed entity, that is, the chain of holding companies or companies; (b) associates, as quite often, the shareholding may be split across several group entities with none of them having sufficient holding to be termed as holding company; (c) the chain of companies above or below a listed company where the chain is snapped by use of a chain-breaker, that is, an entity which itself is not a subsidiary of the listed entity, but owns or is owned by a vertical chain of entities. The plausible economic reasons for existence of group structures are: efficiencies in operations, reduced dependence on external finances, and economies of scale. And as such, one would often see overlaps in asset use (e.g. asset of one entity being shared across group entities, or used as security against borrowings of entities), liabilities (group entities being joint obligors, third party security providers), common stakeholders (shareholders, directors, lenders, etc.) across group entities. However, such complex group structures have the potential to house complex web of transactions, thereby increasing the opacity of such structures and chances of wrongdoings, misconduct and lawlessness. Holding entities are most commonly employed to raise finance for group holdings, using pledge of operating companies’ shares, and use such borrowings to finance the operating companies. It is also commonplace practice to have a group’s brand or intellectual property owned by a promoter group entity. As there were many cases where group transactions were involved and/or put to question by the courts during insolvency proceedings[3].

The complete article has been published in the “Annual Publication 2023: IBC – Evolution, Learnings and Innovation” and can be accessed on the link here, from Page 281 onwards.

[1] With research support and assistance, gratefully acknowledged, by Neha Malu

[2] https://www.oecd.org/corporate/ca/Company-Groups-in-India-2022.pdf

[3] Yadubir Singh Sajwan & Ors. Vs. M/s. Som Resorts Private Limited [Company Petition No. (IB)-67(ND)/2022], ArcelorMittal India Pvt. Ltd. v. Satish Kumar Gupta [Civil Appeal nos.9402-9405 OF 2018] etc.

ARC rights to use SARFAESI for debts assigned by non-SARFAESI entities

– Archana Kejriwal

Asset reconstruction companies, formed under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (‘SARFAESI Act’/‘the Act’) are an important part of the country’s ecosystem to tackle non-performing loans. ARCs buy and resolve non-performing loans by acquiring them from the financial system.

ARCs were traditionally focusing on acquiring large corporate loan exposures. However, recently, there is increasing participation of the ARCs in retail loans. When ARCs buy retail loans, it is quite likely that the lender or the loan does not qualify for SARFAESI right when the loan was with the lender. This may be either because of the nature of the lender (NBFCs having assets of less than Rs 100 crores) or the size of outstanding (less than Rs 20 lakhs). In such cases, once the ARC acquires the loans, will it have the rights under the SARFAESI Act?

The question becomes important, because in case of corporate loans, the advantage that ARCs had over the original lender was one of aggregation, that is, ARCs acquiring loans given to the same borrower by various lenders, and thus getting significant strength in relation to the borrower. This cannot be the case, obviously, with retail loans. Hence, if the acquiring ARC is no better than the outgoing NBFC, in what way does the transfer of the loans help to accelerate the recovery?

In this article, we discuss this important question.

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Rainbow versus Raman: A Riddle so crucial and so hard to resolve

– Vinod Kothari

The heart of insolvency law is the priority order or the waterfall given in sec. 53, and one of the very crucial issues in the priority of secured creditors is whether statutory claims will rank at par with secured creditors by virtue a provision in the respective laws giving the Government a status of a secured creditor, or will have to rank at the fifth priority as provided by sec. 53 (1) (e), there is a situation of uncertainty.

Essentially, the statute will have to step in, because courts can only interpret the law as seen and read by the courts; courts cannot mend the law to meet what might have been the design of the law. On the contrary, if the lawmakers leave the law as is, liquidators will have to face claims, as they already are facing, from state governments claiming equality of ranking with secured creditors, even though many liquidations might have already closed or distributed their assets.

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Clog on redemption of mortgage after publication of sale notice – SC reiterates word of law u/s 13(8)

– Team Resolution | resolution@vinodkothari.com

Introduction

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 ( ‘SARFAESI Act’) provides methods that can be undertaken by a secured creditor to recover its dues in case of a default.

Section 13 of the SARFAESI Act being an important section contains provisions relating to ‘Enforcement of Security Interest’. Sub-section (2) and (4) of section 13 describes the manner and timeline within which the creditor can enforce its rights to recover the dues against a Non-Performing Asset (‘NPA’). While, on one hand, the creditor has a right to sell the secured asset; in juxtaposition is the right of the borrower to have the property released on repayment of dues. These rights are in conflict with each other and therefore, there is a need to have clarity around the point of time at which the borrower would lose the right of redemption and the lender’s right of sale becomes absolute.

At this stage, section 13(8) of the SARFAESI Act comes into picture. The present provision of section 13(8) states that where any default has been made by the borrower in terms of repayment of the dues, the amount outstanding if repaid by the borrower at any time before the date of publication of auction notice by the creditor, such a creditor shall not have any further right to transfer or to take any other step in relation to transfer of such secured asset. On a contrary, the earlier provision stated that the right of the borrower to redeem the mortgaged property shall be available till the date fixed for sale or transfer.

The provision of section 13(8) has often been debated upon wherein, several High Courts have held different views. However, a recent ruling of the Hon’ble Supreme Court in the matter of Celir Llp v Bafna Motors (Mumbai) Pvt. Ltd.[1] , has clarified the position and scope of section 13(8) before and after the amendment.

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Defaulters at will, and defaulters of size: RBI proposes new Directions: Middle and Upper Layer NBFCs also part of the system

Team Finserv, Vinod Kothari Consultants 

finserv@vinodkothari.com

Introduction

The Reserve Bank of India on September 21, 2023 has issued the Draft Master Directions on Treatment of Wilful Defaulters and Large Defaulters (‘Proposed Directions’). The Directions, when finalised, will replace the existing Master circulars (referred below). The draft Directions are largely consolidating in nature, with some significant differences. Importantly, NBFCs of middle and upper layer have been brought into the framework, and additionally, as was clear from the recent circular on compromise/settlements, the tag of willful defaulter may be removed if the borrower does a compromise settlement with the lender. However, a mere sale of the loan will not cause removal of the tag, as the tag will pass on to the buyer. The draft Directions also assimilate the provisions about large defaulters, which was earlier a CIC filing requirement, and make it a part of these Directions.

While a default itself is bad for a bank, where the default is backed by ability, but unwillingness to pay, it assumes a different level of seriousness. Such a borrower, and the entities that such borrower promoters or fosters, should remain deprived of further assistance from the financial system.

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CIRP (Second Amendment Regulations), 2023 – A snapshot

– Team Resolution | resolution@vinodkothari.com

The Insolvency and Bankruptcy Board of India (IBBI), has, vide notification dated 18th September, 2023 introduced the IBBI (Insolvency Resolution Process for Corporate Persons) (Second Amendment) Regulations, 2023 (‘CIRP Amendment Regulations’/ ‘Amendment Regulations’) effective from 18th September, 2023, so as to further streamline the insolvency resolution process. 

The amendments (discussed below) provide some relaxation to the stakeholders thereby extending the timeline for submitting claims. Further, an attempt has also been made to provide assistance to NCLT Benches for dealing with applications u/s 7 or 9 for admission/rejection of claim. However, the obligation of the Resolution professionals (RPs) have also been  increased as the amendment now requires the RPs  to not just take handover of the assets of the Corporate Debtor (CD) but also verify asset by asset list of the CD,  tally the same with the financials of the CD, and to report the same while making application u/s 19(2), if not found in conformity with the assets shown in the financials of the CD. Also, for condonation of delay of claims filed by the stakeholders, the amendment now requires the RP to file application before AA.

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Delving further into Preferential Transactions: NCLAT studies section 43 in light of Jaypee ruling, SC upholds

Shaivi Bhamaria | resolve@vinodkothari.com

When a corporate person undergoes Corporate Insolvency Resolution Process (‘CIRP’) or liquidation process, there is an obvious presumption of precedent financial stress, and hence, all the transactions that have an adverse bearing on the financial health of the distressed corporate person, at the cost of stakeholders, come under the scanner. There is a look-back period, which, based on global equivalents, has been fixed at 2 years prior to commencement of CIRP in case of transactions with related persons, and 1 year prior to commencement of CIRP in other cases. The Insolvency and Bankruptcy Code, 2016 (‘the Code’) has titled such transactions as ‘avoidance transactions’. Such avoidance transactions are classified into 4 categories in the Code, viz- (a) preferential transactions (b) undervalued transactions (c) transactions defrauding the creditors and (d) fraudulent transactions. The provisions with respect to avoidance transactions are inspired by the UK Insolvency Act.

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