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.

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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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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Statutory dues cannot override section 53: Supreme Court clarifies the applicability of Rainbow ruling

– Barsha Dikshit | resolution@vinodkothari.com

Introduction 

Section 53 of Insolvency and Bankruptcy Code, 2016 (‘IBC’) has created a waterfall citing priority of dues. Whether it is distribution in liquidation process or resolution plan – both processes would need to honour the priorities under Section 53 of IBC. However, in September, 2022, in State Tax Officer v. Rainbow Papers Ltd., the Hon’ble Supreme Court (SC) held that by virtue of the ‘security interest’ created in favour of the Government under GVAT, the State is a ‘secured creditor’ as per the definition in IBC. Hence, as workmen’s dues are treated pari passu with secured creditors’ dues, so should the debts owed to the State be put at the same pedestal  as the debts owed to workmen under the scheme of section 53(1)(b)(ii). [Read our detailed analysis on Rainbow Papers ruling here]. As such, this ruling led to anomalies in interpretation, as it shuffled the already well-settled view on priorities of tax dues vis-a-vis secured creditors. 

Interestingly, the recent ruling of SC in Paschimanchal Vidyut Vitran Nigam Ltd. Vs. Raman Ispat Private Limited & Ors. [Civil Appeal Nos. 7976 of 2019] has confined the applicability of Rainbow Papers to its own factual circumstances, thereby, providing relief to all stakeholders, especially IPs undertaking liquidation/resolution processes, who started receiving demands from tax authorities on the strength of Rainbow Papers.

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GoAir Insolvency: Lessors’ rights gone in thin air?

– Financial Services Division, finserv@vinodkothari.com

A Special Bench of NCLT,  New Delhi admitted the insolvency of Go Airlines (India) Ltd, popularly known as GoAir, on the 10th May 2023. The insolvency was admitted on an application of the company itself, on the ground of a self-admitted default of Rs. 11.03 crores towards interest to financial creditors, out of a pile of debt, that is, Rs. 2660 cr towards aircraft lessors and Rs. 1202 cr towards its vendors. The application was admitted in the face of strong opposition by the financial creditors and the lessors of aircrafts taken on lease by the company.

Subsequently, on an appeal before the NCLAT, the appellate forum affirmed the order of the NCLT, rejecting the contention that the filing of the insolvency application was malicious. The matter may still be taken up to higher or other forums, but in the meantime, there are question marks on India as a favoured jurisdiction for aircraft leasing. Aircraft lessors need certainty as to the exercise of their rights over the leased aircraft in the event of a lessee default, and the Cape Town Convention (CTC), signed under the auspices of UNIDROIT way back in 2021, is a set of minimum assurances that the countries signing that convention have provided to aircraft lessors. The question is, India having actually been a signatory to the Convention, is it okay to have stayed the rights of the lessors by way of a moratorium during the entire period of insolvency resolution?

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NCLAT gives a go signal to the Go Airlines insolvency application

– Neha Malu, Senior Executive & Tanay Dubey, Legal Intern | resolution@vinodkothari.com

Background

In India, airline companies prefer acquiring aircrafts through lease rather than buying them. According to a report released by PwC, as of 2018, around 80% of India’s commercial aircrafts are leased, much more than the global average of leased commercial aircrafts as compared to commercial aircrafts in use, 53%. According to the report, airlines prefer leasing aircrafts predominantly due to two reasons: first, the lower overall cost of leasing which allows the airlines company to spend available capital on giving price advantage to the price sensitive customers in India and; second, because of the shorter fleet replacement cycles, leasing aircrafts provides airlines an option to quickly increase or decrease the capacity, thereby keeping the fleet younger.

Go Airlines, an ultra-low-cost airline, possesses a fleet of 54 aircraft, with the majority obtained through leasing arrangements with different aircraft lessor companies. Unfortunately, the airline is currently facing financial difficulties caused by the non-delivery of engines from Pratt and Whitney (P&W), a US-based jet engine manufacturer. As a result, they have been compelled to ground over 50 planes. Due to concerns about the feasibility of the CIRP and the airline’s revival, the lessors want to recover their aircrafts from the airline.

Go Airlines (‘Corporate Applicant’) has been defaulting towards the aircrafts lessors, vendors, and financial creditors from 2022 onwards. In order to keep the company as a going concern and retain the possession of leased aircrafts, the Corporate Applicant filed an application under Section 10 of Insolvency and Bankruptcy Code, 2016 (‘IBC’). The umbrella of moratorium was opened for Go Airlines after its voluntary application for resolution under section 10 of IBC was admitted by the NCLT leading to a complete prohibition on transfer of any of the leased aircrafts which were in possession of Go Airlines as on the date of admission of the CIRP application. In the present case, though the lessors of the aircrafts had terminated the lease agreement days before the admission of the CIRP application by NCLT, the possession remained to be transferred to the lessor as on the date of admission.

An appeal was preferred by the lessors against the order of the NCLT contending that the said application was filed with fraudulent and malicious intent. Further, the lessors were not given the notice providing for an opportunity of hearing before admitting the application. In addition to this, given the fact that the lease agreement was cancelled by the lessor prior to the admission of CIRP application, the Corporate Applicant has no legal right to claim possession and moratorium under Section 14(1)(d) of IBC on the assets of the lessor.  

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Income tax issues in IBC

-Vinod Kothari and Sikha Bansal | finserv@vinodkothari.com

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Comments on the MCA Discussion Paper on changes being considered to IBC, 2016

– Team Resolution, Vinod Kothari and Company | resolution@vinodkothari.com

The Ministry of Corporate Affairs (‘MCA’) issued a Discussion Paper on 18th January, 2023 on changes being considered to the Insolvency and Bankruptcy Code, 2016 (‘Discussion Paper’). Since the very inception of the Insolvency and Bankruptcy Code, 2016 (‘IBC’), it has undergone six amendments besides, several amendments in the respective regulations. However, the proposals in this Discussion Paper seem to be the most comprehensive one – covering all major aspects of the law.

Broadly speaking, the amendments proposed in the Discussion Paper can be categorized as follows:

  1. Proposals that try to overcome past difficulties:
    1. Voting in CoCs, direct dissolution, etc
    2. Enhancing the scope of pre-packs and fast track insolvency
  2. Proposals that codify amendments in regulations already done or IBBI circulars:
    1. Mandatory filing of information of default with IU
    2. Presumption of relinquishment of security interest
  3. Proposals to override or respond to some court rulings:
    1. Vidarbha Industries Power Limited v. Axis Bank Limited
    2. State Tax Officer v. Rainbow Papers Limited
    3. Gujarat Urja Vikas Nigam Limited v. Amit Gupta & Ors
  4. Fundamental or progressive amendments:
    1. Partial resolution
    2. Collapsing the levels in the waterfall
    3. Separation of resolution and distribution
    4. Resurrection of entity from liquidation to resolution
    5. Aggregation of assets of guarantors
    6. Collaboration for the purpose of group insolvency
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