Supreme Court’s status-quo on Essar Steel-How the tables could turn for ArcelorMittal!

– CS Megha Mittal

(mittal@vinodkothari.com)

[This article is intended for academic debate on the law around powers of the Committee of Creditors vis-à-vis the adjudicatory authorities, as it continues to evolve]

As anticipated by many, the finish line for Essar Steel still seems to be distant and blurry. Pursuant to an appeal filed by the creditors against the order of the Hon’ble National Company Law Appellate Tribunal in the matter of Standard Chartered Bank v. Satish Kumar Gupta, R.P. of Essar Steel Ltd. & Ors, the Hon’ble Supreme Court, vide its order dated 22.07.2019, has ordered a status-quo on the sale of Essar Steel India Limited to ArcelorMittal India Private Limited (AMIPL/ ArcelorMittal).

In what seems to be an inspiration from the amendments approved by the Union Cabinet on 17.07.2019, the Apex Court has upheld the distinction between financial and operational creditors. In an interim, the Hon’ble Supreme Court has directed that the Monitoring Committee, comprising of the members of the Committee of Creditors and the Resolution Professional to continue its work until the matter is heard on 07.08.2019

While the Apex Court hears the matter “expeditiously”, in the following write up, we shall analyse the order of the Hon’ble NCLAT.

In its notable judgement, the NCLAT, in the matter of Standard Chartered Bank v. Satish Kumar Gupta, R.P. of Essar Steel Ltd. & Ors, reiterated the principle of equitability/proportionality between the rights of financial creditors and operational creditors, echoing, with probably with much greater clarity and stress, its earlier views in Binani Industries Limited v. Bank of Baroda & Anr. In the course of the ruling, the Hon’ble NCLAT also makes certain observations about the dos and don’ts of the Committee of  Creditors (CoC) and the ambit of the powers vested upon them, which continue to add to the evolving body of law on the delicate balance between creditors’ supremacy and the role of the adjudicatory body., also discussed in the our article titled “Role of Adjudicating Authority in Approving/ Rejecting a Resolution Plan”, authored by Ms. Richa Saraf & Ananya Raghuvendra.

The ruling also makes extremely interesting observations about the (ir)relevance of section 53 to the framing or prioritisation of claims in case of a resolution, initiating a completely new line of thinking.

More than being just another matter in the list of insolvency cases in India, the Essar Steel matter has always been in the spotlight, not only for its sheer magnitude in the core sector to which the company belongs, but also  for the significant judicial principles being determined by the authorities. One amongst the “dirty dozen” cases, the SBI-initiated insolvency process of Essar Steel has now extended way beyond the statutory period of 180/270 days; with only a month left for the insolvency process to turn two, NCLAT has finally upheld the Resolution Plan of ArcelorMittal India Private Limited (ArcelorMittal/ AMIPL), approved by Hon’ble National Company Law Tribunal, Ahmedabad Bench on 8^th March, 2019, however, subject to modifications.

In its order dated 4^th July, 2019, NCLAT, along with several other questions of law, has taken a stride towards determining the role of the (CoC) in the CIRP and the various portents of a resolution plan, mainly around the distributive justice involved in the plan. The Order can be segregated into two main segments: one dealing with eligibility of ArcelorMittal u/s 29A of the Insolvency and Bankruptcy Code, 2016, (Code/ IBC) and the other dealing with various questions of law around the resolution plan. In this article, we are not concerned with the first set of issues; we focus on the second one only.

Equitable Treatment of Similarly Situated Creditors

What seems to be one of the most prevalent principles throughout the order, is upholding the spirit of equitable treatment of the creditors. The initial Resolution Plan gives indications of an arbitrary discrimination, not only between the financial and operational creditors, but also between the various sub-classes from amongst the same category of creditors. While one class of the financial creditors was proposed to get a hefty 92.5% of their dues, the Operational creditors on the other hand were either nominally assessed at Re. 1/- or were proposed to get 0% of their dues. This plan when put before NCLT, Ahmedabad, was approved with the condition that Operational creditors who have dues below Rs. 1 Crore must be paid in full. It is for this very reason that the aggrieved Operational Creditors, filed an appeal before NCLAT for rejection of the Resolution Plan proposed by AMIPL.

CoCs consist of financial creditors only; they sit and decide on the fate of all creditors. Their interests compete with others, because the limited size of the cake will be cut and apportioned between competing claimants, in a situation of deep shortfall. The apparent question of conflict of interest has already been settled by the Apex Court in Swiss Ribbons Pvt. Ltd. & Anr v. Union of India & Ors, whereby the constitutionality of the structure of CoC was upheld. Therefore, the fact that the CoC consisting of financial creditors can arbiter on the fate of operational creditors is already a settled part of the Indian law. However, the NCLAT is certainly not prepared to allow the CoC the ability to conveniently leverage its position to approve a plan that was in all obvious ways, inclined in interests and favour of financial creditors. Further, there has been an interesting issue of delegation of powers to the so-called “Core-Committee” comprising of only selective members handpicked from the CoC, discussed in the ruling *

It was observed that the Financial creditors are at the same page as the Operational Creditors as “claimants” from the Corporate Debtor and hence, are in a position of conflict of interest while determining distribution amongst the creditors, especially when the maximum chunk of such distribution falls in the basket of the financial creditors. As also observed in the order and the BLRC Report, the CoC, are bestowed with the power to approve resolution plans for the very reason that members of the CoC being institutions having sound infrastructure andrisk assessing capabilities, shall be much more proficient in analysing and assessing the commercial viability and feasibility of the resolution plans, vis-à-vis theoperational creditors.

As they say, “With great power comes great responsibility”; the CoC too, owes duty to the Code to not take unfair advantage of their position as laid down in the Code; rather, they must be suitable enough to approve those resolution plans which give a fair and equitable treatment to all classes of creditors. It must be noted that the term “equitable” does not connote “equal”; rather, it means that the principles applied to determine the basis of payment to operational creditors shall be the same as that for the financial creditors.

Regulation 38 (1) (b) of the Insolvency and Bankruptcy Code (Corporate Insolvency Resolution Process), 2016 (CIRP Regulations) makes it mandatory for a resolution plan to identify sources of funds to pay to the operational creditors, a sum equivalent to the liquidation value, in priority to the FCs. This implies that a mere mandate for provision of liquidation value due to operational creditors does not rule out a value higher liquidation value for Operational Creditors.

Further, Regulation 38(1A) of the CIRP Regulations, states that a resolution plan shall include a statement as to how it has dealt with the interests of all stakeholders, including financial creditors and operational creditors, of the corporate debtor. It must however be noted that the term “shall” is to be read as “must” as it imposes on a resolution applicant, a duty to comply with the requirements as laid down by the Code in order to ensure the protection of interests of all stakeholders.

The Appellate Authority went on to remind its ruling in Binani Industries Limited v. Bank of Baroda & Anr., wherein it observed that, if the misplaced notions and misreading of section 30 of the Code lead to discrimination against the OCs, it shall act as a demotivator for all those who supply goods and services on credit, which most definitely is not what the Code seeks to achieve. Hence, it is necessary to balance the interests of the FCs and the OCs, while maximization of the assets of the Corporate Debtor. Therefore, the Appellate Authority held that, “Any ‘Resolution Plan’ if shown to be discriminatory against one or other ‘Financial Creditor’ or the ‘Operational Creditor’, such plan can be held to be against the provisions of the ‘I&B Code”

Also, for ensuring equitable treatment of similarly situated creditors, the Hon’ble Supreme Court in “Swiss Ribbons Pvt. Ltd. & Anr.” (Supra) noticed the ‘UNCITRAL Guidelines’ and observed:

“70. Quite apart from this, the United Nations Commission on International Trade Law, in its Legislative Guide on Insolvency Law [“UNCITRAL Guidelines”] recognizes the importance of ensuring equitable treatment to similarly placed creditors.”

  The Hon’ble Supreme Court in the said case further observed:

 “71. The NCLAT has, while looking into viability and feasibility of resolution plans that are approved by the committee of creditors, always gone into whether operational creditors are given roughly the same treatment as financial creditors, and if they are not, such plans are either rejected or modified so that the operational creditors’ rights are safeguarded. It may be seen that a resolution plan cannot pass muster under Section 30 (2)(b) read with Section 31 unless a minimum payment is made to operational creditors, being not less than liquidation value.”

Hence, it is clear that while looking into viability and feasibility of the ‘Resolution Plan’ it is important to note whether the ‘Operational Creditors’ should be given roughly the same treatment as ‘Financial Creditors’, and if they are not, such plans are either rejected or modified so that the ‘Operational Creditors’ rights are safeguarded

Powers of the Committee of Creditors

On perusal of the Order, one may understand that the most significant take-away from the 116 pager order, is the regulation of powers of the Committee of Creditors. Based on the facts that have arisen in the instant matter of Essar Steel, the Appellate Tribunal has very comprehensively laid down its observations w.r.t. the powers of CoC.

Right to delegate its powers-

As discussed earlier, the facts of the instant case, suggest the formation of a “Core-Committee” comprising of only selective members handpicked from the CoC. However, it must be noted neither does the Code provide for, nor does it recognize the existence of any such committee. Hence, constitution of such committee, without the backing of any substantial grounds is an act of the CoC vires its powers. Though the facts suggest that such Committee was formed for operational and technical matters like representation before the Adjudicating Authorities, the Committee has definitely acted in excess of its powers, as “resolution plans” are the very essence of the corporate insolvency process and cannot be decided upon by such committee on their own whims and choices.

It is essential to note that the quorum as provided for in Regulation 21 read with Regulation 25 of the CIRP Regulations, provide that no voting can take place and no matter can be decided upon, even if one member of the CoC is absent. Such a provision is made to ensure the application of mind by all the members so that the pros and cons of the matters, here, Resolution Plan can be effectively assessed. Hence, in such a set-up, constitution of such sub-committee, influencing the resolution plan and determination of manner of distribution, evidently frustrates the intent of the Code and is beyond the scope of powers of that the Code bestows upon the Committee of Creditors.

Determination of distribution amongst the creditors:

As discussed above, Regulation 38(1A) of the CIRP Regulations, clearly requires a resolution applicant to provide a statement as to how it has dealt with the interests of all stakeholders, including financial creditors and operational creditors, of the corporate debtor. Hence, one can draw inference that the power and the responsibility to provide distinct distribution amongst the creditors is that of the resolution applicant and not the CoC.

Hence, the Appellate Tribunal, in its order held that:

“139. Therefore, we hold that the ‘Committee of Creditors’ has no role to play in the matter of distribution of amount amongst the Creditors including the ‘Financial Creditors’ or the ‘Operational Creditors’. The ‘Committee of Creditors’ is only required to notice the viability, feasibility of the ‘Resolution Plan’, apart from other requirements as specified by the Board and ineligibility of the ‘Resolution Applicant’ in terms of Section 29A”

It was further appreciated by the Hon’ble NCLAT that, any question of distribution amongst the creditors, and/or the amount a particular creditor is entitled to receive, is for the Resolution Applicant to decide, not the CoC. The role of CoC is limited to assessing the feasibility and viability of the plan. The CoC shall not interfere in the contents of the plan, especially into the matters of distribution.

 While the Appellate Tribunal, in the matter of Darshak Enterprise Private Limited v. Chhaparia Industries Pvt. Ltd, held that in a particular case, what should be the percentage of claim amount payable to one or other Financial Creditor or the Operational Creditor or Secured Creditor or Unsecured Creditor can be looked into by the CoC based on facts and circumstances of each case. However, the aforesaid decision is not applicable in the present case, as the Appellate Tribunal held that it is the Resolution Applicant who is required to decide the manner in which the distribution to be made amongst all the stakeholders including the Financial Creditors, Operational Creditors and other creditors. It is only when such distribution is found to be discriminatory and to find out what should be the percentage of the claim amount payable to one or other Financial Creditors or Operational Creditors, the CoC, may negotiate and may ask the Resolution Applicant to prepare revised chart re-distributing the amount in favour of Creditors in a manner which is non-discriminatory by providing same treatment to all the stakeholders.

To make commercial decisions

Though the extant Code states that the CoC shall take commercial decisions, it does not explicitly lay down as to what constitutes “commercial.” In such a scenario, based on the infrastructural and evaluation capabilities of the Coc, the Appellate Tribunal in its order has enumerated four key commercial decisions which the CoC is required to take, which are:

• To assess whether the business of corporate debtor is viable or not, and to make all endeavours to rescue such a corporate debtor which is viable and close the one which is not.
• Where the corporate debtor is viable, the CoC must, by its own prudence and creativity, visualise as to what shall be the essential ingredients of the Resolution Plan so as to reorganise the corporate debtor in such a way that it ensures speedy revival of the corporate debtor.
• To ensure that the corporate debtor continues to be a “going-concern” during the insolvency process, at its optimum potential and safeguard the assets of the ‘Corporate Debtor
• To consider only those resolution plans that abide by the provisions of the Code, are feasible and viable and have provision for effective implementation.

Hence, from the above discussions, it can be summarised that the role of the CoC is similar to that of a fiduciary, as all decisions taken by the CoC have a significant impact on the insolvency process and the success or failure of the insolvency process is nothing but a function of the actions taken by the CoC.

Permissibility of inter-se classifications:

The Resolution Plan proposed by AMIPL, shows that the proposed distribution amongst the creditors, not only differentiates the creditors as financial and operational, it rather percolates to the next level and provides for an inter-se classification in both the categories. However, the question that arises here is that whether such inter-se classification is permitted.

The definition of “creditors” as provided for u/s 3 (10), visibly identifies five categories of creditors viz. financial creditor; operational creditor; a secured creditor; unsecured creditor, and decree-holder. However, the definition of neither of these five classes provides for further classifications and hence there cannot be any inter-se classification that leads to differential treatment of the creditors.

One may note that the definition of “operational creditors” under section 5 (20) provides for three separate classes i.e.

1. Those who have ‘supplied goods’ and ‘rendered services’ and thereby entitled for payment.
2. The employees who have ‘rendered services’ for which they are entitled for payment
3. The Central Government, the State Government or the Local Authority who has not rendered any services but derive the advantage of operation of the ‘Corporate Debtor’ pursuant to existing law (statutory dues).

However, such classification, too, does not give a leeway for differential treatment of similarly placed creditors.

Thus, we understand that the Code does not provide for inter-se classification that leads to differential treatment of similarly placed creditors.

Application of section 53 of the Code:

Section 53 of the Code, which provides for priority of distribution of assets during liquidation, is widely acknowledged as the basis of determining distribution of payments during CIRP too. However, the Appellate Tribunal in its order, has laid down that section 53 of the Code shall not be applied to the distribution provided for under CIRP, for the reason that Resolution Applicant proposes the distribution of debt to the Financial Creditors, Operational Creditors and other stakeholders out of the amount proposed to be paid by the ‘Resolution Applicant’, whereas, on the other hand, after liquidation, debt is distributed out of the assets of the Corporate Debtor, and hence, to treat these two as similar situations shall not be valid.

Can distribution parameters be different between insolvency and liquidation?

One of the very important principles, almost marking a watershed in the thought on the issue so far, is that the waterfall/priority order of section 53 is not relevant for a resolution plan. Of course, while doing so, the Hon’ble NCLAT has gone through the language of section 53 which refers to distribution of liquidation estate or the assets of the corporate debtor. In case of resolution, it is not a question of distribution of the liquidation estate or the assets of the corporate debtor; it is a question of distirbution of the money brought by the resolution applicant.

However, the key principle is – insolvency laws are all about distributive justice; are the principles of distributive justice different in case of a resolution rather than liquidation? Bankruptcy is a situation of helplessness and therefore, terminal in nature. Resolution is a stage of helpfulness, and therefore, recuperative in nature. But the key issue in both is the same – there is a deficit of assets to meet liabilities. Can it be argued that the priorities in resolution may be different than liquidation?

Analogically, Company Voluntary Arrangement (CVA) is to UK Insolvency Act, what Resolution Plan is to IBC. Once the CVA is approved by the creditors they are provided a lump-sum payment in lieu of their debts. However, on the basis of several judicial precedents under the UK Insolvency Law[1], it is clear that a supervening liquidation under the UK Insolvency Act does not affect the distributions decided upon under the CVA. This gives a clear implication that distribution during Administration or Winding Up is based to similar rationales and principles, focusing on equitability rather than stage of insolvency.

Further, in a different context, the so-called “vertical approach” adopted under CVA[2], which provides that a creditor must be in better position as compared to when the company goes into liquidation, helps us draw inspiration that the waterfall mechanism U/s 53 of IBC shall also apply to distribution under CIRP, for the reason that if the priority is not maintained under CIRP also, creditors might be in a detrimental position during CIRP, something which the Code does not aim at.

If the priorities in liquidation are not applicable to resolution, it may be well be argued that a secured creditor, who has priority in liquidation, will not be put in the same footing in resolution. However, that will be “unfairly prejudicial” to a class of creditors, because no resolution, which is a debtor-creditor agreement, can be prejudicial as compared to what the statute promises to a secured creditor.

Of course, there is no issue in an RA promising to pay higher than the liquidation values, but the liquidation value must still be the minimum in any resolution. And liquidation values do come from so-called liquidation analysis, which has to be done according to section 53. So, whilst it may be argued that section 53 is not the only guiding factor in resolution distribution, but section 53 must form the bedrock.

 Acknowledging the fact the two situations are separate events during the entire CIRP, Liquidation process, it shall not be correct to totally delink the section 53 of the Code with CIRP process. The author wishes to draw attention to the fact that section 53 acts as the basis to understand the rationality and grounds of distribution even during CIRP and hence, distribution under CIRP can be inspired from section 53 of the Code.

As the crux in both situation remains ensuring the best of interest of the creditors, the two situations have an obvious nexus and hence, to delink the two shall not be in line with the Code.

In what might be a turn of events for ArcelorMittal, we now wait to see the ultimate fate of the long-drawn Essar insolvency as written down by the Hon’ble Supreme Court.

[1] See: Re Halson Packaging Ltd [1997] BCC; Re Arthur Rathbone Kitchens Ltd [1998] BCC 450;

[2] See: Mourant & Co Trustees Limited & another v Sixty UK Ltd (in liquidation) & others [2010] EWHC 1890 (CH); Prudential Assurance Company Ltd v PRG Powerhouse Limited [2007]