Schemes under Section 230 with a pinch of section 29A – Is it the final recipe?

-Sikha Bansal (resolution@vinodkothari.com)

Note: This article is in continuation of/an addition to our earlier article wherein the author discussed various aspects pertaining to schemes of arrangement in liquidation under section 230 of the Companies Act, 2013 read with various provisions of the Insolvency and Bankruptcy Code, 2016. The author has described various factors and principles which the judiciary may consider while sanctioning a scheme of arrangement for companies in liquidation, how a scheme is different from a resolution plan or a going concern sale, what constitutes ‘class’ in the context, whether the waterfall under section 53 will apply to such schemes, etc. The author also pointed out the lack of clarity as to applicability or inapplicability of section 29A on such schemes. However, very recently, NCLAT has clarified that persons ineligible under section 29A are not qualified to propose a scheme during liquidation. This Part discusses this ruling and ponders upon some questions which still remain open-ended/unanswered.


The conundrum as to whether section 29A of the Insolvency and Bankruptcy Code, 2016 (‘Code’) will apply to schemes under section 230 of the Companies Act, 2013 (‘Companies Act’) has been put to rest, at least for the time being, by a recent ruling of the National Company Law Appellate Tribunal (‘NCLAT’). In  Jindal Steel and Power Limited v. Arun Kumar Jagatramka & Gujarat NRE Coke Limited (Company Appeal (AT) No. 221 of 2018), vide order dated 24.10.2019, NCLAT held, while a scheme under section 230 is maintainable for companies in liquidation under the Code, the same is not maintainable at the instance of a person ineligible under section 29A of the Code. The NCLAT relied on the observation of the Hon’ble Supreme Court in Swiss Ribbons Pvt. Ltd. & Anr. v. Union of India & Ors., WP No. 99 of 2018, that the primary focus of the legislation is to ensure revival and continuation of the corporate debtor by protecting the corporate debtor from its own management and from a corporate death by liquidation.

Permissibility of schemes in liquidation under the Code has already been upheld in a string of rulings[1] as well as dealt with under the Liquidation Regulations; as such, we are not detailing the same. However, it would be interesting to see what all concerns and questions may arise while taking into account the impact of section 29A on the schemes.  It might be relevant to note that in Y. Shivram Prasad v. S. Dhanapal & Ors., Company Appeal (AT) (Insolvency) No. 224 of 2018, NCLAT explicitly observed that “As the liquidation so taken up under the ‘I&B Code’, the arrangement of scheme should be in consonance with the statement and object of the ‘I&B Code’”.

Therefore, the scheme, though formulated and approved under the Companies Act, has to be within the four corners of the Code. In essence, the schemes of arrangement and compromise will remain subjected to the principles followed during insolvency proceedings. This appears to the present stand of the judiciary.

  1. Who can and who cannot be the proposer?

A bare reading of section 230 of the Companies Act makes it clear that the company or a creditor or a member or in case of a company being wound up, the liquidator of the company can apply. In Rasiklal s Mardia v. Amar Dye Chemical Ltd., Company Appeal (AT) No.337 of 2018[2], NCLAT held that liquidator is only an additional person and not exclusive person who can move application.  Hence, in general, even when a company is under liquidation under the Code, a creditor, a member or the liquidator can propose a scheme of arrangement under section 230[3].

However, given the recent NCLAT ruling in Gujarat NRE (supra), as of now, the settled position is that a creditor/member who is otherwise ineligible under section 29A is not qualified to be a proposer of a scheme. As such, schemes under section 230 cannot be said to be “surrogate” route for the defaulting promoters to acquire the corporate debtor after a failed resolution.

The rationale, as is understood, is the design of the Code and the intent of section 29A which the SC dealt elaborately in Swiss Ribbons (supra)[4]. Section 29A is directed to oust the former management from taking control of a falling entity which they could not prosper/run. As such, allowing the persons to take recourse to a scheme will defeat this objective.

It might be interesting to note that the Insolvency and Bankruptcy Board of India, in its Discussion Paper on Corporate Liquidation Process along with Draft Regulations, discussed the interplay between section 230 and section 29A[5], however, there was no conclusive/explicit provision in the Amended Liquidation Regulations.

As to whether a member/creditor can directly make an application to NCLT, in Y. Shivram (supra), NCLAT directed that if the members/creditors (or a class of them) approach the company through the liquidator for compromise or arrangement by making proposal of payment to all the creditor(s), the liquidator on behalf of the company will move an application under Section 230 to NCLT.

Given that, only persons named in the section can file a scheme; where the petitioner is not the actual propounder of the scheme with a view to revive the company for the benefit of the company, but they have merely lent their names to a propounder who does not qualify under the section, the application for sanction of scheme is liable to be dismissed. See S Krishna Murthy v. Hoysala Building Development Co. (P.) Ltd. (2012) 113 SCL 409 (Kar)[6]. Further, while an outsider (a person other than a creditor/member) cannot propose a scheme, yet there is no bar on the outsider being a beneficiary of the scheme and being bound by the scheme.

  1. Whether the schemes can provide for retention of existing promoters/management

The question becomes relevant in the context to understand how and in what manner the schemes can impact section 29A persons. Generally, such persons would be majority shareholders of the corporate debtor. Is it possible to contend that even though a section 29A person will not qualify to propose a scheme under section 230, the rights of such persons as shareholders/directors can remain intact under the scheme? As in, is it possible to maintain status quo and/or retain substantial shareholding and management rights of the former promoters under the scheme?

Say for instance, there is a proposed scheme which envisages one-time settlement such that ‘A’, an outsider, infuses loan into the company to pay-off its existing lenders, without any substantial change in existing shareholding/management structure of the company. Assuming that the scheme gets requisite approval(s) from creditors/members, can the scheme be rejected by the NCLT?

Retention of existing management/promoters might not be directly hit by section 29A; however, the question as to its tenability is yet to be examined. In any case, it must be emphasised that the objective of the Code is not to oust the management, who might have failed for purely no fault of their own[7], but to revive the company, and promote entrepreneurship. While in general, an incoming resolution applicant/scheme proposer would induct fresh equity and managerial resource in the company, there might be cases where the resolution applicant/proposer of scheme requires continued presence of existing management for the latter’s expertise, which might be necessary for revival of the business. Further, section 29A or any other provision of the Code no-where debar continuation of existing management/promoters. Hence, each case will have to be assessed separately.

  1. Who can participate and vote in the meetings?

Another interesting question is whether persons ineligible under section 29A can participate and vote in the class meetings. Will such persons be entitled to notice of the meetings and a copy of the schemes?

A consequential concern is whether the number and shareholding of such persons will be included in the numerator/denominator for the purpose of determining the supermajority requirement[8]. If section 29A persons are not allowed to vote, the answer to this question would be automatically ‘no’, for the ‘present and voting’ rule.

Section 230 of the Companies Act requires that the notice of the meeting shall be sent to all creditors/members enclosing therewith a statement containing details of the scheme and the effect of the scheme on creditors, promoters, non-promoter members, etc. Further, there is no embargo on participation and voting rights of any member/creditor. As such, there is no discrimination as to related/unrelated members, or eligible/ineligible members. If the person is a member/creditor, he is entitled to vote.

When one looks at the corresponding provisions for approval of a resolution plan, while there is no question of directors/members voting (as they are not members of CoC), they are entitled to have the notice of the meeting (see section 24) and participate in the same. Further, SC in Vijay Kumar Jain v. Standard Chartered Bank and Ors., Civil Appeal No. 8430 of 2018, held that the directors[9], being vitally interested in resolution plans that may be discussed at meetings of the committee of creditors, must be given a copy of such plans as part of documents that have to be furnished along with the notice of such meetings. More so, as the directors might have given guarantees and as such will be bound by the resolution plan.

Applying the analogy, even a section 230 scheme is binding on all the members/creditors or class of members/creditors, as the case may be; therefore, it can be contended that the schemes shall also be provided to the members, whether covered under section 29A or not. The fact that in most cases, the shareholding of the promoter shareholders will be eroded as per the schemes, also supports the view. Insofar as voting is concerned, given the design and intent of the Code, it might be possible to say that a member ineligible under section 29A shall not be entitled to vote.

Notably, wide powers vest with NCLT to address objections, if any, to the scheme, as also noted by NCLAT in Y. Shriram (supra). NCLAT observed that during proceeding under section 230, if any objection is raised, it is open to the NCLT to pass order under section 230 to overrule the objections, if the arrangement and scheme is beneficial for revival of the corporate debtor. While passing such order, the NCLT is to play dual role, one as the Adjudicating Authority in the matter of liquidation under the Code and other as a Tribunal for passing order under section 230 of the Companies Act. Therefore, it shall be open for any member of the corporate debtor, whether or not covered by section 29A, to invoke the remedy before NCLT.

  1. Closing Remarks

Whether the issue of applicability of section 29A on section 230 schemes has reached finality, is difficult to say. There are few critical issues such as participation and consent, voting thresholds, etc. that need further clarification in the framework during the liquidation proceedings. However, it can be said that a section 230 scheme does not, in any manner, takes the corporate debtor back to pre-insolvency days, and the scheme will be impacted by the insolvency proceedings which the corporate debtor had been subjected to, so far.


[1] See S. C. Sekaran Vs. Amit Gupta & Ors., Ajay Agarwal v. Ashok Magnetic Ltd. , Rajesh Balasubramanian v. Everon Castings Pvt. Ltd. and Y. Shivram Prasad v. S. Dhanapal.

[2] The case, however, did not pertain to the Code. In any case, the principle must squarely apply to liquidation cases under the Code.

[3] The law is already settled in the context of corresponding section 391 of the Companies Act, 1956. See discussion in A Ramaiya’s Guide to the Companies Act [18th Edition, pg. nos. 3704-3705, “Who can apply?]

[4] SC states, “The saying of Jesus comes to mind – if the blind lead the blind, both shall fall into the ditch. The legislative policy, therefore, is that a person who is unable to service its own debt beyond the grace period referred to above, is unfit to be eligible to become a resolution applicant.”

[5] See Para 3.3.3 of the Discussion Paper.

[6] Source: A Ramaiya’s Guide to the Companies Act [18th Edition, pg. no. 3705]

[7] Ironically, BLRC in its report, distinguished between ‘malfeasance’ and ‘business failure’ – see Para 3.2.3 “Drawing the line between malfeasance and business failure”.

[8] Section 230(6) – Majority of persons representing three-fourths in value of the creditors, or class of creditors or members or class of members, as the case may be, voting in person or by proxy or by postal ballot.

At the outset, it might be interesting to note that in case of resolution plan, the voting threshold for approval is 66%. Therefore, given the sequence, the requirement of 3/4th or 75% majority for a scheme, after a resolution plan has failed for want of 66% majority, may not seem plausible. Though, in former case, the threshold is determined taking into consideration persons ‘present and voting’ only.

[9] Note that members (shareholders), per se, are not entitled to notice of CoC meetings. The provision covers only directors. Hence, only such members who are directors, can participate in the meetings.

Other Articles:

Proposed Group Insolvency Framework in India

Home Buyers Provisions in IBC

Amendment in Liquidation Regulations

1 reply
  1. Vinod Kothari
    Vinod Kothari says:

    Schemes of arrangement during winding up has been there ever since – the intuitive idea always was that the initiation of winding up should not mean it is too late for a revival. If there is a hope, there is a way, and that is the scheme. Globally, schemes of arrangement during liquidation have also been used to restructure with the full flexibility of the Companies Act, without being delimited to insolvency principles (essentially, the priorities). However, globally we do not have the equivalent of sec. 29A – hence, in India, NCLAT rulings have super-imposed section 29A on a Companies Act provision. Thereby, the scheme is basically no different from resolution during liquidation. Hence, IBBI has initiated a basic rethinking on whether at all schemes during liquidation have any relevance at all.
    My submission is -schemes have been used all over the world. Schemes are member-creditor arrangement. If a contract can revive the company, we don’t have to wait for law to kill it.

    Reply

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