Forced Contributions to Infructuous Liquidations: Understanding Regulation 2A
-Megha Mittal
Since its inception, the Insolvency and Bankruptcy Code, 2016 (“Code”), along with its regulations, has been subject to many reforms, some aimed at establishing new legal principles and some for removing difficulties faced during the insolvency resolution and/ or liquidation process; one such reform was the introduction of Regulation 2A[1] in the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 (“Liquidation Regulations”), which provides for contribution by financial creditors of the corporate debtor to contribute towards liquidation costs, if so called upon by the liquidator.
In this article, we shall briefly understand the backdrop in which the said provision was introduced, throw light upon the extant provisions and then address the elephant in the room- is it obligatory upon the financial creditors to make such contribution when sought by the liquidator?
Need for meeting deficits in the liquidation fund- The Backstory
A common observation from the 3 years’ experience with the Code was that shortages in liquidation funds, even to carry out basic functions, had become a rampant issue. Liquidators were forced to continue to the liquidation process amidst acute shortage of funds; hence leading to a compromise in the sense that optimal results could not be achieved because of lack of resources.
This concern was acknowledged and put to the fore by IBBI in its Discussion Paper[2] wherein it was proposed that secured financial creditors of the corporate debtor “may be obliged to bring in interim finance to run the CD as a going concern or liquidate the CD, if there is no liquid assets available to defray these expenses. However, if there is no asset, the Insolvency and Bankruptcy Fund under section 224 of the Code may be operationalised and allowed to support the liquidation proceedings for specific expenses within limits in the manner prescribed /specified”
Key takeaways from the proposition placed in the Discussion Paper would be:
- Only such financial creditors which have a secured debt, and are financial institutions (FIs) shall be considered for seeking contribution. The simple rationale behind exclusion of other financial creditors was that it may not be feasible for individual or retail creditor to make such contributions, as unlike financial institutions, they lack the strong infrastructure as well as resources;
- The text of the proposal suggests that it may be obligatory upon such FIs to make such contribution; and
- If there are no assets to recover at all, unnecessary burden may not be imposed on the FIs, and support could be directly sought from the Insolvency and Bankruptcy Fund, which however, remains non-operational till-date.
However, proposals of the Discussion Paper do not become the law- hence, the actual position can only be assessed on the basis on what actually formed part of the Liquidation Regulations. In the following section, we shall discussion the provisions of Regulation 2A, and its impact.
Meeting the Liquidation Costs- What does the law say?
At this juncture, it is important to note that insertion of Regulation 2A must be read in synchronization with Regulation 39B[3] of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (“CIRP Regulations”) which also provides for meeting liquidation costs.
Regulation 39B of CIRP Regulations- Estimation of Liquidation Costs
As per Reg. 39B, while approving a resolution plan or deciding to liquidate the corporate debtor, the committee of creditors (“CoC”) may make a best estimate of the amount required to meet liquidation costs, in consultation with the resolution professional, in the event a liquidation order is passed by the adjudicating authority. Along with the estimated costs, the CoC shall also make a best estimate of value of the liquid assets available to meet the estimated costs. Now, in case the estimated cost is in excess of the available liquid assets, the CoC shall approve a plan “providing for contribution for meeting the difference between the two”. Such plan is to be submitted by the resolution professional to the adjudicating authority along with the submission of resolution plan or decision of CoC to liquidate the corporate debtor.
In this pre-text, attention must be drawn to the fact that Reg. 39B (1) provides that the CoC may make such estimation, thereby implying that, at the very outset, it is not mandatory or compulsory for the CoC to make such estimation. However, if such estimation is at all made, a plan may be proposed to meet the deficit, if any, and be voted upon by the CoC.
A noteworthy aspect here is that no distinction has been made between retail financial creditors and FIs- thus, once the CoC approves a plan for contribution to liquidation costs, and the same is approved by the adjudicating authority, it is now as good as a contract between the financial creditors (forming part of CoC) and the corporate debtor through its liquidator. What is its relevance? We shall discuss in the latter half of this section.
Having discussed the above, the question that arises in here is what if no such plan has been approved- enters Regulation 2A of the Liquidation Regulations.
Regulation 2A of Liquidation Regulations- Understanding provisions
As mentioned above, Regulation 2A comes into the picture when no plan has been reached upon by the CoC, but the deficit exists. Simply put, Regulation 39B and Regulation 2A are mutually exclusive- if one happens, the other does not.
Regulation 2A (1) provides that
“Where the committee of creditors did not approve a plan under sub-regulations (3) of regulation 39B of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, the liquidator shall call upon the financial creditors, being financial institutions, to contribute the excess of the liquidation costs over the liquid assets of the corporate debtor, as estimated by him, in proportion to the financial debts owed to them by the corporate debtor”
It further provides that such contribution shall be deposited in a designated escrow account within seven days of liquidation commencement.
Now, first questions first, what would possibly motivate the FIs to chip in more money into the corporate debtor? The answer is the assurance of a super priority in repayment[4] and interest[5] thereupon.
Despite this one ray of motivation, the author humbly submits that a holistic reading of Regulation 2A with other related provisions of the Liquidation Regulation, render the same to be self-contradictory and not-so-viable.
Where on one hand a liquidator can only assess the claims after atleast 30 days of liquidation commencement[6] , it does not seem practically possible viable that the liquidator can call as well as deposit the contribution all within 7 days of commencement. To counter this loophole, let us assume that the resolution professional is appointed, and hence is aware of the FIs that can be called for contribution. However, now we need to shift focus on Regulation 21A of the Liquidation Regulations which allow the secured financial creditors (including FIs) to decide whether or not they intend to relinquish their security. Thus, it would be a cardinal concern as to how can the liquidator seek contribution from FIs (including secured FIs) unless and until the secured creditor has agreed to relinquish its security?
Further, in addition to above, the most significant question that remains unattended is whether the FIs would be necessarily obligated to make such contributions.
Contribution by FIs- Obligatory or Optional
In terms of the extant position of law, it is the duty of the liquidator to call for contribution; however, it remains unclear whether there is a corresponding liability upon the FIs to make the same. While one line of thought would be affirmative, courtesy- intent as set out in the Discussion Paper; a larger proportion of stakeholders contend otherwise.
The author here, is also of the view that such contribution cannot be made mandatory upon the FIs for the reasons discussed herein below-
Intent vs. Law
As mentioned above, the intent, as is understood from the Discussion Paper suggests that contribution must be obligatory; however, nothing has been imbibed in the Liquidation Regulations to reflect the same. Thus, while the intent may be used as a tool to contend a stance, the nature of liabilities can only be assessed on the basis of the extant law. Hence, in absence on any explicit provision implying mandatory contribution, the same cannot be imposed on the FIs.
Obligations under a contract
Another point of argument in favour of obligatory contribution could be that Regulation 39B of the CIRP Regulations mandates the CoC to contribute as per the approved plan. As mentioned earlier, the contribution plan once approved by the CoC and the adjudication authority, takes on the nature of a contract, thereby binding its parties to ensure performance of their obligations.
However, nothing in Regulation 2A implies a contract, or a mere agreement or undertaking by the FIs to contribute to the cost. Instead, the fact that no contribution plan was approved during CIRP hints at the financial creditors’ (including FIs’) stance to not contribute towards the deficit. Thus, seeking mandatory contribution from the FIs, sans any underlying agreement cannot be held as valid.
Imposition of obligation- vires the scope of a ‘regulation’
For dealing with the instant question, it is important to note that the question of contribution arises out of a regulations. Neither is it pursuant to a Rule, nor does it form part of the substantive law to the Parliament. To formulate regulations is the power of the Insolvency and Bankruptcy Board of India (“Board”), conferred upon it under section 196 of the Code. The purpose of formulating regulations is essentially to complement the principal law (here, the Code). Hence, the Liquidation Regulations must at all times adhere to the Code. Thus, imposing a liability or obligation upon the creditors, where nothing in the Code provides for the same, is a clear breach of its powers.
Further, requiring creditors to contribute to expenses, in a case where nothing is likely to be recovered, is akin to casting an obligation or expense on a person, which amounts to expropriation of property- No such obligation can be cast except on the authority of a law of parliament[7]. Therefore, Regulations 2A cannot force creditors to contribute towards the liquidation costs.
Good money for bad money
One must understand that when calling for contribution from FIs, it expected that the FIs would chip in more ‘good money’ to recover their ‘bad money’. Besides, despite such contribution, there remains no guarantee and/ or assurance that the FIs would recover their bad money. Further, in a worst-case scenario that realisation from assets could not cover the liquidation costs also, lenders may run into the prospect of having to lose all their debt, and yet end up paying for liquidation costs.
Thus, commercial viability of investing fresh money in the corporate debtor cannot be made subject to a straight-jacket obligation; instead it must be left upon the discretion of the FIs who may assess the viability depending upon several factors like risks associated vis-à-vis their risk appetite, quantum of contribution, expected realisation from the assets, their position in the waterfall (since the FIs may be secured or unsecured).
Lop-sided position for Unsecured FIs
Financial dues, especially by FIs, are generally secured- however, it might not always be the case. Thus, in a scenario where the FIs is an unsecured creditor, the interest would be dis-balanced. While the contribution from the unsecured FI would help in realising the assets, there would be bleak chances of recovery for its own debt, reason being its latter standing in the order of priority under section 53 of the Code.
Thus, obligating the unsecured FI to make contribution would impose a liability, whereby the unsecured FI must sow, but shall not reap.
Hence, it may be deduced that expecting all FIs to mandatorily contribute would be simply turning Nelson’s eye towards the concerns raised above. Having said so, it can also not be ignored that the deficit actually exists, and must be met to continue the liquidation process. Thus, if the FIs chose not to contribute, what would be the recourse?
How to ensure funding- an alternate recourse
Firstly, it must be clarified that the question here is whether or not it should be obligatory upon the FIs to contribute. The author does not discourage the proposition of contribution, but favours that the same be made subject to discretion of the FIs. Hence, it must not be assumed that there will be no contribution at all.
If in view of the FIs the contribution seems reasonable, the same might be made and the deficit would be met. However, what would be the recourse for the liquidator if there is no contribution at all? Here, there may be possible routes- (a) Funding from the Insolvency and Bankruptcy Fund; or (b) application before the adjudicating authority seeking suitable orders.
As proposed in the Discussion Paper, one way-out could be seeking assistance and support from the Insolvency and Bankruptcy Fund of India, in terms of section 224 of the Code. However, until the same is operationalised, another window would be to file an application before the adjudicating authority, seeking suitable orders, whereby the adjudicating authority, it deems fit, may direct the financial creditors to contribute towards the liquidation cost, on a case-to-case basis.
In this pretext, it is reiterated that the idea of compulsory contribution by the financial creditors seems disproportionate, and must be subject to their discretion.
[1] Inserted vide the IBBI (Liquidation Process) (Amendment) Regulations, 2019– Notification No. IBBI/2019-20/GN/REG047 dated 25th July, 2019
[2] Dated 27th April, 2019- https://ibbi.gov.in/Discussion%20paper%20LIQUIDATION.pdf
[3] Inserted vide the IBBI (Insolvency Resolution Process for Corporate Persons) (Amendment) Regulations, 2019– Notification No. IBBI/2019-20/GN/REG048 dated 25th July, 2019
[4] The revamped definition of “Liquidation Costs” under Regulation 2 (ea) of the Liquidation Regulations includes contribution received from FIs under Regulation 2A or 39B and interest thereupon
[5] See Regulation 2A (3) of Liquidation Regulations.
[6] As per Regulation 12 (2) (b) of Liquidation Regulations, the last date for submission or updation of claims, shall be 30 days from the liquidation commencement date.
[7] Article 31 of the Constitution of India states that “no person shall be deprived of his property save by authority of law”
Our related articles-
(i) http://vinodkothari.com/2019/07/liquidation-regulations-wide-ranging-far-reaching-changes/
(ii) http://vinodkothari.com/2019/07/amendment-in-liquidation-regulations/
Leave a Reply
Want to join the discussion?Feel free to contribute!