Insolvency and Bankruptcy Code, 2016 (“IBC” or the “Code”) will be completing two years after Chapters II and III pertaining to the provisions relating to Insolvency Resolution and Liquidation for Corporate Persons and Liquidation Process became operational. The Code has proved its purpose and several crores of rupees have been recovered either by way of settlement between the creditor and the corporate debtor, putting in place an acceptable resolution plan or through liquidation of the corporate debtor.
The Code has undergone a couple of amendments including twice through Ordinance route. Committees were constituted to examine the gaps and suggest improvements. It is still evolving to become a complete Code.
Some of the provisions of the Code are yet to be brought into force. When the Code is implemented in full, there could be a manifold increase in the number of cases. The present set up of National Company Law Tribunal (NCLT) and Debts Recovery Tribunal (DRT) would be finding it difficult to cope with the increase in the number of cases. It is required to augment the number of NCLT/ DRT to handle the volume so that the old defaults are addressed and the corporate debtors and borrowers are disciplined.
A scrutiny of cases where resolution plan had been approved indicates that the initial gainers were the operational creditors, who recovered their dues by filing application under the Code. Most of the cases were settled and withdrawn as the promoters of the corporate debtors were unwilling to lose the control over the corporate entity.
Asset Reconstruction Companies (ARCs) were set up under the Securitisation of Financial Assets and Enforcement of Security Interest Act, 2002 and there are at present about 26 ARCs. The ability of ARCs to quickly resolve the non-performing assets of the banks, NBFCs etc., was/is constrained by the attitude of the recalcitrant promoters to give in to find a resolution, who despite committing default in repayment of the dues continued to manage the affairs of the enterprise set up by them. ARCs are required to approach District Magistrate or Chief Metropolitan Magistrate to take possession of the secured assets assigned to them before effecting their sale. In addition, they have to contest the sponsored claims relating to possession of the assets over which security interest was created by the promoters.
The value realised under Corporate Insolvency Resolution Process (CIRP) in a majority of the cases through resolution plan is almost equal to the amount offered by ARCs for acquiring the said stressed assets. However, there is reluctance amongst the banks to sell the assets to ARCs for diverse reasons. IBC, thought as an addition measure for recovery of the dues from the defaulting corporate persons, has to overcome many hurdles to prove itself as a machinery for effective restructuring of the distressed assets or if restructuring is not possible, to sell and liquidate the property of the corporate debtor for the benefit of the stakeholders.
Section 3 of the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 (second amendment Act) inserted two explanations in Clause (8) (f) of Section 5 of the Code. Pursuant to the first explanation any amount raised from an allottee under a real estate project shall be deemed to be an amount having the commercial effect of a borrowing. Thus, a home buyer under a real estate project enjoys the status of a financial creditor of the concerned corporate real estate developer. This enjoins him with a right to initiate CIRP, if there is a default in excess of Rs. one lakh by way of debt. As a financial creditor, similarly placed home buyers also can join in the action for initiating CIRP in terms of section 7 of the Code.
In Pawan Dubey and another vs J B R Developers Private Limited (Company Appeal (AT) (Insolvency) No.104 of 2018) NCLAT expressed a prima facie view that “on cancellation of allotment/ agreement, the debt amount falls due and on non-payment, it can be treated to be ‘default’”. Thus, home buyers who got frustrated over delay in completion of the construction and opted for cancellation of their agreement with the developer, can also initiate CIRP.
As per Schedule to the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016 (AAA Rules), the home buyers have to pay Rs. 25,000 as the application fee for initiating CIRP. The home buyers, due to limited affordability of funds, are dependant on borrowed funds with an obligation to repay the same in equated monthly instalments. In spite of seeking to recover much larger dues, an operational creditor is required to pay only Rs. 2000 as the application fee for initiating CIRP under section 9 of the Code. Hence, there is a need to specify a lower application fee in the case of home buyers, to encourage them to secure relief under the IBC.
The classification of home buyers as financial creditors by itself does not improve their ability to recover their dues. In most of the cases, they have only an agreement with the developer without any document of conveyance in their favour. The execution of conveyance document is ordinarily postponed towards the time of handing over possession of the home they agreed to buy. They, thus, have no security interest on the property of the corporate debtor and consequently relegated to the position of an unsecured creditor to anticipate recovery lower in the waterfall mechanism for distribution under the resolution plan or in the event of liquidation of the corporate person. A deeming provision upgrading their status as secured creditors in respect of the property intended to be purchased will mitigate their position under the IBC. They can expect to recover a part, if not the whole of the amount advanced by them in the failed projects or where the corporate developer agreed to repay the amount after agreeing for cancellation of the booking. The question as to whether the home buyers are unsecured creditors or secured creditors, though brought to the notice of the Supreme Court in Chitra Sharma and others vs Union of India, it left open by that court. In the absence of a definitive pronouncement, it would be better the Code is amended elevating their status as secured creditors.
Change in Form 1
Rule 4 of AAA Rules prescribes the application form for initiating CIRP against the corporate debtor under section 7 of the Code. The Form was devised when Chapter II and Chapter III of the Code were brought into force. At that time, only limited entities were treated as financial creditors. After the second amendment Act including home buyers as financial creditors, there is a need to amend Form 1, on the lines of Form 4 to provide details of transaction on account of which the debt became due. The Form, so altered, will explain the transaction and bring in clarity to the claim.
Majority of the home buyers, would not have any security interest created by the corporate debtor in their favour. They will not able to provide record of default recorded with the information utility. In the absence of documents to prove the default either, as in the case of operational creditor, they may be required to issue a demand notice and produce that as proof for demonstrating the default or the corporate debtor should submit proof of payment to the home buyer of his dues.
The provisions of Limitation Act, 1963 have been made applicable to the proceedings or appeals before the Adjudicating Authority, NCLT, DRT or the Debts Recovery Appellate Tribunal as per Section 238A introduced by the second amendment Act. It would be better the Forms for initiating the CIRP should contain a column to confirm that the claims are within the period of limitation.
Distribution of monies
In the resolution plan, the resolution applicant provides a value for the enterprise or the property of the corporate debtor which it/he proposes to acquire. Barring a few exceptions, the value attributed by the resolution applicant to the enterprise or the property of the corporate debtor is significantly less compared to the book value of the assets and inadequate to meet the entire dues of even the secured creditors.
“Secured creditor” is a defined term in section 3 (30) of the Code. It means a creditor in favour of whom security interest is created. A perusal of the definition of “security interest” will reveal that it includes a variety of right, title or interest or a claim to property created or provided for by the corporate debtor under a transaction. Every kind of security interest cannot be equated with the other kind of security interest. Thus, a creditor which has lent money against the immovable property of the corporate debtor is not at par with the creditor who provided funds to the corporate debtor on hypothecation of a vehicle or other current assets. In distress scenario, the depletion/evaporation of current assets is quite certain.
In respect of mortgage of immovable property, section 48 of the Transfer of Property Act, 1882 (TP Act) provides, “Where person purports to create by transfer at different times rights in or over the same immovable property, and such rights cannot all exist or be exercised to their full extent together, each later created right shall, in the absence of a special contract or reservation binding the earlier transferees, be subject to the rights previously created”.
The inter-se priority between two sets of secured creditors (namely, the first and second mortgage holders) in view of section 529-A of the Companies Act, 1956 and whether section 48 of the TP Act stands over-ridden by section 529-A of the Companies Act were decided by the Supreme Court in ICICI Bank Limited Vs SIDCO Leathers Limited and others (AIR 2006 SC 2088). Observing that “Deprivation of legal right existing in favour of a person cannot be presumed in construing the statute. It is in fact the other way round and thus a contrary presumption shall have to be raised”, the Supreme Court held “merely because section 529 does not specifically provide for the rights of priorities over the mortgaged assets .. would not mean that the provisions of section 48 of the Transfer of Property Act, in relation to a company which has undergone liquidation, shall stand obliterated”.
The Code does not have any provision treating all the secured creditors at par Such position cannot be implied or presumed. In the absence of it, section 238 of IBC does not come into play, for there is no inconsistency between IBC and other laws prescribing priority. Merely because a resolution applicant, when he submits a resolution plan for the entire assets of the corporate debtor, has not specified separate value for various sets of mortgagees or treated them at par is not sufficient to take away the valuable rights conferred by law on the mortgagees. It will be unfair to the senior secured creditors that by virtue of exercising their voting rights in favour of the resolution plan, they accepted to be treated at par with other secured creditors of the corporate debtor. In CIRP, due to order of moratorium, they cannot stand outside the CIRP and enforce their security interest. Even if they have taken steps to enforce their security interest, those proceedings cannot be continued in view of section 14 (1) (a) of the Code. At that stage of consideration of a resolution plan, they are concerned with its approval; for liquidation process would take considerable time and the realisation may be lower than what they could reasonably expect to get by agreeing to the resolution plan. Ascertaining inter-se priorities of various charge holders may call for some additional efforts on the part of the resolution professional; but this reason does not justify denial of the valuable rights of the mortgagees as the secured creditors.
Section 25 (2) (k) of the Code while narrating various actions that could be taken by a resolution professional (as a part of his duties), empowers him with the approval of the Committee of Creditors (CoC), to sell unencumbered assets of the corporate debtor, other than in the ordinary course of business, if he is of the opinion that such sale is necessary for a better realisation of value under the facts and circumstances of the case, albeit within certain limits. This clearly brings out the entitlement of secured creditor is to be tested qua the specific security interest and not qua his status as secured creditor as per the definition contained in section 3 (30) of the Code. Thus, a secured creditor is a secured creditor only in respect of his security interest and that too subject to his ranking vis-à-vis other secured creditors on the same asset. In the absence of distinction amongst the secured creditors, there would not be unencumbered asset of the corporate debtor.
Regulation 36 (2) (d) of the Insolvency and Bankruptcy Board of India (Insolvency Resolution for Corporate Persons) Regulations, 2016 (CIRP Regulations) requires the resolution professional to include in the information memorandum a list of creditors containing the names of creditors, the amounts claimed by them, the amount of their claims admitted and the security interest, if any, in respect of such claims. This requirement will become an empty formality if all secured creditors are to be treated at par.
Section 80 of the Companies Act, 2013 states, “Where any charge on any property or assets of a company or any of its undertakings is registered under section 77, any person acquiring such property, assets, undertakings or part thereof or any share or interest therein, shall be deemed to have notice of such charge from the date of registration”. A creditor having notice that his security interest is subject to previously created security interest on the same property, cannot defeat the existing security holder’s interest and claim pari-passu right without the consent of the prior security holder.
It is necessary that each set of security interest would need to be considered while distributing the amount paid by the resolution applicant pursuant to the approval of resolution plan. Resolution applicant provides a value for the property or asset acquired and he/it is not concerned with the manner in which it is shared by the creditors of the same class. It/he is not authorised or permitted by the Code to determine the manner of sharing the proceeds of the realised value, except to the extent of stating how much amount it/he proposes to allocate to various persons, namely, financial creditor, operational creditor, employees and workmen, statutory dues, unsecured creditor etc., as a class.
Section 20 of the Code mandates the interim resolution professional to make endeavours to manage the operations of the corporate debtor as a going concern. Invariably, the time limit for CIRP extends up to 270 days. In some cases, the operations of the corporate debtor have resulted in generation of surplus cash as, except the processing costs, employee costs and expenses towards essential supplies, no other payment is made during CRIP. There were also cases where certain of the corporate debtor held assets in the form of fixed deposits. These cash and bank balances are due to the stakeholders and not to the resolution applicant as the information memorandum shall contain, inter alia, assets and liabilities as on the insolvency commencement date as specified in regulation 36 (2) (a) of CIRP Regulations. Further, the claims from the creditors of the corporate debtor is also invited as on the insolvency commencement date (cf. Form B, C etc). The cash and bank balance should be distributed amongst the creditors who have security over the accounts/amounts.
There are instances where the Resolution Professional made application against the corporate debtor and others questioning certain transactions as preferential transactions under section 43 or undervalued transactions under section 45. These applications were filed by the resolution professional after collecting information in terms of section 18 (a) of the Code. The Code specifically authorises the resolution professional to file an application to the Adjudicating Authority.
The person suited for distributing the monies and securities offered by the successful resolution applicant and pursuing the applications or defending the appeals against the orders in the applications filed under section 43 or section 45 of the Code is the resolution professional. However, the resolution professional has no duty to distribute the amount realised amongst the creditors or pursue the aforesaid applications / appeals. Under section 31 (3) (b) of the Code, the resolution professional is required to forward all records relating to the conduct of the CIRP and the resolution plan to the Insolvency and Bankruptcy Board of India (IBBI) to be recorded on its database after the approval of a resolution plan by the Adjudicating Authority. There is no machinery for handling these applications or appeals after the cessation of moratorium upon approval of a resolution plan. Though as per the approved resolution plan, the successful resolution applicant constitutes a monitoring committee for supervising the implementation of the approved resolution plan, it is not required to manage distribution of cash and bank balances to the creditors or pursue the pending applications or appeals. This vacuum should be plugged; lest the objective of authorising the resolution professional to file applications under sections 43 and 45 would be rendered nugatory unless the CIRP shifts to liquidation process.
Capping the fee of the resolution professional
The guidelines issued by IBBI insist on the fee charged by the resolution professional has to be reasonable. No minimum or maximum has been mentioned. CIRP regulations are silent with the regard to the quantum of fee of the resolution professional. The financial creditor and corporate debtor when they make application for initiation of CIRP are permitted to agree to the fee payable to the interim resolution professional. If the fee is not agreed, the CoC is authorised to fix the fee. There is no guideline for fixing the fee payable to the resolution professional vis-à-vis the size of the corporate debtor, number of operating units, turnover etc. Many a times the fee demanded by the resolution professional is in excess of the managerial remuneration paid by the corporate debtor. The resolution professional is not discharging the same functions as that of the managing or whole-time director of the corporate debtor. The resolution professional does not bring in any expertise in managing the business as going concern or enhancing value of the property of the corporate debtor by formulating a resolution plan. The resolution professional is authorised to appoint accountants, legal or other professionals as may be necessary in discharge of his functions and the fee payable to them is in addition to the fee payable to the resolution professional. There were instances where the resolution professionals charged unreasonably high fee and IBBI had acted against them.
The fee fixed under Rule 4 of IBBI (Liquidation Process) Regulations, 2016 is based on a scale depending upon time and amount realised. The Legal Practitioners Fees Rules, 1973 (of the Government of Tamil Nadu) prescribe the fee chargeable by an advocate. The Fourth Schedule to the Arbitration and Conciliation Act, 1996 provides a model fee payable to an arbitrator or a member of arbitral tribunal. Hence, IBBI in the interest of the creditors and corporate debtors may look into this area and prescribe reasonable fee for the resolution professional.
Infrastructure inadequacies of resolution professional
Many professionals have been enrolled as resolution professional through their respective Insolvency Professionals Agency without assessing their capabilities of performing the duties expected of a resolution professional. Some of them have health related issues. Post their appointment as resolution professionals, they regret to function as resolution professional; needing a replacement. These persons can apply for temporary surrender of their registration until they are able to discharge the duties of a resolution professional or decline providing consent for their appointment as interim resolution professional. This would save the time in the CIRP.
Ignorance and failure to act in time
The Code being a recent enactment is not forming curriculum for preparing the professionals. It has to be learnt, understood and practised by one’s own efforts. This leads to different understanding by different people; until clarity is provided by the judicial interpretations.
The financial creditors, excluding the home buyers, have not put in place in-house capability to handle the cases financed by them and facing CIRP. Most often, junior dealing officers attend the meetings of CoC and exercise the voting rights. They do not verify whether their claim or the claim preferred by another creditor is properly determined including the amount and the security interest claimed by it. The officials do not take enough care relating to the details contained in the Information Memorandum. They, thus, compromise the interests of the banks in not getting due share of the amount their bank is entitled in the proceeds.
The decision making by the financial creditors suffers as they do not focus on the CIRP, accurate determination of their claims and distribution of proceeds in accordance with the law. They are satisfied if some amount is recovered than what is legitimately due to them. It is advisable that each bank must appoint sufficiently senior official to monitor IBC cases and give directions to their officials regarding the conduct of CIRP or liquidation process.
IRP/RP depends upon outsourced persons for the verification of claims. These outsourced persons lack proper understanding the financial documents. There is no uniformity in their assessment of the claims submitted by the creditors. There is no supervision exercised by the IRP/RP, leading to distortions in the admission of claims.
RP/IRP is made a party in an application filed in NCLT, either as a necessary or proper party to the application. RP without regard to the reliefs claimed in the application, unnecessarily engages senior counsel at the cost of the stakeholders; thus, reducing their share in the realisation. At times he engages counsel when a copy of the application/ appeal is served before its filing even before notice is ordered by NCLT/NCLAT.
The matters to be considered by NCLT while dealing with an application of financial creditor is explained in the order of Innovative Industries Ltd Vs ICICI Bank Ltd. It is limited to ascertaining the existence of default, whether the application is complete and whether any disciplinary proceeding is pending against the proposed IRP. However, in most of the applications, this determination is taking considerable time.
Even after approval of the resolution plan for the corporate debtor, many interlocutory applications, appeals etc., are pending, though initiated prior to approval of the resolution plan. They have a vital bearing on the rights or entitlements of creditors. As order on some of these applications/ appeals may have impact on the distribution of the proceeds amongst the persons entitled thereto, the Adjudicating Authorities may put in their best efforts to dispose of the applications at their earliest convenience keeping in view the provisions of section 64 of the Code.
At present as per AA Rules, only rules 20,21,22,23,24 and 26 of Part III of the National Company Law Tribunal Rules, 2016 have been made applicable for filing applications under the Code. It is time that complete rules are put in place as IBC will only be dealing with insolvency and bankruptcy cases.
Processing/verification of applications
After filing the application for initiation of corporate insolvency resolution process it takes considerable time to verify the application, despite the filing of applications are not too many. It should not take more than two working days to scrutinise the applications as scrutiny does not involve decision making on any matter.
There are/may be many more such instances where the Code has not made any specific provision. IBBI/ Central Government may examine the above and other deficiencies and make suitable provisions to overcome those situations.
[The opinions expressed in this article are the personal opinions of the author. The facts and opinions appearing in the article do not reflect the views of LiveLaw and LiveLaw does not assume any responsibility or liability for the same]