The Insolvency and Bankruptcy Code, 2016 (IBC) has evolved to facilitate and expedite insolvency resolution. It rectifies and considerably shortens the previously lengthy process which offered no economically viable solutions. The revised Code intends to protect the interests of small investors, Micro and Medium Enterprises (MSMEs), creditors, stakeholders of a company etc. By focusing on (legislating) the Corporate Insolvency Resolution Process (CIRP) and the liquidation process, the Code intends to maximize the value of existing assets, ensure the revival and preservation of corporate debtors, and safeguard corporate dealings in the country from unscrupulous parties.
A Quick Overview before we get into the details of the Code and its Amendments
A Promoter is the person(s) who takes the company through the preliminary steps of execution, registration, etc. The formation and practical shape of the company owe their existence, so to speak, to the promoter and the personal resources s/he with others have invested in it. Promoters hold considerable control in the functional affairs of the company and are integral, especially in the Indian corporate landscape. They have a vested interest in the company, whether directly or indirectly as a shareholder, director or otherwise. This establishes a fiduciary relationship by which they owe the company a duty of care, loyalty and protection.
When a company defaults on the payment of its dues, the Corporate Insolvency Resolution Process (CIRP) is initiated. The CIRP is a recovery mechanism for creditors and its first objective or best-case outcome is to revive the company so that the creditors can be paid their dues. Failing that, the company goes into liquidation and the creditors are paid according to the priority of their claims.
The CIRP applicant, or the Resolution Applicant (RA) presents a proposal with suggestions to maximize the value of the company’s assets to the National Company Law Tribunal (NCLT). If the ‘resolution plan’ is accepted, the suggestions are implemented. If it isn’t approved, the company goes into liquidation.
Here’s where the conflict of interests and eligibility of a Resolution Applicant under the IBC comes into play.
What happens if a defaulting promoter misuses the Companies Act provision to gain a back-door entry at substantially discounted rates for the assets of the corporate debtor? It would be like having your cake and eating it too.
Section 29A is a restrictive provision within the IBC Code that prohibits promoters and any party related to them from participating in a CIRP as an RA. It enlists promoters and the people/parties connected to the promoters with varying degrees of separation, who are ineligible to be resolution applicants. Recent amendments to Section 230 of the Companies Act, further restricts these ineligible promoters from participating in the scheme of arrangement. So, defaulting promoters who are found ineligible or barred from the resolution plan under the criterion list under Section 29A are further barred from becoming a party in any manner, whatsoever, to a compromise or arrangement of the corporate debtor under Section 230 of the Companies Act, 2013. This restricts secured creditors from selling or transferring the assets of a company undergoing liquidation process to anyone who is found ineligible under Section 29A. Once a CIRP is underway, anyone found ineligible, can have nothing more to do with the company.
Any ambiguity that may have existed around the applicability of Section 29A of the Code under the scheme of arrangement, was removed by the NCLAT, in deference to the Supreme Court ruling in the case of M/s. Gujarat NRE Coke Limited (Corporate debtor) and Dilip Kumar Singh & Others (Applicants) vs. State Bank Of India & others (Respondent).
In this case the NCLAT observed that, “Even during the period of liquidation, the ‘Corporate Debtor’ is to be saved from its own management, meaning thereby, that the promoters who are ineligible under Section 29A are not entitled to file an application for compromise and arrangement in their favor under Section 230 to 232 of the Companies Act.”
Why is the amendment significant?
Section 230 of the Companies Act, allows for compromises or arrangements between the liquidator and creditors, if the resolution process fails. That still holds true. Compromises can be made, and arrangements arrived at, but not by anyone found ineligible to do so under Section 29A. Prior to the amendment, there was no explicit prohibition on defaulting promoters from proposing a compromise or arrangement, which could have resulted in them acquiring control of the corporate debtor. The amendment prevents promoter-driven attempts to liquidate the company.
Initially, IBBI proposed a relaxation of Section 29A during the scheme of arrangement, in what one might call the ‘service of human interest’. When a company fails the resolution process, it isn’t as if buyers and bidders are jostling each other in the market for its control. So why not, instead of liquidating the company, give it back to the promoters? The promoters might –
- infuse money over and above the liquidation value of the company
- help scores of employees keep their jobs intact
- avoid liquidation, which in itself, is an exception to the purpose of IBC
Yet this last instance of relaxation of Section 29A defeats the purpose of IBC by putting control of the company back in the hands of those responsible for the downfall of the company, i.e. the promoters who may likely regain control of it. The amendment ensures that the ineligible promoters who might have sought to reclaim control during the liquidation stage aren’t allowed to do so, thereby ensuring that a company, distressed or otherwise, can safely turn to the IBC to protect its interests in a safe & unbiased manner.
If you liked this article, we recommend you go through:
- What is Section 29A of IBC?
- Who is an Undischarged Insolvent?
- Wilful Defaulters & their role in the Indian Context
SignalX is purpose-built to help you understand the credibility of the parties you are doing business with and helps you stay compliant with regulatory requirements / internal risk policies through various due diligence checks, including Financial due diligence checks on any concerned party.
We enable Corporate Compliance and Legal teams to assess potential engagements and streamline business partner on-boarding via an air-tight and easy to use due diligence AI automation.