INDIA’S SUPREME COURT RULES ON THE ROLE OF INSOLVENCY STAKEHOLDERS AND EQUALITY OF CREDITORS
On November 15, 2019, the Supreme Court (the “Court”) ruled on several contentious aspects of the Insolvency and Bankruptcy Code, 2016 (the “Code”) and put an end to the long-drawn-out litigation in the insolvency resolution process of one of India’s largest steel manufacturers, Essar Steel India Limited (“ESIL”). This update highlights the key aspects of the Court’s decision.
In August 2017, the National Company Law Tribunal (the “NCLT”) had admitted an insolvency petition filed by ESIL’s financial creditors under the Code. After multiple rounds of bidding interspersed by litigation at each stage, the committee of creditors (the “CoC”) approved the resolution plan submitted by ArcelorMittal India Private Limited (“ArcelorMittal”) by a 92.24% majority and agreed to distribute the proceeds in the manner recommended by a sub-committee of the CoC.
Once approved by the CoC, the resolution plan was placed before the NCLT, which approved the plan with a few changes. The changes suggested by the NCLT required the financial creditors comprising the CoC to take a larger cut on their dues, and pay a higher amount to the operational creditors on the grounds of equity and fair play.
The NCLAT’s order
The NCLT’s order was appealed before the National Company Law Appellate Tribunal (“NCLAT”) and then before the Court. In that appeal, the Court ordered that the changes suggested by the NCLT should not be implemented and directed the NCLAT to consider the original resolution plan approved by the CoC.
After considering the original resolution plan, the NCLAT held that:
- the financial and operational creditors deserve equal treatment under a resolution plan;
- the security interest is irrelevant at the stage of resolution for the purposes of allocation of payments, and therefore, each financial creditor, whether secured or unsecured, is to be treated equally;
- the CoC was not permitted to constitute a sub-committee and delegate its functions;
- the CoC was not empowered to decide upon the manner of distribution of proceeds between the creditors, as there would be a conflict of interest between the financial and operational creditors; and
- the NCLT and the NCLAT have the power to qualitatively assess the resolution plan approved by the CoC and direct appropriate modifications.
On the basis of this ruling, the NCLAT redistributed the proceeds payable under the resolution plan amongst the creditors of ESIL and approved the resolution plan subject to such redistribution. The order of the NCLAT was appealed before the Court.
Immediately after the order, the Code was amended by the Indian legislature to clarify certain key tenets of the Code which were affected by the NCLAT order. The constitutionality of the amendment was also challenged before the Court.
The Court’s ruling
Upon considering the arguments, the Court overruled several aspects of the NCLAT’s order and upheld the constitutionality of the amendments made to the Code. The key aspects of the Court’s decisions are as follows:
- The CoC has been empowered under the Code to approve a resolution plan by a vote of at least 66% majority after assessing its “feasibility and viability,” which takes into account all aspects of the plan, including the manner of distribution of funds.
- The approval of the resolution plan has been left to the CoC’s commercial wisdom under the Code. In doing so, the CoC must seek to maximize the value of assets and balance the interests of all stakeholders before it arrives at a mechanism of distribution. However, balancing the interest of the stakeholders does not imply that each creditor must be paid a proportionate amount.
- The NCLT and the NCLAT are only empowered to conduct a limited judicial review of the resolution plan, which cannot in any circumstance trespass upon a business decision of the CoC. The NCLT and NCLAT are required to assess whether the resolution plan conforms to the requirements of the Code.
- The role of the resolution professional is administrative and not adjudicatory. The Court reiterated that a resolution professional should only “examine” and “confirm” that each resolution plan conforms to the requirements of the Code.
- The Code expressly differentiates between financial and operational creditors as well as secured and unsecured creditors on the basis of the creditor’s importance to keep the debtor running as a going concern. Following an “equality for all” approach would be detrimental as secured financial creditors will be incentivised to vote for liquidation rather than resolution. This approach would defeat the objective of the Code which is to prioritize the resolution of distressed assets.
- While the CoC’s responsibility is administrative in nature, this responsibility cannot be delegated to any other person. However, the Court examined the minutes of the CoC’s meetings and observed that while the sub-committee had been responsible for the initial negotiation with ArcelorMittal, the resolution plan was approved by the CoC with adequate majority and due consideration. Therefore, such limited delegation did not contravene the requirements of the Code.
- The 2019 amendments to the Code cannot be struck down solely on the basis of allegations that they were enacted to set aside the NCLAT’s order. In case of an economic legislation, the legislature must be given “free play in the joints,” and the motive behind the legislation cannot be examined by the Court. The Court reiterated that the doctrine of colorable legislation extends only to a determination of the legislature’s capacity to pass a particular legislation.
- The amendment to the Code which increases the time period for completion of the resolution process to three hundred and thirty (330) days also includes the time required for litigation before the tribunals and the Court. While the Court upheld this amendment’s constitutionality, the Court struck down the word “mandatorily” as such compulsion would infringe upon a litigant’s right to pursue its remedies. The Court held that, ordinarily, the timeline would be sacrosanct and could only be extended in exceptional cases.
- The amendment to the Code which guarantees the payment of a minimum amount to operational creditors and dissenting financial creditors was held to be constitutionally valid on the ground that it was a mechanism to safeguard such creditors against any oppression by the CoC.
Given these observations, the Court held that the NCLAT was not empowered to modify the resolution plan approved by the CoC as the plan conformed to the requirements of the Code. Therefore, the Court directed the resolution professional to implement the original resolution plan, as approved by the CoC.
In our view, this ruling of the Court is a landmark decision in the nascent jurisprudence relating to the Code. In overruling the NCLAT order on various aspects, the Court has adopted a progressive stance and paved the way for the resolution of one of the largest insolvencies in India.
After examining the failures of the previous insolvency regimes in India, which were rendered ineffective due to delays caused by excessive litigation, the Court has clearly demarcated the role of the tribunals, the resolution professional and the CoC. This decision may mitigate excessive interference by the tribunals in the insolvency resolution process and will assure stakeholders that the government is committed to ensuring timely resolution of insolvency matters.
Further, although the Code provides for a clear distinction between the different classes of creditors, the NCLAT’s decision had sown seeds of doubt among stakeholders who were left unsure of their rights under the Code. Furthermore, in extinguishing the distinction between secured and unsecured creditors, the NCLAT order had threatened to undermine settled economic principles such as the prioritization of secured debts. In exhaustively laying down the distinctions between different categories of creditors, the Court has cleared the air on the rights available to stakeholders and preserved one of the key tenets of a developed insolvency regime.
In respect of the mandatory period for completion of the resolution process, however, the Court has attempted to tread a thin path between curbing the rights of litigants and upholding the sanctity of a timely resolution. The Court has expressly directed that the timelines may be extended only in exceptional cases where the resolution of the debtor is within reach, and where the delay is attributable to the faults in the judicial process and not to the parties. However, it remains to be seen whether this relaxation of the mandatory period imposed by the amendment is applied strictly by the tribunals or causes the resolution process to meander into court litigation, mimicking the failures of the past insolvency regimes.