Major Amendments introduced to the Insolvency and Bankruptcy Code
The President of India promulgated the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018 (‘Ordinance’), which has become effective from June 6, 2018. Pursuant to the Ordinance, many of the amendments suggested by the Insolvency Law Committee (‘ILC’), which included our founding partner Mr. Bahram N Vakil, have now been implemented. The major changes introduced by the Ordinance have been summarised below:
- Homebuyers Upgraded as ‘Financial Creditors’
Prior to the Ordinance, the Insolvency and Bankruptcy Code, 2016 (‘IBC’) did not recognise persons who had paid advances towards completion of real estate projects as either ‘financial creditors’ or ‘operational creditors’. The Ordinance now provides that any amount raised from an allottee under a real estate project shall be considered a financial debt under the IBC. Since the number of such allottees could be numerous and their participation in a committee of creditors (‘CoC’) could be unwieldy, the Ordinance provides that allottees may appoint authorised representatives to attend CoC meetings on their behalf, with prior instructions on voting matters.
- Amendments to Eligibility Criteria for a Resolution Applicant
Section 29A sets out ineligibility criteria for potential bidders in a corporate insolvency resolution process (“CIRP”). The ambit of Section 29A may have been in some instances too wide and could have unintentionally disqualified some sophisticated bidders on technical grounds. The Ordinance has, therefore, introduced the following amendments to Section 29A :
i. Section 29A(c): NPA Related disqualification
(a) Section 29A(c) provides that persons controlling accounts which have remained non-performing assets (‘NPA’) in excess of one year are barred from acting as resolution applicants in an ongoing CIRP. However, no clarification had been provided on whether the one-year period would be determined from: (i) insolvency commencement date of the corporate debtor; or (ii) the time at which the bid was submitted in the ongoing corporate insolvency resolution process (‘CIRP’) of the corporate debtor. The Ordinance has clarified that the relevant date should be the latter.
(b) The Ordinance provides that the disqualification under Section 29A(c) shall not apply to a ‘financial entity’ (scope of which is discussed under Paragraph iii below).
(c) Successful resolution applicants acquiring companies under the CIRP end up being in control or management of accounts which have turned NPA. Such acquirers would, as a result, fall foul of Section 29A(c) and would be estopped from making any further bids for any other company undergoing CIRP. In order to rectify this anomaly, the Ordinance provides for a grace period of three years in favour of a resolution applicant, calculated from the date of acquisition of such corporate debtors with NPAs during which the acquirer will not be disqualified from bidding for other companies undergoing CIRP. A similar carve-out has also been granted under Section 29(A)(g) of the IBC, to successful bidders, who have acquired companies in CIRP where certain avoidable transactions may be been undertaken by the previous promoters or officers.
ii. Section 29A(d): Disqualification on account of Criminal Convictions
(a) Section 29A(d) of the IBC disqualified a resolution applicant if it or any of its ‘connected persons’ had been convicted for an offence punishable with imprisonment for two years or more. It was argued that there must be a rational nexus between the underlying offence and the ability of the bidder to successfully restructure the corporate debtor.
(b) This sub-section has been amended to provide that: (i) conviction for two years or more is a bar only if the offence relates to certain statutes prescribed in the newly introduced Twelfth Schedule to the IBC; and (ii) conviction for seven years or more would be a bar irrespective of which statute the offence fell under.
(c) A list of twenty-five laws is specifically mentioned in the Twelfth Schedule covering areas such as money laundering, foreign exchange, pollution control norms, tax, anti-corruption and securities market regulations. The Twelfth Schedule only covers Indian statutes and an interpretation may be taken that similar violation by the bidder or its connected persons under foreign laws may not attract the disqualification. However, the disqualification relating to conviction for seven years or more would apply under Indian as well as foreign laws.
(d) The Ordinance provides that the bar under Section 29A(d) will not apply if more than two years have elapsed from the date of release from imprisonment (rather than a bar in perpetuity).
iii. Explanation to Section 29A(i) : Reducing the Scope of ‘Connected Person’
(a) Part (iii) of the definition of ‘connected person’ under Section 29A(i) of the IBC, is extremely broad and includes the holding company, subsidiary company, associate company or any related party of the proposed acquirer, its promoters, the acquirer’s board as well as the proposed management of the corporate debtor or its promoters. By virtue of their business model, it was inevitable that several pure play financial entities would have connected persons through their investee companies in India or abroad which suffered from the disqualifications (especially relating to NPAs) listed in Section 29A. The IBC was amended late last year to create a carve-out from part (iii) of the definition for scheduled banks, asset reconstruction companies and alternate investment funds registered with the Securities and Exchange Board of India (‘SEBI’) – however this exemption did not benefit foreign private equity players, venture capital and distressed assets funds.
(b) Pursuant to the Ordinance, relaxation has now been provided to foreign financial investors. The definition of ‘financial entities’ now includes the following additional classes of entities: (i) any entity regulated by a foreign central bank or any other financial sector regulator of a jurisdiction outside India; and (ii) any investment vehicle, registered foreign institutional investor, registered foreign portfolio investor or a foreign venture capital investor as defined in regulation 2 of the Foreign Exchange Management (Transfer of Issue of Security by a Person Resident Outside India) Regulations, 2017.
iv. Section 29A(d): Disqualification on account of Criminal Convictions
(a) The impact of Section 29A of the IBC was such that in many cases, it would force a change of control of the erstwhile promoter under a resolution plan or in liquidation. There was a concern that there may not be enough interest from third party buyers in companies under IBC, which are of a comparatively smaller size. A ‘one size fits all’ approach could hamper recoveries where there is little scope for turnaround of smaller companies unless the promoters submit a resolution plan. Recognizing this, the Ordinance provides for limited exemptions from the provisions of Section 29A of the IBC for Micro, Small and Medium Sector Enterprises (‘MSMEs’).
(b) However, the statutory thresholds for recognizing MSMEs under the Micro, Small and Medium Enterprises Development Act, 2006 (‘MSME Act’) are low. For instance, for companies engaged in manufacturing, the thresholds for classification as MSMEs are investment in plant and machinery ranging from less than INR 25,00,000 (approximately USD 37,000) to INR 10,00,00,000 (approximately USD 1.5 million). The Central Government had approved an amendment to the MSME Act on February 7, 2018 providing that the thresholds in the MSME Act be redefined. The proposal is to re-align the definition of MSMEs on the basis of annual turnover ranging from less than INR 5,00,00,000 (approximately USD 750,000) to INR 250,00,00,000 (approximately USD 37 million). Once the proposed amendment to MSME Act is notified, it will provide significant relief to promoters of a large number of small companies facing financial distress.
- Withdrawal of an Ongoing CIRP Proceeding
Once an application filed under the IBC is admitted, it can either lead to a successful resolution plan or liquidation. Under the IBC, a company undergoing the CIRP process did not have the power to arrive at a settlement or compromise by which the ongoing CIRP proceedings could be withdrawn. However, in a few cases, the courts had gone beyond the purview of the IBC and allowed settlement of the claims of a creditor, bilaterally leading to withdrawal of the matter.
The Ordinance clarifies that withdrawal of a CIRP proceeding will be permissible if 90% of the CoC approves it. However, such withdrawal will be permissible only prior to the resolution professional formally inviting resolution plans from interested bidders.
- CoC voting thresholds reduced
The IBC provided that all decisions by the CoC be taken by a vote of 75% of the CoC by value. The Ordinance has reduced the voting threshold from 75% to 66% for major decisions such as: (i) applying for an extension for the CIRP period from 180 to 270 days; (ii) replacement of an interim resolution professional or resolution professional; and (iii) approving a resolution plan. For other routine decisions, the voting threshold has been reduced to 51%.
- Role of shareholders of the corporate debtor in approving resolution plans
The consent of shareholders of the corporate debtor is generally required for significant corporate actions. The Ministry of Corporate Affairs (‘MCA’) released a clarification last year to the effect that approval of shareholders of the company for any corporate action in the resolution plan (otherwise required under any law) is deemed to have been given on its approval by the NCLT. The Ordinance specifically amends the IBC to incorporate the clarification proposed by the MCA.
- Resolution professional responsible for ongoing legal compliances by the corporate debtor
Under Section 17 of the IBC, on insolvency commencement date, the board of the company is suspended and an insolvency professional takes control over management control. However, several laws including many provisions of the Companies Act, 2013, regulations issued by SEBI, Factories Act, impose obligations on the board of the company. The Ordinance clarifies that insolvency professionals shall be responsible for complying with the requirements under all applicable laws on behalf of the corporate debtor.
- Participation of ‘related party’ financial creditors in the CoC
The IBC provided that financial creditors which were related to the corporate debtor would not be allowed to participate, attend or vote in CoC meetings. Financial institutions which had converted their debt into substantial equity stakes in the corporate debtor under any previous restructuring, were deemed ‘related’ to the corporate debtor and were thereby precluded from attending or voting in CoC meetings. The Ordinance provides an exemption from this prohibition for such financial creditors provided they are regulated by a financial sector regulator.
- Grace period for fulfilling statutory obligations
A critical issue for acquirers in the IBC process is obtaining governmental and regulatory consents, dispensations and permits. Currently, acquirers tend to draft their resolution plans treating National Company Law Tribunal (‘NCLT’) as a single window clearance for all such approvals. But this approach is susceptible to legal challenge. The Ordinance provides for a one year grace period for the successful resolution applicant to fulfill various statutory obligations required under various laws to implement the resolution plan.
- Issue of guarantors’ liability resolved
Section 14 of the IBC imposes a stay on any recovery action against the corporate debtor and the enforcement of any security interest created by a corporate debtor over its assets during the CIRP period. However, in a few cases, courts had taken the view that the moratorium in an ongoing CIRP will also stay enforcement of guarantees or security interest from promoters and group companies of the corporate debtor. The Ordinance states that the moratorium under Section 14 will not apply to the enforcement of guarantees granted by promoter guarantors or other group companies which are not undergoing a CIRP.
- Further regulations to govern the bidding process
In most CIRP proceedings, the CoC formulates a process memorandum which governs the timelines for receiving bids, procedure for rebidding, grounds for rejection of bids etc. Such provisions and their application have been subject to several legal challenges at the NCLT by unsuccessful bidders. In a press release accompanying the Ordinance, the government has indicated that the regulations will govern issues such as non entertainment of late bids, bar on negotiations with late bidders and a standardised process for maximization of value of the corporate debtor.
- Triggering CIRP by a company voluntarily
The IBC provided that a company may initiate its own CIRP and that the persons eligible to initiate a voluntary CIRP were: (i) the corporate debtor itself; (ii) a shareholder of the company specifically authorised to do so under the articles; (iii) director and key employees; and (iv) the chief financial officer. The Ordinance now makes a special resolution of shareholders mandatory for filing for its CIRP. It remains to be seen if a special resolution will be possible in closely held companies where promoters have a dominant stake. But directors and officers will need to be mindful of provisions in the IBC which impose civil and criminal sanctions on erstwhile directors and officers of the company for wrongful trading.
- Limitation Act to apply to IBC
Lenders have benefited from judicial decisions which indicated that the Indian limitation legislation did not apply to an application under the IBC (although the doctrine of laches might still apply). However this has not been confirmed by the Supreme Court till date, as it had declined to comment on this issue. The Ordinance now provides that the law of limitation will apply to IBC applications.