Comparative Analysis of the two Insolvency framework models
“Creditor-in-Control” and “Debtor-in-possession”
Priyanshu Fauzdar
(4th Year Student, National Law University and Judicial Academy, Assam)
India’s Insolvency Model
In reaction to what can be called as a failure of past regimes that controlled the issues of loan restructuring and recovery, the Insolvency and Bankruptcy Code, 2016 (hereinafter ‘IBC’) was implemented. The preceding regimes failed because there were several agencies involved and no set deadlines for the activities included in the restructuring process.[1] The enterprise remained belonging to the defaulter i.e., debtors in possession regime. The Banking Law Reforms Committee (BLRC) in its November 2015 report mentioned as under[2]:
“The Committee believes that there is only one correct forum for evaluating such possibilities, and making a decision: a creditors committee, where all financial creditors have votes in proportion to the magnitude of debt that they hold. In the past, laws in India have brought arms of the government (legislature, executive or judiciary) into this question. This has been strictly avoided by the Committee. The appropriate disposition of a defaulting firm is a business decision, and only the creditors should make it.”
The shareholders and creditors are a company’s two primary types of immediate stakeholders, according to the BLRC. If debt is paid off, creditors have no influence over the company’s management and shareholders are in total control.[3] For the purpose of resolving insolvency, control of the company should transfer to the creditors when it is unable to pay its debts. This was not permitted by the previous system. The debt wasn’t realised by the creditors until the cows came home. The power dynamics among a firm’s stakeholders in terms of their rights and interests were redefined under the Code. The Supreme Court issued a thorough ruling in the very first case decided under the Code to highlight this fundamental shift in the law. It was decided that if an entrenched management is unable to pay its debts, they cannot remain in management.[4]
The IBC, 2016, architecture is built on the principle of “creditors in control” as opposed to the previous position of “debtors in possession,” and as a result, management control is transferred from the hands of the current owners to a new management headed by IRP/RP who practically acts under the supervision and control of CoC for all purposes. The Insolvency and Bankruptcy Code, 2016 allows for reorganisation through a market-driven procedure to save an insolvent company if its business is viable or to close it if not. It adumbrates a new ethos of insolvency resolution with a creditor-in-control regime as opposed to the debtor-in- possession format of the legacy laws.[5] If rescued, the company is reorganised to carry on as a going concern. The restructured claims of the creditors are paid to them either immediately or over time. A stakeholder has the right to cause the CD’s CIRP to be triggered, and if it is, the CD switches from debtor-in-possession to creditor-in-control. One of the most distinctive aspects of this model is that from the beginning to the completion of the CIRP, all significant decisions are made by the CoC, with the assistance of the Resolution Professional. With a creditor-in-control management, the CoC is expected to apply their commercial wisdom for the benefit of the corporate debtor. And with this in view, an IRP is saddled with the crucial responsibility of properly constituting the CoC and also to assign voting share to each creditor based on the financial debts owed to such creditor and without that done, there cannot be a meeting of the CoC.[6] In addition to addressing and balancing the interests of all stakeholders, the RP is entrusted with facilitating and overseeing the whole CIRP and will serve as a liaison between the Adjudicating Authority and CoC throughout the process.[7]
The creditor in control model also has its own shortcomings and benefits. For example, the behavioural changes that the IBC is causing among lenders and borrowers are among its most significant results. There is substantial evidence that debtors are avoiding defaults, for instance, as a result of their fear of the unavoidable effects of IBC processes. As debtors make payments out of fear of losing control of their businesses[8], many applications for the beginning of CIRP are being withdrawn both before admission and occasionally after admission. There have been considerable behavioural shifts among creditors. [9] On the other hand, it is also believed that the company’s management is in better position to look after its affairs, than any other third party.
Therefore, in 2021, keeping its streak of continuous changes/amendments, the Code was once again amended in 2021 to include a Pre-Packaged Insolvency Resolution Process (PPIRP) for Micro, Small, and Medium-sized Enterprises (MSMEs) to an alternative insolvency resolution process to ensure quicker outcomes. This was done in keeping with the Code’s dynamic nature, which led to changes being made along the way as needed. This combines a debtor-in-possession regime having a blend of creditor-in-control. So, it is kind of a hybrid model having debtor in possession with creditor in control. Pre-pack, as the name implies, is a reorganisation plan that has been approved by the debtor and its creditors before the filing for insolvency and has been swiftly approved by the court. PPIRP is a new programme that will assist MSMEs in negotiating with FCs (Financial Creditors) and reviving their businesses while still in management by the management, promoters, and partners.
Comparative Analysis of IBC with US and UK Insolvency Resolution Models
First of all, if we are to briefly summarise the Bankruptcy processes in UK and US, it can be said that UK follows majorly the creditor-in-control approach only while US adopts the debtor in possession approach.
The UK’s bankruptcy laws are perhaps the ones that are most similar to those in India. Scepticism about leaving the current management in charge of businesses that have gone into financial problems has had an impact on how the UK approaches its insolvency procedure.[10] Together with the Insolvency Act of 1986, the UK judiciary has a more sympathetic stance towards the rights of creditors during insolvency.[11] In UK, the Administrator serves as the RP’s counter-part. With the purpose of “rescuing the company as a going concern,” the Administrator who assumes charge of the company’s affairs during administration carries out their tasks. If accomplishing this goal is not possible, then the Administrator’s goal must be to provide the firm’s creditors with a better outcome than if the company were to wound up. In the event that none of the aforementioned goals can be realistically attained, the Administrator will concentrate on realising the value of the company’s assets in order to pay out secured and preferred creditors. So, the interests of Creditors are clearly aligned with the goals of the administration process.[12] The UK, thus, has a management displacing, creditor-in-possession regime.[13]
Societies with a debtor-in-possession regime are less likely to ascribe company’s failure primarily to people in charge of an enterprise than societies those with a creditor-in-control regime. Even if this implies having declared bankruptcy, US investors actually favour business owners who have had some prior experience. The corporate resolution and reorganisation process can be traced back to Chapter 11 of the US Bankruptcy Law. It is seen to be a very company friendly structure and, in fact, is stated to assist businesses in moving forward as far as is practical throughout the process.[14] The management of the company may continue to run its activities while bankruptcy proceedings are taking place, thanks to Chapter 11 of the US Bankruptcy Code, which contains the reorganisation process for distressed companies. A reorganisation plan may only be submitted by the CD for a period of 120 days following the start of Chapter 11 proceedings.[15] It is much easier to use Chapter 11 proceedings quickly, when there is guarantee that the current management won’t be replaced and that the CD will be given the chance to submit a plan as in Chapter 11, the debtor keeps control of its company operations and simultaneously pays creditors through a reorganisation plan that has been approved by the court. The Chapter 11 case’s development and the debtor-in-management possessions of the company are both under the control of a US Department of Justice officer known as the US Trustee.
Both approaches have their own merits and demerits. An argument of the debtor-in-possession strategy is that, in some situations, removing the debtor’s current management could jeopardise any chance of rehabilitation. This is because management may, in some cases, have the best understanding of the operation of the business. On the other hand, a debtor could be enticed to use the rehabilitation processes when it is obviously impossible to do so if they believe they have nothing to lose (no loss of business during the process) and everything to gain (the stay on creditors). In particular, a non-viable debtor may try to employ rehabilitation processes only to postpone the inevitable, which would result in the debtor’s assets continuing to disappear. The chance that the debtor’s management may behave recklessly and, in some situations, even fraudulently during this time exists even when the firm can be recovered.
The creditor-in-control strategy, on the other hand, has its own advantages and disadvantages. This strategy assumes that an insolvency professional can manage the company more effectively than the prior leadership. This strategy enables creditors, who play a significant role in the insolvency process, to make important choices, such as accepting the resolution plans.[16] With less room for appeals, better outcomes for the bankrupt company and the creditors are likely to result from the hiring of a Resolution Professional (RP) with experience in the insolvency process. The mindset of the involved creditors has a significant impact on how well the creditor-in-control system works. On the other hand, in terms of debt repayment, creditors might only have an eye on their own interests, leading them to make choices that are not optimal for the debtor company as a going concern or its shareholders or employees.[17] This eliminates any chance for development or renewal and could result in subpar resolutions. Furthermore, when creditors cannot come to an agreement, the process of making choices about the bankrupt organisation and finally reaching a resolution plan may be difficult. The process can be delayed as a result. Although the statutes favour going-concern resolution plans over liquidation in both cases.
Reference
[1] Rathi Graphic Technologies Limited and Ors. vs. Raj Kumar Rathi and Ors. (2022) ibclaw.in 773 NCLT
[2] Venus India Asset-Finance Pvt. Ltd. v Suresh Kumar Jain, RP of MK Overseas Pvt. Ltd. (2023) ibclaw.in 121 NCLAT.
[3] BLRC (2015), The Report of the Bankruptcy Law Reforms Committee.
[4] M/s. Innoventive Industries Ltd. Vs. ICICI Bank & Anr., Supreme Court [2017] ibclaw.in 02 SC.
[5] ibid.
[6] Edelweiss Asset Reconstruction Company Ltd v Mohit Goyal, (2022) ibclaw.in 897 NCLAT.
[7] supra note 2.
[8] Much thanks to Section 29A of the code that prohibits the related parties from submitting a resolution plan or become the Resolution Applicant.
[9] Report of the Working Group on Tracking Outcomes under the Insolvency and Bankruptcy Code, 2016, dated 10th November, 2021.
[10] McCormack G. (2007), “Control and Corporate Rescue: An Anglo-American Evaluation”, The International and Comparative Law Quarterly, Vol. 56(3), pp. 515-551.
[11] The Insolvency Act 1986.
[12]M. P. Ram Mohan and Vishakha Raj, Entrepreneurship and Insolvency: Why Rules of Exit Matter.
[13] Supra note 10.
[14] V. Anantha Nageswaran and Aakanksha Arora, Insolvency, And Bankruptcy Code: A Path Well Travelled.
[15] Title 11 U.S.C. 1101 (2021).
[16] supra note 14.
[17] ibid.
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