Critical Analysis of Section 29A of the Code

CRITICAL ANALYSIS OF SECTION 29A

ABSTRACT

The Insolvency and Bankruptcy Code, after receiving its assent from the President, has been into effect since 2016. It has emerged as a comprehensive legislation with a speedy and specific procedure for dealing with the issue of insolvency. Since then it’s been an evolving legislation have been many ordinances and amendments in the IBC.

One of the main objectives of the code is to provide the corporate debtor with a resolution plan. Earlier, a resolution applicant could have been any person who submits a resolution plan to the resolution professional and a resolution plan could be a plan proposed by any person for insolvency resolution of the corporate debtor. There was no specific criteria or qualification, due to which any party including the promoters of the corporate debtor or any related party could propose a resolution plan. This scheme was highly criticized on the basis that the wide scope permitted by the code served as a loophole and paved a way for the promoters to gain a back-door entry to the management of the corporate debtor

The code aims for resolution of insolvency as opposed to liquidation. The law was framed with the intention to expedite and simplify the process of insolvency and bankruptcy proceedings in India ensuring fair negotiations between opposite parties and encouraging revival of the company by formulation of a resolution plan.

In order to rectify this provision, the Government brought forth the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2017 and later the Insolvency and Bankruptcy Code (Amendment) Act, 2018 wherein section 29A was inserted into the Code.

INTRODUCTION

Section 29A of the Insolvency and Bankruptcy Code, 2016 has emerged as one of the key statutes in determining the eligibility of Resolution Applicants in the Corporate Insolvency Resolution Process. The Code, in its original form had not incorporated any provisions to prevent defaulting promoters from buying-back the corporate debtor, which could occur potentially at steep discounts. Subsequently, through an amendment to the Code, Section 29A was inserted with retrospective effect from November 23, 2017. A second amendment to the Code, effective from June 6, 2018, included amendments to Section 29A.

Before 29A, every individual or body corporate can participate in a bidding process of Corporate Debtor which is subject to Corporate Insolvency Resolution Process irrespective he is original promoter, director or person connected to them directly or indirectly. So, persons who, by their misconduct or fraudulent motives, contributed to the default of the Corporate Debtor, can regain the control of their company again by bidding in heavy discounts while banks and other financial institutes taking haircuts.

Thus, this section was introduced to disqualify those who had contributed in the downfall of the corporate debtor or were unsuitable to run the company.

APPLICABILITY OF SECTION 29A

An Application was filed by the resolution applicant before the National Company Law Tribunal (“NCLT”), Mumbai Bench seeking permission to grant approval of the resolution plan and to hold that he is not debarred or disqualified under the provisions of Section 29A of the Code.[1] The resolution applicant was an individual who was related to the Promoter Directors of the Corporate Debtor i.e. Wig

Associates Private Limited. Therefore, the question to be considered by the NCLT was whether the resolution plan submitted by the resolution applicant can be approved by the NCLT in view of the bar created under Section 29A and Section 30 of the Code which states that the Committee of Creditors would not accept the resolution plan if the resolution applicant is ineligible under Section 29A of the Code. In the present case, the Committee of Creditors had approved the resolution plan.[2] 

The NCLT vide its order dated June 4, 2018, recorded its “satisfaction” for granting approval to the resolution plan and consequently, allowed the Application of the resolution applicant on the following grounds: 

  • The IBC Amendment Act vide which Section 29A has come into place on January 18, 2018, is operative with effect from November 23, 2017. Further, the IBC Amendment Act does not provide for any retrospective operation of the amended provisions including Section 29A to the insolvency proceedings pending on November 23, 2017.
  • It is a settled position of law that any amendment to a statute, affecting the legal rights of an individual must be construed to be prospective unless it is made expressly or impliedly retrospective. Various judicial precedents were cited and relied upon by the NCLT in support of the aforesaid proposition of law.
  • The NCLT specifically referred and relied upon the case of Videocon International Limited vs. SEBI reported in (2015) 4 SCC 331, wherein it was held that pending proceedings are to continue as if the unamended provisions continue to exist. Accordingly whilst relying on the various judicial precedents and specifically the case of Videocon International Limited , the NCLT held that Section 29A of the Code is effective from the date of the passing of the IBC Ordinance i.e. November 23, 2017 and would not apply to the present insolvency proceedings which were initiated on July 19, 2017 i.e. prior to the IBC Ordinance. 

INELIGIBILITY UNDER SECTION 29A

Section 29A – Who is ineligible?  

A person shall not be eligible to submit a resolution plan, if such person, or any other person acting jointly or in concert with such person –

1. Is an undischarged insolvent;

2. Is a willful defaulter in accordance with the guidelines of the RBI issued under the Banking Regulation Act, 1949;

3. Has an account, or an account of a corporate debtor under the management or control of such person or of whom such person is a promoter, classified as non-performing asset in by the RBI and at least a period of 1 year has lapsed from the date of such classification;

Provided that the person shall be eligible to submit a resolution plan if such person makes payment of all overdue amounts with interest thereon and charges relating to non-performing asset accounts before submission of resolution plan;

4. Has been convicted for any offence punishable with imprisonment for 2 years or more;

5. Is disqualified to act as a director under the Companies Act, 2013;

6. Is prohibited by the SEBI from accessing the securities markets;

7. Has been a promoter or in the management or control of a corporate debtor in which a preferential transaction, undervalued transaction, extortionate credit transaction or fraudulent transaction has taken place and in respect of which an order has been made by the Adjudicating Authority under this Code;

8. Has executed an enforceable guarantee in favor of a creditor in respect of a corporate debtor against which an application for insolvency resolution made by such creditor has been admitted under this Code.

There are three layers of ineligibility:

  • Person acting in concert: Persons who have the common objective/purpose of acquisition of shares/ voting rights in/exercising control over a company pursuant to an agreement or understanding, formal or informal, directly or indirectly co-operate for acquisition of shares/voting rights in/ exercise of control of the company.
  • Connected Persons:  Any person who is the promoter or in the management or control of the resolution applicant;

Any person who shall be the promoter or in management or control of the business of the corporate debtor during the implementation of the resolution plan; or

Holding company, Subsidiary company, Associate company or related party of a person referred in above

  • Related Party: anyone in relation to the individual (defaulter promoter) or their spouse; partner in a partnership firm or trustee in a trust in which the defaulter individual is associated; a private company in which is the individual is a director and holds over 2% share capital including family and relatives.[3]

REPORT OF INSOLVENCY LAW COMMITTEE (MARCH 2018)

In the month of March 2018, the Insolvency Law Committee, which was set up to make recommendations to the Government on issues arising from the implementation of IBC and issues raised by stakeholders, submitted its report. Among various amendments proposed by the Committee were some recommendations pertaining to eligibility to submit a resolution plan. The Committee made the following recommendations:

  • The scope of the section was seen as too wide as the terms ‘person acting in concert’ may be read to apply to connected person under clause (j). Further, the definition adopted from SEBI SAST Regulations will also cast a wide net for the applicants. Hence the terms ‘person acting jointly or in concert’ must be removed.
  • Regarding NPAs, the Committee recognized that ARCs, AIFs, IVs, etc could by virtue of nature of their business be classified as NPAs under 29A(c) and be subject to disqualification. Hence an explanation for ‘financial entities’ was proposed which will be exempt from the ambit of the clause. The possibility of acquiring NPAs due to previous CIRPs were considered and a time limit of 3 years was proposed from the time of acquisition within which such NPAs acquired from CIRP will not be hit by 29A(c).
  • In the same clause, the classification of accounts as NPA has been limited to Banking Regulation Act 1949. This must be expanded to include accounts declared as NPA under other guidelines issued by a financial sector regulator in India.
  • Considering the personal nature of 29A(d) relating to conviction for offences and 29A relating to disqualification to act as director, both these clauses must be exempted from the scope of clause (iii) of ‘connected persons’, i.e., the holding company, subsidiary company, associate company and related persons.
  • In 29A(d), merely having a condition of conviction of 2 years for any offence was to wide an ambit as it could also include certain minor offences which have nothing to do with the ability to run the company in question efficiently. Hence, a list of relevant laws could be provided in a schedule, similar to one in Companies Act 2013 thereby narrowing the scope of the provision. Further, similar to a provision under Representation of People Act, 1951 the disqualification period must be reduced to six years instead of indefinitely as is the case with the section.[4]
  • Further, in the same clause, the Committee considered insertion of a proviso to clarify that in case of stay of an order by a court, the disqualification will not be attracted. In extension of this, the Committee also proposed that in case of disqualification in this clause and others such as willful defaulter, disqualification from directorship or prohibition under SEBI, the ineligibility will not apply in case an appeal is preferred against such disqualification or until the expiry of statutory period for filing an appeal. The Committee was also conscious of the possibility of exploitation and misuse of such a provision.
  • In 29A(g) dealing with preferential, extortionate, undervalued or fraudulent transactions have taken place, the Committee opined that the acts of predecessors should not impede those in management or in control from submitting plans. Hence a proviso, similar to that of NPAs must be inserted stating that is such transaction has taken place in an entity acquired through CIRP and such action took place prior to such acquisition, this clause will not apply.
  • In 29A(h), the Committee took the view similar to that taken by NCLT in the RBL Bank case pertaining to disqualification of guarantors that the intent of the provision is not to disqualify all guarantors merely for the presence of an enforceable guarantee. Hence the term “enforceable” is to be deleted and the guarantee must be invoked by the creditor and must subsequently remain unpaid in part or full for disqualification under this clause to be invoked.
  • Considering the nature of disqualifications and the wide ambit, it was proposed that an Affidavit be submitted by applicant stating that the person does not attract ineligibility under any of the clauses of 29A. In this regard, Regualation 38(3) of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations 2016 inserted by way of Third Amendment Notification on 05/10/17 be removed since the details under the regulation will be covered by the above-mentioned affidavit. Further, considering the tedious and extensive nature of verification under 29A, the timeline of 270 days for the Resolution was proposed to be extended.
  • Finally, certain amendments to Section 30 (Submission of Resolution Plan) were proposed pertaining to the applicability of amendments to 29A so as to not impede CIRPs that are at an advanced stage (which was the case in the RBL Bank case).

ANALYSIS OF SECTION 29A

The inclusion of section 29A in the Code, persons who have contributed to the defaults of the corporate debtor or are undesirable due to incapacities as specified in the section or are a ’related party’ to another defaulting party, are prevented from gaining control of the corporate debtor by being declared ineligible to submit a resolution plan under the Code. This provision asserts protection to the creditors of the company by safeguarding them against unscrupulous persons who irrespective of their earlier defaults are trying to reward themselves by undermining the whole objective of the Code and do not aim to contribute to the revival of the corporate debtor.[5]

The Resolution Professional has the responsibility to conduct Section 29A due diligence. A prospective Resolution Applicant submitting an affidavit stating that he/she is eligible under Section 29A to submit resolution plan will not suffice. Adequate due diligence on the prospective Resolution Applicants and its connected persons needs to be conducted effectively and within the requisite timeline to identify ineligibility, if any. The Resolution Professional should seek clarifications or additional information or document from the prospective Resolution Applicants, if needed for conducting the due diligence. The CoC should review the due diligence report submitted by the Resolution Professional at the time of approving or disapproving a resolution plan specifically lists down the persons who are not eligible to be resolution applicants. Section 29A in its entirety not only restricts promoters but also the people related/connected with the promoters. It is obvious that the intention behind inserting Section 29A is to restrict those persons from submitting a resolution plan who could have an adverse effect on the entire corporate insolvency resolution process. This would also aid in adhering to the timelines outlined under IBC which were otherwise being hampered due to the exploitation of the loopholes in the bidding process.[6]

In the case of Jaypee Infratech Case/Homebuyers case [See Endnote XIV] has clarified and put an end to the questions raised with respect to application and scope of section 29A. While dealing with the eligibility of Jaiprakash Associates Limited (‘JAL’), the parent company of Jaypee Infratech Limited as a resolution applicant under section 29A, the Supreme Court has observed that JAL and other promoters are disqualified from submitting a resolution plan as they fall within the scope of the section 29A and therefore are ineligible. It has described insertion of section 29A as a ‘plugging loophole’ and has ruled that strict adherence to Section 29A is mandatory and that willful defaulters shall not be permitted to participate in the corporate insolvency resolution process.[7]

It provides for a diligence framework enabling the committee of creditors to make proper assessment of the solvency, integrity and credibility of a resolution applicant before approving a resolution plan keeping in view the scale, complexity, viability and feasibility of a resolution plan to avoid entry of frivolous applicants. It also aims to protect the insolvency resolution process from any impurity or intoxication which had recently been seen in the matter of Synergies Dooray where the corporate debtor company got merged with a related party while Edelweiss ARC as a lender undertook nearly a 95% haircut on its recovery. The Ordinance prescribes penalty for violation of the Code which will ultimately prove to be a deterrence for frivolous applicants participating in the resolution process.

The section also allows the applicant if it clears off all its dues to be eligible as a resolution applicant under Section 29A, as per the instructions of the apex court. in the case of Essar Steel, the bidders — ArcelorMittal and Numetal — were held ineligible due to the related party clause. Numetal had Rewant Ruia, the son of Essar Steel promoter Ravi Ruia, as beneficiary, while ArcelorMittal owned 29.05% stake in defaulter Uttam Galva. ArcelorMittal’s bid for Essar Steel was finalized after it paid outstanding dues of Uttam Galva to the tune of Rs 7,000 crore. The promoters of Essar Steel offered the lenders a settlement offer which was approximately 25% higher than the amount being offered by the H1 bidder. The promoters were barred from offering a competing bid due to Section 29A of the IBC. The promoters of Essar Steel sought withdrawal of the CIRP under the newly introduced Section 12A. [8]The lenders of Essar Steel offered to proceed with the H1 bidder, thereby rejecting the offer of the promoters to withdraw the CIRP process under Section 12A of the IBC.

The insertion of Section 29A cured a few gaps in the law under the Code, the insolvency resolution procedure had become complicated as the resolution professional or liquidator had been accorded with an additional responsibility of inspecting the eligibility of resolution applicants putting a strain on the deadline for completion of the corporate insolvency resolution process.

Due to its stringent qualifying criteria, the Ordinance disqualifies majority of the domestic and international aspirants from participation in the bidding process. This has the potential to further weaken an already depressed financial value of any resolution plan.

The definition of ‘related party’ in relation to an individual is extensive bringing a large number of people in the ineligibility criteria. Moreover, in determining the connected persons of an individual where he/she is married, the relatives of the spouse of the individual will also be included in the scope of the term ‘connected persons’ for the purpose of section 29A.

The ‘financial entity’ have been excluded from the purview of ‘related party’ in the Code. It also provides for limited exemptions to the micro, small and medium sector enterprises (‘MSMEs’) from the application of section 29A and allows its promoters to submit a resolution plan provided he is not a wilful defaulter as concerns with respect to third party interest in submitting a resolution plan for the MSMEs was recognized[i].

The insolvency proceedings of Ruchi Soya Industries Ltd. is a noteworthy example showcasing the wide ambit of ineligibility that could be used by other bidders to challenge the eligibility of the resolution applicants. In this case, the committee of creditors declared Adani Wilmar as the highest bidder and a resolution plan was being finalized. Meanwhile, a claim of ineligibility was raised by Patanjali Ayurveda, the second highest bidder against Adani Wilmar contesting its eligibility under Section 29A of the Code. The peculiarity of this case is that Adani Wilmar is claimed to be ineligible because the spouse of the managing director of Adani Wilmar is the daughter of a defaulting promoter. Patanjali Ayurveda has approached NCLT challenging the decision of the committee of creditors approving the bid of Adani Wilmar.

As a consequence of inclusion of section 29A in the Code, persons who have contributed to the defaults of the corporate debtor or are undesirable due to incapacities as specified in the section or are a ’related party’ to another defaulting party, are prevented from gaining control of the corporate debtor by being declared ineligible to submit a resolution plan under the Code. This provision asserts protection to the creditors of the company by safeguarding them against unscrupulous persons who irrespective of their earlier defaults are trying to reward themselves by undermining the whole objective of the Code and do not aim to contribute to the revival of the corporate debtor.

The promoters are willing to pay to the lenders sums higher than that offered by the highest bidder. Accordingly, the lenders are in a better position by accepting the offer made by the promoters as opposed to that of the highest bidder. The restrictions under Section 29A result in the lenders being devoid of this higher price being offered by the promoters. the legislature has to tow a fine line between protecting the interests of the creditors and not harming them. Any amendments that are brought in, have to provide strict qualifying parameters to prevent dubious promoters from regaining control of the corporate debtor and its assets but at the same time who is bidding the highest and providing the creditors with greatest returns must be kept in mind.

For instance, in the case of bankrupt Monnet Ispat, the related party clause created some confusion. The only bidder of the company was AION Capital and JSW consortium consortium. JSW Steel promoter Sajjan Jindal is the brother-in-law of Monnet Ispat’s founder Sandeep Jajodia. The lenders had to take legal opinion before finalizing the bid. Sajjan Jindal, being furious about this section, commented that, it’s an immature provision which stops the highest bidder from reviving the company and paying the greatest return just because of certain ineligibility.

When the creditors are getting what they want and the resolution plan is meeting all the requirements then what is the need of reconsidering it.

The ultimate aim of the legislation is to revive the company and avoid liquidation and this section is not meeting that aim as it disqualifies most competent resolution applicants.

CONCLUSION

Section 29A laid down a multiple layered and comprehensive standard of disqualification that will exclude bona fide resolution applicants. The application of the section might also disbar crucial stakeholders to bid for the revival of the company. Therefore, certain amount of leniency by the courts in deciding the issue of disqualification is the need of the hour to maximize the objectives of the Code. As an alternate to the current restriction, a middle ground could be adopted, which permits promoters to bid for the corporate debtor, while ensuring there are sufficient safeguards in place to ensure that the lenders make the most of the resolution process.

Also, ensuring a middle path permitting promoters from becoming a resolution applicant, although ensuring appropriate safeguards (such as the above) to protect the other stakeholders may make the IBC and the CIRP process much more economically viable for the promoters and the lenders, without compromising the sanctity of the process.

There must also be certain relaxations in the related party transactions so that the excess of payments that the competent companies’ promoters are willing to make to the lenders cannot be let go for the cost of morality. 

Authors:

Shivangi Pathak (author)

LL.M students

Aherar Patel (co-author)

LL.M students

 

 

REFERENCE

[1] http://www.financialexpress.com , last visited on December 17,2019, 7”00pm
[2] Taxman’s’ Insolvency and Bankruptcy Code, Page59, Paragraph 4
[3] http://www.businessstandards.com last visited on December10 ,2019, 4pm
[4] https://www.ibbi.gov.in/ , last visited on December 12,2019, 6pm
[5] Treaties on Insolvency and Bankruptcy Code by VS Wahi, Page no. 104, Para2
[6] https://www.ibbi.gov.in/
[7] http://www.manupatra.com last visited on December 11,2019 10am
[8] Corporate Insolvency by Sumant Batra, Page no, 88, Para 5

 

Disclaimer:

The opinions expressed herein are those of the contributors (which shall, for these purposes, include guests) in their personal capacity and do not, in any way or manner, reflect the views of the organizations that the contributors are presently associated with, or that have previously employed or retained the contributors. Postings on this blog are for informational purposes only. Nothing herein shall be deemed or construed to constitute legal or investment advice. Discussions on, or arising out of this, blog between contributors and other persons shall not create any attorney-client relationship.

 
  • : LL.M students

One comment

  1. Discussion in respect of Micro, Small, Medium Enterprise (MSME) is required to fix or determine on eligibility under Section 29A of IBC 2016.

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