The Committee of Creditors in a Resolution Process – Alterations, Exclusions and Recent Developments – By Mr. Naman Sharma & Ms. Kareena Bakhtyarpuri

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The Committee of Creditors in a Resolution Process – Alterations, Exclusions and Recent Developments

– By Mr. Naman Sharma & Ms. Kareena Bakhtyarpuri
4th year B.A. LL.B. Students at Institute of Law, Nirma University, Ahmedabad  

~ Introduction ~

The Indian Bankruptcy Regime has been in a continuous development stage since the advent of the Insolvency and Bankruptcy Code in the year 2016. Though there have been various statutes in place to deal with different types of financial crises faced by individuals and/or companies however no law was robust and technical enough to cover all the aspects. This was proven to each and every stakeholder through the utter and lucid failure of Sick Industrial Units Act, 1987 (SICA) and it is only after this failure, the efforts towards development of a consolidated and an all-encompassing law were initiated in full swing. The recognition for development of the consolidated law on the insolvency regime is attributable to the Bankruptcy Law Reforms Committee (BLRC)that submitted its report in the year 2015 which has led to the consolidation of the insolvency laws.

Taking note of the origin of and need for enactment of any statute becomes important to understand the tacit objective behind bringing any provision in the law. The BLRC in its 2015 report mentioned that “the creditors are supposed to take control of the company and there shall be no say of the equity holders after recognition of such default.”[1] By this statement the important thing that can be inferred is that the creditors of a company are the ones at the weaker end of negotiations and if not given their due powers they will be deprived of their rightful dues. The Committee was observant enough to give such position to the creditors so that the trust of the investors is maintained and they are satisfied that even when the Corporate Debtor defaults; the insolvency regime shall be present to their rescue.

This power provides the creditor to be in control of the affairs of corporate debtor till the time the insolvency process gets completed and dues of the creditor are received. The Supreme Court has also affirmed to this view of the Committee and stated in the case of Innoventive Ind. v. ICICI Bank,[2] wherein it was observed that “when the company or a corporate entity makes any kind of default, the control shall necessarily shift to the creditors and shall not remain in the hands of the management of the company.” Hence, it is certain that creditors of a company play a significant role in its development as well as in the circumstances where the company goes into insolvency.

The Act provides for the Committee of Creditors (CoC) who are given charge of the proceedings of the company till the completion of the insolvency proceedings. This committee is formed by the Interim Resolution Professional as per Section 18[3] and Section 21[4] of the Act. The CoC consists of the financial creditors as is mentioned under Section 21(2) of the Act. The CoC is given the highest powers when the insolvency resolution process in a company is carried on. The CoC not only has the power to take decisions regarding the debts of the company but also is allowed to take administrative decisions of an entity.

At this juncture, it becomes pertinent to understand that what are the developments that took place after the Code was brought into force, in the powers of CoC, their constitution and other such developments which are relevant for the future course of insolvency regime in the country.

~ Inclusion of Operational Creditors in CoC ~

The BLRC did not include the operational creditors in the CoC which is entitled to take all the necessary decisions pertaining to administration, revival and implementation of revival plan for the company. The BLRC in its report clearly mentions the reason for non-inclusion of the operational creditors in the CoC. The reason which is attributed to this decision is that there is an apprehension that the operational creditors will not be willing to take the brunt of postponing their rightful dues so as to ensure a better future for the Corporate Debtor. However, there is a very important role that is attributed to the operational creditors in an entity. The functioning of the company can only be carried on a smooth manner when there are enough operational creditors present to support the working of the Company. Such a differential treatment towards one kind of creditors is certainly discouraging and may lead to squeezing of the operational creditors out of the market. This has also led to much litigation in the past and has sought varied responses from different adjudicating authorities.

In the case of Binani Industries v. Bank of Baroda & Anr.,[5] it was observed that “if there is a preferential treatment extended to one kind of creditor, it is certain that the other type shall go out of the market, and may create hindrances in availability of credit.” It is important to understand that there are some scenarios where it shall be important to include even the operational creditors in the CoC so as to serve the very objective of the Code. Some criteria have to be introduced in the Code through which these scenarios can be catered and even the operational creditors get their rightful dues.

The brunt faced by the operational creditors due to such non-inclusion has also been challenged on the grounds of unreasonable and arbitrary discrimination in the various courts. In the case of Akshay Jhunjhunwala v. Union of India,[6] the differentiation was challenged on the ground of being unreasonable. However, the same was rejected by the Hon’ble Calcutta High Court and it was held that the “BLRC has given due rationale behind such classification and differentiation being created between the Financial Creditors and Operational Creditors. The Court also stated that the rationale provided is plausible enough to ensure a time bound resolution process in a company.” Similar finding was also brought forth by the Apex Court in the case of Swiss Ribbon v. Union of India,[7] where the court stated that “the Financial creditor are involved in the processes of Corporate Debtor from the beginning and hence their presence in restructuring is essential to ascertain and remove the financial stress, which is not present with the operational creditors.”

From the precedents stated above, it can be ascertained and inferred that the Apex Court has also upheld the legislative wisdom and ensured that there is no undue interference with the same. The continuous emphasis over such exclusion of BLRC along with the other authorities however has not withheld the possibility of creation of an exception to this rule. These possible exceptions are also catered into the legislation through the Insolvency & Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, where the Regulation 16 clearly mentions that in cases where there is no financial debt present or if all the financial creditors are covered under the aegis of “Related Party”, in such circumstances the CoC can be constituted with operational creditors being part of the same. It is however important to note in this pretext that such committee does not solely remains for the operational creditors but also has a representation of workmen of the entity and also a representation from employees of the corporate debtor. The powers enshrined with this CoC are however same as that held by CoC formed through Financial creditors.

However, even after such inclusion, the assurance that the needs of operational creditors be catered equally when they are not treated at equal footing with financial creditors in the CoC still remains a concern. The argument certainly sustains that the OCs shall aim at a quick recovery of their dues and for the same recover the short-term debts which may not be effective for saving a company and its continuation as a going concern. Giving due consideration to the same some way out has to be found so that a feeling of equalisation be imparted to the OCs so that their existence does not get wiped out from the present credit market.

~ Exclusion of Certain Financial Creditors from the CoC ~

There have been continuous developments that took place after the Code came into force and these developments through the judicial precedents have led to evolution of a robust insolvency regime in India. Though the Code tried to cater to all the difficulties which were earlier faced by creditors in getting their rightful due and to ensure a speedy resolution process, yet there were certain practical difficulties and legal questions that arose in these processes.

One such interesting yet important issue arose relating to the faux parties claiming their roles in the CoC through collusive transactions even after no such entitlement. The issue arose relating to Section 21[8] of the Code which is pertaining to the creation and constitution of the CoC. This provision of the Code though provides that it is only the financial creditors that should constitute the CoC however if such creditor is a related party of the corporate debtor in any manner shall not have any right in the CoC. Hence, there has been a restriction imposed through the provision of the Act to exclude related parties so as to ensure that there are no arbitrary actions that are carried out in such functioning of the entity. The issue that is decided in the case of PhoenixArc Private Limited v. Spade Financial Services Limited, was whether the related party status if extended to a FC shall be as per the present status or shall be as per the time when the financial debt was incurred. The case involved an entangled arrangement between the corporate debtor, its controller and a close associate of such controller. The relation between the involved parties was explicit of having financial interests. However, such relations in were severed in a formalistic manner before the initiation of the Resolution Process.

The Supreme Court in this case was very sceptical of taking a literal interpretation of the provision. A literal interpretation would have meant to include the financial creditors who had relations with the debtor which were severed to seek inclusion in the CoC. A fraudulent inclusion would have been crept in which would have ruined the whole purpose of formation of the CoC. Hence, a purposive interpretation was imparted to the same by the Hon’ble Apex Court and it was held that if an FC who is a related party tries to do away with such tag of related party through any act and acts in such manner with a sole motive of entering the CoC, shall not be the part of the CoC and will be restricted through provision first of Section 21(2).

Hence, it must be understood that the Court has not been interpreting the law in a positivist manner but is continuously analysing the scope of improvisation in the comparatively young Insolvency Code of the country. The recent development of such nature shall certainly be a boon for the insolvency regime in the country and will lead to development of trust in the same. It shall also ensure that the Resolution Proceedings be not only expeditious but also genuine and fair.

~ Alteration of CoC by Resolution Professionals ~

A very brief yet important discussion pertaining to Resolution Professionals and their roles in formation of CoC is important so as to understand certain nuances of the insolvency regime which are not directly dealt through the Code. It is important to note that the core duty of IRP is formation of the Committee of Creditors which is done after receiving all the claims from the creditors and their verification. However, there are quite new and entangled issues that arise in such formation.

One such issue is that does the IRP has power in any manner to alter the status of creditors from financial creditors to operational creditors and thus resulting in alteration of CoC. This act can only be conducted when a financial creditor after being granted such status, is altered to an operational creditor and thereby taking such financial creditors’ position in the CoC. It is certain that such an arrangement can also take place in cases where a settlement deed is entered into between the IRP and CoC and such action is thereby allowed. However, the NCLAT, Delhi had the opportunity to clear the fog in this regard through the judgment of Rajnish Jain v. Manoj Kumar Singh,[9] where a similar issue arose as to what are the powers present with IRP to alter the status of creditors after the categorisation of claims.

In this case, NCLAT, Delhi looked upon all the acts carried out by the CoC with scepticism. In one of the meetings of CoC, the IRP brought in the claim for not considering one of the financial creditors as a part of CoC as the CoC ‘no longer wished’ the party to carry on as an financial creditor. The Tribunal in this case clearly condemned the action and stated that there cannot be such a change on the whims and fancies of the IRP or CoC after the categorisation of claim. Hence, the NCLAT has provided a clear answer to the issue and has settled the position in this regard.

It is certain that such a strict action from NCLAT is required in this regard. If the same shall not been taken there would have been chaos as IRP and CoC then could have entered into settlement deeds and even genuine claims of financial creditors would have been altered into an operational creditor thus altering the CoC. The core feature of CoC that is it is formed from all the Financial creditors in itself would have been at stake if such authorisation would have been granted. A restrictive yet welcoming step is taken by the adjudicating authority for ensuring a better and transparent resolution process.

~ Conclusion ~

From a holistic discussion regarding the Committee of Creditors and the developments in law that are brought in regard to its position and functioning, it must be understood that there are continuous efforts being made by the legislature as well as the judiciary to bring in a robust insolvency regime with minimal to zero deficiencies. The developments that took place pertaining to the CoC such as allowing non-inclusion of Financial creditors in certain conditions, restrictions imposed on RP and IRP on alteration of status of creditors and many other such acts in themselves have cleared the object of the government and the judiciary to ensure that there is no unreasonable and arbitrary action taken in any manner by misusing the loopholes in the new insolvency regime. It is a slow yet gradual development that is taking place in the country and shall certainly lead to a robust system.

Reference

[1] BLRC, Ministry of Corporate Affairs. (2015). The report of the Bankruptcy Law Reforms Committee Volume I: Rationale and Design. (https://ibbi.gov.in/BLRCReportVol1_04112015.pdf)

[2] Innoventive Industries v. ICICI Bank, [2017] ibclaw.in 02 SC

[3] Insolvency and Bankruptcy Code, 2016, Act No. 31 of 2016, §18.

[4] Insolvency and Bankruptcy Code, 2016, Act No. 31 of 2016, §21.

[5] Binani Industries Limited v. Bank of Baroda & Anr., [2018] ibclaw.in 06 NCLAT

[6] Akshay Jhunjhunwala v. Union of India, Cal. H.C., [2018] ibclaw.in 03 HC.

[7] Swiss Ribbon v. Union of India, [2019] ibclaw.in 03 SC

[8] Insolvency and Bankruptcy Code, 2016, Act No. 31 of 2016, §21.

[9] Mr Rajnish Jain v. Manoj Kumar Singh, (2020) ibclaw.in 409 NCLAT

 

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