Background
The Insolvency and Bankruptcy Code (Amendment) Ordinance 2018 (Ordinance) was notified on 6th June, 2018 to amend several provisions of the Insolvency and Bankruptcy Code, 2016.Insolvency and Bankruptcy Code (Second Amendment) Bill, 2018 was introduced in LokSabha to repeal and replace the Insolvency and Bankruptcy Code (Amendment) Ordinance,
2018. Parliament has passed the Insolvency and Bankruptcy Code (Second Amendment)Bill,2018 with the Rajya Sabha approving it on 10th August, 2018.
The said Amendment resolves several issues that were coming in the way of smooth workingof the IBC and plugs in loopholes in the Code. This Update contains an elucidation on the keychanges made to the Code by the aforesaid Amendment as under:-
1. Home buyers now recognised as financial creditors
Position before the Amendment
1.1 There was no specific provision in the Code which protected a homebuyer who had paid money to a company for purchase of a real estate property and the question whether such sum paid by homebuyer should be categorised as a financial debt was a subject matter of constant debate.
1.2 The National Company Law Appellate Tribunal (NCLAT) had held that, – only when there was an ‘assured return’ promised by the builder to the home buyer, that the latter could initiate insolvency proceedings in case the builder fails to honor the assured return and not otherwise.
Position after the Amendment and Impact
1.3 Any amounts raised from an allottee under a real estate project would have the commercial effect of a borrowing, and therefore be considered as a financial debt. Bulwark Solicitors Research Update Insolvency Law Practice I & BC (Second Amendment) Bill, 2018 – Analysis Page 2 of 8
1.4 Homebuyers will now be treated as ‘financial creditors’ and form a part of the committee of creditors (the “CoC”) of a corporate debtor and play a part in the decision-making process, which includes whether to accept or reject a resolution plan. The classification as a ‘financial creditor’ also enables homebuyers to initiate the CIRP against large real estate houses.
1.5 During a corporate insolvency resolution process, the CoC may choose to: (i) resolve the debtor company, or (ii) liquidate (sell) the debtor’s assets to repay loans. In case of liquidation, secured creditors are paid first after payment of the resolution fees and other resolution costs. This is followed by payment of employee wages, and then payment to all the unsecured creditors.
1.6 Although homebuyers have been classified as ‘financial creditors’, no amendment has been made to the Code to clarify whether homebuyers would be treated as secured or unsecured creditors when it comes to the distribution of proceeds arising from the sale of assets in the event of liquidation of the corporate debtor. It therefore seems unclear whether homebuyers will rank pari passu with secured financial creditors in a liquidation scenario.
1.7 As per Real Estate (Regulation and Development) Act, 2016, an allottee includes any person to whom a plot, apartment, or building has been allotted, sold, or transferred by a promoter (real estate developer or development authority).
2. Existence of a “dispute” in case of an Operational Creditor and dispensing off with the requirement of providing a certificate to that effect
Position before the Amendment
2.1 While the financial creditors can initiate the insolvency resolution process by directly filing the application with the National Company Law Tribunal (hereinafter to be referred as the “NCLT”), on the occurrence of a default, the ‘operational creditors’ are first required to deliver a demand notice (and invoices) to the corporate debtor, under Section 8 of the Code, who had 10 days to either pay off the debt or notify the creditor of the existence of a dispute. One of the practical concerns under the Code, in the context of operational creditors, was that a corporate debtor was required to establish both the existence of a dispute and the pendency of a suit or arbitration proceeding, to dispute an insolvency application brought by an operational creditor.
2.2 The operational creditor also had to file a certificate from their banker to certify that no amount had been received from the corporate debtor to satisfy the operational debt, which was problematic for a number of reasons, particularly non-cooperation from banks. In the case of Macquarie Bank Limited v. Shilpi Cable Technologies Ltd, it was however held by the Hon’ble Supreme Court that, – submission of bank certificate was not mandatory to evidence non payment of operational debts.
Position after the Amendment and Impact
2.3 An operational creditor will be barred from filing an application for initiating the insolvency resolution process if a dispute exists but is yet to be filed before the courts or an arbitration tribunal. The amendment, in effect, incorporates the judgement of the Hon’ble Supreme Court in Mobilox Innovations Private Limited v. Kirusa Software Private Limited.
2.4 It is not compulsory for an operational creditor to submit a certificate from a financial institution confirming that the operational debt is due. Alternate means of proving non-payment of operational debt, such as records from information utilities or other record as may be notified by the Central Government, has also been permitted. The amendment, in effect, gives legislative effect to the judgement of the Hon’ble Supreme Court in Macquarie Bank Limited v. Shilpi Cable Technologies Ltd.
3. Application of Limitation Act, 1963 to insolvency proceedings
Position before the Amendment
3.1 There was an ambiguity regarding the applicability of the Limitation Act, 1963 to the Code. (i.e. the right of creditors holding time-barred debts to file for insolvency resolution).
3.2 In the case of Black Pearl Hotels Pvt. Ld. v. Planet M Retail Limited, the NCLAT ruled that the limitation period (3 years) for initiating insolvency proceedings for all claims existing prior to the Code would begin from the date of its coming into effect, i.e. 1 December 2016. This gave an opportunity to the creditors to initiate fresh insolvency proceedings for debts which otherwise were not recoverable due to the expiry of the limitation period.
Position after the Amendment
3.3 The Limitation Act would apply to proceedings under the Code and Insolvency Proceedings cannot be initiated, if the debt is time barred.
4. Initiating IBC proceedings where winding-up proceedings are pending
Position after the Amendment and Impact
4.1 Where a winding up petition is pending in the High Court, the petitioner may apply for transfer of proceeding to the NCLT and to treat the petition as one under the Insolvency Code.
4.2 The leave of the High Court or NCLT must be obtained for initiating insolvency proceedings under the Code, if any petition for winding up is pending in any High Court or NCLT against the corporate debtor under the Companies Act. This amendment has now given the litigants an option to opt for a faster and more effective remedy under the Code. In the case of Jotun India Pvt. Ltd. V. PSL Ltd., it was held by the Hon’ble Bombay High Court that the Company Court cannot injunct insolvency proceedings even when a winding up petition is pending before the Bombay High Court.
5. Voting threshold for decisions of the Committee of Creditors.
Position before the Amendment
5.1 Important decisions pertaining to the corporate resolution insolvency process such as approval of a resolution plan, extension of CIRP beyond 180 days, appointment of the resolution professional, required approval of 75% of the financial creditors by value.
Position after the Amendment and Impact
5.2 Threshold for approval of a resolution plan, extension of CIRP beyond 180 days, appointment of the resolution professional, and certain other critical decisions has been reduced from 75% to 66% of the financial creditors by value.
5.3 Threshold for approval of other routine decisions has been reduced from 75% to 51% of the financial creditors by value.
5.4 The object of the ordinance that is to promote resolution over liquidation is better achieved because earlier the corporate debtor went into liquidation as the voting percentage fell slightly short of the 75% figure.
6. Applicability of Moratorium to Guarantors
Position before the Amendment
6.1 Upon the admission of an insolvency application under the Code by the NCLT, a moratorium of 180 days applies which prohibits the creditors from taking any action to recover or enforce any security interest created by the debtor. There have been divergent judgements on whether the scope of the moratorium includes enforcement action against assets of third parties such as the promoter or guarantor provided as security to the creditor.
6.2 NCLAT held in a recent case that a security or guarantee provided by a third party and a guarantor’s personal property can be proceeded against by a financial creditor to recover its outstanding dues even during the moratorium period, as properties not owned by the debtor would not fall within the ambit of the moratorium declared under the regulations.
Position after the Amendment and Impact
6.3 Moratorium will not be applicable to a surety in a contract of guarantee – the scope of the moratorium is restricted to the assets of the corporate debtor only.
6.4 Enforcement actions can be taken against the assets of a guarantor to a corporate debtor even during the moratorium period.
7. Eligibility of Resolution Applicant, Related Parties – Section 29A
Position before the Amendment
7.1 Related parties and connected persons of the corporate debtor and other entities or their promoters whose loans have been non-performing assets (NPAs) for a period of 1 year, were disqualified from being resolution applicants.
7.2 The definition of ‘connected person’ under the Code, was 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. The underlying intent of the amendment was to prevent persons who had contributed to the failure of the debtor from getting back their assets at significant discounts. The provision was criticized for having the effect of eliminating people who might genuinely be interested in buying stakes in the entity.
7.3 A ‘one size fits all’ approach of section 29A also seemed to be potentially hampering recoveries for MSMEs because there may not be enough interest from third party buyers in companies under the Code for MSMEs which are of a comparatively smaller size and where there was little scope for turnaround unless the promoters submit a resolution plan.
7.4 Further, Resolution applicants, who have provided a guarantee to a creditor in respect of a corporate debtor against which an application has been admitted under the Code, were previously barred from submitting a resolution plan.
Position after the Amendment and Impact
7.5 The following persons will not be disqualified from participating in the resolution process:
i. financial entities which is not a related party of the corporate debtor. 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.
ii. entities who hold an NPA account pursuant to the acquisition of a corporate debtor under an earlier insolvency resolution process – this exemption is available for a period of 3 (three) years 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 insolvency resolution.
iii. regulated financial creditors who are affiliated to the debtor solely because of their equity holdings pursuant to a debt restructuring scheme implemented prior to the initiation of insolvency proceedings.
iv. guarantors of a corporate debtor, unless the guarantee has been enforced and remains unpaid in full or part by the guarantor
7.6 A person would now be tested for ineligibility at the time of submission of resolution plan rather than at the time of commencement of insolvency.
7.7 In case of MSMEs1 , not only the promoters of MSMEs (if they do not suffer from other disqualifications such as being wilful defaulter) have been allowed to bid for their own companies even though they had become NPA but also any bidder for MSMEs who is otherwise disqualified on account of its account being NPA..
7.8 Further, a minimum one-year grace period has been provided for the successful resolution applicant to fulfil various statutory obligations required under different laws which allows more time for the new management to efficiently implement the resolution plan.
7.9 The Code also 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. This 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 Code; and (ii) conviction for seven years or more would be a bar irrespective of which statute the offence fell under. The Amendment also 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).
8. Authorised representative for creditors
8.1 Debenture holders, deposit holders, retail creditors (such as large numbers of homebuyers in real estate projects) and other specified classes of financial creditors in the CoC to be represented in CoC meetings through a separate trustee, agent, authorised representative or insolvency professional, who would act on their behalf in CoC meetings.
8.2 Such authorised representative shall attend the meetings of CoC and vote on behalf of such financial creditors (homebuyers) to the extent of his voting share. If any financial creditor (homebuyer) fails to give prior instructions to the authorised representative, he shall abstain from voting on behalf of such financial creditor. Authorised representative to circulate the agenda and minutes of the meeting of CoC to the financial creditors he represents
8.3 Further, prior to amendment, 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. This prohibition has now been removed for such financial creditors provided they are regulated by a financial sector regulator.
9. Resolution professional responsible for ongoing legal compliances by the corporate debtor
On insolvency commencement date, the board of the company is suspended and an insolvency professional takes control over management control. The Amendment clarifies that insolvency professionals shall be responsible for complying with the requirements under all applicable laws on behalf of the corporate debtor.
10. Withdrawal of NCLT Proceedings
Position before the Amendment
10.1 Previously there was no provision under the Code enabling the withdrawal of the application after admission by the NCLT. Under Rule 8 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016, the NCLT could only permit the withdrawal of an application on a request by the applicant before its admission.
10.2 the Supreme Court in the case of Lokhandwala Kataria Construction Pvt Ltd v. Nisus finance and Investment Managers LLP had held that the power to recognize settlement after the admission of insolvency was not conferred under the Code to the NCLT and NCLAT and only the Supreme Court could recognize such settlement under Article 142.
10.3 Several parties were invoking section 142 of the Constitution of India before the Hon’ble Supreme Court.
Position after the Amendment
10.4 NCLT may allow withdrawal of insolvency commencement application upon application made by the applicant with the approval of 90% voting share of CoC. However, such withdrawal will be permissible only prior to the resolution professional formally inviting resolution plans from interested bidders.
11. Approval of shareholders for initiation of insolvency resolution process by corporate applicant
Position before the Amendment
11.1 For a corporate applicant (the corporate debtor itself or persons in control or management) to file an application for initiation of the insolvency resolution process, there was no requirement to obtain shareholders’ approval.
Position after the Amendment
11.2 Section 10 of the Code has been amended to provide that a special resolution approving the filing of the application by the corporate applicant is now a pre-requisite.