[Aditi and Abha are students at Rajiv Gandhi National University of Law.]
In the case of Grand Developers Private Limited v. Nitin Batra and Others (Grand Developers), a group of homeowners filed an application under Section 7 of the Insolvency and Bankruptcy Code 2016 (IBC) for initiating a corporate insolvency resolution process (CIRP) against the landowning company and the developers (Corporate Debtors) for defaulting to complete the project and providing possession to them. The Corporate Debtors challenged the maintainability of the application before the National Company Law Appellate Tribunal (NCLAT). Before the present case before NCLAT, the Corporate Debtors had taken multiple legal steps to contest the insolvency proceedings, including filing objections, appeals, and intervention petitions from the National Company Law Tribunal (NCLT) to the Supreme Court of India (SC). The appeal before the NCLAT involved the same matter in a different packaging.
While the Hon’ble NCLAT ultimately dismissed the appeal on the observation that the Corporate Debtors have been using these appeals as a delaying tactic, what is of importance in this proceeding is the NCLAT’s observation on the interaction between Section 230 of the Companies Act, 2013 (CA 2013) and the IBC. The Corporate Debtors had objected to acceptance of the application under Section 7 application on the grounds of pendency of an application under Section 230 of the CA 2013 which allows for a compromise or arrangement between the company and its creditors/members. The NCLAT held that these applications under Section 230 of the CA 2013 and Section 7 of the IBC are distinct and the former cannot be grounds for rejection of the latter. In this blog, the authors analyze the consequences of such a dictum within the broader context of the IBC and particularly, the implications with respect to Section 7 and Section 9 of the IBC, against the backdrop of prospective pre-pack insolvency regime which intends to provide for an informal settlement of claims with limited court intervention. The authors ultimately conclude that the said dictum is prone to irony and contradicts the objectives of the IBC which puts the revival of the distressed concern as the top priority.
The Interplay between Section 230 of the CA 2013 and Section 7 or Section 9 of the IBC
Both Section 7 and Section 9 of the IBC allow for the initiation of CIRP against the corporate debtor by the financial creditor and operational creditor respectively. The contrast between Section 230 of the CA 2013 and Section 7 or Section 9 of the IBC arises from the similar yet different objectives these provisions serve. While Section 7 or Section 9 allow for the initiation of the CIRP process to recover debts owed to the creditors which may lead to liquidation or the sale of the company’s assets, Section 230 focuses on a more collaborative approach wherein the company and its creditors engage in negotiations for compromise or arrangement, potentially leading to restructuring. The issue in the current landscape is that once a Section 7 or Section 9 application is admitted, the company loses control of its operations and is handed over to a resolution professional, leaving little to no room for the management to propose solutions under Section 230. Adding to that, Section 14 of the IBC imposes a moratorium, halting all legal actions against the company and further hindering any restructuring attempts as the company’s operations are frozen, affecting the credibility of the company and limiting the possibility of preserving jobs, maintaining the company’s business relations and safeguarding its market reputation. Moreover, it negatively impacts the morale and trust of shareholders, whose interests could be better served through the process of restructuring under Section 230.
Section 230 of CA 2013 provides a key opportunity for out-of-court restructuring, an informal process, under the NCLT’s oversight, allowing companies to negotiate with creditors without court intervention. This informal process provides for faster, cost-effective, and greater flexibility in terms of reaching mutually beneficial agreements. Further, it mitigates damage to the company’s goodwill by avoiding the prolonged timeline and potential conflicts associated with the formal process. In India, while this process is legally allowed under Section 230, its practical application faces challenges. The prioritization of Section 7 applications under IBC often hinders the effective use of this process, as the moratorium triggered by insolvency proceedings limits the scope of restructuring negotiations.
Judicial Outlook on the Interplay of Section 230 of the CA 2013 and Section 7 of the IBC
Prioritization of Section 7 application under IBC over Section 230 of the CA of 2013, is flawed. The creditor recovery is essential but the broader goal of corporate rehabilitation or restructuring, achievable under Section 230 should not be sidelined in the process.
In the aforesaid case of Grand Developers, the Hon’ble NCLAT’s assertion that a petition under Section 230 of CA 2013 is independent and cannot obstruct proceedings under Section 7 of IBC is to be noted. Admission of the Section 7 application triggers the CIRP, which focuses on resolving insolvency through a creditor-driven process. Once CIRP is initiated, the NCLT declares a moratorium and an independent resolution professional is appointed to overtake the management. Moratorium under Section 14 of the IBC, freezes all legal proceedings and restricts the sale of assets thereby obstructing the process of corporate restructuring under Section 230 including any merger or acquisition. Therefore, treating the application under Section 230 as an independent application is flawed as the moratorium once imposed also affects Section 230 proceedings. This moratorium not only halts creditors' actions but also affects the credibility of the company as a financially sound venture, making it difficult to secure new investments that could lead to corporate revival.
Furthermore, if the proceedings under Section 230 proceed independently of Section 7, it will be rendered unenforceable if the NCLT admits Section 7 application on account of the “clean slate doctrine”, which extinguishes the past claims of the corporate debtor once the resolution plan is approved.
To add to the misery, SC in the case of Arun Kumar Jagatramka v. Jindal Steel and Power Limited, ruled that the individual ineligible to submit a resolution plan under Section 29A of IBC is to be considered ineligible to propose a scheme of compromise and arrangement under Section 230. This further narrows the potential for distressed companies to pursue corporate restructuring which has been pending before the initiation of CIRP due to the potential ineligibility of the previous management of the company concerned.
The NCLAT’s aforesaid position of law on the interplay of Section 230 of the CA 2013 and Section 7 of IBC can be corrected by virtue of the SC’s judgment in Vidarbha Industries Power Limited v. Axis Bank Limited. In the said case, the Hon’ble SC shed light on the discretionary power vested in the NCLT under Section 7(5)(a) of the IBC as contrary to the supposed mandatory power. The section mentions the word “may” and not “shall” which allows the NCLT to consider the debtor’s financial viability before admitting insolvency applications. It is a pivotal case wherein it was held that NCLT could refuse to initiate CIRP if there are valid reasons such as the company’s financial condition or prospects of resolution. This case hereby challenges the mechanical prioritization of insolvency proceedings under Section 7, reaffirming the need for a broader, case-by-case evaluation which could also incorporate effective alternative restructuring methods, including Section 230’s compromise and arrangement mechanisms. However, the compulsory admission of the application under Section 9 of the IBC on account of the existence of debt and the occurrence of default continues to pose problems.
Enabling Out-of-Court Debt Restructuring/Pre-Packed Insolvency Resolution
The process of out-of-court debt restructuring is recognised as a vital informal exercise to present the distressed company one last chance at evading the formal insolvency proceedings. The World Bank while analyzing the various insolvency systems around the world states that most systems follow hybrid procedures wherein the advantages of both formal and informal approaches to indebtedness problems are combined. The benefit of the hybrid procedures lies in the flexibility offered to the creditors and debtor to arrive at an arrangement before the option of formal tribunal monitored CIRP is utilized. The informal procedures provide a speedier route for revival than the formal insolvency resolution process which takes an average of 843 days for closing the CIRP process and 679 days for CIRP resulting in liquidation as per the latest data for 2024. In the US, the average time taken by the courts to approve prepackaged plans is a mere 2 to 4 months while the formal process takes 11 months in comparison. Below are certain salient features related to pre-packaged insolvency and its interaction with Section 230 across jurisdictions have been mentioned. Jurisdictions like Singapore, Ireland, and France have incorporated the provision of approaching the court for a temporary stay on legal actions to facilitate the process of compromise outside the court. The Insolvency and Bankruptcy Board of India in its “Report of the Sub-Committee of the Insolvency Law Committee on Pre-Packaged Insolvency Resolution Process” has also recognised the need for providing a calm period in the form of the moratorium to work out a plan for resolution of insolvency. In this report, has recommended extending the application of Section 14 of IBC to the pre-pack commencement date till its closure either successfully or otherwise. This is essential to provide the company with a chance at revival without Section 7 or Section 9 applications of IBC encroaching upon what could be a way out.
Conclusion and Way Forward
The current prioritization of section 7 and section 9 of the IBC over section 230 of the CA 2013 creates significant barriers to effective corporate restructuring. To create a more balanced insolvency framework, it is essential to enable out-of-court restructuring opportunities as envisaged under Section 230, which offers crucial life support for the revival of distressed companies, facilitates a restructuring process that can protect employment, ensures continuity of the business and maximizes asset value without undermining the credibility of the company. A reevaluation of the legal interplay between these sections can foster a hybrid approach that accommodates both corporate revival and credit recovery, ensuring the overall health of the economy and the welfare of the stakeholders remain paramount. In the end, we must remember that realization, not being an objective of the IBC, is only a bi-product of revival of failing firms, and wherever possible, the primary focus should be revival.
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