Factual Background

The Corporate Insolvency Resolution Process (CIRP) was commenced against Essar Steel Limited (Essar Steel) under the Insolvency and Bankruptcy Code, 2016 (IBC). Arcelor Mittal was the successful resolution applicant in this process. The resolution plan proposed by Arcelor Mittal involved a payment of approximately Rs. 42,000 crores (Resolution Amount) to the creditors of Essar Steel. The decision on how this amount would be divided between the various financial creditors of Essar Steel was left to be determined by the Committee of Creditors (COC) of Essar Steel. The COC decided that approximately 92% of the loan outstandings of the secured financial creditors would be met out of the Resolution Amount. The operational creditors would, therefore, receive nothing more than the liquidation value of Essar Steel, which was negligible. The National Company Law Tribunal (NCLT) approved the resolution plan with some modifications. This decision was challenged by Standard Chartered Bank and the operational creditors before the National Company Law Appellate Tribunal (NCLAT). NCLAT rejected the claims of the financial creditors and held that both operational and financial creditors must be treated equitably. As a result, from the Resolution Amount, 60.7% of the outstanding dues was payable to each of the creditors, whether financial or operational. The NCLAT also held that the COC cannot determine the distribution of payments pursuant to a resolution plan which must be decided by the resolution applicant. This decision caused considerable heartache to the financial creditors as a class and to the Government who sees the IBC as a major economic reform. To mitigate the impact of the NCLAT order the Government amended the IBC in 2019 to provide that the COC could decide the distribution of amounts pursuant to a resolution plan under the IBC. We have prepared updates on both the NCLAT decision and the IBC Amendment. These can be obtained here and here.

Decision of the Supreme Court

On appeal to the Supreme Court, the Supreme Court overturned most of the decisions of NCLAT in the Essar Steel case. The resolution plan of Arcelor Mittal was approved and the distribution of the Resolution Amount as determined by the COC was upheld. In doing so, the Supreme Court gave finality to a number of issues that had arisen on the interpretation of the IBC. Briefly, the Supreme Court held:

  • Corporate resolution under the IBC is ultimately in the hands of the COC. Under the applicable regulations (Regulations), it is clear that it is the commercial wisdom of the COC which operates to approve what is deemed by a majority of such creditors to be the best resolution plan, which is finally accepted after negotiation of its terms by the such COC with prospective resolution applicants.
  • If the COC has approved a resolution plan, the resolution professional must submit such plan to the NCLT for approval. On receipt, NCLT is required to satisfy itself that the resolution plan as approved by the COC meets the requirements of Section 30(2) of the IBC. This includes whether the resolution plan provides for costs of insolvency, payments to operational creditors, management of the corporate debtor and does not contravene any provision of law. This is clearly spelt out in Section 31 of the IBC which provides that the scope of judicial review of the NCLT is limited to determining that such requirements are met. NCLT cannot substitute its opinion on the resolution plan for that of the COC since the commercial wisdom of the COC is the driver for approval of resolution plans. Similarly, the scope of judicial review of NCLAT is limited to the factors mentioned in Section 61(3) of the IBC. These include (i) the resolution plan contravenes law; (ii) there has been material irregularity in the exercise of powers by the resolution professional; (iii) the debts owed to operational creditors have not been provided in the plan in the manner determined by the Insolvency and Bankruptcy Board of India (Board); (iv) the costs of insolvency have not been provided for; and (v) any other requirement laid down by the Board has not been met. Thus, while the relevant adjudicating authority cannot interfere on merits with the commercial decision taken by the COC, the limited judicial review available is to see that the COC has taken into account the fact that the corporate debtor needs to keep going as a going concern during the insolvency resolution process; that it needs to maximise the value of its assets; and that the interests of all stakeholders including the operational creditor have been taken care of. If the adjudicating authority finds, on a given set of facts, that these parameters have not been kept in mind, it may send a resolution plan back to the COC to re-submit such plan after satisfying these parameters.
  • A bankruptcy code should not be read so as to imbue creditors with greater rights in a bankruptcy proceeding than they would enjoy under general law, unless it is to serve some bankruptcy purpose. If an “equality for all” approach recognising the rights of different classes of creditors as part of the insolvency resolution process is adopted, secured financial creditors will, in many cases, be incentivised to vote for liquidation rather than resolution, as they would have better rights if the corporate debtor was to be liquidated rather than a resolution plan being approved. This would defeat the entire purpose of the IBC. Equitable treatment is only of similarly situated creditors. Financial and operational creditors cannot be paid the same amounts in any resolution plan before it passes muster. It is the commercial wisdom of the COC that determines the payments to be made to the various creditors in terms of the IBC and this may involve differential payments to financial creditors and operational creditors set out in the resolution plan. Equitable treatment is to be accorded to each creditor depending upon the class to which it belongs: secured or unsecured, financial or operational.
  • Delegation of authority to a sub-committee to negotiate with the resolution applicant is within the power of the COC since the subject matter of delegation is not a core function of the COC.
  • The moratorium under the IBC would not apply to claims under a personal guarantee pursuant to Section 31 of the IBC and the decision of the Supreme Court in State Bank of India v. V. Ramakrishnan (2019). Further, all claims under the IBC are deemed to be settled so that the successful resolution applicant can make a fresh start on a clean slate.
  • The relevant changes brought about by the Amendment Act of 2019 were constitutionally valid.

MHCO Comment: The judgment of the Supreme Court delivered by Justice Rohinton Nariman has certainly clarified a number of issues that plagued the effective implementation of the IBC. However, at its core the judgment suffers from an infirmity in so much as operational creditors will now be left with little or no money from a distribution of proceeds pursuant to an approved resolution plan that does not cater to this class of creditors. The liquidation value of debt-intensive companies is likely to be negligible or even negative which leaves operational creditors in the lurch. This appears unfair given that the day-to-day functioning of a company depends on providers of goods and services. If such providers face the risk of non-recovery of dues they are likely to suspend the provision of goods and / or services to the company, which would affect its ability to continue as a going concern.

This update was released on 19 Nov 2019.

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or for any assistance.

Legal Update Team
Advocates, Solicitors and Notaries
T: +91 22 40565252
Mumbai Office: Surya Mahal, 2nd Floor, 5, Burjorji Bharucha Marg, Fort, Mumbai-400 023, India
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