BQExplains: Ordinance That Amends IBC And Delivers A Stern Message To Promoters

A quick explainer on the ordinance that has India Inc. shocked!

(Source: BloombergQuint)
(Source: BloombergQuint)

In an effort to “prevent unscrupulous, undesirable persons from misusing or vitiating the provisions of the Insolvency and Bankruptcy Code” the government has laid down 10 ineligibility conditions via an ordinance.

A person shall not be eligible to submit a resolution plan if he is:

  • An undischarged insolvent.
  • Tagged as a wilful defaulter by RBI.
  • Whose account has been a non-performing asset for one year or more and who has failed to make payment of all overdue amounts with interest before submission of the resolution plan.
  • Convicted of an offence punishable with imprisonment for two years or more.
  • Disqualified as a director under Companies Act, 2013.
  • Barred by SEBI from accessing capital markets.
  • Indulged in preferential/undervalued/fraudulent transaction as per judicial order.
  • Executed an enforceable guarantee in favour of a creditor for a company facing insolvency proceedings.
  • Connected persons.

Well known lawyer Shardul Shroff, executive chairman of law firm Shardul Amarchand Mangaldas & Co, explains the application of these criteria and other changes made via the ordinance.

How do you view this development where promoters of insolvent assets cannot participate in the bidding?

They have taken a strict view. Because if you look at it as an extension of an Strategic Debt Restructuring or Corporate Debt Restructuring process, there they were giving haircuts to people who were promoters, who were working out a plan on principles which were part of the RBI guidelines. Whereas now they are taking up a position that if you’ve not paid, you’re not eligible.

Is there any scope hereafter for promoters of the assets in insolvency to be part of the resolution process?

The consequence of the second element of Section 29 regarding eligibility will be that if they were non-performing assets for one year or more, and unable to settle the overdue amount, they will be ineligible to settle defaults then. So, there is a requirement of settling the overdue amount.

What can happen before the corporate insolvency process commences is that they scale down the debt and pay it. If they bring in some third party white knight effectively at a stage prior to the resolution process and have a settled value, they can clean up the default. Assuming satisfaction of overdue amount and interest as scaled down, if they pay it before the resolution plan, there is no issue.

Does a promoter, who has not settled his previous defaults at a time when resolution plans are pending to be submitted to the committee of creditors, have scope to subkit a resolution plan?

The word used here is ‘before’ the submission of the resolution plan. If the promoters have submitted the resolution plan, while their overdue amounts are standing, they will be ineligible. But suppose the resolution process has begun, but before the resolution plan is submitted, they made the payment of the overdue amount including interest, then yes. But if the resolution plan is already submitted, then no.

If they have not submitted the resolution plan then they still have an opportunity to find a way to repay the default amount and then be allowed to submit a resolution plan. But if they had means to pay they would have to begin with, right?

You (the promoter) did not settle because there was no pressure of being evicted. It puts a level of pressure. It is intended to knock off people who have defaulted. It is that principal that they don’t want anybody to misuse. Their intention is to knock off people who have fiddled with the system.

What if somebody else has submitted a resolution plan and the promoter has not yet done so?

If they have not submitted, then there is scope. If somebody else has submitted, it does not affect any of the disqualification criteria concerning the promoter. A third party making a resolution plan is not relevant for the purpose of 29A (c). Only their own submitted plan is relevant for the disqualification.

What if a promoter has already submitted a resolution plan?

If some promoters have filed resolution plans but they are ineligible by virtue of this ordinance their plan will be treated as invalid. It will be treated as if it was not available at all. The resolution professional will have to call for fresh submissions.

Do you expect these restrictions on promoters to hurt the price discovery process of assets? After all they know the asset best and would bid aggressively if they want to retain it.

The resolution process has been put in for viability rather than just the haircut. So, the principal that the government has enunciated through the ordinance is that I want the people who are going to run this project in a viable manner and not just the promoters running it.

In case of Jaypee Infra, there are 18 proposals. If you can’t discover pricing in 18 proposals you will never discover price. You can’t say that the old promoter is the price leader in a price discovery system. Even if he has asymmetrical knowledge and is in position of having much more information than the third party.

Do you think the promoters have any grounds to challenge this ordinance/law?

It is very difficult to challenge. Because look at it from perspective of mischief that is sought to be remedied. None of the persons who are disqualified are persons who don’t share the blame. When the promoters asks for a haircut that it is 40-60 percent and he is the cause of that non-performance which impacts the banking system the sympathy will not be with the promoter. The government is acting on principles of equity. If the person has caused the injury to the banking system, would it not be prudent to keep the person out of the resolution process?

But many promoters could seek to be heard on the merits of their own case. They may believe circumstance or events outside their control are to blame for the default. Will they find the grounds to get relief?

If you read Section 29 (A) C, it says, if a period of one year or more has passed from the date of classification as a non performing asset...If you had all these grievances, you could have made those grievances clear to the RBI, promoters, bankers at that point of time and said that these are beyond my control. But if despite all that, it has been classified as an NPA, then I don’t think this argument will stand. This clause is absolute and not subject to causes. Causation is not part of Section 29 A (C). The exception to the rule that I have to be permitted to participate in an insolvency resolution process where I can ask 50-60 percent haircut for reasons beyond my control, the flip side is that it is also beyond the control of the bank. Why would the banking system take such a loss?

Could you explain the criteria pertaining to guarantors?

In Section 2 sub clause (e), they have split it in three subsections. Personal guarantors to corporate debtors will also be subject to the moratorium. So, the claims to the guarantors will get discharged. That could be my reading of how the amendments work.

Take a situation where for instance in the Ruia case (hypothetically speaking), a Mr Khaitan has given a guarantee for Essar Steel. Therefore, the promoter is per se barred by virtue of the ordinance. In relation to the guarantees, Mr Khaitan would be the beneficiary because his guarantee will also be subject to moratorium during the process of a rehabilitation scheme which is a resolution plan. If Mr Khaitan has executed an enforceable guarantee in favor of creditors, namely the banks, in respect of the corporate debtor which is Essar Steel under insolvency resolution process, then Mr. Khaitan can’t submit a resolution plan.

Do you expect many promoters to challenge this in court?

They will go to court to argue the point that there is retrospectivity in the ordinance.

Somebody may take up the issue that there is a time limit within which resolution plans have to be filed and the ordinance has not dealt with how the time limit gets expanded if there are no valid resolution plans. They proceed on the basis that if you are not eligible and no resolution plan is available then the resolution professional is to invite further resolution plans. But there is a time limit within which the committee of creditors shall get all things approved and that time limit is 270 days. So, depending on what stage it is then there might be some problem on the retrospective applicability of Section 13(4). So, there are some openings but they are fact based. They are not law based.