This blog is written by Ms. Renuka Nevgi. She is penultimate-year law student at Maharashtra National Law University, Mumbai.
The far-reaching effect of Sec. 29A, IBC
The objectives of Insolvency and Bankruptcy Code 2016 (hereinafter referred as “IBC”) are timely insolvency resolution of corporate debtor, balancing interests of all stakeholders and maximization of value of assets. Sec. 29A of IBC lists down criteria of ineligibility for the resolution applicants. The role of resolution applicants is significant because they propose resolution plans for the revival of corporate debtor. Sec. 29A bars promoters of the corporate debtor from introducing a resolution plan so that they do not gain a back door entry in the ownership of corporate debtor. This provision not only bars the promoters but also their but also the connected persons and related parties. Thus, this provision disables a lot of prospective resolution applicants from contributing to the revival of company. The rationale behind this provision is to prohibit vesting control with the promoters due to whose misconduct the corporate debtor underwent insolvency.
Ineligibility under Sec. 29A is not limited to proposing a resolution plan and extends during other stages of the proceedings as well. If the resolution process fails or resolution plan is contravened as under Sec. 33, the company goes into liquidation. Before stripping off its assets, an endeavour is made to enter into compromise or arrangement under Sec. 230 of Companies Act. The amendment that was introduced on 6th Jan, 2020 closed the window for promoters here as well. Furthermore, if such compromise or arrangement is not possible or viable, the liquidator attempts to sell corporate debtor as a going concern. At this stage too, Sec. 35 of IBC prohibits the promoters from buying the assets.
The misplaced element of morality
The extensive disqualification of promoters under Sec. 29A assumes that they are at the fault whenever a company becomes insolvent and hence, they should never be given the control of company. However, it is pertinent to note that there are various causes for insolvency and the promoters’ misconduct is neither sole nor leading reason in most of the cases. The insolvency of most companies is circumstantial. For instance, when the steel sector was going through cyclical recessions, Bhushan Steel, Essar Steel, Monet Ispat, Alok Industries, Electrosteel, Jaypee Infratech, Amtek Auto, Jyoti Structures, Era Infra, ABG Shipyard and many other companies were not able to pay debts and went bankrupt. Claims against all these companies were admitted under IBC in 2017.
Furthermore, the assumption in favour of prohibiting the promoters from buying their own assets back at a lower price and benefitting at the cost of the lenders also contains a moral basis. However, IBC is an economic legislation and revival of corporate debtor should be prioritized over any other moral considerations. In the case of Binani Industries Ltd. v. Bank of Baroda, the NCLAT allowed the promoter of Binani Cements backed by Ultratech Cement to introduce a resolution plan as their bid was substantially higher than the other bidders. This order was also approved by the Hon’ble Supreme Court. In contrast to this, in the Ruchi Soya Industries case, the highest bid was made by Adani Wilmar Ltd. which was approved by the CoC by a voting share of 96.85%. However, this resolution applicant was considered as a related party within the meaning of Sec. 29A because the daughter of a defaulting promoter was a spouse of resolution applicant’s managing director. Therefore, the plan proposed by second highest bidder i.e., Patanjali Ayurved Limited was approved by the NCLT.
Economic efficiency and revival of corporate debtor
Richard Posner propounded the theory of economic analysis of law. He argues that most of the common law is based on simple principle of economic outcomes. The judges look at which outcome maximizes the aggregate wealth of society while determining rights of parties. By the term ‘wealth maximization in society’, Posner implies giving resources to those who value them the most. This is determined by examining who is able and willing to pay the highest amount to get those resources. The economic efficiency and principle of optimality should be the guiding factors behind an economic legislation. Applying this theory, the most efficient and optimal alternative has to be chosen by taking economic considerations into account and not just the factors such as mismanagement by promoters. The maximization of wealth would take place if the company survives. If the company is liquidated, all the employees become jobless and this also has a knock-on effect on the other companies transacting with the corporate debtor. This detrimentally affects the market at large. Therefore, if there are no other bidders, insolvency resolution by promoters or their related parties should certainly be preferred over liquidation of the company. Thirdly, applying the calculation method, if promoters place the highest bid, they should be given an opportunity to regain the control of company because they would value it the most.
Due to the above-mentioned reasons, a complete disqualification of promoters under Sec. 29A of IBC is undesirable. An exception should be drawn for the promoters who did not intentionally and knowingly make the defaults. They would infuse credit which would save the company from being liquidated. Liquidation is deemed as an exception under IBC and utmost efforts are to be made for insolvency resolution. Such a policy would be in line with the spirit of IBC which is recovery of stressed assets and revival of debt-ridden companies. Therefore, an economic analysis of Sec. 29A suggests that the promoters and related parties should be eligible to participate in the insolvency resolution process as well as liquidation proceedings unless an malafide intent to defraud is otherwise proven. Even if the de jure ineligibility of promoters is eliminated, there are enough safeguards because the Committee of Creditors would ultimately take the commercial decision of accepting bids.
The views expressed in this article are those of the author and in no way do they reflect the opinion of the Centre for Insolvency and Financial Laws.