INSOLVENCY & BANKRUPTCY CODE 7 Supreme Court upholds the sanctity of Resolution Plan & the ‘Clean Slate Theory’ under IBC

Supreme Court upholds the sanctity of Resolution Plan & the ‘Clean Slate Theory’ under IBC

DEEPAK JOSHI - FCA, Advocate

7

Insolvency & Bankruptcy Code, 2016 (“IBC”) is a legislation aimed at timely resolution of an entity (“corporate debtor”) which has defaulted in payment to its creditors (including the statutory authorities). The corporate debtor has to undergo baptism by fire in the form of a Corporate Insolvency Resolution Process (“CIRP”). Once the corporate debtor is admitted into CIRP, it is the duty of the resolution professional to collate all the outstanding claims from all classes of creditors against the corporate debtors. It is only once all such claims have been crystallised, that the IBC allows for interested parties (“resolution applicant”) to submit their respective resolution plans which include the treatment of the aforesaid claims. These plans are then put to vote before the body of financial creditors (“Committee of Creditors”/”CoC”) who then vote for the most commercially viable resolution plan. The successful resolution plan then carries through the transition of the corporate debtor into the new entity. Amidst the very brief overview of the abovementioned process, there arises an interesting issue. As has been the experience so far, most of the resolution plans provide for a ‘haircut’ in payment to the creditors. This means that the successful resolution applicant will implement the plan by paying some value of the outstanding claim and extinguish the unsatisfied part of the claim. The IBC does not expressly provide for the treatment of the unsatisfied part of the claim. Would this mean that the creditors who have suffered a haircut or whose claims have been rejected out rightly, can still initiate legal proceedings against the new avatar of the corporate debtor for recovery of their outstanding claims? Further, would pending demands from the statutory authorities also face the same treatment as that of a normal class of creditors and hence they cannot also continue the demands post a successful resolution? The Hon’ble Supreme Court in a very recent decision in Ghanshyam Mishra v. Edelweirs Asset Reconstruction Co. Ltd. [Civil Appeal No. 8129 of 2019] has laid to rest the above doubts and controversies.

Factual Narration

The Hon’ble Supreme Court was presented with a batch of matters wherein a common issue arose - whether after approval of resolution plan by the Adjudicating Authority a creditor including the Central Government, State Government or any local authority is entitled to initiate any proceedings for recovery of any of the dues from the Corporate Debtor, which are not a part of the Resolution Plan approved by the adjudicating authority? The creditors in these batch matters included statutory authorities like the State commercial tax department, State mining department, income tax department etc. in respect of their respective outstanding demands against the corporate debtors. In each of these matters, the concerned successful resolution plan had stipulated that the claims (including statutory liabilities and contingent liabilities) to the extent not satisfied or received under the plan will be extinguished. The corporate debtor in its new avatar shall not be liable to bear the same.

The Hon’ble Adjudicating Authority in each of these cases had approved the resolution plans exercising jurisdiction under section 31 of the IBC. On appeal, the approval of these resolution plans was upheld. However, the Hon’ble NCLAT had given the following liberty to various class of creditors:

u Workmen can move appropriate applications before the labour court for recovery. u Statutory dues of various government departments are dues outstanding & would qualify as operational debt. u Corporate Guarantee can be invoked against the new entity.

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The effect of these observations was that the creditors were now filing claims/ suits/recovery actions against the corporate debtor in its new avatar (under a new management). The statutory authority continued to press their demands for outstanding dues.

Hence, the successful resolution applicants were aggrieved with these observations of the Hon’ble NCLAT and the matters were carried to the Hon’ble Supreme Court. The above factual narration has culminated into the present decision.

Decision of the Supreme Court

u Once a resolution plan is duly approved by the Adjudicating Authority under Section 31, the claims as provided in the resolution plan shall stand frozen and will be binding on the creditors (including statutory authorities, employees and guarantors) u On the date of approval of resolution plan by the Adjudicating Authority, all such claims, which are not a part of resolution plan, shall stand extinguished and no person will be entitled to initiate or continue any proceedings in respect to a claim, which is not part of the resolution plan. u The amendment made to section 31 of the IBC is clarificatory and declaratory in nature and therefore will be effective from the date on which I&B Code has come into effect. u Consequently all the dues including the statutory dues owed to the Central Government, any State Government or any local authority, if not part of the resolution plan, shall stand extinguished and no proceedings in respect of such dues for the period prior to the date on which the Adjudicating Authority grants its approval under Section 31 could be continued.

Comments

1. The decision furthers the objective of the Act

u The intent of the I&B Code was to inter alia permit a restructuring process whereby the liability of a corporate debtor could be reset in order to enable a new management to begin with a clean slate for reviving the business of the corporate debtor. u This becomes clear from the debate in Rajya Sabha when the IBC was first introduced. The Hon’ble Finance Minister had clearly envisaged a system of resetting the debt in the following words:

“…There is a reset and then after the reset the company is competitive once again and it goes forward and it becomes successful. That is what happens consistently in the United States. They go into bankruptcy, the liabilities are reset, they become competitive again and then thereafter they do fine…” In this regard, it is instructive to refer to the Supreme Court’s decision in

Committee of Creditors of Essar Steel India Ltd. v. Satish Kumar Gupta

[2019] 111 taxmann.com 234, which held as under:

“88.…….A successful resolution applicant cannot suddenly be faced with

“undecided” claims after the resolution plan submitted by him has been accepted as this would amount to a hydra head popping up which would throw into uncertainty amounts payable by a prospective resolution

applicant who successfully take over the business of the corporate debtor. ……….This the successful resolution applicant does on a fresh slate, as has been pointed out by us hereinabove. For these reasons, the NCLAT judgment must also be set aside on this count.”

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u If a civil suit/recovery proceeding is permitted to be initiated after the conclusion of insolvency proceedings and after the moratorium is lifted, it will lead to a multiplicity of endless legal proceedings. Clearly, such an argument defeats the very objective of I&B Code and any legal proceedings so initiated in respect of a rejected claim once the moratorium is lifted, will be in teeth of the provisions of I&B Code u Further, the SC in the case of Swiss Ribbons (P.) Ltd. v. Union of India [2019] 101 taxmann.com 389/152 SCL 365 has held that the aim of the IBC, 2016 is to economically rehabilitate the Corporate Debtor and for that purpose, the timelines protect the corporate debtor’s assets from further dilution. To achieve the said purpose, it is essential that creditors are barred from raising belated claims against the successfully Resolution Applicant who is trying to resuscitate the Corporate Debtor. u Lastly, the approach propounded by the NCLAT has the effect of giving liberty to the fence sitters to raise their claims belatedly even after the resolution of the corporate debtor. In such a case, most of the creditors will not submit their claims and will wait for the resolution so that they can initiate proceedings against the corporate debtor. There will never be clean slate as is envisaged by the IBC.

2. IBC allows for settlement of debt at a reduced value

u Regulation 37 of the IBBI (Insolvency Resolution of Corporate Persons) Regulations, 2016 (“CIRP Regulations”) mandates a Resolution Applicant to provide in its resolution plan any reduction in the amount payable to a particular category of creditor. Accordingly, settlement of a debt at a reduced value is clearly permissible pursuant to a Resolution Plan.

3. Section 31(1) makes the resolution plan binding on all stakeholders – Since the inception of IBC

u Any entity which is involved in the CIRP Process shall be bound by the Resolution

Plan, including any provision for extinguishment of claims. A creditor which submits its claim is certainly involved in the CIRP Process as it has submitted its claim as per the provisions of IBC to get his claim resolved under the CIRP

Process. u In fact, the Government recently passed the 2019 Amendment to the IBC, 2016 [Act No. 26 of 2019] wherein it was further clarified that the rigours of Section 31 also apply to the Central and State Government, as well as local authorities.

Therefore, once the Resolution Plan is approved by the Adjudicating Authority, it is binding on all parties under Section 31 of the Code. u The Finance Minister, while answering questions about the 2019 Amendment

Act, explained before the Rajya Sabha on 29.07.2019 that,

“The amendment now is clearly making it binding on the Government. It is one of the ways in which we are providing that. The Government will not raise any further claim. The Government will not make any further claim after resolution plan is approved. … So, now, they need not be scared that the taxman will come after them for the faults of the earlier promoters….”

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u Therefore, we need to read Regulation 37 along with section 31. On one hand, Regulation 37 allows for settlement of debt at a reduced value. On the other hand, Section 31 makes the Resolution Plan binding on all stakeholders involved in the Resolution Plan. Therefore, a creditor is bound by the Resolution Plan even if his claim has not been decided on merits. However, there is a note of caution for professionals, practitioners and lawyers – these observations have been made wherein the plan explicitly mentioned that the rejected claims shall be extinguished forever. Hence, the application of the law will depend on the actual wording of the resolution plans.

Conclusion

This decision is a welcome one because there were increasing instances wherein statutory departments as well as other creditors were filing/continuing recovery proceedings despite a successful resolution. Further, owing to observations of the NCLAT, the creditors in whose favour guarantee was provided by the erstwhile corporate debtor, had the liberty to initiate recovery against the new entity. This was a big impediment for the prospective resolution applicants because there was always an apprehension that even after crystallised part payments of debts, the new entity will be saddled with claims. The Hon’ble Supreme Court has established it beyond any doubts that the dominant purpose of IBC is that the corporate debtor should start with fresh slate on the basis of the resolution plan. The scope for a “hydra head” monster to appear again in form of fresh claims has been rightly restricted by this important ruling.

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