-by Sai Srinivas, 5th Year B Com. LLB (Hons) student at Lovely Professional University.
Introduction
The moment to trigger the Insolvency Resolution Process by the creditors as convened under the Insolvency and Bankruptcy Code 2016, necessarily imparts a financial and operational obligation with the entity defaulted. The financial obligations attached with the disbursement of a loan, debt security, and any other debts arising due to the provision of goods and services are to be classified as operational obligations of the debtor. In the event of IRP, the code has curated a differential approach for creditors based on their financial and transactional relationship with the entity. The code insists on a slanted approach towards financial creditors owing to their expertise in assessing the economic viability of the submitted resolution plans to determine the outcome of the corporate debtor in the event of IRP.
The constitution of the CoC as sec.21(2) accommodates only the financial creditors to take part in the meetings of the CoC and to exercise policy decisions on behalf of the corporate debtor. The exclusion of operational creditors in CoC has left them without a means of representation. As a result, the principles of fair and equitable treatment for the realization of claims during IRP become impossible on behalf of unendorsed operational creditors. Tracing back to the successful resolutions of Essar Steel, Alok Industries, and Electro Steel, the extent of haircuts undertaken by operational creditors indicates a dominant imposition of resolution plans at the expense of curtailing the franchise rights to the operational creditors in the wake of the resolution process.
This blog post proposes a reformatory insight for a legislative consideration to advance the rights of enfranchisement as a benefit for the value maximization of the claims and a change in time approach to ensure the equal protection and sustainability of operational creditors during the insolvency resolution process.
The Search for Collectivism: Indian Insolvency Model
The underlying significance of approaching any insolvency resolution as indicated in the UNCITRAL legislative guide on insolvency, affirms the principles of collectivism through a group of creditors representing a committee. The committee was statutorily formulated to decide on matters concerning approval of resolution plans, and deliberations in assessing the submitted plans. Overall, it serves as a forum for the creditor’s bargaining mechanism in the recovery of the debts from a distressed entity.
The constitution of the committee of creditors to the Indian practice under Sec. 21 of the IBC, functions on an ad-hoc basis and it is entrusted to determine upon matters of the corporate debtor through the exercise of franchise fully delegated to the financial creditors. The disengagement of operational creditors in the meetings of the CoC has defeated the objectives of collectivism in the resolution framework. This has a severe impact on the part of operational creditors in securing and endorsing the value of the claims in the resolution process.
The unjust restriction in the code led to the marginalisation of operational creditors in the resolution process and has resulted in selective collectivism barring their involvement in the vital stages of the insolvency process. A thorough analysis of the IBC code lays out two scenarios for the role of operational creditors in the resolution process firstly, to head start initiation of the resolution process under Sec. 9 of the IBC, and secondly, a statutory assurance to recover the amount as to not less than the threshold value that ought to be decided in the event of the liquidation process in a distribution waterfall. Apart from those scenarios outlined earlier, there is no further reference to facilitate the recovery of operational creditor’s claims present in the code.
BLRC recommendations: From Inception to Present
Tracing back to the rationale for the denial of voting franchise to operational creditors, the BLRC (Bankruptcy Law Reforms Committee) report has been reasoned that the financial creditors (mostly the banks and financial institutions) were well positioned, with their acumen to understand the matters of business and finance and make informed decisions that would ideally benefit the interest of operational creditors. The BLRC committee has placed significant trust in the financial creditor’s expertise in (i) keeping the entity as a going concern (ii) assessing the viability factor of the resolution plans, and (iii) for quicker and efficient completion of the resolution process. These recommendations eventually formed a basis for the framers of the code in denial of voting franchise to operational creditors.
Over time a gradual practice of treating the claims of operational creditors submissively has taken root in the course of insolvency resolution. As an effect of disenfranchisement to the operational creditors the financial creditors have assumed authority over the resolution process often prioritizing their interests over the claims of operational creditors. This narrative runs contrary to the indispensable notions of insolvency resolution and value maximization that stem from the preamble of IBC and vehemently upheld in the historical ruling of Swiss Ribbons v. Union of India.
The Concept of Going Concern vis-à-vis Fate of Operational Creditors
The going concern as a fundamental assumption, to keep the entity alive at the penultimate stage to prevent corporate death is rooted in its implicit application of the resolution process. Though the legislative intent to preserve the corporate debtor bears a strong resemblance to the objectives of the code, an inquiry into the extent of efforts as realized to sustain the corporate debtor at the expense of the sacrificial position assumed by the operational creditors is a subject for debate.
It is reasonable to assert that the role of operational creditors is instrumental to the going concern of a corporate entity. From the initiation of the resolution process till the approval of the resolution plan the coordination and cooperation of operational creditors is crucial in sustaining the corporate debtor as a going concern. Considering this, it becomes both a moral and legal obligation on the part of the CoC and the prospective acquirer of the corporate debtor to sensitize themselves to the claims of the operational creditors. In the absence of such conditions, the efforts to preserve the value of the claims become effective only with the provision of voting rights for the operational creditors in the CoC deliberations.
Further, a trend of raising haircuts has heightened concerns regarding the valuation and recovery of claims for operational creditors. The code has disregarded in acknowledging the operational creditor's autonomy as an inalienable aspect attached to their claims. In most of the cases, the claims of operational creditors were decided hastily due to the complexity and time constraints involved in the resolution process. It potentially impedes their freedom to secure a value and compels them to accept a reduction for the actual value of claims. This procedural inconsistency can be addressed by conferring economic sovereignty through the grant of enfranchisement to operational creditors.
Challenging the Absolutism of Commercial Wisdom
Secondly, the jurisprudence unfolded with the commercial wisdom in K. Sashidhar v. Indian Overseas Bank, the ruling by the apex court has granted financial creditors an authoritative position in shaping the policy decisions of the Committee of Creditors (CoC). It was reasonably expected that the CoC would exercise prudence in evaluating prospective plans, ensuring they align with the interests of other creditors including operational creditors. Conversely, it is crucial to acknowledge that the lack of a monitoring authority to oversee the actions of the CoC has enabled financial creditors to adopt an indefinite approach, in determining the fate of operational creditors and thereby leaving no scope for adequate representation.
In practice, the process for approving the resolution plan undertaken by the CoC is not free from procedural shortcomings. Nevertheless, Explanation I to sec 30(2) reinstates the principles of fairness and equity as obliged to be adopted by the Coc in deciding the rights of the operational creditors. In a realistic sense, the actions of the CoC in assessing the viability of the resolution plans to cater to the interests of the operational creditors diverge significantly from the theoretical framework of principles established by the code. The absence of solid legislative backing to enforce these principles has turned them into little more than a rhetorical exercise, ultimately impacting the interests of operational creditors.
It is evident to be reasoned that post the ruling by the apex court in Essar Steel India Limited, significant reliance on the wisdom exercised by the financial creditors under the guise of going concern, has effectively undermined the equitable principles, which if implemented would ensure a safeguard for the value of operational creditor’s claims. This disparity arising from the advancement of commercial wisdom doctrine calls for a swift legislative intervention to equalize its impact by ensuring participatory rights and extending equal suffrage to operational creditors within the resolution process.
Conclusion
The Insolvency and Bankruptcy Code 2016 is hailed for its codification of procedural aspects for the quicker resolution of entities that are on the verge of becoming insolvent. The code guarantees equal access for financial and operational creditors to initiate the insolvency resolution process, paradoxically the existence of inherent bias to deny the voting rights for the operational creditors compromises its foundational objectives of value maximization. From a macroeconomic perspective, an established trend to dishonour the smaller fraction of claims that belonged to the disenfranchised creditors is a matter of grave concern impacting the survival of the suppliers in regular business operations. A recourse to a provision under Chapter 11 of the U.S. Bankruptcy Code that allows for the formation of a committee exclusively for unsecured creditors with relatively smaller claims, granting them voting rights. This approach can serve as a model framework that could be adopted within the Indian Insolvency framework to ensure the representation and participation of operational creditors in the insolvency resolution process.
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