Is Liquidation Irreversible - Schemes of Compromise in Liquidation

The 2005 Report of the Expert Committee on Company Law (JJ Irani Committee Report) had noted that an effective insolvency law:

should strike a balance between rehabilitation and liquidation. It should provide an opportunity for genuine effort to explore restructuring/ rehabilitation of potentially viable businesses with consensus of stakeholders reasonably arrived at. Where revival / rehabilitation is demonstrated as not being feasible, winding up should be resorted to.

Where circumstances justify, the process should allow for easy conversion of proceedings from one procedure to another. This will provide opportunity to businesses in liquidation to turnaround wherever possible. Similarly, conversion to liquidation might be appropriate even after a rehabilitation plan has been approved if such a plan was procured by fraud or the plan can no longer be implemented”.

The objective of the Insolvency and Bankruptcy Code, 2016 (IBC) is “to ensure revival and continuation of the corporate debtor by protecting the corporate debtor from its own management and from a corporate death by liquidation”[1] and provides for liquidation only as a last resort.[2] Accordingly, the IBC has clear restructuring/rehabilitation proceedings (in the form of corporate insolvency resolution processes (CIRPs)). These can only convert into liquidation proceedings if the committee of creditors so decides by requisite majority[3], if no resolution plan is approved by the committee of creditors[4] or the National Company Law Tribunal (NCLT)[5], or if an approved resolution plan is contravened by the corporate debtor.[6]

As liquidation is the last resort, the IBC does not make any provision for the conversion of liquidation proceedings into restructuring/rehabilitation proceedings. On the contrary, irreversibility of the liquidation process was a feature recommended in the Report of the Bankruptcy Laws Reform Committee.

Liquidation proceedings are now evolving into restructuring/rehabilitation proceedings by taking recourse to Section 230 of the Companies Act, 2013 (Companies Act). Section 230 allows the liquidator of a company undergoing liquidation to file an application before the NCLT to seek sanction for a scheme of arrangement between the company and its creditors and, where applicable, its members. Similar provisions also exist in other jurisdictions, notably in the Companies Act 2006 of the United Kingdom (UK Act) and the Companies Act, 1967 of Singapore (Singapore Act).

Section 230 and its corresponding sections – section 391 of the Companies Act, 1956 and section 153 of the Indian Companies Act, 1913 – have been borrowed from scheme provisions in the laws of England (including the UK Act), which have been used extensively for debt restructuring. The application of Indian provisions to debt restructuring schemes, particularly in respect of companies in liquidation, has been infrequent and has received less attention until recently. The National Company Law Appellate Tribunal (NCLAT) has turned the spotlight on the section in a series of orders beginning with S.C. Sekaran vs. Amit Gupta and Ors.,[7] (Sekaran Case). In this case, the NCLAT directed the liquidator, appointed under the IBC, to “take steps in terms of Section 230” for the revival of the corporate debtor before undertaking the sale of its assets.[8]

The Insolvency and Bankruptcy Board of India (IBBI) has also published a discussion paper on the liquidation process for companies[9] wherein it has proposed amendments to the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 (Liquidation Regulations), which require that the liquidation process be suspended for a period of ten days from the liquidation commencement date, during which time schemes for compromise or arrangement may be proposed by the liquidator, a creditor (or class of creditors), or a member (or class of members). This time period may be inadequate to consider a scheme and perhaps time could be allowed until the claim submission deadline to consider any scheme also.

Against this background, we examine some critical issues in proposing and implementing schemes under Section 230 to companies undergoing liquidation in terms of the IBC.

Who Can Propose a Scheme?

A scheme under Section 230 can be filed by the liquidator, a creditor (or class of creditors), or a member (or class of members). (Similarly, under the UK Act and the Singapore Act, the liquidator can file a scheme of compromise or arrangement. In fact, the UK Act goes a step further and allows for schemes to be filed by administrators also.) When approved by the NCLT, the scheme binds the company, its members and its creditors. It is also possible for third parties to propose and contractually agree to be bound by a scheme of compromise or arrangement. Such schemes, while uncommon, have been approved under the erstwhile Section 391 of the Companies Act, 1956.[10]

Currently, neither Section 230 of the Companies Act, nor the IBC/Liquidation Regulations extend the application of Section 29A of the IBC to schemes under Section 230. This may lead to a situation where persons (including promoters) who were ineligible to submit a resolution plan in the CIRP, may wish to propose a scheme under Section 230. The IBBI, in its discussion paper, has invited public comments on this aspect. In practice, where liquidators invite proposals to submit a scheme, such invitation may include eligibility criteria for prospective scheme proponents, including the criterion of compliance with Section 29A.

Whose Approval is Necessary for a Scheme?

In terms of Section 230, if a scheme envisages “corporate debt restructuring” (i.e., seeks to restructure or vary the debt obligations of a company towards its creditors), it would be subject to additional requirements including consent of not less than 75% (by value) of secured creditors even before an application is made before the NCLT. In many instances, the class of secured creditors may be identical to the committee of creditors, thereby giving the members of the committee an opportunity to negotiate with the scheme proponent a suitable scheme acceptable to them.

After filing with the NCLT, the NCLT will call a meeting of each class of creditors and members for consideration of the scheme. The approval of a majority (in number) and three-fourth (in value) of each class of creditors and each class of members is required for the scheme to be sanctioned. Unlike the IBC, the term “creditor” is undefined under the Companies Act. Since the IBC provides for a process of claim verification, it is such creditors whose claims have been admitted under the liquidation process who should be considered for voting. [11]

The Companies Act specifically permits objections to be raised but restricts the right to persons who hold not less than 10% of shareholding or have outstanding debt amounting to not less than 5% of the total outstanding debt as per the latest audited financial statement. Objectors will be heard by the NCLT before sanctioning a scheme.

Classification of Creditors

The Companies Act does not prescribe any consideration for identification of specific “classes”, but the application to the NCLT has to disclose the basis on which each class of members or creditors has been identified for the purposes of approval of the scheme. Case laws have stipulated the test of “commonality of interest” for constitution of classes and it is common practice for schemes under the Companies Act is to classify creditors as ‘secured creditors’ and ‘unsecured creditors’.[12] If this classification is adopted for consideration of a scheme in the liquidation process, operational creditors may be included in the class of unsecured creditors and will get to vote. It is debatable whether class voting is desirable for companies in liquidation given that the same may impede revival.

The NCLT may also dispense with the calling of a meeting of the creditors or any class of creditors only where the “creditors or class of creditors, having at least ninety per cent. value, agree and confirm, by way of affidavit, to the scheme of compromise or arrangement”. There is no provision in the Companies Act for dispensing with a meeting of members, unless it is demonstrated that the scheme is ‘neutral’ to the members and is a compromise or arrangement only involving the creditors and the company. Where the scheme contemplates acquisition of the company, such demonstration may not be possible. In one case, where a members’ meeting was dispensed with, the members had approved the scheme in writing.[13] It is to be seen if the NCLT would exempt application of this requirement in relation to a scheme proposed when a company is undergoing liquidation under the IBC (which does not require shareholders’ approval for a resolution plan).

In the context of schemes under Section 230 for companies in liquidation, there is a need to reconsider the voting/consent requirements. As stated above, companies are admitted to the liquidation procedure only if the committee of creditors so decides by requisite majority, if no resolution plan is approved by the committee of creditors or the NCLT, or if an approved resolution plan is contravened by the corporate debtor. i.e, only upon failure of the CIRP to arrive at a viable resolution. In these circumstances, a higher requirement of voting/consent, would make the chances of a scheme being approved highly implausible.

Accordingly, the approval threshold may be reduced to 66 per cent, in line with the CIRP threshold, and the requirement of shareholders’ approval should be completely dispensed with (including, where required, through suitable amendments to the Scheme Rules and the Liquidation Regulations) as shareholders are, in the CIRP and liquidation process, disenfranchised. In fact, the NCLAT in Y. Shivram Prasad vs. Dhanapal[14] has stated that “as the liquidation so taken up under the IBC, the scheme of arrangement should be in consonance with the statement and object of the IBC. Meaning thereby the scheme must ensure maximisation of the assets of the ‘Corporate Debtor’ and balance the stakeholders such as, the ‘Financial Creditors’, ‘Operational Creditors’, ‘Secured Creditors’ and ‘Unsecured Creditors’ without any discrimination.” There is basis to suggest that for a scheme of a company under liquidation, substantive aspects of the IBC should be taken into account.

Additionally, varying from the IBC framework, the scheme provisions mandate that the notice be sent to Central Government, the registrar of companies and the income-tax authorities (in all cases), the Reserve Bank of India (RBI), the Securities and Exchange Board of India (SEBI), the Competition Commission of India (CCI) and the stock exchanges (if applicable), and such other sectoral regulators/ authorities which are likely to be affected by the scheme (as per its discretion). Such authorities that have made representations and who desire to be heard will be heard by the NCLT before sanctioning a scheme.

The Supreme Court has held in the case of K. Sashidhar v. Indian Overseas Bank & Ors.[15] that the NCLT’s jurisdiction in respect of approval of the plan is limited to the NCLT being satisfied that the resolution plan meets the requirements under Section 30(2) of the IBC. The commercial decision of the committee of creditors is non-justiciable. On the other hand, when sanctioning a scheme, apart from satisfying itself in relation to compliance with requisite statutory procedure, the NCLT may also inquire into whether the scheme is just and fair to all the members of a class, whether the creditors/ members, as the case may be, were acting in good faith and were not coercing the minority to promote any adverse interest and whether on the whole the scheme appears to be just, fair and reasonable from the point of view of prudent businessmen taking commercial decisions.[16]

Implementation of Schemes

During the scheme process, the order of the NCLT commencing liquidation will generally be stayed. It needs to be clarified that notwithstanding such a stay, the bar on legal proceedings under Section 33(5) continues throughout the scheme process.

In order that schemes under Section 230 of companies in liquidation are implemented with efficacy, regulatory exemptions that have been provided in respect of resolution plans are also to be extended to such schemes. For instance, SEBI has exempted issuance of shares by delisting of securities of tender offers triggered by acquisition of shares under a resolution plan from various compliance requirements, with limited conditions. In particular, a scheme of arrangement involving a listed company requires pre-clearance from SEBI/the stock exchanges and compliance with specified requirements. The exemptions regime should be made available on a par with what is available for resolution plans.

As stated above, upon sanction, a scheme becomes binding only on the company, its creditors/ members (or classes thereof), the liquidator (if any) and the contributories. Compared with a resolution plan, if there are stakeholders, who are not creditors or members, such stakeholders will not be bound by the scheme. The NCLT enjoys a broader jurisdiction when considering a scheme that has been presented for its sanction[17] compared with a resolution plan placed before it under the IBC.[18] It is empowered to give directions or make modifications to the scheme as it deems necessary for proper implementation. Such orders, which are not contemplated under the IBC, may be made at the time of sanction of the scheme or even after. The problems that have arisen in the context of failure to implement approved resolution plans under the IBC, may effectively be addressed.

Conclusion

Schemes in liquidation could give a fresh opportunity for company revival by giving more time to creditors and other stakeholders to facilitate resolution. Suitable amendments may have to be brought into the regulations made under the IBC, however, to provide a more clear procedural framework in respect of shareholders’ consent  dispensation, dispensation with class voting, re-defining approval thresholds in creditor meetings and extending regulatory dispensations available for a resolution plan to schemes in liquidation.

*The authors were assisted by Associate Ms. Anumeha Saxena


[1] Swiss Ribbons Pvt. Ltd. and Anr. v. Union of India & Ors., AIR2019SC739

[2] Id.

[3] Section 33(2) of the IBC.

[4] Section 33(1)(a) of the IBC.

[5] Section 33(1)(b) of the IBC

[6] Section 33(4) of the IBC.

[7] Order dated 29 January, 2019 in Company Appeal (AT) (Insolvency) No. 495 & 496 of 2018.

[8] The NCLAT has passed similar orders in a number of matter, including, Ajay Agarwal & Anr. vs. Ashok Magnetic & Ors. (Order dated 22 February 2019 in Company Appeal (AT) (Insolvency) No. 793 of 2018), Rajesh Balasubramanian vs. M/s Everon Castings Pvt. Ltd. & Anr. (Order dated 25 February 2019 in Company Appeal (AT) (Insolvency) No. 182 of 2019.), Y. Shivram Prasad vs. S. Dhanapal Order dated 27 February 2019 in Company Appeal (AT) (Insolvency) No. 224 of 2018), and Daiyan Ahmed Azmi vs. Rekha Kantilal Shah, Liquidator & Ors. (Order dated 20 March 2019 in Company Appeal (AT) (Insolvency) No. 271 of 2019).

[9] IBBI’s Discussion Paper on Corporate Liquidation Process along with Draft Regulations dated April 27, 2019.

[10] Order of the High Court of Bombay at Goa dated January 15, 2010 in Company Petition No. 23 of 2009. Western India Shipyard Limited (WISL) had proposed a scheme with its members and creditors whereunder ABG Shipyard Limited (not being a member or creditor of WISL) acquired equity stake in WISL and agreed to be bound by the scheme as a confirming party.

[11] Chitta Ranjan (Benode) Guha v. Ameen, (1964) 34 Comp Cas 151.

[12] Miheer H. Mafatlal v. Mafatlal Industries Ltd., (1996) 87 Comp Cas 792 (SC); Maneckchowk and Ahmedabad Manufacturing Co. Ltd., In re, (1970) 40 Comp Cas 819 (Guj).

[13] Order of the Kolkata bench dated October 11, 2017 in Company Application No. (CAA)245/KB/2017.

[14] Order dated 27 February 2019 in Company Appeal (AT) (Insolvency) No. 224 of 2018).

[15] AIR 2019 SC 1329

[16] Miheer H. Mafatlal v. Mafatlal Industries Ltd. (1996) 87 Com Cases 792 (SC).

[17] Id.

[18] Section 31(1) of IBC.