The recognition of a company’s separate juristic personality by the UK’s House of Lords in its landmark ruling in Salomon v. Salomon A Company Ltd.,[1] remains the basis for modern corporate law.[2] The ruling in effect drew a corporate veil around the legal personality of the company thereby establishing the separate legal identity of a corporate.
While India also follows the separate juristic personality of corporates as a general principle, exceptions have been incorporated over the years by way of legislative action[3] and juridical pronouncements.[4] In the context of insolvency law, the corporate veil is typically lifted in instances where a group company could be held liable for the debts of its associate and subsidiary companies, or if a group of companies functioned as a collective.
Market data suggests that a significant percentage of Indian businesses are structured as intrinsically-linked group entities that operate as a single economic unit.[5] It comes as no surprise that according to a World Bank Report, India ranked 20th on the related party transaction index out of 190 jurisdictions.[6] It is common business practice for group entities to regularly engage in related party transactions such as inter-corporate loans, cross collateralisation and significant influence arrangements. While such structures largely respect the separate legal status of the group companies, practice suggests such interlinkages in business, operations and management often raise significant challenges when individual group entities become insolvent.[7]
The recent collapse of the IL&FS Group, which involves 169 other group entities, or the collective default by the Videocon group entities, has highlighted the need to lift the corporate veil for group entities in certain situations, and regulate the insolvency of groups.[8]
Presently, the Indian Insolvency and Bankruptcy Code, 2016 (IBC) does not deal with the insolvency or financial re-organisation of groups and conglomerates. Nonetheless, be it cross-collateralisation, guarantee comforts or tunneling[9], the courts are taking cognisance of such corporate behaviour while adjudicating upon insolvency matters.[10] Recently, the Hon’ble National Company Law Tribunal (NCLT) Mumbai Bench in Videocon ordered for substantive consolidation of the assets and liabilities of 13 group entities.[11] Similarly, in Jaypee group[12] and Amrapali group,[13] disregarding the separate identity of the companies, the Supreme Court directed the parent company in the former to deposit money, while the properties of the latter group were attached and bank accounts frozen.
In another instance, in the case of Adel group, the National Company Law Appellate Tribunal (NCLAT) initiated procedural coordination to ensure simultaneous proceedings with a common Resolution Professional (RP) for certain companies belonging to the same group.[14] Independent of court intervention, even market participants acknowledge the benefits of procedural co-ordination, and have themselves proposed the appointment of a common resolution professional in separate instances.[15]
The Insolvency and Bankruptcy Board of India (IBBI), recognising the growing need for a framework on group insolvency, set up a Working Group on Group Insolvency (WG)[16]. Following consultations with stakeholders, the WG compiled its recommendations (Report)[17] that highlight principles that will form the foundation of India’s corporate group insolvency regulatory framework (CIRP).[18] It is anticipated that the group insolvency regulations would lead to value maximisation of the group entities, avoid multiple insolvency proceedings, reduce information asymmetry and related costs, and increase certainty for stakeholders in the insolvency of the group.[19] While discussing the scope of applicability of the regulations, in the interest of certainty it was recommended that the definition of ‘group’ should be specific and may include holding, subsidiary and associate companies.[20] However, the WG added that the Adjudicating Authority (AA) may have the discretion to include companies in proceedings not technically part of a ‘group’ if such companies are ‘…intrinsically linked as to form part of a ‘group’ in commercial understanding’[21].
The WG has suggested that the group insolvency framework may be introduced in two phases.
First Phase
The first phase shall introduce procedural co-ordination and rules against perverse behaviour.[22] Procedural co-ordination facilitates synchronisation between multiple insolvency proceedings against group entities. These rules look to mandatorily facilitate co-operation, co-ordination and information sharing between the AA, Committee of Creditors (CoC) and the RP.[23] Procedural co-ordination may be implemented by way of a combination of the following measures:
- A joint CIRP application against group entities.[24]
- The appointment of a common RP in case there is no ‘conflict of interest’ and subject to ‘availability of resources’.[25]
- The formation of group CoCs without supplanting ‘substantive rights of creditors’ at the individual CoC level.[26]
- A common AA to administer insolvency proceedings.
Recognising the need to permit CoCs and resolution applicants to explore synergies of group entities, the Report examined group co-ordination proceedings. It was proposed that a framework agreement approved by the members of each CoC should govern the combined proceedings including the appointment of a group co-ordinator.[27] However, such a framework would be optional and empower each CoC of a group entity to opt out of such proceedings.[28]
The timely conclusion of insolvency proceedings is important and the Report accordingly suggests a 420-day timeline for conclusion of the CIRP of group entities.[29]
Given India’s unique business environment and corporate holding structures, the WG examined existing provisions of the IBC that deal with perverse corporate behaviour – i.e. corporate transactions that abuse group structures leading to unfair treatment of certain stakeholders. While opining that the existing provisions of the IBC sufficiently deal with avoidance transactions[30], the WG recommended that claims of group entities should stand subordinate to claims of unrelated creditors in ‘exceptional situations of fraud, diversions of funds, etc.’[31]. A legislative amendment to this effect would be a welcome change considering the Hon’ble NCLT[32] has already upheld it earlier.
Second Phase
The WG noted that the second phase should introduce substantial consolidation and cross border insolvency “depending on the experience of implementing the earlier phases of the framework…”[33] With this backdrop, the Report briefly discusses substantive consolidation mechanisms. Substantive consolidation refers to the pooling of assets of all group entities into a single estate to fulfil payment obligations. The stakeholders noted substantive consolidation may be ‘opted for’ or ordered by the AA,[34] except where entities were incorporated for ‘bankruptcy remoteness’.[35]
Conclusion
An international study of the largest insolvencies in India (2018) evinces that the majority of India’s insolvent entities are conglomerates owned by promoter groups.[36] Statistics such as these amplify the need for a comprehensive framework to deal with group insolvency in the Indian context. It is indeed reassuring to see that the WG has examined international best practices including UNCITRAL recommendations. Though the WG has extensively drawn references from western legislation, considering that India’s strong promoter group culture predominantly shares common characteristics with its Asian counterparts, the WG could have studied other Asian legal systems as well. For instance, the legal practice in Japan would have been a good reference point for specialised rules for procedural co-ordination,[37] necessity of creditors’ consent for substantive consolidation,[38] and the treatment of claims of creditors that have security interest in one entity and a guarantee from another entity belonging to the same group[39].
Separately, in light of the Report, modifications to the Prudential Framework for Resolution of Stressed Assets released by the Reserve Bank of India (RBI) on June 7, 2019, may also be considered in relation to asset restructuring for group entities. For instance, introduction of provisions catering to group structures for governing the synchronisation of asset classification norms amongst entities, pre-IBC restructuring and specialised asset classification, will aid in the growth of a symbiotic relationship between the Code and RBI norms. This may serve in expediting the revival of group entities.
[1] Salomon v. A Salomon & Co Ltd [1896] UKHL 1, [1897] AC 22.
[2] John H. Matheson, The Modern Law of Corporate Groups: An Empirical Study of Piercing the Corporate Veil in the Parent-Subsidiary Context, North Carolina Law Review, 87 N.C. L. Rev. 1091 1092(2009).
[3] Inter alia Sections 34, 35, 39, 339 of Companies Act, 2013.
[4] Life Insurance Corporation of India v. Escorts Ltd. & Ors. Workers Employed in Associated Rubber Industry Ltd., v. Associated Rubber Industry & Anr., (1986) 1 SCC 264; New Horizons Ltd v. Union Of India, 1995 SCC (1) 478.
[5] Credit Suisse, The CS Family 1000 in 2018, September 2018, pg. 10. See: <https://www.credit-suisse.com › docs › about-us › research › publications> [Last accessed on October 15, 2019].
[6] Dan W. Puchniak and Umakanth Varottil, Related Party Transactions in Commonwealth Asia: Complicating the Comparative Paradigm, NUS Law Working Paper No. 2019/001, pg. 5.
[7] UNCITRAL, UNCITRAL Legislative Guide on Insolvency Law, Part Three: Treatment of Enterprise Groups in Insolvency, (2012), paras. 92-94, pgs. 54-55.
[8] See Union of India v. Infrastructure Leasing & Financial Services Ltd. & Ors., NCLAT, Order dated October 15, 2018; State Bank of India & Mr. Venugopal Dhoot v. Videocon Industries Limited & Ors., NCLT Mumbai Bench, Order dated August 8, 2019 (Videocon Order).
[9] Tunnelling refers to a practice wherein wealth is transferred by the subsidiary company to the holding company.
[10] Axis Bank Ltd. v. Anuj Jain, Resolution Professional for Jaype Infratech Ltd. & Ors., NCLAT, Order dated August 1, 2019; State Bank of India v. Reliance Communication Infrastructure Limited, NCLT Mumbai Bench, Order dated September 25, 2019; Edelweiss Asset Reconstruction Company Limited v. Sachet Infrastructure Pvt. Ltd. & Ors,, NCLAT, Order dated September 20, 2019. (Adel Order); Supra note 8, Videocon Order.
[11] Supra note 8, Videocon Order.
[12] Chitra Sharma & Ors. v. Union of India & Ors., Supreme Court, Order dated September 11, 2017.
[13] Bikram Chatterji & Ors. v. Union of India & Ors., Supreme Court, Orders dated May 17 and August 1, 2018.
[14] Supra note 10, Adel Order. See also an instance of procedural co-ordination in Ericson India Pvt. Ltd. v. Reliance Infratel Ltd. & Ors., NCLT Mumbai Bench, Order dated May 17, 2018.
[15] Corporation Bank v. Amtek Auto Limited, NCLT Chandigarh Bench, Orders dated July 24 and July 27, 2017; State Bank of India v. Metalyst Forgings Limited, NCLT Chandigarh Bench, Order dated December 15, 2017; State Bank of India v. Castex Technologies Limited, NCLT Chandigarh Bench, Orders dated December 20 and December 22, 2017; State Bank of India v. ARGL Limited, NCLT Principal Bench, Order dated March 16, 2018.
[16] Insolvency and Bankruptcy Board of India, Constitution of Working Group on Group Insolvency, File No: IBBI/CIRP/GI/2018-19/001, Office Order dated January 17, 2019.
[17] Working Group on Group Insolvency, Report of the Working Group on Group Insolvency, submitted to IBBI on September 23, 2019.
[18] Ibid, Part I, pg. 9.
[19] Ibid, Part II, para 2.3, pg. 20-21.
[20] Ibid, Part III, para 3.3, pg. 29.
[21] Ibid, pgs. 9, 29.
[22] Ibid, pg. 9.
[23] Ibid, Part IV, para 1.3.1, pg. 41.
[24] Ibid, Part IV, para 1.3.2.1, pg. 42.
[25] Ibid, Part IV, para 1.3.2.3, pg. 43.
[26] Ibid, Part IV, para 1.3.2.4, pg. 44.
[27] Ibid, Part IV, para 1.3.2.6, pg. 46.
[28] Ibid, Part IV, para 1.3.2.6, pg. 46.
[29] Supra note 17, Part IV, para 1.3.4, pg. 48.
[30] Avoidance transactions under the IBC are provided under Sections 43, 44, 45, 46, 47, 48, 49, 50 and 66.
[31] Supra note 17, Part IV, Para 2.2.1, pg. 59.
[32] J.R. Agro Industries P. Ltd v. Swadisht Oils P. Ltd, NCLT Allahabad Bench, Order dated July 24, 2018.
[33] Supra note 17, pg. 9.
[34] Supra note 17, Part IV, para 3.3.3, pg. 66.
[35] Supra note 17, Part IV, para 3.3.1, pg. 66.
[36] Debtwire Special Report, India Bankruptcies Status Report: The Dirty Dozen + 28, dated August 17, 2018.
[37] Taro Awataguchi, Anderson Mori & Tomotsune, Restructuring & Insolvency 2019, Getting the Deal Through, Law Business Research, pg. 282, Nov. 2018.
[38] Michihiro Mori, Natsuki Taira, Nishimura & Asahi, Insolvency and Directors’ duties in Japan: Overview, Thomson Reuters, Practical Law, April 1, 2018, See: <https://gettingthedealthrough.com/download/area/35/edition/709/jurisdiction/36/> [Last accessed on October 15, 2019].
[39] Ibid.