0

CIRP & WATERFALL MECHANISM UNDER IBC, 2016 – A GUIDE TO HASSLE FREE AND SWIFT LIQUIDATION OF COMPANIES

Blog , , , , ,

ABSTRACT

The Insolvency and Bankruptcy Code, 2016 (IBC), introduced in India to address inefficiencies in the previous insolvency processes, provides a comprehensive framework for resolving insolvency and bankruptcy. This article delves into the roles and definitions of Corporate Debtors, Financial Creditors, and Operational Creditors within the IBC, highlighting their distinct rights and responsibilities. It explores the initiation of the Corporate Insolvency Resolution Process (CIRP) by financial creditors under Section 7 and operational creditors under Section 9, detailing the procedural requirements and the role of the National Company Law Tribunal (NCLT). The article further examines the IBC’s waterfall mechanism for distributing liquidation proceeds, which prioritizes insolvency resolution costs, secured creditors, workmen, unsecured financial creditors, government dues, and shareholders. The significance of the Technology Development Board vs. Anil Goel case is discussed, emphasizing the equal treatment of secured creditors under Section 53. The article concludes by underscoring the IBC’s transformative impact on insolvency resolution in India and the evolving jurisprudence that continues to shape its application, ensuring clarity and effectiveness in the insolvency and bankruptcy framework.

Keywords: Insolvency, Creditor, Resolution, liquidation, Company

 INTRODUCTION

The primary purpose of enacting the Insolvency and Bankruptcy Code, 2016 (IBC) in India was to establish a comprehensive and time-bound framework for resolving insolvency and bankruptcy cases. The IBC was introduced to address various issues and challenges that were present in the earlier fragmented and time-consuming insolvency resolution processes. Under the Insolvency and Bankruptcy Code, 2016 (IBC), the terms “Corporate Debtor,” “Financial Creditor,” and “Operational Creditor” have specific legal definitions:

  1. Corporate Debtor: A corporate entity, such as a company or limited liability partnership (LLP), against which an insolvency resolution process is initiated. It is the entity that owes a debt to its creditors. In the case of Maitrya Doshi vs. Anand Rathi Global Finance Ltd.[1] the Hon’ble Supreme Court of India held that CIRP may be initiated against two corporate debtors but the same amount cannot be realised from both.
  2. Financial Creditor: A person or entity that has extended financial debt to the corporate debtor, including loans, deferred payment obligations, and other forms of credit. Financial creditors have the right to initiate the insolvency resolution process against the corporate debtor.
  3. Operational Creditor: A person or entity that has provided goods or services to the corporate debtor and holds an operational debt. Operational debts arise out of transactions in the ordinary course of business, such as unpaid invoices, supplier dues, and service bills. Operational creditors can also initiate the insolvency resolution process under certain conditions.

In the context of the IBC, the differentiation between financial creditors and operational creditors is significant because their rights and roles in the insolvency resolution process vary. Financial creditors are generally given a more active role and have a higher priority in the distribution of proceeds from the resolution process compared to operational creditors. This is to ensure a more efficient and fair mechanism for resolving insolvency cases.

CORPORATE INSOLVENCY RESOLUTION PROCESS (CIRP) UNDER IBC, 2016

Section 7 (Financial Creditor)

Section 7 of the Insolvency and Bankruptcy Code (IBC), 2016, pertains to the initiation of the Corporate Insolvency Resolution Process (CIRP) by financial creditors. This section provides the procedure that a financial creditor needs to follow to trigger the insolvency resolution process against a corporate debtor.

  1. Application by Financial Creditor: A financial creditor, who is owed a debt by a corporate debtor, can file an application before the National Company Law Tribunal (NCLT) to initiate the CIRP against the corporate debtor. The application must be filed in the prescribed format along with supporting documents.
  2. Default: The application should demonstrate that the corporate debtor has committed a default in repayment of the debt. The default amount must meet the minimum threshold as specified in the IBC.
  3. Documents: The application should be accompanied by documents such as records of default, evidence of the debt, and proof that an attempt for resolution has been made, if applicable.
  4. NCLT’s Role: The NCLT examines the application and, if satisfied, admits the application. Upon admission, a moratorium period comes into effect, during which no legal actions can be taken against the corporate debtor and its assets are protected.
  5. Appointment of Interim Resolution Professional: The NCLT appoints an Interim Resolution Professional (IRP) to manage the affairs of the corporate debtor during the moratorium period. The IRP’s role is to assess the financial position of the corporate debtor and invite claims from other creditors.
  6. CIRP Period: The CIRP typically lasts for 180 days, with the possibility of an extension of up to 90 days if required. During this period, a resolution plan is formulated and approved by the creditors.
  7. Resolution Plan: The objective of the CIRP is to come up with a resolution plan that outlines how the corporate debtor’s affairs will be restructured to repay its debts and become a viable business entity again.
  8. Liquidation: If a resolution plan is not approved within the specified timeframe or if the plan fails to achieve the desired outcomes, the corporate debtor may be subjected to liquidation

Section 9 (Operational Creditor)

An OC is defined under section 5(20) of the IBC as any person to whom an operational debt is owed (and includes a legal assignee/transferee).

An “operational debt” is defined in section 5(21) as a claim in respect of the provision/supply of goods or services to the CD including employment or a debt in respect of payment of dues arising under any applicable law and payable to the Central Government, any State Government or any local authority.

An application to initiate a CIRP against a CD may be filed by an OC under section 9 of the IBC. However, before filing the application, the OC must serve a demand notice on the CD under section 8 of the IBC.

Demand Notice (section 8)

Section 8 of the IBC states that a demand notice is either a notice or a copy of an invoice (both in the prescribed form) that should be served by an OC on the CD, demanding payment of unpaid operational debt, prior to the initiation of a CIRP against the CD. The notice must be on Form 3, while the invoice demanding payment must be on Form 4, appended to the Application to AA (Adjudicating authority/NCLT) Rules

Rule 5 of the Application to AA Rules states that the demand notice must be delivered to the CD:

  1. At the registered office of the CD by hand, registered post, or speed post with acknowledgement due, or
  2. By electronic mail service to a wholetime director or designated partner or key managerial personnel, if any, of the CD.

Section 8(2) of the IBC states that the CD shall, within 10 days of receiving the demand notice, bring to the notice of the OC:

  1. If there is existence of any dispute or any pending suit or arbitration process before receiving the notice.
  1. If any evidence that the debt has been settled.
  2. Any evidence cheque or cash issued by CD.

Thereafter, no payment has been received after the expiry of the 10-day period, the OC may file an application before the AA to initiate a CIRP.

Section 9 (The OC may file an application to initiate a CIRP against the CD under section 9 of the IBC.)

After 10 days, the OC files an application under section 9 of the IBC using Form 5 (as per rule 6 of the Application to AA Rules). This is accompanied by the documents and records required by and specified in the Application to AA Rules.

The form is divided in five parts, each providing for the submission of the following particulars:

  1. Part I: Details of the applicant OC—name, identification number, and more.
  1. Part II: Details of the CD—its name, identification number, nominal share capital, and paid-up share capital.
  2. Part III: Details of the proposed IRP—the name, address, email address, and registration number of the proposed IRP.
  3. Part IV: Particulars of the operational debt— the total amount of debt, details of the transactions that resulted in the debt, along with the date(s) on which the debt fell due, the default amount claimed, and the date on which the default occurred.
  4. Part V: Details of the operational debt, documents, and records and evidence of default.

As per section (3) of the IBC, the OC shall, along with the application, furnish:

  1. A copy of the demand notice delivered by the OC to the CD;
  2. An affidavit to the effect that there is no notice given by the CD relating to a dispute in the unpaid operational debt (that is, no notice under section 8(2) of the IBC);
  3. A copy of a certificate from financial institutions maintaining accounts of the operational creditor confirming that there is no payment of an unpaid operational debt by the CD, if available;
  4. A copy of any record with an IU confirming that there has been no payment of an unpaid operational debt by the CD, if available;
  5. Any other proof confirming that there has been no payment of the unpaid operational debt by the CD or such other information as may be prescribed

Once the OC has furnished the prescribed information the AA shall, under section 9(5) of the IBC, either: Admit the application or reject the application.

WATERFALL MECHANISM UNDER IBC, 2016

The Insolvency and Bankruptcy Code (IBC) in India follows a waterfall mechanism for the distribution of funds during the insolvency process. This mechanism outlines the priority in which creditors receive payments from the liquidation proceeds of a distressed company. The order of priority is typically as follows:

  1. Insolvency Resolution Process (IRP) Costs: Costs incurred during the insolvency resolution process, including fees of insolvency professionals and other administrative expenses.
  2. Secured Creditors: Creditors with secured claims, such as those holding mortgages or pledges over the company’s assets, are given priority in repayment.
  3. Workmen and Employees: Dues owed to employees and workmen for their services rendered during the liquidation process.
  4. Unsecured Financial Creditors: Creditors who have extended loans without collateral or security fall into this category.
  5. Government Dues: Unpaid dues to government authorities, including taxes and statutory payments.
  6. Remaining Unsecured Creditors: This includes other unsecured creditors who do not fall into the categories mentioned above.
  7. Preference Shareholders: Shareholders who hold preference shares and are entitled to receive a fixed dividend before other shareholders.
  8. Equity Shareholders: Equity shareholders are at the bottom of the priority list and typically receive any remaining funds after satisfying higher-priority claims.

In the case of Technology Development Board vs. Anil Goel[2], the National Company Law Appellate Tribunal (NCLAT) held that – “that when secured creditors have the option between relinquishing their right in favour of the liquidation estate and realising their security interests individually, once they choose to relinquish interest, the repayment will take place strictly as per Section 53 of IBC, which does not recognise any distinction between different classes of ‘secured creditors’”. This case law is of crucial importance as far as interpretation of Section 53 of IBC, 2016 is concerned.

It’s important to note that the actual distribution might vary depending on the specific circumstances of each case and the available assets for distribution. The waterfall mechanism ensures a structured and prioritized approach to distributing the assets of a distressed company among its various creditors and stakeholders.

CONCLUSION

The IBC, 2016 is a statute which is transforming the way, companies dissolve and clear off their liabilities. The robust framework provided by act for insolvency resolution, liquidation, distribution, etc. are precise and clear, which removes scope of ambiguity. Although, the act is relatively new, the Hon’ble Supreme Court has been explaining the intention of the legislature behind provisions (such as Section 53), thus playing its part in evolving the jurisprudence relating to insolvency and bankruptcy effectively.

“PRIME LEGAL is a full-service law firm that has won a National Award and has more than 20 years of experience in an array of sectors and practice areas. Prime legal fall into a category of best law firm, best lawyer, best family lawyer, best divorce lawyer, best divorce law firm, best criminal lawyer, best criminal law firm, best consumer lawyer, best civil lawyer.”

Written by – Anurag Das

[1]Maitrya Doshi vs. Anand Rathi Global Finance Ltd.,2022 SCC OnLine SC 1276.

[2] Technology Development Board vs. Anil Goel, Company Appeal (AT) (Insolvency) No.731 of 2020.

0

Secured Creditors and the Rainbow Impact on IBC

Articles , , , , , , , , , ,

Abstract

This article is based on the decision given by the hon’ble supreme court on STATE TAX OFFICER ( 1 ) VERSUS RAINBOW PAPERS LIMITED LNIND 2022 SC 596  and it will further dissect the legal question raised in this case along with the previous precedents of the hon’ble SC in similar cases.

The Verdict in this case basically held that the resolution plan proposed by the Committee of Creditors (COC) wouldn’t pass the scrutiny of law if the debtor fails to pay off the tax dues owed by him to the relevant tax authority, in such a case the Debtor is bound to liquidate its assets under section 53 of the IBC.

It goes without saying that the aforementioned judgement has raised worries within the insolvency sector, and as a result, the stakeholders have been considering what has to be done in order to comply with the aforementioned ruling.

Introduction

The controversy brought up in the judgement was outstanding taxes under the Gujarat Value Added Tax Act of 2003 (the “GVAT”) and how they conflicted with the waterfall system under Section 53 of the IBC. The waterfall mechanism, which is covered by Section 53 of the IBC, was only implemented as a legal tool to establish a hierarchy for prioritising the payment of obligations at the time of the corporate debtor’s liquidation. In essence, the dispute in the case is around outstanding claims from governmental bodies and privately secured debts. It is essential to review the ruling at this time and comprehend how it affects the IBC’s goal. Section 48 of the Gujarat Value Added Tax Act, 2003 (“GVAT Act”), according to the Supreme Court (“SC”), is not in conflict with or in contravention of Section 53 of the Insolvency and Bankruptcy Code, 2016 (“the Code”).

Analysis of the Court

In reaching the aforementioned conclusion, the Court made an important ruling by concluding that because the State Government has first charge over the property and is considered a “secured creditor” under the Gujarat Value Added Tax, 1974, it will also be treated as such under Section 53 (1) (b) (ii) of the IBC for liquidation purposes.

The State’s claim has been ruled to be untimely by the adjudicating authority (NCLT) and the appellate authority (NCLAT). Regulation 12 of the 2016 Regulations addresses the deadline for submitting a claim and supporting documentation, which is outlined in the public notification made according to Section 15 of the IBC. However, the time period is merely a guide and not required.

It also observed in the case of Vishal Saxena & Anr. v. Swami Deen Gupta where NCLT held that the time limit under Regulation 12 for submitting a claim is directory and not necessary in the matter of Resolution Professional. In its ruling and decision of June 10, 2021 in Assistant Commissioner of Customs v. Mathur Sabhapathy Vishwanathan, the NCLT adopted a similar stance. Thus, State’s claim cannot be rejected without violating the law.

The Adjudicating Authority may only approve the Resolution Plan, as approved by the Committee of Creditors (CoC), if the Adjudicating Authority is satisfied that the Resolution Plan complies with Section 30(2) of the IBC. This is made clear by Section 31 of the IBC, which governs the approval of a Resolution Plan by the Adjudicating Authority. The Resolution Plan cannot be authorised if it does not adhere to Section 30(2)’s standards.

The hon’ble court also took note of, Ghanshyam Mishra & Sons (P) Ltd. v. Edelweiss Asset Reconstruction Co. Ltd.,

“A simple reading of Section 31 of the I&B Code would also make it abundantly clear that the corporate debtor, as well as its employees, members, creditors, guarantors, and other stakeholders, are bound by the resolution plan once it has been approved by the adjudicating authority and it has determined that the resolution plan as approved by CoC satisfies the requirements referred to in Subsection (2) of Section 30. Such a clause is necessary since one of the main goals of the I&B Code is to revive the corporate debtor and turn it into an operating business.”[1]

“The resolution plan submitted by the successful resolution applicant must include a number of provisions, including a payment provision for the costs of the insolvency resolution process and a payment provision for operational creditors’ debts, which must not be less than the amount that would be paid to those creditors in the event that the corporate debtor was liquidated in accordance with Section 53, or the amount that would have been paid had the amount to be distributed under that section been less. The resolution plan must also include provisions for paying the obligations of financial creditors who reject the resolution plan, which also must not be less than the sum paid to those creditors in accordance with Section 53, subsection (1), in the event that the corporate debtor is liquidated. To dispel confusion, Explanation 1 to Clause (b) of Subsection (2) of Section 30 of the I&B Code specifies that a distribution made in line with the terms of the aforementioned clause must be just and equitable to such creditors. The resolution plan must also include provisions for the administration of the corporate debtor’s affairs following approval, as well as for the execution and oversight of the resolution plan, Clause a(e) of sub-section (2) of Section 30 of the I&B Code also casts a duty on RP to examine that the resolution plan does not contravene any of the provisions of the law for the time being in force.”[2]

A resolution plan approved by the Committee of Creditors in accordance with Subsection (4) of Section 30 of the IBC may, under Section 31 of the IBC, only be approved by the Adjudicating Authority if the Adjudicating Authority is satisfied that the resolution plan meets the conditions outlined in Subsection (2) of Section 30 of the IBC. The fulfilment of Sub-Section (2) of Section 30 of the IBC criteria is a prerequisite for the approval of a resolution plan.

The Central Government, any State Government, any statutory or other authority, any financial creditor, or any other creditor to whom a debt in respect of dues arising under any law currently in effect is owed would be bound by a resolution plan that is valid and complies with Sub-Section (2) of Section 30 of the IBC. When there are still unpaid statutory obligations owed by a corporate debtor, such a resolution plan would not be binding on the State.

It also held that a company must be liquidated and its assets sold and distributed in accordance with Section 53 of the IBC if it is unable to pay its debts, which should include any statutory obligations to the government and/or other authorities, and there is no plan that envisages dissipation of those debts in a phased manner, uniform proportional reduction.

In the opinion of the court, the Committee of Creditors—which may include financial institutions and other financial creditors—cannot secure its own obligations at the expense of any other obligations, including statutory obligations to any government or governmental authority. Section 48 of the GVAT Act is not in conflict with Section 53 of the IBC or any other IBC requirements. According to Section 53(1)(b)(ii), debts payable to a secured creditor—which, under the GVAT Act, would include the State—rank equally with other specified obligations, including debts related to workman’s compensation for the 24 months prior to the liquidation beginning date. the GVAT Act designates the State as a secured creditor. A creditor to whom a security interest is credited is referred to as a secured creditor in Section 3(30) of the IBC. Such a security interest might be established legally. Any government or governmental authority is not excluded from the IBC’s definition of secured creditor.

Thus, the Court allowed the appeal of the appellant and set aside the order of the tribunal.

Claims Countering the verdict

The legal position is quite poles apart from this verdict, as the apex court had already stated in its verdict in “PR Commissioner of Income Tax v. Monnet Ispat and Energy Limited”, where it categorically held that “IBC has overriding effect on the every existing law inconsistent to it including the Income tax law. Further, the Apex Court also took a note that because Income Tax debts are in the nature of Crown Debts, they do not take precedence even over secured creditors who are private individuals, citing the case of Dena Bank vs. Bhikhabhai Prabhudas Parekh and Co., reported in 2000 (5) SCC 694 [LNIND 2000 SC 721].”[3]

The Bombay High Court recently held that secured debt shall take priority over “Government” dues/tax dues in the case of M/s Edelweiss Asset Reconstruction v. M/s Tax Recovery Officer, 5 dated July 28, 2021. The court based this decision on the fact that the Income Tax Act makes no reference to the obligations of the Income Tax Department taking precedence over secured debt. The Revenue was not permitted to impede the petitioner’s rights as a secured creditor. The order for attachment was invalid.

“The tax dues, being an input to the Consolidated Fund of India and of the States, clearly come within the ambit of section 53(1)(e) of the Code. If the Legislature, in its wisdom, assigned the fifth position in the order of priority to such dues, it is not for this Court to delve into or belittle the rationale underlying the same”[4]

A secured creditor often falls under the category of financial creditors. However, there may be circumstances in which even an operating debtor qualifies as a “secured creditor.” For instance, the National Company Law Appellate Tribunal recognised an operational creditor as a secured creditor in the Concast Steel & Power Ltd. v. MSTC Limited case because of a pledge agreement that had been made with the corporate debtor.

Conclusion

Thus it is advised that the Supreme Court must review the current ruling and clarify the law in light of this. It is obvious that if the existing legal situation is allowed to continue, it would harm the goal that the Code is meant to accomplish. As a result, the added responsibility of paying current or potential government and legislative dues is likely to deter any prospective resolution application. In the end, it could lead to fewer settlement requests, lower asset valuations, and higher haircuts for creditors.

[1] Para 65 Ghanshyam Mishra & Sons (P) Ltd. v. Edelweiss Asset Reconstruction Co. Ltd.

[2] Para 66 Ghanshyam Mishra & Sons (P) Ltd. v. Edelweiss Asset Reconstruction Co. Ltd.

[3] Para 4, PR Commissioner of Income Tax v. Monnet Ispat and Energy Limited

[4] Leo Edibles & Fats Limited v. Tax Recovery Officer, Writ Petition No. 8560 of 2018.

“PRIME LEGAL is a full-service law firm that has won a National Award and has more than 20 years of experience in an array of sectors and practice areas. Prime legal fall into a category of best law firm, best lawyer, best family lawyer, best divorce lawyer, best divorce law firm, best criminal lawyer, best criminal law firm, best consumer lawyer, best civil lawyer.”

Written By – Shreyanshu Gupta