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

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.

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Reconciling the jurisdiction: Harmonizing Insolvency proceedings and Anti-Money laundering efforts in India’s legal landscape  

ABSTRACT

The intersection of the Insolvency and Bankruptcy Code (IBC) and the Prevention of Money Laundering Act (PMLA) represents a significant legal conundrum in India. Both legislative frameworks serve distinct but crucial purposes—IBC aims to resolve insolvency and bankruptcy cases in a time-bound manner to promote economic stability, while PMLA targets the prevention and control of money laundering. However, their overlapping jurisdiction has led to numerous legal conflicts and interpretative challenges. The intersection of the Insolvency and Bankruptcy Code (IBC) and the Prevention of Money Laundering Act (PMLA) in India has led to significant jurisdictional conflicts, posing challenges for stakeholders and the legal system. The IBC, enacted to streamline and expedite insolvency resolution, often clashes with the PMLA’s mandate to combat money laundering and financial crimes. This conundrum arises when assets under insolvency proceedings are simultaneously subjected to PMLA’s attachment orders, creating a legal and procedural deadlock. The Supreme Court and various tribunals have been pivotal in interpreting these conflicts, yet a clear precedence remains elusive. This paper examines the legal frameworks of both statutes, analysing key case laws and judicial pronouncements that highlight the jurisdictional overlap and its implications. It also explores the potential for harmonization through legislative amendments or judicial guidelines to ensure coherent application without undermining either law’s objectives. By scrutinizing the operational challenges and proposing strategic solutions, this analysis aims to contribute to a more integrated approach, balancing the objectives of insolvency resolution and anti-money laundering efforts in India.

Keywords: Insolvency and Bankruptcy Code (IBC), Prevention of Money Laundering Act (PMLA), Jurisdiction conflict, Legal conundrum, Corporate insolvency resolution, Financial regulations, Legal framework, Cross-jurisdictional issues, Debt recovery, Insolvency proceedings, Enforcement Directorate (ED), Adjudicating authority Asset attachment, Creditors’ rights, Legal ambiguity, Judicial interpretation, Economic offences, Financial distress,  Bankruptcy laws in India, Corporate debt restructuring, Insolvency professionals, Legal precedents, Conflict resolution, Financial crimes, Insolvency jurisprudence.

Introduction

The Insolvency and Bankruptcy Code (IBC) and the Prevention of Money Laundering Act (PMLA) represent two critical legislative frameworks in India aimed at addressing insolvency and financial crimes, respectively. On the other hand, the PMLA was enacted in the year 2002 to prevent money laundering and confiscate the proceeds of crime. It provides for the attachment of property and freezing of assets of a person being investigated for an offence under the Act. In practice, law enforcement agencies have used the provisions of the PMLA to attach the assets of corporate debtors who are also being investigated for money laundering offences. However, the overlap between these two statutes has given rise to significant legal and practical challenges, resulting in what is commonly referred to as the IBC-PMLA conundrum. The IBC, enacted in 2016, seeks to consolidate and amend laws relating to the reorganization and insolvency resolution of corporate persons, partnership firms, and individuals in a time-bound manner to maximize the value of assets and promote entrepreneurship. On the other hand, the PMLA, established in 2002, aims to prevent money laundering and provide for the confiscation of property derived from, or involved in, money laundering. The crux of the conflict lies in the contrasting objectives and procedures of these two laws: while the IBC focuses on the revival of distressed businesses and equitable distribution of assets, the PMLA is geared towards penalizing financial misconduct and seizing assets involved in illicit activities. This clash of jurisdictions poses a dilemma for stakeholders, particularly insolvency professionals and enforcement agencies, as they navigate the legal landscape to prioritize asset distribution and penal measures. The ambiguity regarding which law takes precedence complicates insolvency proceedings when assets under consideration are tainted with allegations of money laundering. Consequently, the resolution of this conundrum is crucial for ensuring legal clarity, protecting stakeholder interests, and maintaining the integrity of India’s financial and legal systems. Further, the addition of Section 32A to the IBC, has given this issue a new dimension.

The new provision aims to encourage resolution applicants to take over distressed companies without fear of being prosecuted for offences committed by the previous management. However, it is unclear how Section 32A would affect the attachment of property under the PMLA during the moratorium period. Recently, the Hon’ble Apex Court has taken cognizance of the matter in the case of Ashok Kumar Sarawagi v. Enforcement Directorate 2023. Till the Apex court pronounces its decision, we will examine the legal position on the issue and analyse the relevant provisions of the IBC and the PMLA, as well as the decisions of courts and tribunals in this piece. We will also evaluate the practical implications of the issue on the insolvency resolution process and the interests of creditors, as well as the impact of the issue on the larger policy objectives of the IBC and the PMLA.

The Objectives and Frameworks

Insolvency and Bankruptcy Code (IBC):

Enacted in 2016, the IBC consolidates laws relating to insolvency and bankruptcy, creating a unified legal framework for resolving insolvency in a time-bound manner. Its primary objective is to maximize the value of the debtor’s assets, promote entrepreneurship, and balance the interests of all stakeholders. Prevention of Money Laundering Act (PMLA): The PMLA, enacted in 2002, aims to combat money laundering and provide for confiscation of property derived from or involved in money laundering. The Enforcement Directorate (ED) is the primary agency responsible for investigating offenses under the PMLA. The primary clash between IBC and PMLA arises from their differing priorities. The IBC focuses on the rehabilitation of the debtor and equitable distribution of assets, while the PMLA emphasizes the confiscation of tainted assets and punishing the offenders involved in money laundering activities. This fundamental difference creates several specific points of conflict Asset Freezing and Attachment Under the PMLA, the ED has the authority to attach properties involved in money laundering. These attachments often include assets of companies undergoing insolvency proceedings under the IBC. The attachment of assets impedes the resolution process envisaged under the IBC, leading to delays and complexities in asset distribution. Moratorium Under IBC: Section 14 of the IBC imposes a moratorium, which halts all legal proceedings against the debtor’s assets during the insolvency resolution process. However, the ED’s actions under PMLA often disregard this moratorium, leading to legal battles over jurisdictional supremacy.

Jurisdictional Overlap:

Insolvency proceedings under IBC are supervised by the National Company Law Tribunal (NCLT), while offenses under PMLA are adjudicated by the Adjudicating Authority constituted under the PMLA. This duality of jurisdictions often leads to conflicting orders, further complicating the resolution process. IBC seeks to resolve insolvency and maximize asset value for creditors through a structured resolution process PMLA empowers the Enforcement Directorate (ED) to attach and confiscate properties involved in money laundering activities, which may overlap with the assets under insolvency proceedings. IBC: Enacted in 2016, the Insolvency and Bankruptcy Code aims to consolidate and amend laws relating to reorganization and insolvency resolution of corporate persons, partnership firms, and individuals in a time-bound manner for maximization of value of assets. PMLA: The Prevention of Money Laundering Act, 2002, aims to prevent money laundering and to provide for confiscation of property derived from or involved in money laundering and for matters connected therewith or incidental thereto.

Enforcement Directorate (ED): The ED is responsible for investigating offences related to money laundering and enforcing the PMLA. Adjudicating Authority: An authority appointed under the PMLA adjudicates matters related to attachment and confiscation of properties involved in money laundering. Appellate Tribunal: An Appellate Tribunal hears appeals against orders of the Adjudicating Authority. High Court: Appeals against the orders of the Appellate Tribunal can be made to the jurisdictional High Court. While the IBC and PMLA serve different purposes, their jurisdictions can overlap in certain situations, particularly where financial crimes and insolvency intersect: Attachment of Assets: During insolvency proceedings under the IBC, if assets are found to be involved in money laundering, the ED may attach these assets under the PMLA. This can complicate the insolvency resolution process. Coordination between Authorities: There may be a need for coordination between the NCLT, which handles insolvency resolution, and the ED, which handles money laundering cases. In some cases, courts have had to intervene to resolve conflicts between the attachment of assets by the ED and the resolution processes under the IBC.

Legislative Amendments:

Amending both IBC and PMLA to clearly define the extent and limits of their respective jurisdictions can help reduce conflicts. Clarifying the interplay between the moratorium under IBC and the attachment powers under PMLA is essential. Establishing a coordination mechanism between the ED and the Insolvency Professionals (IPs) can ensure smoother resolution processes. Joint efforts can help balance the objectives of both laws without compromising on their core mandates.

Jurisdiction and Authorities:

National Company Law Tribunal (NCLT): The NCLT is the adjudicating authority for companies and limited liability partnerships (LLPs) under the IBC.

Debt Recovery Tribunal (DRT): For individuals and partnership firms, the DRT is the adjudicating authority.

National Company Law Appellate Tribunal (NCLAT): Appeals against NCLT orders can be filed with the NCLAT.

Supreme Court of India: Appeals against (NCLAT) orders can be filed with the Supreme Court of India.

Judicial Interpretation:

The Supreme Court can play a pivotal role by laying down comprehensive guidelines to address the overlapping areas between IBC and PMLA. Clear judicial precedents can provide lower courts and tribunals with the necessary framework to handle such conflicts.

Supreme Court of India:

Lalit Kumar Jain vs. Union of India (2021): The Supreme Court upheld the supremacy of the IBC over other conflicting laws in matters related to insolvency resolution. The Court emphasized that once a moratorium is declared under Section 14 of IBC, it prohibits the initiation or continuation of any legal action or proceeding against the corporate debtor, including under PMLA.

Embassy Property Developments Pvt. Ltd. vs. State of Karnataka (2019): The Supreme Court clarified that statutory authorities cannot act in a manner that defeats the resolution process under IBC. The Court ruled that the adjudicating authority under the IBC has the power to decide the legality of actions taken by other statutory authorities, including the ED under PMLA.

National Company Law Appellate Tribunal (NCLAT)

Varrsana Ispat Ltd. vs. Deputy Director, Directorate of Enforcement (2019): NCLAT held that the attachment of properties by the ED under PMLA cannot continue once a moratorium under IBC is in place. The judgment reinforced that the IBC aims to preserve the corporate debtor as a going concern and hence any attachment by the ED would hamper the resolution process.

Bank of India vs. Deputy Director, Directorate of Enforcement (2020): NCLAT reaffirmed its stance that properties attached under PMLA cannot be excluded from the moratorium imposed under IBC. The tribunal noted that the resolution professional has the right to take control of all assets, including those attached under PMLA, to ensure effective resolution.

Conclusion

The clash of jurisdiction between the IBC and PMLA is an evolving challenge in the Indian legal landscape. While both laws serve critical functions, their intersection necessitates a nuanced approach to avoid protracted legal battles and ensure both economic stability and the integrity of financial systems. Through legislative clarity, coordinated enforcement, and judicial guidance, a balanced resolution to the IBC-PMLA conundrum can be achieved, fostering a more robust legal framework for handling insolvency and financial crimes in India. The conflict between IBC and PMLA represents a classic case of jurisdictional overlap, reflecting the challenges in harmonizing economic and criminal laws. Judicial interpretations have so far leaned towards ensuring that insolvency resolution under IBC is not derailed by actions under PMLA, thus maintaining the primary objective of asset maximization and creditor protection. Going forward, a balanced approach that respects the intents of both laws, possibly through legislative amendments and inter-agency cooperation, is crucial for a cohesive legal framework. The interplay between the Insolvency and Bankruptcy Code (IBC) and the Prevention of Money Laundering Act (PMLA) presents a complex legal conundrum in India, primarily revolving around the conflict of jurisdiction and priorities between insolvency proceedings and anti-money laundering measures. The IBC, enacted in 2016, aims to consolidate and amend laws relating to reorganization and insolvency resolution of corporate persons, partnership firms, and individuals in a time-bound manner to maximize the value of assets. Its primary goal is to ensure the revival and continuation of the debtor company by protecting it from its creditors and providing an equitable distribution of assets. Conversely, the PMLA, 2002, seeks to combat money laundering and provide for confiscation of property derived from or involved in money laundering. The PMLA empowers authorities to attach and confiscate properties involved in money laundering, regardless of any proceedings under other laws.

 The friction arises when assets of a company undergoing insolvency under the IBC are simultaneously attached or confiscated under the PMLA. Courts have had to navigate the delicate balance between the creditors’ rights under the IBC and the state’s interest in curbing money laundering under the PMLA. The National Company Law Tribunal (NCLT) and the Enforcement Directorate (ED) often find themselves at loggerheads, leading to uncertainty and delays in insolvency resolution. Recent judicial interpretations suggest that the IBC should prevail over the PMLA in cases of conflict. The rationale is that the primary objective of the IBC is the revival of the debtor and maximizing asset value, which could be undermined if assets are indiscriminately confiscated under the PMLA. However, this precedence does not negate the importance of the PMLA but rather emphasizes the need for a harmonious interpretation where both statutes can operate without encroaching upon each other’s domains. The resolution of the IBC-PMLA conundrum requires a nuanced approach that respects the objectives of both laws. Harmonious interpretation, guided by judicial oversight, is essential to ensure that insolvency proceedings are not unduly hampered by anti-money laundering actions, and vice versa, thus fostering a balanced legal framework that supports both economic revival and financial integrity.

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Written By: HARIRAGHAVA JP