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This post, the selected entry of the RFMLR-IBBI Blog Series Competition, 2021, is authored by Nency Shah, third-year law student at the Institute of Law, Nirma University & Devanshu Anada, fourth-year law student at the Gujarat National Law University, Gandhinagar, Gujarat.
This is the second part of the two-part blog on regulating the commercial wisdom of CoC by imposing a Code of Conduct. This part discusses alternative solutions to the issue and concludes the blog. The first part can be accessed here.
1. Alternative Solutions – Identifying the Middle-Ground
Some other alternative approaches are required to deal with the shortcomings of the proposed code of conduct. The approaches should provide a way in which a code of conduct will ensure fairness, transparency and accountability of CoC and at the same time also preserve the core objectives of IBC. Some approaches are suggested by the authors in the following part.
1.1.Inter-Regulatory Approach
It has been observed that most of the financial creditors which are members of CoC are either banks or financial institutions which are very well regulated by the RBI or SEBI under their respective regulatory framework. The code of conduct, if made mandatory, might open floodgates of litigation as discussed previously. So, it would be wise to make the code of conduct prescriptive and ensure its compliance by the financial creditors by extending their regulatory framework to the process of insolvency resolution and providing for penalties in case of non-compliance of code in their respective frameworks. At the same time, it should be seen that the inclusion of disincentives for non-compliance of the code in the regulatory framework of RBI/SEBI does not amount to “law” under section 30(2) or section 61(3) of IBC. This would ensure that the NCLT is not empowered to reject the resolution plan because of non-compliance with the code. This approach would ensure that the resolution plan is not open to challenge because of the non-compliance of the code causing extended delays and will also help in seeking out compliance to the code by the financial creditors, thus avoiding the pitfalls of it being merely prescriptive.
The Ministry of Finance has also shown its inclination towards an inter-regulatory and coordination-based mechanism instead of IBBI being the sole regulator. As per the government, the IBBI can issue guidelines but cannot regulate the CoC as there are different regulators which are empowered to regulate the members of the CoC. So, there have been discussions to allow different regulators such as SEBI and RBI to coordinate and supervise the CoC and ensure compliance with the code of conduct.
1.2.Establishing a Consultation Process with the Interested Stakeholders
To protect the interests of the stakeholders who are not a part of the CoC under Section 21, a consultation process can be established under the code where before placing the resolution plan before the NCLT for its approval, it should be required to be placed before the stakeholders for their objections and suggestions. During this window, the CoC would address the concerns of the stakeholders and try to clarify their reasons behind the adoption of the resolution plan. After the 2018 amendment to the CIRP regulations, under Reg. 39, the CoC is also required to record the reasons for accepting or rejecting the resolution plan. During this consultation process, the CoC can strive to explain these reasons to the stakeholders which will lead to restoring their confidence in the management of the company.
This reform may appear to be time-consuming leading to further delay of the CIRP, but to avoid this, the procedure of reform shall begin immediately after the approval of the resolution plan and a window of only a few days should be provided to the stakeholders to object to the plan. This step will go a long way in reducing future litigations by the stakeholders which generally happen because of the lack of trust of the stakeholders in the CoC. Thus, a consultation process will help in increasing the fairness, transparency and accountability of the CoC, and also confirms with the objectives of the proposed code of conduct.
1.3.Laying down Specific Grounds for Challenge of Resolution Plans approved by CoC
It has been observed by the Supreme Court in the case of Arun Kumar, that with respect to the role of the NCLT and NCLAT under the IBC, to ensure the efficacy of the legislation and fulfilment of its core objects, the judicial intervention or innovation from NCLT and NCLAT should be kept at its bare minimum so that they do not disturb the foundational principles of the IBC. In light of this pronouncement, it is proposed that certain specific grounds can be laid down, in the IBC or the regulations framed thereunder, on which the resolution plan can be challenged by the interested stakeholders. These grounds should only include instances where there has been a flagrant misuse of their commercial wisdom by the CoC leading to unfairness and perversity to other interested stakeholders. In the Companies Act, 2013, there are provisions such as Section 241 r/w Section 244 which empower minority stakeholders to apply before the NCLT in case the affairs of the companies are being conducted in a manner prejudicial to public interest or to the interest of the members. A similar safeguard, but in more specific terms, can be included in the IBC which would prevent the CoC from acting in a manner that is prejudicial to the interests of the stakeholders of the company. Further, the following grounds can be proposed in existence of which the resolution plan can be open to challenge:
a) Attempt to transfer control of the company to the promoters responsible for default or to the related parties of the company.
b) Inclusions of unwarranted and unreasonable expenditures such as payment of fees to legal counsel of creditor in insolvency resolution process costs in the guise of providing undue benefit to the creditors.
c) Misclassification of financial creditors as operational creditors and vice-versa by the Resolution Professional.
d) Illegal constitution of the CoC by the inclusion of related party financial creditors in contravention of Section 21(2) of IBC.
These grounds are merely indicative and are derived from the previous observations of NCLT/NCLAT in past cases of misuse of commercial wisdom by the CoC, as also highlighted in a discussion paper by the IBBI. One should be cautious that the grounds are worded in a manner such that they can only be invoked under exceptional circumstances where the decision of the CoC is in complete contravention to the objects of IBC otherwise it may also lead to questioning the commercial wisdom of the CoC and thereby curtailing its independence.
1.4.Prescribing a Maximum Limit for Permissible Haircut
The Parliamentary Standing Committee on Finance observed that the recovery rate from the resolution has gone up to 95% of haircuts and delays in CIRP are a norm rather than an exception. In light of this, the IBC could also be amended to provide a maximum haircut limit for the resolution plan which can be decided in a manner that ensures that a higher value is realized from the resolution process as compared to the liquidation of the company. Reg. 35 of the CIRP Regulations provide for the determination of fair value and liquidation value of the CD by two registered valuers and its intimation to the members of CoC by the RP. The maximum limit of haircuts can be set in light of these values decided under the said regulation. This limit will help in preventing cases like Videocon Industries where the CoC in the exercise of their commercial wisdom accepted haircuts of around 95-96% of its total dues and the NCLT had to accept the resolution plan in absence of any upper limit in the haircut.
It can be argued that prescribing a maximum limit to the haircut would lead to infringing the commercial wisdom of the creditors and restricting it to set parameters. But it should be kept in mind that unfettered exercise of commercial wisdom by the CoC which is prejudicial to the interests of the stakeholders is also not in line with the objectives of the code and thus needs to be regulated.
2. Concluding Remarks – The Way Ahead
It is evident from a catena of decisions of the Supreme Court referred above that the importance of commercial wisdom of the CoC cannot be stressed enough. However, it should also be kept in mind that this unfettered commercial wisdom of the CoC does not become a reason for defying the objects of the very code it derives its powers from. At the same time, the importance of the commercial wisdom of the committee of creditors which lies at the heart of the present insolvency regime should not be undermined by its excessive regulation. It has been made clear that regulating the unfettered commercial wisdom of the creditors in a way that the impudence of the creditors is preserved and its misuse is curbed is the need of the hour. The alternative solutions suggested by the authors can be adopted to ensure that there is very limited regulation of the commercial wisdom of the creditors without affecting their independent decision-making powers enshrined in the code.