Author: Mohd. Fahad Ansari
Fourth-year law student at National University of Study and Research in Law, Ranchi
I. Introduction
The creation of the Insolvency and Bankruptcy Code, 2016 (Code), was driven by the necessity to maintain economic value through swift actions. Nevertheless, its enforcement has exposed imbalance in powers among types of creditors. The Corporate Insolvency Resolution Process (CIRP) is led by the Committee of Creditors (COC), which effectively assumes control from the corporate debtor’s former Board of Directors. Giving representation and voting power only to financial creditors, the COC’s decisions regarding the corporate debtor’s future have been consistently endorsed by Adjudicating Authorities, under the pretext of respecting its "commercial wisdom.". This post aims to briefly explore the development of this deference and the potential for change, especially in light of the recent ruling of the Apex Court in the case of M.K. Rajagopalan v. Dr. Periasamy Palani Gounder.
II. Supreme Court's Stance on Commercial Wisdom: Evaluating COC's Accountability and Legal Boundaries
Entrusted with the duty of assisting the corporate debtor in recovering, the COC can choose to pursue lucrative resolutions from the market, potentially involving a reduction in claims for any or all stakeholders, or, if necessary, move towards liquidation. The choice between reviving the corporate debtor’s operations or opting for liquidation is fundamentally a "business" decision made by the COC. While it’s clear that respecting commercial wisdom will accelerate the CIRP or liquidation process, the critical question remains: what is the price of this expediency?
The COC is composed exclusively of financial creditors, leaving operational creditors in a disadvantaged position, unable to effectively claim their dues or participate meaningfully in the proceedings that might otherwise facilitate this. Despite the Supreme Court's ruling in Essar Steel India v. Satish Kumar Gupta, which stressed the need for the COC to ponder upon the interests of all stakeholders when finalising a resolution plan, the lack of clear limitations on the COC’s powers disadvantages those creditors not included in the COC.
The rising frequency and extent of haircuts, though an improvement from the pre-IBC era, pose additional challenges, especially for operational creditors. For example, during the insolvency process of Videocon Industries Ltd., secured financial creditors faced a haircut of about 96%,while operational creditors experienced a haircut of nearly 99%. Moreover, judicial interpretation and innovation are crucial given that the Code is a relatively new piece of legislation. In this scenario, the judiciary's unreserved commitment to upholding the COC’s commercial wisdom is potentially harmful, not only to the corporate debtor but also to the broader economy.
A series of rulings, ranging from K Sashidhar v. Indian Overseas Bank to Gail India v. Ajay Joshi, have consistently reinforced the significant authority granted to the COC. While it could be argued that judicial scrutiny serves to check the unrestricted exercise of these powers, the reality is that there is limited comprehensive judicial oversight to hold the COC accountable for its actions. The case of Kalpraj Dharamshi v. Kotak Investment Advisors is particularly noteworthy, as it delves into the conflict between the COC and the Adjudicating Authority concerning the approval of resolution plans. The Apex Court emphasised that such commercial decisions should not be interfered with, except as specified under Section 30 and Section 61 of the Code. These sections allow a resolution plan to be challenged if it violates any laws, fails to meet the Board’s standards, involves significant irregularities in the resolution professional's actions, etc. The Court also affirmed the COC's supremacy, declaring that its commercial wisdom makes it the most qualified to assess the feasibility of a resolution plan. On June 3, 2023, the Supreme Court further endorsed this stance by approving a 93.5% haircut in the settlement amount, overturning the NCLAT's order for liquidation in the case of Vallal Rck v. Siva Industries and Holdings.
The Apex Court has made a modest but significant move in the right direction by curbing the supremacy of COC in the Rajagopalan case. It was acknowledged by the court clearly that the COC's commercial wisdom should not be over-extended to overlook a major flaw in its decision-making when it failed to consider the application of any existing law, particularly since the resolution plan violated Section 88 of the Indian Trusts Act. In this instance, the COC's commercial wisdom was called into question on several fronts within the insolvency process, such as the ineligibility of the resolution applicant and the omission of presenting the resolution plan to the COC. However, the Court held the COC accountable only in a very limited way. While issues like the ineligibility of the resolution plan (due to its violation of Section 88) may not have been part of the COC’s deliberations, the Supreme Court emphasized that the COC's status does not justify ignoring such significant deficiencies. Furthermore, the CIRP grants primacy to commercial wisdom, provided that every element of the resolution plan is made available for the COC's consideration. Given that the Code is structured to prioritize the claims of financial creditors over those of operational creditors, the narrow grounds for challenging commercial wisdom as outlined in Sections 30 and 61 are insufficient to do more than check blatant abuses of power and ensure legal adherence.
III. Code of Conduct and Consultation: Enhancing operational creditors’ participation in the Resolution Process
While the heavy dependence on the COC’s decisions might, in a narrow sense, achieve the Code’s objective of swiftly resolving insolvency, it is crucial to eventually focus on how the Code genuinely supports collective participation and the equal rights of all creditors. Instead of establishing a broader framework to challenge the Code's liberties, the Supreme Court has largely reaffirmed its commercial wisdom but with a crucial stipulation: it cannot be used to overlook significant deficiencies. The affirmation of commercial wisdom comes with specific conditions, such as the thorough examination of the final resolution plan and access to all pertinent information. Thus, although this judgment represents a shift from an unquestioning reliance on the COC, its impact is still limited. This post contends that the COC’s actions should be assessed against a standard set by a comprehensive code of ethics, not just the narrow criteria outlined in the Code. Although the IBBI has in its Discussion Paper recognised the necessity of drafting a Code of Conduct, it is essential for authorities to consider the economic and legal repercussions of granting unchecked powers to the COC.
It is also important to note that many operational creditors often possess a deeper understanding of the corporate debtor's business than the financial creditors. The Supreme Court in Swiss Ribbons Pvt. Ltd. v. Union of India has noted the unique role that operational creditors play in the business, given their direct involvement in the company's day-to-day operations. The court recognised that operational creditors are typically more involved in the operations of the business, even though they do not have a voting right in the CoC. The Court emphasized that while the financial creditors are primarily concerned with the recovery of their financial investments, operational creditors are more closely tied to the operational aspects of the company, which may give them a deeper understanding of the business.
In addition to recommending a Code of Conduct, this post advocates that even if operational creditors can’t be given a seat in the CoC, some level of participation of operational creditors in the decision-making process is required. This could be achieved by requiring the CoC to consult with operational creditors before approving any plan. Given that CIRP typically involves claims of a large number of operational creditors, it should be mandatory for the CoC to consult with at least the top 10% (or other appropriate percentage) of operational creditors who hold the largest claims. It is essential to ponder that accepting resolution plans which give heavy haircuts to operational creditors’ debts may, in long-run, discourage numerous operational creditors to work on credit basis, thereby eventually demoralizing the enterprise and economy as a whole.
It is apposite to state that, to run the company not only capital is important but also the materials and/or services supplied or provided, as the case may be, by the Operational Creditor. The World Bank Principles for Effective Insolvency and Creditor/Debtor Regimes has also fairly recommended that "creditor interests should be safeguard by appropriate means that enable creditors to effectively monitor and participate in insolvency proceedings to ensure fairness and integrity. At the least, consulting with a limited number of operational creditors, the COC can better protect the interests of all stakeholders.
IV. Conclusion
While the Supreme Court’s endorsement of the COC’s commercial wisdom underscores its pivotal role in the insolvency resolution process, it also highlights the need for more inclusive practices. While tempering the COC's unchecked authority, the Court's recent rulings still leaves significant gaps in stakeholder representation, particularly for operational creditors. To address these imbalances, a more comprehensive approach that includes consulting a broader range of creditors, especially those directly impacted by high haircuts, is essential. Integrating operational creditors more meaningfully into the decision-making process can better safeguard all stakeholders' interests and uphold the integrity of the insolvency framework. As the Code evolves, establishing a robust Code of Conduct and enhancing creditor participation will be crucial for ensuring fairness and promoting economic stability.
Note: This article has been reviewed by Ms. Anjana Potti (Partner, SAM), at the Tier II Stage.
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