The bitter ownership battle between minority shareholders and a creditor of the debt-laden McDowell Holdings exposes the loopholes in the Insolvency and Bankruptcy Code (IBC) and violates the intent of the process, legal experts told Moneycontrol on September 21.
McDowell Holdings is the demerged investment arm of the UB Group.
The McDowell Holdings versus Sun Star Hotels and Estates Private Ltd case has grabbed eyeballs across the banking and legal fraternity. Moneycontrol, on September 20, had reported that a bunch of minority shareholders have accused Vijay Mallya, the former promoter of McDowells Holdings, of attempting to wrest back control through proxy companies.
“Most of the corporate debtors are working like this and they come from the back door through different company names, different directors and apply as successful resolution applicants,” said Anshul Gupta, managing partner, ANG Partners Advocates & Solicitors.
“They take over the company and try to run it again on their own terms and conditions as before,” he said.
This process of errant promoters trying to take control of their erstwhile bankrupt firms is not a new phenomenon in India’s banking landscape. A recent example is Kapil Wadhawan’s bid for Dewan Housing Finance Corporation Ltd (DHFL) by offering to pay off dues to his creditors over 7-8 years.
“These borrowers know how to use the law to their advantage,” said Sonam Chandwani, managing partner at KS Legal and Associates. “This completely violates the intent of the insolvency procedure and gives the borrowers an unfair advantage. Promoters frequently use their own internal teams or connected parties to buy back the firm during bankruptcy at a cheaper rate,” Chandwani said.
What is the McDowell Holdings case?
McDowell Holdings defaulted on a Rs 16.8 crore-loan given by Sun Star Hotels. Upon default, Sun Star Hotels initiated insolvency proceedings on the company by moving the National Company Law Tribunal (NCLT). However, a clutch of minority shareholders, who together own about 15 percent stake in McDowell, said they were willing to pay off the loan to Sun Star Hotels. Matters took a turn for the worst when Sun Star Hotels allegedly refused to take the money and insisted on bankruptcy proceedings.
The minority shareholders, who include Porinju Veliyath’s Equity Intelligence India, have alleged that this is a game plan by Mallya-backed proxy firms. They alleged that the debt resolution is part of a larger conspiracy by Mallya to gain control of the company through Sun Star Hotels. Sun Star Hotels, minority investors allege, is part of the Balaji Distilleries group that has long-time business links with Mallya’s companies. Both Mallya and Sun Star Hotels have denied the claims.
On September 19, McDowell informed the stock exchanges that creditors had approved the debt resolution plan of a company called Phoenix Theme Infra Projects. Even the NCLT approved the resolution plan. However, the value of the debt resolution plan submitted by Phoenix Theme Infra Projects is only a fraction of the holdings of Mallya’s UB Group, according to the minority shareholders.
The shareholders have now moved the Supreme Court, challenging the NCLT decision.
“The ongoing dispute between the minority shareholders and the creditors of McDowell Holdings is a crucial one, as it touches one of the most important facets of the IBC, being that prohibition on any sort of back-door entry by any person/entity barred under Section 29A,” said Vineet Kumar, an associate at SKV Law Offices.
‘Proceedings reveal ulterior motive’
When insolvency proceedings are initiated against a company, the debtor typically tries to put up a defence to thwart the proceedings and prevent creditors from taking it to the bankruptcy court. This, however, was absent in the McDowell case, said legal experts.
“In the McDowell Holdings case, the company appeared on advance notice (as is reflected from the NCLT order) and appears to have admitted the default without raising any serious objection,” said Soayib Qureshi, associate partner at PSL Advocates & Solicitors. “This does raise a concern that the proceedings have been initiated for an ulterior purpose.”
Qureshi elaborated that a close scrutiny of the case does “raise suspicion” over the manner in which the proceedings have been initiated, especially considering that the actual default took place during the COVID period during which no proceedings were maintainable under IBC. Subsequently, the debt was assigned to Sun Star Hotels, added Qureshi, which surprisingly also gave a financial assistance of Rs 1.5 crore to McDowell, he added.
“It does appear from these facts that such a transaction has been entered into to pass over the limit of Rs 1 crore and also to steer clear of the prohibition under section 10 A,” said Qureshi.
According to Section 10A of the IBC code, no application for initiation of corporate insolvency resolution process of a corporate debtor shall be filed, for any default arising on or after March 25, 2020, for six months or such further period, not exceeding one year from such date.
What can minority shareholders do?
Minority shareholders can offer to pay off the debt by submitting a resolution plan during the insolvency process. They are also free to offer out-of-court resolution to the creditors. They also have other legal options.
Minority shareholders can appear before the court to put forth their grievances. First, they will have to prove that the company is being run in a way that is detrimental to public interest, harmful or oppressive to them or any other member, or harmful to the company's interests, said legal experts.
Second, if there is a significant change in the board of directors, the membership, the share capital, or any other aspect of the company's management and control, and if the minority shareholders can prove that the change is likely to have a negative impact on the company's operations, those of its members, or those of any class of members, they can take legal measures, they added.
Further, a perusal of balance sheets of the corporate debtor may help to establish siphoning of funds into various affiliated companies or entities before the initiation of CIRP (Corporate Insolvency Resolution Process), according to Raj Bhalla, partner at law firm MV Kini.
Additionally, Section 65 of the IBC is in place to prevent any misuse of the provisions of IBC by a person who has initiated the insolvency resolution process or liquidation proceedings, with a fraudulent or malicious intent, and for any purpose other than for the resolution of insolvency or liquidation. Minority shareholders can prove that the insolvency proceedings have been conducted in a fraudulent manner under this section, said legal experts.
“Under Section 65 of the code, if a person initiates an insolvency process fraudulently, the Adjudicating Authority may impose a penalty,” said Soorjya Ganguli, partner at Argus Partners, Solicitors and Advocates.
“In this case, the minority shareholders must prima facie show signs of fraud, collusion or malicious intent. The collusion, as alleged, has to be shown in accordance with law in view of the facts and circumstances of the case.”
End of the road for shareholders?
However, legal experts said that proving malicious intent may not be an easy task for minority shareholders. This is also because the IBC accords superior rights to the Committee of Creditors (CoC) over shareholders. It also entrusts the CoC solely with the right to deal with and approve resolution plans.
“Any decision based on the commercial wisdom of the CoC is not amenable to judicial review. Further, in view of the explanation to Section 30(2)(e) of the (IBC) Code, any objection raised by minority shareholders would not be tenable,” added Ganguli.
Aditya Chopra, managing partner at Victoriam Legalis, Advocates & Solicitors, concurred with Ganguli’s view.
“The CoC is the sole entity authorised under the IBC to handle and approve the resolution plan; shareholders are not involved in this process,” said Chopra. “The promoters' stock is extinguished and cancelled in total without any consideration. Hence, even a minimal exit price for minority shareholders cannot be deemed unjust or inequitable.”Shareholders would stand last in order of precedence under Section 53 in the event of liquidation, added Chopra.