Book excerpt: Defaulter’s Paradise Lost | What to do if your company is facing bankruptcy

Defaulter’s Paradise Lost by Anant Merathia; Thomson Reuters; 400 pages; Rs 1,035. (Image via Amazon.in)

Defaulter’s Paradise Lost by lawyer Anant Merathia is a book about the practical and legal aspects of the Insolvency and Bankruptcy Code (IBC) 2016. Excerpted below is the chapter on "Issues affecting the corporate debtor and promoters":

In this chapter, we shall look at both the conventional and unconventional issues that impact the CD’s (corporate debtor's) status as a running business or even otherwise, independent from the promoter, along with the concerns and issues relating to a promoter, being a stakeholder, in IBC.

There have been ups and downs with respect to the promoter during the course of evolution of this law over the past 6 years, wherein they have been barred in certain contexts albeit with relaxations for promoters from the MSME sector.

‘BETTER SAFE THAN SORRY’ – MEASURES TO MITIGATE INSOLVENCY

IBC has shown faster improvements and progress, comparatively, than previous regimes. There have been both positive and negative impacts on stakeholders during the continuous evolution of the law. The latter cannot be totally ignored as it has resulted in severe challenges for a lot of companies. While the objective of the law was resolution of stressed assets and primarily for the bankers to use it as a mechanism to resolve the NPA issues and in parallel allow the companies an opportunity to rehabilitate themselves, the manner in which the outcome of implementation of IBC panned out has unfortunately resulted in it largely being used more as a recovery tool both by FCs (financial creditors) and OCs (operational creditors). Of course, promoters in many cases have used the law to their advantage to wipe out a huge chunk of liabilities at the cost of OCs and Government dues.

A mere default amount of ₹ 1 lakh was sufficient up until March 2020 in order to initiate CIRP proceedings, after which the minimum default amount was increased to ₹ 1 crore amidst announcements to reduce insolvency cases in the Covid-19 scenario. From the inception of the Code until December 2022, as many as 3,133 applications have been filed by OCs alone. This indicates that this process had become a quickfix money recovery tool for creditors, especially in cases of admitted liabilities. Moreover, in case of a slip by the CD, it resulted in initiation of insolvency and consequential challenges for the promoters.

A straitjacket mitigation formula for ensuring CD’s welfare is next to impossible as ‘default’ is well defined under the law, and thereby only some mitigation measures could be put in practice by CDs such as:

• ensuring calculated and informed expansion policies;

• raising of genuine disputes, if any, then and there with their suppliers and avoid being seen as raising disputes as an afterthought or as moonshine;

• issuing notice(s) of disputes or otherwise as per the contractual documents and the law governing the business transaction; and

• if needed resolving and settling the matter at the appropriate stage before things go out of hand and head into litigation proceedings.

Note: The aforementioned practices are only illustrative.

However, the challenge still remains when multiple creditors file cases against a single company on or around the same time. Businesses (CDs) generally do not have the financial ability to make substantial one-time payments to several creditors around the same time. At some point the CD would give up, which ultimately would also be a prejudicial scenario for OCs given that they have no say in the resolution process. Therefore, whether the IBC is being misused for recoveries continues to be a heated subject of debate. Therefore, implementing adequate measures to mitigate the escalation of exposure would be beneficial to CDs.

THE AFTERMATH UPON ADMISSION

The legal, business, and other practical consequences of admission of a CD into corporate insolvency from the promoter’s perspective need to be well understood. Once a company is admitted into insolvency, there is an immediate suspension of its Board of Directors and hence the day-to-day obligations and responsibilities of running the company shifts to the IP and the CoC, which then becomes the decision-making body. In some cases, the promoters work alongside the IPs to keep the business running, whereas in many, the tussles between them lead to a grinding halt and/or deterioration of the business.

The moratorium certainly is a benefit to the company, as it saves it from other recovery proceedings and litigations. It is important to know that supply of essential goods and services to the company is not to be terminated or suspended during the moratorium. Moreover, there have been subsequent amendments to state that any licence, permit, registration, quota and so on issued by government authorities shall not be suspended or terminated due to the said insolvency.

Further, when the IP considers the supply of certain particular goods or services to be critical to protect and preserve the value of the company and manages the operations of the said company as a going concern; such supplies shall not be terminated, suspended or interrupted during the period of moratorium except where such CD fails to make payments on such supplies during the moratorium period.

In effect, provisions in law are made in such a way that the company can pretty much be kept intact as a going concern and the entire business can be carried on while ensuring that the value proposition is not disturbed. However, on a practical basis, not all of this is followed meticulously, and each of the stakeholders tends to focus on protecting their interests alone. The promoters must keep in mind that the personal guarantees are not protected under moratorium and in fact can be proceeded against, since the notification of regulations in December 2019.

It is important that the promoters accept the implications of the above changes while functioning and also take appropriate professional advice to avoid unwarranted differences and litigation with the IP or CoC members. They need to accept that once the legal process of corporate insolvency has taken over, it is advisable to cooperate with the process in accordance with the law.

IMPORTANCE OF ENSURING COOPERATION POST ADMISSION

Even though the moratorium allows an opportunity for the company to run as a going concern with the objective that the business is unimpacted; given that the concept of corporate insolvency is relatively new and in its initial years in India, there are serious concerns relating to uncertainty amidst the management, promoters and more importantly the employees. Moreover, differences between the IP and the promoter/management are common, primarily due to non-acceptance of the insolvency proceedings by the promoters.

Many times, the employees who have been with the management for a long time are seen taking sides with the erstwhile management over the IP, who has stepped in as per the law. This is despite the legal provisions in the IBC providing for the IP to seek assistance from NCLT for non-cooperation of personnel of the CD, its promoters and other people associated with the management and so on. This leads to further deterioration of the business of the CD and clashes between these stakeholders. At the ground level, it is seen that such proceedings are time-consuming, whereby the necessary data and information sought by the IP are handed over in a delayed manner.

The underlying concern is the lack of trust, which is understandable as the management usually sees the IP as an external person, albeit a court appointed officer, and is therefore reluctant to share information with the insecurity that the said information would, at some point, be held against them. There are always exceptions when such issues of non-cooperation do not crop up, but those are far and few. In the M/s Educomp Infrastructure case, the NCLT decided that the erstwhile management of the CD shall be held responsible for non-submission of the information as well as for non-cooperation with the RP and will be liable for punishment under the penal provisions of the Code13 for misconduct during the CIRP.

It is crucial that the promoter establishes a sense of understanding, coordination and to the extent possible, trust, with the IP to mitigate these issues and avoid unwarranted face-offs and litigation. It is seen on the ground, that in cases where either the promoter or the IP takes steps towards fixing these to arrive at a common working understanding, chances of resolution or at least minimizing the deterioration of businesses are better.

PROBLEMS BETWEEN THE IP AND THE PROMOTERS – IN A NUTSHELL

On admission of a CD into insolvency, the promoters need to realize that ultimately their role has been suspended/minimized and decision-making power has shifted to CoC and the IP. For the same reason, a strained relationship with the IP would not really help the promoter or the CD. Some conventional problems that arise between the IP and promoter are:

• Non-acceptance by the promoter/management of the fact that the control over the company’s day-to-day banking and financial operations would shift to an external person that is being monitored by the CoC.

• Mismatch of expectations in roles and responsibilities and lack of awareness on part of the promoter coupled with the ideological clashes with the IP on the way the business is to be run.

• Communication gaps which tend to sour working relationships between parties.

• Reluctance on part of the promoter to let a new management/RA try and take over the business.

• Lack of trust between the IP and the promoters leading to concealment and/or non-disclosure of crucial information which delays the CIRP and also adversely affects it. Plus, the fear that the said information could be used against the promoters itself.

• Preconceived notions about either party at both ends add fuel to the fire and results in a hostile situation.

• Filing of non-cooperation applications by the IP against the erstwhile management of the CD due to the challenges faced by him or her in obtaining information including financials, whilst fulfilling their statutory duties, ultimately lands the parties before the NCLT only to make matters adversarial in nature, thereby causing delays.

Hence, seeing the adverse impact of these issues at the ground level day in and out, it is better that these two key stakeholders reach a common working ground in the larger interest of the company and work towards a positive solution rather than losing out on the time prescribed in the law amidst the litigations amongst themselves.

THE SUBTLE ART OF LETTING GO

It is understandable that it is extremely difficult for the promoters to let go of the company even if it is in a dire financially stressed situation. There are multiple cases/precedents where the promoter tried to resist the insolvency process right from the beginning all through the prescribed period, and this was amidst others an important factor leading the company into liquidation.

Since the inception of the Code, till December 2022, a total of 24,222 applications for initiation of CIRPs of CDs having underlying default of ₹ 7,69,037.12 crores were resolved before their admission. Further, the Code has rescued 2298 CDs (611 through resolution plans, 894 through appeal or review or settlement and 793 through withdrawal) till December 2022.

In this tussle, the promoter needs to take cognizance of certain harsh realities such as with every passing day:

• the business is losing some amount of its brand value, reputation.

• instead of value maximization, there is an erosion of the business.

• the chances of the promoters being able to get back their company are less unless it offers the settlement and the same is accepted by the CoC with a 90% mandate. As on 31 December 2022, as many as 793 CIRPs have been closed as withdrawn under section 12A of the Code.16

Excerpted from Defaulter’s Paradise Lost by Anant Merathia, with permission from the publisher Thomson Reuters.