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Stakeholders other than financial creditors – how are they protected under the insolvency and bankruptcy law?

We have already seen how the Insolvency and Bankruptcy Code, 2016 (“IBC”) distinguishes between the financial and other creditors of a corporate debtor. Apart from these creditors (some of whom may not be financial creditors), there are a few other stakeholders in the insolvency process. Let’s now look at the statutory protections for stakeholders other than the financial creditors.

Protections for other stakeholders

In the previous article, we explored the procedure for the approval of a resolution plan, and some of the questions surrounding the effect of a resolution plan and the identity of the resolution applicant. As a resolution plan needs to be approved by the committee of creditors, which comprises of only the financial creditors of the corporate debtor, the IBC and allied regulations provide for certain mandatory contents in a resolution plan for the protection of its other stakeholders.

Section 30(2) of the IBC read with Regulation 38 of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, prescribes few mandatory requirements which include the following:

  1. Payment of insolvency process resolution costs in priority to any other payments

This provision protects the expenses incurred in maintaining the corporate debtor as a going concern during the Corporate Insolvency Resolution Process (“CIRP”), without which it would be practically impossible to incentivise RPs and others to aid the CIRP. Insolvency resolution process costs include the costs of running the corporate debtor during the CIRP, the fees and expenses of the RP and its consultants, and any additional finance raised during the CIRP.

  1. Payment to operational creditors and dissenting financial creditors (in that order), in priority to other financial creditors, of an amount they would have received if the corporate debtor had been liquidated

This provision protects the interests of operational creditors (who do not sit on the creditors committee) and financial creditors that do not vote in favour of the resolution plan.

  1. Plan must not be “in contravention of law”

The contours of this requirement, and whether it can play a part in protecting other stakeholders, are yet to be filled in by judicial interpretation.

Protections for operational creditors

We have also seen previously how the amount a creditor would get if the company were to be liquidated (the “liquidation value”) is far lower than its value as a going concern. Take a company which is in the business of providing software solutions and services. Typically such a company would not own too many assets, and would rely on contracts with its customers for revenue inflow. Very little money would be realised if such a company were to be liquidated.

Since operational creditors (who are typically unsecured) are quite far down the hierarchy (other than a few such as workmen) under Section 53 of the IBC, the liquidation value due to them is often zero. Take the example of a corporate debtor whose liquidation value is Rs. 100. Rs. 80 each is owed to financial creditors and (unsecured) operational creditors, and the insolvency process costs are Rs. 20. In a liquidation, the insolvency resolution process costs would be paid out first, followed by debts due to the financial creditors, with nothing left to distribute among the operational creditors.

On the other hand, the logic behind the provision is easy to appreciate — operational creditors are in no worse a position than they would have been if the corporate debtor had been liquidated, or (quite likely) if it had been wound up under the previous Companies Act regime. It should be kept in mind however, that under that regime, operational creditors would have had a chance to persuade a court to prevent a company being wound up. The IBC on the other hand, does not permit them to prevent the initiation of a CIRP, or give them grounds to challenge a resolution plan other than for failure to meet the mandatory requirements.

Protections for homeowners

Another class of stakeholders whose concerns were brought to the fore were homeowners in the CIRP of Jaypee Infratech Limited, who had paid advances to the corporate debtor but had not been allotted the flats due to them. As discussed in a previous article, the homeowners were classified as neither operational nor financial creditors by the NCLT and the NCLAT, leaving their status uncertain. Partly as a reaction to this particular case, it was made mandatory for a resolution plan to include a statement as to how it has dealt with the interests of all stakeholders. While this addition does not provide much tangible protection, it introduces transparency regarding the treatment of various stakeholders, and may result in “soft” pressure on resolution applicants to attempt to address the concerns of all stakeholders.

As can be seen, there are still grounds for concern on how the provisions of the IBC can protect the interests of non-financial stakeholders. The hope is that in time, such concerns can be addressed through legislative amendment or judicial interpretation.

 

Uday Khare is a Partner at Cyril Amarchand Mangaldas.

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