By Oitihjya Sen
On November 15, the Supreme Court (SC) paved the way for ArcelorMittal to take over Essar Steel India Limited (ESIL), by upholding the resolution plan originally approved by the committee of creditors (CoC) of ESIL. The National Company Law Appellate Tribunal (NCLAT) had earlier disregarded the scheme of distribution proposed under this resolution plan by ordering, instead, for a pro-rata distribution among creditors. By setting aside this order, the SC has put an end to a long-standing question regarding the extent to which courts can interfere with the decisions taken by the creditors of a corporate debtor.
To ensure a time-bound and efficient resolution of insolvency, the Insolvency and Bankruptcy Code (IBC) 2016, as originally enacted, had envisaged a limited role for the judiciary by giving financial creditors of a financially distressed firm the responsibility to decide whether to resolve its insolvency, and the manner of such resolution. To balance the interests of operational creditors, who are not included in the decision-making process, every resolution plan was required to ensure minimum protection for operational creditors (such that they at least get the amount that would be due to them if the firm went into liquidation).
Although generally the rates of recovery for operational creditors and financial creditors under a resolution plan have been at par, in certain cases, this safeguard was found to be inadequate as the liquidation value of the claims of operational creditors would be nil or insignificant, owing to their lower rank in the liquidation waterfall under IBC. Therefore, to bring parity between the rates of recovery of financial creditors and operational creditors, the NCLAT, in one case, ruled that similarly placed creditors should be treated similarly under a resolution plan. Although not originally envisaged under the Code, this principle of ‘fair and equitable’ treatment was primarily intended to ensure that a resolution plan does not discriminate against operational creditors. However, being a principle based on equity, it was unclear what exactly constituted a fair and equitable treatment of creditors. Crucially, the NCLAT applied this principle in the resolution plan submitted by ArcelorMittal for taking over ESIL by modifying the distribution scheme of the plan in such a manner that the rate of recovery for every creditor (apart from certain small creditors) was the same.
Curiously, the IBC itself provides a higher priority to unsecured financial creditors than to unsecured operational creditors under the liquidation waterfall. By mandating that every creditor be provided an identical rate of recovery under the resolution plan, the NCLAT essentially disregarded the commercial realities underlying the different types of credit arrangements, which could seriously impact the cost and availability of credit in the economy.
Aggrieved by the order of the NCLAT, the CoC of ESIL moved the SC for reinstating the distribution scheme that was originally proposed under the resolution plan.
In the meantime, the provisions of the Code were swiftly amended to put an end to the uncertainty regarding the treatment of operational creditors under a resolution plan by increasing the minimum protection accorded to operational creditors, and expressly providing that this higher threshold would be considered as fair and equitable treatment.
Last week, the SC set aside the order of the NCLAT, holding that it would be contrary to the objective of the IBC to mandate equal treatment of all classes of creditors under a resolution plan as it would incentivise secured creditors to prefer liquidating the corporate debtor instead of resolving its insolvency. By upholding the improved protections provided to operational creditors under the recent amendments, the apex court finally laid down the precise scope of judicial review to be exercised by the adjudicating authority while approving a resolution plan. While emphasising “what to pay and how much to pay each class or sub-class of creditors” under a resolution plan is a purely commercial decision, to be taken solely by the CoC, it also laid down that the National Company Law Tribunal (NCLT) should ensure that the committee of creditors had considered the key features of the IBC while approving the resolution plan. Therefore, although the NCLT can no longer co-opt the role of the CoC by mandating how proceeds should be distributed under a plan, it has the necessary supervisory jurisdiction to ensure that the decisions of the CoC balance the interests of all stakeholders involved, and maximise the value of assets of the corporate debtor.
In practice, a resolution plan can now provide differential treatment to different classes of creditors so long as it is not contrary to the provisions and the objective of the IBC, and the plan distributes proceeds among operational creditors in accordance with the liquidation waterfall. This is indeed a welcome step as it increases the certainty of the insolvency resolution process under the IBC, and gives due primacy to the decision taken by the creditors of a corporate debtor.
However, although the scope of judicial review is now sufficiently reduced, it remains to be seen to what extent the NCLT and NCLAT would exercise their “limited judicial review” while ascertaining whether the CoC had duly considered the key objectives of the IBC while choosing a resolution plan.
Source- Financial Express.