India Economy

Less wiggle room for promoters

RAKESH NANGIA NEHA MALHOTRA | Updated on January 11, 2018 Published on July 30, 2017

The Insolvency and Bankruptcy Code has the required legal weaponry

Corporate ownership in India is predominantly concentrated in the hands of domestic individuals and promoter groups or the State. Such presence of owner-managers is a situation unique to developing economies such as India.

The promoters are used to having complete control over the operations of the corporate since, till the advent of the Insolvency and Bankruptcy Code, 2016 (Code), the law on Insolvency resolution was spread over a plethora of legislation and was primarily “creditor in possession”.

The promoters and board of directors hoped that they would find means and ways of playing around with this new law on Insolvency i.e. the Code.

Under the Code, primarily the “debtor is in possession” and when the promoters and board are required to step back and give the driving seat to the Insolvency Professional, they are either resisting or finding ways of staying close to the operations of the company during Insolvency Proceedings.

To ensure that the management of the company remains in their hands, they are adding executive roles to their profiles, just before the insolvency proceedings are triggered, when the board of directors would formally stand suspended.

Foreseeing the practical challenges that will arise when promoters are asked to step aside, the required legal weaponry has been put in place under the Code in a fairly robust and clear form.

Where the boards and promoters refuse to hand over possession or resist the exercise of powers by Insolvency Professionals, NCLT has the powers to step in.

Tricky role

The Insolvency Professional has to play a tricky role here, by avoiding any conflict of interest that can arise owing to such change in roles of the board and at the same time ensuring that the management supports his duty of maintaining the going concern of the corporate.

Moreover, under SICA, an automatic stay operated against all kind of recovery and distress proceedings against all creditors upon registration of reference filed by the company.

This led to the BIFR becoming a haven for defaulting companies who misused SICA to seek protection and moratorium from recovery proceedings.

This problem arose due to the fact that unscrupulous promoters entered into the process of rehabilitation by manipulating sickness; taking undue benefits arising out of delay in the decision making of BIFR.

If the reference was rejected, a fresh reference was filed with respect to accounts for the next year and the cycle went on endlessly. There was no fear of reprisal or punitive action against the companies indulging in this malpractice.

Clear directives

However, under the Code, moratorium has been provided with an intent to maximise the value of the entity to continue its operations even as its viability is being assessed. Ensuring that there is no additional stress on the business after public announcement of its insolvency resolution process initiation, the order for moratorium imposes a stay not just on debt recovery actions, but also on any claims from old lawsuits, or on new lawsuits, for any manner of recovery from the entity. Accustomed to malpractice under the erstwhile regime, unscrupulous promoters thought they would find ways and means to misuse the moratorium provided under the Code. However, the NCLT has very finely drawn the line that the stay is in respect of recovery action against the assets of the Debtor and not the assets pledged as collateral for the corporate loan.

It was observed that since the petition for insolvency was filed with a malafide intention to thwart the actions taken so far for recovery of the outstanding debt, NCLT refused to come to the rescue of the Promoters.

Success of any law is only as good as its implementation. The Code, being new legislation, needs conviction from the Indian courts to prove that this is a real deal and defaulters better pull up their socks to witness strict action.

In recent rulings of the Indian courts, we have witnessed them nipping in the bud issues that could have led to loss of time, which is the essence of this legislation.

These landmark rulings shall decide the fate of the promoters under the Code. Wealthy promoters thought that their personal assets would be safe during the moratorium for 180 (or for additional 90 days).

This could be one of the reasons for a company filing for its own insolvency, hoping to get a fresh lease of life by obtaining a stay on recovery proceedings of its personal assets pledged as collateral for the corporate loan.

However, the Mumbai Bench of NCLT ruled that the creditor can continue or even initiate recovery by sale of such personal assets of the promoter, since the moratorium is applicable only on the assets of the company.

Though these strict rulings are being delivered to lay principles for the scrupulous minds, it must not be forgotten that for stressed companies, the factors causing the stress are at times beyond the control of the promoters.

Hoping for a timely and efficacious resolution of stressed assets and turnaround of companies that are viable, we shall witness new principles being laid by NCLT as the Code evolves.

Rakesh Nangia is Managing Partner and Neha Malhotra, Executive Director, Nangia & Co LLP

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