Currently, applications to begin a corporate bankruptcy resolution procedure must first persuade the Tribunal that the petitioner is a “Financial Creditor” or an “Operational Creditor” under the Insolvency and Bankruptcy Code, 2016. A financial creditor and an operational creditor are two essential components of the insolvency procedure under the IBC, 2016.

The Code 2016 distinguishes between financial and operational creditors. Financial creditors are those who have a strictly financial contract with the company, such as a loan or debt security. Operational creditors are those that owe the firm money as a result of a business transaction.

The IBC, which had been much anticipated, received the President’s approval on May 28, 2016. Section 3 (10) of the Code defines the term “creditor” as “any person to whom a debt is due, including a financial creditor, an operational creditor, a secured creditor, an unprotected creditor, and a statutory instrument;”

What Is Financial Creditor

“A person who owes a financial obligation, including anybody to whom such debt has been legitimately assigned or transferred,” according to Section 5(7) of the Insolvency and Bankruptcy Code.

The debt owing to a person must meet the definition of a “Financial Debt” as defined by Section 5(8) of the IBC to establish if that person is a financial creditor.

A “Financial Debt” is defined as follows in section 5(8) of the IBC: – “A debt that is disbursed in consideration for the time value of money, including any interest, and includes:-

1. Money that has been borrowed and will be returned with interest;
2. Any amount raised by the acceptance of a credit card or its dematerialized equivalent;
3. Any money raised through a note purchase facility or by the issuing of bonds, notes, debentures, loan stock, or other similar instruments;
4. The total amount of any liability deriving from a lease or hire purchase arrangement categorised as a finance or capital lease under The Indian Accounting Standards or other accounting standards as stated;
5. Other than non-recourse receivables sold, a receivable sold or reduced
6. Any amount raised by any other transaction, including any forward sale/purchase agreement, with the commercial impact of borrowing;
7. Any counter-indemnity obligation created by a bank or financial institution’s guarantee, indemnity, bond, recorded letter of credit, or other instruments;
8. The amount of any obligations arising from any of the guarantees or indemnities for any of the items listed in subclauses (a) through (h).”

What is Operational Creditor

“Anybody who owes an operational obligation, including anyone to whom such liability has been legally assigned or transferred,” according to section 5(20) of the IBC.

The debt owing to a person must fulfil the definition of an operational debt as defined in Section 5(21) of the Insolvency and Bankruptcy Code to determine if that person is an operational creditor.

“Operational Debt” is defined as “a claim for the delivery of goods or services, as well as employment, or a debt for the repayment of dues originating under any legislation presently in existence and payable to the Central Government, any State, or any regional government” under Section 5(21) of the IBC.

Significant differences between financial Creditor and Operational Creditor

• Someone who owes a financial debt is referred to as a financial creditor, but someone who owes an operational debt is referred to as an operational creditor.
• Debt to financial creditors refers to a debt that is distributed against the consideration for the time value of money, whereas debt to operational creditors refers to a demand for the supply of products and services in exchange for the repayment of government dues.
• In the event of a default, a financial creditor may collectively or separately with other lenders file an application for the onset of arbitration proceedings against a corporate debtor before an adjudicating officer, while an operational creditor may deliver a demand notice of unpaid operational debtor copy for invoice requesting payment of the amount involved in the default. The operational creditor may submit an application at a later date.
• A financial creditor may include the name of a suggested resolution professional in the application for an interim resolution professional appointment, but an operational creditor must recommend a resolution professional for an interim resolution professional appointment.
• Only financial creditors and corporate debt creditors will be represented on the creditor’s committee. Members of the creditor’s committee will not be operational creditors. The operational creditors do not have a vote at the meetings of the committee of creditors.

Let us briefly describe the key differences between Financial creditors and Operational Creditors.

Financial Creditor Are Prioritised

Financial creditors are given higher priority since they are members of the creditor’s committee and have voting power, whereas operational creditors are not members of the creditor’s committee. The underlying issue is that some categories of operational creditors are subjected to discrimination since the statute’s provisions protect the rights and interests of Financial Creditors. This is reinforced by the fact that when the application is submitted by operational creditors, the respective class has no authority to make any proposals during the creditor’s meeting held.

Should operational creditors be treated the same as financial creditors?

In its report dated November 4, 2015, the Bankruptcy Law Review Committee stated that OCs will not risk their dues in exchange for the potentially bright future of the corporate debtor and concluded that the CoC should consist only of financial creditors to carry out the insolvency resolution process more effectively. The theory underlying this viewpoint was that operational creditors would be more interested in the liquidation of the corporate debtor rather than the resurrection of the firm, which would eventually contradict the primary goal of the IBC.

Insolvency law in the United States distinguishes between secured and unsecured creditors. Both groups of creditors, however, have the opportunity to vote on or reject any plan that reduces their claims. Under Chapter 11 of the United States Bankruptcy Code, an unsecured creditors committee is created to guarantee that the rights of such creditors are fairly represented.

Excluding operational creditors from the IBC Committee of Creditors and stripping them of decision-making rights is thus not only contrary to existing bankruptcy rules, but also irrational.

In the recent past, a relatively high number of judicial decisions on the status of operational creditors have been made public. The Supreme Court decided in the case of Swiss Ribbons Pvt. Ltd. and Others v. Union of India that intelligible differentia came into play while differentiating between operational creditors and financial creditors. As a result, this is not discriminatory as defined by Article 14 of the Indian Constitution. The categorization is warranted since the sorts of loans given by these two categories of creditors differ. It was also indicated in this decision that a loan from a financial creditor is to contain a bigger amount of money and a defined payback plan, which caused them to become involved in the reconstruction of the aforementioned loan.

In the case of Akshay Jhunjhunwala and others v. Union of India, through the Ministry of Corporate Affairs and others, this difference was also upheld. The Supreme Court ruled that the separation created between financial creditors and operational creditors did not violate any constitutional requirement. Equitable treatment of operating creditors was favoured above equitable treatment in the case of Maharashtra Seamless Ltd. v. Padmanabhan Venkatesh and others.

Some rulings, such as the Binani Industries Ltd. v. Bank of Baroda case, demonstrated inconsistency with the preceding cases and stated their claims for fair treatment for all creditors. This was a one-of-a-kind ruling that outlined the operational creditor’s interests but omitted to name the operational creditor in the CoC. Some of the decisions in this ruling were based on the Essar Steel Case.

Hon’ble NCLT on the Status of Operational Creditor

According to the Bankruptcy Law Reforms Committee in Paragraph 5.2.1 of its final report, a financial creditor is a person whose connection with the entity is entirely connected to financial transactions, such as a loan or debt security. An operational creditor, on the other hand, is an individual whose liabilities to the company take the form of future payments in exchange for already delivered items or services.

The IBC also provides for circumstances in which a creditor has participated in both a financial and an operational transaction with the firm, according to the research. In such cases, the creditor may be divided into two categories: financial creditors for the amount of the financial debt and operational creditors for the amount of the operational debt.

The National Company Law Tribunal decided in the matter of Col. Vinod Awasthy vs. AMR Infrastructure Limited (C.P. No. (IB) 10 (PB)/2017) that operational creditors are those whose obligation from the firm comes from a transaction on operations. As a result, an operational creditor is a wholesale supplier of replacement parts whose spark plugs are kept in stock by auto mechanics and who is paid only when the spark plugs are sold.

Similarly, the lessor from whom the firm leases space is an operational creditor to whom the company pays monthly rent throughout the duration of a three-year lease arrangement. The Hon’ble Tribunal further decided that the Petitioner had not supplied any goods or rendered any services in order to be classified as an ‘Operational Creditor.’

As a result of the above, it is obvious that Tribunals are unwilling to entertain petitions from anybody who does not fulfil the IBC’s standards for financial and operational creditors. This need must be satisfied in order to initiate business insolvency proceedings under the IBC. The NCLT has made it feasible to severely enforce the new insolvency and bankruptcy legislation.

Conclusion

Efficaciously introduce a corporate insolvency resolution process against a debtor, it is necessary to prove that the creditor falls within the scope and extent of the definitions of ‘Financial Creditor’ as defined in Section 5(7) of the IBC or ‘Operational Creditor’ as defined in Section 5(20) of the IBC. As per the case study, the Tribunals are strict in their interpretation of the phrase “Operational Creditor” under the IBC, refusing to accept petitions when the petitioners do not technically fall within the scope of the IBC and have alternative valid remedies available.

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Introduction

Prevention of Money Laundering Act

The term money laundering means illegally obtained money transferred from foreign banks or illegitimate businesses. Money laundering beyond a certain level is a crime in India. When a person tries to generate profit from an individual or a group in a large amount the crime occurs. Few popular activities through which the processes of money laundering occur are illegal arms sales, smuggling. Other organized crimes like drug trafficking and prostitution rings, Embezzlement, insider trading, bribery, and computer fraud schemes are also part of the money laundering.  This kind of money is called  ‘dirty money’ and the process of converting dirty money into legal money is called money laundering.

The objective behind introducing this act was:- 

1. To stop channelising illegal money into different activities.
2. Seizure of the property derived from money-laundering.
3. Money laundering vis-à-vis and the conveyance of funds. However, earning money or acquiring any property by committing a crime does not amount to money laundering, but it may amount to conveying funds. Acquiring any property by committing a crime which is a Scheduled offense, and holding or possessing such money or property comes under money laundering.

Insolvency and Bankruptcy Code of India

Need of the Law:

• To merge and amend the laws relating to insolvency resolution of corporate persons, partnership firms, and individuals.
• To work in time to maximize the assets value of an insolvent person.
• To motivate enterprise ship, credit availability and balance interests of all stakeholders.
• To construct the Insolvency and Bankruptcy Board of India and related matters the Insolvency and Bankruptcy Code 2016 was introduced.

When matters are related to insolvency and liquidation of corporate debtors, the minimum amount of default is 1 lakh. But the minimum amount of default could be higher if the Central Government thinks fit, but it could not be more than 1 cr rupees. Though, this code does not apply to corporate persons who are regulated under financial service providers like Banks, financial institutions, and insurance companies.

 When assets are not sufficient to meet the liabilities that is called insolvency. Insolvency will lead to bankruptcy for non corporates and liquidation of corporates if unprocessed. The term insolvency is used for both individuals and organizations. Bankruptcy is termed for individuals and for corporate it is called corporate insolvency. The insolvency and bankruptcy code was passed by both the Houses of Parliament and notified in 2016. While insolvency is a situation that arises due to the inability to pay off the debts due to insufficient assets, bankruptcy is a situation wherein an application is made to an authority declaring insolvency and seeking to be declared as bankrupt. A bankrupt would be a conclusive insolvent whereas all insolvencies will not lead to bankruptcies. It has 2 options – resolution and recovery or liquidation. Bankruptcy is a legal proceeding involving a person or business that is unable to repay outstanding debts. The bankruptcy process begins with the petition filed by the debtor or by the creditors. All the debtor’s assets are measured and evaluated and the assets may be used to repay a portion of outstanding debt.

 This code is applicable for insolvency, liquidation, voluntary liquidation, or bankruptcy of

1. Any company incorporated under companies act 2013 or under previous acts 
2. Any other company governed by any special act 
3. Any LLP under LLP act 2008 
4. Any other body incorporated under the law as regulated by the government.

The administrative mechanism is governed by 5 pillars namely:

1. Insolvency and bankruptcy board of India
2. Insolvency professional agent
3. Insolvency professionals
4. Information utilities
5. Adjudicating authority.

Under the code, the most important section is liquidation which is described under sections 33 to 54 as the process of liquidation. Voluntary liquidation governed by section 59 says the voluntary liquidation process is the step by step distribution of assets under section 53 which is different from section 326 and 327 of the Companies Act 2013 and fast track insolvency resolution process under section 55.

1. Who can initiate the process?

Prevention of money laundering

Authorities Entrusted for Investigation:

The Government of India is responsible for investigating the offenses of money laundering under the PMLA and the Department of Revenue in the Ministry of Finance Enforcement Directorate.

Financial Intelligence Unit – India (FIU-IND) –  The Department of Revenue, Ministry of Finance report directly to the Economic Intelligence Council (EIC) which is headed by the Finance Minister. The central national agency is responsible for receiving, processing, analysing, and disseminating the information relating to suspect financial transactions.

Other responsibilities:-

1. National and international intelligence are built up and collaborated.
2. Investigation of money laundering and related crimes globally.
3. The scheduled offenses are separately investigated by respective agencies under respective acts, for example, the local police, CBI, customs departments, SEBI, or any other investigative agency.

A focal role is played by banks and financial institutions in the world of financial crime. They are properly trained on the method to identify and handle money laundering. Almost every bank employee receives training in anti-money laundering, and all financial institutions and banks are legally required to report any suspicious activity. With the help of technology such as special compliance platforms, companies are now able to easily research their customers and ensure that they are not doing business with criminals.

IBC India

People who can initiate corporate insolvency process under the code:- 

Any corporate debtor who committed a default, a financial creditor, an operational creditor, or the corporate debtors can start off the corporate insolvency resolution process.

People not eligible to make an application under the code:- 

a corporate debtor or a financial creditor

(a) who is going through a corporate insolvency resolution process; or

(b) who  has completed corporate insolvency resolution process twelve months prior to the date of application; or

(c) one who violated any of the terms of resolution plan which was approved twelve months before the date of an application; or

(d) who has a liquidation order. 

2. Application on the basis of Monetary limitation 

Prevention of Money Laundering

This act applies the as per the current Prevention of Money Laundering Act (PMLA) rules, which states that reporting is in all cash transactions which values more than  Rs 1 million more than Rs 5000000 in case of all cross-border wire transfer and Rs 5 million or more in case of purchase and sale of immovable property.

Insolvency and bankruptcy code

This act applies when the minimum amount of the default in the matter relating to insolvency and liquidation is one lakh rupees ( though the figures of maximum limit could change as per notification by Central Government but could not be more than 1 cr rupees). 

3. Agencies involved

Prevention of Money Laundering

The Directorate of Enforcement in the Department of Revenue, Ministry of Finance is responsible for investigating the cases of offense of money laundering under the Prevention of Money Laundering Act, 2002. Financial Intelligence Unit – India (FIU-IND) under the Department of Revenue, Ministry of Finance is the central national agency responsible for receiving, processing, analyzing, and disseminating information relating to suspect financial transactions to enforcement agencies and foreign FIUs.

IBC India

The regulatory mechanism consists of five pillars namely 

1. Insolvency and Bankruptcy Board of India
2. Insolvency Professional Agencies
3. Insolvency Professionals
4. Information Utilities
5. Adjudicating Authority

Insolvency and Bankruptcy Board of India provides for the establishment of a Regulator who will oversee all the entities and perform legislative executive and quasi judicial functions with respect to the Insolvency professionals, Insolvency Professional Agencies, and Information Utilities. The Insolvency and Bankruptcy Board of India was established on October 1, 2016. The head office of the Board is located in New Delhi.

The board is a body corporate having perpetual succession and a common seal with power, subject to the provision of this code to acquire, hold and dispose of property both movable and immovable and to contract and shall be the said name sue or be sued.

Composition of the Board

1. A chairperson
2. Three members amongst the officers of the central government not below the rank of joint secretary or equivalent one each to represent the Ministry of Finance, Ministry of Corporate Affairs and Ministry of Law, ex officio
3. One member to be nominated by the Reserve Bank of India, ex officio
4. Five other members to be nominated by the Central Government of whom at least three shall be whole time members.

Insolvency Professional Agencies

The Code provides for the establishment of insolvency professionals agencies to enroll and regulate insolvency professionals as its members in accordance with the insolvency and bankruptcy code 2016 and regulations as mentioned in it.

The code provides for insolvency professionals as intermediates who play a key role in the efficient working of the bankruptcy process. The role of the Insolvency Professional encompasses a wide range of functions which include adhering to the procedure of the law, as well as accounting and financing related functions. He has the power and responsibility to monitor and manage the operations and assets of the enterprise. In the insolvency resolution process, the Insolvency Professional verifies the claims of the creditors, constitutes a creditors committee, runs the debtor’s business during the moratorium period, and helps the creditors in reacting to a consensus for a revival plan. In liquidation, the insolvency professional acts as a liquidation and bankruptcy trustee.

4. Process (application/ process of occurrence of crime respectively)

Prevention of Money Laundering

Following three steps involved in the process of Money Laundering

(a) Placement:- The Money Launderer, The person who is

holding the money obtained from illegal activities, involves the illegal funds into the financial systems. This is usually done by breaking up a large amount of cash into less conspicuous smaller sums which are deposited directly into a Bank Account or purchase of a series of instruments such as Cheques, Bank Drafts, etc., which are then collected and deposited into one or more accounts at another location.

(b) Layering:- The second stage of Money Laundering is layering. In this stage, the Money Launderer typically engages in a series of continuous conversions or movements of funds,

within the financial or banking system by way of numerous accounts, so as to hide their true origin and to distance them from their criminal source. The Money Launderer may use various channels for the movement of funds, as a series of Bank.

Accounts, sometimes spread across the globe, especially in those jurisdictions which do not co–operate in anti Money Laundering investigations.

(c) Integration:-after completion of these  two procedures successfully the money launderer creates criminal profits through

Money Laundering, he then moves to this third stage by reaching the funds in legitimate economy, after getting inseparably mixed with the legitimate money earned through legal sources of income. The Money Launderer might then choose to invest the funds into real estate, business ventures & luxury assets, etc.

IBC India

Step by step resolution process by a company

If a default occurred,

1. a financial creditor by himself or jointly with other financial creditors or any other person on behalf to the Adjudicating Authority for starting off the corporate insolvency resolution process against a corporate debtor before the Adjudicating Authority.

2. an operational creditor can deliver a demand notice of an unpaid operational debtor to a copy of the invoice, demanding payment of the amount which is involved in the default to the corporate debtor.

3. a corporate applicant can file an application to the Adjudicating Authority for starting off the corporate insolvency resolution process against a corporate debtor before the Adjudicating Authority.

The default here include financial debt owed by applicant’s financial creditor as well as the financial creditor of the corporate debtor.

The financial creditor should make the application in manner and fees as mentioned by the Authority.

The financial creditor along with the application needs to file

1. a record of recorded default with an affidavit or information utility or any such similar record or evidence of default.
2. name of resolution professional who will act as interim resolution professional.
3. any other information needed by the Board.

The Adjudicating Authority finds the existence of a default from information utility or the evidence furnished by the creditor within 14 days of receipt of such application.

If it is found that the Adjudicating Authority finds out the default occurred and the application is complete and disciplinary proceedings are not pending against any resolution, professionals will accept the application by order only. If the application is accepted the Adjudicating Authority will inform the financial creditor and corporate debtor.

If there is no occurrence of a default or the application is incomplete and there are pending disciplinary proceedings against any resolution, professionals will reject the application by order by the Adjudicating Authority. Within 7 days from the date of receiving such application, a notice will be given to the applicant to rectify the mistakes in the application if any default is found and the Adjudicating Authority decides to reject it and should inform the financial creditor within 7days of such rejection.

An operational creditor can give a demand notice of an unpaid operational debtor to a copy of the invoice by demanding payment of the amount which is involved in the default to the corporate debtor.

The  Corporate debtor will bring the notice to the operational creditor about the existing dispute, a record of pending suit, or an arbitration proceeding if there is any which was filed before such notice or invoice in relation of such dispute was receipt Within 10 days of receiving of such demand notice or copy invoice or the corporate debtor can repay the unpaid amount along with an attested copy of the record of electronic transfer of the unpaid amount from the bank account of the corporate debtor or an attested copy of the record which has been encashed by the operational creditor from a cheque issued by the corporate debtor.

The aggrieved person can file an application to the Adjudicating Authority along with the prescribed fees by the if the corporate debtor does not respond in any of the way mentioned and 10 days expired from the date of delivery of notice or invoice, demanding payment and the operational creditor did not receive a payment from the debtor or any notice about the dispute as mentioned.

The creditor along with the application needs to furnish

1. a copy of the demanding payment invoice or demand notice delivered by the creditor, 
2. an affidavit that will mention that no notice was given by the corporate debtor relating to the unpaid dispute.
3. a certified copy from financial institutions which will mention the accounting of the operational creditor displaying that no payment of the unpaid amount of operational debt was done by the corporate debtor.
4. information utility copy (any) confirming there is no payment of unpaid operational debt/ any other proof relating to the payment of an unpaid amount by the debtor.

Time limits 

The corporate insolvency resolution process needs to be completed within 180 days which is calculated from the insolvency commencement date. But the resolution professional can file an application to extend the period of fast-track insolvency resolution process beyond 180 days to the Adjudicating Authority only if a resolution is passed in a meeting of the committee of creditors and sixty six percent of the voting share is in favour of such instructions.

If The Adjudicating Authority after receiving such an application is satisfied that the fast track resolution process cannot be completed within 180 days it can extend the time period more than 180 days by order but that period can not be extended beyond 90 days and such extension can not be granted more than once.

A corporate debtor

1. with assets and income below a level  by as the Central Government will notify or
2. class of creditors or  amount of debt as  the Central Government will notify or
3. other categories of corporate persons as mentioned by the Central Govt.

Creditors can also file for a fast track insolvency resolution process which needs to be completed within 90 days which is calculated from the insolvency commencement date. But the resolution professional can file an application to extend the period of fast-track insolvency resolution process beyond 90 days to the Adjudicating Authority only if a resolution is passed in a meeting of the committee of creditors and seventy five percent of the voting share is in favour of such instructions.

If The Adjudicating Authority after receiving such an application is satisfied that the fast track resolution process cannot be completed within 90 days it can extend the time period more than 90 days by order but that period can not be extended beyond 45 days and such extension can not be granted more than once.

5. Penalties

Prevention of Money Laundering

As per Section 4 of PMLA Imprisonment of not less than three years, but which may extend to 7 years/10 years, and shall also be liable to fine. In cases where the offenses are under Narcotic Drugs and Psychotropic Substances Act, 1985 are punishable with rigorous imprisonment up to 10 years. The fine under PMLA is without any limit and the same may be commensurate to the nature and extent of the offense committed and the money laundering.

As Section 19 of PMLA, the appropriate authority under the Act has the power to arrest any person when the authority on the basis of the material in his possession has reason to believe that such person has been guilty of any offense punishable under PMLA. After the arrest, the person arrested has to be informed about the grounds for his arrest. It is also required that the person so arrested shall, within 24 hours, be produced before the Judicial Magistrate or a Metropolitan Magistrate, as the case may be, having jurisdiction.

IBC India

Penalties under the IBC code have differents heads with respect to different persons by an officer of the corporate debtor or the corporate debtor.

Crimes as mentioned under different sections of the code more or less varies from minimum 3 years of imprisonment to maximum 5 years and/or fine varies from 1 lakh to 1 cr in some cases it is 3 lakhs or both related to crimes committed.

Crimes as mentioned under different sections of the code more or less varies from 6 months to below or fine of 5 lakhs or both it could be more as per the code.

Any person on whom the resolution plan is binding

Imprisonment of 3 years to 5 years or 1 year to 5 years as the case may be or/ and fine of 1 lakh to 1 cr or both on the basis of crime. 

Creditors or operational creditor

Imprisonment of  1 year to 5 years or/ and fine of 1 lakh to 1 cr or both on the basis of crime.

Bankrupt

• The imprisonment varies from 6 months to 1 year. Somewhere it is 3 years/ 2 years also and/ or fine of 5 lakhs or both on the basis of crime and the relevant section applied.

Conclusion

Both the acts deal with totally different aspects by both the acts concentrate on the betterment of India and its citizens. Both the acts also prevent and reduce the crime rate in India. Understanding both the process and crime before doing any activity related to money or insolvency is a long and complex process and to avoid penalty, punishment, and time loss or wrong files a creditor/ debtor or any other individual needs to seek proper legal consultation. A consulting firm can provide one experienced insolvency advocate, Advocates, CA, CS, CMA, Resolution Professional or the interim resolution professional, and other legal help under one roof.

The post DIFFERENCE BETWEEN PREVENTION OF MONEY LAUNDERING ACT AND IBC 2016 appeared first on MUDS.

In its objective to usher ineffective economic reforms, the government passed the Insolvency and Bankruptcy Code, 2016 (IBC). This was hailed as a positive step by all stakeholders as it shifted the focus from ‘debtor in possession’ to the much needed ‘creditor in control’ when dealing with debts, defaults and financial failures of Corporates.

IBC 2016 is a comprehensive Act that has helped in doing away with all overlapping regulations that were put to practice previously, like Sick Industrial Companies, 1985 and the Companies Act, 2013, etc. The implementation of the IBC Code has established a robust market mechanism leading to timely and time-bound resolution of corporates in distress.

In its short journey of 3 years, IBC 2016 has turned out to be on the right track as it has churned out the recovery of Rs 70,000 crore in the current fiscal year, thus, leaving a remarkable impact on the corporate ecosystem.

Dire need for Group Insolvency regulations!

There is no doubt that IBC 2016 has provided a well founded platform that has smoothened corporate insolvency but in recent years a dire need has arisen to create a holistic group insolvency framework.

Market data by Credit Suisse brings to light that a considerable percentage of Indian businesses are designed as closely connected group organizations, but operate as a single economic unit. While these companies mostly function as a legal independent entity yet their interdependence exists in matters like common proprietors, common directors, common controls and shared assets, inter-corporate loans etc.

“The interlinkages of these individual units largely work well for the group as a whole but the real problem arises when some of them become insolvent.” Kritika Chabbra (Market Analyst, MUDS Management Pvt. Ltd.)

Right now IBC 2016 lacks a consolidated mechanism to deal with insolvency of associate or subsidiary companies of a group as one. There have been many instances where many companies of the same group have committed a default and eventually, had to be consolidated into one proceeding by the Courts and Adjudicating authorities.

The trigger points!

These are some companies which have given ample reason for the need of a holistic regulation as regards to insolvency of groups.

1. SBI v. Videocon: Recently, the adjudicating authority under the IBC, Hon’ble National Company Law Tribunal (NCLT) Mumbai Bench pronounced order of consolidation of the liabilities and assets of 13 group entities of Videocon.

2. Edelweiss ARC v. Sachet Infrastructure: In this instance, the adjudicating authority has mandated that all the 5 companies, which were working as a consortium and promised to develop a residential plotted colony, shall be treated as one. The court has appointed a single Resolution Professional who will work on a common resolution plan for all the individual entities of this group.

3. Corporation Bank v. Amtek Auto Limited: In a similar instance, independent companies of Amtek group like Metalyst Forgings Limited, Castex Technologies Limited, ARGL Limited, all were clubbed together by the adjudicating authority.

Apart from these there are hundreds of groups of companies like Lanco, Amrapali, Jaypee, Infrastructure Leasing & Financial Services Limited, etc. which are facing group insolvency.

Framing of Working Group on Group Insolvency

In order to overcome these flaws which caused immense practical problems, the Insolvency and Bankruptcy Board of India decided to take some concrete steps to streamline coordinated and synchronized group insolvency.

The first step in this direction by the Bankruptcy Board of India was to constitute a Working Group on Group Insolvency vide office order No. IBBI/CIRP/GI/2018-19/001 dated 17th January 2019.

This Working Group comprising of 11 eminent members working under the able guidance of the Chairmanship of former SEBI chief UK Sinha, submitted ‘Report of the Working Group on Group Insolvency’ on September 23, 2019. 

“The Working Group has presented a blue-print of the group insolvency framework that has been based on extensive consultations with all stakeholders and domain experts.”- Isha Malik (Company Secretary, MUDS Management Pvt. Ltd.)

Salient Points of Working Group on Group Insolvency

In the letter presented along with the submission of the Report presented by the Working Group, UK Sinha, the Chairman of the group stated, “The thrust of the framework is ‘facilitation’, ‘flexibility’ and ‘choice’. It envisages an enabling group insolvency framework, to be implemented in a phased manner. The first phase may facilitate procedural coordination of only companies in domestic groups. Cross-border group insolvency and substantive consolidation could be considered at a later stage, depending on the experience of implementing the earlier phases of the framework, and the felt need at the relevant time.”

The key recommendation of the Working Group touches on all important aspects of insolvency and liquidation of a corporate group.

1)  Identifying the Group: The Working Group has proposed identification of ‘Group’ based on three factors:

1. Firstly, it is important to establish the mutual relationship shared by the companies; identifying them as per the Companies Act, 2013 whether the company is a holding, subsidiary or associate company of a group.
2. Secondly, the company should fall under the category of fulfillment of commencement standard, i.e., it must have committed a ‘default’ as defined under section 3(12) of the IBC Code, 2016. This is a mandatory clause as the Working Group has recommended only insolvent companies to be taken into consideration for the purpose of group insolvency 
3. Thirdly, it is essential to establish that the company in question is a domestic company as groups having overseas ventures are not included in the first phase of the recommendations of the Working Group.

Thus, the Working Group’s recommendation lays stress on two basic ingredients:

• Ownership
• Control

2) Scope of Grouping: WG has set down three rules that will guide the group insolvency mechanism.

(i) Procedural Coordination Mechanisms (PCM):  A set of rules that will work towards coordinating the ‘procedures’ of insolvency but at the same time keeping the assets of each group company separate.

(ii) Substantive Consolidation Mechanism (SCM):  This refers to consolidation of assets and liabilities of different group companies for the purpose of reorganization or distribution in liquidation, in case of being treated as a part of a single insolvency estate.

(iii) Rules dealing with perverse behavior of Companies: This lays down rules for corporate groups, enabling the creation of mechanisms to recapture assets subject to prejudicial transactions between group members, additionally impose liability on group companies for each other’s debts, etc.

The Working Group has recommended the implementation of PCM in the first phase.

3) Mechanism involving Grouping: Elaborating on the procedural coordination mechanisms, WG recommends that there should be flexibility in applying these mechanisms and should not be initiated in those cases where they don’t help maximise value of assets or lower costs of proceedings.

Further, it recommends that in the cases where it is implemented the Insolvency Professionals, CoCs and Adjudicating Authorities should cooperate, communicate and share information with each other, ensuring benefits like:

• Reducing the time taken in proceedings,
• Lowering costs by not duplicating efforts to collect information, and
• Promoting information symmetry.

Thus, these steps need to be followed for Group insolvency:

1. Joint Application: By making a joint application, the applicants shall be saving on the expenses of multiple applications.
2. Common Adjudicating Authority (AA): Continuing with its efforts to save time, money and efforts, the Working Group recommends one Adjudicating Authority. This can be taken up by the AA who has admitted the first application to commence the CIRP of any company in a group.
3. Common Insolvency Professional: Going ahead in the same direction, the Working Group recommends that the adjudicating authority should appoint a single insolvency professional for group insolvency.
4. Group Committee of Creditors: Working Group states that formation of group creditors’ committee will undoubtedly result in a coordinated negotiation yet, the decision must be left at the discretion of Committee of Creditors of each company.

4) Framework Agreement: The Working Group recommends a Framework Agreement for the group coordination proceedings and it shall have approval of the CoC of each participating company.

The Framework Agreement should include:

• Group Coordinator
• Opt-Out Option
• Common Resolution Plan
• Adjudicating Authority
• In case of liquidation

5) Timeframe: The Working Group has recommended that the entire resolution process shall not exceed 420 days; this is inclusive of additional extension of period up to 90 days.

Conclusion

This move, undoubtedly, will channelize the intricacies of Group Insolvency and assist the Bankruptcy Board to tackle Group Insolvency effectively and efficiently. When the recommendations of the report submitted shall be adopted and implemented, it will ensure immense benefits for all stakeholders: saving time, money and efforts.

The Working Group has recommended the implementation of group insolvency in a phased manner; this will help in understanding and decoding the various aspects better. With time the gaps or flaws will be evident and then they can be worked upon to streamline the entire process. A cautious yet progressive approach, as suggested by the Working Group, will help the Bankruptcy Board in framing an effective regulation for Group Insolvency.

“The necessity of a synchronized and coordinated regulation for Group Insolvency has been felt essential at numerous times by different agencies, and thus, framing concrete rules for a smooth resolution is a very welcome move.”
-Shweta Gupta, Founder and CEO, MUDS

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It is a well-known fact that civil recovery matters often take a long time to decide. Due to low recoverability, the trade displays a low credit discipline. This has stirred businesses as it often creates large working capital requirement and hence more emphasis on margins.

There was a choice to begin winding up petitions before High Courts under earlier Companies Act, 1956. The prohibitive cost of litigation often acted as a dampener for the Creditors actions. The fact is that the petition (in the case admitted) would lead to liquidation through the office of Official Liquidator and rest depends upon the Company, the matter used to stretch for two to three years during which the corporate debtor (company) would remain in control of the same management.

There has been a major shift in the Insolvency & Bankruptcy Code 2016 (IBC), and now an operational creditor can initiate action under IBC for recovery of its dues as per a very cost-effective manner.

Operational Creditor

Section 5(20) of the Insolvency and Bankruptcy Act, 2016, defines a person to whom an operational debt is owed as an “Operational Creditor” and it includes such person to whom such debt has been legally assigned or transferred.

It is admissible to note that, a creditor would fall into the category of an operational creditor if an operational debt is owed to him. What exactly will fall under operational debt becomes clear from the case of Vinod Awasthy v A.M.R Infrastructures Limited. In this case, the NCLT has formulated that ‘operational debt’ under the code can be divided into four categories viz. employment, services, goods, and government dues. If the debt owed to the operational creditor does not fall in any of these four heads, the creditor cannot be known as ‘operational creditor’ and therefore he cannot initiate a corporate insolvency resolution process against the corporate debtor.

How to make an application for initiation of the corporate insolvency resolution process (CIRP) against defaulting Corporate Debtor for a debt of more than Rs.100,000/- (Rupees one lakh)

For initiation of CIRP in accordance to Section 9 of the Insolvency and Bankruptcy Code, 2016 and Regulation 7 of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 an operational creditor may make an application to the Adjudicating Authority.

Steps to be followed by the Operational Creditor are:

Step 1: An operational creditor may deliver a demand notice upon the corporate debtor demanding payment in respect of the operational debt in respect of which the default has occurred. The demand notice shall be in prescribed Form 3 or a copy of an invoice with a notice in Form 4(under Rule 5 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016)

Step 2: The Corporate Debtor shall within 10 days of receipt of the demand notice, communicate to the operational creditor the existence of any dispute or payment of the unpaid operational debt. It is important to note that the dispute raised by a corporate debtor has to be pre-existing to the demand notice issuance date.

Step 3: At the expiry of 10 days of delivering the demand notice to the corporate debtor, if the operational creditor does not receive any payment or notice of dispute, the operational creditor may make an application to the Adjudicating authority for initiation of CIRP under Section 9 of the code in Form 5. The operational creditor may propose the name of a resolution professional to act as an Interim Resolution Professional.

Step 4: The applicant (the operational creditor) shall then serve to the corporate debtor at his registered office by speed post or registered post, a copy of the application made to the adjudicating authority (NCLT)
There is only a nominal filing fee of Rs. 2000/- for filing petition in NCLT. CIRP thus gets initiated against a corporate debtor by an operational creditor.

Is the Insolvency Resolution Mechanism more effective than its predecessors?

The standard restoration in the 60 resolved cases under the IBC is around 46 percent as against 25 percent under the earlier board for industrial and BIFR (financial reconstruction).

Another important section, to take the bull by the horns, is the invocation of Section 74 of the IBC that prescribes penal provisions for violation of the moratorium by the officers of the corporate debtor, creditors and bidders, and failure to comply with the resolution plans by the resolution applicants. The purpose fairly acts as a pressure tool for recovery as it protects the code from being taken lightly, and also infuses some pressure in the stakeholders to the transaction.

A Glance at the Recovery through various mechanisms

It is notable that the average recovery by the banks, as per the data available, through the IBC was 41.3% in FY-18 against 13.80% through different modes of recovery. The recovery through SARFAESI stood solely at Rs.26,500 crore as against IBC that stood at Rs.9,92,900 crore. recoveries through the DRTs and the Lok Adalats were even lower which stood at 7200 crores or 5.4% and Rs.1800 crore or 4% respectively.

The periodical report of the IBBI discloses that out of the 12 cases resolved under its regime, the average recovery as a percentage of total claims filed by the financial creditors was quite high i.e. 69.7%. Cases like Kohinoor CTNL Infrastructure owed Rs.2528 crore to the financial creditors and they could recover Rs.2246 crore or 89% of the total claim amount. Cases like forwarding Shoes, Trinity Auto Components, and Propel Valves, recovered full amount to the financial creditors. Two cases sound exceptionally successful. Burn Standard Company and Shree Radha Raman Packaging recovered over the number due.

Instances of Recovery through IBC Mechanism

The threat which the IBC possesses a recovery mechanism in itself. The legal notices or the threatening notices being sent to the debtors are rendering them between the devil and the deep sea, whereby they are leaving no stone unturned in the payment of the dues of the creditors.

If one probe into the Corporate Insolvency Resolution process thoroughly, then each section has an important role to play. The various provisions of the admission of the application in the NCLT have been structured in such a way that the debtors are left with limited options and benefits to state their innocence for the application filed by the financial creditors. The debtors are left with no options other than to repay the debts of the creditors.

Insolvency law, not a Debt Recovery Tool

Insolvency proceedings are not meant to coerce or threaten a debtor to pay. The law has been enacted for reorganization and insolvency resolution of the corporate debtor. Its goal is to maximize the value of assets, promote entrepreneurship and availability of credit, and balance the interests of all the stakeholders. It is meant to prevent the inequitable distribution of available assets to one or a few aggressive creditors to the detriment of the debtor and other creditors. Otherwise, assertive and resourceful creditors will extract their pound of flesh and leave the debtor bleeding to death by eliminating any prospects of its revival. Its use for debt collection by individual creditors is a gross misuse of the legislation.

The proper function of insolvency law is to maximize return to creditors through a collective debt collection mechanism by pooling together of a debtor’s assets for the benefit of all creditors. Creditors make recovery either by the restructuring of debtor’s business or by its quick liquidation where revival is not feasible. Returns or assets are distributed amongst creditors in accordance with insolvency waterfall rules. In fact, insolvency proceedings are meant to avert the problems associated with individual creditors separately rushing to recover their individual debts and the concomitant waste caused by such actions against an already distressed debtor.

NCLT has an important role in preventing the conversion of insolvency law into bad debt recovery proceedings.
The law has been enacted for reorganization and insolvency resolution of the corporate debtor. (Reuters)

Applications filed under the Insolvency and Bankruptcy Code show a disturbing trend of the law being employed by small creditors as a debt collection tool rather than for restructuring of non-performing assets by banks, thereby undermining its import. Out of the 103 applications admitted or disposed of by the National Company Law Tribunal till mid of May, 55 had been initiated by suppliers of goods or services.

Banks had filed only 16. Petitions by ordinary creditors have proved to be an effective threat as in most cases the debtor company has stepped forward to promptly settle with the petitioner who then withdraws the application. Despite the monumental non-performing assets held by banks, they have not stepped forward to use the insolvency law to resolve assets that can be turned around. This is perhaps one of the reasons that prompted the government to promulgate the Banking Regulations Ordinance to empower RBI to direct banks to make use of the insolvency law for the resolution of non-performing assets in fit cases.

Insolvency proceedings are not meant to coerce or threaten a debtor to pay. The law has been enacted for reorganization and insolvency resolution of the corporate debtor. Its goal is to maximize the value of assets, promote entrepreneurship and availability of credit, and balance the interests of all the stakeholders. It is meant to prevent the inequitable distribution of available assets to one or a few aggressive creditors to the detriment of the debtor and other creditors. Otherwise, assertive and resourceful creditors will extract their pound of flesh and leave the debtor bleeding to death by eliminating any prospects of its revival. Its use for debt collection by individual creditors is a gross misuse of the legislation.

The proper function of insolvency law is to maximize return to creditors through a collective debt collection mechanism by pooling together of a debtor’s assets for the benefit of all creditors. Creditors make recovery either by a restructuring of debtor’s business or by its quick liquidation where revival is not feasible. Returns or assets are distributed amongst creditors in accordance with insolvency waterfall rules. In fact, insolvency proceedings are meant to avert the problems associated with individual creditors separately rushing to recover their individual debts and the concomitant waste caused by such actions against an already distressed debtor.

Conclusion

The mechanism of Insolvency resolution has been favorable to quite an extent in preserving the interests of its stakeholders. Though the motive of the mechanism is not recovery, it has successfully acted as a pressure tool of recovery. The number of applications being withdrawn before the pre-admission stage is quite high in number.

The provisions of the resolution mechanism are strictly time bound which are exerting pressure on entire stakeholders to comply with the ideology of the code. There are strict penal provisions as defined in section 74 of the IBC, 2016 for violations on the part of the officers of the corporate debtor, the creditors, and the bidders. The approval of the resolution plans is governed in such a way that failure by the committee of creditors to approve the plan, would lead the company into liquidation.

It’s been two years to IBC, and so far the performance has been more than satisfactory. Needless to say, the code has been demonstrating multifarious interests and things are changing gradually. One can see and analyze the arrows being thrown in all directions by the Insolvency mechanism, leaving debtors between a rock and a hard place.

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