Management Aspects in Insolvency and Bankruptcy Process

Introduction

The Code provides a time bound, market mechanism for reorganisation and insolvency resolution of persons (companies, limited liability partnerships, partnership and proprietorship firms and individuals) in distress. The objective of such reorganisation and resolution is maximisation of value of assets of the persons to promote entrepreneurship, enhance availability of credit, and balance of the interests of all stakeholders. The resolution process begins with admission of an application filed by an entitled stakeholder in the event of a threshold amount of default. The Code envisages a calm period when the stakeholders endeavour to resolve the distress without fear of recovery or enforcement actions. In case of corporate insolvency, the creditors assess the viability of the corporate debtor (CD) and endeavour to rescue it through a resolution plan. Corporate insolvency resolution process (CIRP) ends up either with an approval of a resolution plan rehabilitating the CD or an order for commencement of its liquidation.

Unlike the erstwhile regime, the Code makes provision for professional services for various processes. While elucidating the role of an IP, the Bankruptcy Law Reforms Committee (BLRC), which conceptualised the Code, observed: "This entire insolvency and bankruptcy process is managed by a regulated and licensed professional namely the Insolvency Professional or an IP, appointed by the adjudicator. In an insolvency and bankruptcy resolution process driven by the law there are judicial decisions being taken by the adjudicator. But there are also checks and accounting as well as conduct of due process that are carried out by the IPs. Insolvency professionals form a crucial pillar upon which rests the effective, timely functioning as well as credibility of the entire edifice of the insolvency and bankruptcy resolution process."

As per section 17 of the Insolvency and Bankruptcy Code, from the date of appointment of the interim resolution professional, the interim resolution professional vested with the management of the corporate debtor. The managerial role of IRP/RP during CIRP process can be observed from the legislative framework of Insolvency and Bankruptcy Code, 2016 as follows:

1. Managerial Role in CIRP

In conducting CIRP of a CD, a whole array of statutory and legal duties / powers is vested with Resolution Professional. He manages the affairs of CD, exercises the powers of its Board of Directors and complies with applicable laws on behalf of CD. He is entrusted to protect and preserve the value of assets of CD, manage its operations as a going concern and facilitate the committee of creditors (CoC) in taking prudent decisions for resolution of insolvency. For efficient conduct of the process, IP is entrusted to perform other key activities including making public announcement, verification of claims, preparation of information memorandum, raising interim finance, appointment of valuers, inviting prospective resolution applicants to put forth their resolution plan, etc. The Code empowers him to appoint professionals, seek cooperation from personnel of CD and seek orders from the AA in case of any preferential, undervalued, extortionate, or fraudulent transaction. He acts as a link between the AA and CoC as also other stakeholders. Thus, as IRP / RP, he is tasked with conducting and facilitating the CIRP while attempting to address and balance the interests of all stakeholders. During a CIRP, an IP may also be appointed as authorised representative (AR) for any class of creditors.

The corporate insolvency resolution process envisaged under the Code, 2016 is prominently a creditor driven process, whereby the decision to let the debtor survive or to liquidate the same rests on a collective body of the creditors, i.e. the committee of creditors. Since the RP is an appointee of the creditors, and the IP takes over the management and supervision of the company in insolvency, the business of the company may be said to be in creditors' possession during the resolution process. While, unlike during the liquidation process, there is no vesting of assets and property in the RP, but the RP takes over the management of the business. Hence, the approach is similar to that under the UK Insolvency Act, 1986. The assets of the corporate debtor are taken into custody by the RP chosen by the committee of creditors and the management of the affairs of the corporate debtor too, vests in the RP. Note that prior to appointment of a RP, an IRP is appointed to perform the aforesaid functions till the committee of creditors is constituted and the RP is appointed. The managerial role played by the RP (including an interim resolution professional) has been explained in the following paragraphs:

Management of affairs of the corporate debtor

Section 17 of the Code, 2016 provides for vesting of the management of the affairs of the corporate debtor in the hands of interim resolution professional, which is natural consequence of a creditor in possession regime. The concept of 'debtor possession' implies that the debtor continues to remain in possession of the management of the entity during the resolution process. This was the approach under SICA, as SICA was evidently drawn on the basis of the US Bankruptcy Code. The N L Mitra Committee advocated a deviation from the approach as follows: "The most critical provision in the SICA is that the promoter/management bringing the entity to the BIFR remains in possession and creates incentives for stripping off assets. Therefore, creditors are against most restructuring proposals. It is therefore recommended that if the owner/promoter/existing management files the petition for the bankruptcy of a company, the possession of the company with its entire assets and liabilities must be vested with the Trustee immediately without any loss of time. That ensures the first principle of maximisation of asset value. If a creditor files the petition the possession of the company's assets and liabilities shall vest on the Trustee as soon as the petition is allowed."

The Code adopted the theme of "creditor in possession", and therefore, vests the RP with the management of the affairs of the corporate debtor, starting from the date of appointment itself. Further, the powers of the board of the directors of the corporate debtor shall stand suspended, and the same shall be exercised by the interim resolution professional. However, it is important to note that the powers of the interim resolution professional in such capacity is not unfettered – the powers of the interim resolution professional/resolution professional is subject to the authority of the committee of creditors, as discussed in later paragraphs.

The corporate boards in India are more often supervisory boards while the day to day functioning of the entity is the responsibility of the executive management. Section 17 though provides for suspension of the powers of the board of directors, yet clearly says that all officers and employees will report to the interim resolution professional. Hence, the suspension of the powers of the board of directors must have no bearing on the executive machinery. Note that the executive machinery may typically be headed by the managing director. Therefore, the managing director, who works under the supervision of the board of directors, will now work under the supervision of the IRP. Likewise, executive directors will cease to have the powers of "directors" but will continue their respective functional roles, under the supervision of the interim resolution professional.

That it is not the administrator who starts managing the company, but the existing management starts working under the supervision of the administrator, is clear from reading of Item 64 of Schedule B1 to the UK Insolvency Code, reading as follows:

"64. (1) A company in administration or an officer of a company in administration may not exercise a management power without the consent of the administrator. (2) For the purpose of sub paragraph (1)— (a) "management power" means a power which could be exercised so as to interfere with the exercise of the administrator's powers, (b) it is immaterial whether the power is conferred by an enactment or an instrument, and (c) consent may be general or specific."

It will be impractical for the RP or the administrator to start managing the day to day operations of the entity. Neither does the RP have the technical expertise to do so, nor is the replacement of existing management at all conducive to the idea of preserving or maximising the going concern value of the entity. Of course, the RP has wide powers, but the issue is that the power must be exercised in the interest of the entity, and not as a matter of power play. In rulings like RAB Capital plc vs Lehman Brothers (International) Europe (2008) EWHC 2335 (Ch), courts have taken very liberal view on the powers of the administrator; however, it is a consistent position in the UK that the administrator does not dismiss the existing management23. Sections 18, 20 and 25 of the Code talk about duties and functions of the RP. These may seem to suggest that the actual day to day operations of the entity will be carried out by the RP. However, the RP has to preserve the existing management. The RP has powers to appoint agencies to carry out his management function. The idea behind the law is to put the RP effectively in the steering position, so that the going concern is in the creditors' control.

In order to facilitate the IRP/ RP in fulfilling his responsibility of managing the affairs of the corporate debtor, sections 20 and 25 provide authority to interim resolution professional/resolution professional to do necessary acts, including the following – (i) to enter into contracts on behalf of the corporate debtor or to amend or modify the contracts or transactions which were entered into before the commencement of corporate insolvency resolution process; (ii) to raise interim finance, subject to certain conditions; (iii) to issue instructions to personnel of the corporate debtor as may be necessary for keeping the corporate debtor as a "going concern" (see discussion under the next heading); (iv) to appoint accountants, legal or other professionals as may be necessary; etc. However, section 28 acts as a limit to the authority of the interim resolution professional/resolution professional – it lists out certain acts which shall not be undertaken without the prior approval of the committee of creditors. The acts include – raising interim finance in excess of limits approved by the committee of creditors, creating security interest on the assets of the corporate debtor, changing the capital structure of the corporate debtor, undertaking related party transactions, amending constitutional documents of the corporate debtor, amongst others.

Management of the entity as "going concern" The Code emphasises that the interim resolution professional shall manage the operations of the corporate debtor as a "going concern" – section 20. "Going concern" refers to an enterprise continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations. The provision sets out the guiding principle for the interim resolution professional or the resolution professional managing the corporate debtor during the resolution process. The interim resolution professional/resolution professional, therefore, shall administer the company "as is", without making any material alterations in the scale of operations of the company or selling off material value of its assets which may endanger any possibility of the revival of the corporate debtor.

Custody of the assets of the corporate debtor

Section 18 requires the interim resolution professional to take control and custody of any asset over which the corporate debtor has ownership rights and section 20 obliges the interim resolution professional to make every endeavour to protect and preserve the value of the property of the corporate debtor. Again, section 25 states that it shall be the duty of the resolution professional to preserve and protect the assets of the corporate debtor, including the continued business operations of the corporate debtor. The Code has also amended section 429 (1) of the Companies Act, 2013 empowering the NCLT to pass instructions to executory authorities for taking control and custody of assets, in case the RP is facing difficulties in doing so.

Here, the words "take control and custody" shall not be misinterpreted to mean taking control and custody of the assets for the purpose of disposal thereof – the objective of the provision is to move the custody and control of the assets from the directors to the interim resolution professional for the purpose of adequate monitoring and not as a pre disposal measure. The view transpires from the very fact that the corporate debtor is presently at the stage of "resolution" and not "liquidation" – this also brings out the distinction between the roles played by an administrator and a liquidator.

Bringing the creditors together

The interim resolution professional shall constitute the committee of creditors after collation of all claims received against the corporate debtor and determination of the financial position of the corporate debtor – section 21. The committee of creditors is the collective body of financial creditors of the corporate debtor which, by way of majority vote, decides on the ultimate fate of the corporate debtor, i.e. whether to resolve the insolvency or to liquidate the entity. The committee of creditors appoints resolution professional in its first meeting. The resolution professional is then entrusted with the task of convening and conducting the meetings of the committee of creditors during the resolution process – section 24.

Conducting the Corporate Insolvency Resolution Process

Section 23 states that the resolution professional shall conduct the entire corporate insolvency resolution process and manage the operations of the corporate debtor during the corporate insolvency resolution process period. During the corporate insolvency resolution process period, the interim resolution professional/resolution professional has to undertake the following activities –

(i) making public announcement of the insolvency resolution process in respect of the corporate debtor; (ii) collection of all information relating to the assets, finances and operations of the corporate debtor for determining the financial position of the corporate debtor, including information relating to business operations, financial and operational payments, list of assets and liabilities; (iii) receipt and collation of claims of creditors submitted pursuant to the public announcement; (iv) constitution of the committee of creditors; (v) convening and conducting the meetings of the committee of creditors; (vi) filing necessary information with information utility; (vii) preparation of information memorandum for facilitating the formulation of a resolution plan; (viii) inviting prospective resolution applicants to put forward their resolution plans; (ix) examining each resolution plan received so as to see whether the resolution plan meets the criteria enlisted under section 30 (2) and presenting the eligible resolution plans at the meetings of the committee of creditors; (x) submission of the resolution plan approved by the committee of creditors to the adjudicating authority for approval of the latter; (xi) making applications for avoidance of preference, undervalued, fraudulent transactions; etc.

Preparation of Information Memorandum

Section 29 requires that the resolution professional shall prepare an information memorandum in such form and manner containing such relevant information as may be specified by the Board for formulating a resolution plan. The CIRP Regulations, however, require that certain minimum information shall be provided to each member of the committee of creditors and any potential resolution application before the first meeting of the committee of creditors. This calls for preliminary preparation of information memorandum by the IRP. The information memorandum shall contain details on the basis of which a resolution plan may be formulated. Regulation 36 (2) of the CIRP Regulations lists out the contents of the information memorandum.

Facilitating Resolution Plan

As mentioned in the preceding paragraph, the resolution professional prepares the information memorandum which serves as an input for the formulation of the resolution plan. The task of the RP in respect of the resolution plan does not end here – section 30 of the Code, 2016 read with regulation 38 of the CIRP Regulations mandates that a resolution plan must confirm to certain minimum requirements. The resolution professional must examine each resolution plan received by him to confirm that each resolution plan – (i) provides for the payment of insolvency resolution process costs in priority to the repayment of other debts of the corporate debtor and identifies specific sources of funds to pay the same; (ii) provides for the repayment of the debts of operational creditors which shall not be less than the liquidation value due to operational creditors in priority to any financial creditor and before the expiry of thirty days after the approval of a resolution plan by the adjudicating authority; (iii) provides for the repayment of the liquidation value due to dissenting financial creditors before any recoveries are made by the financial creditors who voted in favour of the resolution plan.(iv) provides for the management and control of the affairs of the corporate debtor after approval of the resolution plan; (v) the implementation and supervision of the resolution plan; (vi) does not contravene any of the provisions of the law for the time being in force.

The RP shall present to the committee of creditors for its approval such resolution plans which confirm the conditions as referred hereinabove. The resolution plan which is approved by the committee of creditors shall then be submitted by the resolution professional to the adjudicating authority. Where the resolution plan is approved by the adjudicating authority, the resolution professional shall forward all records relating to the conduct of the corporate insolvency resolution process and the resolution plan to the Insolvency and Bankruptcy Board of India to be recorded on its database.

The assessment of the fair values of assets, and a preparation of the liquidation value assessment is one of the key tasks at this stage. Resolution is the preferred alternative; liquidation is the ultimate. Therefore, a resolution plan has to offer to the stakeholders something better than what they would get in liquidation. There is a well known "vertical test" used by UK Courts [for example, see T & N Limited, (2005) 2 BCLC 488] that in a resolution, a stakeholder cannot be put to prejudice apropos what he would get in liquidation. So, a creditor either votes on the resolution plan, and therefore, hopes to get a better deal out of a healthier borrower, or votes against (which includes not voting) the resolution plan, in which case, he gets an exit based on what would have been liquidation value of his claim, going by the priority order of distribution and the estimated fair value of the assets.

While the RP acts as the catalyst of the entire process, he is not the one who actually prepares the resolution plan. The plan is prepared by a "resolution applicant", who may either one of the lenders themselves, or an external consultant. A resolution plan is a rescue strategy. Turnaround strategy is always a bespoke solution to the case; it involves close scrutiny of assets, liabilities, incomes and expenses. In terms of assets, the plan may provide for sale of non core assets, or replacing owned assets by leased assets. In respect of liabilities, the plan may provide for conversion of the unsustainable debt into equity, or sacrifice of interest. The plan may involve curtailing expenditure, redirecting operations, etc. Very often, a restructuring plan may also involve alteration of product mix, product markets, etc.

Preparation of rescue plan may include rescue financing as well. Note that the Code gives uppermost priority in the liquidation waterfall to interest and principal on rescue financing. However, it is hoped that resolution applicants do not go ambitiously in restructuring plans for further capital infusion. This strategy has not worked in past SICA revivals or CDR cases. Instead, resolution applicants may provide for interim financing largely for paying off dissenting creditors, and therefore, reducing the burden of liability on the entity.

2. Managerial aspect in Liquidation Process

During a liquidation process, a liquidator has three broad responsibilities; Claim adjudication, sale of business / assets and distribution of liquidation proceeds. For performing these functions, a liquidator is entrusted to make public announcement inviting claims, verify claims, take into his custody or control the assets of CD, form a liquidation estate and endeavour to sell the assets of liquidation estate through public auction, in consultation with the stakeholders' consultation committee. For efficient reporting, a liquidator is required to maintain registers and books of account of CD, prepare reports and submit before AA. The Code empowers him to appoint professionals, seek direction to secure cooperation from personnel, auditor, promoter, partner, IRP, RP of CD. He may also seek orders from the AA in case of any preferential, undervalued, extortionate, or fraudulent transaction. Upon realisation of liquidation estate, he distributes the sale proceeds among the stakeholders as per the waterfall. On completion of liquidation process, he submits an application with the final report to AA for closure of the liquidation process and dissolution of the CD.

3. Managerial aspect in Fresh Start and Individual Insolvency Resolution

During an insolvency resolution process, an IP in capacity of RP files an application before the AA on behalf of debtor or the creditor. He examines the application and submits a report recommending acceptance or rejection of application. In case of a fresh start process, he examines objections of creditors, finalises list of qualifying debts and may seek directions from AA on non compliances by debtor and submit application for revocation of order admitting or rejecting application. In case of insolvency resolution process, he prepares a list of creditors, offers consultation to debtor in preparation of repayment plan and submits repayment plan to AA along with his report on such plan. He convenes meeting of creditors, prepares a report of meeting of creditors and provides thereof to debtor, creditors, and the AA. On approval of repayment plan by AA, he supervises its implementation and upon completion informs AA and persons bound by it. On the basis of repayment plan, he applies to AA for passing a discharge order.

4. Managerial aspect in Bankruptcy Process

On passing of bankruptcy order, the estate of debtor vests in the IP acting as BT. In case order is passed on an application by creditor, BT may require information related to statement of financial position. BT prepares a list of creditors of the bankrupt and convenes meeting of creditors. He is responsible for conducting the administration and distribution of the estate of bankrupt by investigating his affairs, realizing, and distributing the estate. He holds property of every description, makes contracts, sues and may be sued, enters into engagements in respect of the estate of the bankrupt, employs persons to assist him, executes any power of attorney, deed or other instrument and does any other act which is necessary or expedient for the purposes of or in connection with the exercise of his rights. On completion of administration and distribution of estate, he convenes a meeting of committee of creditors and submits a report for approval. He applies to AA for discharge of bankrupt and is released of his duties with effect from the date on which committee of creditors approves his report.

Table showing Management aspects in Insolvency and Bankruptcy Process

The following statement sums up the importance of the management aspects in reorganization or resolution of an entity:

"It is conceivable for an insolvency system to function with minimal interventions by courts or government agencies. It is not conceivable for such a system to function effectively without specialists, especially for reorganization. "The probability of effective reorganization increases when agents of reorganization have the capacity to (a) decide whether rescuing business is feasible and to advise on alternative courses of action (liquidation, reorganization, creative combinations of these); and (b) to reorganize the company itself . . . ."

Such capacities depend on a sufficient supply of expert labor. Public policy must, therefore,

(a) find means to bring the best and brightest into the debt restructuring area,
(b) regulate competition to constrain costs and reduce conflicts of interest,
(c) remove financial and reputational barriers to insolvency professions, and
(d) develop a regulatory system that delivers competency and integrity."