On Monday, the Supreme Court stayed a controversial order by the National Company Law Appellate Tribunal (NCLAT) about the resolution of Essar Steel. The next hearing will be on August 7. On July 4, the NCLAT had given an unexpected ruling that, if upheld, had the potential to upend all existing and former resolutions under the Insolvency and Bankruptcy Code. Perhaps cognisant of the implications, the Union Cabinet has already stated that it will be amending the IBC.
What did the NCLAT ruling say?
The NCLAT ruling in the Essar Steel case stated that all creditors whether financial or operational have to be treated equally in the case of a “resolution” under the IBC. There are two aspects of this statement that have key implications. One is the equality between financial and operational creditors, and two, the distinction between “resolution” and “liquidation” under the IBC.
What did NCLAT say on creditors?
The resolution plan to Essar Steel, proposed by ArcelorMittal, was questioned by both operational creditors, who alleged that they were not treated on par with financial creditors, as well as some financial creditors such as Standard Chartered Bank that alleged that its claims were not honoured adequately. As it happened, the NCLAT ruled that the Committee of Creditors (CoC) had discriminated between creditors. The NCLAT order stated: “… we hold that the ‘Committee of Creditors’ has no role to play in the matter of distribution of amount amongst the Creditors including the ‘Financial Creditors’ or the ‘Operational Creditors’…” As such, the NCLAT amended the resolution plan in a way that both financial and operational creditors would receive roughly 61 per cent of their claims. The NCLAT logic was: financial creditors, being claimants at par with each other and claimants like the operational creditors, face a conflict of interest when deciding whose claims should be honoured and to what extent. This is more so the case when the maximum amount of money is allocated in favour of one financial creditor and minimum (or nil) for other financial creditors and operational creditors.
What did NCLAT say about “resolution” (as against “liquidation”)?
The NCLAT also observed that there is no difference between financial creditors and operational creditors when it relates to the “resolution” plan under IBC. Referring to Section 53 of the IBC that deals with the distribution of assets, the NCLAT argued that “the distribution of debts to the ‘Financial Creditors’ and the ‘Operational Creditors’ during the ‘Corporate Insolvency Resolution Process’ cannot be equated with [the] distribution of debts to all stakeholders after the liquidation.”
In other words, NCLAT sought to distinguish between distribution of assets under a “resolution” process as against under a “liquidation” process. It argued that Section 53 of the IBC lays out the order of priority for the proceeds from the sale of the “liquidation” assets. This order of priority favours financial creditors over operational creditors. However, the NCLAT pointed out, this is not a liquidation and, as such, the differentiation between financial creditors and operation creditors is not merited.
Why was the NCLAT ruling problematic?
The NCLAT ruling goes against the January 25 ruling by a two-judge Bench of the Supreme Court that had clarified why, under the IBC process, paying off financial debts, which are secured, needs to be prioritised over operational debts, which are unsecured. “We have already seen that repayment of financial debts infuses capital into the economy inasmuch as banks and financial institutions are able, with the money that has been paid back, to further lend such money to other entrepreneurs for their businesses.” The SC had favoured prioritising financial creditors because they generally lend finance on a term loan or for working capital that enables the corporate debtor to either set up and/or operate its business. On the other hand, contracts with operational creditors are relatable to supply of goods and services in the operation of a business. The SC had concluded that “while ensuring maximum recovery for all creditors being the objective of the Code, financial creditors are clearly different from operational creditors and therefore, there is obviously an intelligible differentia between the two which has a direct relation to the objects sought to be achieved by the Code.”
What happens next?
The next hearing on this case in the apex court is on August 7. It is quite possible that by that time the government manages to amend the IBC. If that happens, the NCLAT ruling may become pointless because the changes proposed by the government essentially try to blunt the distinctions the NCLAT ruling exposed in the IBC framework.