Cramming down under the Insolvency Code

By Veena Sivaramakrishnan and Dhananjai Charan, Shardul Amarchand Mangaldas & Co
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The hot topic of conversation in India is the (Indian) Insolvency and Bankruptcy Code, 2016 (IBC), and one aspect that demands attention is “liquidation value”. Under IBC, a resolution plan must identify sources of funds to pay (in priority) the liquidation value due to: (a) operational creditors; and (b) dissenting financial creditors. The intention is to allow operational and minority creditors to be crammed down by ensuring optimal recovery, while allowing the reorganization of the debtor company as per majority creditors decision.

Veena SivaramakrishnanPartnerShardul Amarchand Mangaldas & Co
Veena Sivaramakrishnan
Partner
Shardul Amarchand Mangaldas & Co

In order to assess where this places minority creditors, it becomes crucial to look at the options available. In a liquidation scenario, secured creditors have an option either to relinquish security interest in favour of the common pool and take a preferential pay out in the liquidation waterfall, or to enforce their security interest outside of liquidation. A creditor is likely to exercise either option on the basis of the overall returns anticipated and time value of money considerations. A moot question arises as to whether the resolution professional, while producing liquidation value vis-à-vis each creditor before the Committee of Creditors (CoC), takes the preference of each creditor in a liquidation scenario.

Upon relinquishment of security by a secured creditor, Section 53 of the IBC ranks such secured creditors in priority over unsecured creditors. Though there is no specific provision for distribution priority at the stage of a resolution plan, implicitly from a reading of Section 30(2) of the IBC, the principles of Section 53 appear to be incorporated. The resolution plan once approved by the CoC and NCLT is contractual between the financial creditors and the resolution applicant and binding on the corporate debtor acting through the resolution applicant and other stakeholders.

In order to secure 75% of the voting shares of the financial creditors, the provisions for payment would be tailor-made to the composition of the financial creditors. Thus if secured financial creditors are in majority of the financial creditors, the resolution plan will invariably seek to satisfy them first but if the financial creditors are comprised of a majority of unsecured creditors, then the reverse may be true. If such a plan is approved under Section 31 of the IBC then unless the secured financial creditors are dissenting financial creditors, the payouts as per the resolution plan, in circumstances where the unsecured financial creditors are in a majority, may accord priority payments to such unsecured creditors in preference to the secured creditors. The secured creditors’ priority right over the security is not altered by a resolution plan but the sequence of payment in a successful and approved resolution plan, which a secured creditor accepts, may alter the payment priority and make payment to unsecured financial creditors without affecting the security of such secured creditor.

Dhananjai CharanAssociateShardul Amarchand Mangaldas & Co
Dhananjai Charan
Associate
Shardul Amarchand Mangaldas & Co

Where does this place minority unsecured financial creditors who have little leverage in the CoC that vote on resolution plans under the IBC? The idea seems similar to what exists under US Bankruptcy laws, but due to drafting differentiators in provisions on liquidation and realities in India on security interest and enforcement, the interpretation and implementation could be skewed.

To illustrate – Bank A, holding 5% debt, with 100% security cover in the form of a first charge (with others holding subservient charge), intends to initiate insolvency. The choice of initiating insolvency proceedings would depend on the foreseeable recovery in the event the resolution of the majority creditors is crammed down on Bank A. Bank A would look at the proposed liquidation value payable to it as a dissenting financial creditor. In the first scenario, Bank A may pool in its collateral to the liquidation estate, and take a percentage of the payout, based on the claims made from the other creditors who would also have pooled in their charged assets. We can assume Bank A gets a 10% recovery on its total exposure in this scenario. In the second scenario, Bank A may choose to enforce its security outside of liquidation, in which case, it is likely to recover its entire debt, given that it has 100% security cover, but such enforcement would happen over time. It appears that the more logical approach to an insolvency professional in calculating liquidation value vis-à-vis each creditor would be to assume the first scenario, as the second scenario is an event taking place outside of liquidation. This is, however, contrary to US Bankruptcy laws where cramdowns promise a return of at least the full collateral value. In India, it is therefore likely that minority creditors get dissuaded from making references under IBC, as cramdowns could impact their expected returns. Also, in relation to the calculation of liquidation value where there are varied charge rankings in favour of different creditor classes, the IBC is silent as regards how interests of such competing charge holders would be considered. The resolution professional may have to take either scenario (where charges are ranked equally and unequally) in arriving at the “liquidation value”.

All norms under IBC are evolving and keeping up with the demands of the industry and given the importance “liquidation value” demands in the process, Indian distressed assets space would certainly see some interesting developments in this regard.

Veena Sivaramakrishnan is a partner and Dhananjai Charan is an associate at Shardul Amarchand Mangaldas & Co

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