Essar Steel judgment – paving a way to resolution

By Misha, Shardul Amarchand Mangaldas & Co
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The Supreme Court of India recently delivered its much awaited decision in the corporate insolvency resolution process of Essar Steel India. Apart from the fact that this has paved a way for resolution of an astounding amount of about US$500 billion owed to the banks and financial institutions, the judgment is significant for having settled several fundamental aspects of resolution under the Indian Insolvency and Bankruptcy Code, 2016.

The judgment reiterates the supremacy of the committee of creditors (constituted of only the financial creditors of a corporate debtor), in commercial decisions including distribution of proceeds proposed in a resolution plan amongst different classes of creditors and stakeholders, subject to compliance with minimum payment provision with respect to the operational creditors and dissenting financial creditors.

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Misha
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In an earlier decision the Supreme Court in K Sashidhar v Indian Overseas Bank, the Supreme Court had already held that the commercial wisdom of the committee of creditors in rejecting a resolution plan and choosing to put the corporate into liquidation cannot be challenged.

Subsequently, however, the National Company Law Appellate Tribunal (NCLAT) while dealing with the resolution plan of Essar Steel India had held that distribution of resolution proceeds is not a commercial decision and can be judicially reviewed from the touchstone of “equality” and “fairness”.

The Supreme Court, in its Essar Steel India judgement, has, however, clarified that the distribution of resolution proceeds is purely a commercial decision and within the authority of the committee of creditors, and cannot be judicially reviewed, whose jurisdiction is circumscribed in the grounds of review specified in section 30(2) of the Code.

No equality among creditors

The Supreme Court held that there is no equality amongst the financial and operational creditors for distribution of resolution proceeds. The court reiterated that financial and operational creditors are two distinct classes of creditors with separate sets of legal rights under the code, and cannot be treated the same while distributing resolution proceeds under a resolution plan.

The court has, however, clarified that the committee of creditors is expected to apply its mind to the requirement and object under the code for “balancing the interest of all stakeholders”, and as long as the committee of creditors has duly considered such aspects, the discretion as to what and how much to pay to each class/sub-class is with the committee of creditors, which cannot be judicially reviewed.

Differential treatment

The judgment has also upheld permissibility of differential treatment among financial creditors in a resolution plan on the basis of availability and value of security held by different financial creditors. The court in the facts of the case upheld the classification among secured financial creditors on the basis of differential value of security, while recognizing that if during a resolution process the committee of creditors is not permitted to take into account differential rights and status of secured financial creditors on the basis of availability and value of security, the secured financial creditors will be incentivized to vote against the resolution and choose liquidation, where they can enforce their security.

In the process, the court has also upheld the validity of the amendment to the code, which expressly clarified the same. This comes as a huge relief to the banking industry, as otherwise the NCLAT judgment had mandated equal treatment of all the creditors in a resolution plan, hence abrogating age-long universal principles of the protected status of secured creditors.

Treatment of disputed claims

The Supreme Court also accepted the challenge of the committee of creditors to the decision of the NCLAT, holding that disputed claims can be kept outside the resolution process and pursued against the corporate debtor after approval of a resolution plan.

The court clarified that during the process of insolvency resolution, all claims, whether disputed, unmatured or contingent, need to be accounted for and detailed as part of the information memorandum that forms the basis of a resolution plan and, accordingly, can be dealt with, provided for and extinguished in part or full subject to fulfilment of minimum payment clauses for operational or dissenting financial creditors.

Sanctity of timelines

In response to the challenge to the amendment to the code requiring completion of the insolvency resolution process including legal proceedings within a period of 330 days, the court held that this timeline is mandatory except in exceptional circumstances where the process could not be completed within 330 days on account of factors outside the control of the parties and/or on account of tardy judicial process.

The decision of the Supreme Court on each of the above-mentioned aspects brings in necessary clarity in the rules of resolution under the code and is expected to give a fresh boost to insolvency resolution, which had started to suffer on account of contradictory interpretation of the code, judicial uncertainty and delay.

Misha is a partner in insolvency and bankruptcy practice at Shardul Amarchand Mangaldas

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