The proposed amendments in the Insolvency and Bankruptcy Code, 2016 (IBC), approved by the Union Cabinet on July 17, and potentially to be moved as an amendment in the current session of Parliament, may overcome a difficulty arising due to operation of the NCLAT ruling in Essar Steel.

The NCLAT ruling, primarily addressing the plight of operational creditors, called for irrelevance of Section 53 (which lays priorities of distribution in liquidation) in the resolution process. Reason being, payment under resolution plan is not a distribution of the proceeds from sale of the assets of the corporate debtor and, therefore, the resolution applicant cannot take advantage of Section 53 for the purpose of distribution to be made in favour of one or other stakeholders — financial, operational or otherwise.

While the NCLAT ruling was, understandably, coming from the viewpoint of justice due to the operational creditors, the implication of the ruling was to render resolution plan highly uncertain, as any scheme of priorities proposed by the resolution applicant could have been subject to challenge before adjudicating authority on the ground of distributive justice.

While undercurrent of the ruling was “equitability”; however the verdict seemed to have called for “equitable treatment of all creditors” as against “equitable treatment of similarly placed creditors” — a well-established principle in insolvency laws.

The objective of equitable treatment is that, “in collective proceedings, creditors with similar legal rights should be treated fairly, receiving a distribution on their claim in accordance with their relative ranking and interests. This key objective recognises that all creditors do not need to be treated identically, but in a manner that reflects the different bargains they have struck with the debtor.”

Therefore, even the insolvency laws shall honour respective contractual bargains or deals, which a creditor might have struck with the debtor when the debtor was all healthy. According all these creditors the same treatment would negate the importance of contractual relationships, undermine the autonomy of commercial dealings and will diminish the certainty of the creditor’s ability to recover debt , ultimately affecting credit supply and affordability in the long run.

Also, going by widely followed and judicially acknowledged principle of ‘vertical comparison’, a creditor cannot be put into a worse position in resolution than in liquidation. While there is no bar on endowing more benefits on the creditor; however, if for such benefits, another creditor, who is otherwise more entitled, suffers — there is an imbalance.

Then, it makes little relevance as to the source from where the funds are coming — whether from the assets of the corporate debtor or from the pockets of the resolution applicant. Therefore, Section 53 acts a ‘guidance’ or as a ‘benchmark’, while it is open for the resolution applicant to confer beneficial terms on lesser entitled creditors like operational creditors.

The proposed amendments, it seems, imbibe the principles as above, and seek to restore the position understood before the ruling, and make resolution plans abide by the distribution priorities given in Section 53.

The proposed amendments require that the dissenting financial creditors and the operational creditors shall receive such minimum amount under the resolution plan, which shall be higher of — (i) resolution value (say) assignable to the creditors following the priorities under Section 53, and (ii) liquidation value ascribable to the creditors under Section 53. Here, resolution value is the value proposed to be distributed under the resolution plan. The amendment is purported to be retrospective and would be applicable to resolution plans which have not attained finality or have been appealed against.

However, the larger question still remains — will it solve the concerns of operational creditors and render them justice?

Ironically, the proposed amendments will save residual operational creditors only when the resolution value offered by the resolution applicant surpasses the claims of all higher ranking creditors, viz. secured creditors, workmen, employees, unsecured financial creditors, and even government dues. Given the experience so far and that the resolution applicants will pay only for ‘value’ they assess to be inherited in the entity, this proposition or formula is no more than a nullibiety.

The writer is a Senior Associate at Vinod Kothari & Company, a finance consultancy

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