Need For Recognizing “Enterprise” over an “Entity”
Authored By - Chandni Wadhwani
Qualified Company Secretary Pursuing LLB (Hons)
Email id: email@example.com
The Insolvency and Bankruptcy Code of 2016 “The Code" has been enacted to set out a streamlined jurisprudence on issues relating to insolvency and bankruptcy and to strengthen the regime of insolvency proceedings of a corporate entity was envisaged as a complete code governing all matters relating to insolvency.
Continuity of business is the first and foremost objective towards preservation of capital and value of underlying assets. The reliability and efficacy of the ‘corporate insolvency resolution process’ (CIRP) especially as a resolution rather than recovery mechanism, depends inter-alia, on the adherence to the prescribed timelines. The code puts the primary responsibility of diligent pursuance of time-bound processes on insolvency professionals and committee of creditors (COC) supported by the adjudicating/ appellate authorities.
As insolvency law is still evolving in India, successful implementation of resolution framework has already been witnessed for the categories of corporate debtors (CD) In the context of any CIRP, the simplest form could Timely action is imperative to avoid further deterioration in the underlying value of CD, either through change in management or sale as Going Concern involve single or stand-alone company with no inter-corporate linkages in terms of control or ownership.
However, on the other end of spectrum, there may be companies having multiple inter-corporate linkages, through holding/ subsidiary/joint-venture routes of intricate ownership; business, or financial linkages. Managing insolvency of one or more of such inter-connected company (ies) would require a different dispensation from the one prescribed in the code currently. The code does not envisage a framework to either synchronise insolvency proceedings of different corporate debtors in a group or resolve their insolvencies together.
The global jurisprudence supports different frameworks to tackle the complexities of group insolvencies, ranging from procedural co-ordination (conduct of CIRP through a single insolvency professional and single administering court for administrative convenience) to substantive consolidation (treatment of the group as a single economic entity, negating the limited liability principle). The administering courts may often allow other hybrid measures within this broad spectrum.
United States of America -
The United States of America ("U.S.A") has dealt with the notion of substantive consolidation in a very smooth and efficient manner. Though, there exists no express provision in the United States Bankruptcy Code ("Bankruptcy Code") for grant of substantive consolidation, despite this the Bankruptcy Courts have substantively consolidated two or more insolvent debtors by virtue of Section 105 of the Bankruptcy Code. Furthermore, in absence of any concrete rules, the Bankruptcy Courts have also stretched this doctrine to consolidate the assets of a debtor (Insolvent Entity) with a non-debtor (Solvent Entity).
However, there are few judicial precedents/tests which set forth the factors for consolidating a debtor with non-debtor. The first among these tests was laid down by the Massachusetts Bankruptcy Court, In re Snider Brother Inc.1 The court held that to substantively consolidate a proponent must demonstrate, firstly; that there exists a necessity for substantive consolidation or harm to avoided by substantive consolidation and secondly; the benefits of consolidation overweighs the resulting harm to any objecting creditors. Furthermore, Giller, In re2 Eight Circuit court added a third prong to the above-mentioned test, i.e., to consider the prejudice resulting from not consolidating the debtor/non-debtor.
The second test for consolidation is a two-fold test, set forth by the Second Circuit Court, Union Saving Bank v. Augie/Restivo Banking Co.3 This test imparts a
1 Snider Bros., Inc., In re 18 B.R. 230 (Bankr. D. Mass. 1982), relying on the cases Food Fair, Inc., In re 10 B.R. 123, 124 (Bkrtcy.S. D.N.Y.1981) and Vecco Construction Industries, Inc., In re 4 B.R. 407, 6 B.C.D. 461, 1 C.B.C.2d 216 (Bkrtcy.E.D.Va.1980),
2 962 F.2d 796 (8th Cir.1992).
3 In Re Augie/Restivo Baking Co., 860 F.2d 515, 519 (2d Cir. 1988); In Re R.H.N. Realty Corp., 84 B.R. 356, 358 (Bankr.S.D.N.Y. 1988); In Re Blum, 49 B.R. 422, 427 n. 1 (Bankr.W.D. Mo.
burden on the person seeking consolidation to show that the creditors treated the group as a single economic entity or the affairs of entities are so entangled that it is impossible to Conduct an independent insolvency. In a large number of cases, Bankruptcy Courts have applied this test to consolidate a debtor with non-debtor. However, this test does not highlight the rights of prejudiced creditors.
The third and mostly referred test set-forth by the District of Columbia Circuit is commonly known as Auto Train Test.4 It stipulates for substantive consolidation, firstly; where there exists substantial identity between the entity concerned and secondly; to avoid some harm and realize benefits. Furthermore, if creditors oppose the substantive consolidation, it should be ordered only when its benefits overweigh the harms. Here, the first part of this test mirrors the approach adopted by the Bankruptcy Code to determine whether entities are alter egos of each another. The second and third parts require the courts to strike a balance between the benefits and harms of consolidation.5
Although, not a complete list of pronouncements, the afore-said decisions illustrate the principles pertaining to consolidation of a debtor with non-debtor.
The UK Insolvency Act, 1986 does not recognize the concept of group insolvency; rather, they strictly follow the principle of separate legal entity.6 Due to these reasons, at the time of insolvency, each entity within a group commences its proceedings individually. However, it is commonly observed that the administrator or liquidator for these proceedings remains same for the convenience.7 Therefore, it is evident that though United Kingdom does not recognize the concept of substantive consolidation, but they still follow procedural consolidation proceedings for the betterment of creditors & administrative convenience.
Part III of the UNCITRAL legislative guide lays down the procedure for administration of group insolvency proceedings8. It classifies the insolvency of solvent entities into two broad categories. Firstly, inclusion of a solvent entity whose insolvency seems to be imminent. Secondly, inclusion of solvent entity whose insolvency is not imminent. In the former scenario, it recommends the inclusion of such solvent entity in accordance with the normal standards alike other insolvent entities. For later scenario, the legislative guide recommends that factors like significant degree of interdependence or control, intermingling of assets, unity of identity, reliance on the management, financial support or other similar factors should be taken into consideration.
While India also follows the separate juristic personality of corporates as a general principle, exceptions have been incorporated over the years by way of legislative action and juridical pronouncements. In the context of insolvency law, the corporate veil is typically lifted in instances where a group company could be held liable for the debts of its associate and subsidiary companies, or if a group of companies functioned as a collective.
Presently, the code does not deal with the insolvency or financial re-organisation of groups and conglomerates. Nonetheless, be it cross-collateralisation, guarantee comforts or tunnelling, the courts are taking cognisance of such corporate behaviour while adjudicating upon insolvency matters.
India’s first tryst with group insolvency came through judicial intervention by the National Company Law Tribunal (NCLT) in the insolvency of the Videocon Group. Relying upon US precedents, the NCLT ordered the substantive consolidation of the corporate insolvency resolution process (CIRP) of 13 Videocon Group entities in light of intricately connected business. Following this, several group insolvencies have seen arguments on consolidation, successfully or otherwise, including Lavasa, KSK Mahanadi and Adel Landmarks.
It is a Court made law keeping in mind the facts and circumstance of case following the principle laid down by US and UK or have applied general principles of corporate law pertaining to lifting of corporate veil to make group companies liable for each other.
The NCLT's have allowed for group insolvency in various judgments by relying on their inherent powers to meet the end of justice & prevention of abuse of process under Rule 11 of the NCLT, rules 2016.
Group Insolvency is a process in which claims against the corporate debtors belong to the same group of companies are consolidated in a single resolution application to be adjudicated upon by the Adjudicating Authorities.
The process of clubbing together the assets and liabilities of individual companies and undertaking the insolvency proceedings as one substantive consolidation of the holding company, its associates, and its subsidiaries.
INTERLINKAGES: Inter-linkages especially those owing to related party transactions may be prevalent in corporate groups. Stakeholders consulted by the WG brought out that these inter-linkages may take a variety of forms, and include both operational linkages where group companies are dependent on each other for supply of raw materials, etc. and financial linkages such as the provision of inter- corporate guarantees by holding companies. If each company’s insolvency is dealt with entirely in isolation, the costs of recognising these inter-linkages may become extremely high since it would result in duplication of effort for the stakeholders of each entity to piece together information about interlinked entities.
SINGLE ECONOMIC ACTIVITY: Creditors tend to treat group companies as single economic entities consequently, they may make investments and extend credit on the understanding that different group companies are only one entity. If insolvency proceedings treat group companies as a single entity, this would result in the shares of a group company taking on the risk of the entire group. It would be extremely difficult for stakeholders, particularly small investors spread across the globe, to monitor a group of companies to deal with only one of them. On the other hand, if the law forces the asset partitioning without having due regard to the expectation of stakeholders, it may result in an increase in costs of engagement of stakeholders with such groups ex ante.
NATURE OF TRANSACTION: The nature of transactions between different group companies may have relevance in insolvency, especially since there may be asymmetry of information between creditors and promoters and other members of the group. For instance, some studies have indicated that there have been instances
of tunnelling in corporate groups in India9, which leads to “possible undue diversion of created wealth to the dominant shareholding or controlling group.” There is also evidence that in some cases “loans and advances can be given to subsidiary companies down the chain without adequate security, sometimes with unsound financial position and at low rates of interest to the advantage of the latter and detriment of the former. Similarly, improper transfer of assets of one company to another is resorted to with the object of benefiting one to the prejudice of other.”
The Insolvency and Bankruptcy Board of India (IBBI), recognising the growing need for a framework on group insolvency, set up a Working Group on Group Insolvency (WG). Following consultations with stakeholders, the WG compiled its recommendation (Report) dated September 2019 that highlight principles that will form the foundation of India’s corporate group insolvency regulatory framework (CIRP).
The WG considered the need for a framework to facilitate the insolvency resolution and liquidation of companies in a group. In particular, it looked into the facets of the framework, namely, first, elements that enable communication, coordination and cooperation among stakeholders in the insolvency proceedings of companies in a group (i.e. procedural coordination), second, elements that enable the assets of companies in a group to be consolidated in limited circumstances (i.e. substantive consolidation), third, rules to deal with the perverse behaviour of companies in a group, and fourth, interconnection among the companies that would make them part of a group.
In this regard, the WG made the following specific recommendations:
companies which belong to a group and have been admitted into CIRP. (Part IV, Para 1.3.1).
10 Section 2(46) – Holding company, Section2(87) subsidiary company, Section 2(6) Associate company
Procedural Co-ordination: Facilitates synchronization between multiple insolvency proceedings against group entities through coordination of the administration of two or more insolvency proceedings in respect of enterprise group members. Each of those members, including its assets and liabilities, remains separate and distinct.
Procedural co-ordination is Joint administration of insolvency proceedings keeping the corporate separateness apart.
enable a single application to be filed to commence the insolvency resolution processes of multiple companies in a group, before any Adjudicating Authority that has jurisdiction over any one of the companies. (Part IV, Para 22.214.171.124)
CoCs of participating companies, enable the creation of a group creditors’ committee to support individual CoCs, and not supplant them. (Part IV, Para 126.96.36.199)
ordination proceedings, at the option of the CoCs of the companies under CIRP. Group coordination proceedings may be governed by a Framework Agreement among the CoCs of the participating CDs. It may entail appointment of a “group coordinator” who would propose a strategy for the synchronised resolution of insolvency of the group companies. This strategy could propose invitation of a common expression of interest, resolution plan, etc. At this stage, a company may opt out of group coordination proceedings by a vote of the majority of its CoC. Once group coordination proceedings are initiated, one Adjudicating Authority (chosen as per the Framework Agreement) would have jurisdiction over the insolvency proceedings of each of the companies and the group coordination proceedings. Further, these companies may be allowed to seek an extension of the CIRP period by another ninety days to account for the additional time these proceedings may take to enable the value maximising resolution. (Part IV, Para 188.8.131.52)
Substantive consolidation is the pooling of the assets and liabilities of technically distinct corporate entities. The assets of individual members of a corporate group are pooled and intra-group debts forgiven so that claims of third-party creditors may be satisfied from a single common source during proceeding.
Such consolidation is targeted at consolidating the assets and liabilities of different group companies so that they are treated as part of a single insolvency estate for the purpose of reorganization or distribution in liquidation.
Such consolidation disregards the concept of asset partitioning, result in unfair treatment of certain creditor’s constituencies.
The substantive consolidation of the corporate insolvency resolution process (CIRP) of 13 Videocon Group entities in light of intricately connected business.
The Hon'ble Tribunal based upon reading of the history of 'group insolvency', listed the following parameters so that the presence of them can lead to a decisive conclusion of triggering of 'consolidation' of Insolvency process, 14 principals (triggering of 'consolidation' of Insolvency process) laid down by judiciary followed in Videocon case11 and onwards for substantive consolidations : (i)common control; (ii) common directors; (iii) common assets; (iv) common liabilities; (v) inter-dependence; (vi) interlacing of finance; (vii) pooling of resources; (viii) co-existence for survival; (ix) intricate link of subsidiaries; (x) intertwined accounts; (xi) inter-looping of debts; (xii) singleness of economics of units; (xiii) common financial creditors: (xiv) cross-shareholding.
Tribunal also held that, although in all 15 cases, the accounts are inter- mingled and due to the existence of agreements, yet there is a relationship of obligor and/or co-obligors among all these entities. But it was necessary to further ascertain the position of advantage or disadvantage qua the stakeholders. In other words, if an entity is self-serving, self-dependent and self-sustainable, a view can be taken for not granting consolidation.
KAIL Ltd. - An application u/s 9 against the Corporate Debtor KAIL Ltd. was submitted by an Operational Creditor- Cooltech Appliances, which was admitted vide an order of 08.06.2018. KAIL is engaged in the business of manufacturing and trading of various consumer electronic goods and home appliances, such as washing machines, air conditioners, air coolers, television and other electric appliances. Manufacturing facilities are located in West Bengal. The entity is having annual turnover of more than Rs. 400 Crores and has nearly 350 workers in a factory which is undisputedly owned by the Company. It was submitted that the company was self-sufficient, its products were in demand all over the country and its business was also not dependent on the other 14 group companies, this company was capable of maintaining itself as a going concern on its own.
Also, considering interests of the employees and workers of this company, it is seen that this company would be in a better position to pay the dues if kept out of consolidation. It is seen that Infotel (a financial creditor of KAIL Ltd.)
had also sought for keeping this company out of consolidation, due to the reason that its own share as a financial creditor would be reduced if the consolidation is allowed. It was held that the company was kept out of consolidation due to the reason that it can function independently and not because the share of financial creditor would be reduced.
Trend Electronics Ltd. - The company was in the business of manufacturing and selling the dish antenna and Set-Top Box which are mandatory pursuant to the compulsory digitalization by the Ministry of Information and Broadcasting. Set-Top Boxes being in great demand in the country, this company is able to do business despite being referred to the CIRP and is independently capable of maintaining itself as a going concern. Its business was concluded to be not dependent on the other 14 companies. If the company was under common CIRP with other companies, there would be a common resolution plan and this company, which has a good asset value, would be treated at par with the other companies, which may prove to be detrimental to this company's resolution plan.
Undisputedly, also laid down by the courts, before ordering consolidation, a preliminary searching inquiry be ensured, whether consolidation yields benefits to stakeholders by offsetting the harm if not consolidated?
11 CA- 1022(PB)/2018- decision dated 24.10.2018
Conclusion: The following points are relevant while considering consolidation
who can apply for consolidation? Whether the corporate debtor or creditors may request for consolidation or whether reference has to be made only by the insolvency professional?
While the application in the case of Videocon was made by the Chairman of the Corporate Debtor (to reduce his exposure as a personal guarantor), the application for consolidation should be made for the general benefit of the creditors and not to safeguard the personal interest of the guarantors of the Corporate Debtor. This does not imply that merely because third parties like guarantors will be in an advantageous position, NCLT will not consider consolidation, however, the NCLT should allow such application only if the same is made by the insolvency professional for maximisation of value to the stakeholders.
whether NCLT may order for consolidation of a debtor with a non- debtor?
In the case of Videocon, the NCLT has allowed consolidation of
solvency and insolvent companies. In fact, on analysis of the precedents cited above also, it is clear that the courts may order for consolidation of a debtor entity with a non- debtor or solvent entity, however, consolidation will not e a general principle, and will depend on the facts and circumstances of each case.
Certain rules against perverse behaviour: While the provisions enabling the avoidance of certain transactions and imposition of liability for wrongful and fraudulent trading may broadly be sufficient to capture intra-group transactions that are value destructive, the framework may permit the Adjudicating Authority to subordinate the claims of other companies in a group in exceptional circumstances of fraud, etc.
12 CA- 1022(PB)/2018- decision dated 24.10.2018.
13 CA- 1022(PB)/2018- decision dated 24.10.2018.
In Venugopal Dhoot v. State Bank of India & Ors.,12 multiple companies of the Videocon group were being put through insolvency resolution processes. In this case, parties sought that all matters pertaining to the insolvency resolution of different Videocon companies be dealt with by the same Adjudicating Authority and that there be consolidation of separate proceedings of multiple Videocon companies to treat “the corporate insolvency resolution process as one in respect of all of these companies”.13 The Principal Bench of the “NCLT” ordered that all the matters regarding the insolvency resolution processes of these different companies be dealt with by the same bench of the NCLT for the purpose of “avoiding conflicting orders and facilitating the hearing” 14 of these matters.
In State Bank of India & Anr. v. Videocon Industries Ltd. & Ors.,15 the Adjudicating Authority ordered that the assets and liabilities of 13 Videocon companies should be substantively consolidated due to common control, common directors, common assets, common liabilities, interdependence, interlacing of finance, co-existence for survival, pooling of resources, intertwined accounts, interloping of debts, singleness of economics of units, common financial creditors and common group of corporate debtors.
In Axis Bank Ltd. v. Lavasa Corpn. Ltd.16 NCLT consolidated the Lavasa group insolvencies in order to avoid potential losses likely to be caused by fractured insolvencies while noting that the insolvency of the subsidiaries largely depended on the outcome of their parent's insolvency noting that if consolidation of CIRPs of the Corporate Debtors will not be done, then the objective of IBC will be defeated, which is profit maximization of the Corporate debtor.
In Edelweiss Asset Reconstruction Company Limited v. Sachet Infrastructure Pvt. Ltd. & Ors.,17 the Appellate Authority held that “group insolvency proceedings were required to be initiated”18 against five companies that had been working as a joint consortium to develop a residential plotted colony. To enable successful development of this colony, the Appellate Authority ordered that “simultaneous ‘Corporate Insolvency Resolution Processes’ should continue against them under the guidance of same ‘Resolution Professional’”19
14 CA- 1022(PB)/2018- decision dated 24.10.2018.
15 M.A 1306/ 2018 & Ors. in CP No. 02/2018 & Ors- decision dated 08.08.2019
16 MA No. 3664 of 2019 in C.P. (IB)-1765, 1757 & 574/MB/2018, dated 26-2-2020
17 Company Appeal (AT) (Insolvency) Nos. 377 to 385 of 2019- decision dated 20.09.2019.
18 Company Appeal (AT) (Insolvency) Nos. 377 to 385 of 2019- decision dated 20.09.2019.
19 Company Appeal (AT) (Insolvency) Nos. 377 to 385 of 2019- decision dated 20.09.2019.
who should run the processes so that they are “completed in one go by initiating a consolidated ‘Resolution Plan(s)’ for total development”.20
In Radico Khaitan Ltd Vs. BT & FC Pvt Ltd.21 An Operational Creditor has a locus standi to file an application for consolidated CIRP. Hon'ble NCLAT allowed the same and ordered to appoint a single common Resolution Professional/Liquidator who will carry on the duties and perform the function of the Resolution Professional/Liquidator in accordance with the I&B Code for the consolidated CIRP.
In Chitra Sharma v. Union of India,22 where insolvency proceedings had been initiated against Jaypee Infratech Ltd., but homebuyers had entered into contracts with both Jaypee Infratech Ltd. and its parent company Jai Prakash Associates Ltd., the Supreme Court ordered that the parent company which was not subject to the insolvency proceedings at that time, deposit a sum of INR two thousand crores before the court.
In Bikram Chatterji v. Union of India,23 homebuyers in projects developed by different companies of the Amrapali group filed a Writ Petition before the Supreme Court in order to protect their interests in the wake of the insolvency of different Amrapali group companies. The Supreme Court in these proceedings dealt with the group as a whole. Given the nature of the transactions between the group companies, the Court also ordered that the properties of all forty group companies in the Amrapali group be attached and the bank accounts of all companies and their directors be frozen.
20 Company Appeal (AT) (Insolvency) Nos. 377 to 385 of 2019- decision dated 20.09.2019.
21 Company Appeal (AT) (Ins) No. 1069 of 2020- 26.04.2021
22 W.P. (Civil) No(s).744/2017- decision dated 11.09.2017
23 W.P. (Civil) No(s).940/2017- decisions dated 17.05.2018 and 01.08.2018.
No provision for Joint CIRP: Resolution Professional should be allowed to initiate joint CIRP and take charge over assets of subsidiary of CD achieve object of code as
Resolving through different CIRP proceedings shall dent value maximization object
24 Company Appeal (AT) (Ins) No. 1069 of 2020