Curious case of Synergies & its implications for IBC

Is there a loophole in the Insolvency and Bankruptcy Code (IBC), 2016, which creates room for promoters to exercise control over the committee of creditors and ensure the passage of resolution plans to their benefit? The insolvency proceedings of Synergies Dooray are an illustrative example.

& break down the insolvency code.

Is there a loophole in the Insolvency and Bankruptcy Code (IBC), 2016, that creates room for promoters to exercise control over the committee of creditors and ensure the passage of resolution plans to their benefit?

The insolvency proceedings of Synergies Dooray are an illustrative example.

Synergies Dooray was placed under insolvency proceedings in January 2017. At the time, the company owed its financial creditors ~972.15 crore. But the insolvency plan that was approved by the committee of creditors involved paying its financial creditors only ~50 crore. If the plan had not been approved in the mandated time period, the company would have gone into liquidation.

The insolvency procedure

In May 2016, the legal framework for dealing with insolvency resolution in India underwent a monumental change with the passing of the IBC, 2016.

On default of payments, any creditor can approach the National Company Law Tribunal (NCLT) to initiate insolvency proceedings against a corporate debtor. If the NCLT admits it, then an interim insolvency professional is appointed. Once this happens, the board of the company loses control over its affairs.

The insolvency professional then creates a committee of creditors, which appoints an insolvency resolution professional to work on a resolution plan. The plan needs to be approved by a committee of creditors (with 75 per cent of the votes) within 180 days. The law provides for a grace period of 90 days. At the end of the 270 days, if no resolution is approved, the company goes into liquidation. The process is fairly straightforward with clear timelines.

The Synergies Dooray case

At the time the firm was admitted for insolvency proceedings, it had loans worth ~972.15 crore spread across four creditors — Alchemist Asset Reconstruction Company (~122.06 crore), Edelweiss Asset Reconstruction Company (~86.92 crore), Millennium Finance (~673.91 crore), and Synergies Casting (~89.26 crore). Synergies Casting, being a related party of Synergies Dooray, had no voting rights in the committee of creditors. But in the second meeting of the committee of creditors held on June 24, 2017, the resolution plan put forth by Synergies Castings was approved.

What is the allegation?

Under section 21(2) of the IBC, the committee of creditors shall comprise all financial creditors, excluding the corporate debtor’s related parties to which it owes money.

This section is to prevent the related party of the corporate debtor from having any say in the committee of creditors. This implies that in this case, Synergies Casting, which is a related party of Synergies Dooray, did not have any right on the committee of creditors.

Now, Edelweiss ARC says that Synergy Castings had sold 92.93 per cent of its loan, or ~673.91 crore, to Millennium Finance for a sum of ~39.38 crore in November 2016 before the initiation of insolvency proceedings. This transaction, which gave Millennium Finance 76.33 per cent of the voting rights in the committee of creditors, is reported to have allegedly given Synergies Casting, through Millennium Finance, a back-door entry to capture majority voting rights in the committee of creditors. Thereby, getting its resolution plan passed. Edelweiss ARC’s appeals were rejected by the NCLT. It has now approached the National Company Law Appellate Tribunal.

Under the law, parties related to the corporate debtor, in this case Synergies Casting, do not have any voting rights in the committee of creditors. But what if the related party sells off its assets — the loan to the company under insolvency— to a third party, altering the dynamics of the proceedings? In this case, should the transaction between Synergies Casting and Millennium Finance be under the purview of the IBC?

What does the law say?

There are two issues here. One, who is a related party; two, the undervalued transactions. Section 5, sub-section 24 of the IBC defines who a related party is. It lists several possible ways in which entities are related. But some experts say that clause (f) of this sub-section which “anybody corporate whose board of directors, managing director or manager, in the ordinary course of business, acts on the advice, directions or instructions of a director, partner or manager of the corporate debtor,” is difficult to prove. Further, section 45(2) of the IBC, which deals with undervalued transactions, covers only transfers by the corporate debtor and not that of the related-parties that are its creditors.

What are the options now?

Rejecting Edelweiss ARC’s appeal could lead to similar such tactics being employed in cases that are currently in the insolvency proceedings.

This is because even during insolvency proceedings, there is no restriction on the transfer of debt by related parties to companies that are legally not related to the original company under insolvency proceedings.

“Regulation 28 of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, provides for transfer of debt between creditors during the insolvency resolution process period. The regulation also states that in such event the fact shall be made known to the resolution professional and the resolution professional shall in that event update the list of creditors and inform the other creditors and the NCLT of the same. The said regulation does not prevent transfer of debt by related parties during the insolvency proceedings. It is to be noted that transfer of debt between two creditors is a subject matter of their contractual obligation. A corporate debtor is not a party to it. The provisions of the IBC also mandate that a creditor who is a related party to the corporate debtor shall not represent, participate and vote during the meetings of the committee of creditors,” says Mamta Binani, the resolution professional in the Synergies Dooray case. Section 14 of the IBC also does not explicitly bar these transactions, say experts.

Andastheresolutionplanneedsto beapprovedby75percentofthevotes, promoterswouldgetoffeasy, if25.1per cent of the votes are in the hands of friendly parties than of creditors who want to recover a higher percentage of their loans. Experts that Business

Standard spoke to say it’s a matter of judicial interpretation. A purposive interpretation of corporate debtor could provide clarity.

“Rather than examine corporate debtor in isolation, as a single entity, it can be interpreted to expand its scope to cover all related parties as well,” said a lawyer. In which case, even undervalued transactions of the corporate debtor by related parties could be brought under the scanner.

There is another option. If the transaction by the related party is deemed in the interest of the corporate debtor then under sub-section (2) of section 43, transactions of the corporate debtor are covered. This gives the resolution professional under section 45(1) the right to make an application to the adjudicating authority to declare such transactions void.