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Suspension of IBC: Spotlight now on schemes under the Companies Act

A few alterations to the legal provisions will make schemes even more efficient for debt restructuring
The finance minister has announced the suspension of fresh insolvency proceedings for up to one year. During this period, the Insolvency and Bankruptcy Code, 2016 (IBC) will not be available for debt resolution and distressed companies and their creditors may turn to ‘schemes’ under the Companies Act, 2013.


The Companies Act provides the framework for schemes of ‘compromise or arrangement’ between ‘a company and its creditors or any class of them’ or ‘a company and its members or any class of them’. These provisions are used extensively in mergers, demergers, and amalgamations; their use for debt restructuring has not been as common. This is even though Section 230 expressly provides for a ‘scheme of corporate debt restructuring’; that is, ‘a scheme that seeks to restructure or vary the debt obligations of a company towards its creditors’.  


Despite its disuse, the scheme process under the Companies Act is a viable alternative to the IBC. first, it is a collective process. A scheme that is approved by the prescribed majority at meetings of creditors (or of each class) or members (shareholders) and is sanctioned by the National Company Law Tribunal (NCLT), is binding on the company and all its creditors and shareholders. The identification and classification of creditors is based on the company’s books and the treatment proposed in the scheme. Creditors do not submit proofs of claims and are not classified into operational and financial creditors.


Second, it gives creditors the ability to work with the existing managements of distressed companies. Unlike the IBC, which is based on a ‘creditor-in-control’ model of insolvency resolution, the scheme process is premised on ‘debtor-in-possession’. The directors remain in charge. Practically, creditors can consider proposals without change in ownership/management, except in cases of fraud or wilful default.


Third, the scheme process can be used effectively to implement resolution plans approved under the stressed assets framework of the Reserve Bank of India (RBI).


Fourth, the grounds for review of schemes by the NCLT are narrow. Courts have traditionally examined whether the process and proposed terms of a scheme, on the whole, are fair, just and reasonable for all parties involved.


Fifth, the process costs are lower than the typical insolvency resolution process costs under the IBC.


A few alterations to the legal provisions will make schemes even more efficient for debt restructuring. The first relates to the approval of the scheme by creditors. For debt restructuring schemes, the rules provide that before such a scheme is filed with the NCLT, it must be approved in writing by at least 75 per cent in value of the secured creditors, who must provide a ‘creditors responsibility statement’. The rules may be amended such that this requirement be deemed to be complied with when the scheme is approved by the requisite threshold (which is higher than that under the rules) of creditors who have signed an inter-creditor agreement in terms of the stressed assets framework of the RBI. Further, with such an approval, the NCLT may dispense with the post filing meeting of creditors. Alternatively, all creditors who approve the scheme at the pre-filing stage may be required to give an irrevocable proxy to the lead bank to vote in the statutory meeting.


Secondly, while the approval of a scheme at a meeting of shareholders may be required in case of a solvent restructuring, the NCLT must have the power to dispense with such a meeting in insolvent restructurings. Shareholders with no present economic interest should not frustrate viable schemes. Certain common law jurisdictions have allowed discounting of shareholders’ votes in cases where shareholders lacked economic interest in the company. This will require an amendment to the Companies Act.


Thirdly, it is necessary to give the company a ‘calm period’. A moratorium will help, as the company and creditors will have less apprehension of enforcement action. While the Companies Act, 1956, allowed the court to stay proceedings against the company, the provision is absent in the current Companies Act. Similar provisions exist in the laws of England and Singapore, where schemes are used extensively for debt restructuring. The Companies Act may be amended to provide that an interim moratorium be imposed automatically at the time of filing the scheme with the NCLT, like under the IBC for financial sector companies. The NCLT may confirm the moratorium if it is satisfied of the reasonable prospect of success of the scheme based on affidavits filed. This will prevent misuse of the moratorium.


Fourthly, preparation and approval of a scheme needs to be completed swiftly. Companies and creditors may consider appointing insolvency professionals to take care of procedural compliances. Firm timelines for the approval of a scheme may be provided for, say a period of 45 days, such that the process is not unduly delayed. This will also mitigate any adverse impact of the moratorium. Grounds for intervention before the NCLT may also be limited to instances where schemes do not meet the principles of vertical and horizontal equity.

Individual creditor action for recovery and enforcement will be far more inefficient and value-destructive than a collective debt resolution framework. In view of the suspension of the IBC, the government must create an alternative framework. It is the need of the hour.

Disclaimer: Views expressed are personal. They do not reflect the view/s of Business Standard.

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