Essar Steel vs RBI: Testing the Insolvency and Bankruptcy Code in courts

Lawyers said till now high courts have not largely intervened in matters that come under the Code

Even as the first legal challenge to the new Insolvency and Bankruptcy Code (Essar Steel vs the Reserve Bank of India) plays out in the Gujarat high court, experts appear divided over the impact that litigation would have on the efficacy of the nascent insolvency resolution process. This comes at a time when more such companies that are involved in insolvency proceedings are likely to put the Code to test in the courts. 

“The Code is as litigation-prone as any other new law,” says Alok Dhir, managing partner, Dhir & Dhir Associates. Lawyers say this is more so as the Code deals with the commercial and conflicting rights and obligations of contesting parties. “It provides for change and modification of rights and claims of stakeholders, takeover of management from existing promoters, change of management, liquidation, among others,” Dhir says. 

Legal experts point out that challenging various aspects of a new law in courts is par for the course. “These are initial days — so we will see stakeholders testing various aspects of the Code. In fact, it will be good to get these various points tested and settled,” says Bahram N Vakil, partner, AZB & Partners. Vakil feels once this is done in the course of the next one year or so, there will be greater confidence in the process and its time-bound structure. 

The Code lays out an insolvency resolution mechanism spread out over 180 days — extendable up to 270 days. In that period, a new class of professionals — insolvency or resolution professionals — take control of the management of the distressed firm or assets, and come out with a resolution plan along with the creditors. Liquidation of assets kicks off if the resolution process fails to meet the deadline.

However, a key concern among different stakeholders — creditors, debtors, promoters, lawyers, turnaround experts and potential buyers of stressed assets — remains. No one is sure about the impact that litigation would have on the speed and success of the bad loan resolution process. 

Contentious points

The Code has a clear-cut grievance resolution mechanism for various stakeholders involved in insolvency resolution. Only the National Company Law Tribunal (NCLT), National Company Law Appellate Tribunal (NCLAT) and the Supreme Court have the jurisdiction to deal with any appeal concerning the Code.  “The Code has taken care to weed out frivolous litigation,” says Manoj K Singh, founding partner, Singh & Associates. 

Lawyers point out that till now high courts have not largely intervened in matters that come under the domain of the Code. However, there are several aspects of the Code that are likely to be put to test in the court of law. These include issues around the approval or rejection of an insolvency petition, valuation of the assets, arriving at the liquidation values, management of the company by resolution professionals, classification of debt into various classes and settlement of claims, among others. 

Lawyers point out that some overlapping provisions in the Code could require interpretation of the courts. Some business decisions of resolution professionals are also likely to be challenged, they add. Stakeholders are likely to exhaust the options prescribed for appeal if they are not satisfied with the outcome of the proceedings, say legal experts. “One cannot stop people from challenging decisions. What is important is how courts treat these cases and how quickly they are resolved,” says Sumant Batra, managing partner, Kesar Dass B & Associates.

Bahram N Vakil, Partner, AZB & Partners

Vakil points to the need for testing the liability of the resolution professional under the Code. “The resolution professional has a good faith exemption but how the courts determine that will be key,” he adds. His advice to resolution professionals is to ensure that they have their own legal counsel — separate from those of other creditors and stakeholders. This will help to avoid conflict of interest when there is a test of a resolution professional’s liability.

Sundaresh Bhat, partner-business restructuring, BDO India, points out that currently there is no insurance cover available for the insolvency or resolution professionals in India. “This is the most important requirement of the hour,” he says.

Another foreseeable bone of contention is the liquidation value. “Valuers will need to make a judgement call and stakeholders may fight this in the courts,” says Vakil. 

Safeguarding stakeholder interest

To mitigate the toll that litigation may take on the resolution proceedings, Batra feels it is important for all stakeholders to appreciate the spirit and objective behind the Code and the benefits it offers. “Litigation would serve the purpose of none as it would only decrease the value and returns for each stakeholder,” he says. 

He says it is important to respect the commercial decisions taken by resolution professionals and the committee of creditors as long as they are taken in accordance with law.  However to ensure quick disposal of cases, even if they land up in the courts, it is important for the government to ensure that there are adequate number of judges, benches and infrastructure available with the NCLT.

Alok Dhir, managing partner, Dhir & Dhir Associates

Dhir points out that the mindset of courts will play a key role in reducing litigation risks.  “If they follow the spirit of the Code and allow the commercial will of the creditors to prevail, the litigation risk will reduce,” says Dhir. However, if the courts take a strictly legalistic point of view, the whole enactment may get bogged down with litigation, say lawyers. 

Legal experts point out that in jurisdictions such as the United States and the United Kingdom, the courts have been reluctant to interfere in the insolvency and bankruptcy process. These courts have largely refrained from substituting their judgment with those of experts in commercial matters. “The key here is for such litigation to be fairly and quickly resolved: That will be in the best interests of all stakeholders,” says Vakil.

What makes the Code litigation-prone
 

• The approval or rejection of an insolvency petition

• Valuation of the assets

• Arriving at the liquidation values

• Questions around management of the company by resolution professionals

• Classification of debt into various classes

• Settlement of claims

• Overlapping provisions in the Code

• Testing the liability of the resolution professional