Interim finance during CIRP.

In most of the cases of CD under insolvency, the CD is either facing negative cash flows or the operations are closed. It’s very difficult to envisage a company under insolvency with positive cash flows. It’s only companies with negative cash flows face difficulty in meeting their obligations and slip into insolvency.

As per the Code and regulations, IRP/RP is broadly responsible for the follow;

1. Execution of Corporate Insolvency Resolution Process in accordance with the provisions of the Code & Regulations thereof.

2. Manage the CD as a going concern, if it has not stopped operations prior to the date of commencement of insolvency.

Following are the provisions of the Code in respect of the interim finance;

# Section 5(15) “interim finance” means any financial debt raised by the resolution professional during the insolvency resolution process period;

# Section 20. Management of operations of corporate debtor as going concern. -

(1) The interim resolution professional shall make every endeavour to protect and preserve the value of the property of the corporate debtor and manage the operations of the corporate debtor as a going concern.

(2) For the purposes of sub-section (1), the interim resolution professional shall have the authority-

• (a)......

• (b)......

• (c) to raise interim finance provided that no security interest shall be created over any encumbered property of the corporate debtor without the prior consent of the creditors whose debt is secured over such encumbered property:

Provided that no prior consent of the creditor shall be required where the value of such property is not less than the amount equivalent to twice the amount of the debt.

# Section 28. Approval of committee of creditors for certain actions. -

(1) Notwithstanding anything contained in any other law for the time being in force, the resolution professional, during the corporate insolvency resolution process, shall not take any of the following actions without the prior approval of the committee of creditors namely: -

• (a) raise any interim finance in excess of the amount as may be decided by the committee of creditors in their meeting;

• (b) create any security interest over the assets of the corporate debtor;

• …….

• ……..

(2) The resolution professional shall convene a meeting of the committee of creditors and seek the vote of the creditors prior to taking any of the actions under sub-section (1).

(3) No action under sub-section (1) shall be approved by the committee of creditors unless approved by a vote of sixty-six per cent. of the voting shares.

(4) Where any action under sub-section (1) is taken by the resolution professional without seeking the approval of the committee of creditors in the manner as required in this section, such action shall be void.

(5) The committee of creditors may report the actions of the resolution professional under sub-section (4) to the Board for taking necessary actions against him under this code.

# Regulation 2A.(ea) “liquidation cost” ( Liquidation Process Regulations) under clause (16) of section 5 means-

• (i) fee payable to the liquidator under regulation 4;

• (ii) remuneration payable by the liquidator under sub-regulation (1) of regulation 7;

• (iii) costs incurred by the liquidator under sub-regulation (2) of regulation 24;

• (iv) costs incurred by the liquidator for preserving and protecting the assets, properties, effects and actionable claims, including secured assets, of the corporate debtor;

• (v) costs incurred by the liquidator in carrying on the business of the corporate debtor as a going concern;

• (vi) interest on interim finance for a period of twelve months or for the period from the liquidation commencement date till repayment of interim finance, whichever is lower;

• (vii) the amount repayable to contributories under sub-regulation (3) of regulation 2A;

• (viii) any other cost incurred by the liquidator which is essential for completing the liquidation process:

Provided that the cost, if any, incurred by the liquidator in relation to compromise or arrangement under section 230 of the Companies Act, 2013 (18 of 2013), if any, shall not form part of liquidation cost.

In a fairly good number of cases, CoC is reluctant to approve interim finance. This puts the IRP/RP in a precarious situation, as he is responsible to carry out certain statutory duties under the Code besides managing the CD as a going concern. Author is of the opinion that CIRP Regulations should have enabling provision (similar to Liquidation process regulations), that the FC with the biggest vote share will provide interim finance, as estimated by IRP /RP, with interest @ MCLR + 2%.

# Regulation 2A. Contributions to liquidation costs.( Liquidation Process Regulations)

(1) Where the committee of creditors did not approve a plan under sub-regulations (3) of regulation 39B of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, the liquidator shall call upon the financial creditors, being financial institutions, to contribute the excess of the liquidation costs over the liquid assets of the corporate debtor, as estimated by him, in proportion to the financial debts owed to them by the corporate debtor.

Note;-  The above provisions of the Code & Regulations speaks of interim finance for Management of operations of CD as a going concern. The Code as well as Regulations are silent for the situation where the CD is not a going concern and the operations of the CD stopped prior to the DOC of insolvency.

Disclaimer: The sole purpose of this blog is to create awareness on the subject and must not be used as a guide for taking or recommending any action or decision. A reader must do his own research and seek professional advice if he intends to take any action or decision in the matters covered in this blog.

Altman Z-Score

A slew of unforeseen corporate failures in India has brought to the fore the need for a reliable bankruptcy indicator.

 

Multiple companies – Jet Airways, Videocon, and Reliance Communications, to name a few – have crumbled into insolvent pitcher plants, seemingly from positions of strength. Jet Airways, for instance, had a market share of 13.9% in November 2018, second only to IndiGo Airlines, before it went belly up earlier this year.

 

Further, the debt of companies such as travel major Cox & Kings and Dewan Housing Finance Limited had healthy long-term ratings, with very low-to-moderate risk of non-payment, before they ultimately defaulted.

 

In hindsight, it appears that their financial strengths were merely an accounting facade, and credit rating agencies have been caught napping.

 

There is a need, therefore, to evaluate companies on an academically proven parameter that is consistent across jurisdictions. One such time-tested early warning system for corporate distress is the Altman Z-Score.

 

A brief history

Edward Altman, in 1968, introduced the Altman Z-Score as part of a scholarly article published in the Journal of Finance. Altman, currently professor emeritus of finance at New York University’s Stern School of Business, analysed companies based on five financial ratios.

1. Liquidity: the availability of financial assets that can be quickly converted to cash.

2. Solvency: a measure of the assets possessed by a company that will help in meeting its long-term debts.

3. Profitability: an indicator of a firm’s ability to sustain its profits in the long-run.

4. Leverage: how much capital comes in the form of debt?

5. Activity: how effectively a firm uses its operating assets to convert them into sales or cash.

 

In a subsequent paper in 2002, Altman examined 86 distressed companies from 1969-’75, 110 bankrupt companies from 1976-’95, and 120 bankrupt companies from 1997-’99. The Z-Score had an astonishingly high accuracy of 82%-96%.

The methodology rose to prominence during the 2008 financial crisis when it successfully predicted corporate defaults that ultimately led to the bust of Lehman Brothers.

The Z-Score

Here is how a company’s Z-Score is calculated:

Z-Score (Z) = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E

Where:

A = Working Capital/Total Assets

B = Retained Earnings/Total Assets

C = Earnings Before Interest and Taxes/Total Assets

D = Market Value of Equity/Total Liabilities

E = Sales/Total Assets

The score translates to the financial state of a company as follows;

Z - Score	Corporate Distress
Z < 1.81	Distress zone (High probability of bankruptcy)
Z is between 1.81 and 2,99	Grey zone (moderate chance of bankruptcy)
Z > 2.99	Safe zone (negligible chance of bankruptcy)

Indian context

Does the Z-Score work in the Indian context? Let us undertake an analysis of a few stocks.

The stocks selected are either on the verge of bankruptcy or under tremendous financial stress. To avoid any confirmatory bias; every stock is being put under the scanner based on their annual reported financial figures as of March 2018 – well before their troubles started making headlines.

1. Infrastructure Leasing & Financial Services: IL&FS, which lent to infrastructure companies, was the harbinger of India’s shadow banking crisis. In September 2018, the company defaulted on its payments, which spelt trouble for its many investors, which included banks, insurance companies, and mutual funds.
   Z-Score = 1.2*(-0.254) + 1.4*(-0.031) + 3.3*(0.073) + 0.6*(0.071) + 1*(0.352) = 0.29

2. Dewan Housing Finance Ltd: DHFL has been a victim of the double whammy of a liquidity crunch and financial irregularities. In June this year, the company delayed interest rate payments, which hit mutual funds that had lent to it. Initially, its troubles were considered a casualty of the IL&FS crisis, but lately, after a forensic audit, massive irregularities by promoters have been highlighted.
   Z-Score = 1.2*(0.939) + 1.4*(0.082) + 3.3*(0.089) + 0.6*(0.164) + 1*(0.101) = 1.73

3. Cox & Kings: The travel and tourism company is undergoing insolvency proceedings after it defaulted numerous times on its loans this year due to a liquidity crisis. The International Air Transport Association has terminated its licence to sell air tickets.
   Z-Score = 1.2*(0.167) + 1.4*(0.297) + 3.3*(0.091) + 0.6*(0.621) + 1*(0.595) = 1.88

4. Reliance Communications: The Anil Ambani-led Reliance Group company’s plight is one of the many high-profile bankruptcy cases in India. The telco was plagued by intense price wars, ballooning debt, and plunging profitability. In March this year, Anil Ambani nearly faced a jail term for non-payment of dues to equipment maker Ericsson.
   Z-Score = 1.2*(-0.094) + 1.4*(0.019) + 3.3*(0.002) + 0.6*(0.084) + 1*(0.062) = 0.03

5. Adlabs Entertainment: The owner of the Adlabs Imagica theme park, has been struggling to pay off its loans after it took up massive debt while constructing hospitality-based assets. Its loans were declared as non-performing assets in June 2018.
   Z-Score = 1.2*(-0.084) + 1.4*(0.193) + 3.3*(-0.018) + 0.6*(0.349) + 1*(0.142) = 0.46

From the above computations, it can be deciphered that the Z-Score is significantly effective and accurate at predicting corporate bankruptcies across sectors.

 

(Courtesy - Vatsal Bhandari, qz.com) 

Contradictory judgements & Fundamental Right of Equality

Recently, I came across some contradictory judgements of the same bench of NCLAT, which are as follows;

Situation 1. Filing  Claim in  Guarantor’s CIRP (Maturity of claim - invocation of guarantee). 

The question here was whether a creditor can file a claim in the CIRP of  Corporate Guarantor, without invoking guarantee, in other words when the claim has not matured.

NCLAT (14.08.2018) In the matter of Export Import Bank of India and Ors. Vs. RP JEKPL Pvt. Ltd. and Ors. [CA No. 304 of 2017, 16 of 2018 and 302 of 2017]  

 # 53 …………. Any person who has the right to claim payment, as defined under Section 3(6), is supposed to file the claim whether matured or unmatured. The question as to whether there is a default or not is not to be seen.

 # 54. Therefore, stand taken by the respondents that the claim has not been matured cannot be ground to reject the claim.

 # 56. Therefore, we hold that maturity of claim or default of claim or  invocation of guarantee for claiming the amount has no nexus with filing of claim pursuant to public announcement made under Section 13(1)(b) r/w Section 15(1)(c) or for collating the claim under Section 18(1)(b) or for updating claim under Section 25(2)(e).

NCLAT (23.04.2019) Edelweiss Asset Reconstruction Company Limited  Vs Orissa Manganese and Minerals Limited & Ors.[CA (AT) (Insolvency) No. 437, 438, 444,500 of 2018] 

 # 26. It is also not the case of the Appellant- ‘Edelweiss Asset Reconstruction Limited’ that it has not received the amount from the ‘Principal Borrower’ on default and, therefore, it was liable to invoke the Bank Guarantee which it invokes. In this background, the claim having not matured in absence of alleged default on the part of the ‘Principal Borrower’ and for non-invocation of the Bank Guarantee, the Appellant- ‘Edelweiss Asset Reconstruction Limited’ claim cannot be accepted the debt payable by the ‘Corporate Debtor’ as on the date of the admission (initiation of Corporate Insolvency Resolution Process’).

Situation 2. Filing for  insolvency of Principal Borrower & Corporate Guarantor by the same Financial Creditor.

Question here was whether a financial creditor can file application U/s 7, against Corporate Debtor & Corporate Guarantor, simultaneously. As per sub-section (2) of section 60, of the Code, a creditor can file an application relating to the insolvency resolution or liquidation of a corporate guarantor, during the pendency of  CIRP or liquidation proceeding of a corporate debtor.

NCLAT (18.04.2018) State Bank of India Vs. D. S. Rajender Kumar [CA (AT) (Insolvency) No. 87 to 91/2018] 

- #5……….. However, it is made clear that order of ‘Moratorium’ will be applicable only to the proceedings against the ‘Corporate Debtor’ and the ‘Personal Guarantor’, if pending before any court of law/Tribunal or authority but the order of ‘Moratorium’ will not be applicable for filing application for triggering ‘Corporate Insolvency Resolution Process’ under Sections 7 or 9 or 10 of the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as “I&B Code”) against the ‘Guarantor’ or the ‘Personal Guarantor’ under Section 60(2).

NCLAT (08.01.2019) in Dr. Vishnu Kumar Agarwal  Vs  M/s. Piramal Enterprises Ltd [CA (AT) (Insolvency) No. 346 of 2018]

- #32. There is no bar in the ‘I&B Code’ for filing simultaneously two applications under Section 7 against the ‘Principal Borrower’ as well as the ‘Corporate Guarantor(s)’ or against both the ‘Guarantors’. However, once for the same set of claim application under Section 7 filed by the ‘Financial Creditor’ is admitted against one of the ‘Corporate Debtors’ (‘Principal Borrower’ or ‘Corporate Guarantor(s)’), second application by the same ‘Financial Creditor’ for same set of claim and default cannot be admitted against the other ‘Corporate Debtor’ (the ‘Corporate Guarantor(s)’ or the Principal Borrower’). Further, though there is a provision to file joint application under Section 7 by the ‘Financial Creditors’, no application can be filed by the ‘Financial Creditor’ against two or more ‘Corporate Debtors’ on the ground of joint liability (‘Principal Borrower’ and one ‘Corporate Guarantor’, or ‘Principal Borrower’ or two ‘Corporate Guarantors’ or one ‘Corporate Guarantor’ and other ‘Corporate Guarantor’), till it is shown that the ‘Corporate Debtors’ combinedly are joint venture company.

Situation 3. Distribution of funds under resolution plan approved by the CoC.

The question here is whether CoC is empowered to decide the distribution of funds under resolution plan amongst ‘Financial Creditor’ or ‘Operational Creditor or ‘Secured Creditor’ or ‘Unsecured Creditor’ and whether the same can be adjudicated by NCLT / NCLAT.

NCLAT (02.05.2018) in  Darshak Enterprise Pvt. Ltd. Vs.Chhaparia Industries Pvt. Ltd. & Ors.[Company Appeal (AT) (Insolvency) No. 327 of 2017]

- # 6. ………………………..In a particular case, what should be the percentage of claim amount payable to one or other ‘Financial Creditor’ or ‘Operational Creditor or ‘Secured Creditor’ or ‘Unsecured Creditor’ can be decided by the Committee of Creditors based on facts and circumstances of each case. In absence of any discrimination or perverse decision, it is not open to the Adjudicating Authority or this Appellate Tribunal to modify the plan.

SCI (05.02.2019) in  K. Sashidhar :Vs. Indian Overseas Bank & Ors.(Civil appeal no..10673 of  2018)

- # 61. ………………Concededly, if the objection to the resolution plan is on account of infraction of ground(s) specified in Sections 30(2) and 61(3), that must be specifically and expressly raised at the relevant time. For, the approval of the resolution plan by the CoC can be challenged on those grounds. However, if the opposition to the proposed resolution plan is purely a commercial or business decision, the same, being nonjusticiable, is not open to challenge before the Adjudicating Authority (NCLT) or for that matter the Appellate Authority (NCLAT).

NCLAT (04.07.2019) in Standard Chartered Bank Vs. Satish Kumar Gupta, R.P. of Essar Steel Ltd. & Ors.[Company Appeal (AT) (Ins.) No. 242 of 2019] 

- # 200. In view of the aforesaid observations, instead of rejecting the ‘Resolution Plan’ submitted by ‘ArcelorMittal India Pvt. Ltd.’, we modify the plan to safeguard the rights of the ‘Operational Creditors’ and other ‘Financial Creditors’. The impugned order dated 8th March, 2019 stands modified to the extent above.

From the above cases, it can be observed that NCLAT, not only had passed the contradictory judgements, but in situation 3, it had disregarded the law laid down by the Hon’ble SCI in its judgement dated 05.02.2019 quoted supra above. Probably it has lost sight of provisions of the Constitution of India & The Doctrine of “Per Incuriam”.

Constitution of India

As per Article 141 of The Constitution of India, the law laid down by the Hon’ble Supreme Court of India is binding on all courts in India. 

# Article 141. The law declared by the Supreme Court shall be binding on all courts within the territory of India.

The Doctrine of “Per Incuriam”.

i). Constitution Bench of Hon’ble SCI in Union of India v. Raghubir Singh [(1989) 2 SCC 754], observed as under:

-"The doctrine of binding precedent has the merit of promoting certainty and consistency in judicial decisions, and enables an organic development of the law, besides providing assurance to the individual as to the consequence of transactions forming part of his daily affairs. And, therefore, the need for a clear and consistent enunciation of legal principle in the decisions of a court."

ii). Hon’ble SCI  in Government of A.P. and Another v. B. Satyanarayana Rao (dead) by LRs. and Others [(2000) 4 SCC 262], observed as under:

- "The rule of per incuriam can be applied where a court omits to consider a binding precedent of the same court or the superior court rendered on the same issue or where a court omits to consider any statute while deciding that issue."

Another important question arises, whether the contradictory judgements do infringe the “Fundamental Right of Equality” of the individuals (any of the litigant) guaranteed under Article 14  the constitution of India.

Article 14. Right to Equality The State shall not deny to any person equality before the law or the equal protection of the laws within the territory of India.

I request the seniors in the legal fraternity to examine the issue for remedial measures, including filing of PIL with Hon’ble SCI & to devise a framework to prevent these situations in the future.

Disclaimer: The sole purpose of this blog is to create awareness on the subject and must not be used as a guide for taking or recommending any action or decision. A reader must do his own research and seek professional advice if he intends to take any action or decision in the matters covered in this blog.