28 January 2021

Board Distorts the provisions of Regulatory Controls in IBC.

Recently there has been a flood of Disciplinary Cases against the Insolvency Professionals. Let’s look into some of the important provisions of the Code & Regulations framed by the Board, in respect of appointment of Inspecting / Investigating Authority and constituting the Disciplinary Committee.

Insolvency and Bankruptcy Code, 2016.

# Section 218. Investigation of insolvency professional agency or its member or information utility. -

(1) Where the Board, on receipt of a complaint under section 217 or has reasonable grounds to believe that any insolvency professional agency or insolvency professional or an information utility has contravened any of the provisions of the Code or the rules or regulations made or directions issued by the Board thereunder, it may, at any time by an order in writing, direct any person or persons to act as an investigating authority to conduct an inspection or investigation of the insolvency professional agency or insolvency professional or an information utility.


# Section 220. Appointment of disciplinary committee. –

(1) The Board shall constitute a disciplinary committee to consider the reports of the investigating Authority submitted under sub-section (6) of section 218:

Provided that the members of the disciplinary committee shall consist of whole-time members of the Board only.


Insolvency and Bankruptcy Board of India (Inspection and Investigation) Regulations, 2017.

# Regulation 2. Definitions.

(1) In these regulations, unless the context otherwise requires –

(c) “Disciplinary Committee” means a committee of whole time member(s) constituted by the Board under sub-section (1) of section 220 of the Code:

Provided that the whole time member(s) in the Disciplinary Committee shall not be associated with the investigation or inspection;

(e) “Investigating Authority” means an officer or a team of officers of the Board, which has been directed by the Board, to conduct the investigation of a service provider;

(f) “Inspecting Authority” means an officer or a team of officers of the Board, which has been directed by the Board, to conduct the inspection of a service provider;


Conflict between the provisions of the Code & Regulations;

S.No.

Area of Conflict

Provisions of the Code

Provisions of Regulations

1.

No. of members of Disciplinary Committee

Provided that the members of the disciplinary committee shall consist of whole-time members of the Board only.

“Disciplinary Committee” means a committee of whole time member(s) constituted by the Board under sub-section (1) of section 220 of the Code:

2.

Investigating Authority

direct any person or persons to act as an investigating authority to conduct an inspection or investigation 

Investigating Authority” means an officer or a team of officers of the Board,

3.

Inspecting Authority

direct any person or persons to act as an investigating authority to conduct an inspection or investigation 

Inspecting Authority” means an officer or a team of officers of the Board,


From the above table, it can be observed that Board distorted the the provisions of the Code, mainly in following two areas;


1. The Code provides that members of the disciplinary committee shall consist of whole-time members of the Board only. The legislative intent of the Parliament in using the word “members” in the provisions of the Code, denotes that the disciplinary committee will have two or more members. Logic behind the disciplinary committee having two or more whole time members of the Board might be that decisions of the disciplinary committee may not have the disconnect with the policies of the Board.


Whereas the Board framed distorted regulations reading; 

  • “Disciplinary Committee” means a committee of whole time member(s) constituted by the Board”

Thus with the distorted regulations, the Board gave itself authority to constitute a single member disciplinary committee. Accordingly most of the decisions in disciplinary cases are being taken by the single member disciplinary committee.


Now the following questions arise;

  1. Whether the Board has the mandate to frame regulations beyond the provisions of the Code & Legislative intent of the Parliament. On this aspect the observations of NCLT are quite significant, quoted below.

  2. Whether the decisions of the single member disciplinary committee are legally enforceable. The Code does not provide for the validity of orders of the disciplinary committee during vacancy in the disciplinary committee. In my view, the decisions of a single member disciplinary committee are bad in law and are not enforceable.


2. For appointment of investigating authority the Code gave the Board the authority to  direct any person or persons to act as an investigating authority to conduct an inspection or investigation, whereas the Board under the regulations restricted the appointment of investigating/inspection authority of  officer or a team of officers of the Board,( mostly non-professionals / babus). This way objectivity & professionalism of inspection & investigations have been lost. In one case the Inspecting Authority / Disciplinary Committee failed to identify a fraudulent transaction, sanctioned by CoC, despite having discussed the same in the Disciplinary order.


Fraudulent Transactions in IBC - A case study


NCLT (PB) New Delhi (2020.09.16) in  Invest Asset Securitisations and Reconstruction Pvt Ltd v/s Mohan Gems & Jewels Pvt. Ltd. [IA 1490/2020 in CP No. (IB)-590 (PB)/2018] observed as under

# 13. If the Code is carefully read, it could be ascertained that wherever the Code felt that IBBI assistance is required, it has been specifically stated "as specified by the Board or in such manner as may be specified or prescribed" we must at the cost of repetition reiterate, this clause is indicative of the fact that beyond the procedure inbuilt in the Code, if additional mechanism or paraphernalia is required to accomplish implementation of the statute, there it has been mentioned as "as specified by the Board or in such manner as may be specified or prescribed”. The point to remember is, it is for supplementation, not for supplantation. 

# 15. If these two provisions are read together, it could be understood that Section 196 is to confer powers and functions upon IBBI, Section 240 is to confer upon IBBI general power (subsection 1) to regulate and particular power (subsection 2) to regulate the areas mentioned in subsection-2. If section 240 (2) regulating powers are read along with other provisions of the Code, it is evident that in whichever Section it has been mentioned as "as specified by the Board or in such manner as may be specified or prescribed”, over those sections alone, regulating power is conferred upon IBBI in subsection 2 of section 240. 

# 16. Of course implicit overriding effect is given in Section 240 (1) of the Code stating that regulating power over particular Sections  will not cause prejudice to the general regulating power of subsection 1, which is as follows;

  • "(1). The Board may, by notification, make regulations consistent with this Code and the rules made there under, to carry out the provisions of this Code” 

# 17. By reading this sub section, it is understandable that IBBI is given discretion to notify regulations. But those regulations are qualified by later-part of the subsection above. 

# 18. Those regulations shall be not only consistent with the Code but shall also be consistent with Rules issued u/s 239. So these Regulations shall be subordinate and supplemental to the Code as well as Rules. 

# 19. The purpose and object of the Regulations issued by IBBI is to carry out the provisions of the Code, not for carrying out the purpose of the Code. ………

# 20. It is explicitly mentioned in subsection -1 of section 240, Regulations are to sub-serve sections of the Code in implementation. There are umpteen citations of Hon'ble Supreme Court saying though general power is given in one sub section and when the factors enumerated in another subsection are illustrative in nature, the rule making power mostly limited to those illustrations only. In this case, IBBI is to regulate the working of insolvency professionals relating to the duties of them. IBBI regulating power is even subject to rule-making power of the central government u/s 239 of the Code. In Kerala Samsthana Chethu Thozhilali Union v. State of Kerala (2006) 4 SCC 327, it has been held as follows: 

  • "17. A rule is not only required to be made in conformity with the provisions of the Act where under it is made, but the same must be in conformity with the provisions of any other Act, as a subordinate legislation cannot be violative of any plenary legislation made by the Parliament or the State Legislature. 

  • 37. Furthermore, the terms and conditions which can be imposed by the State for the purpose of parting with its right of exclusive privilege more or less has been exhaustively dealt with in the illustrations in sub-section (2) of Section 29 of the Act. There cannot be any doubt whatsoever that the general power to make rules is contained in sub-section (1) of Section 29. The provisions contained in sub-section (2) are illustrative in nature. But, the factors enumerated in sub-section (2) of Section 29 are indicative of the heads under which the statutory framework should ordinarily be worked out. 

  • 43. The submission of Mr. Iyer that there exists a distinction between carrying out the provisions of the Act and the purpose of the Act, is not relevant for our purpose. The power of delegated legislation cannot be exercised for the purpose of framing a new policy. The power can be exercised only to give effect to the provisions of the Act and not dehors the same. While considering the carrying out of the provisions of the Act, the court must see to it that the rule framed therefore is in conformity with the provisions thereof. 

  • 46. In Hotel Balaji and Others v. State of A.P. and Others (1993 Supp (4) SCC 536), whereupon Mr. Iyer placed reliance, it is stated: "The necessity and significance of the delegated legislation is well accepted and needs no elaboration at our hands. Even so, it is well to remind ourselves that rules represent subordinate legislation. They cannot travel beyond the purview of the Act. Where the Act says that rules on being made shall be deemed "as if enacted in this Act", the position may be different. (It is not necessary to express any definite opinion on this aspect for the purpose of this case.) But where the Act does not say so, the rules do not become part of the Act." 


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.


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9 January 2021

Pre-packaged Insolvency Resolution Process

GOI vide notice dated 08.01.2021, invited comments from the public on Pre-packaged Insolvency Resolution Process under Insolvency and Bankruptcy Code, 2016. Let’s look into the Salient Features of Proposed Pre-pack vis-à-vis CIRP.

Parameter

CIRP

Proposed Pre-pack

Objective

Resolution through a resolution plan 

Resolution through a resolution plan

Legal framework

Relatively more in the statute and less in regulations

Relatively less in the statute and more in regulations

Applicability

Companies and LLPs

Companies and LLPs

Initiation of process

Default above Rs.1 crore

excluding COVID-19 Default

Pre and post default stress, including COVID-19 default. In a phased manner, if required

Initiation by

FC, OC, or CD

CD, with consent of majority of

unrelated Fcs

Management of the CD

IP-in-possession with

creditor-in-control

Debtor-in-possession with

creditor-in-control

Role of IP

IRP appointed by the applicant and then RP by the CoC

RP, to be appointed with consent of majority of unrelated Fcs

Role of IP

Managing affairs of the CD and conducting the process

Conducting the process

Claim collation

IRP to invite and collate

CD to provide. RP to verify

Information memorandum

Prepared by RP

Draft prepared by CD and finalised by RP

Moratorium

Moratorium under section 14 

Limited Moratorium

Interim finance

Yes 

Yes

Avoidance transactions 

Yes

Yes

Valuation

By two valuers

By two valuers

IRPC

Includes cost of running operations

Does not include cost of running

operations

Invitation for resolution plans

Public process

First right of offer to promoters,

Swiss Challenge

Ineligibility for resolution plan

Section 29A to apply

Section 29A to apply

Early closure of process

Under section 12A, on request of the applicant

With approval of 66% of voting share, present and voting; Suo moto by CoC

Approval of resolution plan by CoC

66% of voting share

66% of voting share, present and voting

Consequence of termination of process 

No termination allowed

Liquidation, with 75% of voting

share of CoC

Consequence of failure of process

Liquidation

Closure

Binding outcome

Resolution plan binding 

Resolution plan binding 

Regulatory benefits

Yes

Yes

Clean Slate, post resolution

Yes

Yes

Role of IP and AA

Relatively more

Relatively less

Timeline

180 days till approval of resolution plan by the AA

90 days for filing of resolution plan with the AA plus 30 days for the AA to approve it

Cooling off

12 months between two CIRPs

Three years between two Pre-packs


My Comments;

Majority of Insolvencies are due to mismanagement or corrupt practices of the management of the CD. In the present & proposed pre-pack  insolvency regime there is no disincentive for the corrupt management. Pre pack will rather provide premium for corrupt management as debtors will continue to be in management. It will provide a way out to legally evade the liabilities. 


Hon’ble Supreme Court of India, in Swiss Ribbons Pvt. Ltd. & Anr. v. UOI & Ors, while examining the constitutional validity of IBC  had  observed that;


  • “The Defaulters’ paradise is lost. In its place, the economy’s rightful position has been regained.”

                                ~ Justice RF Nariman

By permitting the debtors to retain the control of the business during insolvency, we will be going back to the pre IBC era & all advantages of the IBC will be negated. Pre pack or post pack whatever the procedure may be, the debtor should not be in the control of the business. The idea behind pre-packs is to speed up the process. The need of the hour is to strengthen the judicial system to avoid delays. The concept of swiss challenge can be imported in the IBC regime. 


Concepts of pre-pack & debtors in control can only be considered in the case of MSME, where generally resolution applicants are few. 


System should have some disincentive for the promoters in case the company goes into insolvency / liquidation. Least, the promoters can be disqualified from becoming KMP (Key Managerial Person) of a company for the next 5/10 years. 


I am not able to reconcile with the concept of “Cooling off period between two Insolvencies” Every insolvency has its own cost which is borne by the society. It’s taxpayers' money on the one hand and (i) Lower interest on deposits to elderly depositors of the banks (FC’s) (ii) Higher interest cost for efficient businesses. Why should the incompetent managements be given the second/third chance to splurge the public money? Second insolvency, within a certain time frame raises questions, whether earlier resolution of CD was a right decision? Second insolvency within a certain time frame, should result in direct liquidation of CD & permanent disqualification of the promoters/directors. 


PSBs' NPAs accounted for 85 per cent of the NPAs of the banking system in 2013 as compared to 75 percent in 2003. During this period, the PSB's share in total bank credit increased only marginally, from 74 percent to 76 percent.


"The gross non-performing assets of public sector and private sector banks as on September 30, 2017 were Rs 7,33,974 crore, Rs 1,02,808 crore,respectively," the finance ministry said citing RBI data.


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