Reforms required for Inspection of CIRP

Recently  the Appellate Authority NCLAT in Mr Rajnish Jain vs Anupam Tiwari Resolution Professional for M/s Jain Mfg (India) Private Limited & Ors1. observed as under;

• # 31. It is apparent that every action of Resolution Professional, either about the change of status of ‘BVN Traders’ from financial to Operational Creditor or regarding the elimination of name of ‘BVN Traders’ from the ‘Committee of Creditors’ was being done in collusion with erstwhile Member of suspended Board of Directors, Promoter and Managing Director Mr Rajnish Jain. It is pertinent to mention that, the Resolution Professional even in disregard of the orders of the Adjudicating Authority dated 23rd January 2020, subsequently proposed the Resolution before ‘Committee of Creditors’ for considering BVN Traders as Operational Creditor and further for the elimination of name of BVN Traders from ‘Committee of Creditors’. It is also evident that when Appellant and Resolution Professional could not succeed in getting permission from the Adjudicating Authority to change the status of BVN Traders from Financial Creditor to Operation Creditor, Resolution Professional adopted the route of ‘Committee of Creditors’ for the elimination of name of BVN Traders from ‘Committee of Creditors’. In the last, the Appellant and RP succeeded in getting Resolution passed with 100% of the voting share for withdrawal of Petition under Section 12(A) of I&B Code, in total disregard of the Orders of Adjudicating Authority dated 23rd January 2020, whereby the Adjudicating Authority had not permitted Resolution Professional to change the status of BVN Traders from Financial to Operational Creditor.

The above observations of the Appellate Authority highlight the following;

1. Lack of regulatory control of the Board. Resolution Professional & CoC had the courage to blatantly flout the orders of the Adjudicating Authority.

2. Lack of understanding of the Code by the CoC members.

3. Lack of professionalism amongst CoC members.

To prevent such types of situations, the Board needs to beef-up its regulatory controls, which may include the following reforms in the inspection of CIRP / Liquidation processes. I understand that the Board conducts post facto inspections that too in only 15% to 20% of cases. A large no. of irregularities may / can go unnoticed. 

Board may consider moving from 15% to 20% post-facto inspection, to 100% concurrent inspection of insolvency processes. For concurrent inspections, the Board may appoint  Independent Insolvency Professionals as Inspecting Authority/non voting members in CoC. 

i). These Insolvency Professionals(IP) / Inspecting Authority (IA) may be required to perform the following functions;

1. Participate in the proceedings / discussion of CoC, but do not have the right to vote.

2. Inspection of the CIRP process & books of accounts of CD & CIRP.

3. Submit a monthly report of the concurrent inspection to the Board. If required IA may submit an interim inspection report.

Advantages;

1. This way, the Board will get regular and timely professional feedback on the working of RP & CoC. 

2. Submission of CIRP forms (1 to 7) by IRP/RP can be done away with, which will reduce the compliance burden of the IRP/RP & he will be able to devote his time & energy for insolvency & management of CD. Secondly the Board will be spared from the burden of scrutiny of CIRP forms.. 

ii). Independent Insolvency Professional, so appointed as Inspecting Authority / Non Voting CoC member,  should not be;

1. Related part of IRP/RP.

2. Related party of the members of CoC. 

3. Related party of CD & Directors of suspended BOD.

4. Member of CoC or AR of a CoC member.

5. On the panel of any of the members of CoC.

iii). Fees of the Insolvency professional so appointed by the Board, may be fixed by the Board on a sliding scale based on the amount of claims admitted and/or no. of creditors, in the CIRP. Out of pocket expenses may be paid equivalent to payable to the Under Secretary of the GOI. All the Fees & Expenses paid / payable to IP / IA to form part of Insolvency Resolution Process Cost (IRPC).

An Insolvency Professional can be appointed as Inspecting Authority, under the provisions of 

Section 218 of the Code, reading as under;

• Section 218(1). ………..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.

Appointment as an Inspecting Authority will not tantamount to an assignment under the Code, as such will not require AFA & secondly, the services of senior Insolvency Professional above the age of 70 years can also be availed.

Here, my observations in the blog  "Fraudulent Transactions in IBC - A case study" dated 16th July, 2020, as follows, has relevance in the matter.

Issues;

1. Independence of the working of the Resolution Professionals. RP in the present case, despite his reservations,  succumbed to the pressures of CoC, as he holds the post of RP at the will of CoC, which has the powers to replace RP without assigning any reasons [section 27]. To help RP to maintain its independence, following reforms in the conditions of appointments of RP are suggested;

• i). The provisions of the replacement of RP under section 27, may provide for specifying  the reasons for replacement in the concerned resolution of the CoC, subject to the approval of AA. 

• ii). Secondly in case CoC does not replace IRP with RP in the 1st meeting of CoC (section 22), IRP may be deemed to be appointed as RP.

 

2. Deficient regulatory control of the Board. In the instant case, regulatory control of the Board was found lacking on the following counts;

i). Board’s inspection of the resolution process failed to identify the fraudulent transaction during CIRP, may be due to; 

• (a) lack of professionalism & objectivity of the inspecting authority or; 

• (b) lack of processing of the inspection reports at the Board's back end office. 

For appointment of inspecting authority Code provides as under;

• Section 218(1). ………..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.

However, under the regulations Board restricted the appointment of inspection / investigating authority, to the officers of the Board, who are usually not qualified professionals;

• Regulation 2; 

• (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;

For objectivity & professionalism in the inspections, insolvency professionals should be associated alongwith officers of the Board, for inspections / investigations of the CIRP.

 

ii). In the instant case, the Board initiated action post facto. The Board, instead of taking post facto actions, should have some system to timely prevent such transactions. Secondly the Board is inspecting only in 15 to 20% cases, a large no. of irregularities may / can go unnoticed. To address both the issues it is suggested that the Board should have authority to appoint an independent insolvency professional as observer/non voting member in CoC, with rights to participate in the proceedings/discussion of CoC. This way, the Board will get regular and timely professional feedback on the working of RP & CoC.

 

3, Lack of professionalism in the working of the CoC. In the instant case, despite RP expressing reservations, CoC went ahead in passing resolution for payment of fees of the lender's legal counsel as IRPC. CoC further decided that if the Board does not allow this arrangement, then the fee amount will be recovered on a pro rata basis from upfront cash recovery amount to be paid to lenders. 

 

Most of the financial creditors in CoC are banks. Banks being impersonal legal entities, usually appoint their employees as their authorised representative in CoC, who are not professionals and do not understand the insolvency ecosystem. Here the provisions of the Code are of quite significance.

• # Section 24(5) Subject to sub-sections (6), (6A) and (6B) of section 21, any creditor who is a member of the committee of creditors may appoint an insolvency professional other than the resolution professional to represent such creditor in a meeting of the committee of creditors:

• Provided that the fees payable to such insolvency professional representing any individual creditor will be borne by such creditor.

 

The main import of the Section 24(5) of the code is that a financial creditor can attend the meeting of CoC, through a representative who has to be an insolvency professional other than IRP/RP.

 

The appointment of IP’s as authorised representatives of the banks in CoC will definitely improve the working of the CoC & inculcate the professionalism in the decisions of the CoC. Secondly IP's are being regulated by the Board & IPA’s, their misconduct  can be examined by the Board & IPA’s. It is suggested that the Board may make suitable provisions in the regulations and issue a circular on this aspect.

References; 

1. NCLAT 18.12.2020) in Mr Rajnish Jain vs Anupam Tiwari Resolution Professional for M/s Jain Mfg (India) Private Limited & Ors.[Company Appeal (AT) (Insolvency) No. 519 of 2020 ]

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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Why approval of fees of a professional by CoC, is not treated as commercial wisdom of CoC & not-justiciable ?

In a recent judgement Hon’ble Supreme Court of India in Alok Kaushik Vs  Bhuvaneshwari Ramanathan and Others1 held as under;

• Adjudicating Authority is sufficiently empowered under Section 60(5)(c) of the IBC to make a determination of the amount which is payable to an expert valuer as an intrinsic part of the CIRP costs. Regulation 34 of the IRP Regulations defines ‘insolvency resolution process cost’ to include the fees of other professionals appointed by the RP. Whether any work has been done as claimed and if so, the nature of the work done by the valuer is something which need not detain this Court, since it is purely a factual matter to be assessed by the Adjudicating Authority.

• The availability of a grievance redressal mechanism under the IBC against an insolvency professional does not divest the NCLT of its jurisdiction under Section 60(5)(c) of the IBC to consider the amount payable to the appellant. In any event, the purpose of such a grievance redressal mechanism is to penalize errant conduct of the RP and not to determine the claims of other professionals which form part of the CIRP costs.

Facts of the case ;

1. The National Company Law Tribunal, Bengaluru (“NCLT” or “Adjudicating Authority”) initiated the Corporate Insolvency Resolution Process (“CIRP”) against the Corporate Debtor by its order dated 21 March 2019. By an order dated 26 August 2019, the first respondent was appointed as the Resolution Professional (“RP”).

2. By a letter dated 16 September 2019, the first respondent (RP) appointed the appellant as a registered valuer (RV) of the Plant and Machinery of the Corporate Debtor.

3. The appellant’s appointment fee (Rs 7.50 lakhs plus applicable GST) and other expenses were ratified by the Committee of Creditors (“CoC”), led by the second respondent, in its meeting held on 9 December 2019.

4. The National Company Law Appellate Tribunal (“NCLAT” or “Appellate Authority”) set aside the initiation of CIRP against the Corporate Debtor by an order dated 18 December 2019. The NCLAT remanded the matter back to the NCLT to decide on the issue of CIRP costs. 

5. By an order dated 20 December 2019, the NCLT decided on the fee of the RP and reduced it by 20% from the fee ratified by the CoC.

6. In view of the order dated 18 December 2019 of the NCLAT, the first respondent (RP) cancelled the appointment of the appellant on 19 December 2019. In relation to the fee payable to the appellant (RV), the first respondent (RP) requested him to consider a waiver. In return, the appellant (RV) agreed to reduce his fee by 25% from the fee ratified by the CoC, along with the expenses payable. However, on 2 March 2020, the first respondent (RP) informed the appellant (RV) that the fee as ratified could not be paid, and paid a sum of Rs 50,000.

7. The appellant (RV) then filed an application under Section 60(5) of the Insolvency and Bankruptcy Code, 2016 (“IBC”) before the NCLT challenging the non-payment of the fees. However, the NCLT dismissed the application by an order dated 29 June 2020 concluding that it had been rendered functus officio. In appeal, the NCLAT by an order dated 13 October 2020 rejected the contention of the appellant, noting that an amount of Rs 50,000 had already been paid over. The appellant moved Supreme  Court in an appeal under Section 62 of the IBC, for challenging the order of the NCLAT.

Now the following questions arise;

1. Whether the approval of the fees of a professional by CoC during CIRP is to be treated as commercial wisdom of the CoC & not-justiciable, or is justiciable as ordered by NCLAT in the above referred case.

2. Who is required to pay the CIRP cost in case the National Company Law Appellate Tribunal (“NCLAT” or “Appellate Authority”) set aside the initiation of CIRP against the Corporate Debtor.

In the following cases the decisions of CoC on various matters had been held as commercial wisdom of the CoC, as such not-justiciable.

a. Supreme Court of India in  K. Sashidhar vs. Indian Overseas Bank & Ors.2 held;

• 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)

• The legislature has not envisaged challenge to the “commercial / business decision” of the financial creditors taken collectively or for that matter their individual opinion, as the case may be, on this count.

b. NCLAT in Naveen Kumar Jain Vs. CoC of K.D.K Enterprises Pvt. Ltd. & Ors.3

held; 

• It is well settled that the commercial wisdom of the Committee of Creditors which covers matters including the replacement of the Resolution Professional does not fall within the limited scope of judicial review and is not justiciable.

• In so far as the issue regarding fee is concerned, the Adjudicating Authority has rightly observed that under Regulation 33(3) of the IBBI, fee has been fixed by the Committee of Creditors at Rs.50,000/- which does not brook interference.

c. NCLAT in Committee of Creditors of LEEL Electricals Ltd. Vs Leel Electricals Ltd. Through its IRP, Arvind Mittal4  held that;

• Appointment of RP is governed by Section 22 which provides that the first meeting of CoC shall be held within 7 days of constitution of CoC and the CoC may by a majority vote of not less than 66% of the voting share of Financial Creditors either resolve to appoint the IRP as a Resolution Professional or to replace the IRP by another Resolution Professional. It is now well settled that the decision in regard to appointment of IRP as RP or replacement of IRP by another RP falling within the ambit of Section 22 of I&B Code is a decision based on commercial wisdom of CoC which is not amenable to judicial review.

Author’s comments; When appointment/replacement of IRP/RP is a decision based on commercial wisdom of CoC which is not amenable to judicial review, how come the fees of professionals approved by CoC can be justiciable or  amenable to judicial review

d. NCLAT in Committee of Creditors of EMCO Limited Vs Mrs. Mary Mody & Sundaresh Bhat, Resolution Professional of EMCO Limited5 held that;

• Keeping in view all the aforenoted reasons and the ratio of the Hon’ble Supreme Court in ‘K. Sashidhar’ (Supra) that the commercial or business decision of the CoC is non-justiciable, and at best, the Adjudicating Authority may cause an enquiry on limited grounds, and does not have Jurisdiction to undertake scrutiny of the justness of the opinion expressed by the CoC when it has voted by a majority share, we are of the opinion that this ratio is applicable to the facts of this case as the CoC has by a majority vote rejected to raise any ‘Interim Funds’ and the Adjudicating Authority cannot direct the CoC to do the same. 

It is well established that the commercial or business decisions of the CoC are non-justiciable.

Now let’s look into the concerned CIRP Regulations about the fees of the professionals;

• # Regulation 33. Costs of the interim resolution professional.

• (1) The applicant shall fix the expenses to be incurred on or by the interim resolution professional.

• (2) The Adjudicating Authority shall fix expenses where the applicant has not fixed expenses under sub-regulation (1).

• (3) The applicant shall bear the expenses which shall be reimbursed by the committee to the extent it ratifies.

• (4) The amount of expenses ratified by the committee shall be treated as insolvency resolution process costs.

• Explanation. - For the purposes of this regulation, “expenses” include the fee to be paid to the interim resolution professional, fee to be paid to insolvency professional entity, if any, and fee to be paid to professionals, if any, and other expenses to be incurred by the interim resolution professional.

From the regulations it can be seen that even the fees of IRP fixed by the Adjudicating Authority needs to be ratified by CoC for to be treated as Insolvency Resolution Process Cost. Thus AA has no role to play in fixation of the fees of the professionals and also cannot sit in judgement for the fees of the professionals fixed /approved by CoC.

Now the second question arises as to who is to bear the cost of CIRP in the present situation when National Company Law Appellate Tribunal (“NCLAT” or “Appellate Authority”) set aside the initiation of CIRP against the Corporate Debtor

a. Supreme Court of India in S3 Electricals and Electronics Private Limited Vs Brian Lau & Anr.6 held that;

• A bare reading of Regulation 33(3) indicates that the applicant is to bear expenses incurred by the RP, which shall then be reimbursed by the Committee of Creditors to the extent such expenses are ratified. We are informed that, in this case, no Committee of Creditors was ever appointed as the interim resolution process did not reach that stage. In these circumstances, it is clear that whatever the Adjudicating Authority fixes as expenses will be borne by the creditor who moved the application.

b. NCLAT in M/s. Kotak Resources Vs Dharmendra Dhelaria & Ors.7  held that;

• Admittedly, Mr Dharmendra Dhelaria was nominated as ‘Interim Resolution Professional’ by the Appellant (Financial Creditor) who was subsequently confirmed as ‘Resolution Professional’ by the ‘Committee of Creditors’. He managed the operations of the ‘Corporate Debtor’ as a going concern. ARCIL was included in the ‘Committee of Creditors’ upon its constitution by the ‘Resolution Professional’ with its consent. The ‘resolution cost’ of Rs.12,12,831/- was ratified and approved by the ‘Committee of Creditors’ in its meeting dated 7th August, 2018. 

• Since the ‘Committee of Creditors’ comprised of both, Appellant and ARCIL, the ‘corporate insolvency resolution process costs’ had necessarily to be borne by them in equal proportion. 

• It is indisputable that the ‘Corporate Debtor’ could not be saddled with the liability of the ‘corporate insolvency resolution process costs’. It would be preposterous to hold that the whole amount of the ‘corporate insolvency resolution process cost’ should have been reimbursed by the ARCIL alone to the ‘Resolution Professional’. 

References;

1. Supreme Court of India (15.03.2021) in Alok Kaushik Vs  Bhuvaneshwari Ramanathan and Others  [Civil Appeal No 4065 of 2020]

2. Supreme Court of India (05.02.2019) K. Sashidhar vs. Indian Overseas Bank & Ors. (Civil Appeal No.10673 of 2018)

3. NCLAT (2020.11.03) Naveen Kumar Jain Vs. CoC of K.D.K Enterprises Pvt. Ltd. & Ors. [Company Appeal (AT)(Insolvency) No. 882 of 2020]

4. NCLAT (21.12.2020) in Committee of Creditors of LEEL Electricals Ltd. Vs Leel Electricals Ltd.Through its IRP, Arvind Mittal [Company Appeal (AT) (Insolvency) No. 1100 of 2020]

5. NCLAT (02.03.2021)  in Committee of Creditors of EMCO Limited Vs Mrs. Mary Mody & Sundaresh Bhat, Resolution Professional of EMCO Limited [COMPANY APPEAL (AT) (Insolvency) No. 307 of 2020]

6. Supreme Court of India (05.08.2019) in S3 Electricals and Electronics Private Limited Vs Brian Lau & Anr. [Civil Appeal No. 103 of 2018] 

7. NCLAT (26.06.2020) in M/s. Kotak Resources Vs Dharmendra Dhelaria & Ors.  [Company Appeal (AT) (Insolvency) No. 569 of 2020] 

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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A tale of two judgements; Appropriation of Margin Money FD towards invoked Bank Guarantee during CIRP

Query; Whether the margin money FD can be appropriated towards invoked Bank Guarantee during CIRP.

On the above issue, there are divergent judgements of Appellate Tribunal (NCLAT). 

In Bank of Baroda Vs. Sundaresh Bhatt, Resolution Professional [1], NCLAT (Three member bench) held that margin money FD cannot be appropriated towards invoked bank guarantee during CIRP, & ordered as under;

• # 6. Considering the submission made by both the sides, looking into the documents and keeping in view the reasons recorded by the Adjudicating Authority, it does appear that money which was lying with the Bank as margin money in the Form of 3 FDs in the name of Corporate Debtor were appropriated after the CIRP was initiated and thus the same could not have been done under Section 14 of IBC. What internal instructions the Bank gave on 01.08.2017 is not relevant. Admittedly, F.D. Accounts were closed on 02.08.2017 when Moratorium was in force. We do not find any error in the Impugned Order passed by the Adjudicating Authority.

• 5.5.7 Accordingly, the instant IA is disposed of with the following directions:

• a) The Respondent Bank is directed to roll back/reverse the wrongfully appropriated amount of Rs. 9.74,62,608/- (Rupees Nine Crore Seventy- Four Lakh Sixty-two Thousand Six Hundred and Eight only) into the TRA account of the Corporate Debtor Company maintained with ICICI Bank.

• b) The Respondent Bank is directed to pay the Applicant accrued interest on the wrongfully appropriated amount of Rs. 9,74,62,608/- (Rupees Nine Crore Seventy-Four Lakh Sixty-two Thousand Six Hundred and Eight only) from the date of wrongful appropriate of the fixed deposit till the actual date of the reversal/roll back into the TRA account of the Corporate Debtor Company maintained with ICICI bank.

However, subsequently in Indian Overseas Bank Vs. Arvind Kumar RP/Liquidator M/s Richa Industries Ltd [2] NCLAT (Three member bench)  held that margin money FD can be appropriated towards invoked bank guarantee during CIRP.

• # 13. The ‘margin money’ is the contribution on the part of the borrower who seeks ‘Bank Guarantee’. The said margin money remains with the Bank, as long as the Bank Guarantee is alive. If the Bank Guarantee expires without being invoked, then the margin money reverse back to the borrower, and in case the bank guarantee is invoked by the beneficiary, the margin money goes towards payment of bank guarantee to the beneficiary, and nothing remains with the financial institutions, which can be reversed to the Corporate Debtor.

• # 14. In this case, Bank Guarantee was invoked on 27th December 2018 by the beneficiary M/s Tata Steel Processing & Distribution Limited, and the margin money amount was used towards the payment of the Bank Guarantee. Once this margin money was used to honour the bank guarantee, nothing remained with the Bank, and as such, the Respondent Resolution Professional cannot demand that amount.

• # 15. The Resolution Professional/IRP is only entitled to those payments to which the Corporate Debtor is entitled if no orders of Moratorium would have been passed under Section 14 of the Code. The Corporate Debtor had no right to claim the margin money after the invocation of Bank Guarantee.

So the situation is in flux, till such time the issue is decided by a bigger bench of NCLAT or the Hon’ble Supreme Court of India.

The Doctrine of “Binding Precedent”.

Constitution Bench of Hon’ble SCI (1989.05.16) in Union of India v. Raghubir Singh [(1989) 2 SCC 754], held that:- 

• The doctrine of binding precedent has the merit of promoting a 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 transaction 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. 

References;

[1] NCLAT (2020.02.20) Bank of Baroda Vs. Sundaresh Bhatt, Resolution Professional, [Company Appeal(AT)(Insolvency) No. 635 of 2019]

[2] NCLAT (2020.09.28) Indian Overseas Bank Vs. Arvind Kumar RP/Liquidator M/s Richa Industries Ltd [Company Appeal (AT)(Insolvency) No. 558 of 2020]

[3] Hon’ble SCI (1989.05.16) in Union of India v. Raghubir Singh [(1989) 2 SCC 754]

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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