CORPORATE GOVERNANCE FROM LENS OF S.29A: PROHIBITING BACKDOOR ENTRY THROUGH PURPOSIVE INTERPRETATION

Author: Ayush Rastogi, V year of B.A.,LL.B.(Hons.) from National Law University, Nagpur Co-author: Priya Ganotra, B.A. LL.B (Hons.) from National Law University, Nagpur

ABSTRACT

The Insolvency and Bankruptcy Code 2016 (hereinafter “Code”) is a beneficial law that promotes a debtor-friendly model and creditors interest whilst choosing a resolution plan for revival of the corporate debtor. In this process, the Code has emerged quite unambiguous with its perspective that erstwhile promoters are ineligible for participation and bidding in the resolution process. In view of this, the enactment of §29A into the Code is a key provision that determines the ineligibility criteria of the promoters and prohibits their back-door entry. Over time, the courts have construed §29A as a provision facilitating larger public interest and effective corporate governance. In this essay, the author attempts to analyze §29A of the Code w.r.t. the initial lacunae of backdoor entry of promoters. The author establishes the crucial link between §29A and corporate governance principles by addressing the purposive construction resorted by the judiciary in its decisions in this concern. Lastly, author argues for careful navigation of the §29A in an exceptional circumstance where there is no external bidder other than an honestpromoter willing to resuscitate the debtor.

Introduction

Sir Adrian Cadbury defines corporate governance as a system by which companies are directed and controlled[1]. It consists of a framework of rules, policies, and procedures which prescribe the organizational objects, and the means of achieving them. The corporate governance system of a company serves as a key tool of maintaining a balance between the economic and social goals of an entity, and is prominent in regulating the accountability between the company management and its stakeholders[2]. Good corporate governance involves a voluntary key commitment of a company to organize and run itself legally, ethically, and transparently – and this dedication must flow from the very top management of an organization, and shall permeate throughout. Hence, corporate governance principles explicitly suggest that affairs of a corporate should carry on in a manner as to orchestrate best interests of the company and its stakeholders Therefore, to meet the principles of efficient corporate governance, corporate leaders of a company must prioritize company welfare, and must not think and act for their own private enrichment[3].

Insolvency of a company means that an enterprise has entered its loss-making phase, and is unable to generate revenue and profit. The situation of insolvency indicates the inability of corporate incumbents to operate the organization successfully. Hence, one may say that corporate governance and insolvency arrangements constitute to be distinct parts of the continuum in the lifespan of a company.

The Code is a major economic reform that has contributed to high standards of corporate governance by fastening personal liability to promoters and the incumbent management of the corporate debtor by disqualifying them from insolvency procedures set forth by the law. Another such method of effecting corporate governance is evident through the enactment of §29A[4], which disqualifies those promoters from bidding for the corporate debtor in the processes established by the Code, and surreptitiously regaining control of the company through any directly or indirectly.

In this essay, the author discusses the enactment of lacunae of backdoor promoter entry in respect of its consequences. The next section attempts to understand the enactment and purpose of §29A to the Code. The author then establishes therelevance of §29A and corporate governance principles by discussing the purposive judicial interpretation done by courts. The final section attempts to understand the role of §29A and addresses curious concern of the bar of §29A in cases where no potential resolution applicant exists other than an honest promoter wishing to genuinely revive the debtor.

Primer of Section 29A – Prohibition of Backdoor Entry of Promoters

A. Lacunae of Backdoor Entry

The Code bought structural change by moving away from the “debtor in possession” model to a “creditor in possession” regime by taking away the control of a debtor and its management onceCorporate Insolvency Resolution Proceeding (hereinafter “CIRP”) commences. A key feature of the rehabilitative thrust of the Code is that it displaces defaulting promoters from the management of the debtor.The recommendations of the Bankruptcy Law Reforms Committee Report (hereinafter “BLRC Report”) form the base of the Code state that the control of a company is not a divine rightand while the creditor-in-possession model of the Code is in operation, the control of the corporate debtor shall vest with the creditors. Along with this, the Code shall have swift and decisive mechanisms existent to prevent the erstwhile management from retaining control of the corporate debtor and give it an honest chance of revival[5].

However, initially in the Code, the resolution plan aimed towards resurrecting the corporate debtor could be presented before the Committee of Creditors (hereinafter “CoC”) by any person and there was no restriction on their eligibility. Over time, concerns arose regarding the misconduct of persons who had resulted in the downfall of the corporate debtor and that such persons must not be permitted to become resolution applicants[6]. The possibility of back-door entry of promoters from participation in the processes set out by the Code raised concerns about unscrupulous persons misusing or undermining the procedural integrity of the lawby becoming participants in the resolution and liquidation procedure[7]. By missing out on the creation of a bar on this back-door entry, the Code in its original form ended up creating room for defaulting promotersto regain control of the corporate debtor. As a result, promoters could be rewarded at the expense of the lender and could obtain control of assets at a fraction of the assets of the corporate debtor. The ability of defaulting promoters to bid for stressed assets at steep discounts led to an imbalance between their position and financial creditors who are confronted with sizeable haircuts[8].It is pertinent to note that the potential acquisition of the corporate debtor by a new management through a resolution plan relies on the confidence that the existing defaulting management has been removed and cannot buy back the corporate debtor. Hence, to mitigate the above-mentioned issues, §29A was inserted into the Code through the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2017.

B. Insertion of §29A

§29Alays down a multi-layered and comprehensive criterion of disqualification and ineligibility. Whilst §29A contains several categoriesas a ground for disqualification, significantly, it extends its pool of ineligibility to those persons who led to the default of the corporate debtor. This is inclusive of any person who at the submission of a resolution plan is a promoter or in control of a company classified as a non-performing asset by the Reserve Bank of India for one year or more[9]. It also includes a person who has been a promoter or in management or in control of the corporate debtor in which there exists an antecedent preferential, undervalued, or fraudulent transaction[10]. Additionally, it restricts all direct and indirect persons falling within these ineligibilities and their connected persons i.e., any person who is the promoter or in the management or control of the resolution applicant or of the business of the corporate debtor at the time of the implementation of the resolution plan in the Code[11].

Therefore, §29A serves as a deterrent provision to control errant behavior of promoters and incumbent management by establishing a prohibition on who may be a resolution applicant. It plays a significant role in ensuring the sustainable revival of a corporate debtor by preventing defaulting promoters from regaining control of the corporate debtor leaves and very little room for a narrative that provides them with a second chance of control. The key moralistic argument here is that a person who led to a problem of default cannot be a part of the process that is leading to a solution. To further ensure the purpose sought out by §29A, the courts have resorted to a purposive interpretation of §29A to prevent this backdoor entry and terming §29A to be a key player in the Code in ensuring its purpose of effecting corporate governance.

Judiciary Preserving Public Interest– PurposiveInterpretation of §29A

The judiciary plays an imperative role in constructing a statute in a way that enhances the true intent of the legislature, reduces the mischief, and advances the remedy. The principles of statutory interpretation state that it is the duty of the court to consider the significance of a provision and the relation of the provision with the general aim legislation seeks to achieve. In this aspect, the Code serves the primary objective of the revival of the corporate debtor through preservation of value, and to fulfill this aim. The restrictive§29A makes it mandatory for the corporate debtor to move to fresh hands. It aims at value maximization of the corporate debtor by debarring promoters and hence, has been subject to a lot of judicial diagnosis and analysis to justify its enactment and purpose.

A. Understanding the narrative Behind §29A through judicial expansion

The Code debunks the belief in feudal entitlement and the “divine right to run” a corporate. The scheme of the Code attempts to divest the former management of its powers and ensure the handover of the corporate debtor to competent management once a resolution plan is drawn up and accepted. Indeed, the Code also works on the fundamental premise that the identity and interest of a company is not identical with that of its promoters. This is where the rule of corporate jurisprudence of lifting of corporate veil comes into the picture which is understandable from the case of Soloman v. A. Soloman and Co. Ltd.[12]. TheEnglish case holds that a company has an independent legal personality that distinguishes it from its shareholders and promoters, and this veil can be lifted to recognize the individual members for who they are. Further settling the doctrine, the SC inLife Insurance Corpn. Of India v. Escorts & Ors.[13]affirms that a company is distinct from its individual members and the corporate veil can be lifted in special cases. These cases depend on the relevant statute or provisions, the object sought to be attained, and the connection of elements of public interest. In respect of §29A, the doctrine of corporate veil finds relevance in the SC judgment of Arcelormittal India Private Limited v. Satish Kumar Gupta & Ors.[14]. Herein, the SC ruling resorts to a purposive interpretation of §29A and states that the provision must be interpreted based on its text and the context of its enactive purpose. Additionally, this judgment establishes the role of §29A and remarks it to be a “see-through provision” that pierces the corporate veil to determine who is the real person or entity who is acting jointly, or in concert with others for submission of a resolution plan in the Code.

To understand this larger public interest goal, we may look at the SCholdingin Chitra Sharma v. Union of India[15]. Herein, the SC states that the persons responsible for insolvency must not participate in the resolution process. The ruling discusses that the purpose of enacting §29A by the Parliament of India is to fix the loophole in the law that permits back-door entry of erstwhile management in the CIRP which weakens the salutary objective and purpose of the law. This salutary object is seen in Swiss Ribbons Pvt. Ltd. Anr. v. Union of India[16],wherein the SC elucidates the underlying object of the Code. In this judgment, it is given that the primary purpose of the Code is to revive and continue the corporate debtor as a “going concern” by being protective of its interests, shielding it from its own management, and preventing death by liquidation. It states that as a beneficial legislation, the Code separates the interests of the corporate debtor from promoters and other management and includes provisions that remove them from control once CIRP commences with a goal to ensure speedy resolution through which new management can resuscitate the corporate debtor. Additionally, while upholding the constitutional validity of the Code and §29A, the SC holding states that the legislative purpose of creating eligibility criteria of resolution applicants permeates both the proceedings in the Code i.e., resolution and liquidation. Hence, the “defaulter’s paradise is lost”. Finally, it is noteworthy that the feature of separation of private enrichment vis-à-vis §29A was recently been acknowledged in the SC matter of Bank of Baroda &Anr. v. MBL Infrastructures Limited and Ors.[17]. The judgment herein remarks §29A to be a facet of the Code that creates a disqualification criterion that avoids any unscrupulous elements to become a part of the resolution process of the corporate debtor and prevents their personal interests to intervene.

B. Judicial Expansion in the Interplay of §230 Companies act and §29A of the Code

In the Code, liquidation of the corporate debtor commences at the failure of the CIRP, or, if the CoC decides to liquidate the corporate debtor during the pendency of CIRP. Significantly, alongside the §29A to the Code, §35(1)(f) of the Code states that the liquidator shall not sell the movable property, immovable property, or actionable claims of the corporate debtor in liquidation to any person termed ineligible to be a prospective resolution applicant within the Code. Hence, the ineligibility criterion under §29A is equally applicable to buyers of liquidation assets. Significantly,liquidation proceedings in the Code permit the recourse to §230 of the Companies Act 2013 (hereinafter “Act”) for effecting of schemes of compromise or arrangement to restructure and revive the corporate debtor at the stage of liquidation. The explicit recognition of schemes of compromise or arrangement under the Act into the liquidation process is evident in the judgment of the Hon’ble National Company Law Appellate Tribunal (hereinafter “NCLAT”) in Y. Shivram Prasad v. S. Dhanapal & Ors.[18]. Herein, it is given that the pursuance of a scheme under §230 is a necessary step taken by a liquidator for the revival of the corporate debtor, protection of the corporate debtor from its former management, and preventing the last resort of insolvency law i.e., liquidation death.

However, the most crucial development in this interplay is evident in the SC judgment of Arun Kumar Jagatramka v. Jindal Steel and Power Ltd. &Anr[19]. Herein, the SC states that prohibition under §29A and §35(1)(f) of the Code mustapply on a compromise or arrangement scheme under §230 of the Act for a company undergoing liquidation in the Code. In arriving at this stance, the SC lays emphasis on the core objectives of the Code terms it an economic legislation enacted to ensure good corporate governance, control of deviant behaviour, and protection of the integrity of the resolution process. The judgment affirms the purposive expansion of §29A done in Chitra Sharma, Swiss Ribbons, and Arcelor Mittal and reaffirms that the enactment of §29A as a provision fulfilling the purpose of ensuring larger public interest and facilitation of corporate governance by preventing backdoor entry of erstwhile management in the CIRP of the corporate debtor. Notably, the decision also holds that just like the applicability of §29A exists at the stage of submission of a resolution plan, sale of assets of the company or sale of the company as a going concern during liquidation, it must also exist at the stage where a scheme under §230 is proposed because it is a part of the same continuum.

At this juncture, it is pertinent to note that the decision of the SC also reflects the viewpoint of the Insolvency and Bankruptcy Board of India (hereinafter “IBBI”) on the issue of whether §29A should apply to a scheme proposed under §230 of the Act. In the public comments received for the Discussion Paper on Corporate Liquidation Process dt. November 3, 2019, the IBBI had favored the minority viewpoint of 3 stakeholders who expressed that §29A should apply on §230 to prevent any back-door entry of persons deemed ineligible or disqualified under §29A. In view of this, the IBBI had shared its perspective that §29A intends to impose a bar on persons who can in most probability result in the risk of successful resolution of insolvency of a corporate debtor, and this rationale is equally applicable at a stage of compromise or arrangement. Thereafter, the IBBI expressed a concern that the non-applicability of Section 29A may undermine the processes under the Code and end up rewarding unscrupulous persons at the expense of the creditors of the corporate debtor.

Analysis and Concern

The literal reading of general provisions of §29A indicates that there is an exclusion promoter and management in regaining control of the corporate debtor through general provisions. However, through means of judicial deference and beneficial construction, the objective of the Code and §29A, we see that the judiciary addresses issues of corporate misgovernance by terming the provision as a facilitator of ethics and integrity of the Code. The consequences of a promoter losing control of the corporate debtor at the initiation of CIRP serves as a vital catalyst in enacting a debtor-friendly insolvency regime, encouraging efficiency in the management of the corporate debtor, and setting an example of corporate governance by weeding off unscrupulous promoters. When one looks at the illegibility criterion of §29A with the creditor-friendly regime of the Code, there is a clear indication that the Code looks at the promoters and incumbent management of the company with an eye for scrutiny. Undoubtedly, from the mandate of §29A, the promoters are apprehensive about losing control of the corporate debtor after CIRP forever and are instilling corporate discipline among them to not operate at sub-optimal levels that could lead to insolvent conditions of a company. The diffusion of a false sense of propriety of the promoters has emerged as a key factor in the enactment of §29A and increases efficiency in corporate management. Having stated above, it is also pertinent to note that the recognition of principles of corporate governance through §29A is through judicial decisions resorting to the purposive interpretation of the provision which warrants that the enactment of §29A is for larger public interest and promoting effective corporate governance – which is the core objective of the Code.

A concern emerges that there may be some promoters that may not be responsible for the account of insolvency of the corporate debtor. However, this does not absolve them of their responsibility to ensure efficient corporate management and also does not permit an escape from the bar of §29A. It is possible that these promoters may with the use of genuine attempts wish to regain the control of the corporate debtor and one may even wonder that in an absence of other prospective resolution applicants or a scheme of reorganization, §29A may push the corporate debtor towards liquidation death. This will be contrary to the core principle of the Code that “liquidation should be a matter of last resort”. Hence, even though this intention of a promoter wanting to be a bidder may be subject to a scornful eye of the court, it may protect a corporate debtor from liquidation i.e., the last resort of insolvency. This, however, may be an exceptional circumstance that would require additional analysis of a resolution plan or the scheme to determine if the bid presented is fair and equitable. Unfortunately, this will result in a delay in resolution and may result in a loss in value of the corporate debtor, along with a deviation of the attachment of the corporate governance principle to §29A, the underlying intent of the Code, and can be an effort in vain[20]. In case of such paucity of resolution applicants other than an honest erstwhile promoter, the result still may not be beneficial to the insolvency regime. Therefore, this may require a model timeline to ensure §29A may not be counterintuitive and push the corporate debtor into liquidation while balancing the interests of corporate governance and the corporate debtor.

Conclusion

In conclusion, §29A has come up as a turning point in the implementation of the Code and fills the gap of backdoor entry in the Code by prohibiting those who were unsuitable in running the corporate from regaining its control. Though the understanding of effecting corporate governance is through means of judicial interpretation, the effectiveness and purpose of this provision is still evolving over time. However, in cases where no external bidder of resolution plan other than the promoter or incumbent management, the corporate debtor may find on a thin rope that which leads to its path towards rehabilitation of liquidation. Further developments may be required to ensure this blanket ban does not tweak the purpose of ensuring revival and continuation of the corporate debtor and the key larger purpose of §29A – promotion of larger interest and corporate governance and discipline amongst corporate management.

[1]Report of The Committee on The Financial Aspects Of Corporate Governance (1992), Cadbury, A., Comm. Fin. Aspects Corp. Governance, available at: https://ecgi.global/sites/default/files/codes/documents/cadbury.pdf, last seen on January 11, 2022. [2]G20/OECD Principles of Corporate Governance, OECD (2015), available at: https://www.oecd.org/corporate/principles-corporate-governance, last seen on January 11, 2022. . [3]Daniel J.H. Greenwood, Corporate Governance and Bankruptcy (2018), Vol.13 Issue 1, Brooklyn Journal of Corporate Financial & Commercial Law, 99, available at: at 102, https://brooklynworks.brooklaw.edu/bjcfcl/vol13/iss1/6/, last seen on January 14, 2022. [4]Section 29 of the Insolvency and Bankruptcy Code: Persons Not Eligible to Be Resolution Applicant, available at: Section 29A of Insolvency and Bankruptcy Code, 2016 (IBC): Persons not eligible to be resolution applicant - IBC Laws, IBC Laws, last seen: January 14, 2022. [5]Report of the Bankruptcy Law Reforms Committee Volume I: Rationale and Design (November 2015), Insolvency and Bankruptcy Board of India, available at: BLRCReportVol1_04112015.pdf (ibbi.gov.in), last seen on January 14, 2022. [6]Stated by the Hon’ble Minister of Finance and Corporate Affairs, Late Shri Arun Jaitley, while presenting the Insolvency and Bankruptcy Code (Amendment) Bill, 2017 – December 29, 2017 to the floor of the House. [7] Said by the Hon’ble Minister of Finance and Corporate Affairs, Late Shri Arun Jaitley, while moving the Insolvency and Bankruptcy Code (Amendment) Bill, 2017 - December 29, 2017 on the floor of the House. [8]Koushik Chatterjee, Pratosh Gupta, Raghav Sud, 8. Experiencing the Code, Insolvency and Bankruptcy Board of India, Government of India, Quinquennial of Insolvency and Bankruptcy Code, 2016, available at: 1d8b31fc65f7ac6f09a973be8f12f868.pdf (ibbi.gov.in), last seen: January 15, 2022. [9] Section 29A(c) of the Code. [10]Section 29(g) of the Code. [11]Section 29A(j) of the Code. [12]Soloman v. A. Soloman and Co. Ltd., (1897) AC 22 (1896) UKHL. [13]Life Insurance Corpn. Of India v. Escorts & Ors., (1986) 1 SCC 264. [14]Arcelormittal India Private Limited v. Satish Kumar Gupta & Ors., (2019) 2 SCC 1. [15]Chitra Sharma v. Union of India, [2018] (9) SCALE 490 (SC). [16]Swiss Ribbons Pvt. Ltd. Anr. v. Union of India, (2019) 4 SCC 17. [17]Bank of Baroda & Anr. v. MBL Infrastructures Limited and Ors., 2022 SCC OnLine SC 48. [18]Y. Shivram Prasad v. S. Dhanapal & Ors., 2019 SCC OnLine NCLAT 172. [19]Arun Kumar Jagatramka v. Jindal Steel and Power Ltd. & Anr.2021 SCC OnLine SC 220. [20]Akhil Gupta, 16. Section 29A of IBC: A Key Feature, Insolvency and Bankruptcy Board of India, Government of India, Quinquennial of Insolvency and Bankruptcy Code, 2016, available at: 1d8b31fc65f7ac6f09a973be8f12f868.pdf (ibbi.gov.in), last seen: January 15, 2022.