Lacunae in the Insolvency & Bankruptcy Code: Call for the Third Amendment

Although the intent of IBC is undoubtedly right, its execution is a matter of concern

"The only thing that is constant is change" - Heraclitus

India is currently witnessing a situation where for the first time, the three pillars of democracy: the Executive, Legislature and Judiciary are working in tandem, to clean out the plague of non-performing assets, saddling the Indian economy, this is being done through the 'Insolvency & Bankruptcy Code, 2016' ("IBC"). But, though the intent of IBC is undoubtedly right, its execution is a matter of concern.

IBC has now been amended twice to tackle its shortcomings as well as that of erstwhile prevailing laws. But, have all the wrinkles been ironed out yet?

Two important scenarios under IBC are bound to create a furore. Firstly, the overlap of arbitration proceedings and IBC and secondly, the impact of IBC on the subsidiaries of corporate debtor companies.

Moratorium, the most 'hailed' and controversial' provision under IBC is enforced to observe a calm on the assets of the debtor company undergoing resolution. For its enforcement, strict measures are imposed by adjudicating authorities. One of them being stay on arbitration proceedings 'against' the debtor company.

Interestingly, the Appellate Tribunal ("NCLAT") in 'Jharkhand Bijli Vitran Nigam Ltd. v. IVRCL Ltd. & Anr.' held that, there lied no bar under IBC on adjudicating upon a counter claim filed against the corporate debtor in an arbitration proceeding initiated by the corporate debtor, during the subsistence of Moratorium.

NCLAT's ruling on the first blush might seem to follow the law laid down by the Apex Court in 'K.V. George v. Secy. to Govt., Water and Power Deptt.' that a claim and a counterclaim ought to be decided together. However, as per the ruling now, during an on-going arbitration proceeding, 'moratorium' shall not bar a counter claim 'against' the corporate debtor from being proceeded with. This ruling is clearly contrary to the intent of IBC which clearly forbids any proceedings against the corporate debtor during the period of moratorium. The NCLAT seems to have erred in applying the correct ration of the Apex Court's ruling in K.V. George.

The correct application would have mandated a stay on the continuation of both the claim as well as the counter claim during 'moratorium', since the claim could not be decided piecemeal and the counter claim could not be proceeded with against the corporate debtor during the period of moratorium under IBC.

The Legislature and the higher judiciary should act swiftly to uphold the spirit and applicability of IBC and iron out this lacuna.

The second lacuna lies in the interplay of Moratorium upon the corporate debtor and its subsidiaries. It is settled law, that a parent and its wholly owned subsidiary ("WOS") company are two distinct juristic entities. NCLT, Mumbai in 'Alpha & Omega Diagnostics (India) Ltd. v Asset Reconstruction Company of India Ltd. & Ors.' held that the term "its" used in Section 14 of IBC applies strictly upon the property owned by the corporate debtor itself, which was also upheld by NCLAT. Notably, certain provisions of IBC explicitly bar its implications upon the assets of WOS of a corporate debtor.

However, what is yet to be adjudicated in strict sense, is the impact of a resolution process on the WOS of a corporate debtor. Undoubtedly, a corporate debtors' financials would reflect the 100% shareholding in the WOS as 'its asset'. Importantly, during the resolution process, 'assets' and 'liabilities' form two most important criterions for preparation of a resolution plan / liquidation report of a corporate debtor by the resolution professional and consequently the resolution applicants.

Thus, a situation may arise where a resolution applicant may propose to sell off the WOS shares to overcome the corporate debtors' indebtedness, effectively leading to its closure. The impact upon the creditors / stakeholders of the distinct and separate WOS in such a scenario would be writ large and appears to be silent under IBC.

Recently, the Legislature amended the IBC to end the confusion surrounding applicability of Moratorium upon the Guarantors of a corporate debtor. This amendment annulled the refuge being sought by guarantors from seeking extension of Moratorium upon themselves. This was upheld by the Apex Court as well in 'State of Bank of India v. V. Ramakrishnan & Anr'.

Thus, indirect extension and consequent impact of Moratorium during resolution process of a corporate debtor upon its subsidiaries, seems to presently lie in unchartered waters. It will be interesting to watch, which pillar of our Democracy blinks first, to iron out this wrinkle?