Government contemplates ways to distribute insolvency resolution proceeds to avoid delays and litigation

The government is in the process of devising a formula for distributing the proceeds of insolvency resolution among financial and operational creditors in a fixed proportion with the intention of protecting the interests of operational creditors and reduce delays due to litigation and ensuring that the objective of the Insolvency and Bankruptcy Code (IBC) is preserved.

However, the government will take a final decision only after extensive deliberations.

Distribution of resolution proceeds has emerged as one of the key factors behind the extended litigation, delaying major insolvency cases.

The Supreme Court has reserved the judgment in the case of Essar Steel and is currently deciding on the distribution of proceeds. Arcelor Mittal’s Rs. 42,000-crore bid for the debt-ridden steel manufacturer was approved in March 2019. But the resolution plan was opposed by the original promoters – the Ruias, questioning Arcelor Mittal’s eligibility.

Operational creditors rejected the plan on the grounds of discriminatory treatment. Financial creditor Standard Chartered Bank had also knocked the doors of the court against the resolution plan on the same grounds.

Later, the financial creditors moved the Supreme Court after the National Company Law Appellate Tribunal (NCLAT) ordered proportional recovery for both financial and operational creditors.

According to a government official, the distribution of proceeds is currently decided by the committee of creditors (CoC) consisting of financial creditors. The committees typically set aside about 5% of resolution proceeds for operational creditors, which, on an average have 6-7% of total claims against insolvent companies.

The Centre is looking at further changes to the Insolvency and Bankruptcy Code (IBC) as it doesn’t want to leave any room for litigation on the distribution of proceeds. The process faced difficulties because of litigation in some of the biggest cases, which shunned the IBC’s target of speeding up bankruptcy resolution. The IBC has already certain amendments till date.

Operational creditors had slightly higher recoveries than financial creditors, according to data available with the government according to government sources. The Insolvency and Bankruptcy Board of India has pegged the average recovery for financial creditors in cases where there was successful resolution at 41.5% at the end of the September quarter.

In the latest set of amendments to the IBC, carried out in the budget session of Parliament, the Government had clarified that the CoC would have the right to decide on the distribution of proceeds but that all creditors must receive liquidation value or the amount they would receive if resolution proceeds were distributed according to the ‘waterfall mechanism,’ whichever is higher.

The waterfall mechanism under the IBC outlines the order of priority for repayment to creditors in the event of liquidation. Under this, secured creditors have to be paid fully before any payments can be made to unsecured financial creditors who are to be prioritized over operational creditors.