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  • Aditi Bharadwaj, Pratishtha Shrivastava

Redefining Insolvency: A Case for Prioritizing Ecological Concerns

[Aditi and Pratishtha are students at Institute of Law, Nirma University.]

The economic turmoil of a corporation places its environmental and social responsibilities in jeopardy, raising an important question: should the environment be sacrificed for insolvency? This question has forced legislators worldwide to look further into the insolvency laws. A 12-member working group from the World Bank, INSOL International, and the International Insolvency Institute recently initiated a worldwide discussion on integrating climate action with insolvency processes. This step has led to debates in India around revising the Insolvency and Bankruptcy Code 2016 (IBC) to include environmental claims and liabilities, accentuating the need to prioritize environmental concerns even during economic distress.

This post aims to, firstly, scrutinize the interaction of IBC with environmental claims and CSR responsibilities under Section 135 of the Companies Act 2013. Secondly, it argues that both claims must prevail over the effect of the moratorium and must be given priority treatment under the waterfall mechanism. Lastly, it offers a way for lawmakers to bridge the gaps in the existing framework.

Balancing IBC and Environmental Claims

Environmental claims, including damages, fines, or penalties, are typically unliquidated and difficult to ascertain, complicating their inclusion during the corporate insolvency resolution process (CIRP). The CIRP regulations mandate that resolution professionals estimate the best amount for such claims. However, the ruling in the Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta and Others allows disputed claims to be admitted at a nominal value, creating space for environmental claims to be settled similarly.

Environmental laws broadly impose responsibilities on corporate debtors (CD) for pollution remediation. If unmet, these costs often fall on the government, necessitating re-evaluating the IBC's treatment of such claims. Some critics have argued that the resolution plan includes payment of CIRP costs, which cover government expenses for insolvency resolution and could be interpreted to include pollution remediation costs, ensuring environmental claims receive priority.

Moreover, the courts in India have emphasized balancing economic growth with ecological preservation. However, the IBC's non-obstante clause could override environmental statutes, reducing environmental claims to lower priority. Such instances highlight the need to re-evaluate the IBC's interaction with environmental laws, ensuring that real money spent on environmental remediation is recognized as essential, not peripheral, in insolvency proceedings.

In Canada, in the case of Orphan Well Association v. Grant Thornton Limited, the Supreme Court of Canada remarked, "bankruptcy is not a license to ignore rules." Insolvency professionals must comply with valid provincial laws during bankruptcy, including non-monetary obligations that bind the bankrupt estate, even if this affects secured creditors. This ruling was an essential step towards limiting the misuse of the Insolvency laws to evade environmental liabilities.

Challenges in CSR and IBC

CSR activities are mandated for a specified class of companies under Section 135 of the Companies Act 2013. These activities include investing in social, economic and environmental initiatives to contribute to societal development. The companies must allocate the prescribed percentage of funds for such activities, and a Board must be established to regulate and monitor these activities. However, all activities halt when a petition is filed under Section 7 of IBC and a moratorium is imposed. Although Section 14 of IBC does not explicitly mention CSR activities, companies often find it challenging to allocate funds to CSR during this period due to financial distress.

One of the significant objectives of IBC is to ensure the maximization of the value of the assets of a CD. Therefore, when the company enters insolvency, its financial priorities shift significantly and fulfilling CSR obligations takes a backseat. Further, the claims of financial, secured and operational creditors take precedence under the waterfall mechanism. The claims regarding CSR obligations are considered under the "other creditors" category and often filed in Form F, thereby decreasing the chances of obtaining the penalty dues under Section 135 of the Act. Moreover, there is no mandate for resolution plans to incorporate the mandatory fulfilment of CSR responsibilities for companies in their post-resolution phase.

The recent BRSR framework is also silent in cases where the company has failed to make the necessary ESG disclosures and goes into insolvency. The obligations of the resolution applicants, the committee of creditors (CoC) and the resolution professionals must be outlined in the framework that makes it mandatory for them to consider the ESG disclosures. Integrating CSR and ESG obligations into the resolution process can promote long-term sustainability. Companies considering these factors are better positioned to recover and thrive in their post-resolution phase. These ambiguities about CSR and ESG obligations under the Insolvency regime are due to a lack of environmental considerations during the law-making process.

A Case for Green Insolvency

In light of the challenges discussed above, it is argued that, firstly, environmental claims must prevail over moratorium, and secondly, environmental claims must be given priority under the waterfall mechanism.

Environmental claims must prevail over the moratorium period

The objective of imposing a moratorium during the CIRP is to ensure that all the assets of the CD are utilized in satisfying the debts of creditors and that the value of those assets is not minimized due to any other proceedings. As discussed above, when a corporate debtor fails to remediate pollution, the financial burden often shifts to the government, impacting public funds immediately or in the future. It is unjust for the public to bear these costs due to corporate negligence. Exempting environmental proceedings and decrees from the effect of a moratorium ensures that companies remain accountable for their liabilities. Some experts have argued that it is fair and just that companies that have neglected their environmental responsibilities suffer the consequences of their silence and inaction.

Furthermore, in the case of Swiss Ribbons Private Limited and Another v. Union of India, the Supreme Court emphasized the role of financial creditors in assessing the viability of the CD. The court opined that creditors are well-informed about the debtor's business and should be aware of environmental liabilities. Suppose financial creditors, armed with detailed market studies and periodic reports, remain silent on environmental claims. In that case, it is again just and fair that they bear the consequences of this silence, ensuring that environmental claims are prioritized.

Environmental claims must be given priority under the waterfall mechanism

The waterfall mechanism under the code currently differentiates between secured and unsecured creditors, often reducing unsecured creditors, including environmental claimants, to minimal or no compensation. This prioritization marginalizes critical environmental claims, resulting in unresolved liabilities and ongoing ecological harm. Environmental claims, typically under contingent environmental claimants or environmental decree holders, face significant challenges in receiving their dues. Environmental decree holders, often classified as unsecured creditors, fall under 'other debts and dues'. Contingent environmental claimants are similarly classified under 'any remaining debts and dues,' reducing their chances of recovery. The extinction of environmental claims during the CIRP leads companies to escape the liabilities imposed by various environmental statutes. Such escape not only undermines corporate responsibility but also goes against the public interest. Communities affected by environmental damage continue to suffer without adequate remediation or compensation. This outcome also conflicts with the principles of sustainable development and the polluter pays principle, which is essential for ensuring long-term ecological balance and social justice.

The Way Forward

It is clear from the above-mentioned ambiguities and gaps that environmental laws were not considered when the legislators drafted the code in 2016. Although the code was drafted around the same time as the Paris Agreement in 2015, the potential intersection of environmental laws was overlooked. As a result, it is unclear whether environmental regulations would have overriding powers over IBC. However, the authorities have recently started paying the long due attention to environmental claims and sustainability. In light of these developments, it is recommended that, first, environmental claims must be explicitly mentioned in the code and should be treated as a priority under the waterfall mechanism.

Second, during the CIRP, the CoC must be mandated to pay attention to the CD's CSR activities. The CoC should mandate a thorough environmental audit of the CD as part of the resolution process. Such an audit should identify all existing and potential environmental liabilities, including pollution remediation, compliance with environmental regulations, and future environmental risks. Resolution applicants must be required to submit detailed environmental due diligence reports evaluating the corporate debtor's adherence to environmental laws and the steps needed to mitigate any identified issues.

Third, the resolution plans should explicitly distribute funds for addressing environmental liabilities, which includes setting aside resources for pollution remediation, compliance upgrades, and ongoing environmental monitoring and management. Environmental costs should be treated as part of the CIRP costs and prioritized and addressed early in the resolution process. It must also provide a comprehensive long-term plan for environmental sustainability.

Climate change can lead to higher costs for litigation for environmental damages, increased expenses for insurance and reinsurance, and even potential insolvency due to direct and indirect losses. Therefore, fourthly, companies must also consider climate change as they shape their corporate strategies. This includes conducting carbon footprint assessments, exploring technological innovations to improve energy efficiency, and carefully evaluating the impact on asset valuation and business reputation.

Further, some industry insiders have suggested that prioritizing environmental claims during bankruptcy proceedings could diminish a company's overall value, underscoring the need for express legal provisions. Therefore, lastly, establishing a dedicated environmental body involved at the resolution plan approval stage will ensure that the CoC, while business-savvy, can adequately address climate-related issues. This body should assess environmental impacts and provide binding recommendations to the CoC, ensuring that environmental claims are prioritized alongside other claims.

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1 Comment

आनंददत्त भारद्वाज
आनंददत्त भारद्वाज
Jul 01

Very nicely elaborated. Good going👌

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