What Counts as Property under the CIRP? The Spectrum Licence Conundrum

[Anushka is a student at National Law University Delhi.]

The recent ruling of the Supreme Court (Court) in the case of State Bank of India v. UOI has effectively held in respect of a telecom service provider (TSP) going through the corporate insolvency resolution process (CIRP), that a spectrum license is an excluded asset under the Insolvency and Bankruptcy Code 2016 (IBC) and cannot be transferred to the successful resolution applicant, as they are material resource held in public trust by the government. The ruling of the Court favours the public trust doctrine over the value maximisation objective of the IBC. 

The post critiques the judgment for relying on external statutes, such as the Transfer of Property Act 1882 (TPA) and the Sale of Goods Act 1930 (SOGA), to define ‘property’ while overlooking the IBC's definition of property under Section 3(27). The Court has utilised the provisions of TPA and SOGA to determine ownership of the spectrum license, whereas IBC is primarily concerned with identifying who has an interest in the property to facilitate a successful CIRP. Additionally, the Court has misapplied the provisions of the liquidation stage under Section 36(3) and 36(4) to determine assets that are excluded during the CIRP process. Together, these misinterpretations by the Court have created a precedent that can effectively exclude categories of businesses that have licensed assets from a successful resolution under IBC. 

Asset as per Indian Accounting Standards 

To determine what will constitute an asset of the corporate debtor (CD), the Court first examines whether the spectrum license qualifies as an asset of the CD under the Indian Accounting Standards (IAS). IAS 38, which governs intangible assets, states that an asset is part of the balance sheet of the CD if the asset is the present economic resources controlled by the entity as a result of past events that produce economic benefits (here, control is an important aspect to call an entity asset). The Court recognised that the TSP satisfies the conditions in the IAS 38, and that makes spectrum licenses an asset of the CD as recorded in the balance sheet. However, the Court refused to take that into account, as it held that the balance sheet is not the determinant of ownership, and that recognising an asset for accounting purposes does not mean conferring title over it.

The reasoning provided by the Court is flawed for the reason that the determination of ownership at the stage of the resolution is not the concern of the IBC; it is concerned about the estate that a resolution applicant is reviving. Similarly, in Victory Iron Works v. Jeetendra Lohia, the Court held that assets recognised in the balance sheet of the CD constitute part of the estate of the CD for the purposes of the IBC. The Court in the present case does not engage with or distinguish this precedent. 

Property as Defined under IBC 

Alternatively, the Court, instead of relying on the IAS 38, has chosen to rely on TPA and SOGA to indicate that property is something that indicates title and ownership. Since a license only provides control for a period of time, it cannot be considered an asset. Thus, there cannot be complete ownership of the spectrum by TSPs. It is the critique of the author that the Court placed reliance outside IBC to define what property is, when Section 3(27) already exists and provides a comprehensive definition. 

The definition specifies that every description of interest will be construed to be property, and a spectrum licence, even if it does not confer ownership of the underlying spectrum, confers a vested or contingent interest in the right to use such spectrum. This provision should have been adequately discussed and delved into to conclude. 

Further, the Court placed its reliance on TPA and SOGA. It is the critique of the author that before placing reliance on external statutes, they should have placed reliance on Section 3(37) of the IBC, which specifies that for the definitions that are not present in the code, one can rely on the Security Exchange Board of India Act 1992 (SEBI) Companies Act 2013, The Recovery of Debts and Bankruptcy Act 1993 (RDB Act). The RDB Act defines the word property in Section 2(jb), in clause (e) of the section, it defines a licence to be the property. The Court, in addition to TPA and SGA, should have first placed its reliance on the RDB Act, which defines property adequately. Thus, insufficient reliance was placed on the IBC to decide on the property of the company that is undergoing CIRP. 

Reliance Placed on Section 36 of IBC 

The Court has placed its reliance on Section 36(3) and Section 36(4) to specify that the liquidation estate excludes assets owned by a third party in possession of the CD, including under other contractual arrangements which do not stipulate transfer of title but only the use of the assets. These sections are explained because the spectrum is the property of the Department of Technology, and only the right to use has been given under the contractual arrangement to use the asset. Thus, it cannot be made part of the liquidation estate.

In the present factual matrix of the case, the company was going through the CIRP, not liquidation. Thus, applying the provisions of liquidation to exclude the asset from the company undergoing CIRP is a misplaced reliance by the Court. During liquidation, there is a transfer of ownership; in the case of CIRP, there is no transfer of assets, but a takeover by the successful resolution applicant wherein the company holds the license. Thus, during the CIRP, there is no transfer of ownership, only the management changes hands. 

Implication of the Judgment on Prospective Resolution Applicants 

The judgment has real-life implications for the CIRP process. The judgment, to an extent, undervalues the valuation of the CD by keeping its most lucrative asset out of the CIRP. This directly undermines the value maximisation objective of the IBC, as affirmed in the case of Swiss Ribbons Private Limited v. Union of India. A difference in valuation would lead to multiple issues that would undermine the working of the creditors, the resolution applicant, and the overall feasibility of the CIRP. 

First, the creditors (leading banks) have to do a detailed credit appraisal process mandated by the Reserve Bank of India, which requires assessment of various things, including the assets of the borrower, which include the licenses and rights to use held by the borrower. Therefore, lending decisions are intrinsically premised on the legal recognition and recoverability of the corporate debtor’s assets. If key operational rights like spectrum are excluded from the definition of assets under IBC, that would create uncertainty in the market, where banks would be discouraged from providing loans, because there is no assurance regarding recovering the money in case the borrower defaults. 

Second, the effect on the prospective resolution applicant, the ruling materially chills bidder behaviour. To understand this, let us break down the resolution process into stages. The information memorandum that is prepared by the resolution professional lists out the assets and liabilities, licenses, and leases of the CD. Based on this information, the resolution applicant submits its plan. Now, with this ruling, a prospective resolution applicant must factor in any significant uncertainty regarding the licence the CD holds. This uncertainty would lead to fewer bids in the sector, where the key asset is a licence, and this would lead to depressed bid value. 

Third, this would ultimately impair value maximisation and overall feasibility of CIRP, for businesses that are in the telecom and aviation sectors, where most crucial assets are licensed. As the resolution applicant, if successful, would be stripped of its primary revenue-generating asset, it would be disincentivised from bidding, thus impairing the resolution of such entities. 

Conclusion 

The piece does not seek to go against the judgment of the Court, but the Court did not adequately discuss the provisions of the IBC to determine whether the spectrum license can be considered an asset and can be treated under the IBC. In the judgment, Court has not agreed with the treatment of assets as per the IAS and has relied on the traditional understanding of property as in the case under TPA and SOGA, which indicate title or ownership in the property or goods. In doing so, the Court has failed to account for the definition of property as provided in the IBC and the RDB Act. 

Further, the Court, when discussing the assets of a company undergoing CIRP, has placed reliance on the provisions under Sections 36(3) and 36(4) of the IBC. However, these specifically exclude assets from the liquidation estate, not CIRP. Thus, the reliance here is misplaced because of how structurally different both liquidation and CIRP are. 

The effective consequence of this judgment is that the CD that holds a license, concession, or right to use in any sector, i.e. aviation, pharmaceutical, can have a hard time getting a resolution in the IBC. For all these different licenses, there is a specialised regulatory body that will decide the treatment of its license, not the IBC, whose purpose is to resolve distressed entities.