Clean Slate Approach under IBC: An Impetus to Insolvency Proceedings
[Divyani is a student at National Law University, Nagpur.]
The Insolvency and Bankruptcy Code 2016 (IBC) is one of the most dynamic statutes to be enacted in recent times. Since its implementation, India’s ranking has meteorically risen under the insolvency head of the World Bank Group’s Ease of Doing Business Report. However, at the same time, a pall of uncertainty prevails for the resolution applicants under the IBC over the implementation of clean slate approach. The doctrine of clean slate stipulates that after the culmination of the corporate insolvency resolution process (CIRP), any pending claims qua the corporate debtor (CD) shall be extinguished, and the successful resolution applicant shall take over with a clean slate. This post will explore the legislative and the judicial evolution of the clean slate doctrine. The author will then analyse the limitations of this approach by highlighting practical challenges and conclude by discussing potential changes which will help strengthen the Indian insolvency regime.
Recent Developments under Clean Slate Approach
Recently, the Rajasthan High Court (HC) in the Ultra Tech Nathdwara Cement case decided that a successful resolution applicant should not be saddled with the dues of statutory operational creditor (OC) (in this case, the GST authorities) which are not included in the resolution plan and it should be able to start with a clean slate. The matter arose when the resolution professional (RP) admitted statutory OCs’ claims to a fractional amount while the rest was not included in the information memorandum. The GST authorities approached NCLAT contending that the RP had acted improperly in not appreciating their claims and the Committee of Creditors (CoC) did not afford them a hearing before reducing their liability.
The HC held that statutory authorities are OCs and the amount payable to them is part of operational debt. More importantly, the legislative intent of IBC is to ensure revival of the business and not insist on recovery of every dime so that the resolution applicant can take over the reins of CD with a clean slate. Thus, allowing creditors to make pre-CIRP claims already covered under the aegis of an approved resolution plan would frustrate its object and dis-incentivise potential resolution applicants.
This was shortly followed by Electrosteel Steels decision which at the first glance was seemingly in contrast to Ultra Tech’s ratio. The matter arose when the GST authorities initiated garnishee proceedings against the CD for recovery of taxes. However, it is worth noting that the resolution plan was passed without public announcement of CIRP. In doing so, the claims of the GST authorities could not be considered. Thereafter, the court placed reliance on the unamended Section 31 of IBC which makes the resolution plan binding on all “stakeholders involved”. Since the GST authorities were not involved in CIRP, they were held to not be bound by the plan. Further still, the tax amount that was sought to be realised by the GST authorities had been collected by the company from its customers but not deposited with the government exchequer. In fact, this money was being utilized for business purposes and was characterized as criminal misappropriation of government money. That being said, crucially, the ratio of Ultra Tech case was sustained.
As things stand today, the Electrosteel case has proved to be an outlier when we consider the insertion of Section 32A of IBC which ensures that the incoming resolution applicant is not held liable for the misdeeds of the erstwhile CD. In another development, affirming this doctrine, the Finance Minister while addressing the Rajya Sabha also declared that the government shall make no claim after the resolution plan is approved. That way, primacy could be given to the revival of businesses which could eventually contribute to the exchequer by way of taxes and generating employment.
Prior to the Ultra Tech Judgment
The clean slate approach has evolved significantly through judicial process. In this context, it is pertinent to mention that there are two types of claims that will be considered here - proceedings that have been initiated prior to CIRP but resulting in subsequent crystallization, and proceedings initiated after CIRP but relating to the period up to the insolvency date and crystallising thereafter. In the first scenario, it was observed that creditors of undecided claims were not recognised as 'creditor' under Section 3(10) of IBC. This was predicated on their claims being rejected by RP and thus getting classified as disputed claims under Sections 8 and 9 of IBC. As a consequence, although they were creditors, they could not partake in CIRP because of failing to fulfil Section 3(10) of IBC. For further context, Section 3(10) of IBC includes any person to whom a 'debt is owed' and even a 'decree holder'. From this, we can conclude that Section 3(10) does not extend its coverage to include non-crystallised or disputed claims.
Understandably, this gave rise to concerns as after passing of resolution plan, Section 31 of IBC makes it binding on all 'stakeholders' and not 'creditors' that were previously recognised to have their claims considered. In view of this, since 'stakeholders' is not defined under IBC, in common parlance, it would even include creditors of such disputed, non-crystallised or contingent claims that were not earlier recognized under CIRP. As a result, not only were their claims precluded from CIRP, but they were also bound by resolution plan. This was illustrated in Kotak Mahindra v. Bijay Murmuria.
However, a similar conclusion cannot be drawn in the second scenario of claims maturing after CIRP. To better understand the nuances of the same, let us consider NCLAT’s ruling in Edelweiss v. Orissa Manganese where the court opined that a bank guarantee that has been invoked can be pursued against CD even after CIRP as it would be considered as 'debt' under Section 3(11) of IBC. This was in sharp contrast to the landmark Essar Steel case. In Essar Steel, the court addressed the clean slate discussion by stating that Section 31(1) of IBC makes the resolution plan binding on all stakeholders which ensures that the resolution applicant takes over the business of the CD with a clean slate. This is done so that the prospective resolution applicant knows the exact amount to be paid at the time of taking over the CD and is not faced with previously unsurfaced claims. Hence, no creditor can make any claims after the resolution plan is passed, and if such claim has been considered in the plan with haircuts, it shall preclude such creditor from agitating its claim again.
Although this was a step in the right direction, it was far from final as there continues to be lack of judicial clarity over the interpretation of Section 31 of IBC. This can be seen from the divergent views on resolution plans being binding on creditors who were not involved in CIRP. Towards this end, it is necessary that clarifications are issued to provide greater predictability and consistency.
Limitations of Clean Slate Approach
While the recent developments indicate a tilt towards a clean slate approach, this predictably comes with its own practical challenges. First, the Ultra Tech case relied upon Essar Steel judgment to uphold the clean slate doctrine. However, the dictum in the Essar Steel case proceeds on the misplaced assumption that all claims against CD have to be decided by RP. While this may be the case insofar as the RP is empowered to act in an administrative capacity to collate all claims, it fails to consider the instances when the National Company Law Tribunal (NCLT) also has the power to adjudicate claims under Section 60(5) of IBC. This is crucial as sometimes RP may not aptly consider claims that are categorized as disputed, uncrystallised or contingent. As a result, creditors have to take recourse to challenge rejection of such claims by RP before the NCLT under Section 60(5) of IBC. In view of this, it is plausible that if the resolution plan is approved before deciding the admissibility of such rejected claims, these claims would stand extinguished qua the CD and the creditor will be rendered sans remedy under this approach.
Besides this, some claims involve a complete trial for admission, but the IBC does not provide the RP or NCLT with powers to admit claims which involve a question of fact and evidence. Consequently, some creditors may be left without a forum since their claims cannot be admitted by RP or NCLT owing to the summary nature of IBC. Therefore, in light of these aforesaid concerns, there is a need felt to reorient the insolvency framework to deal with such claims.
The UNCITRAL Legislative Guide on Insolvency Law recognises the clean slate approach emphasising that successful insolvency resolution is to be evaluated along the axes of commercial certainty and simplicity. Thus, the clean slate approach of IBC aligns with such international principles.
However, at the same time, emerging concerns of creditors being rendered without a forum for their undecided claims or claims not adequately considered under the aegis of a resolution plan should be addressed. Especially since after the approval of resolution plan, these claims have no locus in the eyes of law to be pursued against the CD. One way to address this is to introduce a mechanism under IBBI (Insolvency Process for Corporate Persons) Regulations 2016 to provide for liabilities that may crystallise in the future which emanate from such undecided claims. This modified framework to clean slate approach would be beneficial to not only help trim dockets of the courts but will also give a fillip to business activity by prioritizing revival of businesses and incentivising prospective resolution applicants.