The banking sector in India has been facing some headwinds on account of the overhang of stressed assets in the system for the last few years and the liquidity crisis (which can largely be seen as a consequence of the former) within the system. The focus has been on bank recapitalisation and strengthening the resolution framework for stressed assets to allow the sector to limp back to normalcy. The two key legislative/regulatory frameworks are the Insolvency and Bankruptcy Code, 2016 (IBC), which has been updated this year, and the new Prudential Framework on Resolution of Stressed Assets (New Prudential Framework) introduced by the Reserve Bank of India (RBI) earlier this year.
The introduction of the IBC has been the watershed moment in respect of resolution of stressed assets. Numerous cases have gone in for resolution with some of the big ticket cases having reached finality in terms of either an approved resolution plan or liquidation. However, the IBC is still in early stages of its development and its effective implementation has been facing some challenges. While the legislature is constantly trying to address these issues, some of them may continue to linger around and delay the process. The New Prudential Framework has been designed to allow flexibility to lenders to tailor resolution packages outside the legislative framework of the IBC and incentivises early resolution. With the regulatory insistence on swift resolution of NPAs, banks have been permitted to opt for bolder resolution solutions.
These developments have come a long way in resolving the NPA issue. Banks have already reported improved provision coverage ratios, capital adequacies and return on capital and the gross non-performing ratios are also expected to fall over the next year.2 We expect this trend to continue in the coming year.
ii SIGNIFICANT RECENT CASES
Given that the IBC has come into force recently, the jurisprudence under it is still evolving and each decision explores a new area of interpretation. In the past three years, the IBC has successfully overcome two sets of challenges on its constitutional validity with the most recent one being in the case of Swiss Ribbons Private Limited v. Union of India,3 where the Supreme Court of India upheld the vires of the IBC. Additionally, the judgment of the Supreme Court lays out some key principles that we have set out as follows:
- The distinction drawn between financial creditors and operational creditors is not arbitrary and is constitutionally valid.
- The intention of the law is 'maximisation of value' of the corporate debtor and liquidation should be seen as a last resort. As such, the resolution process should not be seen as an adversarial proceeding against the corporate debtor.
- Evidence from information utilities under the code is only prima facie in nature.
- The role of the resolution professional is administrative in nature as opposed to quasi-judicial.
- Resolution applicants do not have a vested right to have their plans considered by the committee of creditors.
- Related parties or relatives of persons ineligible to present a resolution plan must be connected with the business of the ineligible person to be ineligible.
A few other key areas that banks should be aware of, based on decisions seen so far, are as follows:
- the categorisation as financial creditors;
- the treatment of claims against guarantors and third-party security providers; and
- the justiciability of approval or rejection of resolution plans by committee of creditors.
i Categorisation as a financial creditor
Under the IBC, a financial creditor is a creditor to whom the corporate debtor owes a financial debt along with interest disbursed to the corporate debtor for consideration of time value of money. This includes financial transactions such as a loan, discounting of receivables, derivative transactions in connection with price protection, debentures and other debt securities, forward purchase agreements (including purchase of a real estate units in a real estate project) and a guarantee or indemnity in connection with financial transactions being included within the category of a 'financial debt'.
Financial creditors can initiate a corporate insolvency resolution process (CIRP) under the IBC upon occurrence of a default in the debt owed to them. They form the committee of creditors, which takes over critical management-level decisions of the corporate debtor and is responsible for approving resolution plans or liquidation of the corporate debtor. Operational creditors, on the other hand, do not enjoy any decision-making powers during a CIRP (unless in cases where the corporate debtor has no financial creditors). Courts have been developing jurisprudence around classifying various structured transactions in one or the other basket. The underlying principle that has emerged is that a transaction with an element of consideration of time value of money will be categorised as a financial debt. Below, we have set out some key cases that have been decided in the last year.
In the case of Shailesh Sangani v. Joel Cardoso4 the National Company Law Appellate Tribunal (NCLAT) clarified that the requirement of interest is not a sine qua non to classify money disbursed as a financial debt if such money had a commercial effect of borrowing. In that case, monies advanced by way of shareholder loans without any requirement to pay interests were held as financial debts owed by the corporate debtor. This principle has been applied in cases of structured obligations as well. By way of illustration, in the case of Pushpa Shah v. IL&FS Financial Services Limited (IFIN),5 the National Company Law Tribunal (NCLT) was considering an application to initiate CIRP by IFIN as a financial creditor of La-Fin Financial Services Private Limited (La-Fin) on account of an undertaking provided by La-Fin in respect of the investment by IFIN in MCX Stock Exchange Limited. In terms of the undertaking, La-Fin agreed to purchase the shares of MCX Stock Exchange Limited from IFIN at the higher of a predetermined internal rate of return or the price at which the last sale of shares of MCX Stock Exchange Limited would have taken place. The court observed that the transaction was not a purchase of shares, simpliciter, but involved an element of time value of money on account of the prescription of a minimum internal rate of return at the time of purchase of shares of La-Fin.
Similarly, in ICICI v. Era Infrastructure (India) Limited,6 the corporate debtor agreed to purchase a loan provided by ICICI Bank in case of a default by the principal borrower. The court found such undertaking to be akin to a guarantee in respect of the loan and, therefore, a financial debt. While the cases set out in this section recognise structured arrangements as financial debt, they also make it imperative for banks to evaluate and diligence such commitments of the borrowers at the time of credit evaluation, which, unlike a guarantee simpliciter, may or may not be disclosed in the accounts of the borrower.
ii Treatment of claims against guarantors and third-party security providers
The definition of a financial debt expressly recognises a guarantee or an indemnity provided in respect of a financial debt as also being a financial debt. However, the rights of beneficiaries under guarantees given by corporate debtors has been a contentious issue under the IBC. By way of the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, the legislature clarified that the moratorium against the principal debtor would not apply to enforcement of invocation of guarantee. Some other clarifications have been provided by the NCLAT/NCLT and we have summarised them here.
In the case of Edelweiss ARC v. Orissa Manganese and Minerals Limited7 the NCLAT was adjudicating on the claim of a beneficiary of a guarantee provided by the corporate debtor. The beneficiary did not invoke the guarantee prior to the admission of the CIRP and declaration of the moratorium. The NCLAT allowed the insolvency professional to reject the claim of the beneficiary on the ground that the guarantee claim did not mature in absence of alleged default on the part of the 'principal borrower' and consequentially on account of non-invocation of the guarantee prior to the admission of insolvency.8 In light of the judgment, it is important to ensure that in cases where primary or substantial credit comfort is drawn from a third-party guarantee, an adequate mechanism is documented to ensure that the guarantee can be invoked, in time, before any admission of insolvency of the guarantor (while no payment default may have occurred in the underlying facility).
Where a transaction draws support by way of security created by a third party, the ability of the beneficiary of such security to stake claim as a financial creditor of the security provider was discussed in Phoenix ARC v. Ketulbhai Patel.9 The NCLAT held that where the corporate debtor only provided a pledge over certain shares as collateral, it did not by itself amount to a disbursement of any amount against the time value of money and therefore it did not amount to a financial debt vis-à-vis the security provider. We note that this order of the NCLAT is under challenge in the Supreme Court and no further orders have been passed as of yet.
In Vishnu Agarwal v. Piramal Enterprises,10 Piramal Enterprises Limited provided a loan to the All India Society for Advance Education and Research that was guaranteed by two corporate guarantors. The creditor filed for initiation of CIRP against the corporate guarantors without initiating a CIRP against the principal debtor.11 The court allowed a CIRP to be initiated against the guarantors without having to proceed against the principal debtor. However, given that it was the same underlying debt in the case of both the guarantors, the NCLAT ruled that simultaneous proceedings for CIRP could not be initiated against the guarantors. However this does not restrict a beneficiary of a guarantee from filing simultaneous claims with the resolution professionals for both the principal borrower and the guarantor, where they are undergoing a CIRP at the same time. This has been clarified by the NCLT in ICICI v. Ritu Rastogi,12 where the creditor was allowed to file its claims under the same debt with the resolution professional of the principal debtor as well as the guarantor.
iii Justiciability of approval or rejection of resolution plans
The IBC requires a resolution plan to be approved or rejected by the committee of creditors after considering the viability, feasibility and manner of distribution proposed in the plan. If approved, the resolution plan is then submitted to the NCLT for its approval. At this stage, the IBC restricts the inquiry by the NCLT to ensure that the mandatory contents of the resolution plan (such as, payment of insolvency resolution costs, payments to dissenting financial creditors and operational creditors, management of the corporate debtor, implementation and supervision of the plan, etc.) have been provided for in the plan. In K Sashidhar v. Indian Overseas Bank,13 the Supreme Court was considering a challenge to an NCLAT order that ordered the liquidation of the corporate debtor as no resolution plan was approved by the requisite majority of the committee of creditors within the statutory timelines. Upholding the order of the NCLAT the Supreme Court has observed that the decision of approval or rejection of the resolution plan is a collective decision of the committee of creditors and the legislature has not envisaged a challenge to the commercial or business decision of the committee of creditors. Further, the Supreme Court also observed that it is not open to the NCLT to entertain any revised resolution plans after the expiry of the statutory period prescribed for the completion of the CIRP.
While judicial scrutiny has been restricted in cases of commercial decisions, to the extent the resolution plan is required to meet certain criteria (as set out above) and is required to deal with the claims of the operational creditors, similarly situated financial creditors and dissenting financial creditors in a fair and equitable manner,14 it is open to the adjudicating authority to withhold its approval to the resolution plan on these grounds. The extent to which the adjudicating authority can go in terms of a redistribution of amounts proposed by a resolution applicant or the committee of creditors has been the subject matter of a fair amount of controversy and has also led to some legislative amendments discussed in Section III.
iii RECENT LEGISLATIVE DEVELOPMENTS
The RBI has issued a general circular15 to banks and non-banking financial companies requiring lenders to recognise incipient stress in loan accounts and resolve the stress upon a default in such account (if not prior to the default). The lenders are required to finalise a resolution strategy within a review period of 30 days following the default or choose to initiate a legal procedure for insolvency or recovery. Where a resolution plan is to be implemented, lenders are required to enter into an inter-creditor agreement setting out the ground rules for implementation of the resolution plan. Among other things, the inter-creditor is required to provide for decision-making by a resolution of 75 per cent of the lenders by value and 60 per cent by number and payment of liquidation value to dissenting creditors.
The resolution plan is required to be implemented within 180 days from the reference date or the date of first default from the reference date.16 Any delay in implementation of the resolution plan involves enhanced provisioning by the lender. The Revised Framework provides for categorising restructured assets as non-performing until such assets show satisfactory performance (absence of a default) during the prescribed monitoring period.
In 2016, the government completely overhauled the existing insolvency regime by enacting the IBC. Since coming into effect, the IBC has been amended thrice – once through the Insolvency and Bankruptcy Code (Amendment) Act 2018, the Insolvency and Bankruptcy Code (Second Amendment) Act 2018 and recently through the Insolvency and Bankruptcy Code (Amendment) Act 2019 (2019 Amendment) – in each case, to address specific interpretational issues that have arisen in the course of its implementation. The latest set of complexities came to light in the ongoing resolution process of Essar Steel Limited where the process has been inordinately delayed on account of cross-litigation and lack of clarity on various issues under the IBC. Further, the decision of the NCLAT and the apex court in relation to the fair treatment of creditors in a resolution plan17 and the application of these principles while approving the resolution plan for Essar Steel Limited by the NCLAT created the need for specific clarification on the issue. The key features of the 2019 Amendment are as follows:
- The 2019 Amendment provides for an outer timeline of 330 days from the insolvency commencement date, which will be inclusive of any extension granted in respect of any legal proceedings in relation to the CIRP.
- An authorised representative of financial creditors (a class of creditors or holding debt securities) is required to cast its vote in respect of any matter on behalf of all such financial creditors in accordance with the decision taken by a vote of more than 50 per cent of the vote share of such financial creditors, who have cast their vote. The amendment does not save any previous arrangements among such creditors. This voting mechanism however is not mandatory in the case of a syndicated loan which provides for an authorised representative such as a facility agent – in that case a lender can choose to vote either directly or through the agent, but the agent is required to vote each lender's share in the outstanding debt separately.
- Resolution plans are required to provide for the payment of debts as specified by the Insolvency and Bankruptcy Board of India (IBBI) to dissenting financial creditors (at least the amount payable to them in accordance with their priority at the time of liquidation) and operational creditors (at least (1) the amount payable to them in accordance with their priority at the time of liquidation; or (2) the amount that would be paid to them, if the amount proposed to be distributed under the resolution plan would be distributed to them in accordance with their priority at the time of liquidation).
- The 2019 Amendment empowers the committee of creditors to approve or reject a plan after considering the proposed manner of distribution, which may be based on the order of priority set out under the IBC and the value of the security of a secured creditor.
- A resolution plan can include a proposal for corporate restructuring by way of merger, demerger or amalgamation. This will allow resolution plans to provide for more dynamic solutions and maximise the value of the corporate debtor.
- It has been clarified that a resolution plan, once approved, will be binding on the central government, the state government and any local authority to whom a debt in respect of payment of dues arising under any law and any statutory dues are owed. This puts to rest the question on the binding effect of a resolution plan to the extent the same deals with payment of any statutory dues owed by the corporate debtor.
- The committee of creditors may decide to liquidate the corporate debtor at any time after its constitution but before the approval of a resolution plan.
IV CHANGES TO COURT PROCEDURE
In 2015, the government passed the Commercial Courts Act 2015 (the Commercial Courts Act). The Commercial Courts Act provides for setting up commercial courts at a district level and setting up commercial divisions and commercial appellate divisions in the High Courts. These courts will deal with commercial disputes, which will include 'disputes arising out of ordinary transactions of merchants, bankers, financiers and traders such as those relating to mercantile documents, including enforcement and interpretation of such documents'. The idea behind the Commercial Courts Act is to speed up resolution of commercial disputes in India and, to that effect, the Commercial Courts Act has various provisions (on process and timelines) that, if enforced, would have the effect of streamlining processes and reducing timelines for resolution of disputes. However, given that banks already have recourse to debt recovery tribunals and to NCLTs (under the IBC) to address their disputes, the impact of the Commercial Courts Act on banks may be limited.
The Commercial Courts Act has been recently amended to reduce the minimum value of disputes (to determine pecuniary jurisdiction) to 300,000 rupees, thereby bringing more matters into the purview of the commercial courts. The amendment also introduced a mandatory pre-institution mediation for suits not requiring urgent interim relief.
V INTERIM MEASURES
The Specific Relief (Amendment) Act 2018 has been notified by the government. The key takeaway from the amendment is that it makes specific performance of contracts the rule rather than the exception. Under the new amendments, the promisee (the aggrieved party), has a right to have the (breached) contract performed through a third party or by his or her own agency. The promisee can then recover the expenses and other costs incurred for such 'substituted performance' from the promisor (the defaulter). Although the amendment specifically clarifies that exercising such substituted performance does not limit the other rights of the aggrieved party, such as claiming compensation, it conveys a clear message that specific performance should be adhered to as a rule.
Separately, the amendment includes a new provision in the Specific Relief Act, 1963 under which the courts are not permitted to grant injunctions in a dispute involving contracts relating to infrastructure projects (separately defined in the amendment) if granting of such injunctions would impede or delay the progress or completion of such projects. Additionally, the amendment proposes to designate certain civil courts as special courts to try suits under the Special Relief Act in respect of contracts relating to infrastructure projects.
VI PRIVILEGE AND PROFESSIONAL SECRECY
The Indian Evidence Act 1872 (the Evidence Act) attaches privilege to communication made during the course of professional employment to legal practitioners, against disclosure of any advice given to the client or against disclosure of communication made during the course of his or her employment. That privilege continues even after the employment has ceased. The protection is given to what might constitute legal advice and not to any other communications from the adviser. In addition, such protection is not granted to the disclosure of any communication made in furtherance of any illegal purpose or the disclosure of any fact observed by the legal practitioners in the course of employment, in case a crime or fraud has been committed since the commencement of his or her employment (as opposed to before the employment commenced).
The law further provides that a person cannot be compelled to disclose to a court any confidential communication that has passed between that person and his or her legal professional adviser. However, where such person voluntarily offers himself or herself as a witness, he or she may be compelled to disclose such communications to the court that appear necessary in order to explain any evidence that he or she has given.
The privilege under the Evidence Act also extends to the contents or condition of documents with which the legal adviser becomes acquainted in the course and for the purpose of his or her professional employment. Communications containing facts of a matter for the benefit of the legal adviser that are shared for the purpose of seeking legal advice may enjoy privilege.
The principle of litigation privilege – that privilege is attached to any document prepared for the purposes of, or in anticipation of, litigation – recognised under English law, is not reflected in the Evidence Act. This common law principle has, however, been recognised by the Bombay High Court.18 In that case, the management of the company had directed for studies to be conducted by its advertising and public relations departments. It was held that the company was entitled to claim legal privilege on the internal communications with the legal and other departments because the documents were brought into existence with the sole purpose of obtaining legal advice. This decision seems to suggest that if any work has been commissioned for the purpose of seeking legal advice, such work product in the form of a document will enjoy privilege.
VII JURISDICTION AND CONFLICTS OF LAW
In contracts where one of the parties is foreign, Indian law generally allows the parties to decide the forum19 and the governing law of the contract.20 Parties have the option of submitting to the exclusive jurisdiction or non-exclusive jurisdiction of courts within whose jurisdiction they reside or a neutral forum (i.e., a forum not having a nexus with either of the parties to the contract). The only exception to the rule is if the forum chosen violates domestic law or is against public policy.
Other than judgments of superior courts in reciprocating territories,21 foreign judgments cannot be automatically executed in India. To enforce foreign judgments from non-reciprocating territories, the judgment creditor will have to file a fresh suit in a domestic Indian court of competent jurisdiction, on that foreign decree or on the original, underlying cause of action, or both.22 However, foreign judgments are considered conclusive as to the matters adjudicated upon as part of the judgment.
Both the execution of judgments from superior courts in reciprocating territories and the conclusiveness of judgments from non-reciprocating territories can be challenged on certain grounds, including: (1) the judgment not being given by a competent court; (2) the judgment not being on the merits of the case; (3) the judgment being founded on an incorrect view of international law or refusal to recognise Indian law, in cases where such laws are applicable; (4) when the proceedings in which the judgment was obtained are opposed to natural justice; (5) the judgment being obtained by fraud; and (6) where the judgment sustains a claim founded on a breach of any law in force in India.
VIII SOURCES OF LITIGATION
In terms of litigation against banks, common causes have included: (1) failure or delay in repaying deposits; (2) wrongful dishonour of cheques; (3) refusal to grant loans; (4) failure or delay in paying bank guarantees; (5) charging interest at rates higher than those stipulated in the loan agreement; and (6) deficiency in service on various other matters.
In addition to the above, for the next couple of years, banking litigation in India is likely to, in large part, revolve around IBC proceedings and matters ancillary thereto (such as resolution of assets, creditor rights inter se, etc.). We have already seen jurisprudence around the IBC evolve substantially since it was enacted and as banks and other creditors continue to make the IBC their first port of call to resolve NPAs and stressed assets, we expect to see the jurisprudence around the IBC evolve even more.
IX OUTLOOK AND CONCLUSIONS
Given the current volume of NPAs in the system, the issue of stressed assets will continue to dominate the landscape in the coming year. Despite facing teething challenges, the IBC has proven to be a game changer in the last few years. The New Prudential Framework introduced by the RBI is also likely to alleviate the situation. Alongside, the government has also floated discussion papers in respect of notifying the insolvency framework in respect of individuals under the IBC and introduction of a legal framework for resolving cross-border insolvency. These developments will go a long way in modernising the insolvency resolution framework in the country.
1 Sonali Mahapatra is a partner and Tanay Agarwal is a senior associate at Talwar Thakore and Associates.
2 Financial Stability Report June 2019, Reserve Bank of India, accessible at: www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=925.
4 Company Appeal (AT) (Insolvency) No. 616 of 2018.
5 Company Appeal (AT) (Insolvency) No. 521 of 2018.
6 CPNO IB 1151(PB)/2018.
7 Company Appeal (AT) (Insolvency) No. 437 of 2018 & IA No. 1830 of 2018.
8 It is relevant to note that in a previous decision in the case of Axis Bank Limited v. Edu Smart Services Private Limited (CA(AT) Insolvency No. 302 of 2017), the NCLAT held that the maturity of the claim under a guarantee has no nexus with filing of claim pursuant to the public announcement and allowed a beneficiary to file a claim where the guarantee was not invoked prior to the admission of CIRP. In the facts of that case, the underlying obligor was in default however, in the case at hand, there was no default by the principal obligor.
9 Company Appeal (AT) (Insolvency) No. 325 of 2019.
10 Company Appeal (AT) (Insolvency) No. 346 of 2018.
11 In this case, the principal borrower was not a Company and a CIRP could not be initiated against it under the IBC. However, subsequently, in the case of Ferro Alloys v. REC Limited (Company Appeal (AT) (Insolvency) No. 92 of 2017), the NCLAT allowed initiation of a CIRP against the guarantor without initiating the same against a principal debtor, against whom a proceeding could be initiated under the IBC.
12 CA 366(PB)/2017 Connected with (IB)-102(PB)/2017.
13 Civil Appeal No. 10673 of 2018.
14 See the judgment of the NCLAT in Binani Industries Ltd v. Bank of Baroda & Anr (Company Appeal(AT) (Insolvency) No. 82 of 2018) (Binani) and the judgment of the Supreme Court in Swiss Ribbons, supra at note 3.
15 RBI Circular No. DBR.No.BP.BC.45/21.04.048/2018-19 dated 7 June 2019 on 'Prudential Framework for Resolution of Stressed Assets'.
16 Reference date has been provided with respect to loan accounts on the basis of their size. In cases where borrower's exposure to banks, non-banking financial companies and All India Term financial Institutions is more than 20 billion rupees, reference date is the date of the directions and in cases where such exposure is between 15 billion and 20 billion rupees, the reference date is 1 January 2020.
17 See the judgment of the NCLAT in Binani and the judgment of the Supreme Court in Swiss Ribbons.
18 Larsen and Turbo v. Prime Displays Ltd and others, 2002 (5) Bom CR 158.
19 Modi Entertainment Network and Anr v. WSG Cricket Pte Limited, AIR 2003 SC 1177; Piramal Healthcare Limited v. DiaSorin SpA 172 (2010) DLT 131; M/s Gupta Coal India Private Limited v. M/s Swiss Marine Services SA 2014(4)ABR353; Sunrise Industries India Limited v. PT OKI Pulp and Paper Mills and Ors 2017 GLH (2) (226).
20 National Thermal Power Corporation v. Singer Company, AIR 1993 SC 998, the only limitation to this rule is that the intention of the parties must be expressed bona fide and should not be opposed to public policy.
21 Some of the reciprocating territories are: Bangladesh, Hong Kong, Papua New Guinea, Singapore, Trinidad and Tobago and the United Kingdom.
22 Marine Geotechnics LLC v. Coastal Marine Construction & Engineering Ltd 2014 (2) Bom CR 769.