Schemes of Arrangement in Liquidation Under IBC

Introduction

The intersection of corporate insolvency law and schemes of arrangement represents one of the most intricate aspects of modern Indian corporate jurisprudence. The Insolvency and Bankruptcy Code, 2016 (IBC) fundamentally transformed the landscape of corporate restructuring and liquidation in India, introducing stringent eligibility criteria that have profound implications for schemes of arrangement under the Companies Act, 2013. This legal framework reflects the legislature’s intent to prevent backdoor entries of defaulting promoters while maintaining avenues for genuine corporate rescue efforts.

The 2005 Report of the Expert Committee on Company Law articulated a vision for effective insolvency legislation that would “strike a balance between rehabilitation and liquidation” and “provide an opportunity for genuine effort to explore restructuring/rehabilitation of potentially viable businesses with consensus of stakeholders reasonably arrived at.” This vision has been substantially realized through the IBC’s provisions, though not without creating complex legal questions regarding the interplay between insolvency proceedings and traditional corporate restructuring mechanisms.

Understanding Schemes of Arrangement: Conceptual Framework

A scheme of arrangement constitutes a statutory mechanism enabling financially distressed companies to reach binding agreements with creditors for debt restructuring, repayment, or reorganization. This legal instrument serves as a crucial tool for corporate rehabilitation, allowing companies to avoid liquidation while providing creditors with structured recovery mechanisms. The scheme process involves judicial oversight to ensure fairness and protection of minority interests, making it a preferred alternative to informal workout arrangements.

The Companies Act, 2013, recognizes schemes of arrangement as legitimate corporate restructuring tools available to companies facing financial difficulties. These schemes can encompass various forms of corporate reorganization, including debt restructuring, asset sales, business transfers, and capital reorganization. The statutory framework ensures that properly approved schemes bind all stakeholders, providing certainty and enforceability that informal arrangements may lack.

Companies that should consider schemes of arrangement typically include those with substantial debt burdens requiring restructuring, entities experiencing operational difficulties but retaining viable business models, companies under creditor pressure seeking structured relief, and organizations attempting to avoid liquidation through negotiated settlements. The scheme mechanism offers these entities a legal pathway to financial recovery while protecting stakeholder interests through judicial supervision.

Regulatory Framework: The Insolvency and Bankruptcy Code Provisions

Section 29A of the Insolvency and Bankruptcy Code, 2016

The cornerstone of eligibility restrictions in the IBC is Section 29A, which establishes comprehensive disqualification criteria for resolution applicants. This provision was introduced through the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2017, to address the significant loophole that allowed defaulting promoters to regain control of their companies through the corporate insolvency resolution process (CIRP) [1].

Section 29A states: “A person shall not be eligible to submit a resolution plan, if such person, or any other person acting jointly or in concert with such person— (a) is an undischarged insolvent; (b) is a wilful defaulter in accordance with the guidelines of the Reserve Bank of India issued under the Banking Regulation Act, 1949; (c) at the time of submission of the resolution plan has an account, or an account of a corporate debtor under the management or control of such person or of whom such person is a promoter, classified as non-performing asset in accordance with the guidelines of the Reserve Bank of India issued under the Banking Regulation Act, 1949 or the guidelines of a financial sector regulator issued under any other law for the time being in force, and at least a period of one year has lapsed from the date of such classification till the date of commencement of the corporate insolvency resolution process of the corporate debtor.”

The provision includes important exceptions, particularly the proviso that allows eligibility if the person “makes payment of all overdue amounts with interest thereon and charges relating to non performing asset accounts before submission of resolution plan.” Additionally, the section provides that “nothing in this clause shall apply to a resolution applicant where such applicant is a financial entity and is not a related party to the corporate debtor” [2].

These disqualifications extend beyond the immediate applicant to include persons acting jointly or in concert, ensuring that the legislative intent cannot be circumvented through nominee arrangements or structured transactions designed to mask the true identity of ineligible persons.

Companies Act Framework: Section 230 Provisions

Statutory Provisions and Scope

Section 230 of the Companies Act, 2013, provides the foundational framework for schemes of arrangement. The provision states: “Where a compromise or arrangement is proposed— (a) between a company and its creditors or any class of them; or (b) between a company and its members or any class of them, the Tribunal may, on the application of the company or of any creditor or member of the company, or in the case of a company which is being wound up, of the liquidator, order a meeting of the creditors or class of creditors, or of the members or class of members, as the case may be, to be called, held and conducted in such manner as the Tribunal directs” [3].

This provision explicitly recognizes that schemes of arrangement can be proposed during liquidation proceedings, with the liquidator having the statutory authority to initiate such proposals. The inclusive language of the section suggests that various stakeholders, including creditors and members, possess the right to propose schemes, subject to tribunal approval and stakeholder consent.

The procedural framework established under Section 230 requires tribunal oversight at multiple stages, including the initial application, convening of meetings, approval of the scheme, and final sanction. This multi-stage process ensures adequate protection for minority shareholders and creditors while facilitating genuine restructuring efforts.

Judicial Interpretation: Key Case Law Analysis

Jindal Steel and Power Limited vs. Arun Kumar Jagatramka

The landmark case of Jindal Steel and Power Limited vs. Arun Kumar Jagatramka & Gujarat NRE Coke Limited fundamentally clarified the relationship between Section 29A of the IBC and Section 230 of the Companies Act, 2013. The National Company Law Appellate Tribunal (NCLAT) in its judgment dated October 24, 2019, established the principle that persons ineligible under Section 29A of the IBC cannot propose schemes of arrangement under Section 230 of the Companies Act during liquidation proceedings [4].

The case arose when Arun Kumar Jagatramka, a promoter of Gujarat NRE Coke Limited, attempted to propose a scheme of compromise and arrangement under Sections 230-232 of the Companies Act, 2013, while the company was undergoing liquidation under the IBC. The NCLAT held that allowing such schemes would defeat the purpose of Section 29A and create an indirect route for ineligible persons to regain control of corporate debtors.

The tribunal’s reasoning centered on the legislative intent behind Section 29A, which was to prevent backdoor entry of defaulting promoters and related parties into the insolvency resolution process. The NCLAT observed that permitting ineligible persons to propose schemes of arrangement would undermine this legislative objective and create an inconsistency in the legal framework.

Supreme Court Affirmation: Arun Kumar Jagatramka v. Jindal Steel and Power Ltd.

The Supreme Court of India, in its judgment dated March 15, 2021, upheld the NCLAT’s decision and provided further clarity on the application of Section 29A restrictions to schemes of arrangement. The apex court relied on its previous decisions in Chitra Sharma v. Union of India and ArcelorMittal India Private Limited v. Satish Kumar Gupta & Ors., emphasizing that Section 29A was enacted to serve the larger public interest and facilitate effective corporate governance [5].

The Supreme Court observed that Section 29A “rectifies a loophole in the IBC, which allowed backdoor entry to the erstwhile management of corporate debtors into corporate insolvency resolution process.” The court noted that the provision was designed to ensure that the insolvency process serves its intended purpose of maximizing value for all stakeholders rather than providing opportunities for defaulting promoters to regain control at discounted valuations.

The judgment established that the disqualifications under Section 29A apply not only to resolution plans submitted during CIRP but also to schemes of arrangement proposed under the Companies Act when companies are undergoing liquidation under the IBC. This interpretation ensures consistency in the legal framework and prevents circumvention of IBC provisions through alternative statutory mechanisms.

Legal Analysis: Intersection of IBC and Companies Act

Harmonious Construction Principle

The judicial interpretation of the relationship between Section 29A of the IBC and Section 230 of the Companies Act reflects the principle of harmonious construction, which requires courts to interpret statutory provisions in a manner that avoids conflict and promotes the overall legislative scheme. The courts have recognized that both provisions serve complementary purposes in the corporate restructuring landscape while maintaining distinct procedural frameworks.

The harmonious interpretation ensures that the IBC’s objective of preventing backdoor entry by ineligible persons is not undermined through alternative statutory mechanisms. This approach maintains the integrity of the insolvency framework while preserving legitimate opportunities for corporate restructuring by eligible parties.

Policy Considerations and Legislative Intent

The legislative intent behind Section 29A extends beyond mere procedural restrictions to encompass broader policy objectives related to corporate governance, creditor protection, and market integrity. The provision reflects Parliament’s determination to ensure that the insolvency process serves genuine restructuring purposes rather than facilitating the return of failed management to corporate control.

The policy rationale recognizes that allowing defaulting promoters to propose schemes of arrangement during liquidation would essentially provide them with an alternative route to regain control of their companies without addressing the underlying reasons for financial distress. This outcome would contradict the fundamental premise of the IBC, which seeks to separate ownership from management in cases of corporate failure.

Procedural Framework for Eligible Schemes

Eligibility Determination Process

The determination of eligibility for proposing schemes of arrangement during liquidation involves a careful analysis of the proposed applicant’s status under Section 29A of the IBC. This process requires examination of various factors including the applicant’s financial history, relationship with the corporate debtor, and compliance with regulatory requirements.

Liquidators and tribunals must conduct due diligence to ensure that proposed schemes do not violate the spirit of Section 29A, even when proposed by parties who may not be directly covered by its literal provisions. This involves examining the substance of the arrangement rather than merely its form, preventing circumvention through nominee or structured arrangements.

Stakeholder Protection Mechanisms

The procedural framework for schemes of arrangement includes multiple safeguards designed to protect stakeholder interests. These mechanisms include mandatory disclosure requirements, creditor voting procedures, minority protection provisions, and judicial oversight throughout the process.

The tribunal’s supervisory role ensures that proposed schemes serve genuine restructuring purposes and provide fair treatment to all stakeholders. This oversight function becomes particularly important in the context of liquidation proceedings, where stakeholder interests may be more vulnerable to exploitation.

Regulatory Oversight and Compliance

Role of the Insolvency and Bankruptcy Board of India

The Insolvency and Bankruptcy Board of India (IBBI) plays a crucial regulatory role in overseeing the implementation of IBC provisions, including the eligibility criteria under Section 29A. The IBBI has issued various regulations and guidelines to clarify the application of these provisions and ensure consistent interpretation across different cases.

The regulatory framework established by the IBBI includes requirements for affidavits confirming eligibility status, disclosure obligations for resolution applicants, and penalties for violations of eligibility criteria. These measures strengthen the enforcement of Section 29A restrictions and promote transparency in the insolvency process [6].

Compliance Requirements and Due Diligence

Parties proposing schemes of arrangement during liquidation must demonstrate compliance with all applicable eligibility criteria through detailed documentation and verification processes. This includes providing corporate histories, financial statements, regulatory clearances, and other evidence establishing their qualification to participate in the restructuring process.

The due diligence requirements extend to examination of related party relationships, concert party arrangements, and other structures that might be used to circumvent eligibility restrictions. This thorough scrutiny helps maintain the integrity of the scheme process while preventing abuse of the legal framework.

Practical Implications for Corporate Restructuring

Impact on Restructuring Strategies

The judicial clarification regarding the application of Section 29A restrictions to schemes of arrangement has significant implications for corporate restructuring strategies in India. Companies and their advisors must carefully consider eligibility issues when developing restructuring plans, particularly in cases involving potential insolvency proceedings.

The restrictions have led to greater emphasis on involving eligible third parties in restructuring arrangements, including financial investors, strategic buyers, and other parties not disqualified under Section 29A. This shift has contributed to the development of more sophisticated restructuring transactions that comply with regulatory requirements while achieving commercial objectives.

Market Response and Adaptation

The legal framework established through the IBC and its judicial interpretation has prompted significant changes in market practices related to corporate restructuring. Professional service providers, including legal advisors, financial consultants, and insolvency professionals, have developed specialized expertise in navigating the complex eligibility requirements.

The market has also witnessed the emergence of new financing structures and investment vehicles designed to participate in distressed asset transactions while maintaining compliance with regulatory restrictions. These developments reflect the adaptability of market participants to evolving legal frameworks.

Challenges and Limitations

Definitional Ambiguities

Despite the clear legislative intent behind Section 29A, certain definitional ambiguities continue to create challenges in its practical application. Issues such as the scope of “persons acting in concert,” the definition of “related parties,” and the interpretation of various disqualification criteria require ongoing judicial clarification.

These ambiguities can create uncertainty for parties seeking to participate in restructuring transactions, potentially deterring legitimate investment or leading to unnecessary litigation. The ongoing development of jurisprudence in this area helps address these concerns, though complete clarity may take time to achieve.

Balancing Rehabilitation and Restriction

The legal framework must carefully balance the objective of preventing backdoor entry by ineligible persons with the need to facilitate genuine corporate rehabilitation. This balance requires nuanced interpretation that considers both the letter and spirit of the law while promoting the overall objectives of the insolvency system.

Courts and regulators continue to grapple with cases that test the boundaries of this balance, developing precedents that help clarify the appropriate scope of restrictions while preserving opportunities for legitimate restructuring efforts [7].

International Perspectives and Comparative Analysis

Global Best Practices

The approach adopted by Indian insolvency law reflects international best practices regarding the prevention of abuse in corporate restructuring processes. Many developed jurisdictions have similar restrictions designed to prevent defaulting management from regaining control of failed companies through restructuring arrangements.

The Indian framework’s emphasis on eligibility restrictions and judicial oversight aligns with global trends toward more stringent regulation of insolvency processes, reflecting lessons learned from various jurisdictions about the importance of maintaining process integrity [8].

Adaptations to Local Context

While drawing from international experience, the Indian framework has been adapted to address specific challenges in the local business environment. This includes consideration of the prevalence of promoter-driven corporate structures, the need for rapid resolution of stressed assets, and the importance of maintaining investor confidence in the restructuring process.

The resulting legal framework reflects a balance between international best practices and local requirements, creating a system that serves India’s specific needs while maintaining consistency with global standards.

Future Developments and Reform Prospects

Evolving Jurisprudence

The legal framework governing schemes of arrangement in liquidation continues to evolve through ongoing judicial interpretation and regulatory development. Recent cases have begun to address more nuanced questions about the scope of restrictions and the boundaries of eligible participation in restructuring processes.

This evolutionary process is likely to continue as courts encounter new factual scenarios and market participants develop increasingly sophisticated transaction structures. The resulting jurisprudence will further refine the legal framework and provide greater clarity for future transactions.

Potential Legislative Reforms

The experience of implementing the IBC and related provisions has revealed areas where legislative refinement might be beneficial. Potential reforms could address definitional clarity, procedural efficiency, and the balance between restriction and rehabilitation objectives.

Any future reforms are likely to maintain the core principle of preventing backdoor entry by ineligible persons while potentially providing greater flexibility for legitimate restructuring arrangements. The legislative process will need to consider stakeholder feedback and emerging market practices in developing any modifications [9].

Conclusion

The legal framework governing schemes of arrangement in liquidation under the IBC represents a sophisticated approach to balancing corporate rehabilitation opportunities with the prevention of abuse by ineligible parties. The judicial interpretation of the relationship between Section 29A of the IBC and Section 230 of the Companies Act has established clear principles that promote consistency and integrity in the corporate restructuring process.

The framework’s emphasis on eligibility restrictions reflects a broader policy objective of ensuring that insolvency proceedings serve genuine restructuring purposes rather than facilitating the return of failed management to corporate control. This approach aligns with international best practices while addressing specific challenges in the Indian business environment.

The ongoing development of jurisprudence in this area continues to refine the legal framework, providing greater clarity for market participants while maintaining the core objectives of preventing backdoor entry and promoting genuine corporate rehabilitation. As the Indian insolvency system continues to mature, the principles established through cases like Jindal Steel and Power Limited vs. Arun Kumar Jagatramka will serve as foundational precedents for future developments in corporate restructuring law.

The success of this legal framework ultimately depends on its effective implementation by courts, regulators, and market participants, all working together to ensure that the insolvency system serves its intended purpose of maximizing value for all stakeholders while maintaining the highest standards of process integrity and corporate governance.

References

[1] Insolvency and Bankruptcy Code, 2016, Section 29A. Available at: https://www.indiacode.nic.in/show-data?actid=AC_CEN_2_11_00055_201631_1517807328273&orderno=34 

[2] Vinod Kothari Consultants, “Ineligibility criteria u/s 29A of IBC: A net too wide!” Available at: https://vinodkothari.com/2018/02/section29a-ibc-a-net-too-wide/ 

[3] Companies Act, 2013, Section 230. 

[4] Jindal Steel And Power Ltd vs Arun Kumar Jagatramka & Anr, NCLAT, October 24, 2019. Available at: https://indiankanoon.org/doc/144360866/ 

[5] Arun Kumar Jagatramka vs Jindal Steel And Power Ltd., Supreme Court of India, March 15, 2021. Available at: https://indiankanoon.org/doc/54725749/ 

[6] TaxGuru, “Eligibility of Resolution Applicant: Section 29A of IBC Code, 2016,” April 21, 2020. Available at: https://taxguru.in/corporate-law/eligibility-resolution-applicant-section-29a-ibc-code-2016.html 

[7] IBC Laws, “Summary of Supreme Court judgment in Arun Kumar Jagatramka Vs. Jindal Steel and Power Ltd. & Anr.” Available at: https://ibclaw.in/summary-of-supreme-court-judgment-in-arun-kumar-jagatramka-vs-jindal-steel-and-power-ltd-anr/ 

[8] Lexology, “Spotlight: insolvency proceedings in India,” October 18, 2021. Available at: https://www.lexology.com/library/detail.aspx?g=6b73bb3c-767d-4759-bd23-9499527e49aa 

[9] Reed Law, “Supreme Court denies back-door entry of defaulting promoters in CIRP under section 29A of IBC,” June 7, 2021. Available at: https://www.reedlaw.in/post/supreme-court-denies-back-door-entry-of-defaulting-promoters-in-cirp-under-section-29a-of-ibc