Introduction

The concept of valuation lies at the heart of any insolvency regime, serving as the foundational pillar that determines recovery outcomes, influences creditor decisions, and ultimately shapes the effectiveness of bankruptcy laws. Since its enactment in 2016, India’s Insolvency and Bankruptcy Code (IBC) has placed significant emphasis on the valuation process as a critical mechanism for asset maximization and stakeholder protection. This comprehensive analysis explores the multifaceted dimensions of valuation under the IBC framework, examining its theoretical underpinnings, practical challenges, international comparisons, and the evolving jurisprudence that continues to shape its implementation.

The Conceptual Framework of Valuation in Insolvency Proceedings

Justice Louis Brandeis in the landmark case of Missouri ex rel. Southwestern Bell Telephone Co v. Public Service Commission astutely observed that “value is a word of many meanings”. This profound statement encapsulates the inherent complexity of valuation in insolvency proceedings. The determination of value is not merely a mathematical calculation but a nuanced assessment that incorporates multiple dimensions including market value, value to owner, utility cost, fair value, intrinsic value, justified price, and normal value – each critical to different stakeholders in bankruptcy proceedings.

Valuation in the insolvency context presents unique challenges compared to standard business valuations. When a company enters insolvency, traditional valuation metrics may become less reliable due to financial distress, operational disruptions, and market perceptions. The valuation methodology must therefore adapt to capture both the current economic reality and the potential recovery scenarios available to creditors.

Theoretical Underpinnings of Valuation in Distressed Scenarios

The valuation of distressed firms follows the same fundamental principles as valuing healthy ones, but with significantly higher complexity and uncertainty. The process involves three key steps: estimating the company’s value, establishing the appropriate standard, and applying methodologies specific to distressed scenarios. Unlike regular valuations, distressed valuations must address the bifurcated question of whether to apply a going-concern premise or a liquidation premise.

The going-concern premise assumes the business will continue operations into the future, while liquidation value assumes operations will cease and assets will be sold off either in an orderly manner or through forced sale. This critical determination shapes the entire valuation framework and ultimately influences recovery outcomes for all stakeholders.

Valuation Framework Under India’s IBC Regime

Objectives of Valuation under IBC

The IBC established valuation as one of its cornerstone objectives to ensure value maximization, timely resolution of the Corporate Insolvency Resolution Process (CIRP), and balanced consideration of stakeholder interests. The valuation process under IBC serves multiple strategic functions:

1. It provides an objective benchmark for assessing resolution plans
2. It establishes a baseline for creditor negotiations with prospective resolution applicants
3. It informs the Committee of Creditors (CoC) in their decision-making process
4. It facilitates transparency and fairness in the insolvency resolution mechanism
5. It serves as a comparative measure against the liquidation scenario to ensure optimal outcomes

The Supreme Court of India in the landmark case of Swiss Ribbons Pvt. Ltd & Anr. v. Union of India emphatically affirmed that “maximization of the value of the assets of the corporate debtor” constitutes the core objective of the IBC. The court noted that unless reorganization is effected in a time-bound manner, asset values will inevitably deplete, hindering the corporate debtor’s potential to operate as a going concern.

Categorical Classification of Valuation Types under IBC

The IBC regulatory framework delineates two primary types of valuation that must be conducted during insolvency proceedings:

1. Fair Value

As defined in Regulation 2(hb) of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, Fair Value represents “the estimated realizable value of the assets of the corporate debtor, if they were to be exchanged on the insolvency commencement date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had acted knowledgeably, prudently and without compulsion”. This definition aligns with internationally accepted valuation standards and emphasizes the following key elements:

• The transaction is hypothetical but realistic
• Both parties are willing participants without undue pressure
• The assessment is anchored to the Insolvency Commencement Date (ICD)
• Proper marketing is assumed to have occurred
• Parties possess adequate information about the assets

2. Liquidation Value

Complementing the Fair Value assessment, Liquidation Value is defined in Regulation 2(k) as “the estimated realizable value of the assets of the corporate debtor, if the corporate debtor were to be liquidated on the insolvency commencement date”. This represents a distress-sale scenario where assets must be sold within a compressed timeframe, often resulting in significantly lower valuations compared to Fair Value assessments.

The dichotomy between these two valuation approaches creates a structured framework that provides the CoC with both the best-case scenario (Fair Value) and a fallback position (Liquidation Value), enabling more informed decision-making regarding resolution plans.

The Institutionalized Role of Registered Valuers Under IBC

Regulatory Framework for Registered Valuers

The IBC ecosystem operates through a network of specialized professionals, with Registered Valuers (RVs) occupying a position of critical importance. These professionals are entrusted with determining the current market value of property, land, securities, the net worth of the company, and other assets or liabilities under the provisions of both the Companies Act, 2013, and the IBC, 2016.

The regulatory architecture for RVs includes:

1. The Companies (Registered Valuers and Valuation) Rules, 2017, which establish qualification requirements, registration procedures, and conduct standards
2. The IBBI (Registered Valuers) Regulations, 2017, which provide the operational framework for valuation professionals
3. Registered Valuer Organizations (RVOs), which serve as frontline regulators for valuers

RVs are categorized into three asset classes based on their expertise:

• Plant and Machinery (P&M)
• Land and Building (L&B)
• Securities or Financial Assets

Procedural Mandates for Valuation Under IBC

The IBBI (CIRP) Regulations, 2016, prescribe a structured procedural framework for the valuation process:

1. Dual Valuer Requirement: Regulation 27 mandates the appointment of two registered valuers to determine both fair value and liquidation value of the corporate debtor
2. Time-Bound Execution: Valuers must be appointed within seven days of the resolution professional’s appointment and must submit valuation reports within a specified timeframe
3. Physical Verification Requirement: Valuers must physically verify the inventory and fixed assets of the corporate debtor before submitting their assessment
4. Resolution of Valuation Discrepancies: If the two estimates differ “significantly” (defined as a difference of 25% or more in liquidation value within an asset class), the resolution professional may appoint a third valuer. The calculation formula specified is (L1-L2)/L1, where L1 represents the higher valuation and L2 the lower valuation
5. Determination of Final Value: In cases where a third valuer is appointed, the average of the two closest estimates is considered the final fair value or liquidation value
6. Fast Track Provisions: For fast-track CIRP cases, Regulation 26 permits appointment of a single registered valuer, with similar standards for valuation methodology

This structured approach aims to minimize subjectivity and enhance consistency in the valuation process, although significant challenges remain, as discussed later in this analysis.

Methodological Approaches to Valuation in Insolvency

Valuation Techniques in the CIRP Process

Valuation under the CIRP is a methodical exercise conducted by IBBI-recognized Registered Valuers, employing a range of internationally accepted insolvency valuation methods.

1. Income Approach: Primarily uses Discounted Cash Flow (DCF) methodology, which measures the present value of projected future cash flows. This approach is particularly relevant for going-concern valuations where future earning potential is a significant consideration.
2. Market Approach: Utilizes market multiples from comparable companies or transactions to determine relative value. This approach is effective when suitable market comparables exist but may be challenging in distressed scenarios where comparable transactions are limited.
3. Replacement Cost Approach: Estimates the cost to replace assets at current market prices, adjusted for depreciation and technological obsolescence. This is particularly useful for specialized assets where market transactions are infrequent.
4. Asset Value Approach: Focuses on the company’s balance sheet, valuing individual assets and liabilities. This method is often employed when liquidation is the likely outcome or when a company’s value is primarily derived from its tangible assets rather than future earning potential.

The selection of appropriate methodologies depends on numerous factors including the nature of the business, asset composition, industry dynamics, and the likely resolution outcome. Best practice typically involves employing multiple approaches to develop a range of values that provide a more robust assessment.

Valuation Anchoring to the Insolvency Commencement Date

A distinctive feature of IBC valuation is the temporal anchoring to the Insolvency Commencement Date (ICD). This provides a fixed reference point for all valuations, ensuring consistency and preventing manipulation of the timeline to influence valuations. However, this approach also presents challenges when proceedings extend over prolonged periods, as market conditions and asset values may evolve significantly since the ICD.

Comparative Analysis: International Valuation Standards in Bankruptcy

Global Frameworks for Insolvency Valuation

The development of valuation standards in bankruptcy contexts varies significantly across jurisdictions, though a trend toward international harmonization is emerging:

1. International Valuation Standards (IVS): The International Valuation Standards Council (IVSC) has developed a comprehensive framework of standards that serve as the global benchmark for valuation practice. The IVS 2022 (effective January 2025) represents the latest iteration, addressing specific issues related to distressed assets and liquidation scenarios. The IVS framework includes specialized bases of value such as Liquidation Value and Replacement Value, which are particularly relevant in bankruptcy proceedings.
2. US Chapter 11 Approach: The US bankruptcy system places significant emphasis on valuation during reorganization proceedings. The Bankruptcy Code §506 specifies that value determination must consider “the purpose of the valuation and of the proposed disposition or use of such property”. Valuation in US bankruptcy proceedings occurs at multiple stages, including adequate protection assessments, plan confirmation, and bankruptcy litigation contexts such as preference actions and fraudulent transfer claims.
3. UK Insolvency Valuation Framework: The UK employs a structured approach to valuation in insolvency, with guidance from the Bank of England specifying four distinct valuation stages: failing or likely to fail assessment, asset and liability valuation, equity valuation, and estimated insolvency valuation. The UK framework emphasizes the distinction between “Hold Value” and “Disposal Value” as critical concepts in resolution planning.

Adoption of International Standards in India’s IBC Context

The IBC regulations require valuation to be conducted “in accordance with internationally accepted valuation standards”, but do not explicitly mandate which standards should be applied. This ambiguity has led to inconsistencies in practice, with valuers affiliated with different Registered Valuer Organizations (RVOs) potentially following different methodological approaches.

The IBBI has been working toward greater alignment with international standards, recognizing that inconsistent valuation practices undermine the effectiveness of the resolution process. India’s infrastructure valuation association has become a corporate member of the IVSC, signaling a commitment to international standards and valuation professionalism. However, full adoption and implementation of a unified valuation framework remains a work in progress.

Critical Challenges in the Valuation Ecosystem Under IBC

Empirical Assessment of Valuation Inconsistencies

One of the most significant challenges in the IBC valuation framework is the persistent inconsistency in valuation estimates provided by different registered valuers. The current system, which mandates multiple valuers, can lead to substantial discrepancies in assessments of the same assets.

These inconsistencies manifest in several ways:

1. Methodological Divergence: Different valuers may employ varying methodological approaches or assumptions, leading to substantially different outcomes even when applied to identical assets.
2. Third Valuer Discrepancies: In cases where a third valuer is appointed due to significant differences between the first two, there have been instances where the third valuation diverges drastically from both previous assessments, further complicating the resolution process. In one notable case referenced in the search results, initial valuations ranged from INR 121.01 crore to INR 126.30 crore, while a third valuer estimated the liquidation value at only INR 52.69 crore.
3. Interpretation Challenges: The 25% threshold for “significant difference” may itself be subject to interpretation, particularly in complex asset classes or when applying different valuation methodologies. In a case before the NCLAT Chennai, the tribunal deemed a difference of 15.62% between valuations as “minimal,” noting that values provided by registered valuers “are only estimates” and that differences are to be expected.

Temporal Challenges in Valuation Under IBC

The time-sensitive nature of insolvency proceedings creates additional challenges for the valuation process:

1. Delay-Related Value Deterioration: The Supreme Court has emphasized that unless reorganization occurs in a time-bound manner, asset values will inevitably deplete. However, the average CIRP process in India takes approximately 384 days to complete, during which significant changes in asset condition, market dynamics, and business operations may occur.
2. Valuation Date Constraints: The regulatory requirement to anchor valuations to the Insolvency Commencement Date creates a temporal disconnect when proceedings extend over prolonged periods, potentially rendering initial valuations obsolete by the time resolution decisions are made.
3. Market Perception Issues: Courts have recognized that “markets tend to undervalue entities in bankruptcy,” necessitating adjustments to market-based approaches in certain contexts. This market perception bias further complicates the already challenging task of accurate valuation.

Regulatory and Structural Issues 

Several structural and regulatory factors compound the valuation challenges under IBC:

1. Valuation Standard Ambiguity: While the IBC mandates adherence to “internationally accepted valuation standards,” it does not specify which standards should be applied, leading to inconsistent practices among valuers.
2. Information Asymmetry: Valuers often face challenges related to incomplete financial information, limited access to operational data, and difficulties in physical verification of assets, particularly in contentious insolvency cases.
3. Credential Disparities: Variations in the qualification, experience, and specific expertise of registered valuers can lead to significant differences in the quality and reliability of valuations.
4. Incentive Misalignment: Concerns have been raised about potential “perverse incentive structures” when parties pay valuation professionals based on achieving specific valuation outcomes, potentially compromising objectivity.

Judicial Interpretation and Evolving Jurisprudence

Supreme Court Perspectives on Valuation Under IBC

The Indian judiciary has played a significant role in shaping the valuation framework under IBC through several landmark judgments:

1. Swiss Ribbons Case: In Swiss Ribbons Pvt. Ltd & Anr. v. Union of India, the Supreme Court unequivocally identified maximization of asset value as a core objective of the IBC. The court emphasized that timely reorganization is essential to prevent value deterioration and enable the corporate debtor to operate as a going concern.
2. Ebix Singapore Case: In Ebix Singapore Private Limited v. Committee of Creditors of Educomp Solutions Limited & Anr, the court reinforced that timely implementation of resolution plans is crucial to protect against asset dissipation. This ruling underscores the temporal dimension of valuation and the need for expeditious processes.

NCLAT Interpretations and Practical Applications

The National Company Law Appellate Tribunal (NCLAT) has further refined the application of valuation principles in specific cases:

1. Binani Industries Judgment: In Binani Industries Limited Vs. Bank of Baroda, the NCLAT articulated a hierarchical framework of IBC objectives, positioning “resolution” as the first-order objective, “maximation of the value of assets” as the second-order objective, and “promotion of entrepreneurship and credit availability” as the third-order objective.
2. Variance Threshold Interpretation: In Dr. Vijay Radhakrishnan Vs. Bijoy P Pulipra, the NCLAT Chennai considered a difference of 15.62% between two valuers as “minimal,” suggesting a practical interpretation of the “significantly different” threshold below the 25% regulatory definition. The tribunal noted that valuation estimates “can at best be an aid to the Committee of Creditors” in making commercial decisions.

These judicial interpretations collectively emphasize the instrumental role of valuation in achieving the broader objectives of the IBC while acknowledging the inherent limitations and practical challenges in the valuation process.

Strategic Recommendations for Enhancing the Valuation Framework Under IBC

Regulatory Reforms and Standardization

1. Unified Valuation Standards: The IBBI should adopt a comprehensive set of valuation standards specifically tailored to the insolvency context, drawing from the International Valuation Standards but adapted to India’s unique economic and legal environment.
2. Methodological Guidance: Detailed guidance on the appropriate application of different valuation methodologies for specific industry sectors and asset classes would enhance consistency and reduce unwarranted discrepancies.
3. Time-Sensitive Valuation Framework: Develop mechanisms for updating valuations when CIRP proceedings extend beyond a specified duration, ensuring that decisions are based on current economic realities while maintaining procedural integrity.

Professional Capacity Enhancement

1. Specialized Certification: Implement advanced certification requirements for registered valuers participating in insolvency proceedings, focusing on distressed asset valuation techniques and bankruptcy-specific considerations.
2. Inter-Disciplinary Expertise: Encourage the development of valuation teams that combine financial, legal, and industry-specific expertise to produce more comprehensive and nuanced valuation reports.
3. Knowledge Repository: Establish a centralized database of anonymized valuation reports and methodologies from previous insolvency cases to build a knowledge base that informs future valuations and promotes standardization.

Procedural Improvements 

1. Collaborative Valuation Process: Consider a collaborative approach where appointed valuers work together to resolve methodological differences before finalizing independent reports, reducing extreme discrepancies while maintaining the benefits of multiple perspectives.
2. Structured Disclosure Requirements: Implement standardized disclosure formats for valuation reports that clearly articulate key assumptions, limitations, methodologies, and sensitivity analyses, enhancing transparency and facilitating informed decision-making by the CoC.
3. Objective Third Valuer Selection: Develop a systematic approach for selecting third valuers when required, potentially through a blind assignment mechanism that minimizes potential bias or strategic appointments.

Conclusion: The Path Forward for Valuation Under IBC

Valuation under the Insolvency and Bankruptcy Code represents a critical intersection of financial expertise, legal frameworks, and economic analysis. As India’s insolvency regime continues to evolve, the refinement of valuation practices will play an increasingly important role in achieving the twin objectives of value maximization and stakeholder protection.

The current framework has established a solid foundation, but persistent challenges related to consistency, timeliness, and methodological rigor necessitate continued attention from regulators, practitioners, and the judiciary. The incorporation of international best practices, technological innovations, and specialized expertise will be essential in addressing these challenges.

Ultimately, an effective valuation framework must balance the need for accuracy and comprehensiveness with the practical constraints of the insolvency context, including time limitations, information asymmetries, and resource constraints. By addressing the identified challenges and implementing strategic reforms, India’s IBC valuation ecosystem can better serve its intended purpose: providing a reliable and objective basis for informed decision-making in complex insolvency scenarios.

The journey toward a more robust valuation framework is ongoing, but each incremental improvement brings the system closer to its ideal state—one where stakeholders can trust that asset valuations reflect economic realities, enabling optimal outcomes in even the most challenging insolvency situations.

Written by : Aditya bhatt

Associate: Bhatt and Joshi Associates

The post Valuation Under IBC: A Global Perspective on India’s IBC Framework appeared first on Bhatt & Joshi Associates.

Introduction

In a significant judgment, the National Company Law Appellate Tribunal (NCLAT) addressed the issue of whether the Income Tax Department can set-off tax dues with refunds during the intervening period when the Corporate Insolvency Resolution Process (CIRP) timeline has expired, but a liquidation order has not yet been passed. The judgment also examined if a secured creditor could realize secured assets after the expiry of the CIRP period and before the liquidation order is issued. Additionally, it explored if the Income Tax Department, as a government authority, can be considered a secured creditor entitled to realize security interest.

Case Background

The case involves Kotak Urja Pvt Ltd, which was admitted into CIRP on November 18, 2019, with Mr. Devarajan Raman appointed as the Resolution Professional (RP). The Income Tax Department adjusted a tax refund of Rs. 90.42 lakhs against outstanding tax dues while the moratorium under Section 14 of the Insolvency and Bankruptcy Code (IBC) was in effect. The RP filed an application seeking a refund of this amount, which was dismissed by the Adjudicating Authority. The RP then appealed to the NCLAT.

Key Issues Addressed : Set-off tax After the CIRP Expired

1. Set-Off by Income Tax Dept. During Interregnum Period

   – The central question was whether the Income Tax Department could set-off tax dues with refunds during the period after the CIRP timeline had expired but before the liquidation order was passed. The NCLAT clarified that the moratorium under Section 14 of the IBC continues until the liquidation order is passed or the resolution plan is approved by the Adjudicating Authority.

 “From a bare reading of Section 14(1)(a), (b) and (c) of the IBC, the legislative intent seems to be quite clear that during the period of moratorium qua the Corporate Debtor, there shall be a stay on the commencement and continuation of all legal proceedings against the Corporate Debtor and prohibition of action whatsoever of foreclosure, recovery or enforcement of any ‘security interest’ which has been created by the corporate debtor vis-a-vis its property.”

2. Realization of Secured Assets by Secured Creditors

   – The NCLAT addressed whether a secured creditor could realize secured assets after the CIRP period had expired but before the liquidation order was passed. The tribunal held that secured creditors could only exercise their right to realize security interests after the liquidation proceedings had commenced.

   “The option to realize security interests becomes available to a secured creditor only after liquidation proceedings commence in terms of Section 33 of IBC with the passing of the liquidation order.”

3. Status of Income Tax Department as Secured Creditor

   – The NCLAT examined whether the Income Tax Department could be considered a secured creditor entitled to realize security interest. The tribunal noted that the Income Tax Department could not claim the status of a secured creditor merely by being a government authority.

   “The Respondent representing the Income Tax Department cannot be treated as a secured creditor. It was pointed out that there is no provision in the Income Tax Act which vests on them a statutory charge in respect of the tax liability.”

Conclusion: Clarifying Set-off Tax Concerns Post CIRP Expiry

The NCLAT’s judgment clarified that the moratorium under Section 14 of the IBC continues until the liquidation order is passed, preventing creditors from setting off or adjusting tax refunds against dues during this period. The tribunal also reaffirmed that the realization of security interests by secured creditors is permissible only after the commencement of liquidation proceedings. Furthermore, the Income Tax Department cannot claim the status of a secured creditor merely by virtue of being a government authority.

Key Takeaways

– The moratorium under Section 14 of the IBC remains in effect until the liquidation order is passed or the resolution plan is approved.

– Secured creditors can only realize security interests after the liquidation proceedings commence.

– The Income Tax Department does not automatically qualify as a secured creditor.

For further details, you can refer to here.

[Full Judgement]

The post Can Income Tax Dept. Set-Off or Realize Secured Assets During Interregnum Period, Expiry of CIRP Period, and Initiation of Liquidation? appeared first on Bhatt & Joshi Associates.

Introduction

Within the complex realm of business transactions, unsecured creditors frequently encounter a dangerous predicament when a debtor declares insolvency. This predicament becomes even more evident when a large client, who owes a substantial amount of money, declares bankruptcy, causing tiny businesses to be in a condition of uncertainty. Unsecured creditors must have a clear understanding of their rights and the proactive choices they have under the Insolvency & Bankruptcy Code (IBC).

Exploring the Function of Unsecured Creditors

Unsecured creditors, referring to individuals or businesses who lack any collateral to reclaim their debts, play a crucial role in the financial ecosystem. Contrary to a widely held belief that smaller creditors are not adequately protected, Corporate Law guarantees identical rights and safeguards for all creditors without collateral. This protection applies regardless of the magnitude of the debt or the financial status of the debtor enterprise.

Understanding the Creditors’ Spectrum

Secured creditors possess a security interest in the debtor’s property, which entitles them to recover their debts. The purpose of establishing a security interest is to secure the borrower’s compliance, albeit without a guarantee.

Financial and operational creditors can be categorized based on the type of debts they are owing. Financial creditors refer to people who are owed financial debts, while operational creditors encompass individuals or entities who are owed money, such as workers and employees. Financial creditors can be classified as either secured or unsecured, whereas operational creditors are generally unsecured. This puts them at a greater risk in insolvency scenarios, presenting them with distinct issues.

Enhancing the Authority of Creditors through the Insolvency and Bankruptcy Code (IBC)

The Corporate Insolvency Resolution Process (CIRP) is initiated in accordance with Chapter II of Part II of the IBC. It can be initiated by financial creditors, operational creditors, or the corporate debtor that has defaulted. The procedure requires a minimum debt of Rs. 1 lakh, with financial creditors submitting their claims under Section 7 and operational creditors utilising either sections 8 or 9.

Debt recovery by operational creditors is a vital aspect of the overall debt recovery process. Prior to initiating any course of action, it is imperative for them to issue a demand notice to the corporate debtor. The recipient of the debt notice is given a period of ten days to reply, furnishing comprehensive details regarding the current status of the debt. Operational creditors that possess uncontested liabilities are the only ones eligible to initiate a Corporate Insolvency Resolution Process (CIRP).

The payment of liquidation proceeds is governed by the IBC, which sets up a definitive hierarchy for dispersing these funds. This encompasses the payment of charges related to the bankruptcy resolution process, expenses associated with liquidation, and the remuneration of employees. Prioritised ahead of all other claims are the payments owing to labourers for the past two years, followed by creditors with collateral, outstanding debts of creditors without collateral, and any remaining obligations.

Conclusion: Empowering Unsecured Creditors

The implementation of the Insolvency and Bankruptcy Code in 2016, together with later modifications, has brought about a substantial change in how business-related insolvencies and bankruptcies are dealt with. This comprehensive legislation simplifies the process of resolving disputes, replacing lengthy legal conflicts with a more effective technique that can be applied to individuals, partnerships, and corporate debtors. It is vital for unsecured creditors to comprehend their rights and utilise the available remedies under the IBC. Consulting a company lawyer is crucial when dealing with the intricacies of insolvency proceedings. The IBC 2016 guarantees that unsecured creditors are not left vulnerable, enabling them to actively engage in the settlement or liquidation process and protect their interests. Ultimately, the IBC 2016 serves as a prominent symbol of transformation, offering a strong structure for dealing with economic hardship in the corporate realm. Unsecured creditors, typically considered susceptible entities, can now confidently negotiate the insolvency terrain, equipped with an understanding of their entitlements and the options at their disposal to safeguard their financial interests.

The post Unsecured Creditors Empowered: Rights and Remedies Under the Insolvency & Bankruptcy Code appeared first on Bhatt & Joshi Associates.

Introduction

The Insolvency and Bankruptcy Code (IBC) has been a subject of intense legal scrutiny and interpretation in recent years. One of the most contentious issues pertains to the entitlement of dissenting financial creditors under the IBC.

The Contention: Security Interest of Financial Creditors

A frequently vexed question arises as to the claim of a secured financial creditor either on the basis of the security interest it holds or otherwise. Such creditors, along with workmen, are first in the order of priority under Section 53(1) of the Code. However, what the other creditors would receive also depends upon how the secured creditors are settled.

Divergent Rulings: The Need for Clarification

In Essar Steel (India) Ltd. v. Satish Kumar Gupta, the Supreme Court observed that a secured creditor would be entitled to the value of its security. On the other hand, in India Resurgence ARC (P) Ltd. v. Amit Metaliks Ltd., the Court held that the secured creditor would not be entitled to the value of its security but would receive in proportion to what the others in the same class receive. These rulings seem to contradict one another but according to some legal experts, it is not so.

The CoC’s Role: Exercising Commercial Wisdom

In both cases, the Court proceeded on the premise that in the insolvency regime, the Committee of Creditors (CoC) is entitled to exercise commercial wisdom in dealing with the revival of the ailing corporate debtor and determine what amounts were to be paid to each class of creditors.

Dissenting Financial Creditors : A Position of Compromise?

The Supreme Court in Essar Steel (India) Ltd. v. Satish Kumar Gupta has held that in a corporate insolvency resolution process, as per Section 30(2)(b), a dissenting financial creditor would be entitled to at least what it would receive under Section 53(1) in case of liquidation (i.e., minimum liquidation value). However, the position in corporate insolvency resolution process (CIRP) is much different than that in an insolvency process.

In insolvency process, there is a moratorium in place where there is a freeze on the assets of the corporate debtor and all the financial creditors come together to form the CoC. Approval to a resolution plan by the requisite majority is binding on all the stakeholders including dissenting financial creditors. It is thus, possible that under the approved resolution plan a dissenting financial creditor may not receive the value of the security held by it.

Dissenting Financial Creditors : Court’s Clarification for Larger Bench

The Court also rejected the argument of the respondent that Section 30(2)(b)(ii) is unworkable because it involves deeming fiction relating to liquidation, which is inapplicable during the CIRP period. It noted that the dissenting financial creditor has to statutorily forgo and relinquish his security interest on the resolution plan being accepted, and his position is same and no different from that of a secured creditor who has voluntarily relinquished security and is to be paid under Section 53(1)(b)(ii) of the Code.

“We wish to clarify that Section 53(1) is referred to in Section 30(2)(b)(ii) with the purpose and objective that the dissenting financial creditor is not denied the amount which is payable to it being equal to the amount of value of the security interest. The entire Section 53 is not made applicable,” the judgment authored by Justice Sanjiv Khanna stated.

Since it was taking a contrary view from a coordinate bench’s judgment, the bench said that it is proper and appropriate that the issue is referred to a larger bench. The matter be, accordingly placed before the Hon’ble the Chief Justice for appropriate orders, the judgment stated.

Conclusion: Dissenting Financial creditors under IBC

The entitlement of dissenting financial creditors under the IBC is a complex issue that requires careful consideration. The Supreme Court’s rulings provide some guidance, but the final decision often rests with the CoC. As the law continues to evolve, it will be interesting to see how these issues are resolved in the future.

The post Dissenting Financial Creditors under IBC: A Matter for Larger Bench Consideration appeared first on Bhatt & Joshi Associates.

The Insolvency and Bankruptcy Code, 2016 (IBC) represents a watershed moment in India’s insolvency resolution framework, establishing a time-bound and comprehensive mechanism for corporate insolvency resolution and liquidation [1]. Central to the liquidation process is the role of the liquidator, who bears the critical responsibility of maximizing asset value and ensuring equitable distribution among stakeholders. The determination of liquidator’s remuneration has emerged as a contentious issue, particularly regarding the computation methodology and exclusion of certain periods from the liquidation timeline.

The IBC was enacted to replace the fragmented legislative framework that previously governed insolvency proceedings through various statutes including the Companies Act, 2013, the Sick Industrial Companies Act, 1985, and the SARFAESI Act, 2002 [2]. This comprehensive legislation aims to provide a unified approach to insolvency resolution while ensuring speedy and efficient proceedings.

Case Analysis on Liquidator’s Fee and Exclusion of Period

Legal Framework Governing Liquidator’s Fee

Statutory Basis Under the IBC

Section 34 of the IBC provides the foundational framework for liquidator remuneration. Subsection (8) specifically mandates that an Insolvency Professional proposed for appointment as liquidator shall charge fees as specified by the Insolvency and Bankruptcy Board of India (IBBI) [3]. The fee structure is intrinsically linked to the value of liquidation estate assets, ensuring proportionate compensation based on the complexity and scale of assets under liquidation.

Section 34(9) establishes that liquidator fees constitute a priority payment from liquidation proceeds under the waterfall mechanism prescribed in Section 53 of the IBC [4]. This statutory recognition underscores the critical importance of liquidator services in the insolvency ecosystem.

The definition of “liquidation cost” under Section 5(16) of the IBC encompasses any cost incurred by the liquidator during the liquidation period, subject to IBBI regulations [5]. This expansive definition was further clarified by the Bombay High Court in Amit Gupta v. IBBI, which held that Parliament intended a wide interpretation of liquidation costs, rejecting attempts to curtail its meaning through regulatory provisions [6].

IBBI Liquidation Process Regulations, 2016

The IBBI (Liquidation Process) Regulations, 2016 (Liquidation Regulations) operationalize the statutory framework through detailed provisions. Regulation 4 establishes a three-tier fee structure based on different decision-making authorities and circumstances.

Under Regulation 4(1), the Committee of Creditors (CoC) holds primary authority to determine liquidator fees pursuant to CIRP Regulation 39D [7]. This provision was inserted to maintain continuity between the resolution and liquidation phases, allowing the CoC to make informed decisions based on their understanding of the corporate debtor’s circumstances.

Regulation 4(1A), introduced through the Second Amendment Regulations, 2022, empowers the Stakeholders’ Consultation Committee (SCC) to fix liquidator fees when the CoC has not made such determination [8]. This amendment recognized the practical reality that many liquidation cases proceed without CoC involvement, necessitating alternative mechanisms for fee determination.

Regulation 4(2) provides a default fee structure when neither the CoC nor SCC determines the liquidator’s remuneration. This regulation establishes a detailed percentage-based fee schedule linked to asset realization and distribution timelines [9]. The regulation incorporates time-based fee reduction, reflecting the legislative intent to incentivize expeditious liquidation proceedings.

Regulation 4(3) and Period Exclusion Provisions

Regulation 4(3) addresses scenarios where asset realization or distribution occurs beyond the initial two-year period from liquidation commencement. The regulation provides that liquidators shall receive half the standard rate for assets realized or distributed after two years, or such extended period as may be allowed by the Adjudicating Authority under Section 33(7) or Section 33(8) [10].

This provision embodies the IBC’s time-bound philosophy while recognizing that genuine delays may occur due to circumstances beyond the liquidator’s control. The reference to Section 33(7) and Section 33(8) creates a direct link between judicial extensions and fee calculation methodology.

Case Analysis: Mr. Sanjay Kumar Aggarwal v. Canara Bank

Background and Factual Matrix

The case of Mr. Sanjay Kumar Aggarwal (Liquidator of Punjab Basmati Rice Ltd.) v. Canara Bank, decided by the NCLT Chandigarh Bench on March 15, 2023, presents a comprehensive examination of liquidator fee computation and period exclusion principles [11]. The corporate debtor, Punjab Basmati Rice Ltd., entered CIRP on August 23, 2019, following default on various credit facilities.

The CIRP failed to yield a viable resolution plan, leading to liquidation order on February 24, 2020. Mr. Sanjay Kumar Aggarwal, who served as Resolution Professional during CIRP, was appointed as liquidator. The total asset realization amounted to Rs. 1,03,00,00,000, while Canara Bank held secured claims worth Rs. 1,02,62,00,000.

Procedural History and Period Exclusion Applications

The liquidator filed multiple applications seeking exclusion of various periods from the liquidation timeline due to extraordinary circumstances including the COVID-19 pandemic, lockdowns, and legal disputes. The NCLT Chandigarh Bench allowed these applications, excluding a total of 365 days from the liquidation period calculation.

This exclusion was granted under established judicial precedents recognizing that force majeure events and unforeseen circumstances should not prejudice liquidators who demonstrate due diligence in asset realization. The court’s approach aligns with the Supreme Court’s guidance in various IBC matters emphasizing substance over form.

Core Legal Issues

The primary dispute centered on whether the liquidator was entitled to full-rate fees under Regulation 4(2) or reduced fees under Regulation 4(3), considering the excluded period. The liquidator contended that when the excluded period was deducted, asset realization and distribution occurred within the initial two-year timeframe, entitling him to standard rates.

Canara Bank opposed this interpretation, arguing that the excluded period was merely a calculation adjustment rather than an extension under Section 33(7) or Section 33(8). This distinction was crucial as Regulation 4(3) specifically references extensions “allowed by Adjudicating Authority under section 33(7) or section 33(8).”

NCLT Chandigarh Bench Decision

The NCLT Chandigarh Bench delivered a comprehensive judgment addressing both the legal and factual aspects of the dispute. The court made several key findings that have broader implications for liquidation proceedings under the IBC.

The tribunal held that Mr. Aggarwal had performed his duties with due diligence and without prejudice to any stakeholder. This finding was critical as it established the liquidator’s bona fides, distinguishing the case from scenarios involving liquidator negligence or misconduct.

The court referenced the NCLAT decision in SIDBI v. Shri Vijender Sharma, which established the principle of excluding certain periods from liquidation timelines for fee calculation purposes [12]. This precedent was instrumental in supporting the liquidator’s position and demonstrates the evolving jurisprudence on this issue.

Legal Precedents and Jurisprudential Development

SIDBI v. Shri Vijender Sharma – NCLAT Precedent

The NCLAT decision in SIDBI v. Shri Vijender Sharma (2022) represents a landmark judgment establishing the principle of period exclusion for liquidator fee calculation [13]. The appellate tribunal held that Regulation 44 read with Regulation 4(3) permits exclusion of periods where delays occur due to circumstances beyond the liquidator’s control.

This decision recognized that rigid application of time limits without considering genuine impediments would create inequitable outcomes and potentially discourage qualified professionals from accepting liquidator appointments. The judgment emphasized that fee calculation should reflect actual performance rather than calendar-based timelines when extraordinary circumstances intervene.

Bombay High Court Decision in Amit Gupta v. IBBI

The Bombay High Court’s decision in Amit Gupta v. IBBI (2024) addressed the constitutional validity of IBBI’s clarificatory circular on liquidator fee computation [14]. The court struck down certain provisions of the circular as ultra vires, particularly those requiring court approval for period exclusions.

The judgment held that IBBI cannot introduce new requirements through circulars that materially alter regulatory provisions. This decision reinforces the principle that substantial changes to liquidation regulations must follow proper legislative procedures rather than administrative clarifications.

National Company Law Appellate Tribunal Jurisprudence

The NCLAT has consistently emphasized the importance of protecting liquidator interests while ensuring accountability. In various decisions, the appellate tribunal has recognized that liquidator fees should reflect the complexity and challenges faced during the liquidation process.

The tribunal’s approach balances stakeholder interests while acknowledging that experienced insolvency professionals require appropriate compensation to maintain the quality and effectiveness of the insolvency ecosystem.

Regulatory Framework Evolution

IBBI (Liquidation Process) Regulations Amendments

The Liquidation Regulations have undergone several amendments since their initial notification in 2016. The Second Amendment Regulations, 2022, introduced significant changes including the empowerment of SCC to determine liquidator fees and enhanced transparency requirements [15].

These amendments reflect IBBI’s continuous efforts to refine the regulatory framework based on practical experience and stakeholder feedback. The evolution of liquidation regulations demonstrates the adaptive nature of India’s insolvency framework.

Stakeholders’ Consultation Committee Role

The introduction of Regulation 31A establishing Stakeholders’ Consultation Committees marked a significant development in liquidation governance [16]. The SCC serves as an advisory body representing diverse stakeholder interests while providing oversight of liquidator activities.

Recent amendments have expanded the SCC’s role to include fee determination, asset sale decisions, and ongoing consultation requirements. These changes reflect the regulator’s intent to balance liquidator independence with stakeholder accountability.

Computation Methodology and Practical Implications

Fee Calculation Under Regulation 4(2)(b)

Regulation 4(2)(b) establishes a complex fee structure based on asset realization and distribution amounts, with varying rates for different time periods [17]. The regulation creates incentives for rapid asset realization while ensuring adequate compensation for liquidator services.

The fee table distinguishes between realization fees and distribution fees, recognizing that these activities may occur at different times and involve distinct challenges. Higher rates in initial months encourage prompt action while reduced rates for extended periods reflect the diminishing complexity of remaining assets.

Period Exclusion Criteria and Application

Courts have developed criteria for determining when period exclusions are appropriate. Key factors include the nature of the impediment, liquidator’s due diligence, impact on asset realization, and whether delays were beyond the liquidator’s control.

The COVID-19 pandemic provided a clear example of circumstances warranting period exclusion, with various courts recognizing that lockdowns and health restrictions created genuine obstacles to liquidation activities.

Comparative Analysis with International Practices

Cross-Border Insolvency Fee Structures

International insolvency frameworks typically provide more flexible fee determination mechanisms compared to India’s structured approach. Countries like the United States and United Kingdom rely heavily on court supervision and stakeholder negotiation rather than predetermined fee schedules.

The Indian approach seeks to balance predictability with fairness, though it may lack the flexibility seen in more mature insolvency systems. The IBC’s relatively young age suggests that further refinements may occur as the system matures.

Best Practices and Recommendations

International experience suggests that effective insolvency systems require appropriate incentive structures for insolvency professionals while maintaining accountability to stakeholders. The Indian framework’s emphasis on time-bound proceedings and percentage-based fees represents a reasonable approach to these competing objectives.

Future Implications and Recommendations

Legislative and Regulatory Considerations

The evolving jurisprudence on liquidator fees suggests potential areas for legislative or regulatory clarification. Clear guidelines on period exclusion criteria, enhanced transparency in fee determination, and standardized procedures for addressing disputes could improve system efficiency.

Future amendments might consider creating more granular fee structures that better reflect the complexity and value addition of liquidator services across different sectors and case types.

Impact on Insolvency Ecosystem

Appropriate liquidator compensation is crucial for maintaining a robust pool of qualified insolvency professionals. Under-compensation could lead to talent exodus, while excessive fees might burden already distressed enterprises.

The current framework’s evolution through judicial interpretation and regulatory amendments suggests a maturation process that should ultimately enhance the effectiveness of India’s insolvency system.

Conclusion

The NCLT Chandigarh Bench’s decision in Mr. Sanjay Kumar Aggarwal v. Canara Bank represents a significant contribution to the jurisprudence on liquidator fee computation and period exclusion under the IBC. The judgment affirms the principle that liquidators who demonstrate due diligence should not be penalized for delays caused by circumstances beyond their control.

The decision aligns with the IBC’s broader objectives of encouraging efficient asset realization while ensuring fair compensation for insolvency professionals. The court’s reliance on established NCLAT precedents demonstrates the developing consistency in judicial interpretation of liquidation regulations.

The case highlights the importance of balancing liquidator interests with stakeholder protection, a theme that runs throughout the IBC framework. As India’s insolvency system continues to mature, decisions like this contribute to the predictability and fairness that are essential for an effective insolvency regime.

The evolution of liquidator fee regulations through judicial interpretation and regulatory amendments reflects the adaptive nature of India’s insolvency framework. Future developments should continue to prioritize both efficiency and equity while maintaining the time-bound nature that distinguishes the IBC from previous insolvency legislation.

References

[1] The Insolvency and Bankruptcy Code, 2016 (31 of 2016), available at: https://www.indiacode.nic.in/handle/123456789/2046 

[2] Ministry of Corporate Affairs, Report of the Bankruptcy Law Reforms Committee (2015) 

[3] Insolvency and Bankruptcy Code, 2016, Section 34(8)

[4] Insolvency and Bankruptcy Code, 2016, Section 34(9) read with Section 53

[5] Insolvency and Bankruptcy Code, 2016, Section 5(16)

[6] Amit Gupta v. Insolvency and Bankruptcy Board of India, (2024) ibclaw.in 250 HC (Bombay), available at: https://ibclaw.in/amit-gupta-vs-insolvency-and-bankruptcy-board-of-india-and-anr-bombay-high-court/ 

[7] IBBI (Liquidation Process) Regulations, 2016, Regulation 4(1) read with CIRP Regulation 39D

[8] IBBI (Liquidation Process) (Second Amendment) Regulations, 2022, available at: https://ibbi.gov.in/en/legal-framework/regulations 

[9] IBBI (Liquidation Process) Regulations, 2016, Regulation 4(2)(b)

[10] IBBI (Liquidation Process) Regulations, 2016, Regulation 4(3)

[11] Mr. Sanjay Kumar Aggarwal v. Canara Bank, NCLT Chandigarh Bench (March 15, 2023)

[12] Small Industries Development Bank of India v. Shri Vijender Sharma, (2022) ibclaw.in 879 NCLAT, available at: https://ibclaw.in/small-industries-development-bank-of-india-sidbi-vs-shri-vijender-sharma-nclat-new-delhi/ 

[13] Ibid.

[14] Amit Gupta v. IBBI, supra note 6

[15] IBBI (Liquidation Process) (Second Amendment) Regulations, 2022, supra note 8

Download Full Judgement

[pdfjs-viewer url=”https://bj-m.s3.ap-south-1.amazonaws.com/p/2023/09/the_insolvency_and_bankruptcy_code_2016-4-1.pdf” attachment_id=”26332″ viewer_width=100% viewer_height=800px fullscreen=false download=true print=false]

[pdfjs-viewer url=”https://bj-m.s3.ap-south-1.amazonaws.com/p/2023/09/6f25e2e303fb1cec921523b337ab0c80.pdf” attachment_id=”26334″ viewer_width=100% viewer_height=800px fullscreen=false download=true print=false]

[pdfjs-viewer url=”https://bj-m.s3.ap-south-1.amazonaws.com/p/2023/09/BLRCReportVol1_04112015.pdf” attachment_id=”26333″ viewer_width=100% viewer_height=800px fullscreen=false download=true print=false]

[pdfjs-viewer url=”https://bj-m.s3.ap-south-1.amazonaws.com/p/2023/09/b37ac2f0201e2e3c41cfa3d989f58f4d.pdf” attachment_id=”26335″ viewer_width=100% viewer_height=800px fullscreen=false download=true print=false]

[pdfjs-viewer url=”https://bj-m.s3.ap-south-1.amazonaws.com/p/2023/09/Insolvency-and-Bankruptcy-Board-of-India.pdf” attachment_id=”26336″ viewer_width=100% viewer_height=800px fullscreen=false download=true print=false]

The post Liquidator Fee Computation and Period Exclusion under the IBC appeared first on Bhatt & Joshi Associates.

Government Debt vs Secured Debt

Introduction

The question of priority between government debt and secured debt has emerged as one of the most contentious issues in India’s insolvency jurisprudence. When a company faces liquidation, multiple creditors compete for limited resources, making the order of payment critical. The Insolvency and Bankruptcy Code of 2016 introduced a structured waterfall mechanism under Section 53 to address this challenge, fundamentally altering the traditional understanding of debt priority. This analysis examines how Indian courts have interpreted the relationship between government dues and secured creditor claims, with particular focus on the evolving legal framework and recent judicial pronouncements that have shaped current practice.

The Debt Recovery Appellate Tribunal in Mumbai addressed this precise conflict in a landmark decision that reaffirmed the priority of government debt over secured debt, while also upholding the primacy of secured creditors during liquidation proceedings under the Insolvency and Bankruptcy Code. This case exemplifies the broader tension between facilitating business recovery and protecting revenue interests, a balance that remains central to insolvency law reform in India

The Insolvency and Bankruptcy Code and Its Waterfall Mechanism

The Insolvency and Bankruptcy Code represents a paradigm shift in how India handles corporate insolvency. Before its enactment, various laws governed different aspects of debt recovery, creating confusion and prolonged litigation. The Code consolidated these fragmented provisions into a unified framework designed to enable time-bound resolution of insolvency cases.

At the heart of this framework lies the waterfall mechanism prescribed by Section 53 of the Insolvency and Bankruptcy Code, which establishes a clear hierarchy for distributing proceeds from liquidated assets. This provision begins with a non-obstante clause, meaning it overrides conflicting provisions in other laws. The distribution priority under Section 53 follows a carefully designed sequence: first come insolvency resolution process costs and liquidation costs, which must be paid in full. Second, workmen’s dues for twenty-four months preceding liquidation and debts owed to secured creditors who have relinquished their security are treated equally. Third are wages and unpaid dues to employees other than workmen for twelve months. Fourth come financial debts owed to unsecured creditors, followed fifth by government dues and any amounts still owed to secured creditors after enforcement of their security. The remaining categories include operational creditors, preference shareholders, and finally equity shareholders[1].

This structured approach reflects deliberate policy choices made by Parliament. The Bankruptcy Law Reforms Committee, which drafted the Code, explicitly recommended prioritizing secured creditors to encourage lending and reduce the cost of capital. The committee recognized that placing government dues below secured creditors would boost investor confidence and facilitate corporate rescue[2]. This represented a significant departure from the traditional crown debt doctrine, which historically gave government claims precedence.

The waterfall mechanism applies not only during liquidation but also influences distribution under resolution plans. Section 30 of the Code requires that any approved resolution plan must ensure operational creditors receive at least what they would have gotten under liquidation, effectively incorporating the Section 53 priorities into the resolution process as well.

Legal Framework Governing Priority of Claims

The Pre-IBC Regime

Before the Insolvency and Bankruptcy Code came into force, the legal position regarding Government Debt vs Secured Debt was governed primarily by judicial precedents and specific statutes. The Supreme Court in Union of India vs SICOM Ltd established that secured creditors enjoyed priority over crown debt, but this priority was subordinate to any statutory first charge created in favor of the government[3]. This meant that while secured creditors generally ranked above unsecured government dues, specific tax statutes creating first charges could trump secured claims.

The Recovery of Debts and Bankruptcy Act of 1993 established Debt Recovery Tribunals to expedite recovery by banks and financial institutions. Subsequently, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act of 2002 empowered secured creditors to enforce security interests without court intervention. However, neither statute initially addressed the priority conflict between secured creditors and government statutory charges comprehensively.

The 2016 Amendments: A Watershed Moment

The Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act of 2016 marked a crucial turning point. This amendment inserted Chapter IVA into the SARFAESI Act and introduced Section 26E, which categorically states that after registration of security interest, debts due to secured creditors shall be paid in priority over all other debts and all revenues, taxes, cesses and rates payable to central, state or local authorities. The provision opens with a non-obstante clause, giving it overriding effect over conflicting laws[4].

Similarly, Section 31B was added to the Recovery of Debts and Bankruptcy Act, providing that rights of secured creditors to realize secured debts shall have priority over all other debts and government dues including revenues, taxes, cesses and rates. These amendments represented parliamentary intent to definitively resolve the priority question in favor of secured creditors, subject to registration requirements under the Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI)[5].

However, these amendments came with important conditions. Section 26D made registration with CERSAI mandatory for secured creditors to invoke provisions of Chapter III of the SARFAESI Act. Without such registration, secured creditors lose the priority benefit granted by Section 26E. This registration requirement ensures transparency and provides notice to all stakeholders about existing charges on assets.

The Rainbow Papers Controversy

The seemingly settled priority framework faced unexpected disruption with the Supreme Court’s decision in State Tax Officer vs Rainbow Papers Limited. In this case, the Gujarat State VAT officer challenged a resolution plan that had been approved without adequately providing for government tax dues. Section 48 of the Gujarat Value Added Tax Act creates a first charge on the dealer’s property for amounts payable as tax, interest or penalty. The National Company Law Tribunal and National Company Law Appellate Tribunal had rejected the tax officer’s claim on grounds that it was filed beyond the stipulated timeline and that government dues did not qualify as secured debts[6].

The Supreme Court reversed these findings and held that Section 48 of the GVAT Act created a security interest by operation of law, making the state a secured creditor within the meaning of the Insolvency and Bankruptcy Code. The Court ruled that under Section 53 of the Code, debts owed to secured creditors, including the state under the GVAT Act, rank equally with workmen’s dues for twenty-four months preceding liquidation. Most significantly, the judgment stated that if a resolution plan ignores statutory demands payable to any government or governmental authority altogether, the adjudicating authority is bound to reject it. The Court emphasized that financial creditors cannot secure their dues at the cost of statutory dues owed to the government.

This decision created considerable controversy within the insolvency community. Critics argued that the judgment failed to properly consider the waterfall mechanism under Section 53, which explicitly places government dues at a lower priority than secured creditors. The decision appeared to conflate the concept of a statutory charge created by operation of law with security interests created through consensual transactions, potentially undermining the Code’s carefully calibrated priority structure.

When review petitions were filed challenging this judgment, the Supreme Court dismissed them, reaffirming its position in October 2023[7]. This dismissal intensified concerns among lenders and insolvency professionals about the treatment of government dues in ongoing and future insolvency cases.

Clarification Through Paschimanchal Vidyut Vitran Nigam

The confusion and anxiety created by Rainbow Papers found resolution in the Supreme Court’s subsequent decision in Paschimanchal Vidyut Vitran Nigam Limited vs Raman Ispat Private Limited. This case involved electricity dues owed by a corporate debtor to a state electricity distribution company. Under the Uttar Pradesh Electricity Supply Code, the electricity company had created a first charge over the debtor’s assets for unpaid electricity bills. When the corporate debtor went into liquidation, the electricity company attached its property and claimed priority status as a secured creditor.

The National Company Law Tribunal and National Company Law Appellate Tribunal both held that the electricity company was an operational creditor and that its dues would be satisfied according to the waterfall mechanism under Section 53. The company appealed to the Supreme Court, relying heavily on the Rainbow Papers judgment to argue that it should be treated as a secured creditor with priority rights.

The Supreme Court delivered a comprehensive judgment that addressed several critical issues. First, it confirmed that Section 238 of the Insolvency and Bankruptcy Code has overriding effect over the Electricity Act, despite the latter containing its own non-obstante clauses in Sections 173 and 174. The Court held that when a special statute like the IBC is enacted later to address a specific problem comprehensively, it prevails over general or earlier special laws[8].

Most importantly, the judgment provided crucial clarification on the Rainbow Papers decision. The Court observed that Rainbow Papers had not considered or discussed the waterfall mechanism under Section 53 at all. The judgment noted that under the careful design of Section 53, amounts payable to secured creditors and workmen are placed at the second position after liquidation costs, while government dues are placed much lower, even below unsecured and operational creditors. The Court stated this design was either not brought to the court’s notice in Rainbow Papers or was missed altogether.

The Supreme Court further clarified the meaning of government dues under the Code. While the term is not specifically defined, Section 53 refers to amounts due to central and state governments, including amounts received on account of the Consolidated Fund of India and Consolidated Fund of States. The Court held that major public utilities and statutory corporations like the electricity distribution company are not, in the ordinary sense, the central or state government. Amounts due to such entities are secured operational debts or financial debts depending on the nature of transactions, not government dues. Only amounts accruing to the Treasury under Article 265 of the Constitution, such as taxes and tariffs, constitute government dues for purposes of the waterfall mechanism.

Crucially, the Supreme Court confined the applicability of Rainbow Papers to its own factual circumstances. The judgment emphasized that Rainbow Papers dealt with the resolution process and approval of resolution plans, whereas the present case concerned liquidation and distribution under Section 53. Since Rainbow Papers had not analyzed the waterfall mechanism, its observations could not be treated as binding precedent for determining priority during liquidation.

Regulatory Framework for Priority Enforcement

SARFAESI Act Provisions

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act provides secured creditors with powerful remedies to enforce security interests without court intervention. Under Section 13 of the Act, secured creditors can issue notice to borrowers demanding payment within sixty days, failing which they can take possession of secured assets and sell them to realize dues.

Section 26E, introduced through the 2016 amendment, creates a clear priority for registered secured creditors. However, this priority is subject to mandatory registration under Section 26B. Secured creditors must file details of their security interest with CERSAI within thirty days of creation. Section 26C provides that registration constitutes public notice from the date and time of filing, giving it legal effect against third parties.

Courts have consistently held that without CERSAI registration, secured creditors cannot claim the benefit of priority under Section 26E. The Bombay High Court in Jalgaon Janta Sahakari Bank Ltd. vs Joint Commissioner emphasized that registration is a prerequisite for invoking Chapter IVA provisions. This requirement balances the priority granted to secured creditors with the need for transparency in secured transactions[9].

Recovery of Debts and Bankruptcy Act

The Recovery of Debts and Bankruptcy Act establishes Debt Recovery Tribunals as specialized forums for adjudicating disputes involving banks and financial institutions. Section 31B of the Act, also inserted in 2016, mirrors Section 26E of the SARFAESI Act in granting priority to secured creditors over government dues.

However, courts have clarified that Section 31B applies only when proceedings are initiated under the RDDB Act before the Debt Recovery Tribunal. A secured creditor who opts to enforce security under the SARFAESI Act cannot subsequently invoke Section 31B if they fail to meet CERSAI registration requirements. The two statutes provide alternative remedies, and creditors must choose their remedy and comply with applicable conditions.

Practical Implications for Stakeholders

Impact on Financial Creditors

The judicial clarification that government dues rank below secured creditors in the liquidation waterfall provides certainty to banks and financial institutions. Lenders can more accurately assess recovery prospects when extending credit, knowing that properly secured and registered interests enjoy clear priority. This clarity reduces credit risk and potentially lowers borrowing costs for businesses.

However, secured creditors must ensure strict compliance with registration requirements. Failure to register security interests with CERSAI within the prescribed timeframe can result in loss of priority benefits. Financial institutions have accordingly strengthened their compliance processes to ensure timely registration of all security interests created in their favor.

Government Revenue Departments

The subordination of government dues in the insolvency waterfall represents a significant shift from the traditional crown debt doctrine. Tax authorities can no longer assume that their dues will be recovered before private creditors. This reality necessitates more proactive monitoring of defaulting assessees and timely initiation of recovery proceedings before insolvency sets in.

The distinction drawn in Paschimanchal Vidyut Vitran Nigam between government dues (taxes, tariffs flowing to Consolidated Funds) and dues of public utilities or statutory corporations provides some relief. Public sector undertakings and government companies that supply goods or services can claim secured or operational creditor status based on their transactions, rather than being automatically relegated to the government dues category.

Insolvency Professionals

Resolution professionals and liquidators must carefully analyze the nature of various claims to correctly classify them within the waterfall mechanism. The position established by recent judgments requires professionals to distinguish between genuine government revenue dues and claims by government-owned entities that may qualify as secured or operational creditors based on transaction specifics.

The Rainbow Papers controversy highlighted the risk of approving resolution plans that inadequately address certain categories of claims. While the decision has been confined to its facts, professionals must ensure all legitimate creditor claims receive appropriate treatment in resolution plans to avoid challenges that could derail the process.

Comparative Analysis: Insolvency and Bankruptcy Code vs Companies Act

The treatment of secured creditors under the Insolvency and Bankruptcy Code differs significantly from the regime under the Companies Act. Under the Companies Act of 2013, Section 326 provides that workmen’s dues and secured creditors’ dues rank pari passu and have priority, while Section 327 subordinates government dues to this priority. However, the Companies Act does not contain as detailed or structured a waterfall mechanism as Section 53 of the IBC.

The Insolvency and Bankruptcy Code’s approach is more comprehensive and leaves less room for interpretational disputes. By explicitly setting out eight distinct priority categories and providing that this order has overriding effect over other laws, Parliament sought to eliminate the uncertainty that characterized the earlier regime. The Supreme Court in Swiss Ribbons Private Limited vs Union of India upheld this design, noting that the differential treatment of financial and operational creditors, and the subordination of government dues, is based on intelligible differentia and serves the Code’s objectives of maximizing value and enabling efficient resolution.

Recent Developments and Future Directions

The 2023 Discussion Paper

In January 2023, the Ministry of Corporate Affairs released a discussion paper seeking public input on proposed amendments to the Insolvency and Bankruptcy Code. One key proposal addressed the priority of government debt over secured debt. The paper suggested that all debts owed to government authorities, whether secured through statutory charges or otherwise, should be treated equally with other unsecured creditors. Only where government entities create security interests through consensual transactions with the corporate debtor would they qualify as secured creditors with corresponding priority.

This proposal aimed to clarify the confusion created by Rainbow Papers and restore the Code’s original intent of subordinating government dues to secured creditor claims. However, the discussion paper also recognized the need to balance revenue protection with creditor rights, suggesting that the issue requires careful calibration.

The Insolvency and Bankruptcy Code (Amendment) Bill 2025

Building on the discussion paper, the government introduced the Insolvency and Bankruptcy Code (Amendment) Bill in 2025 to address the government dues controversy legislatively. The bill proposes amendments to Section 3 defining security interest to clarify that security interests encompass only those created through consensual transactions, not by mere operation of statute. This definitional change would legislatively overrule the Rainbow Papers interpretation and ensure government statutory charges do not confer secured creditor status.

The bill also proposes explicit language in Section 53 to confirm that government dues, regardless of how created, rank in the fifth priority category below secured creditors, unsecured financial creditors, and operational creditors. If enacted, these amendments would definitively resolve the ambiguity and provide certainty to all stakeholders about the treatment of government claims in insolvency proceedings.

Conclusion

The evolution of law regarding priority between government debt and secured debt illustrates the dynamic nature of India’s insolvency jurisprudence. From the traditional crown debt doctrine through the watershed 2016 amendments to the Rainbow Papers controversy and its subsequent clarification, the legal framework has undergone significant refinement. The current position, as established by the Paschimanchal Vidyut Vitran Nigam judgment, reaffirms that secured creditors enjoy clear priority over government dues in liquidation proceedings under the Insolvency and Bankruptcy Code.

This priority structure serves important policy objectives. By assuring secured creditors of preferential treatment, the law encourages lending and reduces credit costs. The requirement of CERSAI registration balances this benefit with transparency, ensuring all stakeholders have notice of existing charges. The subordination of government dues, while marking a departure from historical practice, reflects the Code’s focus on maximizing value for all creditors and enabling efficient resolution of distressed companies.

For the framework to function effectively, stakeholders must understand their rights and obligations clearly. Secured creditors must meticulously comply with registration requirements to preserve priority rights. Government departments must adapt collection strategies to the new reality of subordinated claims. Insolvency professionals must correctly classify claims and ensure resolution plans respect the statutory waterfall. With pending legislative amendments likely to provide further clarity, India’s insolvency ecosystem continues maturing toward greater certainty and efficiency in handling corporate distress.

References

[1] Insolvency and Bankruptcy Board of India. (2016). Insolvency and Bankruptcy Code, 2016. https://ibbi.gov.in/Agenda_8_210917.pdf 

[2] Vinod Kothari Consultants. (2020). Section 53 of IBC: The Heart of Insolvency Law. https://vinodkothari.com/wp-content/uploads/2020/04/Section-53-of-IBC.pdf 

[3] SCC Online. (2024). Varied hues of Government dues under IBC. https://www.lexology.com/library/detail.aspx?g=06361356-e132-4738-a36f-3d6c262ba4f4 

[4] Lexology. (2022). Bombay High Court: Under SARFAESI and RDDB Act, claims of secured creditors would take priority. https://www.lexology.com/library/detail.aspx?g=0d2b41b9-7fb5-4de3-9719-8d32c4bb1a3e 

[5] IBC Laws. (n.d.). Section 26E of SARFAESI Act, 2002: Priority to secured creditors. https://ibclaw.in/section-26e-priority-to-secured-creditors/ 

[6] Cyril Amarchand Mangaldas. (2023). Government Dues under IBC: Rainbow Papers Explained. https://www.cyrilshroff.com/wp-content/uploads/2023/11/Client-Alert-Rainbow-Review_1711.pdf 

[7] India Law. (2023). Supreme Court Re-Affirms The Law Laid Down In Rainbow Papers By Dismissing Review Petition. https://www.indialaw.in/blog/insolvency-bankruptcy/supreme-court-reaffirms-rainbow-papers-case-law-dismisses-review-petition/ 

[8] SCC Online. (2023). IBC overrides Electricity Act; Supreme Court explains hierarchy for settling dues. https://www.scconline.com/blog/post/2023/07/21/ibc-overrides-electricity-act-sc-explains-hierarchy-for-settling-dues-in-insolvency-cases/ 

[9] Vinod Kothari Consultants. (2022). Tax dues subservient to dues of secured creditors under SARFAESI Act and RDDB Act. https://vinodkothari.com/2022/09/tax-dues-subservient-to-dues-of-secured-creditors-under-sarfaesi-act-and-rddb-act/ 

Authorized and Published by Rutvik Desai

The post Government Debt vs Secured Debt: A Case Analysis appeared first on Bhatt & Joshi Associates.

Introduction

The introduction of the Insolvency and Bankruptcy Code, 2016 marked a transformative shift in India’s approach to corporate insolvency and debt resolution. Among the various provisions designed to facilitate the Corporate Insolvency Resolution Process (CIRP), the mechanism of interim finance stands out as a critical element that ensures business continuity during the resolution period. When a corporate debtor enters insolvency proceedings, it faces an immediate and pressing challenge: maintaining operations while navigating the complex terrain of creditor claims, asset preservation, and eventual resolution or liquidation.

Interim finance addresses this fundamental challenge by providing a structured framework through which companies undergoing CIRP can access necessary funding to continue operations, meet working capital requirements, and cover the substantial costs associated with the resolution process itself. The significance of this provision extends beyond mere financial support; it represents the legislative intent to preserve the going concern value of enterprises, thereby maximizing returns for all stakeholders involved in the insolvency proceedings [1].

The framework governing interim finance under the IBC reflects a delicate balance between multiple competing interests. On one hand, it recognizes the urgent need for operational funding to prevent asset deterioration and value erosion. On the other, it establishes safeguards to protect existing creditors whose claims might be subordinated to new financing arrangements. This balance is achieved through a carefully designed priority structure, approval mechanisms, and oversight provisions that collectively ensure interim finance serves its intended purpose without compromising the fundamental principles of insolvency law [2].

Understanding interim finance requires examining not just the statutory provisions but also the regulatory framework established by the Insolvency and Bankruptcy Board of India (IBBI) and the evolving jurisprudence developed through tribunal and appellate decisions. The practical application of these provisions has revealed both the strengths and limitations of the current framework, prompting ongoing discussions about potential reforms and improvements.

The Conceptual Foundation of Interim Finance in Insolvency Law

The concept of interim finance, also referred to as debtor-in-possession financing in some jurisdictions, serves a dual purpose within insolvency proceedings. Primarily, it enables the corporate debtor to maintain operational continuity during the CIRP period, which typically extends for a maximum of 330 days including any extensions. Without such financing, most companies entering insolvency would face immediate closure, resulting in rapid asset deterioration, employee displacement, and ultimately, minimal recovery for creditors [3].

The legislative design of interim finance under the IBC incorporates several distinctive features that differentiate it from conventional corporate borrowing. First, interim finance enjoys super-priority status, meaning it ranks ahead of most other claims in the distribution waterfall during liquidation proceedings. This prioritization is essential to incentivize lenders to provide funding to distressed companies that would otherwise be considered unacceptable credit risks under normal commercial circumstances.

Second, the raising of interim finance is subject to specific approval requirements depending on the stage of CIRP and the party exercising control over the corporate debtor’s affairs. During the initial phase when an Interim Resolution Professional (IRP) manages the company, certain powers exist to raise limited interim finance. However, once a Resolution Professional (RP) is appointed and the Committee of Creditors (CoC) is constituted, more substantial interim financing arrangements require explicit CoC approval through a prescribed voting threshold.

Third, the creation of security interests over the assets of the corporate debtor in favor of interim finance providers is subject to additional safeguards, particularly when such assets are already encumbered by existing creditor claims. This prevents the dilution of secured creditor positions without their knowledge or consent, thereby maintaining the integrity of the existing capital structure while facilitating new financing.

The practical necessity of interim finance becomes evident when examining the typical financial condition of companies entering CIRP. Most such companies suffer from depleted working capital, strained supplier relationships, and limited access to conventional credit channels. The CIRP process itself generates significant costs including professional fees, operational expenses, and statutory payments that must be met regardless of the company’s financial difficulties. Without interim finance, Resolution Professionals would find it nearly impossible to maintain operations, preserve asset values, or create conditions conducive to meaningful resolution attempts.

Statutory Provisions Governing Interim Finance

Definition and Classification as Insolvency Resolution Process Costs

The Insolvency and Bankruptcy Code, 2016, establishes the foundational framework for interim finance through several interconnected provisions. Section 5(13) of the IBC provides the statutory definition of “insolvency resolution process costs,” which explicitly includes the amount of any interim finance raised and the costs incurred in raising such finance. This definitional inclusion is significant because it automatically grants interim finance the priority status associated with CIRP costs in the distribution waterfall established under Section 53 of the Code [1].

The classification of interim finance as part of CIRP costs means that such financing takes precedence over virtually all other claims against the corporate debtor, including those of secured financial creditors, operational creditors, and shareholders. This super-priority status serves a crucial function in making interim finance commercially viable for potential lenders. Without such priority, few financial institutions or investors would be willing to provide funding to companies in active insolvency proceedings, given the inherent risks and uncertainties involved.

Beyond interim finance itself, Section 5(13) encompasses several other categories of expenses within CIRP costs. These include fees payable to Resolution Professionals, expenses incurred in running the business as a going concern, costs incurred by government authorities in facilitating the resolution process, and other costs as may be specified by the IBBI. This comprehensive definition ensures that all essential costs associated with conducting a meaningful CIRP are afforded appropriate priority, thereby preventing the process from being derailed by funding shortages.

The legislative intent behind granting super-priority to CIRP costs, including interim finance, is rooted in the recognition that successful resolution requires adequate resources. If creditors could prevent the raising of interim finance or if such finance was subordinated to existing claims, the entire resolution process would become unworkable. The corporate debtor would be unable to maintain operations, asset values would deteriorate rapidly, and the prospects for successful resolution would diminish significantly. By prioritizing these costs, the IBC creates an environment where resolution efforts can proceed with necessary financial support.

Powers and Responsibilities of Interim Resolution Professionals

Section 20 of the IBC delineates the management responsibilities and powers of the Interim Resolution Professional concerning the operations of the corporate debtor. Under Section 20(1), the IRP is mandated to make every endeavor to protect and preserve the value of the property of the corporate debtor and manage its operations as a going concern. This fundamental obligation establishes the context within which the power to raise interim finance must be understood and exercised.

The specific authority to raise interim finance is provided under Section 20(2)(c), which states that the IRP has the authority to raise interim finance, subject to an important caveat regarding security interests. The provision specifies that no security interest shall be created over any encumbered property of the corporate debtor without the prior consent of the creditors whose debt is secured over such encumbered property. This protection ensures that existing secured creditors are not prejudiced by new financing arrangements that could dilute their security positions [4].

However, Section 20(2)(c) also contains a crucial exception to the consent requirement. It provides that no prior consent of the creditor shall be required where the value of the encumbered property is not less than twice the amount of the debt secured against it. This exception recognizes situations where substantial equity exists in charged assets, making additional encumbrances commercially reasonable without necessarily disadvantaging existing secured creditors. The two-times threshold provides a clear, objective standard that balances the need for financing flexibility against creditor protection concerns.

The practical application of Section 20 powers during the IRP phase is generally limited to raising interim finance for immediate operational necessities and urgent requirements. IRPs typically exercise these powers conservatively, focusing on maintaining minimal operations rather than undertaking substantial new financing arrangements. This cautious approach reflects both the temporary nature of the IRP’s role and the pending constitution of the CoC, which will eventually assume primary decision-making authority over significant financial matters.

Committee of Creditors’ Approval Requirements

Once the Committee of Creditors is constituted and a Resolution Professional is appointed, the framework for raising interim finance undergoes a significant shift in terms of approval requirements. Section 28 of the IBC addresses this transition by specifying actions that require CoC approval, including matters related to interim finance. This provision represents a critical check-and-balance mechanism, ensuring that major financial decisions affecting the corporate debtor are subject to creditor oversight [5].

Section 28(1)(a) explicitly requires that the Resolution Professional shall not raise any interim finance in excess of the amount as may be decided by the CoC in their meeting without obtaining prior approval. This means the CoC essentially sets a limit or threshold for interim financing, and any amount beyond this predetermined limit requires specific CoC authorization. The approval threshold for such decisions is generally sixty-six percent of the voting share, consistent with the IBC’s approach to significant decisions affecting the CIRP.

Similarly, Section 28(1)(b) requires CoC approval for creating any security interest over the assets of the corporate debtor. This provision complements the interim finance approval requirement by ensuring that the manner in which such finance is secured also receives creditor scrutiny. Together, these provisions create a robust framework where both the quantum of interim finance and the security arrangements supporting it are subject to collective creditor decision-making through the CoC mechanism.

The rationale behind requiring CoC approval for interim finance beyond a certain threshold is multifaceted. First, it ensures that creditors, who have the most substantial economic interest in the outcome of CIRP, exercise meaningful control over decisions that could affect recovery rates and resolution prospects. Second, it prevents Resolution Professionals from taking unilateral financial decisions that might benefit some stakeholders at the expense of others. Third, it creates accountability and transparency in the interim financing process, as all significant arrangements must be disclosed to and approved by the CoC.

In practice, the interaction between Section 20 and Section 28 creates a two-tiered system. During the initial IRP phase, limited interim finance can be raised under the IRP’s inherent powers, subject to the security interest limitations discussed earlier. Once the RP is appointed and the CoC is functional, more substantial interim financing arrangements require CoC approval, with the specific thresholds and approval mechanisms determined by CoC decisions in accordance with the Code’s voting requirements.

Priority and Treatment in Distribution Waterfall

The treatment of interim finance and other CIRP costs in the distribution of proceeds from asset realization is governed by Sections 52 and 53 of the IBC, which establish clear priority rules applicable in liquidation scenarios. These provisions are crucial because they ultimately determine the practical effectiveness of interim finance as a tool for facilitating CIRP by assuring potential lenders of their priority status.

Section 52 deals specifically with secured creditors in liquidation proceedings and their options for dealing with their security interests. Section 52(8) contains a particularly important provision regarding CIRP costs. It states that the amount of insolvency resolution process costs, due from secured creditors who realize their security interests independently, shall be deducted from the proceeds of any realization by such secured creditors, and they shall transfer such amounts to the liquidator to be included in the liquidation estate [6].

This provision means that even secured creditors who choose to enforce their security interests outside the liquidation framework must contribute toward CIRP costs, including any interim finance that was raised during the resolution process. This ensures that CIRP costs, being essential for attempting resolution, are borne proportionately by all creditors who ultimately benefit from the resolution attempt, whether successful or not. The provision prevents secured creditors from avoiding their share of CIRP costs by opting to realize their security independently.

Section 53 establishes the complete distribution waterfall for liquidation proceeds, and Section 53(1)(a) places insolvency resolution process costs at the very top of this priority structure, mandating that such costs be paid in full before any other claims are satisfied. This super-priority status is absolute and applies regardless of the nature or timing of other creditor claims. The provision states that CIRP costs, which include interim finance and the costs of raising such finance, take precedence over secured creditors, workmen’s dues, employee claims, operational creditors, and all other stakeholders.

The practical implication of this priority structure is profound. It means that interim finance providers have a virtually guaranteed position in terms of recovery, subject only to the availability of sufficient assets in the liquidation estate. This assurance is essential for attracting interim financing from external sources, as lenders need certainty regarding their ability to recover their advances even if the resolution attempt ultimately fails and the corporate debtor enters liquidation.

The combination of Sections 52 and 53 creates a comprehensive framework ensuring that CIRP costs, including interim finance, receive consistent priority treatment regardless of how the insolvency proceedings conclude. Whether through successful resolution, where such costs are typically factored into the resolution plan, or through liquidation, where they receive first priority from asset realization proceeds, interim finance providers have clear legal protection for their advances.

Regulatory Framework Under IBBI Regulations

Regulation 29: Asset Sales During CIRP

The IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, provide detailed operational guidelines for implementing the IBC’s provisions regarding CIRP. Regulation 29 specifically addresses the sale of assets outside the ordinary course of business, which often becomes necessary for generating funds to meet interim finance requirements or other CIRP costs when operating cash flows are insufficient.

Regulation 29(1) empowers the Resolution Professional to sell unencumbered assets of the corporate debtor, other than in the ordinary course of business, if the RP is of the opinion that such sale is necessary for better realization of value under the facts and circumstances of the case. However, this power is subject to an important quantitative limitation: the book value of all assets sold during the CIRP period under this provision cannot exceed ten percent of the total claims admitted by the Interim Resolution Professional [7].

This ten percent limitation serves multiple purposes. It prevents excessive asset stripping during CIRP that might leave insufficient assets for meaningful resolution or fair distribution to creditors. It ensures that the core business and significant assets remain intact for potential resolution applicants to evaluate and incorporate into their proposals. It also creates a clear boundary for the RP’s unilateral asset disposal authority, beyond which creditor approval becomes necessary.

Regulation 29(2) requires that any sale of assets under this provision must receive approval from the CoC by a vote of sixty-six percent of the voting share of the members. This approval requirement ensures creditor oversight of significant asset disposal decisions and prevents potential conflicts of interest or value destruction through improvident sales. The sixty-six percent threshold reflects the IBC’s general approach to major decisions, requiring substantial creditor consensus rather than simple majority approval.

Regulation 29(3) provides an important protection for purchasers of assets sold under this provision. It states that a bona fide purchaser of assets sold under Regulation 29 shall have free and marketable title to such assets, notwithstanding the terms of the constitutional documents of the corporate debtor, shareholders’ agreements, joint venture agreements, or other documents of similar nature. This provision addresses a common concern in distressed asset sales: the risk that pre-existing contractual restrictions might cloud the title transferred to purchasers, thereby deterring potential buyers and depressing realization values.

The practical interaction between Regulation 29 and interim finance requirements is significant. When a corporate debtor lacks sufficient operating cash flows to meet CIRP costs or interim finance obligations, the RP may utilize Regulation 29 to sell non-core or surplus unencumbered assets, using the proceeds to fund the resolution process. This provides an alternative or supplement to external interim financing, particularly in cases where attracting external lenders proves difficult due to the specific circumstances of the corporate debtor or broader market conditions.

Regulation 31: Components of CIRP Costs

Regulation 31 provides comprehensive detail regarding the various elements that constitute “insolvency resolution process costs” under Section 5(13)(e) of the IBC. This regulation is crucial because it clarifies which specific expenses qualify for the super-priority status accorded to CIRP costs under the Code’s distribution provisions. Understanding these components is essential for Resolution Professionals managing budgets and for potential interim finance providers assessing their priority position relative to other expenses.

Under Regulation 31, CIRP costs include amounts due to suppliers of essential goods and services under Regulation 32. This ensures that critical suppliers who continue providing necessary inputs during CIRP despite the corporate debtor’s financial distress receive priority treatment for their post-commencement supplies. Such priority is essential for maintaining supplier confidence and ensuring continued supply of essential goods and services necessary for keeping the corporate debtor operational during the resolution period.

The regulation also specifically includes fees payable to authorized representatives under sub-regulation (8) of Regulation 16A, along with out-of-pocket expenses of authorized representatives for discharge of their functions under Section 25A. These provisions recognize the role of authorized representatives in facilitating collective action by similarly situated creditors, particularly operational creditors who might otherwise lack effective voice in CIRP proceedings.

Regulation 31 further includes amounts due to persons whose rights are prejudicially affected on account of the moratorium imposed under Section 14(1)(d). This category addresses situations where the broad moratorium protecting the corporate debtor from legal proceedings inadvertently prejudices third-party rights in ways that merit compensation as part of CIRP costs. The inclusion of such amounts reflects the principle that the societal benefit of facilitating corporate resolution should not come at the unfair expense of innocent third parties whose rights are collaterally affected.

Critically, Regulation 31 specifies that expenses incurred on or by the Interim Resolution Professional to the extent ratified under Regulation 33, and expenses incurred on or by the Resolution Professional fixed under Regulation 34, form part of CIRP costs. This covers the substantial professional fees and operational expenses that Resolution Professionals incur while managing the CIRP process. The ratification and fixing mechanisms under Regulations 33 and 34 ensure that such expenses are subject to appropriate scrutiny while providing reasonable certainty to professionals regarding compensation for their services [8].

Finally, Regulation 31 includes a catch-all provision for other costs directly relating to the corporate insolvency resolution process and approved by the committee. This flexibility allows the CoC to recognize and approve additional legitimate expenses that may not fit neatly into the specified categories but are nonetheless essential for conducting an effective resolution process. However, the requirement for CoC approval ensures that this flexibility is not abused and that creditors retain ultimate control over what expenses receive priority treatment.

The comprehensive nature of Regulation 31 provides clarity to all stakeholders regarding which expenses qualify as CIRP costs and thereby receive priority treatment in distribution. For interim finance providers, this clarity is particularly important because it defines which other obligations will share the super-priority status with interim finance advances. While all CIRP costs receive priority over other creditor claims, among CIRP costs themselves, the specific priority may depend on the nature and timing of the obligations, making precise categorization essential.

Judicial Interpretation and Landmark Decisions

CoC’s Responsibility for Professional Fees and Costs

The question of who bears responsibility for CIRP costs, particularly when the corporate debtor lacks sufficient internal resources, has been the subject of several important tribunal decisions. These judgments have clarified the obligations of CoC members and established important precedents regarding the financing of resolution proceedings when the corporate debtor cannot self-fund the process.

In the matter of Aqua Omega Services Pvt. Ltd. vs Great United Energy Pvt. Ltd. decided by NCLT Mumbai-I on October 31, 2018, the tribunal addressed a situation where the Resolution Professional’s fees remained unpaid due to insufficient funds in the corporate debtor’s accounts. The tribunal examined the relevant provisions of the CIRP Regulations and held that as per Regulation 33 and Regulation 34, it is the responsibility of the Committee of Creditors to make payment of the Resolution Professional’s costs.

In that particular case, the CoC consisted of a sole financial creditor, ICICI Bank. The tribunal specifically directed ICICI Bank to make payment of the Resolution Professional’s costs along with IRP expenses, which had been ratified by the CoC. This decision established an important precedent: when CIRP costs cannot be met from the corporate debtor’s internal resources, the CoC members, particularly financial creditors, may be required to fund these costs to ensure the resolution process can continue [9].

The Aqua Omega decision was significant because it addressed a practical challenge frequently encountered in insolvency proceedings. Many corporate debtors entering CIRP have exhausted their liquid resources and cannot generate sufficient cash flows to meet even basic operational expenses, let alone professional fees and other CIRP costs. Without a mechanism to compel creditors to fund these costs, the CIRP process would stall, potentially causing the corporate debtor to deteriorate further and reducing ultimate recoveries for all stakeholders.

Proportionate Sharing of CIRP Costs Among CoC Members

Building upon the principle established in Aqua Omega, the National Company Law Appellate Tribunal (NCLAT) further refined the framework for CoC members’ contributions to CIRP costs in the matter of Committee of Creditors M/s. Smartec Build Systems Pvt. Ltd. vs B. Santosh Babu & Ors., decided on January 10, 2020. This case involved a dispute regarding payment of fees to an Interim Resolution Professional who had acted during the resolution process but was not permitted to continue as Liquidator.

The NCLAT agreed with the observations made by the Adjudicating Authority (NCLT) that the Committee of Creditors is responsible for paying the fees and costs incurred by the Interim Resolution Professional who acted during the resolution process beyond 30 days until the date of liquidation, despite not being allowed to continue as Liquidator. This judgment reinforced the principle that CIRP costs, including professional fees, are obligations that ultimately fall upon the creditor community when the corporate debtor cannot bear them.

Perhaps the most significant development in this area came with the NCLAT’s decision in Newogrowth Credit Pvt. Ltd. vs Resolution Professional, Bhaskar Marine Services Pvt. Ltd. & Ors., decided on December 10, 2020. This judgment established a specific formula for allocating CIRP cost obligations among multiple CoC members. The tribunal held that a CoC member is required to bear their share of CIRP costs in proportion to their voting share and the period during which they were members of the CoC.

This proportionate allocation principle addresses situations where the CoC composition changes during CIRP, either through claim transfers or other mechanisms. By linking contribution obligations to both voting share (which reflects the relative size of creditor claims) and membership duration, the Newogrowth Credit judgment created a fair and predictable framework for distributing CIRP cost responsibilities among creditors. The decision recognized that creditors with larger claims or longer involvement in the resolution process have correspondingly greater obligations to ensure the process remains adequately funded [2].

These judicial developments collectively establish that while CIRP costs nominally rank as obligations of the corporate debtor and receive super-priority in distribution, the practical responsibility for funding these costs, when the corporate debtor cannot do so, falls upon the creditor community through the CoC mechanism. This framework ensures that resolution processes do not fail due to funding shortages while maintaining fairness among creditors through proportionate allocation of cost-bearing obligations.

Implications for Interim Finance Practices

The judicial precedents regarding CoC responsibility for CIRP costs have important implications for interim finance practices. If CoC members are ultimately responsible for ensuring CIRP costs are met, this creates both opportunities and challenges for interim finance arrangements. On one hand, it suggests that CoC members have strong incentives to approve reasonable interim finance arrangements from external sources, as such financing may be preferable to direct contributions from their own resources.

On the other hand, the established principle that CoC members bear ultimate responsibility for CIRP costs when internal resources are insufficient might reduce the willingness of external parties to provide interim finance in certain situations. If external lenders believe that CoC members will eventually be compelled to fund CIRP costs anyway, those lenders might demand higher interest rates or more favorable security arrangements to compensate for the perceived risk that CoC members might seek to minimize external borrowings.

The judicial framework also highlights the importance of early and transparent financial planning in CIRP proceedings. Resolution Professionals must assess funding requirements comprehensively and present clear proposals to the CoC regarding how CIRP costs will be met. CoC members, understanding their potential obligation to fund shortfalls, have incentive to scrutinize these proposals carefully and ensure that interim finance arrangements, if pursued, are on commercially reasonable terms.

Practical Challenges in Implementing Interim Finance Provisions

Reluctance of CoC Members to Approve Financing

Despite the clear statutory framework and supportive judicial precedents, practical implementation of interim finance provisions faces significant challenges. One of the most persistent issues is the reluctance of CoC members to approve interim finance, even when such financing is clearly necessary for maintaining operations and preserving asset values. This reluctance stems from multiple factors that create complex dynamics in CIRP decision-making.

First, CoC members, particularly financial creditors who typically dominate voting shares, often view interim finance as potentially diluting their recovery prospects. Even though interim finance ranks as CIRP costs and would receive priority only in liquidation scenarios, creditors may be concerned that additional liabilities will reduce the net asset value available for distribution or make the corporate debtor less attractive to potential resolution applicants. This concern is especially acute when the corporate debtor’s asset base is limited or when existing claims already exceed estimated asset values substantially.

Second, disagreements may arise among CoC members regarding the necessity, quantum, or terms of proposed interim finance. Different creditors may have varying risk appetites, time horizons, and strategic objectives regarding the resolution process. Some creditors might prefer to minimize further exposure and push toward liquidation, while others might favor more aggressive operational continuation requiring substantial interim finance. These conflicting interests can lead to protracted negotiations or outright rejection of financing proposals even when objective analysis suggests such financing is necessary.

Third, the judicial precedents establishing CoC responsibility for CIRP costs create a paradoxical disincentive in some situations. If CoC members know they will ultimately be required to fund CIRP costs proportionately if internal resources are exhausted, they might prefer to delay or minimize interim finance arrangements from external sources, planning instead to provide direct contributions only if and when absolutely necessary. This approach, while potentially reducing interest costs, can compromise the timeliness and effectiveness of the resolution process.

Fourth, concerns about potential liability for wrongful decisions may make CoC members excessively cautious about approving interim finance. If interim finance is raised but the resolution ultimately fails, creditors might face questions about whether such financing was prudent or whether it merely postponed inevitable liquidation while adding to total claims. This risk aversion can lead to suboptimal decision-making where CoC members reject beneficial financing proposals due to unfounded concerns about potential criticism or liability.

Information Asymmetry and Evaluation Challenges

Another significant practical challenge involves the information asymmetry between Resolution Professionals who possess detailed knowledge of the corporate debtor’s operations and financial condition, and CoC members who must evaluate interim finance proposals based on the information provided to them. This information gap can lead to misunderstandings, delays, or rejection of necessary financing proposals due to creditor concerns about the reliability or completeness of information presented.

Resolution Professionals must prepare detailed proposals justifying interim finance requirements, including cash flow projections, working capital assessments, and analysis of how the proposed financing will enhance resolution prospects or preserve value. However, creditors who lack operational expertise in the corporate debtor’s industry or who distrust the RP’s judgment may question these projections or demand additional analysis and guarantees that may not be feasible to provide.

The evaluation challenge is compounded in situations where the corporate debtor’s business is complex, operates in multiple segments, or faces rapidly changing market conditions. Creditors must make approval decisions within limited timeframes, often without the ability to conduct independent due diligence or verify the RP’s assumptions comprehensively. This creates pressure to either approve financing proposals based on incomplete evaluation or to reject proposals due to insufficient confidence in the underlying analysis.

Market conditions and broader economic factors further complicate evaluation decisions. During periods of economic stress or industry-specific challenges, creditors may be skeptical about the viability of continuing operations even with interim finance support. Conversely, during favorable economic conditions, creditors might be more willing to approve financing in the hope that improved market dynamics will enhance resolution prospects. These external factors, while relevant, can sometimes overshadow the specific merits of individual financing proposals, leading to decisions that may not optimize value preservation.

Structural Reforms and Proposed Solutions

Addressing these practical challenges requires a multifaceted approach combining regulatory clarifications, procedural improvements, and possibly legislative amendments. One proposal that has gained attention involves creating an automatic or presumptive interim finance mechanism similar to Regulation 2A of the IBBI (Liquidation Process) Regulations, 2016, which addresses contributions to liquidation costs.

Regulation 2A provides that where the CoC did not approve a plan under the relevant provisions, the liquidator shall call upon financial creditors who are financial institutions to contribute the excess of liquidation costs over liquid assets in proportion to the financial debts owed to them. This creates a clear, mandatory framework for funding liquidation costs when internal resources are insufficient. A similar provision for CIRP could establish that the financial creditor with the largest voting share has a presumptive obligation to provide or arrange interim finance as estimated by the Resolution Professional, subject to specified interest rates and terms.

Such a provision could specify that interim finance should be provided at a rate benchmarked to the State Bank of India’s Marginal Cost of Funds based Lending Rate (MCLR) plus a reasonable margin, perhaps 2%, ensuring that the financing terms are neither exploitative nor commercially unreasonable. The largest financial creditor would have the option to provide the financing directly or to identify alternative sources willing to provide financing on equivalent terms. This approach would reduce delays, ensure predictable financing availability, and address the collective action problems that often plague CoC decision-making on interim finance [3].

Another potential reform involves enhancing the information and analysis requirements for interim finance proposals. IBBI could issue detailed guidelines or formats for Resolution Professionals to follow when proposing interim finance, ensuring that CoC members receive comprehensive, standardized information to support informed decision-making. Such guidelines could specify required elements including detailed cash flow projections, sensitivity analyses, alternative scenarios, and clear articulation of how the proposed financing supports resolution objectives versus merely delaying liquidation.

Procedural reforms could also address timing issues by establishing presumptive timelines for CoC consideration of interim finance proposals. Currently, CoC meetings and decision processes can be time-consuming, creating situations where urgently needed financing is delayed while the corporate debtor’s condition deteriorates. Clear regulatory expectations regarding the timeframe within which the CoC must consider and decide upon interim finance proposals would create appropriate pressure for timely decision-making while still preserving creditor oversight rights.

Comparative Perspectives and International Practices

While the IBC’s approach to interim finance contains innovative elements, examining international practices provides useful context and potential insights for further development of India’s framework. Debtor-in-possession financing, as interim finance is known in many jurisdictions, has been a feature of insolvency systems in various countries for decades, with different approaches to priority, approval mechanisms, and creditor protection.

The United States Bankruptcy Code, particularly Chapter 11 reorganization provisions, contains detailed provisions regarding debtor-in-possession financing. US law allows bankruptcy courts to authorize post-petition financing with super-priority status, including granting liens senior to or equal with existing secured creditors under certain conditions. The threshold for such financing typically requires showing that the debtor cannot obtain credit otherwise, and that the terms are fair and reasonable. This judicial oversight model contrasts with India’s creditor-driven approach through CoC approval.

United Kingdom insolvency law, while not using identical terminology, provides mechanisms through which companies in administration can obtain financing for continuing operations. The UK approach emphasizes administrator discretion while recognizing that certain financing arrangements require creditor consultation or court approval depending on their terms and potential impact on existing secured creditors. The UK framework provides flexibility for administrators to take urgent actions while preserving oversight for decisions with significant distributional consequences.

European Union member states implement various approaches to financing companies undergoing restructuring or insolvency proceedings, with recent EU Directives encouraging member states to facilitate rescue financing by providing appropriate priority status and safe harbors for good faith financing that supports viable restructuring attempts. The EU framework recognizes the importance of interim finance for maximizing resolution prospects while maintaining core creditor protections.

Drawing from these international practices, several observations emerge that might inform India’s ongoing development of interim finance frameworks. First, most sophisticated insolvency regimes recognize the necessity of providing significant priority protection for rescue financing, with variations in exactly how such priority is structured and what approvals are required. Second, there is general recognition that some degree of flexibility is essential to accommodate the diverse circumstances of different insolvencies, arguing against overly rigid or prescriptive rules regarding interim finance.

Third, successful frameworks typically balance the need for decisiveness in authorizing necessary financing against the legitimate interests of existing creditors in preventing value transfers or unjustified dilution of their positions. Fourth, transparency and information disclosure are universally recognized as essential for enabling informed decision-making by creditors or courts evaluating interim finance proposals. These principles provide useful guideposts for evaluating potential reforms to India’s interim finance provisions.

Conclusion

Interim finance represents a critical component of the Corporate Insolvency Resolution Process under India’s Insolvency and Bankruptcy Code, 2016. The statutory and regulatory framework governing interim finance reflects careful attention to competing considerations: the need to maintain corporate debtor operations and fund the resolution process versus the protection of existing creditor interests and prevention of value transfers. Through provisions in the IBC, IBBI Regulations, and evolving jurisprudence, India has developed a multifaceted approach to interim finance that provides both enabling powers and appropriate safeguards.

The super-priority status accorded to interim finance through its classification as insolvency resolution process costs serves the essential function of incentivizing lenders to provide funding to distressed companies. Without such priority protection, the practical availability of interim finance would be severely limited, compromising the effectiveness of CIRP as a value-preserving resolution mechanism. The priority structure established through Sections 52 and 53 of the IBC ensures that interim finance providers receive preferential treatment in liquidation scenarios, thereby reducing lending risks to acceptable levels.

The regulatory framework established through IBBI Regulations provides operational detail that bridges the gap between statutory provisions and practical implementation. Regulations governing asset sales, CIRP cost components, and various procedural matters create a workable system for managing the complex financial dimensions of corporate insolvency. These regulations continue to evolve based on experience and stakeholder feedback, demonstrating the adaptive nature of India’s insolvency framework.

Judicial precedents, particularly those addressing CoC members’ responsibilities for CIRP costs, have significantly shaped the practical operation of interim finance provisions. By establishing that CoC members bear proportionate responsibility for ensuring CIRP costs are met when internal resources are insufficient, these decisions have created both accountability and predictability in the financing of resolution processes. The principles articulated in cases such as Aqua Omega Services, Smartec Build Systems, and Newogrowth Credit provide practical guidance for Resolution Professionals and creditors navigating funding challenges during CIRP.

Despite these positive developments, practical challenges persist in the implementation of interim finance provisions. The reluctance of CoC members to approve necessary financing, information asymmetries between Resolution Professionals and creditors, and collective action problems inherent in multi-creditor decision-making continue to create obstacles in many cases. These challenges underscore the need for ongoing refinement of the regulatory framework, potentially including provisions that create presumptive obligations for financing by the largest financial creditor or other mechanisms to ensure timely availability of necessary funding.

Looking forward, the continued evolution of India’s interim finance framework will benefit from attention to international best practices, empirical analysis of outcomes under current provisions, and stakeholder input regarding practical obstacles encountered in real-world insolvency proceedings. The ultimate objective must remain clear: creating a system where corporate debtors undergoing insolvency resolution can access necessary financing to preserve value, maintain operations, and maximize the prospects for successful resolution, all while protecting the legitimate interests of existing creditors and maintaining the integrity of the insolvency process.

The success of the Insolvency and Bankruptcy Code in achieving its transformative objectives depends significantly on the effective operation of supporting mechanisms like interim finance. As India’s insolvency ecosystem continues to mature, the interim finance provisions will undoubtedly undergo further refinement based on accumulated experience and evolving commercial realities. The foundational framework established through the IBC and supporting regulations provides a solid basis for this ongoing development, positioning India’s insolvency system to meet the complex challenges of corporate distress and resolution in a dynamic economic environment.

References

[1] Ministry of Law and Justice. (2016). The Insolvency and Bankruptcy Code, 2016. Government of India. https://www.mca.gov.in/Ministry/pdf/TheInsolvencyandBankruptcyofIndia.pdf 

[2] Insolvency Tracker. (2020). Can a CoC member be asked to contribute towards CIRP cost? https://insolvencytracker.in/2020/12/18/can-a-coc-member-be-asked-to-contribute-towards-cirp-cost 

[3] Insolvency and Bankruptcy Board of India. (2016). IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016. 

[4] Committee on Insolvency Law Reforms. (2015). Report of the Bankruptcy Law Reforms Committee, Volume I: Rationale and Design. Ministry of Finance, Government of India. https://ibbi.gov.in/BLRCReportVol1_04112015.pdf 

[5] Baird, D. G., & Rasmussen, R. K. (2006). Private Debt and the Missing Lever of Corporate Governance. University of Pennsylvania Law Review, 154(5), 1209-1251. https://scholarship.law.upenn.edu/penn_law_review/vol154/iss5/2/ 

[6] National Company Law Tribunal. (2018). Aqua Omega Services Pvt. Ltd. vs Great United Energy Pvt. Ltd. [MA 986/2018 IN CP (IB)-2104/MB/2018]. https://www.iiipicai.in/ckfinder/userfiles/files/Judgment-31-10-18-NCLT-Mumbai-Aqua-Omega.pdf 

[7] Insolvency and Bankruptcy Board of India. (2021). Annual Report 2020-21. https://ibbi.gov.in/annual-report 

[8] National Company Law Appellate Tribunal. (2020). Committee of Creditors M/s. Smartec Build Systems Pvt. Ltd. vs B. Santosh Babu & Ors. [Company Appeal (AT) (Insolvency) No. 48 of 2020]. https://nclat.nic.in/ 

[9] National Company Law Appellate Tribunal. (2020). Newogrowth Credit Pvt. Ltd. vs Resolution Professional, Bhaskar Marine Services Pvt. Ltd. & Ors. [Company Appeal (AT) (Insolvency) No. 1053 of 2020]. https://nclat.nic.in/Useradmin/upload/15427515855e7272e97b04b.pdf 

Author: Prapti Bhatt

The post Interim Finance in CIRP: Legal Framework, Regulatory Mechanisms, and Judicial Precedents appeared first on Bhatt & Joshi Associates.

Introduction

The intersection of insolvency resolution and entrepreneurial rehabilitation has always presented a delicate balance in commercial law. The question of whether promoters who led a company into financial distress should be permitted to reclaim their businesses through resolution plans has been particularly contentious. The Insolvency and Bankruptcy Code, 2016 initially adopted a strict approach through Section 29A, which disqualified certain categories of persons from submitting resolution plans. However, recognizing the unique position of Micro, Small and Medium Enterprises in India’s economic ecosystem, the legislature carved out specific exemptions through Section 240A, creating a framework that balances creditor protection with the imperative of business revival.

This framework underwent judicial scrutiny when questions arose about the timing of MSME registration and its impact on promoter eligibility. The Supreme Court’s intervention in this matter has clarified the law and provided much-needed certainty to stakeholders in the insolvency resolution process.

The Legislative Framework: Section 29A and the Ineligibility Regime

Section 29A of the Insolvency and Bankruptcy Code, 2016 was introduced through an amendment that became effective on November 23, 2017. This provision emerged as a response to what the legislature perceived as a significant loophole in the original Code whereby defaulting promoters could regain control of their companies through the Corporate Insolvency Resolution Process at discounted valuations, effectively rewarding financial mismanagement while leaving creditors with substantial losses.

The provision establishes multiple categories of ineligibility for resolution applicants. Under Section 29A(c), a person becomes ineligible if they have an account, or control a corporate debtor whose account has been classified as a non-performing asset in accordance with Reserve Bank of India guidelines, and at least one year has elapsed from such classification until the commencement of the corporate insolvency resolution process [1]. This temporal element is crucial as it distinguishes between companies that quickly entered insolvency proceedings versus those whose financial distress became prolonged.

The provision also disqualifies individuals under Section 29A(h) who have executed guarantees in favor of creditors for corporate debtors against whom insolvency proceedings have been admitted, where such guarantees remain unpaid in full or part. The rationale behind these disqualifications was articulated by the Supreme Court in ArcelorMittal India Private Limited v. Satish Kumar Gupta [2], where the Court observed that Section 29A prevents persons responsible for the financial situation of a company from attempting to submit a plan and take over the company.

The Supreme Court in ArcelorMittal further clarified that the stage at which ineligibility attaches is when the resolution plan is submitted by the resolution applicant. The Court held that the date of commencement of the Corporate Insolvency Resolution Process is only relevant for calculating the period of one year from the date of classification of an account as a non-performing asset.

Constitutional Validation and Policy Rationale

The constitutional validity of Section 29A was challenged and ultimately upheld by the Supreme Court in Swiss Ribbons Private Limited v. Union of India [3]. The petitioners had contended that Section 29A treats unequals as equals and that good erstwhile managers cannot be lumped together with bad erstwhile managers. They argued that keeping out competent former managers from the resolution process would be counterproductive.

The Supreme Court rejected these contentions and upheld Section 29A, emphasizing that the provision serves the legitimate purpose of preventing unscrupulous persons from taking advantage of their own defaults. The Court held that resolution applicants have no vested right to be considered in the resolution process and that the classification created by Section 29A serves a rational purpose related to the Code’s objectives.

The Swiss Ribbons judgment reinforced the principle that economic legislation deserves significant deference from courts. The Court noted that the Insolvency and Bankruptcy Code represents a paradigm shift in India’s approach to corporate distress, moving from a debtor-friendly regime to one that prioritizes creditor rights and time-bound resolution.

The MSME Exception: Section 240A

Recognizing that the strict disqualification regime under Section 29A could have unintended consequences for the MSME sector, the legislature introduced Section 240A through the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, which came into force on June 6, 2018. Section 240A provides: “Notwithstanding anything to the contrary contained in this Code, the provisions of clauses (c) and (h) of section 29A shall not apply to the resolution applicant in respect of corporate insolvency resolution process of any micro, small and medium enterprises.”

This exemption reflects a deliberate policy choice to treat MSMEs differently from larger corporate entities. The Insolvency Law Committee Report of 2018 provided the rationale for this distinction, noting that MSMEs are the bedrock of the Indian economy and that the intent is to resolve their insolvency rather than push them into liquidation, which would affect the livelihood of employees and workers. The Committee observed that MSME businesses attract interest primarily from their promoters and may not be of interest to other resolution applicants [4].

The legislative wisdom behind Section 240A recognizes several commercial realities. First, MSME businesses often involve specialized knowledge or niche markets where the promoter’s expertise is integral to the business’s viability. Second, external investors may lack interest in acquiring small enterprises with limited scalability. Third, forcing MSMEs into liquidation due to promoter ineligibility could result in significant value destruction and employment losses.

However, the exemption is not absolute. Section 240A only exempts promoters from the disqualifications under clauses (c) and (h) of Section 29A. Other disqualifications, such as those relating to willful defaulters under Section 29A(a), continue to apply to MSME promoters. This partial exemption maintains a balance between facilitating MSME revival and preventing abuse of the insolvency process.

The Timing Question: Hari Babu Thota and the Supreme Court’s Clarification

The critical question that emerged in practice was whether a corporate debtor needed to possess MSME status at the time of commencement of the Corporate Insolvency Resolution Process or whether obtaining such status during the proceedings would suffice for the promoter to claim the benefit of Section 240A. This question came before the Supreme Court in the case of Hari Babu Thota v. Pritha Srikumar Iyer [5].

In that case, Shree Aashraya Infra-Con Limited was admitted into Corporate Insolvency Resolution Process on April 6, 2021. Subsequently, the corporate debtor obtained its MSME Registration Certificate on July 15, 2021, after the commencement of insolvency proceedings but before the submission of the resolution plan. The resolution professional presented a plan submitted by the promoters and approved by the Committee of Creditors. However, the National Company Law Tribunal dismissed the application on February 28, 2023, holding that since the MSME certificate was obtained after the initiation of proceedings, it should be ignored and the promoters were ineligible under Section 29A.

The National Company Law Appellate Tribunal affirmed this decision on June 2, 2023, relying on its earlier judgment in Digamber Anandrao Pingle. The appellate tribunal held that when the MSME certificate was obtained after commencement of proceedings, the promoter could not avail the benefit of Section 240A to submit a plan for the corporate debtor.

On appeal, the Supreme Court reversed these decisions in a judgment delivered on November 29, 2023. The Court held that even if MSME registration was obtained after commencement of the Corporate Insolvency Resolution Process, the promoter of such corporate debtor would be eligible to submit a resolution plan under Section 240A, provided the registration was obtained before submission of the resolution plan.

The Supreme Court’s reasoning emphasized several key points. First, the Court noted that Section 240A begins with a non-obstante clause (“Notwithstanding anything to the contrary contained in this Code”), which indicates the provision’s overriding nature. Second, the Court observed that the objective behind introducing Section 240A was to facilitate resolution rather than liquidation for MSMEs due to the nature of business carried out by such entities and their importance to the Indian economy.

Third, and most significantly, the Court clarified that consistent with its earlier holding in ArcelorMittal, the relevant date for determining eligibility under Section 29A is the date of submission of the resolution plan, not the commencement date of insolvency proceedings. By logical extension, the Court held that the relevant date for determining MSME status under Section 240A should also be the date of submission of the resolution plan.

The Court appointed an amicus curiae to assist in the matter given the absence of opposing parties. The amicus supported the resolution professional’s position, contending that if the MSME certificate is obtained prior to presentation of the resolution plan, the disqualification under Section 29A would not apply and the benefit of Section 240A would be available.

The Supreme Court’s judgment has significant practical implications. It permits corporate debtors to obtain MSME certification during the pendency of insolvency proceedings and still qualify their promoters for the Section 240A exemption. This interpretation aligns with the legislative intent of facilitating MSME resolution and prevents technical interpretations from defeating the substantive purpose of the provision.

Regulatory Framework for MSMEs

The definition of MSMEs for purposes of the Insolvency and Bankruptcy Code is derived from the Micro, Small and Medium Enterprises Development Act, 2006. Under this Act, enterprises are classified based on investment in plant and machinery or equipment. The notification issued by the Ministry of Micro, Small and Medium Enterprises on June 26, 2020 provides the current classification criteria.

For manufacturing enterprises, a micro enterprise is one where investment in plant and machinery or equipment does not exceed one crore rupees and turnover does not exceed five crore rupees. A small enterprise has investment not exceeding ten crore rupees and turnover not exceeding fifty crore rupees. A medium enterprise has investment not exceeding fifty crore rupees and turnover not exceeding two hundred and fifty crore rupees.

For service enterprises, the investment and turnover thresholds are identical to those for manufacturing enterprises. The classification depends on both investment and turnover criteria, with enterprises required to satisfy both thresholds to qualify for a particular category.

The registration process for MSMEs has been simplified through the Udyam Registration portal. Enterprises can self-register based on Aadhaar authentication, and the system automatically captures investment and turnover data from government databases including the Income Tax Department and the Goods and Services Tax Network.

Pre-Packaged Insolvency Resolution Process for MSMEs

In addition to the exemption under Section 240A for regular Corporate Insolvency Resolution Process, the legislature introduced a special framework for MSMEs through the Pre-Packaged Insolvency Resolution Process. This framework was introduced through the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021, which came into effect on April 4, 2021.

The Pre-Packaged Insolvency Resolution Process represents a hybrid model that combines elements of formal insolvency proceedings with informal workout mechanisms. Unlike the regular Corporate Insolvency Resolution Process where control of the corporate debtor shifts to a resolution professional, the Pre-Packaged process allows the existing management to retain control while working on a resolution plan.

Under this framework, the corporate debtor initiates the process by filing an application with the National Company Law Tribunal. The application must be accompanied by a base resolution plan that has been approved by financial creditors representing at least sixty-six percent of the financial debt. The process is significantly shorter than regular insolvency proceedings, with a maximum duration of one hundred and twenty days from the date of admission.

The Pre-Packaged Insolvency Resolution Process is available only for MSMEs with a default of at least ten lakh rupees. However, it is not available for corporate debtors who have undergone the Pre-Packaged process or regular insolvency proceedings in the preceding three years. Additionally, persons ineligible under Section 29A cannot initiate the Pre-Packaged process.

The framework requires the corporate debtor to submit a detailed information memorandum along with the application, providing transparency to all stakeholders. The Committee of Creditors evaluates the base resolution plan and may approve it with modifications. If the Committee does not approve the base plan or if it impairs the claims of operational creditors, the resolution professional invites alternative resolution plans through a competitive process.

Judicial Interpretation and Emerging Issues

The application of Section 240A has generated considerable judicial discourse beyond the timing question addressed in Hari Babu Thota. Courts have grappled with several related issues that illuminate the boundaries of the MSME exemption.

One significant question concerns the role of the resolution professional in determining whether a corporate debtor qualifies as an MSME. In certain cases, resolution professionals have obtained MSME certification during the Corporate Insolvency Resolution Process without explicit authorization from the Committee of Creditors. The National Company Law Tribunal has held in some instances that such actions by the resolution professional, undertaken without Committee approval, are invalid and the MSME certificate should not be considered.

This raises important questions about the resolution professional’s powers and responsibilities. While the resolution professional manages the affairs of the corporate debtor during insolvency proceedings, significant decisions typically require Committee of Creditors approval. Whether obtaining MSME certification constitutes a ministerial act within the resolution professional’s authority or requires specific authorization remains an area requiring further clarification.

Another emerging issue concerns the interaction between Section 240A and the requirement for resolution plans to meet minimum thresholds such as net worth requirements or earnest money deposits. Some tribunals have held that exempting MSME promoters from Section 29A disqualifications does not automatically exempt them from competitive bidding requirements or financial qualification criteria imposed by the resolution professional.

The National Company Law Tribunal has observed in certain matters that while Section 240A permits MSME promoters to submit resolution plans despite disqualifications under clauses (c) and (h) of Section 29A, it does not grant them preferential treatment in the evaluation of their plans. The Committee of Creditors retains the commercial wisdom to evaluate all resolution plans, including those submitted by promoters, based on feasibility, viability, and the value offered to creditors.

However, other judicial pronouncements have suggested that the spirit of Section 240A requires facilitating promoter participation in the resolution process for MSMEs. Some tribunals have held that imposing prohibitively high net worth or earnest money requirements on MSME promoters would defeat the purpose of the exemption, as such requirements would effectively exclude promoters who may lack significant personal wealth but possess the expertise necessary to revive the business.

Comparative Analysis and Policy Considerations

The Indian approach to MSME insolvency resolution reflects a pragmatic balancing of competing policy objectives. On one hand, the strict eligibility criteria under Section 29A serve to maintain creditor confidence in the insolvency resolution process by preventing moral hazard and ensuring that defaulting promoters do not benefit from their own mismanagement. On the other hand, the exemption under Section 240A recognizes that MSMEs operate in a different economic context where rigid application of general rules could lead to suboptimal outcomes.

This calibrated approach finds some parallels in international insolvency regimes, although the specific mechanisms differ. The United Kingdom’s insolvency framework, for instance, permits pre-packaged administrations where existing management can retain control of a business through a pre-negotiated sale, subject to certain safeguards. The United States Bankruptcy Code provides for debtor-in-possession financing and reorganization plans under Chapter 11, which similarly recognize that existing management may be best positioned to rescue a distressed business.

However, these international frameworks do not make categorical distinctions based on enterprise size in the manner that Section 240A does. The Indian approach represents a distinctive policy choice to provide explicit statutory protection for a particular category of enterprises deemed critical to economic and employment objectives.

Critics of the Section 240A exemption argue that it creates moral hazard by reducing the consequences of financial mismanagement for MSME promoters. They contend that permitting defaulting promoters to submit resolution plans undermines the fundamental principle that insolvency law should penalize incompetent or dishonest management. There is concern that unscrupulous promoters might deliberately default and then use the Section 240A exemption to acquire their companies at reduced valuations.

Proponents counter that the exemption is partial rather than absolute, as willful defaulters remain disqualified even for MSMEs. They emphasize that the Committee of Creditors retains full authority to accept or reject any resolution plan, including one submitted by a promoter, based on commercial wisdom. The exemption merely permits promoters to participate in the bidding process rather than guaranteeing them success.

The Supreme Court’s decision in Hari Babu Thota has been generally welcomed by MSME advocates as it provides clarity and prevents technical interpretations from defeating the legislative intent. However, concerns remain about potential abuse, particularly in situations where MSME certification is obtained during insolvency proceedings specifically to claim the Section 240A benefit.

Regulatory Oversight and Anti-Abuse Mechanisms

To address concerns about potential abuse of the Section 240A exemption, various safeguards exist within the regulatory framework. The Insolvency and Bankruptcy Board of India, as the regulatory authority overseeing insolvency professionals and processes, has issued regulations that govern the conduct of resolution professionals and the treatment of resolution plans.

The resolution professional bears responsibility for verifying the eligibility of resolution applicants and ensuring that information provided about MSME status is accurate. Professional misconduct by a resolution professional, including facilitating abuse of the MSME exemption, can result in disciplinary proceedings and sanctions by the Board.

The Committee of Creditors serves as a crucial check on potential abuse. Even if a promoter is eligible to submit a resolution plan under Section 240A, the Committee evaluates the plan based on its merits and the value it offers to creditors. The Committee can reject a promoter’s plan in favor of a better alternative or recommend liquidation if no satisfactory resolution plan emerges.

Additionally, the National Company Law Tribunal exercises judicial oversight over the entire process. The Tribunal must approve any resolution plan before it becomes binding, and in doing so, it verifies compliance with the Code’s requirements. The Tribunal can reject plans that violate legal requirements or appear to involve fraud or misrepresentation.

The appellate mechanism through the National Company Law Appellate Tribunal and ultimately the Supreme Court provides further safeguards. Aggrieved parties, including dissenting creditors or operational creditors whose interests may be affected, can challenge the approval of resolution plans that they believe involve improper application of Section 240A or other irregularities.

Conclusion

The framework governing MSME promoter eligibility to submit resolution plans under the Insolvency and Bankruptcy Code represents a nuanced approach to balancing multiple policy objectives. Section 29A establishes a general regime of strict eligibility criteria designed to prevent defaulting promoters from exploiting the insolvency process. Section 240A creates a targeted exemption for MSMEs, recognizing their unique economic significance and the limited interest that external investors may have in small enterprises.

The Supreme Court’s decision in Hari Babu Thota has clarified a critical aspect of this framework by holding that MSME status at the time of resolution plan submission, rather than at commencement of insolvency proceedings, is the relevant criterion. This interpretation aligns with the legislative intent of facilitating MSME resolution and prevents overly technical constructions from defeating the substantive purpose of the exemption.

As the insolvency resolution ecosystem matures, continued judicial interpretation and regulatory refinement will shape the practical application of these provisions. The balance between creditor protection and business revival, between preventing moral hazard and enabling entrepreneurial recovery, remains delicate and context-dependent. The MSME exemption under Section 240A exemplifies the challenges of crafting legal frameworks that are simultaneously principled in their approach to accountability and pragmatic in their recognition of economic realities. The coming years will reveal whether this framework successfully achieves its twin objectives of maximizing creditor recovery and preserving viable MSME businesses, or whether further refinements are necessary to address emerging challenges and prevent unintended consequences.

References

[1] Insolvency and Bankruptcy Code, 2016, https://ibclaw.in/section-29a-persons-not-eligible-to-be-resolution-applicant/ 

[2] ArcelorMittal India Private Limited v. Satish Kumar Gupta, (2019) 2 SCC 1, https://ibbi.gov.in/webadmin/pdf/whatsnew/2018/Oct/33945_2018_Judgement_04-Oct-2018_2018-10-04%2018:02:45.pdf 

[3] Swiss Ribbons Private Limited v. Union of India, (2019) 4 SCC 17, https://ibbi.gov.in/webadmin/pdf/order/2019/Jan/25th-Jan-2019-in-the-matter-of-Swiss-Ribbons-Pvt.-Ltd.-and-Anr-Writ-Petition-Civil-No.37-99-100-115-459-598-775-822-849-and-1221-2018-In-Special-Leave-Petition-Civil-No.28623-of-2018_2019-01-25-13-58.pdf 

[4] Insolvency Law Committee Report 2018, https://www.ibbi.gov.in/uploads/publication/e42fddce80e99d28b683a7e21c81110e.pdf 

[5] Hari Babu Thota v. Pritha Srikumar Iyer, Civil Appeal No. 4422 of 2023, https://www.latestlaws.com/latest-caselaw/2023/november/2023-latest-caselaw-919-sc 

The post MSME Promoter Eligibility Under Insolvency Law: Resolution Plans and Regulatory Framework appeared first on Bhatt & Joshi Associates.