Essar Steel Verdict: Ensuring the Interest of all Stakeholders?

Mayank Shyamsukha and Utkarsh Pandit*

The Insolvency and Bankruptcy Code, 2016 [IBC] is a consolidation of laws for the issues related to the Insolvency and Bankruptcy of the Companies. The objective of this code is to make an attempt to revive a debt-ridden company. However, as the IBC, 2016 is a new law; a lot of developments are taking place. A need for clarity in the Code arises when the stakeholders encounter problems while applying the law laid down in the Code. The Supreme Court encountered one such dilemma in the case of Committee Of Creditors Of Essar vs Satish Kumar Gupta, where the court determined the primacy of the financial creditors in the Committee of Creditors [CoC]for allocation of claims.

Facts of the Case

In this case, ArcelorMittal India Private Limited and Numetal Limited applied as resolution applicants to acquire Essar Steel in December 2019. After duly analyzing the resolution plans of both the applicants, the Resolution Professional for Essar Steel disqualified and declared them ineligible for the same in accordance with Section 29 A of the Code. Both ArcelorMittal India Pvt. Ltd. and Numetal Ltd. approached the National Company Law Tribunal [NCLT], Ahmedabad Bench and contended to set aside the decision to disqualify the Resolution Applicants. The NCLT, Ahmedabad approved the Resolution Plan of ArcelorMittal India Pvt. Ltd. and suggested the CoC to distribute the funds as is proposed in the Resolution Plan of ArcelorMittal. However, this order was then challenged by Operational Creditors, Standard Chartered Bank, past promoters and suspended directors of the Corporate Debtor before the National Company Law Appellate Tribunal [NCLAT].

The NCLAT observed the case in order to bring parity among the financial and operational creditors of Essar Steel in matters of distribution of the proceeds. Therefore, it approved the Resolution Plan of Essar Steel. However, the NCLAT modified the distribution of funds in the Resolution plan.  After this, appeals were filed before the Hon’ble Supreme Court to set aside the NCLAT ruling and set aside the decision of the CoC on how the funds offered by ArcelorMittal are to be distributed among the creditors.

Fair treatment of Stakeholders

This judgment by the Supreme Court settled many questions of law. However, we analyse the verdict of the Supreme Court with respect to the principle of ‘Equality’ where the Apex Court expressively and extensively observed that the financial creditors hold superiority in the Resolution Plan with respect to the settlement of dues.

The Supreme Court has placed its confidence in the CoC and the commercial intelligence with regards to the viability and practicality of a resolution plan and the manner in which distribution is to be made under the same. The same principle was outlined in a previous judgment of the Hon’ble Supreme Court in the case of K. Sashidhar v. Indian Overseas Bank. The Hon’ble court has asserted that fair treatment among the creditors falling in the identical category is necessary, even if the IBC lays down dissimilar classes of Creditors to be treated differently.  However, the Supreme Court has constantly preserved the view that claims of financial creditors are of prime importance, and further, the judgment identifies the payment of dues of operational creditors to make sure that a corporate debtor can continue to hold on to its business as a going concern.

The Supreme Court has, although given the authority to the CoC to decide on the aspect of distribution of funds, however, the manner in which the funds are to be distributed is still a matter of debate. This has thus raised important questions in the Corporate Insolvency Resolution Process[CIRP] and the Corporate Liquidation Process.

The Waterfall Mechanism

Section 53 of the Code provides for the Waterfall Mechanism in order to distribute the assets during Liquidation. As per this mechanism, the assets are distributed giving first priority to the insolvency resolution process costs and the liquidation costs, workmen’s dues, debts owed to a secured creditor, etc. However, Section 53 has no mention of Operational Creditors in the priority list, thus leaving them in the bracket of “any remaining debts and dues.” In the 2020 Report of the Insolvency Law Committee, this confusion was addressed and it was recommended that a proper elucidation can be provided by inserting an explanation under Section 53(2) to support the validity of inter-creditor and subordinate agreements. However, its implementation is still awaited.

Moreover, regulation 38 of the CIRP Regulations provides for the mandatory contents in the Resolution Plan. Rule (1A) of this regulation provides for the Resolution Plan to include the interests of all stakeholders (Financial and Operational creditors of the Corporate Debtor). However, even this regulation remains silent on the way the interests of the stakeholders can be maximized.

Discrimination between Creditors

As the code does not provide a particular mechanism to ensure that the interest of all stakeholders is taken into consideration, the IBC thus in a way discriminates between the operational and financial creditors. Section 21 of the IBC, 2016 provides for the establishment of CoC. However, sub-section 2 of Section 21 provides that the members of the Committee of Creditors shall include only the Financial Creditors, thus leaving the Operational Creditor without having any voting power for or against the resolution plan or insolvency and related matters. As the Financial Creditors have a decisive power, the payments of dues to the Financial Creditors are thus kept on a higher pedestal.

Furthermore, in the Essar Steel Case, the Supreme Court has held that all creditors are not entitled to equal recovery but the principle of equality applies to similarly situated creditors. As per the resolution Plan of ArcelorMittal, there was a recovery of 20% for the operational creditors while the secured creditors recovered 89% of their dues. This shows the way in which the dues of operational creditors are being compromised.

Need for Settlement of Issue

The Hon’ble Supreme Court in the Essar Steel Case had the opportunity to settle the issue with respect to the manner in which the interest of stakeholders could be maximized. However, the Supreme Court left this discretion with the CoC to ensure that there is fair and equitable treatment with regard to the claims. As the CoC consists of Financial Creditors, they have more leverage in recovering their dues.

Position in Other Countries

The IBC, 2016 does not provide a voice to the unsecured creditors in the CoC, however the same is not the case with developed countries like the United States of America and the United Kingdom. Chapter 11 of the US Bankruptcy Code empowers the unsecured creditors by formulating a committee that consists of the largest seven unsecured creditors. Thus, the unsecured creditors are also responsible for formulating the revival plan for the Company. As unsecured creditors are very important in order to keep the debtor’s business a going concern, including unsecured creditors in the committee gives them an opportunity to safeguard their interests at the time of restructuring of the Company.

The position in the UK is also empowering for the unsecured creditors as there is a provision for at least three unsecured creditors to form the Committee of Creditors as per Sections 49 and 68 of the Insolvency Act, 1986. The role of the CoC is to help the Resolution Professional in running the Company as a going concern. However, the Resolution Professional cannot fulfil his obligations if the CoC comprises only a particular kind of creditors. The Bankruptcy Law in USA and UK provides the secured as well as the unsecured creditors to be part of the Committee and participate in formulating the Resolution Plan.

The financial creditors have huge stakes, but the Operational Creditors cannot be left out of the Committee just because they have comparatively smaller claims. The Resolution Plan is one of the key aspects for the revival of an Insolvent Company. As the resolution plan impacts all the creditors, the Operational Creditors should also be included in the decision-making committee. Like the bankruptcy laws in the UK and USA, India needs to relook its insolvency law to provide the Operational Creditors with a voice of their own.  

Conclusion

Although IBC 2016 was successful enough in bringing reform into the existing banking system, however, this success appears to be at the cost of the interests of other stakeholders. While the Hon’ble Apex Court in the Essar Steel Case has settled the issue of the rights of the Committee of Creditors, it has still not clarified the procedure of the distribution of the dues. This gives an unfair advantage to the Secured Creditors, who form the CoC and have an opportunity to discriminate against the Operational Creditors. Thus, another verdict of the Hon’ble Apex Court is required which could provide guidelines in order to ensure that the interest of all stakeholders is maximized.  

*The authors are third-year students at the Institute of Law Nirma University.