[Karthika S. Babu is a third-year B.A. LL.B. Student at Gujarat National Law University]

The Insolvency and Bankruptcy Code, 2016 (“Code”) provides for a specialized mechanism, i.e., the corporate insolvency resolution process (“CIRP”) for the resolution of insolvency of financially distressed entities. The CIRP aims to mitigate the claims of the affected creditors against the distressed corporate debtor by settling their financial claims through the framework provided by the resolution plan, which is approved by at least 66% of the committee of creditors (“CoC”). Although the Code confers priority status to the repayment of debts to financial creditors vis-à-vis operational creditors and other stakeholders, the preamble to the Code clearly states that its object is to ‘balance the interest of all the stake-holders’ in the event of insolvency. However, there is much debate about the efficacy of the Code in balancing the interests of the all stakeholders, especially that of the operational creditors due the priority status given to the financial creditors during the resolution process.

In light of this ongoing debate, this post aims to analyse the current position of law on the distribution of profits accrued during the resolution process and suggests how the procedure of allotment of such profits may be streamlined in such a way that the claims of the operational creditors can be realised without intervening with the priority rights of the financial creditors. Furthermore, the post also explores a situation wherein the profits may be distributed in favour of the resolution applicant when the claims of all classes of creditors are adequately represented in the resolution plan and subsequently in the distribution of profits.

Profits Accrued During the Resolution Process: The Current Position

Generally, the profits accrued during CIRP are to be distributed according to the resolution plan. However, the current position of law is largely silent on the procedure for distribution of profits when the resolution plan does not provide for the same. Recently, this issue was dealt with by National Company Law Tribunal (“NCLT”) Dhaka in Kalyan Janata Sahakari Bank Ltd. v. Arun Kapoor, Resolution Professional of CICIL Biochem Private Limited, wherein the NCLT ordered that such profits be distributed to the financial creditors.

According to the facts of the case, much after the resolution plan was approved by the CoC, it was noted that profits accrued from the business of the corporate debtor as a going concern. Owing to the same, the resolution professional advised the financial creditors by way of a letter that the profits may be allotted to the resolution applicant. The financial creditors moved the bench seeking a direction for the withdrawal of this letter and, subsequently, for the profits to be allotted to the financial creditors.

While arriving at a decision in favour of the financial creditors, the NCLT referred to recommendations in the Report of the Insolvency Law Committee wherein two primary views were advanced. Firstly, such profits may be distributed to the creditors of the corporate debtor as they suffer the haircuts in ensuring that the corporate debtor continues as a going concern. Secondly, since the profits arise from the business, the resolution applicant may obtain such profits when the business is taken over. Given this, the Committee recommended that the law must remain flexible on who is allocated such profits. In the present case, the NCLT ordered that the profits be distributed to the secured financial creditors of the corporate debtor, relying on the ‘commercial stipulation’ of the resolution plan, which provides that all receivable shall go to the resolution applicant after the plan approval date and not prior to that.

The Equity Dilemma in Profit Distribution

Although the Report of the Insolvency Law Committee recommended that the law should be flexible in deciding the beneficiary of the profits, it further added that the resolution plan should mandatorily include provisions for such distribution, which may be allocated to creditors, resolution applicants, or apportioned between the two, or any other stakeholders laying claim to the same.

However, it can be presumed that while voting for the resolution plan, the CoC consisting only of financial creditors will only approve for such an arrangement wherein the profits will first be allotted to them over the claims of the other classes of creditors and stakeholders. This is because, the waterfall mechanism under section 53 of the Code provides priority to the financial creditors. This would mean that until the claims of the financial creditors are settled, the operational creditors and resolution applicant would have no claim over such profits, thereby indefinitely prolonging the settlement of their debts. Therefore, it is pertinent for the Code to provide within itself a framework by which the profits accrued during the CIRP are to be distributed equitably.

The Approach to Balancing Claims

According to section 20 of the Code, the business of the corporate debtor is to be run as a going concern during the CIRP. To run the business of the corporate debtor as a “going concern” means to continue the operation of the business without liquidation. Thus, for operating a business, the contributions of operational creditors cannot be downplayed vis-à-vis the financial creditors, as their services determine the overall viability of the business. Similarly, the resolution applicant taking over the business must have some incentive to keep the corporate debtor as a going concern. Often, it is difficult to find resolution applicants willing to take over the business of the corporate debtor in its entirety, thereby pushing the corporate debtor into liquidation. Therefore, it would only be reasonable to provide incentives to these stakeholders by distributing the profits from the business accrued during CIRP first to the operational creditors and then to the resolution applicant.

In the present case, the issue of distribution of profits arose much later after the approval of the resolution plan. The already approved resolution plan provided for the rehabilitation of the financial creditors and the same was in process. Therefore, the resolution plan as approved by the majority of the CoC in its current state provides for a satisfactory settlement mechanism for the financial creditors. Thus, in a case of subsequent accrual of profits, the same can be considered as a surplus and may be allotted to the other stakeholders without it intervening with the waterfall mechanism under section 53. A proposal for the amendment to the Code for the distribution of any ‘further surplus’accrued during the resolution process was suggested by a Discussion Paper issued by the Ministry of Corporate Affairs (“MCA”). The Discussion Paper suggested distributing such surplus to other stakeholders and partners of the corporate debtor to ensure a fair and equitable resolution process.

Moreover, the Discussion Paper also proposed an amendment to the Code to separate the approval of the resolution from the manner of distribution of proceeds. The scheme of distribution will be in accordance with the suggestions as mentioned in the paragraph above i.e., along with provisions of equitable distribution to all the stakeholders. This separation will ensure that the successful resolution applicant (“SRA”) can take over the business of the corporate debtor after the NCLT approves the resolution plan. Thus, the operation of the business will continue even during the pendency of the NCLT’s approval of the manner of the distribution of the proceeds enabling a much faster resolution of the insolvency process.

Further, under this separation, a situation could be envisioned whereby, as per the Committee Report the NCLT can exercise its discretion over deciding on the distribution of the profits accrued during CIRP. An opposing argument would be that the ‘commercial wisdom’ of the CoC would be then subjected to the discretion of the NCLT, which is against the settled position on the primacy of the ‘commercial wisdom’. However, separating the resolution plan and the distribution of proceeds will ensure that sanctity of ‘commercial wisdom’ of the CoC will remain intact so far as to the terms of the resolution plan. Moreover, an approach to considering profits as ‘further surplus’ would also ensure that the waterfall mechanism under the Code is not disturbed. The Supreme Court in Essar Steel v. Satish Kumar Guptaemphasised the need for the resolution plan to reflect an equitable treatment of the interests of all stakeholders. Therefore, the distribution of the profits to other stakeholders would ensure more transparency and equity in the insolvency resolution process.

Conclusion

The very purpose of the Code is to ensure that the claims of all stakeholders are settled without the business of the corporate debtor being pushed into liquidation. Thus, it is important to create a conducive legal framework wherein the interests of all the stakeholders are protected so that there are adequate incentives in reviving the business of the corporate debtor. Therefore, the suggestions on reworking the procedure on distribution of profits accrued during CIRP would provide for a more equitable and speedy approach towards settling the claims of stakeholder while upholding the priority rights of the financial creditors.

– Karthika S. Babu