Insolvency code amendment carries unintended negative effect – India

By Ambarish and Roma Das, Shardul Amarchand Mangaldas & Co

On 23 November 2017, the president of India exercised his special powers and issued an ordinance to amend the relatively new Insolvency and Bankruptcy Code, 2016, by introducing section 29A.

An ordinance is used to address urgent issues when parliament is not in session. The urgency in this case was to provide for the prohibition of certain persons from submitting a resolution plan who, on account of their antecedents, may adversely impact the credibility of the process under the code. The persons with undesirable antecedents were, seemingly, the shareholders, promoters and persons managing the insolvent company.

Principal associate
Shardul Amarchand Mangaldas & Co

In order to ensure that that the persons with undesirable antecedents did not take benefit from the code, section 29A was very widely worded and provided for eight categories of disqualifications, ranging from disqualification on account of being an undischarged insolvent to disqualification on account of issuance of an enforceable guarantee in favour of a creditor, in respect of the insolvent company. Another disqualification was having an account categorized as non-performing for a period of one year or more.

The disqualifications under section 29A also applied if: (1) there was a corresponding disqualification under any law in a jurisdiction outside India; and (b) a “connected person” suffered from disqualification.

The “connected person test” was applied widely and includes: (1) a person who is a promoter or in management or control of a resolution applicant (i.e., the potential acquirer); (2) a person who will be a promoter, or in management or control of the insolvency company during implementation of a resolution plan (i.e., the plan proposed by the resolution applicant); or (3) the holding company, subsidiary company, associate company, or a related party of persons referred in (1) and (2). The expression “related party” was also widely defined. For example, relatives of directors would also be considered to be related parties.

Unintended consequences

Such widely worded disqualifications had several unintended consequences. It forced even those resolution applicants who were unrelated to the insolvent company to assess section 29A disqualifications against several group companies, management personnel and their relatives, across jurisdictions.

In some cases, the management personnel and relatives were not comfortable in sharing their details. In addition, assessment of a corresponding disqualification under foreign laws also turned out to be a challenge, as foreign laws are not always aligned with Indian laws.

Section 29A also disqualified those who were in the business of dealing with non-performing assets or asset reconstruction. For example, a fund or a bank completely unrelated to the insolvent company but having an investment in a company having non-performing assets, were likely to be disqualified.

The ordinance, being temporary, was replaced by an amendment act that was notified on 18 January 2018. The amendments were twofold: (1) disqualification on account of non-performing assets was allowed to be overcome by payment of all overdue amounts with interest and charges before the submission of a resolution plan; and (2) the “connected person test” was made non-applicable to banks, alternative investment funds registered with the Securities and Exchange Board of India, and asset reconstruction companies registered with the Reserve Bank of India.

Issues and solutions

The amendment act does not address all the issues and still suffers from several problems, some of which are listed below:

  • The amended section 29A extended its applicability to persons acting “in concert” with the resolution applicant. However, this expression is not defined, and section 29A already applies to a person “acting jointly”. It is not clear if acting jointly and in concert have different meanings;
  • While the disqualifications apply if there is corresponding disability under any law in a jurisdiction outside India, the exceptions granted to funds, asset management companies and banks are limited to those existing in India, and do not exempt similarly placed entities outside India. This runs contrary to the Indian government’s policy of encouraging foreign investment;
  • The code doesn’t contain definitions for expressions in section 29A, and reference to other laws often leads to ambiguity; and
  • There is still an apprehension in sharing details of relatives, and the assessment of several companies in a group who are largely unrelated to the potential investment in the insolvent company.

The rule-based approach of section 29A has not turned out to be very efficient, and an alternative will be to draft section 29A as a principle-based legislation that specifically disqualifies the promoters and persons in management or control of the insolvent company from being associated with the resolution applicant, either directly or indirectly.

Alternatively, the list of exemptions under section 29A can be expanded with added definitions. In either case, the present section 29A is a limiting factor in the implementation of the code and needs to be amended.

Ambarish is a principal associate and Roma Das is an associate at Shardul Amarchand Mangaldas & Co


Shardul Amarchand Mangaldas & Co

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