IBC and creditors’ committee exclusions

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ren during the Corporate Insolvency Resolution (CIRP) process, the Creditors Committee (COC) is the de facto counsel of the defaulting company. The COC is formed after collecting all the claims on the debtor, and plays an important role when it comes to the CIRP of any defaulting business. Considering that the COC is made up exclusively of financial creditors, the Supreme Court, in the event of Phoenix ARC Private Limited v Spade Financial Services Limited and Ors, proposed new case law on February 1, 2021. This gave a new perspective to the constitution of the COC in terms of its role, power and the exclusion of related parties from it.

Rohit Pradhan

The role of the COC

The professional of the provisional resolution constitutes the COC after having gathered all the complaints formulated against the debtor company. The board of directors of the debtor company is suspended during the CIRP, and the COC becomes the de facto board of the defaulting entity. The COC then appoints the resolution professional, who assumes the role of chair of the committee.

Articles 5 (24) and 5 (24A) of the code define the meaning of related parties in relation to a debtor company and a natural person, respectively, in great detail. Related parties could include a director, key executives, a limited liability company (LLP), a public company, a legal person and the principal advisor of the debtor company. It also includes persons holding more than 20% of the voting rights and those who control the composition of the board of directors.

Article 21 of the code provides that a related party to whom a debtor company has a financial debt has no right of representation, participation or vote at a meeting of the creditors’ committee.

Reasons for excluding a related party

If related parties are involved in the COC, this could disengage the purpose and purpose of its existence. Related parties have certain interests in the debtor company, which could negatively influence the outcome of the CIRP.

In the case of Sushant Aneja and anr v JD Aneja Edibles Pvt Ltd, the NCLT (Bank of Jaipur) considered that the nature of the transactions between the debtor company and related parties could not be assimilated to that of a transaction between a debtor company and a third party. The inclusion of a related party could result in a difference in treatment and nullify the objective of the CIRP. To ensure that there is no “abuse of process under the Insolvency and Bankruptcy Code (IBC)” and to ensure that no negative effects remain on the real stakeholders, the related party has been excluded from the COC.

Although the code explicitly prohibited the inclusion of a related party in the COC, it says nothing about the status of a financial creditor who ceases to exist as a related party and whether such creditors would be allowed to do so. part of the committee. This question remained unanswered until the Supreme Court ruling in the Phoenix ARC case.

In this case, it was realized that the financial creditors concerned were in such a position within the company that they could influence the affairs of the debtor company. The Supreme Court ruled that if such an entity ceases to exist as a “related party” with the debtor company, with the sole intention of entering the COC to sabotage its purpose, then it will be barred from entering. the committee. This judgment had a double impact. First, he broadened the scope of Article 21 (2) of the code and, second, he stressed the importance of protecting the rights of financial creditors.

Conclusion

The court noted that, if it had not interpreted the provision accordingly, there could be a possibility that financial creditors would exclude themselves from the definition of related party before the opening of the CIRP. The very purpose of such an exclusion would have been to influence the functioning of the COC, and therefore to sabotage the CIRP. To avoid this, the Supreme Court widened the scope of Article 21 (2) of the code to ensure that the rights of financial creditors are preserved during the CIRP.

Rohit Pradhan
Symbiosis Law Faculty
Hyderabad


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