CONSOLIDATION OF CORPORATE INSOLVENCY RESOLUTION PROCESS

[Mr. M. GOVINDARAJAN]

Doctrine of consolidation

The doctrine of substantial consolidation, which is widely, used in US and UK bankruptcy laws.   There is no explicit provision available in the Insolvency and Bankruptcy Code, 2016 (‘Code’ for short)   to initiate consolidation of corporate insolvency processes. This doctrine enables the adjudicating authority to merge the assets and liabilities of all such individual entities in a common pool, resulting into a common corporate insolvency resolution process (‘CIRP’ for short). This not only maximizes the asset value of the group company, but also attempts to eliminate cross-debts.

The Insolvency Law Committee in their report on 26.03.2018 paved a way for this doctrine of consolidation to enter the Indian judiciary. The report stated that the treatment of group companies within insolvency laws is a complicated subject. The current system of insolvency laws is new, and it may be too soon to introduce a complex subject, like the present issue.

Case laws

In ‘State Bank of India v. Videocon Industries Limited’  - 2019 (8) TMI 1654 - NATIONAL COMPANY LAW TRIBUNAL, MUMBAI BENCH the Mumbai Bench decided in favor of consolidation of CIRPs vide its order dated 08.08.2019.  In this case, a consortium of banks led by State Bank of India, being the common creditor, moved a petition before Adjudicating Authority, Mumbai Bench, asking for the substantial consolidation of the group of 15 companies under the ‘Videocon Group’, to form the common debtor.  The functions of the companies were so interlinked that it was difficult to ascertain their value as independent entities due to inability to segregate their assets and liabilities. Videocon Group’s consolidated financial statements, or existence of inter-corporate guarantees on loans further established their interdependence on each other.  The said petition was filed by State Bank of India because a separate CIRP petition against each of the companies failed to attract bids due to their complex interdependence, and inability to pay off since they held no separate value or identity.

The question before the Bench was to analyze whether the consolidation so asked for, would be more beneficial than harmful.

The Adjudicating Authority analyzed the case, with reference to previous US and UK case laws, and decided in favor of the consortium, grouping 13 out of the 15 companies into a single entity as the common debtor. The Bench left out two of their companies, KAIL Ltd. and Trend Electronics Ltd., out of the grouping because they did not have any operational dependency on the other companies and were strong financial entities.

Mumbai Bench stated that the problem of consolidation had cropped up sooner than expected, and a matter as pressing as this could not be avoided or deferred till legal provisions are established for the same. The Bench came up with two-pronged tests to determine the test for consolidation in this case-

• A prima facie existence of elementary governing factors; and
• Categorisation based on the governing factors.

The Bench used the approach forwarded by the US bankruptcy courts and laid down a list of 14 factors, whose existence needed to be verified into, such as-

• common control;
• common directors;
• common assets;
• common liabilities;
• interdependence;
• interlacing of finance;
• pooling of resources;
• coexistence for survival;
• intricate link of subsidiaries;
• intertwined accounts;
• interlooping of debts;
• singleness of economic units;
• common financial creditors; and
• common group of corporate debtors.

The first category consisted of companies whose assets and liabilities were so interlinked that their segregation would result in little or no maximization of asset value, whereas the second category would comprise of companies whose asset liability intermingling, when segregated, would still provide for viable profitable restructuring proposals. 

  In ‘RADICO KHAITAN LTD VERSUS BT & FC PVT LTD., BANGALORE DEHYDRATION AND DRYING EQUIPMENT COMPANY PVT. LTD., STATE BANK OF INDIA, UGRO CAPITAL LTD., STATE OF KARNATAKA, MR. PANKAJ SRIVASTAVA, MS. RAMANATHAN BHUVANESHWARI - 2021 (4) TMI 144 - NATIONAL COMPANY LAW APPELLATE , TRIBUNAL PRINCIPAL , BENCH NEW DELHI, the appellant,  an Operational Creditor filed this Appeal against Impugned Order dated 02.09.2020 passed by Adjudicating Authority, Bangaluru Bench.  The Adjudicating Authority rejected the application filed by the appellant for consolidation of two corporate insolvency resolution processes.

The appellant, an operational creditor, initiated corporate insolvency resolution process against the first respondent BT & FC Private Limited for the default of ₹ 5.72 crores.  The said application was admitted by the Adjudicating Authority and appointed interim resolution professional (respondent No. 6).   The Committee of Creditors (‘CoC’ for short) of Corporate Debtor (Respondent No. 1) consists of State Bank of India,  Financial Creditor (Respondent No. 3) and Ugro Capital Limited,  Financial Creditor (Respondent No. 4).

The Ugro Capital Limited, a financial creditor initiated CIRP under Section 7 of the Code against Bengaluru Dehydration and Drying Equipment Company Pvt. Ltd. (Respondent No. 2) for the default of ₹ 25.81 crores as guarantor.  The Adjudicating Authority appointed R. Bhuvaneshwari as IRP. The CoC consist of State Bank of India (Respondent No. 3) and Ugro Capital Ltd. (Respondent No. 4).

The appellant filed an application under Section 60(5) (a) of the Code read with Rule 11 of NCLT Rules, 2016 by inter alia seeking an order for the consolidation of CIRP of Respondent Nos. 1 and 2.  The appellant submitted the following before the Adjudicating Authority-

• The Respondent No. 2 only operates as the land holding Company of Respondent No. 1 without carrying on any business activity.
• The Respondent No. 2 owns immovable property bearing 15, first phase, Peenya Bengaluru and Respondent No. 1 set up its bottling unit thereon to undertake the activity of the blending and bottling for the Company.
• The business of Corporate Debtors is inextricably interlinked and intertwined.
• The shareholding pattern of the Corporate Debtor shows that the Corporate Debtors are promoted, owned and controlled by one Mr. M.V. Murlidher along with his family holding 65% and 71% of the shareholding in Respondent Nos. 1 and 2 respectively.
• The Board of the Corporate Debtors consist of common Directors i.e., Mr. M.V Murlidher and Mrs. Padma Murlidher.
• The claims of Respondent Nos. 3 and 4 show that the Respondent No. 2 stood as a guarantor for the financial debt of Respondent No. 1.
• Therefore, the assets and liabilities of the Corporate Debtors are also interlinked. Therefore, CIRP of the Corporate Debtors ought to be consolidated.

The first and sixth respondent supported the arguments put forth by the appellant before the Adjudicating Authority.  The second and seventh respondent opposed the arguments of the appellant.  They contended that-

• Merely having few common shareholders in Respondent Nos. 1 and 2 cannot be ground for consolidation of CIRP of both the Companies into a single entity.
• There is no provision under the Code to justify such consolidation.

The third and fourth respondents contended that-

• The CoC have already resolved to liquidate the Respondent No. 1 Company and same has been endorsed and submitted by the Resolution Professional on 03.03.2020 before the Adjudicating Authority.
• Thus, the present application has become infructuous.
• There is no ground made out for consolidating the CIRP of the Respondent Nos. 1 and 2.

The Adjudicating Authority held that the applicant being an Operational Creditor has no locus standi to file the application. The CoC of Respondent No. 1 in sixth meeting unanimously decided to go for liquidation.  The Adjudicating Authority rejected the application filed by the appellant on the ground that the application is filed on mis-conception of facts and law and the appellant too has no locus to interfere in the CIRP of Respondent No. 2 by filing the application.

Aggrieved against the order of Adjudicating Authority the appellant filed the present appeal.  The appellant submitted the following before the Appellate Tribunal-

• The Adjudicating Authority, Mumbai Bench, in the case of ‘State Bank of India Vs. Videocon Industries Ltd.’ decided on 08.08.2019 laid down certain parameters while ordering for consolidation of CIRP. The Present case fulfilled the parameters, however, the Adjudicating Authority without considering the parameters rejected the application of the appellant.
• The object of the Code is resolution and rehabilitation of the Corporate Debtors as a going concern as opposed to liquidation.
• Both the Corporate Debtors have not got a resolution plan and the CoCs have resolved to liquidate.
• The only option available to revive the Companies is to consolidate them and offer them as a single unit for CIRP.

The respondent Nos.  3 and 4 contended that-

• The Appellant being an Operational Creditor has no locus standi to seek consolidation of CIPR of the Respondent Nos. 1 and 2 because the Appellant cannot form part of CoC. 
• The Respondent No. 1 has had no business relationship whatsoever with Respondent No. 2 and has no direct nexus with the Respondent No. 2
• The Respondent No. 2 possesses an immovable property (Mortgaged with Respondent Nos. 3 and 4 having a pari passu charge). Therefore, appellant mala fidely seeking consolidation of CIRP of the Respondent Nos. 1 and 2.
• The  respondent Nos. 1 and 2 are two separate and distinct legal entities and apart from the common directors there is no commonality in terms of shareholding, nature of business, Operational Creditors, investments and borrowing/landing.
• There is no cross shareholding or inter-se landing/borrowing between the Respondent Nos. 1 and 2 companies, which is one of the essential ingredients for the said Respondent Companies to be deemed as group companies.

The Appellate Tribunal considered the submissions put forth by the parties to the appeal.  It further analyzed the order in ‘State Bank of India v. Videocon Industries’ (supra) in detail.  The Appellate Tribunal observed that the Adjudicating Authority, Bengaluru Bench, while passing the impugned order there is no finding whether these parameters are fulfilled or not in this case.  The Appellate Tribunal considered whether the Respondent Nos. 1 and 2 have fulfilled the criteria of consolidation of CIRP.

• Common Control - The Respondent Nos. 1 and 2, both the companies are promoted by Mr. M.V Murlidher and his wife Padma Murlidher. Murlidhers family holds approximately 77% of total shareholding and 78% of total shareholding in Respondent Nos. 1 and 2 Company respectively; the shareholder of the Respondent No. 2 Company together holds approximately 85% of the shareholding in the Respondent No. 1 Company. Thus, both Companies are promoted by the same family and there is unity of ownership and interest.
• Common Directors: Mr. M.V. Murlidher and Padma Murlidher both are Directors in Respondent Nos. 1 and 2 Company. Thus, the Directors of the both Companies are Common and there is common control of companies.
• Common Assets:  The Respondent No. 2 Company owns a partial of land admeasuring 2 acres 36 gundas situated at No. 15, First Phase, Peenya, Bengaluru and has constructed warehouse on the land. The Respondent No. 1 Company runs a bottling plant unit in the warehouse and owns the plant and machinery therein, therefore, there is inter-dependency between two Companies and the assets are common to such an extent that the Respondent No. 2 Company has provided its land and warehouse to the Respondent No. 1 Company to carry on its business activity.
• Common Liabilities: In so far as the loan obtained by the Respondent No. 1 Company from the Respondent No. 4 is concerned, the Respondent No. 2 as security had created pari pasu charge over the Peenya land, placed 67% of its shares and provided a corporate guarantee. Therefore, the liabilities of the Companies are also common and Companies had made themselves jointly and severally liable for the loans. Respondent No. 1 and 2 have common creditors i.e. Respondent Nos. 3 and 4. Directors of both the Companies have given personal guarantees for the loans.
• Inter-dependence: The Respondent No. 1 Company was running a Distillery Unit in the Peenya land and warehouse building belonging to the Respondent No. 2 Company as stated by Respondent No. 6 (RP) in its Status Report filed before this Appellate Tribunal. Thus, the Respondent Nos. 1 and 2 are interdependence.
• Pooling of Resources: Undisputedly the Directors are common using their contacts and relationship to run both the Companies. For the sanction of the loan facility for the Respondent No. 1 Company. The Respondent No. 2 Company has mortgaged Peenya land and warehouse and also stood as guarantor for the Respondent No. 1 Company.
• Intricate links between the Companies: The Respondent No. 2 is associated Company of the Respondent No. 1, this fact is admitted by the Respondent No. 3 while submitting its claim form before the RP.
• Common Financial Creditors: The Respondent Nos. 1 and 2 have Common Financial Creditors i.e. the Respondent Nos. 3 and 4.

The Appellate Tribunal was satisfied the criteria for consolidation of CIRPs were fully met and satisfied.  Respondent Nos. 3 and 4 in their written submissions have not pointed out that how the consolidated CIRP shall prejudice their rights. Even if the combined CIRP is ordered the balance of convenience is squarely on Respondent Nos. 3 and 4 herein who are secured Financial Creditors and whose interest will remain protected even during the combined Insolvency as secured Financial Creditors.

The Adjudicating Authority has not appreciated the facts of this case in right perspective.  The Appellate Tribunal allowed the appeal and directed the Adjudicating Authority to appoint a single common Resolution Professional/Liquidator who will carry on the duties and perform the function of the Resolution Professional/Liquidator in accordance with the I&B Code for the consolidated CIRP.

Conclusion

Despite the new benefits arising from this new concept, substantial consolidation brings about a few challenges as well.  The consolidation does not always bring benefit to all the creditors. It goes against those creditors who extended monies to the company as an individual entity, rather than the group.  Financial Creditors will also have their voting shares reduced in the CoC due to the proportionate reduction in the debt owed to them. Operational creditors are at severe disadvantage with some might even losing their right to be present in the CoC meetings.  It is, therefore, expected that while making provisions in this aspect the above ought to be considered.