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Taking Control: Voluntary Initiation of Corporate Insolvency

IBC was enacted to expedite insolvency proceedings and to facilitate timely and effective resolution of insolvency by involving relevant stakeholders such as creditors. Creditors, both financial (under s. 7) and operational (under s. 9), can initiate CIRP against a corporate debtor. Importantly, a company can also voluntarily initiate insolvency proceedings by approaching the NCLT under s. 10 of IBC. Additionally, IBC empowers the NCLT to initiate liquidation in cases where debt restructuring is not possible, and the liabilities of the company are overwhelming. This analysis examines the circumstances when a corporate debtor can use s. 10 of IBC, and whether the same is a desirable route for a corporate debtor with enormous debt and liability, as compared to liquidation under IBC.

Expand to read the Glossary of Abbreviations Used

I. The Legal Provision: S. 10 of IBC

S. 10 of the IBC provides that the insolvency resolution process can be initiated by a ‘corporate applicant’. Now, the definition of ‘corporate applicant’ as per s. 5(5) of IBC, includes the corporate debtor (i.e., a corporate entity or a company with outstanding debts’) and a member or partner of the company, or even any individual responsible for managing the operations and resources of the company or exercising control over its financial affairs. Thus, s. 10 read with s. 5(5) of the IBC provides for initiation of the insolvency resolution process by the defaulting company itself.

The primary purpose of introducing s. 10 of IBC is to provide the corporate debtor itself the option to initiate CIRP in instances of default occurring over time, effectively declaring itself insolvent. While the provision has some linkages and analogies in the provisions and jurisprudence of voluntary winding up, it builds on the creditor-controlled framework of insolvency resolution as mandated by the IBC.

II. Advantages of Self-Initiation of Insolvency

Taking the initiative in a timely manner: Approaching the NCLT by itself, the company can ensure that it puts the business up for resolution before it is too late. Debts compound and interest costs increase, and without working capital the business also falls into shambles with its salvage value decreasing more rapidly than ever. Filing a s. 10 application in a timely manner could work as a savior for the business as well as all stakeholders for minimizing the haircut they have to take on their investments and debts.

Protection from creditors and legal proceedings: Once the application under s. 10 of IBC is admitted by the Adjudicating Authority, CIRP is initiated and consequently, a moratorium is imposed under s. 14 of IBC. During this period, all legal proceedings, suits, and recovery actions initiated by creditors against the corporate debtor are temporarily halted to maintain the status quo of the corporate debtor's business. Moreover, s. 14(2) of IBC stipulates that the supply of essential goods or services to the corporate debtor shall not be suspended, terminated, or interrupted, as outlined in r. 32 of the Insolvency Resolution Process for Corporate Persons Regulations, 2016.

Control over the appointment of IRP/RP: When a company moves for insolvency under s. 10 of IBC, it has the option to propose the appointment of an IRP as per s. 10(3)(b) of IBC. This proposal is submitted along with the application. Once the IRP is appointed, he is authorized to oversee the management of the corporate debtor's assets, ensuring its ongoing operation to maintain asset value. The IRP is also vested with the authority to engage an accountant, legal representative, and enter into contracts on behalf of the corporate debtor.

It is to be noted that this provision is likely to be amended as per the draft amendments proposed by the Ministry of Corporate Affairs in January 2023, and the right of the corporate debtor to propose the IRP/RP has been sought to be taken away. Refer our update on the proposed amendments.

Possibility of settlement not ousted: The Supreme Court, in Utara Foods and Feeds (P) Ltd. v. Mona Pharmachem (2018) 15 SCC 587, exercised its authority under Article 142 of the Constitution to nullify the NCLAT order that had invalidated the settlement between creditors and the corporate debtor. This decision paved the way for a new avenue – amicable settlements between corporate debtors and creditors. Subsequently, on 06.06.2018, s. 12A was inserted in the IBC. This amendment allows for withdrawal of an insolvency application under s. 10, provided it is moved by the corporate debtor and approved by at least 90% of the CoC. The possibility of a settlement is, thus, not ousted with the filing of the s. 10 application, providing the necessary flexibility to the corporate debtor to continue its efforts to salvage the situation.

Overall comparative advantage over other options: A company or business that has defaulted in its debts and has substantial outstanding liabilities, generally has limited options available to it. These options would include, for instance, approaching the creditors (e.g., banks) for a one-time settlement (technically a.k.a. compromise settlement) or restructuring of their debt, or seeking fresh equity infusion from new investors (who probably see the prospect of value creation in the future), amongst other situation-specific options. Of course, when these options fail, the corporate debtor should immediately approach the NCLT under s. 10. But even before that, in case the promoters and decision-makers of the corporate debtor are acceptable with the change of ownership and the creditors find that their debt would be better repaid (though only in part), corporate insolvency resolution can offer much better advantages than these other options.

III. Two Major Issues: Change in Ownership and PUFE

Change of ownership

It is an inevitable outcome of the insolvency resolution process that the promoters or erstwhile owners of the company/business have to part with the ownership. IBC, following the established corporate philosophy, treats the company as a separate entity and attempts to retrieve as much value from it as is seen in it by those who come to its rescue. The whole rationale behind the process is to find that someone (i.e., the resolution applicant) who believes in creating more value and returns from the company and its business than the present promoters or management can. Naturally, the result is the changing of hands as regards the ownership and management of the company.

Because of this longing and attachment with the business and the company's assets, it can be difficult to let them go. Many a time, allegations are raised before the NCLT and Courts that the provisions of s. 10 have been misused by the promoters by themselves, indirectly and through controlled persons/entities, attempting to come in as resolution applicants. Such situations are to be completely avoided because they not only devastate the s. 10 proceedings, but also put the promoters and the corporate debtor at risk of other legal proceedings.

PUFE transactions

IBC contains remedial provisions to handle preferential (s. 43), undervalued (s. 45), fraudulent (s. 66), and extortionate (s. 50) transactions (collectively called PUFE transactions). These provisions have been made a part of the law to prevent defaulting and distressed companies from undertaking transactions that adversely affect the interests of the creditors. When a resolution application is admitted and the RP is put in charge of the operations of the company, he is duty bound to examine all recent transactions and form an opinion regarding whether any PUFE transactions have been undertaken or not.

There may also be scenarios when the transactions may have been entered without any mala fide intent, yet they be in the nature of being PUFE. For instance, if any assets are sold at a distressed price to service any debt (say, a bank interest), such sale may be treated as an undervalued transaction. Of course, transactions with mala fide intent are bound to fall prey to these provisions. For instance, if the promoters have transferred any company assets to themselves or to any of their family trusts or HUFs, these transactions would be perilous considering the PUFE provisions.

Thus, knowingly or unknowingly, a company may have entered into transactions that may attract penal and costly consequences for the promoters. This becomes an important deterring factor for companies from filing for s. 10 resolution before the NCLT. However, if it is well known that other approaches to resolve the situation are bound to fail and ultimately the creditors would knock at the door of the NCLT, self-initiation might diminish the disadvantages associated with the time-delayed, initiated-by-others, insolvency process.

IV. Preconditions and Procedure

A. Preconditions for making an application before NCLT

The NCLT is mandated to ensure fulfilment of certain statutory pre-requisites before admitting an application, in order to ensure that misuse and abuse of the process of IBC, by way of wrongfully benefiting the corporate debtor and adversely affecting the creditors, does not take place:

  • Existence of debts and occurrence of default: The NCLT is required to ascertain the existence of a debt within the corporate entity and a consequential default in discharging payment obligations towards creditors. Once the Adjudicating Authority ensures the presence of a live debt coupled with a default, the application moved under s. 10 of IBC must be admitted.

  • Compliance with ss. 10(2) & 10(3) of IBC: When filing an application under s. 10 of IBC, the corporate debtor must ensure that the application is complete and in compliance with ss. 10(2) and 10(3) of IBC. This implies the inclusion of certain documentation such as books of accounts, proposal for appointment of IRP, special resolution passed by the shareholders, etc.

  • Non-disqualification under s. 11 of IBC: It is important to ensure that the corporate applicant is not caught in the prohibitions mentioned in s. 11 of IBC. This section includes specific types of entities that are not permitted to initiate CIRP, e.g., any corporate debtor that is already undergoing CIRP or has successfully completed CIRP in the preceding 12 months, or any corporate debtor or financial creditor who has violated any terms of a previously approved resolution plan within the last 12 months, or any corporate debtor for whom a liquidation order has been issued.

B. Procedure after the admission of the application

The procedure after the admission of the s. 10 application is the same as that in case of a financial creditor having taken the company to the NCLT (under s. 7) or an operational creditor having done so (under s. 9). This includes the appointment of an IRP and him taking over the control and management of the corporate debtor, imposition of moratorium, invitation of bids from potential resolution applicants, recommendation, finalization and implementation of the resolution plan along with the CoC, besides other procedural aspects.

C. Liquidation and Dissolution

IBC also prescribes liquidation as a process if the resolution plan fails during CIRP. Further, the process of liquidation can also be seen as the last resort adopted by the creditors to liquidate the corporate debtor. As per s. 33 of IBC, liquidation of a corporate debtor may be initiated in four circumstances: (a) where the resolution plan does not meet the statutory requirements, (b) where no resolution plan is received, (c) where the CoC approve through a 66% vote that liquidation should be done, and (d) where the corporate debtor violates the terms of the resolution plan.

If liquidation is initiated by the NCLT vide an order under s. 133, its procedure would involve the appointment of a liquidator, followed by public announcement, verification and reporting of claims of creditors, and the distribution of proceeds to the creditors as per the priority laid down in the IBC.

After the completion and liquidation of the assets of the corporate debtor, the liquidator must move an application before the Adjudicating Authority for the corporate debtor's dissolution under s. 54 of IBC. If the liquidator believes that there are insufficient realizable assets to cover the cost of the liquidation, they may apply for early dissolution at any time after the initial report is submitted. Finally, to conclude the process of liquidation, the order of dissolution must be filed with the appropriate authority where the corporate debtor is registered.

V. Conclusion

IBC offers a way for struggling companies to take charge of their financial difficulties. Section 10 of the IBC lets these companies initiate insolvency proceedings on their own terms. This self-initiation has its pros and cons. On the plus side, it allows timely action to protect the business, puts legal actions on hold, and can lead to settlements with creditors. However, it can also mean losing control, risking liquidation, and a potential drop in asset value. Overall, the decision to file a s. 10 application is an emotional, financial, and legal decision to be made by the corporate debtor with due care and caution.

The process involves certain conditions and steps, including proving debt and default, following the legal process, and avoiding disqualifications. It leads to the appointment of a resolution professional, a change in management, and consideration of resolution plans. Ultimately, the decision should take into account the company's financial health and the potential benefits and drawbacks of the process. The IBC aims for resolution over liquidation whenever possible, benefitting both the company and its creditors.

Authored by Kushagra Gahlot, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinion.

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