The Byju's Insolvency: Reducing IBC To A Farcical Game Of Chicken

In the 1955 classic film Rebel Without a Cause, James Dean challenged his bête noire to a deadly ‘chicken run’. It was a high-stakes car race towards the edge of a cliff with a sheer drop into the Pacific, leading to certain death. Both cars careen towards the precipice, with the one swerving first being a ‘chicken’ and losing the race. The recent David vs. David insolvency saga of Think & Learn Pvt. (Byju’s flagship company) and the Board of Control for Cricket in India evokes memories of the 1955 chicken run.

After much ado, the BCCI’s insolvency petition against TLPL was admitted under the Insolvency & Bankruptcy Code. However, it was a short-lived insolvency since the promoters were allowed to settle BCCI’s dues. NCLAT permitted the settlement and reversal of the insolvency proceeding in spite of vehement objections by the lenders whose debts were manifold higher and whose independent insolvency application had been stayed. Being an operational creditor, BCCI would have recovered nothing in the resolution or liquidation of TLPL due to its low ranking in the statutory distribution waterfall. BCCI’s economic incentive could never have been to engender a corporate restructuring of TLPL but would likely have been to merely extract its dues. The promoters also realised that BCCI had nothing to gain from the insolvency proceeding and refused to settle as per BCCI’s terms. Incidentally, the IBC recognises this scenario and explicitly permits parties to settle and withdraw the insolvency application before admission. However, in this case, neither party swerved, and both hurtled over the cliff—BCCI didn’t withdraw their application, and the Byju promoters didn’t settle before insolvency was admitted. The NCLAT, however, changed the rules of the game and allowed TLPL promoters to chicken out after the race. A bilateral settlement was allowed after the admission of IBC without following the process prescribed by law.

A few cardinal principles underpin insolvency laws. First, after the initiation of insolvency, it no longer remains a bilateral issue between the unpaid creditor and the defaulting company. It transforms into a collective resolution process where all creditors have an interest in an orderly resolution that maximises value. The law envisages an equitable distribution of the resolution proceeds, as per a statutory payment waterfall for the benefit of all creditors without favouring any one of them. If not for this, it would incentivise each creditor to file an insolvency application at the first sign of distress, hoping to recover a quick buck before the ship sinks.

The second principle is the imposition of a'moratorium’ prohibiting any individual recovery action after the initiation of insolvency. If each creditor pursues its own remedies, it will force the company to defend itself against multiple claims in different judicial forums, adding to legal costs, consuming scarce managerial bandwidth, and leading to the loss of consumers and suppliers. Secondly, there will be no material operations left to rescue since all assets will dissipate and key contractual counterparties will walk away. Thirdly, the creditors who act first will gain disproportionately at the expense of others who are willing to display forbearance with a view to rescuing the company.

Intricately linked to the above is the third principle of clawing back preferential recovery by individual creditors. The law takes an uncharitable view of creditors who extract recoveries from a distressed company in the twilight zone of insolvency. The presumption is that an opportunistic recovery by predatory creditors could tilt a sick company into formal insolvency. Further, creditors who made ransom recoveries on the eve of insolvency have gained at the cost of other similarly placed creditors who will find themselves bound by the moratorium.

There is a very narrow exception to these principles under Indian law. After admission to the IBC, if the promoters want to settle the debt bilaterally, they can only do so with the consent of 90% of the committee of financial creditors. If the committee has not been formed yet, then the interim resolution professional must make an application to the NCLT to seek its approval for the bilateral settlement. The lenders who would have constituted the committee of creditors were stridently opposed to the settlement. But the NCLAT had temporarily stayed the constitution of the CoC, leaving only the insolvency resolution professionals with the legal right to table the settlement proposal before the court. The IRP filed no such application before the NCLT. The NCLAT appears to have used its ‘inherent powers’ to permit BCCI’s settlement.

Inherent powers are plenary powers granted to judges to do complete justice between parties where clear statutory provisions are inadequate to offer relief. For instance, the Supreme Court has been granted such powers under the Indian Constitution. High Courts and other civil courts are also conferred such powers under the Code for Civil Procedure and the Code of Criminal Procedure. However, the NCLT/NCLATs’ inherent powers stem from 'rules', which are a form of delegated legislation and were promulgated by the Ministry of Corporate Affairs, a government department. Unlike the inherent powers of other courts, NCLT/NCLAT’s inherent powers seem to be designed to iron over procedural gaps rather than affect the substantive rights of parties. In fact, even the Supreme Court has read down the ambit of the inherent powers vested in NCLTs. In this case, the NCLAT has used its inherent powers to clearly depart from the settlement route prescribed under the IBC.

There are numerous instances of NCLTs staying within the constitution of the committee of creditors and permitting bilateral settlements. The NCLT has effectively made the insolvency court a forum for brinksmanship between operational creditors and debtors. Operational creditors only looking to recover their dues from defaulting companies should ideally approach civil courts. Since the time taken for civil courts to decide money suits in India is notoriously high, NCLTs via the insolvency route are proving to be a convenient alternative for such creditors. Insolvency courts are opening the flood gates to recovery actions as opposed to being a forum for genuine corporate restructuring. This is further elongating timelines for admission of IBC cases.

The IBC has been a landmark success and a flagship reform of this government. It has altered truant borrower behaviour, led to record recoveries for the public exchequer and reduced banks’ NPAs. To preserve the IBC’s continuing efficacy, it is critical that insolvency judges shed activism, exercise inherent powers sparingly and return the coat they borrowed from James Dean.

Suharsh Sinha is a partner at AZB & Partners.