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Group Company Insolvency Framework: Is It Still Too Soon?

The Insolvency and Bankruptcy code 2016 (Code) was developed utilizing the UNCITRAL Legislative Guide on Insolvency (2005) as a benchmark. [1] Even then, a legislative framework to deal with Group Company Insolvency was absent, and it was considered ‘too soon’ to introduce such a complex subject. Owing to that, the insolvency process of each group entity has to be initiated individually.

But, in the last 4 years, the jurisprudence of the code has developed very fast. The Report of The Insolvency Law Committee [2] noted that ‘the treatment of group companies within insolvency laws is a complicated subject. The current system of insolvency law is new, and it may be too soon to introduce a complex subject, like the present issue.

The UNCITRAL Legislative Guide on Insolvency Law also provides that the treatment of group companies is a very complex subject in relation to insolvency law and has multiple different approaches in different jurisdictions. Since lifting of the corporate veil in insolvency may affect corporate debtor entities significantly, this issue may be dealt with in the long-term once the present system is well established. However, the need for it has emerged sooner than anticipated in the case of State Bank of India v. Videocon Industries Limited [3] where applications were filed for consolidation of the insolvency process of 15 companies to make them jointly liable.

Group Company Insolvency

A Group Company is a cluster of corporate entities of parent and subsidiary companies in a vertical structure or horizontal structure format that functions as a single economic entity with common control. According to the Reserve Bank of India, Group Company means two or more enterprises which, directly or indirectly, are in position to exercise twenty-six per cent, or more of voting rights in other enterprise or appoint more than fifty per cent, of members of board of directors in the other enterprise. [4]

Group companies with financial relations, like interlinked corporate guarantees, loans and advances are more prone to group company insolvency rather than group companies with operational relations. When one of the group company becomes insolvent, all the other companies financially linked with the insolvent company gets dragged for insolvency proceedings.

Insolvency And Bankruptcy Code 2016

Before delving into the case study, let’s take a look at what the code offers with respect to the powers/rights of the Resolution Professional/Liquidator over the solvent subsidiaries where the parent company has become insolvent.

Section 18 of the code, which deals with the duties of the Interim Resolution Professional (IRP), provides that the IRP can take control and custody of any foreign asset over which the corporate debtor has ownership rights and securities including the shares held in any subsidiary of the corporate debtor. The relevant excerpt of the provision is reproduced below:

Section 18(f) - Duties of interim resolution professional
The interim resolution professional shall perform the following duties, namely:
(f) take control and custody of any asset over which the corporate debtor has ownership rights as recorded in the balance sheet of the corporate debtor, or with information utility or the depository of securities or any other registry that records the ownership of assets including:
  1. assets over which the corporate debtor has ownership rights which may be located in a foreign country;
  2. assets that may or may not be in possession of the corporate debtor;
  3. tangible assets, whether movable or immovable;
  4. intangible assets including intellectual property;
  5. securities including shares held in any subsidiary of the corporate debtor, financial instruments, insurance policies;
  6. assets subject to the determination of ownership by a court or authority; Section 36 of the code, which deals with liquidation estate, provides that the liquidation estate shall include the shares held in any subsidiary. The section also expressly prohibits the inclusion of any assets held by said subsidiaries. The relevant excerpt of the provision is reproduced below;


Section 36 - Liquidation estate.
(3) Subject to sub-section (4), the liquidation estate shall comprise all liquidation estate assets which shall include the following:

  1. any assets over which the corporate debtor has ownership rights, including all rights and interests therein as evidenced in the balance sheet of the corporate debtor or an information utility or records in the registry or any depository recording securities of the corporate debtor or by any other means as may be specified by the Board, including shares held in any subsidiary of the corporate debtor;

(4) The following shall not be included in the liquidation estate assets and shall not be used for recovery in the liquidation:
(d) assets of any Indian or foreign subsidiary of the corporate debtor From the abovementioned, it is clear that sections 18(f) and 36(3) of the code gives control of the shares of the subsidiary to the resolution professional and liquidator of the parent company. The control rights given to the shareholders of a solvent company may be used by the resolution professional or liquidator to obtain information from solvent group entities easily. Further, a resolution plan of a parent company would deal with the assets of the company, which would include its shares in subsidiary companies. [5]

State Bank Of India V. Videocon Industries Limited

Videocon Industries Limited (VIL) and VOVL Limited mobilized funds for Videocon Hydrocarbon Holdings Ltd. (VHHL) by way of loan. VOVL was the borrower and VIL was named the corporate guarantor. Upon default, as many as 15 applications were filed, some in favour of the ‘Consolidation’ and some opposing the ‘Consolidation’ of insolvency process of the Videocon group Companies to sell the subsidiaries who were the participating interests.

A preliminary question of under what circumstances an order of ‘Consolidation’ can be demanded or suo-moto be passed by a court/tribunal arose and the tribunal answered that the right recourse is to examine the necessity of consolidation. The tribunal took reference from the principles laid down by judicial authorities in U.K. & U.S.A. courts. It relied on the rulings of:
  1. Continental Vending Machine Corp. vs. Irving L. Wharton, Cl. Chemical Bank NewYork Trust Company V. Kheel [6] ,
  2. Vecco Construction Industries, INC and others [7] ,
  3. Auto-Train Corporation, Inc. Florida Corporation [8] ,
  4. Food Fair Inc case [9] , and
  5. Re BAPAJO Ltd. [10]

The tribunal stated that:
it is appropriate and suitable to give a ruling at this occasion that there is no single yardstick or measurement on the basis of which a motion of consolidation can or cannot be approved. The essential ingredients to be examined are, namely:

  1. Common control,
  2. Common directors,
  3. Common assets,
  4. Common liabilities,
  5. Inter-dependence,
  6. Interlacing of finance,
  7. Pooling of resources,
  8. Co-existence for survival,
  9. intricate link of subsidiaries
  10. inter-twined of accounts,
  11. inter-looping of debts,
  12. singleness of economics of units,
  13. cross-shareholding,
  14. Interdependence due to intertwined consolidated accounts,
  15. Common pooling of resources, etc.

The tribunal made it clear that the list is not exhaustive. These are the elementary governing factors,

prima facie to activate the process of ‘consolidation’. After examining the essential ingredients, the tribunal ordered the consolidation of 13 companies out of the 15 companies proposed for consolidation.

Apart from the Videocon case, the adjudication authority had few other instances of consolidation of group companies in the case of Axis Bank Limited v. Lavasa Corporation Limited [11] and Edelweiss Asset Reconstruction Company Limited v. Sachet Infrastructure Pvt Ltd. [12]

Conclusion
Individual insolvency proceeding against each group company is not the way moving forward and we are in a dire need of a robust cross-border insolvency framework. Without it, the enforcement of the tribunal’s order over the foreign subsidiaries becomes cumbersome and complex. Moreover, a plain reading of section 2 & 3(7) of the Code read with section 2(2) of the Companies Act indicates that the Code applies only to Indian Companies and not to foreign companies. The UNCITRAL Model Law on Cross Border Insolvency must be adopted to overcome such challenges and to reduce the burden on tribunals/courts

Until then, the process of consolidation of group companies must be made using equity and fairness as a yardstick to lift or pierce the corporate veil and should be used as a mechanism to maximize the value of financially stressed corporate entities. The extent to which assets of the corporate entities are found to be hopelessly commingled must necessarily be decided on a case-by-case basis.

End-Notes:

  1. Insolvency and Bankruptcy Board of India, The report of the Bankruptcy Law Reforms Committee, https://ibbi.gov.in/BLRCReportVol1_04112015.pdf .
  2. Insolvency and Bankruptcy Board of India, Report of The Insolvency Law Committee, p.83 http://www.mca.gov.in/Ministry/pdf/ReportInsolvencyLawCommittee_12042019.pdf .
  3. State Bank of India v. Videocon Industries Limited & Ors., MANU/NC/2290/2020 (India).
  4. Reserve Bank of India, A.P. (DIR Series) Circular No.68, RBI/2013-14/356.
  5. IBBI, Report of The Working Group On Group Insolvency, https://www.ibbi.gov.in/uploads/whatsnew/2019-10-12-004043-ep0vq-d2b41342411e65d9558a8c0d8bb6c666.pdf
  6. 369F.2d. 845 (2 Cir.1966).
  7. Bankruptcy No. 79-224-A United States Bankruptcy Court E.D. Virginia.
  8. 810 F.2nd 271 (D.C. Cir. 1987).
  9. Bankruptcy No. 78 B 1765, United States Bankruptcy Court, S.D. New York.
  10. Bankruptcy Nos. 882-81848-18.
  11. Axis Bank Limited and others v. Lavasa Corporation Limited, MA 3664/2019 (India).
  12. Edelweiss Asset Reconstruction Company Limited v. Sachet Infrastructure Pvt Ltd, Company Appeal (AT) (Insolvency) No.377 of 2019 (India).

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