Guest Post: “Clean Slate Doctrine” under IBC

[Mr. Aakash Deep Anand is Law Graduate from IP University, Delhi and presently works in a Govt. Department.]

“Clean Slate Doctrine” under the Insolvency & Bankruptcy Code and its evolution

[Aakash Deep Anand]

Introduction

The process of insolvency has undergone a substantial change after the Insolvency and Bankruptcy Code, 2016 [“IBC” or “Code”] has come into force. The ball starts rolling after a Corporate Entity enters into a Corporate Insolvency Resolution Process [“CIRP”] and the Adjudicating Authority [“NCLT”] appoints an Interim Resolution Professional [“IRP”] forthwith. The IRP further constitutes the Committee of Creditors [“COC”].

In accordance with Regulation 6 of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 [“IBC Regulations”], the Claims should be submitted to the IRP within the time period stipulated in the Public Announcement, which should be fourteen days from the date of appointment of the IRP. Creditors who fail to submit their claims within the stipulated timeline may submit it on or before ninetieth day of the insolvency commencement date [Regulation 12 of the IBC Regulations].

After constitution of the COC, first meeting of the COC should be held within 7 days of its constitution [Section 22(1) of the Code]. In the said meeting, the concern of appointing the IRP as Resolution Applicant [“RP”], or appointing a new RP is resolved by the Financial Creditors by a majority vote of not less than sixty-six percent [Sec 22(2) of the Code].

It is the duty of the RP to preserve and to protect the value of the Corporate Debtor and manage the operations of the Corporate Debtor as a going concern [Section 22 of the Code]. Another foremost duty of the RP (under Section 18 of the IBC) is to collect all information relating to assets, finances and operations of the Corporate Debtor and to receive/collate all the claims submitted by the Creditors pursuant to the Public Announcement. Thereafter, the RP invites the potential Resolution Applicant and prepares the Information Memorandum, based on which the Resolution Applicants come up with their Resolution Plan. The Resolution Plans received are then presented before the COC.

On the approval of a suitable Resolution Plan by the COC, the same is submitted to the Adjudicating Authority for its final approval. Once the assent of the Adjudicating Authority is obtained, the successful Resolution Applicant acquires the control over the Corporate Debtor.

The “Clean Slate Doctrine”

Almost every day, we see new developments in IBC, either in the form of Judgments or in amendments to the existing Code/Regulations. One such example is the “Clean Slate Doctrine”. The theory has been put to the effect by the Hon’ble Supreme Court of India in the matter of Committee of Creditors of Essar Steel India Limited vs. Satish Kumar Gupta and Ors.

In the above judgment, the Hon’ble Supreme Court has held that a successful Resolution Applicant cannot suddenly be made to face the undecided claims after the resolution plan submitted by him has been accepted, as this would amount to a hydra head popping up which would throw into uncertainty amounts payable by a prospective Resolution Applicant who successfully took over the business of the Corporate Debtor. The Court added that all claims must be submitted to and decided by the RP so that a prospective resolution applicant knows exactly what has to be paid in order that it may then take over and run the business of the Corporate Debtor.

Thus, according to the Doctrine of Clean Slate, once the Adjudicating Authority approves the Resolution Plan, the plan becomes binding and thereafter, the Resolution Applicant should not face any undecided claim. The doctrine touches upon the intent of the IBC statute, which is very clear to give a suitable opportunity to the interested Resolution Applicant to acquire the dying entity and begin the functions on a clean slate.

Unfortunately, the issue is not that straightforward, as it appears to be. Questions pertaining to the claims being made after the approval of the Resolution Plan by the Adjudicating Authority are always debatable. Amongst the various concerns relating to the rejection of the claims coming up after the approval of the Resolution Plan, recently two High Courts i.e. Rajasthan and Jharkhand pronounced on the issue and reached seemingly diametrically opposite conclusions.

The Debate

Section 31 of the Code lays down that the resolution plan, once approved by the adjudicating authority, is binding on the corporate debtor and its employees, members, creditors, including the Central Government, any State Government or any other local authority such as authorities to whom statutory dues are owed, guarantors and other stakeholders involved in resolution plan.

However, the question arises as to what happen in an instance, where the debts of any creditor against the Corporate Debtor have not been decided during the CIRP or where the claims have been  made after the approval of the resolution plan. There have been two divergent views with regard to this issue which have been elaborated upon in the succeeding sections:

View 1: Clean Slate Doctrine will prevail

In this scenario, where the claim is filed after the approval of the Resolution plan, applying the Clean Slate Doctrine, the claim will be not accepted at the belated stage.

Recently, the Hon’ble High Court of Rajasthan while allowing the Writ Petition in the matter of Ultra Tech Nathawara Cement Limited vs. Union of India & Ors. [Civil Writ Petition No.9480/2019] had butteressed the scope of “Clean State”. The Hon’ble Court held that the purpose of the statute is very clear that it intends to revive the dying industry by providing an opportunity to a Resolution Applicant to take over the same and begin the operation on a clean slate and for that purpose, the evaluation of all dues and liabilities as they exist on the date of finalization of the Resolution Plan have been left in the exclusive domain of the Resolution Professional with the approval of the COC. Further, the Hon’ble Court added that the courts are given an extremely limited power of judicial review into the Resolution Plan duly approved by the COC.

Debts of the Corporate Debtor arising after the approval of the Resolution Plan are rejected for the reason that the same are not incorporated in the approved Resolution Plan. Thus, according to this view, it may not be possible for the Resolution Applicant to consider the claims that never came to his knowledge during the CIRP, as the same would also defeat the purpose of the “Clean Slate”.

View 2: Clean Slate Doctrine will not prevail

The latter view is polar opposite to the prior. There may be cases where the IRP/RP had left over certain claims during the CIRP or had omitted to identify the claims during the CIRP. Therefore, the same would have resulted in unexpected claims after the approval of the Resolution Plan.

In this regard, the Hon’ble Jharkhand High Court recently, in the matter of Electrosteel Steels Limited vs. The State of Jharkhand and Ors. dismissed the prayer of Electrosteel Steels Limited. The company (Electrosteel) entered into the CIRP and a successful Resolution Applicant, M/s Vedanta Limited took over the company pursuant to approval of the Adjudicating Authority.

The dispute arose when the state tax authorities initiated garnishee proceedings against Electrosteel to recover the unpaid taxes. The Petitioner Company (Electrosteel) has challenged the garnishee order issued by the Deputy Commissioner of Commercial Taxes (Bokaro, Jharkhand). The garnishee order was issued on the account of tax/penalty due from the Petitioner Company.

In this regard, the Hon’ble Jharkhand High Court quoted the relevant portion of Regulation 6 of the IBC Regulations which is as mentioned as below: -

 

"6. Public announcement

 

(1) An Insolvency professional shall make a public announcement immediately on his appointment as an interim resolution professional.

[Explanation: 'Immediately' means not later than three days from the date of his appointment.]

 

  (2) The public announcement referred to in sub-regulation (1) shall:

 

(a) be in Form A of the Schedule;

(b) be published-

(i) in one English and one regional language newspaper with wide circulation at the location of the registered office and principal office, if any, of the corporate debtor and any other location where in the opinion of the interim resolution professional, the corporate debtor conducts material business operations; ------------------."

In Electrosteel (supra), the Hon’ble Court observed that the Public Announcement was never made in Petitioner’s principal place of business or a place, where a registered office of the Petitioner Company was situated. The registered office of the Company was situated in the State of Jharkhand. However, the Public Announcement was published in the Business Standard of Kolkata Edition.

This omission resulted in demands of the state tax authorities, which has been made after the approval of the resolution plan. As the state tax auhtorities were not even a part of the CIRP, the purpose of “involved in resolution plan” under Section 31 of the Code was defeated and the Hon’ble Jharkhand High Court dismissed the petition.

In the meantime, the judgment was challenged before the Hon’ble Supreme Court of India by way of a Special Leave Petition [SLP (C) No.7147-7150/2020]. The matter is pending before the Apex Court as on date.

Comments

The “Doctrine of Clean Slate” justifies rejection of claims made after the approval of the plan so as to provide a fresh or a clean start to a successful Resolution Applicant.

The Code stipulates that the powers of the board of directors or partners shall be exercised by the IRP/RP from date of his/her appointment. As a result, the board stands substituted by the IRP/RP. The IRP/RP is also duty bound to reasonably be aware of the assets and liabilities of the Corporate Debtor. Such a duty necessarily entails the IRP/RP to find out if there are statutory dues owed by the Corporate Debtor.

If the existence of any statutory debt can be reasonably determined by the IRP/RP, it would be unjust or illegitimate to consider such debts as wiped out merely on the ground that no claims have been filed by the concerned government department/authority. Ultimately, these statutory debts are public money owed to the people of India. However, the legislative intent of the statute is to ensure the revival of the dying industry but the same shall not result into the loss of public money.

In sum, the doctrine of clean slate has to be applied with a lot of circumspection as regards statutory debts. If the IRP/ RP can reasonably determine pending statutory dues, the same should be brought on record even if no claims have been filed by the concerned department/authority. The nature of function of the IRP/ RP requires him/ her to go to the extent of communicating with statutory authorities, in cases where the IRP/ RP could, with reasonable diligence, find out if the Corporate Debtor owes statutory dues.