by Adam Feibelman.
Last week, the NCLT in Mumbai rejected a resolution plan approved by creditors of Jyoti Structures. This comes relatively soon after the Central Government recently enacted some significant amendments to India’s new Insolvency and Bankruptcy Code. Among the most potentially important of these amendments is a requirement that the National Company Law Tribunals must determine that a debtor's insolvency resolution plan "has provisions for its effective implementation" before approving it. The purpose and scope of this new requirement are unclear, and it could be construed very narrowly or rather broadly. This essay argues that such a requirement can be a useful and valuable component of the insolvency and bankruptcy system, but only if the NCLT judges exercise careful discipline in employing it. Otherwise, it could contribute to pervasive delays and uncertainty in the resolution of insolvency cases. Therefore, this recent amendment will present yet another crucial test in the early development of the IBC system and the role of the NCLT within it. The order explaining the Tribunal's reasoning in the Jyoti Structures case has not yet been released. It is possible that the Tribunal's action was based on a finding that the plan did not provide for effective implementation, but it may have been based on some other rationale. In any event, the Tribunal’s action is likely to provide an important opportunity to assess the NCLT’s role in the insolvency process under the IBC.
Challenging the Logic of the Code
To be sure, the new requirement for approval of resolution plans in corporate insolvencies seems to implicate the core of the animating logic of the Code. One of the primary aims of the new Code is to provide a mechanism for quickly determining if a firm in financial distress would yield more value if reorganized and allowed to continue as a going concern than if it were liquidated for the benefit of its creditors. This function is a key feature of any insolvency or bankruptcy regime, and this decision can be allocated to creditors or to institutional actors or shared by both.
The IBC was designed to empower creditors to make this determination and to dramatically limit or eliminate the authority of judicial officials to do so. Under the Code, after a firm enters the insolvency system, qualified parties can submit resolution plans to a committee of creditors, which is composed of the firm's financial creditors. Most creditors and unrelated third parties are qualified to propose a resolution plan. Promoters of the insolvent firm may also be able to submit a plan unless, among other criteria, they have been a willful defaulter or have owed a loan that is formally non-performing for over one year.
As a general matter, there are very few limitations or constraints on the substantive terms of resolution plans. The Code itself requires that the plan must repay operational creditors – who are excluded from the creditors committee – at least as much as they would receive if the debtor were liquidated, must give priority status to the repayment of costs of the insolvency process, and must provide for the management of the debtor and the implementation and supervision of the plan. Regulations implementing the Code further require that a resolution plan must provide dissenting financial creditors the liquidation value of their claims with priority over the claims of creditors who voted in favor of the plan. To be approved by the committee, a plan must obtain favorable votes from 66% of the voting share of the committee. The voting share required for approval under the Code as originally enacted was 75%, and this was subsequently lowered to 66%, easing creditor coordination and reducing the power of minority creditors to thwart approval.
If a resolution plan is approved by the committee, it is then submitted to the NCLT for approval or rejection. Prior to the recent amendment, the role for the NCLT at this stage was strictly limited to determining whether the plan approved by the creditors' committee satisfied the criteria noted above. Most authorities understood this to mean that the Code did not give any authority or responsibility to the NCLT to assess the terms or substance of a plan approved by the committee or to exercise any judgement or discretion to reject or require any changes to such a plan. (See, for example, Sumant Batra, Corporate Insolvency: Law and Practice (2017), at p.432) But there was some ambiguity in the provisions of the Code, because it did expressly authorize NCLT judges to assess whether plans "provide for the management of the affairs of the Corporate debtor after approval of the resolution plan [and] the implementation and supervision of the resolution plan."
The recent amendments do not fully resolve this ambiguity, but they do now expressly give the NCLT responsibility for determining that a resolution plan can be effectively implemented before approval. It is not clear what motivated this change. Something similar, but much more limited, was recommended by the Insolvency Law Committee. The Committee’s report recommended that “specific power may be given to the NCLT to give directions regarding implementation of the resolution plan while approving it to ensure that a proper implementation strategy has been included in the resolution plan.” But this falls short of the statutory requirement recently adopted that appears to require the NCLT to reject plans that the tribunal believes do not provide for effective implementation.
The U.S. “Feasibility Test”
If the new provision might be understood as authorizing the NCLT to assess the practical or economic viability of resolution plans, a comparative analysis may be illuminating. In the U.S., a bankruptcy court can only confirm a reorganization plan approved by creditors in a Chapter 11 case if it determines that “[c]onfirmation of the plan is not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor ….” (See 11 U.SC. 1129(a)(11)). This is known as the feasibility test, and the proponent of a Chapter 11 plan bears the burden of establishing that its plan has a reasonable prospect for success. Significantly, courts must evaluate the feasibility of a plan, but that is limited to assessing the proponent’s supporting evidence and argument; courts generally do not conduct an independent analysis of the feasibility of Chapter 11 plans.
This requirement under U.S. law fits within a very different regime with a different underlying approach than that of the IBC system. In the U.S., the managers of firms in bankruptcy have significant control of their bankruptcy process. In most cases, debtors file for bankruptcy protection in the first place, the debtor's managers continue to run the firm, and they have an exclusive right to propose a reorganization plan for a long period after filing for bankruptcy relief. These aspects of the U.S. regime tend to favor efforts to reorganize firms if possible. Added to which, other aspects of the regime make it relatively easy to confirm a plan over the objection of a significant number of creditors. In Chapter 11, plans are voted on by classes of creditors, often grouped by secured and unsecured status as well as other commonalities. To approve a plan, a majority of members of the class holding at least two-thirds of the amount of the debt in the class must vote in favor. In a “voluntary” plan approval, all classes impaired under the plan must vote to approve, and, in any event, every creditor must receive under the plan at least the value they would receive if the firm were liquidated (the best-interests test). If a plan cannot garner approval from every class, it is possible to "cramdown" a plan on dissenting classes of creditors if just one impaired class of creditors votes to approve and the plan "does not discriminate unfairly, and is fair and equitable" to any impaired class of dissenting creditors.
In that system, the feasibility test can serve a particularly important function. Debtors will often have strong incentives to propose reorganizations that have a low probability of success. Managers and related stakeholders of an insolvent firm may have little to lose in a failed reorganization and much to gain in a successful one. The feasibility test makes it harder for a firm in bankruptcy to propose a reorganization that is unlikely to succeed and that will waste the debtor’s assets in the meantime. In a prominent case, In re Made In Detroit, which is often assigned in bankruptcy law courses the U.S. to illustrate the operation of the feasibility test, the debtor proposed a plan to raise financing for a real estate development project that had foundered for lack of necessary permits. The court found the debtor’s reorganization plan failed the feasibility test, primarily because the plan was highly contingent on uncertain financing, did "not provide a reasonable assurance of success," and was "based on ‘wishful thinking’ and ‘visionary promises’." The court instead approved a plan proposed by creditors and, pursuant to that plan, authorized the sale of the property that the debtor was trying to develop.
If the feasibility test under U.S. law is a way to place a limit on debtors seeking to reorganize under with low probability of success, it can also be understood as a means for protecting creditors from each other. In many circumstances, the interests of some creditors will align with those of the debtor’s managers – they will have little to lose from a risky reorganization plan that yields little to them and much to gain from the unlikely success of such a plan. Creditors in that position are often willing to support a debtor's plan that imposes risk on other creditors. Such inter-creditor conflict generally pits different classes of creditors against each other. For example, unsecured creditors or junior secured creditors who would receive very little or nothing in an immediate liquidation may be willing to vote for an infeasible reorganization plan that holds some distant promise of a higher return than and that exposes secured creditors to a likely decline in the value of their collateral. Some unsecured creditors, like employee and trade creditors, may have incentives more aligned with the debtor than with other unsecured creditors. Still other creditors may be protected by credit default swaps and are therefore essentially neutral to the success or failure of a reorganization. In a system that enables a single class of impaired creditors to approve a plan that is then crammed down on non-consenting classes, there is real value in a tool that helps make sure that the debtor and a potentially small group of creditors cannot advance a plan that unreasonably risks waste and loss on the other creditors.
Different Codes, Different Contexts
The new requirement that the NCLT can only approve a plans that "has provisions for its effective implementation" will operate within a very different legal landscape. Under the IBC, the mangers of debtor firms are displaced upon the appointment of an interim resolution professional. Generally, management will not propose resolution plans; in many cases, they will be prohibited from doing so. Perhaps most significantly, the voting framework for approving or rejecting plans removes many opportunities for dramatic risk-shifting in a resolution plan. Operational creditors, a significant portion of unsecured creditors, do not participate in the creditors committee and therefore cannot impose a plan on other creditors. And a because two-thirds of the voting share of the committee of creditors must vote to approve a resolution plan, financial creditors with the largest stake in the outcome of the case will determine whether the plan is approved or not. In sum, the likelihood of approving highly unrealistic resolution plans over significant creditor objection should be much lower under the IBC than under Chapter 11 in the U.S.
That said, however, inter-creditor conflicts will proliferate under any insolvency regime, and the IBC regime will not and cannot eliminate all opportunities for some creditors to impose significant financial risks on other creditors. It is certainly possible to anticipate circumstances in which two-thirds of a firm's financial creditors with relatively little to lose in the process will be willing to support a resolution plan with a very low probability of success that effectively imposes a substantial risk on a minority group of other creditors. The requirement that resolution plans must provide dissenting financial creditors priority for the liquidation value of their claims may serve to limit their risk of loss, but it does not eliminate such risk. One of the broader goals of the IBC is to promote increased use of unsecured credit, especially through the corporate bond market – as that begins to occur unsecured creditors will come to comprise a larger portion of creditors committees. Even now, junior secured creditors may represent a significant portion of value on a creditors committee and may have incentives that are adverse to their senior secureds. The basic point is that no system can fully eliminate the chance that resolution or reorganization plans will be premised on very unlikely contingencies and that some such plans will impose the risk of likely failure on non-consenting creditors. In those circumstances, a tool to police for plans that are unlikely to be successfully implemented can be a useful component of an insolvency or bankruptcy system.
To be clear, such a tool might also be used to sort out unviable resolution plans that reflect efforts by financial creditors to avoid realizing losses in liquidation but that do not "cramdown" risks on other dissenting creditors. But this particular problem is an inevitable risk of an insolvency system designed to give decisional authority to financial creditors; and, ideally, it should be addressed through prudential regulation of banks and other financial institutions.
A Limiting Principle
It is possible that the Central Government did not mean to insert something like a feasibility test into the new corporate insolvency regime; and perhaps this new amendment will be construed to refer to specific conditions that must be satisfied for a resolution plan to be implemented. If the new amendment is understood to be something more like the feasibility test in Chapter 11, however, it is certainly possible that the costs of this new requirement will outweigh its potential benefits. It could invite tribunals to assess the merits of every resolution plan approved by creditors committees; if so, the tribunals could alter the essence of the new insolvency system, undermining a key pillar of creditor control, injecting a heavy dose of judicial oversight, and likely slowing down the process considerably.
But the NCLT need not take such an aggressive approach. It could follow the approach to feasibility in the U.S., where it is a low bar, rarely utilized to block a plan, and a yet a useful tool in extreme cases for policing against gross waste and abuse of dissenting creditors. In any event, the new test should not be construed to require or authorize the NCLT to conduct an independent analysis of the likelihood of success of a resolution plan approved by creditors. It should be enough for the NCLT to assess the committee’s determination that the plan can be effectively implemented based on the resolution professional’s report on the plan. And committees will presumably insulate their decisions by conducting explicit and robust analysis of the viability of the plans put before them and ensuring that this analysis is reflected in the resolution professional’s report to the NCLT. If a dissenting creditor believes a plan cannot be effectively implemented, it should be authorized to raise an objection when the NCLT is considering whether to approve the plan. (See Batra, supra, at p.431) But such challenges can be a slippery slope into the long procedural delays that the Code was designed to eliminate if they become commonplace and trigger searching review by the NCLT.
In sum, if the new amendments to the IBC require the NCLT to determine that resolution plans can be effectively implemented before approving them, this can be a useful tool in the IBC toolkit, but perhaps only in rare circumstances where substantial risks are effectively imposed on non-consenting creditors. If so, the NCLT should view the requirement as a low bar, a rare basis for intervention, and not a general invitation to substantively review resolution plans approved by creditors committees.
Adam Feibelman is Sumter Davis Marks Professor at Tulane Law School. The author wants to thank Renuka Sane, Bhargavi Zaveri, and Pratik Datta and two anonymous referees for comments.