Comments on the Securities Market Code Bill, 2025

by Natasha Aggarwal, Pratik Datta, K. P. Krishnan, Bhavin Patel, M. S. Sahoo, Renuka Sane, Ajay Shah and Bhargavi Zaveri-Shah.

Finance is the brain of the economy. It dictates allocative efficiency. The financial system chooses which industries and firms receive capital. This efficiency determines the extent to which investment translates into GDP growth. Getting finance right is critical. The prioritisation of financial reform must be absolute.

The Securities Market Code Bill, 2025 (SMC) marks a substantial advance over the existing Securities and Exchange Board of India Act, 1992, particularly in strengthening governance arrangements and formalising the processes of regulation-making. Importantly, it makes a serious attempt to end the ''circular raj'' by confining the issuance of subsidiary instruments to the Chairperson or senior members of the Board, rather than dispersed internal authorities. Further, it has introduced timelines for investigations and attempted to separate the investigation function from the adjudication function, making the first effort towards a clearer separation of powers. That said, the SMC can make further strides if it focuses on the issues described below.

We now address the issues in relation to specific provisions drafted within the current SMC.

Separation of powers

The SMC raises three related concerns, which demonstrate a concentration of powers at SEBI.

Issue 1: Excessive delegation of essential legislative functions

Clause 96 prescribes imprisonment, a fine, or both as penalties for market abuse (an offence defined under Clause 93). However, Clause 93 also grants the regulatory authority to define new offences within the 'market abuse' category, which would carry the same criminal sanctions. This raises concerns around excessive delegation: the identification of criminal offences is a core legislative function and cannot be delegated. Moreover, such excessive delegation is subject to being struck down in judicial review.

Issue 2: Regulation-making on adjudication

Clause 146(2)(j), read with Clause 17(4), permits SEBI to make regulations on the manner of conducting adjudication proceedings. This should not be done by SEBI itself. SEBI is the agent, and the Parliament is the principal. The Parliament must define the checks and balances on the coercive power of the agent. Otherwise, the agent always has incentives to appropriate more arbitrary power.

Issue 3: Ineffective separation of investigative and adjudicatory functions

Clauses 17 and 27 introduce limited separation of investigative and adjudicatory functions for specific matters. Investigation is an executive function, and adjudication is a quasi-judicial function. A conflation of these two functions in the same individual raises concerns about the separation of powers.

In summary, there is no clear separation of power between the three functions of the regulator. The same regulator is empowered to define the scope of violations and offences, investigate them, enforce them, adjudicate upon them, and impose sanctions for their violations, all under regulations of its own design. This combination blurs the distinction between legislative, executive, and adjudicatory functions and concentrates powers in the same persons.

Proposal:

Remove Clauses 17(4), 92(f), 93(g), and 146(2)(j) from the SMC. Implement strong structural separation between the investigative and adjudicatory functions. One way to do this is to create a distinct career track for adjudicatory officers as Administrative Law Officers (ALO). One SEBI board member should also be designated as an Administrative Law Member, who oversees the functions of ALOs. These officers should be solely responsible for adjudication and must have no involvement in investigative or quasi-legislative functions. Introduce extraordinary safeguards to mandate arm's length operation between investigation and adjudication.

Timelines for investigation and adjudication

Issue: Clauses 13, 16, and 27 introduce timelines for investigation and interim orders. However, provisos allow these timelines to be extended (Clause 27(4), proviso to Clause 13(2)). Additionally, the SMC specifies no timelines for the completion of adjudication proceedings. This allows investigations and adjudications to continue indefinitely, rendering the statutory limits ineffective.

Proposal: Remove the power to extend timelines for investigation. If extensions are retained, mandate the publication of written reasons, subject to mandatory review by the SEBI governing board. Introduce a strict statutory timeline for the conclusion of adjudicatory proceedings. These timelines should be part of the Parliament-specified regulations on the manner of conducting adjudication proceedings that we recommend in our preceding suggestions.

Methodology for calculating unlawful gains

Issue: The SMC requires the determination of unlawful gains by an investigating officer under Clause 13(3), but provides no calculation methodology. This virtually guarantees arbitrary and inconsistent determinations. It defeats the rule of law.

Proposal: Codify standard methods or guidelines for calculating unlawful gains within the SMC. Operationalise these through detailed regulations. Reference the Competition Commission of India (Determination of Monetary Penalty) Guidelines, 2024, as a baseline.

Sanction determination factors

Issue: The SMC lists factors for adjudicating officers to consider while imposing sanctions. Some mirror Section 15J of the SEBI Act, which are unimplementable in practice. Terms like 'impact of the default or contravention on the integrity of the securities markets' (Clause 19(b)(v)) lack precision and invite arbitrariness.

Proposal: Base sanctions strictly on the quantifiable extent of harm caused to specific persons. Codify this methodology. Alternatively, publish binding guidelines detailing specific aggravating and mitigating factors, expanding upon the approach in the SEBI (Settlement Proceedings) Regulations 2018.

Criminal enforcement

Issue: The SMC retains criminal liability, including imprisonment, for some offences. Establishing guilt in Indian criminal law requires proof beyond a reasonable doubt, typically coupled with the requirement to establish intention. This is an inefficient tool for complex financial markets. The boundary between aggressive trading and market manipulation is thin. The threat of criminal sanctions deters contrarian strategies. This reduces market liquidity and harms price discovery. Traditional fraud is adequately covered by the Bharatiya Nyaya Sanhita.

Proposal: Remove all criminal liabilities. Structure sanctions as punitive civil penalties or restorative remedies, scaling to a multiple of the illicit gains. Retain debarment for systemic misconduct.

Power to issue directions

Issue: Clause 23 vests SEBI with open-ended direction-making powers. Moreover, the requirement to record reasons in writing (currently included in Section 11(4) of the SEBI Act) has not been included in Clause 23.

Proposal: Delete Clause 23. Confine non-penal measures to specific, narrowly defined statutory triggers (e.g., immediate asset freezing powers under strict procedural safeguards). All adjudicatory actions must be justified by reasons in writing.

Nominee directors on the SEBI board

Issue: The SMC retains government nominee directors on the SEBI board. Nominee directors prioritise the perspective of their parent departments over market efficiency. They exercise disproportionate influence. Inter-agency coordination should not occur via board representation.

Proposal: Appoint mid-career professionals for fixed terms until a mandatory retirement age. Bind them statutorily to SEBI's specific objectives. Address inter-agency concerns externally through the Financial Stability and Development Council (FSDC).

Commodities markets

Issue: Clause 49 empowers the government to determine commodities eligible for trading. The market must decide which commodities warrant hedging instruments. State determination of eligible commodities is equivalent to the government deciding which firm is permitted to issue equity.

Proposal: Delete Clause 49. Empower SEBI to draft regulations defining objective eligibility criteria for commodity derivatives, identical to the framework for eligible scrips.

Ombudsperson

Issue: Clause 73 empowers SEBI to designate an Ombudsperson. This creates a conflict of interest. The SMC lacks an appeals mechanism for decisions made by the Ombudsperson.

Proposal: Mandate statutory independence for the Ombudsperson. Ensure job security separate from SEBI management. Define a clear appellate process.

Exemptions for PSUs

Issue: Clause 65(2) empowers the Central Government to exempt listed public sector companies from listing and disclosure requirements. This violates Article 14 of the Constitution. State-owned enterprises must face the identical market discipline applied to private enterprises.

Proposal: Delete Clause 65(2). Mandate equal treatment for all market participants.

References

Natasha Aggarwal and others, "'Balancing Power and Accountability: An Evaluation of SEBI's Adjudication of Insider Trading'" (Working Papers, TrustBridge Rule of Law Foundation, 2025).

In Re: The Delhi Laws Act, 1912 (AIR 1951 SC 332).

M S Sahoo and V Anantha Nageswaran, 'Regulatory architecture 2.0: Securities Markets Code marks a decisive shift' (Business Standard, 25 December 2025).

M.S. Sahoo and Sumit Agrawal, "Reimagining SEBI's Consent Settlement Framework" (Chartered Secretary, January 2026).

C.K. Takwani, Lectures on Administrative Law (7th edition, 2023) at page 100.

Bhargavi Zaveri-Shah, 'SEBI does not need unlimited powers – here's what's wrong with the Securities Markets Code' (ThePrint, 5 January 2026).

Bhargavi Zaveri-Shah and Harsh Vardhan, 'Ghost of the Commodities Controller—why India's new financial law feels like the 1970s' (ThePrint, 19 January 2026).

Registration of security interest: A peculiar Indian problem

by Pratik Datta.

When a lender extends credit to a company, it often secures repayment by way of a security (often referred to as a “charge”) created over certain assets or properties of that company. Company law usually requires such security to be registered with an agency. For instance, in the UK, company charges are registered with the Companies House. Registration of security could serve three different purposes:

1. the purpose of registration of security could be to publish the existence of such security to make it available for public inspection. This gives potential lenders to the company information about the extent of prior lending to the company which may rank ahead of their own contemplated advances. Such information may also be of interest to credit analysts, resolution professionals, shareholders and investors.

2. registration may be necessary for ‘perfection’ of the security. That is, registration may be treated by law as a necessary part of the process whereby a person obtains a security interest against the company. Without registration, the person in question would fail to obtain security interest and so would not be able to rely on it against the unsecured creditors of the company during the company’s insolvency.

3. registration could be used in law as a way of determining priority among secured creditors. For example, the law could require that priorities among secured creditors be determined by the date of registration of the security instead of the date of creation of security.

In India, we have a peculiar situation. When a bank or notified financial institution extends a secured credit facility to a company, three different registrations are necessary under three different laws for the same security.

1. Under section 77 of Companies Act 2013, a company creating charge on its assets or properties is required to register the particulars of such charge with the Registrar of Companies (‘RoC’). This involves providing the relevant information in Form No. CHG-1 (for charges other than debentures) or Form No. CHG-9 (for debentures), getting it signed by both the company and the charge holder, and then filing the Form along with the underlying credit agreement with the ROC.

2. Under section 23 of Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (‘SARFAESI Act’), the particulars of every transaction (involving banks and notified financial institutions) creating security interest must be filed with the Central Registry of Securitisation Asset Reconstruction and Security Interest of India (‘CERSAI’). This involves filing Form I with CERSAI.

3. Under section 215(2) of the Insolvency and Bankruptcy Code 2016 (‘IBC’), a financial creditor (which typically includes banks and regulated financial institutions) is mandatorily required to submit financial information and information relating to assets, in relation to which any security interest has been created, to an Information Utility (“IU”). Unlike RoC or CERSAI, IUs are required to authenticate and verify information of default, and issue a record of default in Form D to its registered uses.

As a result of these legal provisions, every single secured credit transaction in India has to be mandatorily registered with the RoC, the CERSAI as well as an IU. More than increasing compliance burden, this institutional overlap increases the legal uncertainties around security creation and enforcement, with potentially adverse implications for the entire secured credit landscape. A recent case illustrates the point.

Case in point

In Bizloan Pvt. Ltd. v. Mr. Amit Chandrashekhar Poddar (“Bizloan judgment”), the NCLAT was seized of a unique situation where a corporate credit transaction was registered only with CERSAI but not with RoC. Bizloan Private Ltd. (“Bizloan”) provided financial credit facilities to Autocop (India) Pvt. Ltd. (“Autocop”) in the form of sales bill discounting and purchase bill discounting of Rs. 1 crore in aggregate. Subsequently, Autocop went into corporate insolvency resolution process (“CIRP”) under the Insolvency and Bankruptcy Code 2016 (“IBC”). Bizloan filed its claims in Form C during CIRP, which were admitted in full without indicating if they were secured or unsecured. It was only when Bizloan received the final resolution plan for Autocop that it realized that Bizloan had been classified as an unsecured financial creditor. Bizloan challenged this classification but by then Autocop had been put into liquidation. The NCLT dismissed Bizloan’s challenge. Consequently, Bizloan approached NCLAT in appeal.

Bizloan’s arguments

1. Bizloan argued that proving security interest in liquidation proceedings under IBC should be governed by Regulation 21 of the IBB (Liquidation Process) Regulations, 2016, which states:

The existence of a security interest may be proved by a secured creditor on the basis of -

1. the records available in an information utility, if any;
2. certificate of registration of charge issued by the Registrar of Companies; or
3. proof of registration of charge with the Central Registry of Securitisation Asset Reconstruction and Security Interest of India.

Evidently, proof of registration of charge with CERSAI is sufficient for proving security interest in a liquidation by virtue of Regulation 21(c) of the Liquidation Regulations.

2. Bizloan further argued that section 238 of the IBC overrides provisions of other statutes. Therefore, if there is any inconsistency between IBC and any other statute, IBC and the regulations issued under it should prevail.

Liquidator’s arguments

1. The Liquidator relied on section 77(3) of the Companies Act 2013, which states:

Notwithstanding anything contained in any other law for the time being in force, no charge created by a company shall be taken into account by the liquidator appointed under this Act or the Insolvency and Bankruptcy Code, 2016 (31 of 2016), as the case may be, or any other creditor unless it is duly registered under sub-section (1) and a certificate of registration of such charge is given by the Registrar under subsection (2).

The underlined portion of the above provision was inserted through the Eleventh Schedule of the IBC itself, which came into effect from November 15, 2016. The liquidator highlighted that the words “shall” makes him duty bound to follow the above provision. Further, if there is any conflict between section 77 of Companies Act 2013 and Regulation 21 of the Liquidation Regulations issued under the IBC, the former will override the latter since section 77 is a specific provision dealing with the particular situation (that is, registration of charges) and it explicitly uses the words ““notwithstanding anything contained in any other law”. Since Bizloan’s charge was not registered with the RoC under section 77 of the Companies Act 2013 and only registered with CERSAI, Bizloan cannot be treated as a secured financial creditor in liquidation governed by the IBC.

2. The liquidator further argued that Regulation 21 is an outcome of section 52(3)(b) of the IBC, which states:

Before any security interest is realised by the secured creditor under this section, the liquidator shall verify such security interest and permit the secured creditor to realise only such security interest, the existence of which may be proved either – (a) by the records of such security interest maintained by an information utility; or (b) by such other means as may be specified by the Board.

The liquidator argued that section 52(3) applies only before a secured creditor chooses to “realise” its security interest, which does not come into the picture in Bizloan’s case since Bizloan had effectively “relinquished it security interest to the liquidation estate” and was to receive the sale proceeds in terms of section 53 of IBC.

3. The Liquidator further highlighted that Regulation 21 uses the words “may prove”, which is discretionary and not mandatory. In contrast, section 77 uses the word “shall” which is mandatory and binding.

4. Additionally, the Liquidator argued that if there is a conflict between section 77 and Regulation 21, Regulation 21 of the Liquidation Regulations issued under section 240 of the IBC will have to give way to section 255 of the IBC, which amended section 77(3) of the Companies Act explicitly giving more weightage to section 77 of Companies Act 2013 in matters of registration of charges on a company’s assets or properties.

5. The Liquidator also drew attention to section 20(4) of the SARFAESI Act 2002, which reads:

The provisions of this Act pertaining to the Central Registry shall be in addition to and not in derogation of any of the provisions contained in the Registration Act, 1908 (16 of 1908), the Companies Act, 1956 (1 of 1956), the Merchant Shipping Act, 1958 (44 of 1958), the Patents Act, 1970 (39 of 1970), the Motor Vehicles Act, 1988 (49 of 1988), and the Designs Act, 2000 (16 of 2000) or any other law requiring registration of charges and shall not affect the priority of charges or validity thereof under those Acts or laws.

Accordingly, the Liquidator argued that SARFAESI Act 2002 is ‘only in addition and not in derogation of’ the provisions of Companies Act 2013 and any other law. Therefore, registration with CERSAI under SARFAESI Act 2002 cannot affect the priority of charges or validity thereof under those other Acts or laws.

NCLAT’s judgment

The NCLAT noted the well-established principle of statutory interpretation that a latter law prevails over an older law. Accordingly, it observed that the IBC came into effect on December 1, 2016 while the amendment to section 77(3) of Companies Act 2013 came into effect earlier on November 11, 2016. Further, Regulation 21 of the Liquidation Regulations came into effect on December 15, 2016, after the amendment to section 77(3) of Companies Act 2013. Therefore, NCLAT concluded that the IBC will override the amended section 77(3) of Companies Act 2013. Consequently, it was held that security interest of a creditor can be proved if the same is available only in CERSAI. It is not completely and exclusively dependent on charge registered with RoC under section 77 of Companies Act 2013. As a result, Bizloan should be treated as a secured financial creditor based on its CERSAI registration pursuant to Regulation 21 of the Liquidation Regulations.

Analysis of NCLAT’s reasoning

The NCLAT’s reasoning is problematic. The general principle of statutory interpretation that a new law overrides an old law is based on the assumption that if both laws have been enacted by the Parliament at different points in time, it is reasonable to assume that the latter law reflects the latest policy intent of the Parliament and therefore, should prevail over the earlier law.

When IBC was enacted by the Parliament, section 255 of IBC amended section 77(3) of Companies Act 2013 to clarify that a liquidator appointed under IBC must take into account a charge created by a company only if such charge was registered under section 77 of Companies Act 2013. The Parliamentary intent was clearly to ensure that only charges registered under section 77 of Companies Act 2013 are taken into account in a liquidation under IBC.

The Ministry of Corporate Affairs (“MCA”) notified different provisions of IBC at different points in time because of administrative convenience. Parliamentary intent cannot reasonably be determined based on whether a provision of IBC was notified before another provision of the IBC by the MCA, that too within a span of a month. Therefore, the fundamental basis of NCLAT’s reasoning stands of unsure footing.

Policy issues

The NCLAT noted that RoC and CERSAI registrations serve different purposes. Registration of charges with RoC under section 77 of Companies Act 2013 is relevant for determining priority of claimants of a company during liquidation under IBC or winding up under Companies Act 2013. In contrast, CERSAI registration under section 20 of SARFAESI Act 2002 is relevant for realization of security interests by banks and notified financial institutions through the SARFAESI Act 2002. It is also noted that CERSAI registration helps in fraud prevention by allowing lenders to check if the asset being offered as security is already hypothecated or mortgaged.

On closer examination, these stated purposes do not appear to be mutually exclusive. When a bank or a notified financial institution extends secured credit to a company, the borrower company is mandated by law to register the charges with the RoC under section 77 of Companies Act 2013. This RoC data is available for public inspection. Potential lenders to the company can use the RoC data to check if the company has already given any of its assets or properties as security to any prior lender(s). Clearly, fraud prevention in corporate lending by banks and notified financial institutions cannot be a reason for setting up CERSAI.

CERSAI becomes relevant only for fraud prevention in the case of loans extended by banks or notified financial institutions to non-corporate borrowers such as individuals, sole proprietorships, societies, partnerships etc. The RoC does not have information on prior borrowings by such non-corporate borrowers or the existing security on the assets or properties of such borrowers. In such cases, CERSAI plays a legitimate role in fraud prevention.

The problem in the current institutional design lies is the overlap between RoC, CERSAI and IUs with respect to corporate secured lending. Banks and notified financial institutions have a strong incentive to register security interests in corporate lending transactions with CERSAI because it enables them to enforce such security interests through the special out-of-court enforcement mechanism under SARFAESI Act 2002. These lenders also have an incentive to get the same information filed with an IU so that they can rely on the IU’s record of default in insolvency proceedings under IBC. And the corporate borrower is anyways legally mandated to register the security with RoC under Companies Act 2013. Overall, these laws have created layers of institutions over one another for the same purpose, muddying the functional clarity between RoC, CERSAI and IUs.

Conclusion

The blurring of functionalities between the RoC, CERSAI and IUs not only creates avoidable transaction cost in corporate secured credit transactions, it also leads to legal risks around security creation as the Bizloan judgment illustrates.

Registration of a particular security interest against assets or properties of a particular corporate debtor should be done only once. Let’s assume that the registration agency is RoC. The corporate debtor should register a particular security interest only once with the ROC. In case of default, that RoC registration alone should be enough for banks and notified institutions to use enforcement rights under SARFAESI against such corporate debtors. Similarly, the same ROC registration alone should be adequate proof of security interest against a corporate debtor for the purposes of IBC. The law should not require the same security interest against the same corporate debtor to be registered with CERSAI or any IU.

CERSAI would, of course, remain relevant for registration of security interests against non-corporate borrowers. The case for IUs is more nuanced. The BLRC had envisaged an open competitive industry in the market for information required for insolvency and bankruptcy. This should be achieved by enabling multiple private competing businesses to perform the role of RoC, which would require a fundamental rethinking of the RoC as a state monopoly under Companies Act 2013. Adding an additional layer of IUs over the existing RoC to perform exactly the same function is not exactly the reform that the BLRC had envisaged.

The legal mechanics of achieving these outcomes is not particularly complex. Suitable amendments would be required to Companies Act 2013, SARFAESI Act 2002 and Insolvency and Bankruptcy Code 2016 and some subordinate legislations issued under these statutes. But first of all, the MCA (for RoC and IUs) and Ministry of Finance (for CERSAI) need to recognize the problems with the current laws on registration of security interests and agree on the policy pathway ahead.

The author is a lawyer.

On the usefulness of Parliamentary law in achieving fiscal responsibility

by Pratik Datta, Radhika Pandey, Ila Patnaik and Ajay Shah.

Economists in India have long pondered the design of a fiscal rule. It is felt that once that ideal rule is embedded into the FRBM Act, we would solve the long-standing excesses of Indian public finance.

Pratik Datta, Radhika Pandey, Ila Patnaik and I looked under the hood, at the legal mechanisms through which such a Parliamentary law works. In a recent paper, Understanding deviations from the fiscal responsibility law in India, we argue that the difficulty lies not in economics but in the Indian constitutional arrangement. Because the budget is enacted through a `money bill', it can readily contain clauses that amend the FRBM Act. We argue that the problem with the FRBM Act lies not in the economic thinking but in the notion that Parliamentary law can constraint leviathan.

On the subject of public finance, the following design elements are embedded in the Constitution:

1. The executive cannot raise money (tax or borrow) or spend money without the authority of the Parliament.
2. The power to raise money (tax or borrow) or spend money belongs exclusively to the Lok Sabha. The philosophy of checks and balances associated with the presence of the Rajya Sabha, so eloquently described by Suyash Rai in 2016, is absent when it comes to money bills.
3. The Parliament cannot authorize expenditure except on demand by the Executive.
4. The Parliament cannot authorize taxation except on recommendation by the Executive.
5. The Lok Sabha has the power to assent to, reject or reduce but not to increase the amount of any demand made by the Executive under Article 113(2). The Parliament can neither suggest any new expenditure nor propose an increase in demand over and above what the government suggests in the Demand for Grants.

Normative public finance in India needs to grapple with this design of the Constitution. The power of the executive, embedded in this design, should be seen as part of the larger problem of the Indian administrative state. A generation of public finance economists in India have tried to solve the chronic deficits of the union government through Parliamentary law. We suggest that this is not a fruitful line of inquiry.

Management takeover under SARFAESI Act - A zombie law

by Pratik Datta.

Introduction

Ever since Caballero et al (2008) coined the phrase, ‘zombie firms’ have attracted much attention in both academic and policy circles. Macey (2021) recently extended the concept to a wholly new genre of zombies - ‘zombie laws’. Freedom from the clutches of zombie laws is a policy priority for India. The Prime Minister himself highlighted the challenge in his recent Independence Day speech. This piece will use the phrase ‘zombie laws’ broadly to refer to provisions of statutes, regulations, and judicial precedents that continue to apply after their underlying economic and legal bases dissipate. Although there are many obvious examples of zombie laws strewn across the Indian legal landscape, this post will illustrate the problem using a slightly more nuanced example. It will explain why section 13(4)(b) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (‘SARFAESI Act’) has become a zombie law since the enactment of the Insolvency and Bankruptcy Code in 2016. To appreciate the original rationale behind this provision, it would be useful to set out the broader legislative backdrop.

Background

Section 69 of the Transfer of Property Act, 1882 allows only some mortgagees the right to sell the mortgaged property (security) without court intervention. This right is not available where the mortgagor is of native origin or where the mortgaged property is situated outside presidency towns or any notified area. This legislative design at the time was meant to ensure that the law does not inadvertently empower unscrupulous moneylenders (as mortgagees) against vulnerable native mortgagors in mofussil towns and villages across India. In contrast, European mortgagors in presidency towns were presumed capable enough to take care of their own interests.

Post-independence, this limited right to sell mortgaged property without court intervention proved unsatisfactory for a state-led financial system. Instead of reforming the general law, the Transfer of Property Act, special statutes were enacted to vest the power of sale without court intervention in certain financial institutions like Land Development Banks and State Finance Corporations (‘SFCs’). For example, section 29 of the State Finance Corporations Act, 1951, empowered an SFC to take over the management, possession, or both, of the borrower industrial concern for recovery of its dues. If the borrower still didn’t pay up, the SFC could sell the unit to recover its dues.

In late 1990s, demands were made to extend similar powers to banks and financial institutions to tackle the fledgling non-performing assets problem. This demand resonated with the Andhyarujina Committee, which in March 2000 recommended a special law to empower banks and financial institutions to take possession of securities anywhere in India and sell them for recovery of loans without court intervention. The SARFAESI Act 2002 was the result of this policy thinking.

Section 13 of SARFAESI Act empowers a secured creditor (bank or financial institution) to enforce a security interest created in its favour without court intervention anywhere in India. On default by a borrower, the creditor may serve a notice in writing to the borrower to repay in full within 60 days of receiving such notice. If the borrower fails to comply, the creditor may take recourse to various measures under section 13(4). Clause (b) of section 13(4) initially empowered banks and financial institutions to take over management of the secured assets of the borrower including the right to transfer by way of lease, assignment or sale and realise the secured assets.

In 2004, section 13(4)(b) was amended to empower banks and financial institutions to take over not only the ‘management of the secured assets’, but the entire ‘management of the business’ of the borrower company without court intervention. This includes the right to transfer by way of sale for realising the secured assets. These powers were not originally envisaged by the Andhyarujina Committee.

A Zombie law

In 2000, the Andhyarujina Committee had envisaged the SARFAESI Act as an exception to the general foreclosure law contained in the Transfer of Property Act. Consequently, SARFAESI Act was designed as a special foreclosure law. Like any other foreclosure law, it dealt only with transfer of security (mortgaged property) and not transfer of corporate control of the borrower’s business from shareholders to creditors (or an administrator). The latter is the subject of corporate insolvency law.

When a corporate debtor faces financial distress, shareholders have a perverse incentive to engage in risky strategies. If the strategy pays off, shareholders benefit. If the strategy fails, the creditors bear the losses. To address this moral hazard inherent in the structure of a limited liability company, corporate insolvency law shifts the power to decide on the future of a financially distressed company from its shareholders to its creditors. The creditors could use insolvency law to either restructure their debt in the company or sale the business as a going concern to a third party. This enables the business to exit financial distress with minimal value destruction.

To achieve this outcome, corporate insolvency laws usually provide sophisticated rules to facilitate collective bargaining by the company’s creditors for debt restructuring, appoint an administrator (resolution professional) to monitor a sale, and market the business publicly to maximise the sale value. They also provide various safeguards to check against unfair wealth transfer away from vulnerable claimants of the corporate debtor such as dissenting financial creditors and operational creditors. These safeguards include several unique provisions dealing with preferential transactions, avoidance transactions, wrongful trading, cram down provisions etc. Implementing these safeguards require court supervision.

Foreclosure laws do not require such complicated rules and safeguards since they simply deal with transfer of security and not transfer of corporate control. As a result, court supervision is not as relevant in foreclosure laws. Since SARFAESI Act was initially designed as a special foreclosure law, neither did it provide for the usual safeguards necessary during transfer of corporate control nor did it mandate court supervision to protect vulnerable claimants during such transfers.

The 2004 amendment fundamentally altered this basic design of SARFAESI Act as a foreclosure law. The amended section 13(4)(b) empowered a secured creditor to take over control of the corporate debtor’s business and decide on its future through a sale, a function akin to that of a corporate insolvency law. Yet, unlike a corporate insolvency law, the amendment did not introduce any safeguard or court supervision during takeover of management and subsequent sale of the distressed business. Effectively, the 2004 amendment inserted selective features of corporate insolvency law within a foreclosure law. As a result of this legislative mashup, the amended SARFAESI Act vested disproportionate powers with secured creditors, without safeguarding the interests of other claimants of a corporate debtor. This is not expected of either a foreclosure law or a corporate insolvency law.

This hybrid section 13(4)(b) of SARFAESI Act could have been justified in 2004 as a mechanism to achieve going concern sale of distressed businesses in the absence of a modern corporate insolvency law in India. In 2016 however, India got a comprehensive corporate insolvency law - the Insolvency and Bankruptcy Code (‘IBC’). The IBC now provides a well-defined mechanism to take over management of a distressed corporate debtor to achieve a going concern sale.  On triggering the IBC, the promoter loses control of the corporate debtor. A resolution professional takes over the management, invites plans from potential investors, and places the eligible plans before a committee of financial creditors. This committee can approve a resolution plan by not less than 66% voting share. Such a resolution plan becomes binding only after it is approved by the court (adjudicating authority). Given such elaborate mechanism (with appropriate safeguards) to achieve going concern sales under the IBC, the underlying economic and legal bases for section 13(4)(b) of SARFAESI Act have dissipated. Yet, when SARFAESI Act was amended in 2016 to harmonise it with the IBC, section 13(4)(b) was not revisited. This provision lives on in the statute book only as a zombie law.

Continued existence of such a zombie law is not only unnecessary but it can also be harmful. For instance, the IBC provides stringent safeguards to prevent unfair wealth transfer from dissenting financial creditors and operational creditors. In contrast, section 13(4)(b) of the SARFAESI Act is designed to protect only the interests of secured creditors. It does not offer any credible safeguard for other claimants of a distressed corporate debtor. Therefore, continued use of this section of the SARFAESI Act to take over the management of a distressed corporate debtor without court intervention is detrimental to a wide range of corporate stakeholders.

This problem could be resolved simply by amending section 13(4)(b) to revert to its pre-2004 position. Banks and financial institutions should be able to use section 13(4)(b) only to take over the ‘management of the secured assets’ of the corporate debtor without court intervention and not the management of its entire business. The latter should be permissible only under the IBC. This legal architecture would restore the character of the SARFAESI Act as a special foreclosure law, as originally recommended by the Andhyarujina Committee.

Conclusion

Section 13(4)(b) of SARFAESI Act became a zombie law with the introduction of the IBC. Many such zombies remain scattered across the Indian legal landscape. The government had in 2014 taken a conscious initiative to repeal such laws. Such initiatives are mostly ad hoc. There is no institutional mechanism to tackle the menace. While highlighting this lacuna, former Finance Secretary Dr. Vijay Kelkar suggested that every new economic legislation should ideally have a sunset clause. Incorporating such clauses could nudge the development of requisite institutional capacity to periodically review parliamentary laws and check the rise of the zombies.

Pratik Datta is a Senior Research Fellow at Shardul Amarchand Mangaldas & Co. All views expressed are personal. The author thanks Rajeswari Sengupta, Ajay Shah and two anonymous referees for their useful suggestions.

Indian Supreme Court on virtual currency: Regulatory governance implications

by Pratik Datta and Varun Marwah.

The Indian Supreme Court in IMAI v. RBI (‘Crypto Judgement’) recently struck down a Reserve Bank of India (‘RBI’) circular that prohibited entities regulated by it from dealing or settling in Virtual Currencies (‘VCs’). While many commentators have lauded the outcome, the judgement itself is a milestone in the history of jurisprudence on rule of law and the working of regulators in India.

In this blog, we contextualise this decision in the broader context of regulatory governance in India. We argue that this decision may not be sufficient to nudge regulators to improve their internal governance arrangements. Instead, deeper legislative reforms are needed along the lines of the US Administrative Procedure Act ('APA') and the draft Indian Financial Code ('IFC').

Regulatory governance in India

When India embarked on a market oriented reform in early 1990s, there was a desire to break away from central planning and government control towards creation of competitive private markets in different sectors. This led to proliferation of specialised statutory regulators across sectors. The dominant motive behind setting up new regulators was to signal credibility to private investors and financial institutions. Another important objective was to create technocratic specialisation, which would have been difficult within the administrative constraints of government departments. Given these priorities, there was hardly much focus on regulatory governance, that is, the formal processes to be followed by a regulator while performing its internal functions. Consequently, the parliamentary statutes setting up these regulators did not provide much guidance on regulatory governance.

Lack of regulatory governance often leads to poor regulatory outcomes. For instance, Roy et al (2018) explains that poor legislative processes within a regulator may prevent its board from systematically evaluating the management’s proposals to regulate. It may also restrict the board from receiving appropriate feedback from regulated entities about proposed regulations. Therefore, one would have reasonably expected the Indian regulators to voluntarily adopt such regulatory governance norms through regulations.

However, the regulators did not make any systematic effort to improve their own regulatory governance. Krishnan and Burman (2019) note that the administrative processes within regulators are strikingly similar to those of government departments. This is because, at least in the initial days, most members as well as officials of these regulators came from the government. In absence of any statutory guidance, they transplanted the administrative processes of the government into the regulators. This became a source of deeper problems.

A statutory regulator is materially different from a government department. Unlike a government department, a regulator concentrates legislative (regulation-making), executive (monitoring and supervision) and judicial (issuing orders) powers. Moreover, the frequency and volume of legislative instruments issued by a regulator is significantly higher than most government departments. None of these unique features of a regulator are addressed by transplanting government processes within the regulator.

Given this vacuum in regulatory governance both in external administrative law (the statute) as well as in internal administrative law (regulations, circulars etc.), judicial precedents came to play a visibly important role in shaping regulatory governance in India. An analysis of these judicial precedents by Krishnan and Burman (2019) reveals two interesting features. First, the judiciary has generally been deferential towards the functioning of regulators, except in cases of blatant disregard of process. Second, judicial review of legislative actions of regulators has been rare. Even in such rare occasions, the ultra vires doctrine has been used to strike down regulations issued without appropriate legal powers. To the best of our knowledge, the only instance where the Indian Supreme Court struck down a regulation for inadequate regulatory governance was in COAI vs. TRAI ('Call Drop Judgement') in 2016. And now, the Crypto Judgement adds to this nascent jurisprudence.

The Crypto Judgment

On April 6, 2018, the RBI issued a circular prohibiting RBI regulated entities from dealing or settling in VCs (‘Circular’). The Circular was challenged by the Internet and Mobile Association of India (‘IMAI’) before the Supreme Court. The court struck down the Circular for infringement of Article 19(1)(g) of the Constitution of India. Article 19(1)(g) guarantees the fundamental right to conduct trade and business in India subject to reasonable restrictions that may be imposed by law in public interest. The Apex Court held that the prohibition in the Circular was an unreasonable restriction on this fundamental right to trade (in VCs and to operate VC exchanges) in India, because it was disproportionate.

The Apex Court found the Circular to be disproportionate primarily on two grounds:

First, RBI did not adduce any cogent evidence of the likely harm that its circular sought to address. RBI had not found the activities of VC exchanges to have actually adversely impacted any RBI regulated entity. In case any such harm was actually caused, the court expected at least some empirical data about degree of harm suffered by the regulated entities. In the absence of any such harm or any empirical data establishing the degree of harm to regulated entities, the court found the absolute ban on trading of VCs and functioning of VC exchanges to be disproportionate.

Second, RBI did not consider any less intrusive alternative regulatory response. An Inter-Ministerial Committee had initially suggested that an absolute ban would be an extreme tool. This Committee had observed that the same objectives could be achieved through less intrusive regulatory measures, as reflected in the Crypto-token Regulation Bill, 2018. Referring to this observation as well as several other authoritative international sources such as the European Parliament and the Financial Action Task Force ('FATF'), the court found that RBI did not consider the availability of alternatives before issuing the Circular imposing an absolute ban. Consequently, the Circular was held to be a disproportionate measure.

Both these reasons suggest that the Supreme Court expected the RBI to perform a basic Cost-Benefit Analysis ('CBA') before issuing the circular. A CBA would have enabled the RBI to identify multiple possible solutions to the problem and then choose the most appropriate one. Statutory laws in most advanced jurisdictions usually require regulators to conduct a CBA before issuing a regulation. In contrast, Indian laws do not impose such high regulatory governance standards on regulators. But this may soon need to change.

A nascent trend

As highlighted by Krishnan and Burman (2019), judicial review of legislative action by a regulator is rare in India and in the rarest of the rare cases, such judicial review hinges on regulatory governance standards. The Crypto Judgement is one such rare instance. To the best of our knowledge,the only other instance was in COAI vs. TRAI (‘Call Drop Judgement’) in 2016. In that case, the Supreme Court had similarly struck down a regulation issued by Telecom Regulatory Authority of India ('TRAI') for inadequate regulatory governance.

The Telecom Consumer Protection (Ninth Amendment) Regulation, 2015 required telecom operators to credit Rs. 1 to a calling customer for a maximum of three call drops per day. A number of telecom operators challenged this regulation for violation of Article 14 (arbitrariness) as well as section 11(4) of the TRAI Act, 1997, that imposes a broad legal obligation on TRAI to act transparently. The Supreme Court held TRAI’s action to be arbitrary since it had failed to substantiate how it arrived at a compensation amount of Rs. 1 and that too only to the calling customer. The court concluded that the regulation was based on mere guess work without any intelligent care and deliberation.

Further, the telecom operators had raised these issues in public comments, but TRAI had failed to consider their arguments while framing the regulations. Relying on the transparency requirements under section 11(4), the court held that TRAI should have responded in a reasoned manner to those comments which raised significant issues. Evidently, the Supreme Court struck down the call drop regulation due to inadequate regulatory governance standards in issuing regulations. For this, the court resorted to a broad interpretation of the transparency obligation under the TRAI Act, 1997.

In contrast to the TRAI Act, 1997, the RBI Act, 1934 does not explicitly impose any statutory obligation on RBI to be transparent or proportionate in regulation-making. The Supreme Court in the Crypto Judgement applied the general administrative law principle of proportionality to strike down the Circular. This has now set a precedent for holding regulators accountable while exercising their legislative powers, irrespective of whether their parent statute explicitly imposes any obligation of transparency or proportionality while issuing regulations.

Potential consequences

These two precedents undoubtedly empower citizens against arbitrary regulatory actions. Regulations issued by different regulators are likely to face legal challenges in the future on grounds of inadequate regulatory governance. Only time will tell whether such challenges would succeed. If they succeed, one would reasonably expect the respective regulators to take corrective actions to avoid more legal challenges (and the associated costs). That would indeed be the best outcome. However, research suggests, this may not be so.

Krishnan and Burman (2019) interviewed three past members of boards of Securities and Exchange Board of India, Pension Fund Regulatory and Development Authority and Competition Commission of India to understand whether statutory regulators undertake corrective exercises if their actions are struck down by courts or tribunals. The unanimous opinion was that regulators have no systematic process to analyse the decisions of courts and tribunals in order to correct defects in procedures and processes. Therefore, risk of future litigation by itself may not result in regulators improving their internal governance. Instead, deeper legislative reforms would be necessary.

Case for legislative reforms

Litigation is welcome in a democracy. It is the most potent tool in the hands of the citizenry to keep a check on the excesses by the powers that be, including the regulators. That tool is not to be blunted at any cost. But what is in question is its efficacy, delays apart, in laying down regulatory governance standards in a holistic manner by taking into consideration all aspects of regulation making.

Robust legislative reforms would be significantly better at improving Indian regulatory governance standards compared to case-law jurisprudence. A litigation at most raises few regulatory governance issues relevant to that particular case. The process takes a long time to complete, moving through the appeals process. Moreover, there could be debate on the applicability of a judgement delivered with respect to the regulations made by one regulator under one statute, to the regulations made under another statute by another regulator. This creates uncertainty in the regulatory regime. In contrast, a parliamentary legislation on regulatory governance would provide a relatively wholesome framework. Such a law could help India leapfrog to higher regulatory governance standards, instead of relying on piece-meal case-law jurisprudence to develop over decades. Between litigation and legislation, legislation is certainly a better tool to improve regulatory governance.

Proposed legislative reforms

In the Call Drop Judgment, Justice Nariman had exhorted the Indian Parliament to enact a regulatory governance law along the lines of the APA in the USA. The APA lays down standard procedures for rule making and adjudication in USA. It applies to all executive branches of the federal government and even independent agencies, subject to suitable modifications. The APA also prescribes standards for judicial review of agency actions.

In India, the Financial Sector Legislative Reforms Commission ('FSLRC') had recommended similar processes for financial regulators in 2013. These recommendations were hardcoded into the draft IFC. Based on this, the Ministry of Finance had released a handbook on regulatory governance in 2016 for voluntary adoption by the financial sector regulators. Evidently, the policy thinking on these issues is mature enough for initiating necessary legislative reforms.

Currently, India does not have a comparable statute like APA or the draft IFC. Each Indian regulator has its own unique regulatory governance standards embedded in its governing statute or in some cases, even in regulations. These standards hardly match up to the global best practices. For instance, Burman and Zaveri (2019) measured the performance of four prominent Indian regulators on a responsiveness index based on international best practices on public consultation process. None of the regulators scored more than 5 out of 10. The situation is likely to be worse in government ministries and departments, since their processes are based more on custom and lack any statutory backing. This creates a situation where not only regulators are following different statutory standards, but government ministries and departments are functioning without any statutory standards at all.

India needs an overarching regulatory governance statute along the lines of APA and draft IFC, applicable to all regulators and government departments. This law should have two broad elements. First, it should lay down standard processes for framing rules and regulations, conducting affairs of the regulatory board, annual reporting, approval for regulated activities, investigation and adjudication. For regulation-making, the minimum standards of public consultation, where feasible, and CBA must be embedded in the statute. While developing such CBA standards, policymakers must ensure adequate flexibility to regulators so that a CBA need not necessarily be quantitative and could also be purely forward looking in nature. Second, the law should lay down precise standards for judicial review of actions taken by government departments and regulators under the law. Judicial review should be restricted to ensure that minimum standards of regulatory governance are complied with. Overall, such a law would enhance regulatory governance and improve predictability.

Conclusion

Since the liberalisation of 1990s, the optimism about specialised regulators has been replaced with concerns about regulatory governance in these institutions. Judicial precedents such as the Crypto Judgement and Call Drop Judgement help address these concerns to some extent. However, the risk of future litigation by itself may not nudge regulators to improve their internal governance. Instead, deeper legislative reform along the lines of APA in the USA and the draft IFC in India, is necessary. Policymakers would do well to heed Justice Nariman’s advice. The good news is, the FSLRC suggested IFC has the draft for consideration.

References

Burman and Zaveri, Measuring regulatory responsiveness in India: A framework for empirical assessment, William & Mary Policy Review (2019).

Krishnan and Burman, Statutory regulatory authorities: Evolution and impact, in Kapur and Khosla, Regulation in India: Design, Capacity and Performance (2019).

Roy, Shah, Srikrishna, Sundaresan, Building state capacity for regulation in India, in Kapur and Khosla, Regulation in India: Design, Capacity and Performance (2019).

 

Pratik Datta is a Senior Research Fellow and Varun Marwah is a Research Fellow, at Shardul Amarchand Mangaldas & Co. We thank Mr. Shardul S. Shroff, Mr. Sudarshan Sen, Mr. Prashant Saran, Mr. Gopalkrishna S. Hegde and two anonymous referees for useful comments. All views expressed are personal.

IBC (Amendment) Bill, 2019: Implications for judicial review of resolution plans

by Pratik Datta and Varun Marwah.

Shroff and Misha (2019) had earlier highlighted that excessive judicial discretion in corporate insolvency resolution is contrary to the express provisions of the Insolvency and Bankruptcy Code, 2016 (“IBC”). Indian policymakers have now recognized this problem. Accordingly, the IBC (Amendment) Bill, 2019 (“2019 Bill”) has been passed by the Parliament.

The immediate trigger for this reform was the National Company Law Appellate Tribunal (“NCLAT”) judgment dated July 4, 2019, in the resolution of Essar Steel Ltd. (“Essar judgment”). In this case, the NCLAT found ArcelorMittal’s resolution plan to be discriminatory. Accordingly, it went on to modify the plan such that the financial and operational creditors enjoy the same recovery rate. In the process, it obliterated the distinction between secured and unsecured creditors. Moreover, the NCLAT also held that the statutory waterfall under section 53 of IBC does not apply to distribution under a resolution plan. By disrupting the basic fundamentals of banking, this decision caused much concern in the Indian financial sector. Among others, the 2019 Bill seeks to address these concerns as well.

In this backdrop, we contextualize the amendments proposed by the 2019 Bill within a hypothetical theoretical framework to analyse their implications on the scope of judicial review of resolution plans under IBC.

Theoretical framework

An insolvency law should have two broad objectives. First, it must achieve the most efficient economic outcome for the insolvent company. This outcome could be going concern sale, restructuring, liquidation or a combination of these outcomes. Second, the value (cash/non-cash) received from the outcome must be distributed among the claimants of the company according to the waterfall provided in the insolvency law.

In a going concern sale, the business of the insolvent company is marketed for price discovery, that is, auctioned. Potential buyers submit their price bids in their respective resolution plans. Once the best price is discovered, the price signifies the precise value of the business. The successful buyer deposits this value in cash or its equivalent in an escrow account and takes over the business, immediately putting the assets to their best use. The resolution plan need not deal with how the deposited value would be distributed among the insolvent company's claimants.

The value deposited in the escrow could be separately distributed by the resolution professional among the claimants of the insolvent company as per the statutory waterfall. This scheme of distribution cannot be altered unless a claimant(s) affected by such alteration specifically consent to it. However, the resolution plan need not deal with any of these distribution issues. Therefore, the resolution plan cannot in any way unfairly discriminate against any claimant. Consequently, there is no need for judicial review of resolution plans to ensure fair and equitable distribution in a going concern sale for cash or its equivalent. The same logic applies to distribution in liquidation involving sale of assets for cash or its equivalent.

However, going concern sales are not always possible or desirable. For instance, during a recession, there could be no buyers in the market. Or even if there are buyers, there could be an oversupply of similar assets in the market due to industry wide factors, pushing down the price for such assets. In such circumstances, instead of a going concern sale to a new buyer, the claimants of the insolvent business may be better off by “selling” the business to some or all of the existing claimants themselves. Such “hypothetical sale” is commonly referred to as restructuring.

In such a restructuring, there is no auctioning of the insolvent business to potential outside buyers. As a result there is no price discovery and the precise value of the insolvent business in cash or its equivalent is not evident. Therefore, the notional distribution of rights (that is, securities in the restructured company) among the claimants is conceptually very different from the distribution of value in cash or its equivalent in a going concern sale.

Unlike a going concern sale, the notional distribution of rights in a restructuring has to be determined by the resolution plan. This creates two unique problems. First, given the uncertainty regarding the value of the restructured business itself, there could be ambiguity about how much value should each claimant receive under the waterfall. Second, even if the value payable to each claimant is agreed upon, there could be ambiguity regarding the value of the rights (that is, securities of the restructured company) allocated to each claimant by the resolution plan. These unique problems create a peculiar risk in restructuring - the rights distributed by the resolution plan may give one or more classes of claimants a value lesser than what they are entitled to under the statutory waterfall. This is often referred to as “unfair discrimination”. To prevent such unfair discrimination, judicial review of resolution plans in non-cash restructuring transactions is necessary.

This conceptual distinction between sale (cash) and restructuring (non-cash) transactions is critical. Minority creditor protection mechanisms including judicial review is necessary primarily for restructuring (non-cash) transactions; not so much for sale (cash) transactions. For example, Chapter 11 of the US Bankruptcy Code deals with restructuring. Section 1129 in this chapter requires a restructuring plan to provide every creditor at least the liquidation value. This safeguard is not applicable to sale transactions (for cash) under Section 363 of Chapter 3 of the US Bankruptcy Code. Evidently, the US law clearly recognises the difference between sale (cash) and restructuring (non-cash) transactions.

So far we have only dealt with neat categories of going concern sale and restructuring. However, in reality, resolution plans could propose transactions that may not squarely fall within these simple categories. For instance, some new investors may pay up cash to buy some equity or take on some debt of the restructured company, while existing lenders may swap some of their debt into equity of the restructured company. Such transactions would then be a hybrid
exhibiting features of both a going concern sale for cash as well as that of restructuring for non-cash considerations. It is important to recognise that such transactions effectively help preserve the going concern value of the insolvent business. Therefore, in such transactions, each claimant of the insolvent company must get at least the amount of value (cash, non-cash or both) that it would have received had the company been sold off as a going concern for cash or its equivalent. In other words, even in such transactions, the distribution of value must follow the statutory waterfall. And this distribution function has to be performed by the resolution plan itself. Consequently, the risk of unfair discrimination may arise even in such transactions, rendering judicial review of resolution plans necessary for minority creditor protection.

Shortcomings in IBC and the proposed solutions

The IBC, as initially envisaged, differed from this ideal theoretical framework on two counts.

First, the statutory waterfall under section 53 of the IBC was initially envisaged only for distribution in liquidation. The Essar judgment held that section 53 cannot apply to distribution proposed by a Resolution Applicant. Consequently, in sale (cash) or restructuring (non-cash) transactions, a resolution plan would have to follow a scheme of distribution different from the statutory waterfall, opening up flood-gates of unfair discrimination allegations.

The 2019 Bill attempts to address this problem. Section 30(2)(b) is proposed to be amended to make the statutory waterfall under section 53 applicable to distribution in resolution as well. This clarity should reduce allegations of unfair discrimination in resolutions and help cut down on unnecessary judicial review in going concern sales.

Second, the IBC does not clearly recognise the conceptual difference between cash and non-cash transactions. Unlike US Bankruptcy Code, section 30(2) of IBC applies minority creditor protection mechanisms, meant primarily for restructuring (non-cash) transactions, to even sale (cash or its equivalent) transactions. This provision has been liberally interpreted by the NCLAT in Binani Industries to hold that every resolution plan must be fair and equitable – a vague judicially determined standard. Consequently, every resolution plan is now open to judicial review without any clear purpose. This has unnecessarily delayed many corporate insolvency resolutions. For example, the Essar resolution has been ongoing for almost 2 years, even after approval of a resolution plan by the CoC.

The 2019 Bill attempts to address this problem too. The proposed Explanation 1 to section 30(2)(b) explicitly clarifies that if a resolution plan follows the order of priority under section 53, it will satisfy the ‘fair and equitable’ standard. This explanation should narrow down the focus of judicial review to ensure distribution as per the statutory waterfall.

Conclusion

Judicial review under IBC should be focused to ensure that distribution of value is as per the statutory waterfall under section 53. In going concern sales for cash or its equivalent, distribution of value among claimants based on the waterfall would be relatively unambiguous and should not require judicial review of resolution plans. In restructuring or other hybrid transactions involving non-cash consideration, notional distribution of non-cash value in form of rights to the restructured business (that is, its securities) is likely to be contentious, given that distribution will be provided by the resolution plan and/or issues relating to price discovery and valuation. This could create opportunities for value extraction from minority to majority claimants through resolution plans in such restructuring or hybrid transactions. Judicial review of resolution plans may be necessary only to prevent such unfair value extractions in violation of the statutory waterfall. But once distribution among claimants as per the statutory waterfall is achieved, there is nothing further to be gained by subjecting each and every resolution plan to judicial review. The 2019 Bill has now modified the law to achieve this optimal outcome. Whether this outcome is achieved in practice will depend largely on how the judiciary interprets and implements these new provisions.

References

Shroff, S. and Misha, A question of balance, via the code or otherwise, Asia Business Law Journal, May 13, 2019.

Datta, P, Value Destruction and Wealth Transfer under the Insolvency and Bankruptcy Code, 2016, NIPFP Working Paper No. 247, Dec. 2018.

 

Pratik Datta is a Senior Research Fellow, and Varun Marwah is a Research Fellow at Shardul Amarchand Mangaldas & Co. We thank Mr. Shardul S. Shroff and four anonymous referees for useful discussions and comments.

Pick your poison: Money bill privilege or government shutdown?

by Pratik Datta and Radhika Pandey.

On January 2, 2019, the government introduced a bill in the Lok Sabha to amend the Aadhaar Act, 2016. Once again, the opposition is up in arms. Once again, there are apprehensions that this amendment bill will be certified as a money bill to avoid the opposition parties in the Rajya Sabha. In a parallel development, Jairam Ramesh filed a review petition against the Puttaswamy decision last week. The majority of the judges in that case had upheld the enactment of the Aadhaar Act, 2016, as a money bill. They refused to let judicial review be used as an institutional check to prevent abuse of money bills by Lok Sabha. The lone dissent was by Justice Chandrachud, who referred to such abuse as a `fraud on the constitution'. Ramesh's review petition now seeks to reopen this issue.

In this backdrop, this post revisits the basics to better appreciate the rationale for the Lower House's money bill privilege. In doing so, we highlight two extreme constitutional designs to overcome a common problem - how to decide on the funding for government agencies?

The problem

All government agencies need funds to function. These funds need to be appropriated from the state's finances every year. In liberal democracies, this funding decision cannot be left to unelected executives. Instead, the citizens through their elected representatives should have a say in this - should funds be released to the government? If so, how much? Consequently, the legal mechanism for such annual appropriation requires the citizens' elected representatives in the legislature to pass an appropriation bill into a law. In India, money bills perform this critical function (see Article 110(1)(d)).

In a bicameral legislature, an ordinary bill becomes a law usually after it is approved by the Lower House, the Upper House and the President. If the bill fails to receive approval from any one of them, it does not become a law. In that event, the prior law continues. Life moves on. Not so for an appropriation bill (or money bill in India). Failure to enact such a law would result in a funding crunch, potentially causing a government shutdown.

Solutions

There are broadly two different ways of resolving this problem.

The simpler solution is to leave it to negotiation among politicians in the Lower House and the Upper House, and the President. This option is costly because of coordination and hold-up costs. And till the negotiated solution is reached, the government remains shutdown, wasting huge public resources.

An alternative solution is to reduce the number of approvals needed to enact an appropriation bill into a law. The Lower House, being directly elected, could be empowered to enact an appropriation bill into law without any approval from the Upper House and the President. However, there is a flip side to this arrangement. The Lower House could abuse this privilege by camouflaging ordinary bills as appropriation bills to avoid opposition from Upper House and the President. Consequently, this arrangement may resolve the government shutdown problem at the cost of diluting the sanctity of the bicameral legislature itself.

Interestingly, the efficacy of these two different solutions are currently being tested in one of the world's oldest democracies - the USA - and the world's largest democracy - India.

USA

The American federal government has been partially shutdown since December 22, 2018. This is the 3rd shutdown of the US federal government in 2018 and the 21st in American history. However, this is the first shutdown of any significant length since 2013, when the government was shut for 16 days. Such government shutdowns arise out of failure to enact appropriation laws.

Under the American constitution, the House of Representatives (Lower House) alone can introduce an appropriation bill. The Senate (Upper House) cannot do this. An appropriation bill passed by both the Lower House and the Upper House must also be approved by the President to become an appropriation law. A direct consequence of this constitutional design is that either the Upper House or the President could block an appropriation bill, starving the federal government of funds. Further, the Anti-deficiency Act prohibits American executive branch agents from authorising expenditures or obligations in excess of the amount appropriated by Congress. Consequently, failure to pass an appropriation law results in government shutdown in the USA.

The ongoing shutdown started when President Trump refused to approve the appropriation bill for the budget for the current fiscal year that began on October 1, 2018. The President refused to approve the bill since it did not provide necessary funds for building the wall on the US-Mexico border. There are now two options to break this deadlock. Either, the proponents of the budget could negotiate with the President to get his approval on the appropriation bill. Or, the bill could be enacted even without President's approval, if a super-majority (ie. two-third) in each House approves the bill.

Both these routes require hard bargaining and trade-offs by Congressmen across party lines. The reason America accepted this cumbersome constitutional design is possibly best captured in Alexander Hamilton's following observation: "[t]he injury that may possibly be done by defeating a few good laws will be amply compensated by the advantage of preventing a few bad ones".

India

India seems to have adopted the exact opposite position. Our constitution, as interpreted by the Supreme Court, favours having a few good laws at the cost of suffering a few bad ones. After the Puttaswamy judgment, the Indian Lower House could potentially enact any bill, appropriation bill or not, into law using the money bill route. In the process, it can completely bypass any opposition from Upper House or the President. Even judicial review is not permitted. Consequently, there is currently no institutional check on potential abuse of money bills by the Lok Sabha. If left unchecked, such abuse may very well end up being the death knell of our bicameral model of legislature. However, from the perspective of resolving government shutdowns, the Indian system is undoubtedly efficient. India never experiences government shutdowns for failure to enact appropriation laws like in USA.

Conclusion

Is this trade-off worth it? The Indian Supreme Court may soon find itself asking this question. Jairam Ramesh's review petition offers the Supreme Court yet another opportunity to revisit this critical constitutional issue.

 

Pratik Datta and Radhika Pandey are Researchers at the National Institute of Public Finance and Policy.

Value destruction and wealth transfer under IBC

by Pratik Datta.

India experienced a major structural change with the enactment of the Insolvency and Bankruptcy Code, 2016 (IBC). Since its enactment, India's ranking under the Insolvency head in the World Bank Group's Doing Business report has sharply risen from 136 to 103, attracting international attention. Yet, as per IBBI data, till end of September 2018, only 20% of the cases admitted were successfully resolved under IBC, while 80% ended up in liquidation. And now, even the constitutionality of IBC is under serious challenge before the Supreme Court of India for discriminating against operational creditors.

In view of these contemporary challenges facing IBC, my paper titled Value destruction and wealth transfer under the Insolvency and Bankruptcy Code, 2016 argues that many of these challenges fall within two conceptual categories - the value destruction problem and the wealth transfer problem. The paper uses the law and economics literature on insolvency to identify the potential sources of these two problems within the IBC.

Value Destruction Problem (VDP)

A well-designed insolvency law should help in correctly determining if an insolvent business is suffering from financial distress or economic distress. A business is financially distressed when total value of its debt exceeds its net present value. Insolvency law should facilitate a going-concern sale or restructuring of a merely financially distressed business. But a financially distressed business could also suffer from economic distress - the net present value of the business could be less than the total value of the assets of the business were they to be broken up from the business and sold separately (break-up `liquidation value'). In such cases, insolvency law should facilitate liquidation, whether through a going-concern sale or a break-up sale.

A poorly designed insolvency law could inadvertently push a merely financially distressed business into liquidation, causing value destruction. Value destruction could also happen due to delayed restructuring. I refer to these as Value Destruction Problem (VDP).

IBC suffers from VDP

VDP could arise under IBC. Secured financial creditors comprising the super-majority (i.e. 66%) in the Committee of Creditors (CoC) may not necessarily have the right incentives to sustain a merely financially distressed, but not economically distressed, company. This is because the secured creditors are not entitled to going concern surplus. Instead, such creditors are likely to have a stronger incentive to immediately liquidate the financially distressed company and realise the liquidation value, thus destroying the going concern surplus of the company.

To illustrate, let's consider a hypothetical example. Suppose a company has two types of creditors - secured financial creditors and unsecured operational trade creditors. It owes USD100 to its secured financial creditors, USD30 to its unsecured operational trade creditors, and the liquidation value ('L') of the company is USD90. If the company is continued as a going concern for next 6 months, there is a 0.5 probability that in good state ('G') it will be worth USD200 and a 0.5 probability that in bad state ('B') it will be worth USD40. In other words, if the company is continued for the next 6 months, the expected going concern value of the company would be USD (0.5).(200) + (0.5).(40) = USD120. Assuming discount rate to be zero (for simplicity), since the net present value (USD120) is higher than the liquidation value (USD90), the company is not economically distressed. It is only in financial distress because the total debt of the company (USD130) exceeds its net present value (USD120). Therefore, the value maximising option would be to keep the company going, so that both the financial and operational creditors can recover a total of USD120 as against only USD90 if the company is liquidated.

However, if things go well and after 6 months the company is actually worth USD200, the secured financial creditors will still get only USD100, the value of debt owed to them. On the other hand, if things go badly and after 6 months the company is actually worth USD40, they will get the entire USD40. Therefore, the expected return for secured financial creditors would be USD (0.5).(100) + (0.5).(40) = USD70 - much lesser than what they would get in liquidation (USD90). Therefore, the secured financial creditors comprising the CoC would rationally prefer to liquidate the company for USD90, although ideally the company should have been sustained to get USD120. Looked at from this perspective, IBC suffers from VDP.

	L	G	B	E(v)
FCs	90	100	40	70
OC	0	30	0	15
Sh. H.	0	70	0	35
Company's value	90	200	40	120

Wealth Transfer Problem (WTP)

When insolvency law provides cramdown powers to majority claimants to facilitate restructuring, it raises the possibility of abuse. Majority claimants in control over the restructuring of the corporate debtor may be able to advantage or disadvantage different groups of beneficiaries by structuring of the securities, contract rights or other property received by each. They could even abuse this control to derive disproportionate private benefits by transferring wealth away from the dissenting minority claimants through the restructuring plan. Wealth transfer could also happen if valuation of the corporate debtor is left to one particular class of creditors. Senior creditors have an incentive to undervalue the company's business, while junior creditors have an incentive to overvalue it. I refer to these as Wealth Transfer Problem (WTP).

IBC suffers from WTP

The IBC empowers majority financial creditors with 66% vote by value in the CoC to impose a resolution plan on the dissenting minority financial creditors as well as the non-voting operational creditors. However, it does not provide proportionate protection to dissenting financial creditors. Till October 5, 2018, IBC regulations required the resolution plan to identify specific sources of funds to pay the `liquidation value' due to dissenting financial creditors. On October 5, 2018, this minimum protection was removed. Therefore, currently there is no specific provision under the statute or regulations to protect dissenting financial creditors from potential wealth transfer by abusive use of cramdown powers by majority financial creditors.

Further, the IBC overlooks a basic distinction between restructuring and going concern sales. Restructuring, being a hypothetical sale of the corporate debtor's business to the claimants of the corporate debtor, some finite notional value has to be placed on the business of the corporate debtor. Therefore, restructuring requires a valuation benchmark, according to which the rights of each claimant in the restructured business has to be determined. No such problem arises in a going concern sale for cash to a third party after proper marketing exercise. Consequently, no such valuation benchmark is necessary for a sale transaction. However, the IBC uses the liquidation valuation benchmark to protect operational creditors in both restructuring as well as sale transactions. This creates opportunities for wealth transfer from operational creditors in sale transactions under IBC.

To illustrate, assume that a corporate debtor has entered insolvency resolution process under the IBC. It has a going concern value of USD130 and break-up `liquidation value' of USD110. The face value of debts owed to its financial creditors is USD100 and to its operational creditors is USD30. If the company is liquidated on break-up basis, then the financial creditors would get USD100 and the operational creditors would get only USD10. However, if the company is sold for cash to a third party at going concern value, then the financial creditors could get USD100 and USD30 will be left over. Applying the creditor protection rules under the IBC, the financial creditors could approve a resolution plan that provides only the break-up liquidation amount (USD10) to the operational creditors and the remaining USD20 to the lower claimaints like shareholders. This would effectively amount to a wealth transfer from the operational creditors. Looked at from this perspective, IBC suffers from WTP.

Conclusion

Recently, the NCLAT in the Binani case tried to solve the WTP by taking an extreme position. It held (para 48) that a resolution plan must not discriminate against dissenting financial creditors or non-voting operational creditors. This broad non-discrimination principle developed by NCLAT is problematic. It could be misused by out-of-the-money minority financial creditors or non-voting operational creditors to engage in hold-up strategies to extract a better deal for themselves, causing wealth transfer from the majority financial creditors. Additionally, an increase in hold-up costs and coordination costs could in turn result in value destruction. It is rather ironic that in a bid to resolve the WTP under IBC, the Binani ruling could end up creating avenues for further WTP as well as VDP.

Solving the contemporary challenges emanating from the VDP and the WTP under IBC would require deeper policy thinking. Indian policymakers need to take into account the root causes of these problems, as highlighted in this paper. Ultimately, the fundamental legislative design choices underlying IBC may need to be revisited.

 

Pratik Datta is a Researcher at the National Institute of Public Finance and Policy.

Free press and criminal defamation: Inspiration from Africa

by Pratik Datta.

One of the biggest threats to the freedom of speech in India is criminal defamation law. There is a shortfall of criticism in society, and we must always support and protect the critic.

Like the law which criminalised unnatural sex, we inherited the concepts of criminal defamation from the British. Criminal defamation was abolished in the UK in 2009, but it continues to survive in the statute books of many former British colonies. However, as Gautam Bhatia points out, judges in some African countries are increasingly taking a progressive stand against criminal defamation to achieve freedom of speech.

Lesotho

Last week, the Constitutional Court of Lesotho struck down the criminal defamation law as unconstitutional. The petition was filed by the owner and publisher of the Lesotho Times. In 2016, the newspaper had published an article in the satirical section ridiculing the then Commander of the Lesotho Defence Force. A week later, criminal defamation charges were brought against the petitioner. The petitioner in turn challenged the constitutionality of section 104 of the Penal Code that proscribed defamation.

In a concise and succinct judgment, the Court struck down the section broadly on three grounds. First, the court found that the section was broader than necessary to achieve the statutory objective of protecting individual reputation. Second, the court observed that the vagueness of the statutory language could potentially be abused by political powers to silence legitimate criticism. Third, the court reasoned that merely because satire distorts reality, it does not necessarily imply that satire does not serve any useful purpose in a democracy. Accordingly, the court concluded that criminalising satire is an excessive infringement of freedom of expression in a democratic society.

Kenya

Last year, the High Court of Kenya at Nairobi also struck down criminal defamation as unconstitutional. In this case, the petitioners were charged with criminal defamation for their Facebook posts. The petitioners in turn challenged section 194 of the Penal Code that criminalised defamation.

The Court gave two broad reasons while striking down the section as unconstitutional. First, the court argued that criminal defamation law aims to protect individual interest and therefore, cannot be protected as a 'reasonable restriction' exception to freedom of expression which is meant to protect only public interest. Second, the court found that criminalising defamation is not absolutely necessary to achieve the statutory objective of protecting individual reputation. Instead, there are alternative civil remedies available to achieve the same objective. On the other hand, criminalising defamation has serious chilling effects on free speech, making it a disproportionate policy response. Based on these reasoning, the Kenyan High Court struck down criminal defamation law as unconstitutional.

African Court of Human and Peoples' Rights (ACHR)

In 2014, the ACHR overruled the conviction of a journalist by Burkina Faso following charges of defamation for publishing newspaper articles that alleged corruption by a state prosecutor. The primary legal issue was whether the criminal defamation law violated international treaties that Burkina Faso has entered into. The Court reasoned that monetary penalties imposed on the journalist and suspension of his newspaper under defamation laws were disproportionate measures to achieve the statutory objective - to protect the honour of a prosecutor. Instead, civil remedies would have been a more proportionate response. Further, the court held that the threshold for defamation of public figures should be higher. Accordingly, the court found the criminal defamation law violated Burkina Faso's international obligations to protect freedom of expression.

Zimbabwe

In 2014, the Constitutional Court of Zimbabwe declared criminal defamation to be unconstitutional. This case arose out of an article published in the The Standard newspaper which claimed that the Green Card Medical Aid Society was unable to pay its employees and was on the verge of collapse. The Society claimed that these were false allegations and subsequently the journalist as well as the editor of the newspaper were arrested and charged for defamation under section 96 of the Criminal Law Code.

The Court struck down this criminal defamation provision as unconstitutional on the ground that it was disproportionate and was unnecessary to accomplish the statutory objective of protecting individual reputation. Instead, monetary damages in civil law could have achieved the same objective. Further, the judge also observed that such a law could adversely silence free flow of information on public matters. Accordingly, the criminal defamation law was struck down.

Conclusion

It is quite remarkable to see that while judges in African countries have taken progressive steps to weed out a vicious colonial legacy to institutionalise free press, the Indian Supreme Court has dismissed challenges to the constitutionality of criminal defamation in the Indian Penal Code. Indian journalists should take inspiration from the jurisprudential developments in Africa and advocate the removal of this barbaric colonial legacy.

 

Pratik Datta is a Chevening Weidenfeld Hoffmann scholar at University of Oxford.

Commercial wisdom to judicial discretion: NCLT reorients IBC

by Pratik Datta and Rajeswari Sengupta.

When a company defaults on loan repayment, there are various possibilities - the debt could be restructured, the business could be sold as a going concern or the company could be liquidated. The crucial policy question here is: who should make this decision about the company's future? Traditionally, Indian laws have brought an arm of the state - judiciary or executive - to bear on this decision. The Bankruptcy Law Reforms Committee (BLRC) broke away from this tradition and recommended that: when 75% of the financial creditors agree on a resolution plan, this plan would be binding on all the remaining creditors. If, in 180 days, no resolution plan achieves the support of 75% of the financial creditors, the company goes into liquidation. Effectively, no judge or bureaucrat is to substitute for the commercial wisdom of a super-majority of financial creditors. The Parliament adopted this legislative design and enacted the Insolvency and Bankruptcy Code, 2016 (IBC). Recently, the Hyderabad bench of NCLT in K. Sashidhar v. Kamineni Steel shifted this position of law.

The NCLT held that even if the committee of creditors (CoC) fails to approve a resolution plan with 75% of voting share, the tribunal could approve the resolution plan. In short, the future of an insolvent company will be determined not by the commercial wisdom of the CoC but by the tribunal. This decision is not only antithetical to the original legislative intent behind IBC, it also militates against the plain language of the statute.

Background

Kamineni Steel went into insolvency resolution in February 2017. The resolution plan proposed by the resolution professional (RP) was supported by financial creditors who had 66.67% of the voting power. The remaining financial creditors with 33.33% voting power did not support the plan. They preferred liquidation. According to them the liquidation value of the company was higher than the enterprise value. Faced with the threat of imminent liquidation under IBC, the RP approached the NCLT to approve the resolution plan supported by only 66.67% votes.

The company had also been undergoing the Joint Lender's Forum (JLF) process under the aegis of RBI. Before IBC was enacted, RBI had issued the JLF Guidelines in 2014. These Guidelines provided that on payment default by a corporate debtor in a consortium lending arrangement, the lenders were required to form a JLF to explore options to resolve the stress of the debtor. Any restructuring decision agreed upon by 75% of creditors by value and 60% of creditors by number in the JLF would be binding on all lenders. To facilitate timely decision making by the JLF, on May 5, 2017, RBI issued another notification lowering this threshold to 60% of creditors by value and 50% of creditors by number in the JLF.

The RP of Kamineni Steel relied on the 2017 RBI notification to argue before NCLT that since 60% of creditors by value can make binding decisions in JLF, a resolution plan under IBC supported by the same 60% should also be adequate. NCLT agreed with this argument and approved the resolution plan of Kamineni Steel supported by only 66.67% creditors.

Analysing the judgement

The judgement was broadly based on three legal arguments.

Argument 1

It relied on section 30(4) of IBC which states:

The committee of creditors may (emphasis added) approve a resolution plan by a vote of not less than seventy five per cent of voting share of the financial creditors.

The tribunal held that since the legislature used the word "may" instead of "shall" in section 30(4), the 75% vote rule is not mandatory. The potential consequence of using "shall" in this sub-section has been overlooked in this argument. Had the legislature used "shall" instead of "may" here, it would have meant that in every case the CoC was mandatorily required to approve any resolution plan submitted to them by the RP. That is not the intent of the law. The intent of the law is to let the CoC and not the RP decide the future of the insolvent company and to give the CoC the discretion to approve or reject a resolution plan. This discretion is reflected in the use of the word "may" in section 30(4). In other words, the use of the word "may" is intentional because not every resolution plan submitted by the RP needs to be approved by the CoC. This reasoning has also been supported by Professor Varottil.

Secondly, the word "may" does not dilute the 75% rule either. Section 30(4) of IBC uses the language, "...committee of creditors may approve (emphasis added) a resolution plan by a vote of not less than seventy five per cent of voting share of the financial creditors". This implies that if the CoC chooses to approve the resolution plan, then the plan can only be approved if it has at least 75% vote of the CoC.

Finally, section 30(6) of IBC states:

"The resolution professional shall submit the resolution plan as approved (emphasis added) by the committee of creditors to the Adjudicating Authority .

This implies that if the resolution plan has not been approved by the CoC (by at least 75% voting share as mentioned in section 30(4)), then it should not be submitted to the adjudicating authority by the RP.

If the relevant provision in IBC were ambiguous, the appropriate external aid to statutory interpretation would have been the BLRC report. For example, the Supreme Court in M/s. Innoventive Industries Ltd. v. ICICI Bank, heavily relied on the BLRC report to interpret various provisions of the IBC. The report would have provided clarity to the legislative intent behind section 30(4). The judgement did not make any reference to the report.

Argument 2

The judgement relied on section 31(1) of IBC which states:

If the Adjudicating Authority is satisfied (emphasis added) that the resolution plan as approved by the committee of creditors under sub-section (4) of section 30 meets the requirements as referred to in sub-section (2) of section 30, it shall by order approve the resolution plan which shall be binding on the corporate debtor and its employees, members, creditors, guarantors and other stakeholders involved in the resolution plan.

NCLT used a broad interpretation of the words "if the Adjudicating Authority is satisfied" in this sub-section to give itself the power to approve any resolution plan which has not been approved by 75% of creditors by value. This argument overlooks the fact that section 31(1) is triggered only after a resolution plan has been approved by the CoC by 75% vote. If the resolution plan has not been so approved, the need for NCLT to check if the resolution plan meets the requirements of section 30(2) does not arise. In the case at hand, since the CoC did not approve the resolution plan of Kamineni Steel by 75% vote, the NCLT could not have used its power to review under section 31(1).

Argument 3

The judgement held that since IBC is a new law and RBI as a banking regulator has issued guidelines governing the voting share of banks, the 75% rule in IBC has to be read in conjunction with RBI's circulars.

There is an inherent problem in this argument. JLF is conceptually based on the London Approach - a non-statutory informal workout mechanism originally developed by the Bank of England since 1970s. In India, the process is guided by notifications issued by RBI under the Banking Regulation Act, 1949. Only lender banks can participate in this process. In contrast, IBC is a formal statutory mechanism for collective insolvency resolution. Unlike JLF, all financial creditors, including non-banks, can vote in the IBC creditors' committee. JLF and IBC provide for different procedures under two different statutes. In the event of any conflict between a subordinate legislation under the Banking Regulation Act, 1949 and the IBC, the IBC being a parliamentary legislation should have overriding effect.

Conclusion

The judgment of K. Sasidhar v Kamineni sets a wrong precedent in the nascent Indian corporate insolvency law jurisprudence. If the dissenting creditors appeal this decision before the relevant appellate tribunal it is likely to be overturned. It is worth noting here that the Mumbai bench of NCLT in a subsequent decision has taken an opposite stand, as highlighted by professor Varottil. The K. Sasidhar v Kamineni judgement should nudge Indian policymakers to consider two issues.

First, in light of IBC, policymakers need to question the rationale for retaining JLF. Even if they choose to retain it, there must be concrete reasons for vital differences between the two procedures. For instance, policymakers need to ask why should there be two different percentage requirements - 60% under JLF and 75% under IBC?

Second, the role of the resolution professional in an insolvency proceeding needs to be reviewed. In the Kamineni case, without securing 75% votes by value of financial creditors, the RP should not have submitted the resolution plan to the adjudicating authority in the first place. Policymakers need to explore institutional reforms to ensure that RPs act in an unbiased manner, like an officer of the court who the adjudicating authority can rely upon.

 

Rajeswari Sengupta is an Assistant Professor at the Indira Gandhi Institute of Development Research. Pratik Datta is a Chevening Weidenfeld Hoffmann scholar at University of Oxford. The authors thank two anonymous referees for their comments.