“Allocation of Profits to Financial Creditors During CIRP: Resolving Ambiguities in the Absence of RFRP and Resolution Plan Provisions”
Author: Alisha Garg
Introduction:
The Mumbai Bench of the National Company Law Tribunal (NCLT) recently addressed the case of Kalyan Janata Sahakari Bank Ltd. vs. Cicil Biochem Private Limited[1], focusing on the distribution of profits accrued during the Corporate Insolvency Resolution Process (CIRP). Financial creditors of Cicil Biochem, referred to as the Corporate Debtor, sought clarification on how these profits should be allocated. The NCLT emphasized that in the absence of explicit provisions in the Request for Resolution Plans (RFRP) or the resolution plan, profits should be equitably distributed among all financial creditors.[2] This case highlights the need for clear terms in resolution plans to prevent disputes over profit distribution. The article further examines the details of the Corporate Insolvency Resolution Process and relevant legislative frameworks.
What is Corporate Insolvency Resolution Process:
The Corporate Insolvency Resolution Process (CIRP) is a structured process for corporate entities that are financially distressed. It commences with the appointment of an insolvency professional, either by the adjudicating authority, such as the National Company Law Tribunal (NCLT), or through creditor consensus. This professional then prepares and implements a resolution plan, which has to be approved at a creditors’ meeting.
The process involves different stakeholders, which include financial creditors, operational creditors, secured creditors, and unsecured creditors. However, the Committee of Creditors (CoC) mainly comprises financial creditors. The Supreme Court clarified in the case of Essar Steel Ltd. (2019)[3] that operational creditors can join the CoC only when there are insufficient financial creditors.
A major shift was brought about by the 2018 amendment to the Insolvency and Bankruptcy Code (IBC), which recognized homebuyers as financial creditors, thus enabling them to participate meaningfully in the process. The Supreme Court in Pioneer Urban Land & Infra Ltd v Union of India (2019)[4] supported their right to have a representative at CoC meetings.
The 2020 Amendment further eased the initiation of CIRP by allowing a group of at least 100 allottees from a single real estate project, or at least 10% of total allottees, to collectively initiate proceedings, thus improving access to resolution options for homebuyers.
Background:
The Report of the Insolvency Law Committee dated February 20, 2020 underlines that even after this law, it leaves the question of determination of the persons or entities who have a right over the profits generated during the CIRP regarding a company quite ambiguous.
The first view, however is that the proceeds of the company in CIRP be distributed to the creditors while all profits made or any losses that may have resulted should fall on the account of creditors. This belief stems from the fact that during this process, creditors are seldom paid interest due to it and subsequently lose out whenever there is a decline in the value of the said company.
The second view argues that profits obtained during CIRP must be characterized as assets of the corporation and should remain in it. Supporters of this opinion suggest that the value obtained at the end through the decision process should accrue to the new corporation purchasing it and hence the profits of the new corporation.
Considering such critical arguments, the Committee deemed fit for law to retain its flexibilities over whether profits will or must be passed to the benefit of creditors or new entity known as the Resolution Applicant.[5] It recommended introducing an express provision within the Resolution Plan that clarifies who should manage such a profit or loss.
In the case of Essar, the Supreme Court held that income accrued during CIRP would have to be applied as per the Resolution Plan and not directly to the debt service. Similarly, in JSW Steel Ltd. v. Mahender Kumar Khandelwal & Ors. (2020)[6], the NCLAT clarified that profits accruing under CIRP would be in consonance with the Resolution Plan introduced by the judgment of the Supreme Court in the Essar case.
An interesting and often ignored point is that in none of these decisions regarding a resolution plan, in contrast, neither of them spoke as regards to an RFRP when profits generated while following CIRP went unsaid.[7] Until this writing, there are no judgments known reported where such a determination on the matter was finally addressed.
Analysis by the NCLT:
One significant challenge facing the tribunal is on the division of profits; no Resolution Framework nor Resolution Plan would be forthcoming about it. Approving the Resolution Plan involves extensive analysis and discussion of all involved parties’ commercial interests by the tribunal.
The Resolution Plan also has detailed provisions about profit distribution, including the clause that states if the unpaid costs of CIRP exceed a specified threshold, distributions to stakeholders will be proportionately reduced. Another clause defines “Receivables” as any amounts received by the Corporate Debtor (CD) from the date of approval by the National Company Law Tribunal (NCLT).
The tribunal also emphasized that the Resolution Plan is replete with commercial terms intended to limit outgoing financial flows to ensure that whatever is available from the benefits are paid to the secured financial creditors. It has further clarified that approval by CoC does not mean that debts of stakeholders are fully settled.[8] In doing so, it has once again strengthened its position to make appropriate remedies against guarantors and to recover funds from voidable transactions.
The tribunal emphasized that voting on a resolution plan is akin to a forced choice between resolution and liquidation, with heavy cost implications for the stakeholders. It also noted that financial creditors advanced the income-generating assets during CIRP without being assured of interest reimbursements and therefore deserved share in surplus profits.
Comment on the Judgment:
In this scenario, the tribunal had to decide on a profit-sharing mechanism because neither the RFRP nor the Resolution Plan had specified this. They were cautious of the commercial interests of all parties and passed the Resolution Plan, which has provisions for sharing profits. For example, in case the unpaid CIRP costs exceed a certain amount, then the distribution to the stakeholders would be reduced. Also, “Receivables” are those monies received by the Corporate Debtor from the date of NCLT approval.
The Resolution Plan caps financial outflows for the protection of secured creditors and the Resolution Applicant would take over receivables only from the date of NCLT approval. The tribunal clarified that the CoC’s approval does not amount to a settlement of debt in its entirety as remedies against guarantors and recoverable funds from certain transactions remain available.
This is mostly a vote for a resolution plan that seems to be a choice between whether there should be resolution or liquidation, which pits significant sacrifices against the stakeholders. Further, financial creditors have funded income-generating assets during the CIRP without earning even interest and deserve their share of surplus profits.
The tribunal finally concluded that it was fair to assign excess profits earned during the CIRP to the Financial Creditors of the Corporate Debtor, aligning with the commercial principles outlined in the Resolution Plan and safeguarding the interests of all parties involved.
Conclusion:
The tribunal in this case made a decisive point about profit distribution during the CIRP. The Resolution Plan lacked specific provisions regarding such a matter. The profit distribution was adjusted clearly in proportion to the unpaid costs with “Receivables” categorized as funds received after NCLT approval. It very categorically held that this endorsement by the CoC cannot be misconstrued as a guarantee of the payment of the entire debt amount and was very clear on holding that the financial creditors did not expect any returns during CIRP. Finally, the tribunal emphatically granted surplus profits to financial creditors and strengthened the commercial terms as provided in the Resolution Plan.
Author(s) Name: Alisha Garg (Symbiosis Law School, Pune)
Reference
[1] Kalyan Janata Sahakari Bank Ltd v Cicil Biochem Private Limited [2024] NCLT Mumbai ibclaw.in 289.
[2] Ankit Handa, ‘An Analysis of the Corporate Insolvency Resolution Process as a Route for Acquisitions in India’ (2020) 29(2) Intl Insolv Rev 234.
[3] Essar Steel Ltd v Satish Kumar Gupta & Ors [2019] SC ibclaw.in 07.
[4] Pioneer Urban Land & Infrastructure Ltd v Union of India [2019] SC ibclaw.in 13.
[5] Ravichandra Rao, Nishanthini and Jayendra Kasture, ‘Sectoral Insights into Corporate Insolvency: A Comprehensive Analysis of Corporate Insolvency Resolution Process (CIRP) Outcomes in India’ (2024) Intl J Law & Mgmt.
[6] JSW Steel Ltd v Mahender Kumar Khandelwal & Ors [2020] NCLAT ibclaw.in 217.
[7] Paola Lucarelli and Ilaria Forestieri, ‘The Three Targets of Insolvency Mediation: Dispute Resolution, Agreement Facilitation, Corporate Distress Management’ (2017) <no journal provided>.
[8] Jyoti Nair and Bhavika Nemade, ‘Creditor Driven Insolvency Resolution Law–A Review of Intent v/s Practice’ (2024) 20(1) J Global Econ 19.
