Rescue finance in Australia

While Australia doesn’t have a formal rescue finance regime, s 447A orders are often used to get court permission for rescue finance. An empirical analysis of rescue finance applications found that the annual average number of applications was five times higher between 2016 and 2021 than it was between 2001 and 2006. So a recent court order in Park (Administrator), in the matter of Ellume Limited (Administrators Appointed) v Evangayle Pty Ltd (Trustee) [2022] FCA 1102 approving such an application under s 447A is not novel or controversial. The court’s reasoning in approving the funding agreement was short and included a call-out to the goals of Part 5.3A.

However, the circumstances leading to the entry into the Funding Agreement were such that, had it not been entered, the business would cease to trade almost immediately.  This would likely have resulted in the termination of the employment of the vast majority of, or all, employees, a dividend to priority creditors, at best a nominal dividend to general unsecured creditors and no return of monies to shareholders.

Another fairly routine but important matter is for the administrator to avoid the personal liability arising under s 443A of the Corporations Act. The court approved this, again stating that the funding agreement is consistent with the goals of 5.3A.

Finally, the court also approved the application for a section 588FM order in respect of the registration time for security granted to the creditor (the one providing rescue finance). As is common the court decision does not provide details of the security granted.

The fact that these practices have developed to ensure that rescue finance is possible in Australia, despite there being no rescue finance regime like there is in other countries is an interesting illustration of the law in action (as against on the books).

Saving the safe harbour

Australia’s (relatively) newly minted safe harbour to directors’ liability under s 588G (insolvent trading liability) has come under much criticism and for good reason. Still, I had been enthusiastic about a provision that can possibly change the incentives that s 588G seemed to create for directors. So, the government’s response to the independent panel’s review and recommendations to improve the safe harbour is welcome. Some of the recommendations are aimed at clarifying aspects of the safe harbour provisions.

I’m most interested in Recommendation 4 to which the government has agreed. It says:

The Review recommends that a plain English ‘best practice guide’ to safe harbour be developed by Treasury in consultation with key industry groups. The Review recommends that this guide set out general eligibility criteria for appropriately qualified advisers.

I think this does two things. First, it attempts to do away with spurious advisors becoming involved in advice re safe harbour. While this is good in theory, the devil will be in the detail and in the implementation. Second, the ‘plain English’ best practice guide to safe harbour will be useful because it might help small business owners understand and use the safe harbour effectively. Also, if key industry groups provide input as recommended, it might help flesh out how the safe harbour works in practice.

There is also an supplemental suggestion (although not a formal recommendation to the government) to updating ASIC’s Regulatory Guide 217 ‘to refer to the insolvent trading prohibition, and the safe harbour provisions, together with general guidance on the operation of the relevant provisions.

Recommendation 14 is also worth mentioning because it says that Treasury should ‘commission a holistic in-depth review of Australia’s insolvency laws’. It does not seem like this is on the government’s agenda, going by the fact that the response simply details the insolvency law reforms undertaken or in the pipeline. Here it is:

The Government notes this recommendation.
The Government has an extensive agenda regarding measures to improve Australia’s insolvency framework for both small and large businesses. On 1 January 2021, the Government introduced new insolvency processes suitable for small businesses, which are the most significant reforms to Australia’s insolvency framework in 30 years. The Government also announced reforms to creditors’ schemes of arrangement and conducted consultation on clarifying the treatment of corporate trusts in insolvency over the course of 2021.

Calling it DIP does not make it DIP

Australia’s small business restructuring reforms (Part 5.1B of the Corporations Act) took effect early this year. The aim of that part of the legislation is stated on s 452A as:

                   The object of this Part, and Schedule 2 to the extent that it relates to this Part, is to provide for a restructuring process for eligible companies that allows the companies:

                     (a)  to retain control of the business, property and affairs while developing a plan to restructure with the assistance of a small business restructuring practitioner; and

                     (b)  to enter into a restructuring plan with creditors.

So obviously the “debtor in possession” model is supposed to be the star feature in this process.

Yet, the restructuring only begins when the restructuring practitioner is appointed! (s 453B)

So what is the restructuring practitioner supposed to do while the debtor company’s management remains in control of the business? Provide restructuring advice and help prepare the restructuring plan, amongst other things. The restructuring practitioner even acts as an agent of the company; and can terminate the proceedings by giving notice to the company and creditors.

For their part, the directors have “to give the restructuring practitioner information about the company’s business, property, affairs and financial circumstances”. This is starting to look a lot like a practitioner is in control right? The only real “DIP” flavour seems to be that a company under restructuring still “has control of the company’s business, property and affairs”; and the fact that directors are allowed to enter into transactions in the ordinary course of business. Other types of transactions should be approved by the restructuring practitioner. This approval can only be given if she or he “believes on reasonable grounds that it would be in the interests of the creditors for the company to enter into the transaction or dealing”.

So I don’t think this is a real DIP model.

I would think that a DIP model with the option for creditors to exit the process would have been much better. I know Professor Jason Harris has been writing/ speaking about the process being too costly for many small businesses and I agree. However, the main point of this post (rant) is to caution against mislabeling the model.

I will end with an extract from Professor Aurelio Gurrea Martinez’ article about MSME restructuring which I highly recommend:

Unfortunately, even if this system reduces the direct costs of the procedure for debtors, many insolvent MSMEs might not even have the resources to afford the appointment of an insolvency practitioner. In these situations, countries may adopt two possible strategies. On the one hand, they can recognize this situation as a “market failure” and respond with a governmental intervention consisting of the appointment of a public trustee. Alternatively, a country can adopt a “private solution” based on a (purely) debtor-in-possession model. Therefore, the procedure would be exclusively managed by the company’s directors, as happens in the US Chapter 11 reorganization procedure.

Does success fee affect the independence of insolvency professionals?

In Jayesh N. Sanghrajka, Erstwhile R.P. of Ariisto Developers Pvt. Ltd. v The Monitoring Agency nominated by the Committee of Creditors of Ariisto Developers Pvt. Ltd., the NCLAT decided regarding the validity of agreements that stipulate a “success fee” for insolvency professionals. The decision refers to inputs by Mr. Sumanth Batra (acting as Amicus Curiae) and is worth reading for its insights on the law dealing with the remuneration of insolvency professionals in India.

I quote two short extracts of the decision here:

Para 32:

In our view, if the Resolution Professional seeks to have success fee at the initial stage of CIRP, it would interfere with independence of Resolution Professional which can be at the cost of Corporate Debtor. If success fee is claimed when the Resolution Plan is going through or after the Resolution Plan is approved, it would be in the nature of gift or reward.

Para 38:

For the above reasons, we hold that ‘success fees’ which is more in the nature of contingency and speculative is not part of the provisions of the IBC and the Regulations and the same is not chargeable. Apart from this, even if it is to be said that it is chargeable, we find that in the present matter, the manner in which, it was last minute pushed at the time of approval of the Resolution Plan and the quantum are both improper and incorrect.

I agree with the idea behind this decision i.e. that the independence of the Resolution Professional is very important. I would even add that the appearance of independence is equally important. I also agree that approving something like this towards the end of the process looks more like a gift or a reward. So this looks like a great decision in this case. I however, do wonder if future cases (where the success fee is approved at the outset) could decide otherwise, and distinguish this decision on the facts. Also, on principle, I’m not sure that a success fee (that is decided upon early on) should necessarily affect the insolvency professional’s independence. As some insolvency professionals are sought after more than others, perhaps a success fee is the way to court these individuals.

An article in the Business Standard had reported in January 2020 that it had become common to see a success fee “in the range of 0.1 to 2 per cent of the winning bid amount after approved by the National Company Law Tribunal.” The article quoted two unnamed experts. One said: “It can take away the focus of the RP from the majority of his work, which is running the stressed company. More importantly, they can find the motivation to leak information and try to get someone to take it”. Whereas another says: “There is concern that by charging such fees, the RP might forego the concerns of creditors. But RP is only a conduit between the committee of creditors and an acquirer, and cannot make any decision”. I mostly agree with the second quote. As for the first quote, unethical practices like that will ultimately affect the outcome of the process when they are brought to the court’s attention. Besides, only those professionals with a strong reputation will be able to have such a success fee approved. Such individuals are likely to be incentivised to preserve their market reputation and thus avoid such unethical practices.

Homebuyers under the Indian Bankruptcy Code

I recently participated in the launch event of Jindal’s insolvency law working paper series. I serve on the editorial board of the series and look forward to reading papers coming out of that. If you are interested in submitting a paper, here are the submission guidelines. Today’s post is a quick summary of my comments (which you can listen to here) regarding Uday Khare’s paper on the homebuyer issue in Indian insolvency law; and some further thoughts.

For those outside India and not aware of the homebuyers problem, you can read Khare’s paper and/ or a short post about this in the IndiaCorpLaw Blog. My super-quick summary is that homebuyers (or people who had made payments to real estate developers for an apartment in the building to be constructed) did not find a place in the scheme of the IBC because they were neither financial creditors nor operational creditors. Judicial intervention followed by legislative amendments have now resulted in classifying homebuyers as financial creditors.

This is concerning because it opens the door for other stakeholders to ask to be classified as financial stakeholders too. In my comments, I referred to an article by Professor Virginia Torrie and Vern DaRe which outlines how Canadian courts have given certain social stakeholders ‘participatory rights’ in special situations (I also hosted Torrie on The Creditors Bargain Podcast to chat about this article). These right do not include voting rights. Instead, it seems to be a way for the court and other parties (debtor company and creditors) to understand the concerns of the stakeholder group in question and account for that in the plan. Much of this sound similar incorporating mediation into the insolvency resolution process which is in fact some I and Aparajita Kaul recommend in an article we have co-written. The solution to the homebuyers problem would have been to co-opt home-buyers into the process. (We will post the article soon – watch this space.) If the real estate companies wanted to continue in business they would have to attract new customers so it would be in their interest to agree on a resolution plan that addressed the concerns of homebuyers.

Khare also outlines how it skews incentives in the negotiations within the CIRP process. He also outlines the collective action problems faced by homebuyers – not enough incentive for each individual homebuyer to participate in the process. While we are all familiar with the creditors bargain theory and the more stakeholder-oriented ideas on two ends of the spectrum, I think that using Professor Casey’s idea (his article proposes the New Bargaining Theory which conceives of the bankruptcy process as a framework to facilitate renegotiation of contract terms) in helpful in this context. Giving the homebuyers voting rights has not allowed for such an effective framework by this measure.

Do watch the panel discussion on the link to listen to the entire discussion. This post only gives a brief summary of my comments.

Aims of insolvency law

What is the goal of insolvency law? This question came up recently at a INSOL Younger Academics catch-up. Apparently, there has been some discussion in this in the EU. That was interesting because I had been thinking of this from the perspective of the Insolvency and Bankruptcy Code in India when Dr. M.S. Sahoo (chair of the insolvency regulator in India) said that the only aim of the IBC was resolution of the corporate debtor, and not recovery. I thought that this cannot always be true. Sometimes, it maybe in the interests of all stakeholders to liquidate the firm. But when I dug backwards, Sahoo seems to have made a somewhat similar statement in in 2018. He said that the ‘objective [of IBC] is to keep the firm alive, to maximise the value of the asset and balance the interests of all stakeholders’ and ‘definitely not liquidation’.

Interestingly, even the focus on resolution has not played out in a way that allows debtors to propose a plan which restructures the firm but allows the debtor to stay in control. Renuka Sane observes that the process under the IBC has in effect, come to ‘require that resolution plans be exclusively in [the] form of bids to purchase the firm’. She further points out that ‘there is a general understanding among creditors that they should accept the highest bid rather than assess operational and management plans for firms’. So the IBC seems to have become (in practice) focused on one type of resolution alone.

With this background, I was curious about the EU discussion on this. Giulia Ballerini  pointed me to some Excellent material on this and I’m grateful to her.

In Chapter 4 of the JCOERE Project, the authors make note of the two goal – resolution (also called rehabilitation or rescue) and liquidation. They then note that there is some resistance to rescue amongst European commentators. One of their arguments against rescue seems to be that ‘a going concern sale can be achieved as easily through liquidation’. For example, Nicolaes Tollenar writes in his book that ‘the going concern value of the business can also be realised through liquidation’ [47].

I find such strong opposition to rescue curious; in the same way that I find strong promotion of rescue as the only goal. Perhaps the EU commentators were simply pushing back against similar regulatory focus on rescue? Indeed the authors of the JCOERE Project note that the EU preventive restructuring framework seems to have endorsed rescue. Rotaru notes that ‘the final Report of the European Law Institute on “Rescue of Business in Insolvency Law”, which laid the foundation of the Restructuring Directive, explicitly sets the protection of jobs and of debtors in some specific industries as legitimate objectives of the’ preventive proceedings.

I think such focus on resolution without allowing commercial factors like viability to determine the route taken is not productive and commentators are right to push back. At the same time, the benefits of resolution, where this is suitable, should not be ignored either. Sean Lee, from Singapore, seemed to echo a similar case specific view when the issue was discussed at the INSOL Younger academics catch-up. In any case, this debate in the EU is an interesting one and worth paying attention to in India as well.

Reflections on the relevance of Canada’s bankruptcy law history for other countries in the present times

A review of Reinventing Bankruptcy Law: A History of the Companies’ Creditors Arrangement Act by Virginia Torrie

This post first appeared in the Singapore Global Restructuring Initiative blog. They have kindly allowed me to republish it here on my blog.

Can an historical analysis of bankruptcy (or insolvency) law in Canada offer some pointers for the present pandemic-induced economic crisis? As Professor Virgina Torrie’s book notes in the conclusion, “usually the political impetus to reform or repeal bankruptcy law arises during or after economic recessions, when many debtors avail themselves of insolvency law, and such activity highlights deficiencies of existing legislation” [169]. While we are dealing with the financial impacts of Covid-19, we are well-aware of the importance of insolvency law reform, across jurisdictions. It may actually be an apt time to turn to an historical analysis of the subject.

Torrie’s book focuses on the evolution of Canada’s Companies’ Creditors Arrangement Act (CCAA). But despite telling a story that is essentially Canadian, the book is relevant to insolvency scholars and practitioners in different jurisdictions. It will make the reader think about how their own jurisdiction’s journey compares. In this review, I make some comparative observations regarding insolvency reform in India, and provide reflections on what the book might offer to our current insolvency reform efforts. The comparison with India is useful as a counter-point to the Canadian experience outlined in this book, at least inasmuch as judicial activism in corporate insolvency is concerned. 

An overview of the book

After a discussion of the theoretical lenses used in the book in Chapter 1 (historical institutionalism and the recursivity of law), Part I of the book, consisting of chapters 2–5, takes us on a journey from the 1920s to the 1950s. Chapter 2 provides an overview of reorganizations in Canada before the enactment of the CCAA along with some discussion of English law origins. Helpfully, the chapter distinguishes between a creditor-centric and a debtor-centric view of reorganization and clarifies that the CCAA was initially used as a creditors’ remedy. The chapter also discusses the contextual factors that lead to the CCAA’s enactment. Chapter 3 discusses the introduction of the CCAA and reiterates that the statute was not meant to be a public interest remedy, i.e. a remedy for stakeholders like employees, but rather one that benefitted large creditors. Chapter 4 discusses constitutional issues surrounding the CCAA. Readers who are not Canadian will find this chapter informative from a constitutional law perspective as well. Chapter 5 tells us about attempts to repeal the statute from 1938 to 1953 on the grounds that it was being abused and that the context for which it was enacted no longer existed. One complaint against the use of the CCAA during this period seems to have been that it was used as a debtor-in-possession (DIP) remedy rather than the creditor remedy that it was intended to be [82]. This becomes particularly interesting as we read about developments in the 1980s and 1990s in later chapters of the book.

Part II of the book sets out to discuss the CCAA’s journey from the 1970s to the 2000s. Chapter 6 takes us from the 1950s to the early 1980s and discusses various legal developments and also changes in attitudes towards creditors’ remedies and reorganization. The legal changes during this time included the introduction of the Personal Property Security Acts by the provinces which, along with other developments, made the use of trust deeds to secure corporate loans less popular. This was a problem because the trust deed was necessary to access the CCAA [89]. The recessions of the 1980s and 1990s brought to light these and other problems with existing corporate restructuring mechanisms [103].

Chapter 7 describes how judicial interpretation of the CCAA in the 1980s and 1990s was instrumental in taking what was mainly a creditor remedy and converting it into a DIP remedy. It notes that this sort of interpretation raises questions about the role of legislature and the judiciary [122-123]. Judicial reasoning during this time seemed to rely on public policy objectives which were not actually present in the statute. This ultimately translated into the goal of preserving “the greater good” through reorganization [121]. This meant that the interests of the debtor (and with it, various stakeholders like employees, the environment, and the wider communities) were extended rather than limited by the CCAA [121]. Thus, insolvency became associated with preserving jobs rather than unemployment. The chapter also notes here that concurrent developments in the U.S., i.e. the introduction of Chapter 11 to the US Bankruptcy Code and theoretical discussions on insolvency, might have influenced Canadian courts to some extent [125]. Interestingly, Torrie points out here that in focusing on “the greater good” or interests of less powerful stakeholders, the courts also ended up advancing the interests of debtor-management, large creditors, and shareholders [126].

Chapter 8 goes on to explain how courts gave effect to these policy objectives despite the CCAA not having had been crafted for such purposes. Since a trust deed was required to access the CCAA, courts began to approve “instant trust deeds” created for this sole purpose [129]. Eventually this requirement to have a trust deed was interpreted away. In its place, a monitor was required to exercise debtor oversight (which was previously achieved by means of the trust deed) [138]. While this sort of innovation through the exercise of judicial discretion might seem laudable (and as Torrie notes, it was indeed praised by commentators), it also compromised predictability and the rule of law [141]. From here, as Chapter 9 tells us, Parliament began to endorse ad-hoc development of the CCAA by providing plan funding in a number of cases [149] and by codifying some of the judicial innovations [156]. This codification, along with the fact that Parliament did not simply repeal the CCAA, created a “positive feedback loop” for further judicial innovation. Torrie notes that such changes to the CCAA could be responsive to evolving commercial realities like corporate financing practices [159]. This chapter also provides a fascinating account of Supreme Court judges getting the newest ideas from academia into their judgements, through their law clerks [151]. These ideas, in turn, seeped into the judgements of lower courts [152].

The concluding point in the book is about how secured creditors have remained the prime players of corporate reorganization under the CCAA throughout the history of the statute. This is an important consideration, especially in light of the “public interest” arguments embraced by the courts during the 1980s and 1990s. On this aspect, the reader is left to wonder whether the courts were intentionally using the “public interest” gloss while seeking to protect secured creditors or whether the focus on vulnerable stakeholders naturally also lead to protection of secured creditors’ rights. The book’s concluding chapter also looks briefly to the future and suggests that the judicial activism might continue even in the face of a much-amended CCAA.

Relevance to insolvency law history in India

There is a clear resonance, particularly in Chapters 7 and 8, with how courts in India interpreted the Sick Industrial Companies Act, 1985 (SICA), which has now been repealed. Professor Kristin van Zwieten, studied the influence of the courts on SICA over time and found that Indian judges, like their Canadian counterparts, seemed to be influenced by the narrative of safeguarding vulnerable stakeholders like employees. The Indian courts were drawing from one of the stated purposes of the SICA, which was to facilitate rescue and rehabilitation of industrial companies.

Van Zwieten’s study finds three judicial innovations with regard to interpreting the SICA. The first was allowing companies to explore rehabilitation after the company had been found to be insolvent by the relevant tribunal; this lead to the second innovation: the erosion of the tribunal’s liquidation power. The third innovation relates to the moratorium on proceedings against the company. On the one hand it was interpreted to extend to the out-of-court right of a secured creditor to take over the company and sell assets over which it held security, while on the other hand, environmental compensation for tort victims and pre-commencement debts owed to workers were allowed to escape the moratorium.

The effect of these innovations was to slow down the process under SICA to a great extent. Unlike in Canada, the judicial innovations in India worked to undermine the statute rather than revitalise it. The difference in approaches could be a result of the Canadian judges being influenced by new academic ideas (as Torrie has observed) while Indian judges might have been resisting the liberalisation of the economy which the government had initiated in the early 1990s (as van Zwieten suggested in her article). These external influences on judicial decision-making in the insolvency context are important and mostly incidental. So, I would think that judicial restraint is preferable, despite Torrie’s book describing some innovations that worked well.

India has introduced new legislation, the Insolvency and Bankruptcy Code, 2016. Comparing the purpose and provisions of this new statute to that of the SICA, van Zwieten has commented that under the IBC, the creditors have discretion to decide on the route to be taken as against courts (or tribunals). Thus, this is less room for judicial discretion in that regard and it is overall, a good thing.

Relevance to the pandemic

Returning now to the relevance of the book for the post-Covid insolvency reform cycle, I want to make two points. The first is that over-reliance on the judiciary is not advisable. Canadian courts seem to have successfully used judicial innovations (sometimes even ignoring provisions of the statute) to provide practical solutions. Yet, such a system is not ideal for predictability and rule of law more generally, as Torrie observes in the book. In the present pandemic-induced crisis, with intermittent lockdowns affecting businesses, predictability in terms of what the law is and how it will be applied is very important. Relying on excessive judicial discretion will therefore not be the optimal path ahead. The second point is about the reliance on the public interest justification. The Indian experience with SICA shows that excessive activism by the judiciary in the public interest (to save jobs), even if well-intentioned, might make all stakeholders worse off. 

Insolvency in air and space and the Cape Town Convention

The High Court of Australia is set to decide on an issue of interpretation of a clause applicable to secured transactions involving international transactions re aircraft. This will also have implications for transactions in the space sector.

The Cape Town Convention (the Convention on International Interests in Mobile Equipment) is relevant for secured transactions re Aircraft, Spacecraft etc. Since airline insolvencies are unfortunately a reality in the aftermath of Covid, the Cape Town Convention has become more relevant than in the past. With corporate activity in space heating up, it is likely to become relevant in the space sector as well. The experience of the use of the Cape Town Convention in the airline industry will be instructive.

Aircraft protocol

The Cape Town Convention and the Protocol on Matters Specific to Aircraft Equipment (Aircraft Protocol) has been in the news thanks to the Virgin Australia insolvency. The Federal Court of Australia (FCA) in Wells Fargo Trust Company, National Association (trustee) v VB Leaseco Pty Ltd (administrators appointed) interpreted Article XI of the Protocol and the appeal is currently being heard in the High Court of Australia (HCA).

The Convention and Protocol establish an international legal system for security interests in aircraft equipment. In a forthcoming book chapter (Airline Insolvencies in India) Hitoishi Sarkar and I discussed Article 3(1) of the Convention which provides that the Convention is applicable if the debtor is situated in a state that is party to the Convention.

We explained Article XI of the Protocol as follows (references omitted; emphasis added):

The most central insolvency provision pertaining to aircraft is provided in Article XI of the Aircraft Protocol which provides contracting States with two alternative provisions. It then provides that contracting States may choose either alternative or choose to adopt neither of the alternatives. If a contracting State elects one of the alternative versions of article XI, then that version will apply when the contracting State is a debtor’s ‘‘primary insolvency jurisdiction.”

Under Alternative A to Article XI of the Aircraft Protocol, the debtor’s ‘‘insolvency administrator’’ or the debtor must give possession of the relevant aircraft object to the creditor holding an international interest in the object before the expiration of a stipulated waiting period. The alternative permits a Contracting State, in its declaration with respect to that article, to specify the applicable waiting period’ that will apply when the Contracting State is a debtor’s primary insolvency jurisdiction.

Under Alternative B, the insolvency administrator or debtor, on a creditor’s request, is merely required to give the creditor notice whether the administrator or debtor “will cure defaults and perform future obligations or permit the creditor to take possession of the aircraft object. This alternative does not provide a creditor with any right to obtain possession of an aircraft object in insolvency proceedings.

Since Australia has opted for Alternative A, “give possession” was being interpreted by the FCA. In the court’s view “give possession” does not include redelivery and so it is up to the creditor to “come and get it“. (There is an excellent article on this by Professor David Brown “Give” and “Take”: Virgin Australia, the Cape Town Convention and Aircraft Protocol (2021) 21(1&2) INSLB 21 where he endorses this interpretation and also discusses further about the “commercial sense” of the court’s interpretation.) This is currently being heard in the High Court of Australia (as Michael Murray reports over at his blog) so we will have to watch how this goes down.

Space protocol

The Protocol to the Convention on International Interests in Mobile Equipment on Matters Specific to Space Assets (Space Protocol) which is not yet in force has a similarly worded provision.

Alternative A under Article XXI also states as follows (emphasis added):

Upon the occurrence of an insolvency-related event, the insolvency administrator or the debtor, as applicable, shall, subject to paragraph 8 and to Article XXVI(2) of this Protocol, give possession of or control over the space asset to the creditor no later than the earlier of:

(a) the end of the waiting period; and

(b) the date on which the creditor would be entitled to possession of or control over the space asset if this Article did not apply.

Thus, the interpretation of the HCA is likely to be relevant to insolvencies in the space sector as well.

Pre-packaged insolvency resolution for MSMEs comes to India

The IBC has had an exciting new amendment via ordinance a few days back (4 April, 2021)! It finally gives us (MSMEs) a pre-pack system of restructuring. Put another way, it works as a debtor in possession (DIP) model of insolvency process. This is a lifeline for MSMEs and others who are eligible because normal IBC filings had been suspended (bad move!) as a post-pandemic measure. (The second recital is trying to spin the suspension as a measure to “mitigate distress” but well, the move likely caused some distress too.)

In any case, the IBC process was not a DIP model so the amendment has rightly caused excitement in the industry. As one news article puts it, ‘corporate debtors remaining in possession is a global best practice in such schemes’. Another great feature is that the debtor company gets to submit a resolution plan first.

So how does it work?

An MSME that has defaulted on its debts can apply to initiate a pre-packaged insolvency resolution process. The riders are that it should not have already undergone a pre-pack process or a full insolvency resolution process in the preceding three years; it is not undergoing a insolvency resolution process or be subject to an order of liquidation; and it should be eligible to submit a plan under s 29A. Once all these boxes are ticked, a majority the board of directors need to declare (in a prescribed form):

(i) the company’s intention to file within a certain period of time (not more than 90 days);

(ii) that the prepack process is not being initiated to defraud any person;

(iii) the name of the insolvency professional (IP) who is proposed and approved by the financial creditors who are not related parties; and

(iv) A members special resolution should approve the decision to initiate the pre-pack.

Finally, the company must get the approval of financial creditors (excluding related parties) representing not less than 66% in value of the financial debt due to them. By the time financial creditors get to the stage of approving the initiation of the pre-pack, they should have been provided with the company’s resolution plan (known as the base resolution plan) and other details. Hence the term ‘pre-packaged’ process.

When the pre-pack application is filed, the NCLT has 14 days to admit or reject (if the application is not complete) it. The moratorium kicks in from the filing date and a public announcement of the prepack process is made by the NCLT. The pre-pack resolution process should be completed within 120 days. The ‘process’ simply means the approval of the resolution plan (which can be different from the base resolution plan) by creditors and its submission by the IP to the NCLT. To that end, the IP convenes creditors’ meetings, the first of which should be within 7 days of initiating the pre-pack. If they cannot approve a resolution plan, the IP submits an application to terminate the prepack process. If a plan is approved by the creditors, then the NCLT approves or rejects the plan on the same basis as under the insolvency resolution process.

The IP, along with the usual functions during the normal insolvency resolution process seems to have one additional function during the pre-pack process – to monitor management of the affairs of the corporate debtor. The board, while remaining in control of the company, is required to ‘make every endeavour to protect and preserve the value of
the property of the corporate debtor, and manage its operations as a going concern’ (s 54H(b)). There is also an option for the creditors to apply to change this default DIP model and put the IP in control by a vote of at least 66% of the voting shares (s54J(1)). The NCLT will approve such a request if it finds gross mismanagement, or fraud or other issues.


Hopefully the prepack will play out as well in practice as it looks in theory. There is room for appealing the approval of a resolution plan – ideally there will not be too many of those. If it does work well, we can expect this to be rolled out for larger companies too. In fact, NCLTs should suggest companies explore the prepack option before filing for the corporate insolvency resolution process considering the huge case load the NCLTs already have.

Who knew that the Australian insolvent trading regime was so attractive?

I’m late to blog about this case but if you are interested in corporate insolvency, Debut Homes (in Liq) v Cooper a New Zealand Supreme Court judgement should not go unnoticed. In deciding the case, the court seems to have incidentally restated the law relating to directors’ duties in the zone of insolvency in a way that makes it veer dangerously close to the Australian s 588G regime (prior to the introduction of the safe harbour).

After stating that a company remaining solvent is in the interest of the company, shareholders, and other stakeholders (no surprises there), the court went on to apply some of the principles underpinning formal insolvency regimes to the directors’ duties in the zone of insolvency regime. It provides the following summary [49]:

Solvency is a key value in the Act. Where a company becomes insolvent, there are statutory priorities for the distribution of funds to creditors and mechanisms to ensure these are not circumvented. There are also a number of formal mechanisms in the Act, apart from liquidation, for companies experiencing financial difficulties. All of the formal mechanisms have carefully worked out processes for decision-making and involve either an independent person or consultation with all affected creditors. None of these formal regimes involve continued unfettered decision-making by directors. Directors can choose to employ informal mechanisms but these must align with formal mechanisms. At all times, including where a company is insolvent, directors must comply with their duties under the Act.

For emphasis, I will restate the one particularly thorny sentence in the above:

Directors can choose to employ informal mechanisms but these must align with formal mechanisms.

What does this imply? The previous paragraph [48] of the judgement says:

[Informal mechanisms] must also align with the available formal mechanisms. This would suggest the need to ensure the agreement of all creditors, including those who would be involved in and affected by the period of continued trading. If all such creditors are not consulted, any informal scheme would have to ensure that those creditors who were not consulted would be paid in full. This also follows from the directors’ duties in ss 135 and 136 …. [Footnotes omitted]

It seems to be a novel idea that informal mechanisms must align with formal mechanism. Nothing in ss 135 or 136 (the law relating to duties of directors in the shadow of insolvency) suggest this. New Zealand determines solvency by a consideration of both the cash flow and the balance sheet tests (s 4) and case law interpreting the insolvent trading duties up until now have allowed directors room to assess the financial condition of the company, investigate potential income streams, etc. before having to enter the company into a formal insolvency procedure. There is no suggestion in these earlier cases that all creditors need to be consulted while making these assessments.

It is therefore surprising to see the court interpret s 135 as follows:

The duty under s 135 must also be assessed in light of the scheme of the Act and in particular Part 15A, which is the formal mechanism specifically designed to be used in an insolvency situation for increasing returns to creditors. Under Part 15A, all creditors are consulted and voting is by value and class.The same applies to compromises under Part 14.90 In this case Inland Revenue was not consulted, even though Mr Cooper’s intention when he decided to continue trading was that it would bear all the loss. [Footnotes omitted.]

I quote a small section (page 108) of an excellent comment by Peter Watts’ here (but highly recommend the entire article [2020] Company and Securities Law Bulletin 107). He rightly says that “the presence of scheme provisions [do not] signal that, before their invocation, directors in running a company, even an insolvent one, are required to give equal weight to the interests of every single unsecured creditor…”. He adds that consultation with all creditors has never been a requirement. He further adds that “all formal insolvency mechanisms start from a premise of pari passu treatment, but that is not the case before those mechanisms are triggered”.

Having drifted away from established precedent, the position now set out by the court would require directors of a company in troubled financial waters to either enter the company into a formal insolvency regime or to consult with all creditors of the company about continuing to trade. It is highly likely that at least one of the creditors would object to the directors’ efforts to steady the ship (if that is possible). The court’s statements in Debut Homes may also encourage more litigation under s 135 which would in turn make directors wary of any informal restructuring efforts. This is not that different from the Australian position under s 588G and before the introduction of the safe harbour. As I say in a previous article (at page 46), prior to the introduction of the safe harbour, “Australian directors, especially in large companies, have been so spooked by the possibility of personal liability that they have tended to put the company into the insolvency -resolution process (known as voluntary administration in Australia) at the slightest possibility of insolvency.” The dicta in Debut Homes is likely to have a similar impact in New Zealand. Hopefully the court has an opportunity to correct itself soon.