Clean Slate Theory Under IBC, 2016

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Introduction

The Insolvency and Bankruptcy Code, 2016 is a special law, which has been lay down for the purpose of bringing out an industry from distress and to ensure that its assets do not go to waste by liquidation. IBC is the bankruptcy law of India which seeks to consolidate the existing framework by creating a single law for insolvency and bankruptcy. The code aims to protect the interests of small investors and make the process of doing business less cumbersome. The Insolvency and Bankruptcy Code was passed by Lok Sabha on 5thMay 2016 and by Rajya Sabha on 11thMay 2016 and thereafter received the assent of the President of India on 28thMay 2016. 

Meaning of Clean Slate Theory

The Clean Slate Theory also known as the Fresh Slate Theory is a doctrine which stipulates that after the culmination of the corporate insolvency resolution process (CIRP), any pending claims qua the corporate debtor (CD) shall be extinguished, and the successful resolution applicant shall take over with a clean slate.

Section 31 of the Insolvency and Bankruptcy Code, 2016 (“IBC”) provides that once the Adjudicating Authority satisfied 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 a resolution plan, it shall be binding on the corporate debtor, its employees, members, creditors including Central/State Government and any local authority to whom a debt arising under any law in force is owed, guarantors and other stakeholders involved in the resolution plan.

The term Clean/Fresh Slate was coined by the Hon’ble Supreme Court in its judgment in Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta (2020) 8 SCC 531. The Theory states that once the Committee of Creditors approves the Resolution Plan, it will be binding on all stakeholders and Resolution Applicant, the court observed that “a successful resolution Applicant cannot suddenly be faced with undecided claims after the resolution plan submitted by him has been accepted as this would amount to a hydra head popping up which would throw into uncertainty amounts payable by a prospective resolution Applicant who successfully takes over the business of the corporate debtor.”

The primary intent behind the enactment of Code is the maximization of the value of assets of the company and promoting entrepreneurship while ensuring the availability of credit, keeping the economy rolling by resolution instead of liquidation of a distressed company. The Clean/Fresh Slate Theory approves this objective of the Code.

Supreme Court Observation on the Clean Slate Theory

The Hon’ble Supreme Court observed on April 13, 2021 in Ghanashyam Mishra and Sons Private Limited through the Authorized Signatory Vs. Edelweiss Asset Reconstruction Company Limited through the Director & Ors Civil Appeal No. 8129 of 2019. “that if additional liabilities are allowed to be imposed on the successful resolution applicant after the approval of the plan, the entire plan would become unworkable. The Court said that such surprise debts cannot be sprung upon the resolution applicant, which were not laid down in its resolution plan. If that is allowed, the very calculations on which the resolution applicants rely to submit their resolution plans would go awry. The Court emphasized that a successful resolution applicant should start with a clean slate, on the basis of its approved plan.”

A successful resolution plan is binding only on those entities which are “involved” in the CIRP process as per Section 31, Insolvency and Bankruptcy Code, 2016. Those creditors who have not got the opportunity to raise claims will certainly not be included here. In terms of regulation 6 of the CIRP Regulations, a notice regarding the initiation of CIRP process must be published where the registered office and principal office of the corporate debtor is situated or where the corporate debtor conducts material business operations. In Electrosteel Steels Limited v. The State of Jharkhand W.P.(T). No. 6324 of 2019, since the resolution professional had not complied with this requirement, the creditors were deprived from making their claims. Accordingly, the claims raised by such creditors even after the approval of the resolution plan were accepted and the resolution plan was held not to be binding on them. However, the Supreme Court in the Edelweiss judgment quashed and set aside this case on finding that the resolution professional did comply with the requirement of publishing notice under regulation 6 of the CIRP Regulations in the prescribed manner.

Evident Nature of the “Clean Slate Theory”

The hon’ble Supreme Court observed in Edelweiss case that the Clean Slate Theory is apparent from section 31 of the Insolvency and Bankruptcy Code, 2016, as per which an approved resolution plan is binding on all the stakeholders involved in the resolution plan. The provision of section 31 of the 2016 code was amended by the code of 2019 to make the successful resolution plan binding on “Central Government, any State Government or any Local authority.” The Court observed the amendment of section 31 of Insolvency and Bankruptcy Code, 2019 to be clarificatory in nature and, hence, retrospective in operation. Hence, any claim, even if it relates to a date prior to the effective date of this amendment, would not be entertained after the resolution plan is approved. 

The Supreme Court further explained that the amendment was not even required in the first place. This is because a successful resolution plan is already binding on “creditors” in terms of section 31. The Court said that Central Government, State Government and Local Authorities are already covered under the term “creditor”, as they can be recognized as operational creditors. Even if that is not the case, they can easily come within the ambit of “other stakeholders” in section 31. Therefore, the Court observed that there was no need for the amendment, as the successful resolution plan is already binding on the mentioned authorities according to the provisions of the Code.

The “clean slate theory” is also evident from section 32A of the Code which was inserted through the  Insolvency and Bankruptcy Code (Amendment) Act, 2020 and provides that once a resolution plan is approved, a corporate debtor cannot be made liable for any offence committed prior to the commencement of CIRP. The Supreme Court recently upheld in the case Manish Kumar v. Union of India, that, the constitutionality of section 32 A and emphasized on the need for a successful resolution applicant “to make a clean break with the past and start on a clean slate.”  Thus, the Edelweiss judgment is of immense significance in the light of increasing instances where creditors raised their claims after the approval of a resolution plan. This decision will certainly help in protecting the interest of successful resolution applicants. 

The scope and ambit of Section 32A came to be discussed by the Hon’ble Company Law Appellate Tribunal, recently, in the matter of JSW Steel Ltd. vs Mahender Kumar Khandelwal & Ors. [Company Appeal (AT)(Insolvency) No. 957 of 2019],  whereby citing Section 32A, the Appellant i.e. JSW Steel Ltd. was granted protection from attachment of the properties of Bhushan Power & Steel Ltd. which JSW became owner after being the successful Resolution Applicant. The officials of JSW were also granted protection citing Section 32A(1)(b).

Retrospective Character of Section 31

The Hon’ble Supreme Court recently upheld the proposition of law that, ‘Clarificatory Amendments are retrospective in nature’ in the case of State bank of India v. V. Ramakrishnan and Anr. The apex court recently observed the retrospective nature of section 31 in Ghanshyam Mishra and Sons Private Limited through the Authorized Signatory Vs. Edelweiss Asset Reconstruction Company Limited through the Director & Ors., the court majorly relied upon the matters of UOI and Ors. v. Martin Lottery Agencies Ltd. and B.K. Educational Services Private Ltd. V. Parag Gupta and Associates while giving retrospective effect to the provision of section 31. From the former cases, it is evident that though the legislative intent in incorporating Section 31 was to extinguish all the debts owed to statutory bodies once the resolution plan received the assent of Adjudicating Authority, however on account of ambiguity, the governmental authorities continued with the proceedings in respect to the debt owed to them. 

To cure the said mischief, the legislature decided to clarify its stance and stipulated that once the Adjudicating Authority approved such a resolution plan, all the claims/dues owed to the Central or State Government or any Local Authority were not part of the resolution plan. The hon’ble court also considered the statement made by the finance minister while answering the query put up, which elucidated that the government will not make any further claim once the resolution plan is approved. The message conveyed by the finance minister was that the amendment concerning Section 31 of the Code was implemented with the intention of lending assurance to the resolution applicant and other people of interest that the government will accept the resolution plan, which carries the seal of Adjudicating Authority as any action besides this will defeat the purpose of Code. Whereas in the latter case, the question that arose was whether Section 238A of the Code is clarificatory or not and the court, answering in affirmation, stated that Section 238A is retrospective in nature.

Conclusion

The Electrosteel case makes it evident that the success of “clean state theory” depends very much on the due compliance of the responsibilities, by the resolution professional.  A few errors or negligence on part of resolution professionals should not lead to the creation of liabilities on the successful resolution applicants. For this purpose, the author suggests that it is important to provide further inspection onto the role of resolution professional. This could be attained by obligating the committee of creditors (“CoC”) under section 30(4) of the Code to counter check whether the public announcement is made by the resolution professional in the prescribed manner. This would be reasonable as a resolution professional already performs most of his or her functions under the guidance of the CoC as per  Section 28, Insolvency and Bankruptcy Code, 2019 and is a mere facilitator in the CIRP process. 

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