M&A Critique

An experience with one of the Corporate Debtors undergoing CIRP/applied for Liquidation proceedings

Background:

The CD is a Land development Company. It is private by the organisation. It issued NCDs for a face value of Rs 7,500/- to a SEBI registered Intermediary who further resold them at Rs 10,000 per NCD to retail investors who were sold the idea of higher than market returns at 18% + 2% penal interest in case of default. The intermediary had shared a profile of the Corporate Debtor (CD) that land plots were developed that will fetch bright returns in the coming years. The fund mobilisation continued the above lines in 5 series until close to Rs 45 crores was mobilized. The Authorised Capital had provided for Rs 50 crores. The total number of NCD holders was just above 200.

The NCDs were secured by the creation of a Debenture Trustee, which was recommended by the Intermediary. The NCD holders gave an authorisation to the Trustees to represent them before any litigation or legal proceedings in connection with securing their principal and interest. The NCDs were secured by pledge of the assets belonging to the promoters in favour of the Debenture Trustee.  The argument put forth by the ex-promoters was that in the State in which the CD was incorporated, a private company was not allowed to own agricultural lands and hence till the conversion into residential plots was completed the funds mobilised were to be in the form of lands bought in the name of the ex-promoters and such properties were pledged in favour of the Debenture Trustee.

The efforts of the CD as indicated by the ex-promoters to get the necessary Local authority approvals to develop the land and convert the same into residential plots never materialised even after spending significant amounts. In the course of the years under existence the CD issued unsecured loans in the form of Trade advances to 3 related parties amounting to Rs 38 crores.

The servicing of the interest continued for 2 years which mostly was by mobilising further loans since there was no business activity in the company.  The CD dealt with the intermediary/debenture trustees only for servicing of the NCDs. Payments to cover interest and or principals were issued by CD in favour of the Trustee, and they transferred the respective portions to the NCD holders. The Trustees had also collected post-dated cheques to cover the interest payments and or principal maturing as per the documents.

After a period of 2 to 3 years, the servicing of both Principal and Interest were stopped, and the post-dated cheques issued could not be presented due to non-availability of funds with the CD.

Start of litigation:

The Trustees and the Intermediaries being registered with the SEBI under separate regulations used to send statements of outstanding principal and interest to each of the NCD holders to whom the NCDs have been sold. Since the dues either in the form of interest or principal have stopped the NCD holders (around 26 of them) joined together and in the year 2017 made a complaint against the CD with the DCP, of the State Police to recover funds under the State Act to protect the interest of Deposit holders. The DCP after a period of 4 years issued direction through the Inspector under his jurisdiction to freeze the bank accounts of the CD which was immediately acted upon.

A petition under Section 138 of the NI Act, 1881 was also filed against the ex-promoters with the Court of appropriate jurisdiction by the Trustees.

The NCD holders also jointly filed a case before the Hon’ble SC against the Intermediary/Trustee for non-compliance of the Regulations.

Again the same set of NCD holders filed an application under Section 7 of the IBC to initiate CIRP process against the CD which was approved by the NCLT in the State HQ in early 2020 approving the appointment of the IRP as recommended by the applicants.

In March 2020 the COVID Pandemic restrictions were put in force and the order of NCLT approving the CIRP process was not issued till early June 2020.

Chronology of events:

  1. The NCLT order approving the commencement of CIRP process was received in June 2020. The IRP took charge and sought claims from the NCD holders.
  2. Since all the NCDs were covered under the Trusteeship agreement, the Debenture Trustee was naturally appointed as the representative of all NCD holders in the COC
  3. Some of the NCD holders who initiated the CIRP application appointed an IP to act as their Authorised Representative in a class under Section 21 (6A) (b) of the Insolvency and Bankruptcy Code, 2016 (Code) read with regulation 16A (1) of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016
  4. With this the IRP held the First COC meeting
  5. The agenda was:
    • Constitution of COC
    • Appointment of RP
    • Fixing his remuneration
  6. The IRP was confirmed as the RP and he tried to take charge of the books, assets and other securities belonging to the CD
  7. The books were never handed over to the RP. The FS showed that there was cash balance of less than 1.50 lacs. There were no assets in the books except for advances issued to related parties and accumulated losses. No fixed assets were in the name of the Company.
  8. The RP commissioned a Transaction audit and valuation of assets through a Registered Valuer regd with IBBI under S&FA.
  9. The Transaction audit could not trace the purpose of issuance of the related party loan due to lack of books availability. Hence the report that came out was a disclaimer report which meant that the report neither gives a clean chit to the CD or its e-promoters nor does t accuse them of any fraud in the absence of any proof.
  10. The Regd Valuer issued a Nil Value report since the books did not contain any assets and as at the end of the FY prior to commissioning of the transaction audit and valuation, the related party loans have been written off under the guidance from the ex-promoters.
  11. The RP had filed 2 or 3 Interlocutory Applications before the NCLT
    • One to make the CD and its promoters to extend their co-operation and to provide the account books for the period the company has been in existence
    • An application under section 45, 49, & 66 of the IBC alleging that the Transaction audit could not arrive at any findings due to lack of any information being made available and that the amounts issued in favour of related parties as loans had turned irrecoverable and subsequently written off and all these come under fraudulent intentions which is not limited by period of time.
    • To grant extension for the CIRP proceedings beyond the period of 180 days was filed (As per the Insolvency and Bankruptcy Code, 2016 (the Code), the procedure involved in the Corporate Insolvency Resolution Procedure (CIRP) should be completed within 180 days or within the extended period of 90 days and mandatorily be completed within 330 days including any extension and the time taken in legal proceedings. In short, the resolution procedure should be completed within 330 days, failing which the Adjudicating Authority will initiate liquidation procedure under Chapter III of the Code. This part of Decoding the Code decodes the Section 12)
    • Since the period of 180 days had long completed even after considering specially excluded period of 122 days due to COVID pandemic, the RP had filed an application for liquidation before the NCLT and the tribunal proceedings have not happened
    • A point must be mentioned here that though under Section 12 the maximum period of CIRP could be only 330 days even after the extension and that the extension application has not been heard and the period of 330 days had completed, the RP included in one of the last COC meetings whether to go in for liquidation clearly indicating that this will happen as an operation of law and though the NCD holders may reject the resolution for liquidation, under the IBC law, he is duty bound to file such an application.
  12. In the meanwhile, the bank accounts were frozen under the orders of the Inspector of Police in the State issued under the instructions of the DCP of the State based on a complaint by the same set of NCD holders who have initiated the CIRP proceedings.
  13. The above freeze has resulted in a situation that the expenses of CIRP could not be met though the FC are willing to contribute as the contributions have to come only through the CD and any moneys brought into the CD’s bank account will get frozen as there is debit freeze
  14. Hence an IA before NCLT was filed. Also, a meeting was held with the DCP on the one side and the AR & the attorney of the RP on the other side to explain that the bank accounts are now under the RP’s charge and are independent of the promoter’s control and that the de-freezing will help smoothly complete the CIRP process. The DCP rejected the request and suggested that he will abide by the order of the appropriate court (PDJ) in the State. Hence a petition before the PDJ was filed which is pending for hearing
  15. Now there is a new development quoting a Bombay HC order stating that the moratorium issued under Section 14 of IBC shall not put a stay on the proceedings initiated before Special courts constituted under the State protection of interests of Depositors Act and that the proper course of action would be for the RP to file his objections when the bank accounts were frozen, before the special court. Now the matter is grey.

Some anomalies and special experiences:

  1. The CD had consistently refused to provide the accounting data with the RP even though they could still generate the FS for the FY prior to the initiation of CIRP process. An IA was filed with the NCLT seeking an order to direct the CD and ex promoters to provide the accounting data. But it had not happened
  2. The format followed in the whole funds mobilisation was:
    • CD approaches an intermediary
    • Issues NCDs at a discount
    • Arranges through the intermediary to resell them at par to retail investors
    • No business activity in the company
    • Debt servicing through further series of NCD issues
    • Collect the funds and issue loans to related parties
    • Write off those loans after a few years
    • The cd will have nil assets and even if the CD goes into liquidation, no one including the RP gets anything. CIRP expenses become the last haircut.
    • The issuance of NCDs is backed by appointment of a Debenture Trustee to whom personal assets of the promoters and not the CD’s assets are pledged
    • The Trustees hold on to those securities and never want to invoke them against the pledgers
    • The NCD holders are HNW individuals who had worked in senior positions in the industry or Govt.
    • They must have applied their thoughts as to whether the CD which is a land development Company with a long gestation period to generate revenues will be able to fulfil the commitments under NCD. Looks like the NCD holders had gotten into the trap with eyes wide open
  3. Does the RP have the authority to ask the Trustee to invoke the pledged assets and bring the sale proceeds into the Liquidators’ estate since technically though the Trustees represent the NCD holders, the securities pledged to them are actually for the beneficial interest of the NCD holders. But the position identified is that the Trustees are in the position of secured creditors and the RP under CIRP does not have any legal right to make the trustees invoke their security
  4. Is IBC an overreaching legislation suspending the operation of other litigations by and against the CD post commencement of CIRP process? The answer appears to be a clear “NO” as the High Courts could exercise writ jurisdiction under Article 226/227 of the Constitution and interfere with the NCLT’s order in IBC proceedings when a statutory remedy of appeal to NCLAT was available and, the grounds for such intervention.
  5. How do we treat a disclaimer report by the Transaction audit due to information not being provided to them due to non-cooperation by the promoters? It is clearly not a clean chit but a disclaimer opinion. Can the IBBI provide inputs by guiding the IPs that the promoters shall be considered for fraudulent dealings (unless they prove otherwise) in cases where disclaimer opinion is given due to their lack of cooperation
  6. If the CD does not have funds and the FC’s contribution into the bank accounts of the CD get frozen, who will foot the CIRP expenses?
  7. If the special court that adjudicates criminal complaints against the CD and its promoters freeze the assets of the CD based on the complaint by a few of the FC and decide to adjudicate by selling the assets frozen and then distributing it to the complainants in some form, will that not amount to preferring a few creditors to the risk of all others? Will that not jeopardise the distribution matrix propounded in Section 53 of IBC?
  8. Section 238 of the Insolvency and Bankruptcy Code, 2016-The marginal note of Section 238 of the Code is “Provisions of this Code to override other laws”. The provision has a non-obstante clause and states that notwithstanding anything inconsistent therewith in any other law for the time being in force or any instrument having effect by virtue of any other law, the provisions of the Code shall have full effect. What will happen if Article 226 and Section 238 conflict? Which one will prevail?
  9. Proceedings against the intermediary and the Debenture Trustees are contemplated under specific SEBI Regulations. But this would mean concurrent litigation by CIRP applicants under multiple laws. Can by an application to the NCLT under IBC by an RP handling a CIRP on behalf of the CD, will the NCLT suitably instruct SEBI to initiate suo-moto proceedings against the fund mobilizers and fund managers?
  10. Lastly under the companies Act 2013, related party transactions cannot be approved by the interested directors u/s Section 184. If till those are done and transactions are completed, what is the remedy when the CD does not have any money left and the related parties also have gone bust?
  11. If the CIRP process gets beyond 330 days not because of any delay by the RP but due to delay in adjudication by NCLT, then what is the remedy available? Is it only liquidation?

It is a learning experience but requires quick addressing by the Govt, Judiciary and IBBI.

This article is written by CA Chandrasekaran Ramadurai, Proprietor at C Ramadurai & CO | Chartered Accountants. He is a chartered accountant, Insolvency Professional and a Registered Valuer. 

You can reach him at – LinkedInTwitter

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M & A Critique