When One Size Doesn’t Fit All: Rethinking Creditor Voting Power
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Introduction
In the past five years, three cases have garnered significant public attention: the India Resurgence Arc Private Limited case, the Ruchi Soya case, and the Paridhi Finvest case. Although the judgments in these cases present two contrasting views, it is essential to note a common angle: the appellant in each case was a secured creditor, dissatisfied with the returns offered in the resolution plans. This indicates that the decision-making is flawed, and the interests of all the creditors may not be adequately represented under the present framework, violating one of the fundamental objectives that the Insolvency and Bankruptcy Code, 2016 (“IBC”) aims to achieve. This leads us to a crucial question: Do the powers of the Committee of Creditors (“CoC”) function as an equitable system for all creditors? Not every time. Voting power under the current system is determined solely by the amount of debt held by each financial creditor, and not by the number of creditors present or the type of debt owed. This raises questions regarding representational equity within the CoC since it puts all the financial creditors in a position where they have an equal voice, regardless of their underlying economic interest or the type of security they possess. The authors of this article believe that reform through the introduction of sub-classification within the CoC could help determine the challenges and loopholes that the current framework contains. The Apex Court in the Swiss Ribbons Case has acknowledged the need for clear distinctions among the creditors to treat them equitably. Not only does the IBC recognise such distinctions, but it does so only under the waterfall mechanism provided in Section 53. Is there a need to recognise this distinction at the time of voting? Absolutely, yes.
The authors put forth the shortcomings of the current CoC structure by examining how decision-making is impacted by the lack of economic differentiation and insufficient voting power in Parts II and III. Following this, in Part IV, taking inspiration from the French insolvency and restructuring regime, the authors suggest introducing a sub-classification framework within the existing CoC. Finally, in Part V, the authors reflect upon the manner in which reforming the current structure helps bolster the position of dissenting creditors, establishing a more equitable, representative, and balanced insolvency resolution process.
Problems with the existing structure of CoC
The primary objectives of the IBC, as mentioned in the object clause, remain to offer a time-bound rehabilitative mechanism to the corporate debtors and an opportunity to balance creditor interests by allowing the conduct of the Corporate Insolvency Resolution Process (“CIRP”). The process was introduced as an opportunity to determine a plan to assist the creditor by attempting to obtain the best returns, while also allowing for the revival or liquidation of the Corporate Debtor. Before the CIRP is initiated, Section 28 of the IBC requires resolution professionals to obtain prior approval of the CoC, which involves a majority of not less than 66% of the voting shares, as mandated by Section 30. Additionally, as held in the Sagar Stone Industries vs. Sajjan Kumar Dokania case, CIRP Regulation 39(1A) allows the CoC to make amendments to an approved resolution plan. While these provisions aim to offer flexibility and control to the creditors, they overlook the fact that not all creditors stand on equal footing when it comes to their economic interests or risks undertaken. This brings into the picture a deeper structural concern: Does the current framework truly ensure fair representation and voice to every stakeholder involved?
Inadequate Voting Power and the Need for Economic Differentiation
The Apex court in the Essar Steel Case made an important observation regarding the higher risk taken by secured creditors while opting for a resolution plan. These risks are substantiated by market practices where the amount of interest that is received by the secured creditors remains much lower in comparison to the unsecured creditors owing to the collateral they hold. However, an important point to note is that Section 14 of the IBC makes provision for a moratorium, which exposes the secured creditor to a potential risk of getting a lower value under the resolution plan than the value security interest held by them, making their situation unfavourable.
In addition to this, the contrasting judgments expose the creditors to structural flaws. The approach taken in the India Resurgence Arc Private Limited case leaves the fate of the secured creditors to the wisdom and will of the CoC, restricting the court’s power to review the resolution passed by the CoC, eventually leading to unfair outcomes. Another observation made in the judgment was regarding abstinence to question the wisdom of CoC for a particular stakeholder, which could ultimately result in blatant violation of natural justice.
Looking at the stance taken by the court in the Ruchi Soya case, the problem arises because, unlike operational creditors, Section 30(2)(b) only mandates that the dissenting financial creditors receive the liquidation value and nothing more, thereby allowing the Resolution applications to cap the amount receivable by the secured creditors to the amount of liquidation. Furthermore, due to the lack of transparency with the valuation data of the Prospective Resolution Applicants (“PRAs”), several complications arise in the calculation, making it difficult to determine the fair liquidation value. As a result, the liquidation value is often calculated on guesswork, making it an unfair case for the dissenting creditors.
Considering these factors, along with the rigid approach taken by the Supreme Court with regard to modification post approval, a better voice and representation of all stakeholders in the CoC becomes quintessential. So, now the question remains: What can be changed to cure this shortcoming? A promising solution lies in the introduction of sub-classification of the CoC based on economic interest. Though class-based practice has been used in major global economies like the United Kingdom (“UK”) and, United States (“US”). However, the one offered by the French restructuring system provides a minimalist yet flexible approach, emerging as a strong contender in addressing the challenges posed by the Indian insolvency and restructuring regime.
Introducing Sub-classification Within the CoC
How is this system better? The French sub-classification framework is better because, firstly, it improves representation and prevents creditors with differing interests from engaging in strategic voting that could disadvantage minority creditors, as observed in recent cases in India. Secondly, the approach adopts a minimal and adaptable method of class formation on a case-by-case basis. And lastly, the French restructuring serves as a better alternative than the practices adopted in the US and the UK.
Unlike the frameworks followed in the US and the UK, the classes are not classified based on the resolution plan introduced by the corporate debtors. This helps reduce the possibility of gerrymandering of votes, which refers to strategic dilution or concentration of voting power by the debtor to serve self-interest by buying support of a few influential creditors, leading to potential harm to other creditors. With court-appointed personnel performing these functions, the risk of debtor bias diminishes.
Furthermore, the US framework is based on a very layered and procedural structure that includes stringent voting thresholds, numerous court approval stages, and thorough disclosures. Although this works well in the US, it is not as effective in India. Many creditors, especially operational creditors, lack the coordination and resources necessary to participate in such a complicated system, and India’s insolvency process already experiences significant delays. Similarly, the insolvency framework in the UK places significant dependence on the court’s interpretation by allowing the dissenting creditors to be bound only if they aren’t left “worse off” under the “relevant alternative.” Why is this problematic? Because the broad scope of interpretation leads to extensive court evaluation and delays, hence rendering the framework is rendered less effective.
Under the French system, creditors are divided into at least two classes: secured and unsecured, based on economic interest and similarities. Additional classes may be formed, such as among secured creditors based on first charge and second charge, depending on the economic nature of the creditors. This division is made by the court-appointed professional, who has voting power proportional to the debt owed to the corporate debtor. Aligning a similar approach in India involves the Interim resolution professional, who is appointed by the National Company Law Tribunal (“NCLT”), to segregate the CoC into different classes as deemed suitable for the interests of all creditors. Therefore, the French system, which adopts a flexible approach of sub-classification complemented with court-held supervision, makes it pragmatic, balanced, and a stable fit for the Indian scenario.
Strengthening the Position of Dissenting Creditors
Does this make life easier for dissenting creditors? Absolutely. The sub-classification approach helps serve the best interests in both scenarios, as outlined in the contrasting judgments. If the approach used in the India Resurgence Arc Private Limited case is adopted, dissenting creditors are limited to the amount decided by the wisdom of the CoC, with liquidation value and priority simply supporting it. This allows the creditors to represent their economic interests without undue influence from the majority and enables them to negotiate better over the restructuring plan. It also allows them to present their interests to the court if the entire class dissents.
Considering whether the higher bench aligns its approach with the order in the Ruchi Soya case, which follows global practices and incorporates international principles such as the “best interest of creditors test” and the “absolute priority rule”, then even when dissent increases from any one group, it should not hinder the representation of another group. In such cases, in case of disagreement on a class basis or within the class, the court can either enforce a cramdown if it considers that the minimum value, i.e., the value creditors would receive in liquidation and the prioritisation of creditors as mandated by Section 30(2)(b) are maintained.
Therefore, whether dissenting or assenting, the sub-classification framework for the CoC for resolution approval and structuring serves as a saviour for all creditors. The approach remains adaptable and ensures fairness during negotiations and final votes. Moreover, it opens the possibility of including operational creditors in the Committee, aligning further with international standards and preventing suppression under the guise of the commercial wisdom of the CoC.
*The authors are Third-year B.A., LL.B. (Hons.) students at Maharashtra National Law University, Mumbai.
