Sikha Bansal

Vinod Kothari & CompanyKolkata

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GROUP INSOLVENCY: MOVING FROM “ENTITY” TO “ENTERPRISE”

Copyright

• The presentation is a property of Vinod Kothari & Company. No part of it can

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About UsABOUT US

• Vinod Kothari & Co.,

o Based in Kolkata, Mumbai

and Delhi

• We are a team of consultants,

advisors & qualified

professionals having over 25

years of practice.

Our Organization’s Credo:

Focus on capabilities; opportunities follow

Group Approach

Entity vs. Enterprise: Relevance• Entity approach: Salomon vs. Salomon

• Present scenario in insolvency laws –

“entity” focused

• Changing business dynamics

▫ Localisation to MNCs

▫ Enterprise value being scattered across

entities

▫ Holding-SPV structures

• Accounting standards

• Securities market regulators

5

A

B

D

C

Looking upLooking

laterally

Looking down

Need for Enterprise Approach

6

Inter-linkages How creditors see it

Prevent/reverse vulnerable transactions

Avoid conflicting orders

Synergy and Synchronisation

Advantages of Enterprise Approach

7

Reduce Information asymmetry

Reduction in costs of insolvency

proceedings

Maximization of value

Increasing certainty for stakeholders and saving judicial time

Reduction in costs of capital

Possible Side Effects

• Costs

• Time

• Magnitude

• Co-ordination complexities

8

Inspiration for Legal Framework in

India

9

UNICITRAL’s ‘Treatment

of enterprise groups in

insolvency

Proposed Framework of Group Insolvency by Working Group constituted by IBBI

EU Regulations

of 2015Judicial Precedents

Insolvenzordnung in

Germany

Identification of ‘Group’

What is a “Group”?

UNCITRAL Model law ‘Enterprise Group’-

Two or more enterprises interconnected by ‘Control’ and

‘Significant Ownership’

Includes other form of entities- such as special purpose entities

(SPE), joint ventures, offshore trusts, income trusts and

partnerships

Significant ownership- ability to control, holdings in the company.

Rebuttal presumption for lower holding and conclusive presumption

for higher holding.

Article 2(13) of the Regulation (EU) 2015/848

‘a parent undertaking and all its subsidiary undertakings’.

Working Group

Holding, Subsidiary and Associate company as defined in CA, 2013

Companies intrinsically linked as to form part of a ‘group’ in

commercial understanding – on application to AA.

11

Elements/Components of Group

12

Solvency

• Only conditional inclusion of solvent companies: UNCITRAL

• As per EU Regulation, solvent companies are NOT be included.

• WG – Company not subject to insolvency proceeding should be allowed toparticipate voluntarily.

Location

• Cross-border insolvency allowed in UNCITRAL and EU Regulation,COMI- Important in EU Regulation

• WG recommends only domestic proceedings. Cross-border to beconsidered at a later stage.

Form of entity

• All form of entity (regardless of legal form) included in UNCITRAL

• WG- Only companies.

Modes of “grouping”

Modes of grouping

14

Joint Application

Procedural Coordination

Substantive Consolidation

Perverse Behaviour of Companies in

Group

Joint Application: General

Qualifying criteria – commencement standard

Single/parallel applications

Permitted applicants

Group members

Creditor of any group member of which he is a creditor.

Different from procedural coordination

joint application is NOT a prerequisite for procedural

coordination

Permitting joint application does not necessarily lead to

procedural coordination but MAY include prayers for procedural

coordination

15

Joint Application: WG Recommendations

By creditors (financial/operational) or group companies

themselves

Companies which have committed a default.

In addition to the mechanism to initiate the CIRP

process against each group company separately.

When the joint application is accepted by the

Adjudicating Authority, it may order for a single public

announcement to be made for all companies.

16

Procedural Co-ordination: General Coordination of the administration of two or more insolvency

proceedings in respect of group members Respect for “separate identity principle” and “asset partitioning”;

therefore, NO consolidation of assets/liabilities Therefore, different from “substantive consolidation”

Who can apply? Creditors, group members, insolvency representatives of group members

Timing Flexible approach- however, application at later stage limited

Mode of creditor participation Single committee (where desirable), or co-operation between different

committees

Courts Single court (priority of filing, amount of indebtedness, location of centre

of control), or coordination between courts important.

17

Procedural Coordination: WG Recommendations (1)

• Inspired by UNCITRAL Guide and the World Bank Principles for

Effective Insolvency and Creditor/Debtor Regimes, 2016 (“WB

Principles”)

• ‘Report of the Working Group on Group Insolvency’ September 23,

2019.

• Preferred mode of “grouping” over substantial consolidation.

• Framework is enabling, voluntary. Provisions relating to

communication, cooperation and information sharing mandatory

for IPs, AAs, and CoCs.

• May be allowed at any stage of the insolvency resolution or

liquidation process for companies.

▫ At the resolution phase may not necessarily continue to the stage of

liquidation – may be allowed on fresh application.

18

Procedural Coordination: WG Recommendations (2)

Common AA

The one which first admits the application w.r.t. any company in

a group

Flexibility to stakeholders as long as AAs share information, co-

operate and communicate

CoCs of different companies by required majority opt for a

single AA.

Common Insolvency Professional

In case of conflict of interest or lack of resources- different IPs,

but mandated to communicate, cooperate and share

information with each other.

Coordinated resolution plan

CoC of each company- approve the plan or opt-out.

19

Procedural Coordination: WG Recommendations (3)

• Group Committee of Creditors

▫ MAY Constitute Group CoC - only enable synchronised

resolution.

▫ Supports not supplants individual CoCs

▫ the composition, constitution and costs of the group creditors’

committee decided by an Framework Agreement.

• Group coordination proceedings

▫ Voluntary

▫ Framework Agreement

▫ Group coordinator (to propose a group strategy)

Only IP

20

Procedural Coordination: WG Recommendations (4)

• Timelines

▫ Opt out at the stage of Framework Agreement

▫ For opting-in mechanism – after Framework Agreement

▫ For completion of process - 420 days including the

additional extension of period up to 90 days and time

taken in litigation.

No specific timeline specified for liquidation

21

Procedural Coordination: Precedents

• Venugopal Dhoot v. State Bank of India & Ors. where

NCLT applied procedural coordination mechanism-

“avoiding conflicting orders and facilitating the

hearing”.

• Edelweiss Asset Reconstruction Company Limited v.

Sachet Infrastructure Pvt. Ltd. & Ors. the NCLAT

initiated group insolvency proceeding against five

companies as they were working as a joint consortium

to develop a residential plotted colony.

22

Substantive Consolidation: General Treatment of the assets and liabilities of two or more group

members as if they were part of a single insolvency estate

Disregards the separate identity of each group member and the

principle of asset partitioning in ‘appropriate circumstances’

consolidate their assets and liabilities treating them- single entity.

Competent Person - creditors and group members

Timing of application- flexible

Factors- Creditor’s benefit, transactions so inter-linked- cannot be

separated.

Not recommended by WG in India for the time being

23

Procedural vs. Substantive

Procedural Coordination Substantive Consolidation

Coordinates the ‘procedures’of insolvency and assets of eachgroup company separate.

Purpose: to make theadministration of proceedingseasier and inexpensive.

Separate legal entity INTACT.

Does NOT effect thesubstantive rights of creditors.

Inter-entity claims notimpacted

Consolidation of assets andliabilities of different groupcompanies- treated as singleinsolvency estate.

Purpose: equitable remedyagainst corporate disregard.

OVERTURNS separate entity.

Affects the substantive rightsof creditors.

Inter-entity claims vanish.

24

Factors favoring substantive consolidation

Common control

Interlacing of finance

Pooling of resources

Inter-dependence

Common assets and liabilities

Common directors

25

Co-existence for survival

Intricate link of

subsidiaries

Intertwined accounts

Inter-looping of

debt

Singleness of economics of

units

Cross-shareholdin

g

Precedents in favour of Substantive Consolidation

State Bank of India & Anr. v. Videocon Industries Ltd. & Ors. the

NCLT consolidated the assets and liabilities of 13 companies of

Videocon leaving out 2 companies- unfair for creditors.

Bikram Chatterji v. Union of India, the Supreme Court initiated

proceedings against the Amrapali group as a whole and the

properties of all forty group companies in the Amrapali group be

attached.

Chitra Sharma & Ors. v. Union of India & Ors., the Supreme Court

disregarding the separate identity of the companies, the Supreme

Court directed the parent company in the former to deposit money

26

Videocon Substantive Consolidation NCLT, Mumbai Bench Order dated August 8, 2019

Consolidation of 13 Videocon companies

Common control, common directors, common assets, common liabilities, etc.

Companies interdependent in terms of business activities

Lending based on co-obligor structure – joint and several liability (inter-lacing of

finance)

CoC mostly common

Lenders treated the companies as single economic unit (at the time of granting loans)

Group companies filing common/consolidated financial statements

Extensive cross-shareholding

No interest shown by RAs in respect of separate companies

Leaving out 2 companies

Capable of being a going concern on their own

Business not dependent on other companies

May be unfair to creditors

27

Re Owens Corning: Classic case against

substantive consolidation $2 Billion loan provided-Credit Agreement- clause to protect the

separateness of the subsidiaries.

Creditors created structural seniority by obtaining guarantees

from the subsidiaries

Separate books to be maintained, separate financial statements

Several restrictions

The court while disregarding the substantive consolidation of the

Corporate Debtor applied twin principle:

Pre-petition they disregarded separateness so significantly their

creditors relied on the breakdown of entity borders and treated

them as one legal entity.

OR

Post-petition their assets and liabilities are so scrambled that

separating them is prohibitive and hurts all creditors

28

Other United States rulings

Continental Vending Machine Corp. v. Irving L. Wharton in UnitedStates Court of Appeals- Consolidation approved- inequities itinvolves must be heavily outweighed by practical considerations whichmay occur where the interrelationships of the corporate group arehighly complex.

Vecco Construction Industries, INC and others- Consolidation wasapproved as difficulty in ascertaining individual assets and liabilitiesas well as presence of consolidated financial statements orconsolidated profitability.

Auto-Train Corporation, Inc. Florida Corporation- Before orderingconsolidation, a Court must conduct a searching inquiry to ensure thatconsolidation yields benefits offsetting the harm it inflicts onobjecting parties

Food Fair Inc. Debtor ; United States Bankruptcy Court , S.D. NewYork-the separate proceedings merge into a single proceeding asmerging all assets and liabilities- seven elements taken intoconsideration

29

Other forms of Consolidation Deemed Substantive Consolidation- legal entities are NOT

combined but distributions to creditors are made “as if” there had

been a business combination

In re Genesis Health Ventures, Inc., 402 F.3d 416 (3d Cir. 2005)-

voting, distribution and/or claims are estimated as if the

formally distinct entities were consolidated

In re T-L Brywood, LLC, Case No. 13-21804 (Bankr. N.D. Ill.

September 07, 2013)- “the concept of ‘deemed substantive

consolidation’ is not a legal concept

In re ADPT DFW Holdings, LLC- Court authorized the “deemed

consolidation” (i.e., consolidation for the limited purpose of

voting and distribution under the plan)

Partial Substantive Consolidation- where creditor shows- he

actually and reasonably relied on an entity’s separateness from the

overall corporate group- claims settled solely from the assets of

that entity.

30

Case Study – (1)

31

ABCD Group

C(Power)

B(IT Services)

A(Telecom)

D(Steel)

Insolvent

Insolvent

Insolvent

Solvent

Lenders

Different set of

shareholders,

directors,

employees,

end-users, etc.

Single RA

might not be

possible.

Case Study (2)

32

ABCD Group

C

B

A

D

Lender group 1

Lender group 2

Lender group 3

Lender group 1

A, B, C, D are SPVs and

in same business, but

substantially different

values.

Common group of

shareholders/directors/

end-users/common

employees, etc.

Possible to have a

single RA.

Case Study (3)33

D

B

A

C

Process 1

Process 3Process 2

End Customer

Assembling

of customised end

product

Raw Material suppliers

Lenders

Operational

interlinkages,

closed structure,

one company

focal for front-

end dealings, etc.

ABCD Group

Perverse Behaviour of Companies

34

Subordination of Claims

Extension of Liability

Contribution Orders

Avoidance of Certain

Transactions

Subordination of claims

Rights of group members under intra-group arrangements could be

deferred to the rights of external creditors of those group members

subject to insolvency proceedings.

WG: AA be empowered to subordinate the claims of other companies in a

group in exceptional situations of fraud, diversion of funds, etc.

35

Extension of Liability

The liabilities incurred by an entity which is undergoing insolvency

can be extended to other entities which are related to it or are part

of the same group.

Contribution Orders A contribution order is an order made by a court directing a solvent

group company to contribute certain funds to another group company

which is undergoing insolvency.

There are adequate provisions in the Code to deter perverse

behaviour. Therefore, the WG recommends that no provision may be

made to extend liability to parent companies or issue contribution

orders.

36

Avoidance of certain transactions

Certain kinds of transactions taking place within the group in the pre-

distress period are declared null and void.

No further provision is required to be made to set aside transactions

between companies that are part of the same corporate group.

resolution@vinodkothari.com