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CASE NAME: Comm. of Creditors of Essar Steel India Ltd. v. Satish Kumar Gupta.

Case Comment, Publications

DATE OF JUDGEMENT: 15 November, 2019 

CASE NUMBER: CIVIL APPEAL NO. 8766-67 OF 2019 

                                    DIARY NO.24417 OF 2019

BENCH:  V. Ramasubramanian, Surya Kant, R.F.  Nariman

CITATION: AIRONLINE 2019 SC 1494

INTRODUCTION

The Essar Steel case was a landmark ruling by the Supreme Court of India that significantly reshaped the understanding of judicial review and clarified the powers of the Committee of Creditors (CoC) under the Insolvency and Bankruptcy Code (IBC), 2016. The dispute arose when Essar Steel, one of India’s largest corporate defaulters, entered the Corporate Insolvency Resolution Process (CIRP). At the heart of the conflict was the question of how different categories of creditors—financial and operational—should be treated, and whether the National Company Law Appellate Tribunal (NCLAT) had the authority to alter a resolution plan already approved by the CoC. The CoC, comprising financial creditors, had sanctioned a plan for Essar Steel’s revival, but the NCLAT modified the distribution of proceeds to balance payouts between creditor classes. This move triggered a legal challenge, ultimately reaching the Supreme Court. In its judgment, the Court underscored that commercial decisions made by the CoC hold primacy and are generally beyond judicial interference, except in situations where such decisions contravene statutory provisions or the law’s intent. By doing so, the ruling reinforced creditor autonomy within the IBC framework and limited the scope of tribunals to re-evaluate commercial wisdom.

 FACTS 

Essar Steel India Limited was a carbon steel manufacturing company which was involved in producing steel from iron ore to finished goods but had began to incur financial losses after 2010. However it was compelled to take loans amounting to several crores of rupees from both public and private sector to maintain balance. The company was undergoing insolvency proceedings initiated by Standard Chartered Bank under the IBC on August 2,2017. 

The company by 2015 was burdened with debt of Rs 54,000 crores from both operational & financial creditors. Therefore the company had filed for insolvency under the Insolvency and Bankruptcy Code before the National Company Law Tribunal in the year 2017 as it was not able to pay its debts. 

The Reserve Bank of India had identified Essar Steel as one of the twelve large corporate defaulters whose massive non-performing assets (NPAs) posed a significant threat to the stability of the Indian banking sector. Major lenders, including the State Bank of India and Standard Chartered Bank, incurred considerable financial losses due to the company’s default. Consequently, these institutions approached the National Company Law Tribunal (NCLT) to initiate insolvency proceedings against Essar Steel. Following the declaration of insolvency, the matter proceeded under the Corporate Insolvency Resolution Process, during which the company’s assets were put up for sale to recover dues. In the competitive bidding process, global steel giant ArcelorMittal emerged as the highest and most successful bidder, proposing a resolution amount of approximately ₹48,000 crore. However, the resolution professional scrutinised the proposal in light of the eligibility criteria laid down under Section 29A of the Insolvency and Bankruptcy Code (IBC).

ISSUES RAISED

  1. The financial creditors had disagreed with the decision of the NCLAT, which had directed for equal distribution of funds between financial and operational creditors. Their objection had basically stemmed from the fact that financial creditors had owed significantly larger amounts compared to operational creditors. 
  2. The Committee of Creditors (Coc) primarily it comprises of financial creditors was largest lender headed by the State Bank of India (SBI) had subsequently challenged NCLAT’s ruling by filing an appeal before the Supreme Court. 
  3. This had raised a legal contention whether the constitutional validity Insolvency and Bankruptcy Code (Amendment Act), 2019 is defensible or not?

CONTENTIONS RAISED

  1. Resolution Plan by ArcelorMittal – under the resolution plan proposed by ArcelorMittal , the CoC had full discretion over fund distribution among secured financial creditors. The plan included an amount of Rs 42,000 crore alongwith an equity infusion of Rs 8,000 crore. As per the plan the unsecured financial creditors were to receive 4% of their claims and operational creditors with claims below 1 crore along with employees and workmen had to be paid full while those with claims above 1 crore would receive nothing. Therefore all security interests with the exception of promoter guarantees were to be either terminated or transferred to ArcelorMittal. Creditors were still able to demand personal or corporate guarantees against the former promoters but the subrogation  rights were terminated with NCLT approval.
  2. NCLT proceedings- the National Company Law Tribunal (NCLT) had granted for conditional approval to ArcelorMittal’s resolution plan on 8th March 2019. The tribunal has advised the Committee of Creditors to re-evaluate the distribution of funds to ensure equitable treatment of operational creditors with claims exceeding Rs 1 crore and Standard  Chartered Bank , a dissenting financial creditor.  Therefore several parties following the NCLT’s order including the multiple operational creditors had suspended the board of directors and thereby the former promoters of Essar Steel has filed appeals challenging the approval of the plan. 
  3. NCLAT proceedings – The NCLAT by passing an interim order on 20th March 2019,  instructed the Committee of Creditors to hold a meeting and take a decision in consultation with the directors issued by the NCLT. The CoC had thereby approved a pro rata distribution of funds among all secured financial creditors excluding Standard Chartered and an ex gratia payment of Rs 1,000 crore to operational creditors whose claims exceeded 1 crore. 

The Coc had argued that Standard Chartered was in different position compared to other secured financial creditors because:

It was not a direct lender to Essar Steel instead it had obtained a guarantee from Essar Steel for the debt of its offshore subsidiary. Additionally its security was provided by pledged shares of the offshore subsidiary which had a low fair value as opposed to a charge on the company’s primary assets. Because of the security’s low value the Coc had suggested for paying to the Standard Chartered about 61 crore or 1.7% of the total price. 

The NCLAT on 4th June 2019 had subsequently – approved the Arcelor Mittal’s resolution plan and had thereby restructured the distribution of proceeds to treat all creditors equally which had resulted in an overall recovery of nearly 60.7%. 

It had also increased the admitted claims of operational creditors to nearly four times the initial amount and had therefore permitted operational creditors whose claims had not been recognised by NCLT or NCLAT to pursue or continue appropriate legal proceedings against Essar Steel following the resolution process. It was determined that the guarantees had issued for Essar Steel’s debts and would stand extinguished once the underlying debt was cleared.

RATIONALE 

The decision by NCLAT was overturned by the Supreme Court in July 2019 after the financial creditors had filed appeal before the court. The court’s decision had confirmed that Arcelor Mittal would take over Essar Steel that the Committee of Creditors would continue to have primary authority over how their contributions would be distributed. The Supreme Court had made it clear that NCLT and NCLAT are powerless which  influences  the Coc’s business decisions. 

The Supreme Court had further underlined that since the financial creditors lend money to businesses and are backed by collateral, they need to be given priority above operational creditors who are unsecured lenders with no such guarantees. Therefore the court had decided that the creditors shouldn’t be compelled to accept discounted recovery just to fulfil the 330 day resolution deadline and therefore it wasn’t required. Additionally it had benefited the banks by enabling them to recoup about 90% of their obligations thereby improving their financial stability.

According to Section 29A of the Insolvency and Bankruptcy Code, 2016 which lists groups of people who are not permitted to submit their plans, the Court thereby noted in its judgement that both the resolution applicants were initially excluded. However the Supreme Court had given the applicants a 14-day window from the date of the order to pay off their Non- Performing Asset (NPA) debts, using its extraordinary authority under Article 142 of the Constitution.  Article 142 gives the Supreme Court the authority to take whatever decision or order it deems fit to guarantee full justice in cases that are still pending.

The Supreme Court while setting aside the NCLAT’s order had ruled the principle of “equality” cannot be interpreted to mean all the creditors must receive the same amount of money whether they are categorized as operational or financial creditors or what kind of security interests they have under a resolution plan. The court further explained it is acceptable to treat secured financial creditors based on the value of their securities. Therefore it was noted that the primary objective of the IBC code, which was to restore the assets through resolution may be undermined if security interests were ignored during the bankruptcy process and creditors choose liquidation over resolution.

DEFECTS OF LAW 

  1. Inherent Conflict of Interest in CoC decisions : The Supreme Court had concluded that the Committee of Creditors is not subject to a fiduciary duty to any class of creditors emphasizing the significant value of the CoC. Financial creditors have a direct interest in maximizing their own recoveries which thereby leads to a conflict of interst. Although the court had urged the CoC to take operational creditors interest into account it had failed to establish legally enforceable protections setting aside the protection of operational creditors upto the CoC’s discretion.
  2. Exclusion of Operational Creditors from Voting Rights: The Supreme Court ruling had recognized operational creditors as a separate class and had maintained their differential treatment. Although their dues are substantial they are still not allowed to vote in the Committee of Creditors despite this recognition. According to the Insolvency Law Committee Report the results in a representational gap, raising the possibility that operational creditors should have fewer voting rights in subsequent amendments.
  3. Inadequate Role of the Resolution Professional(RP) : The Court had limited the role of the resolution professional to a non adjudicatory one, mainly administrative and procedural(gathering and confirming claims). Therefore allowing the RP to perform even minimal adjudication may lead to delays and litigation particularly when claims are contested as claim verification leads to legal intricacy.
  4. Uncertainty Regarding the Invocation of Guarantees after resolution: the ruling had provided relief to resolution applicants by upholding the guarantors subrogation rights being terminated. The Supreme Court however had reached a definitive ruling on the question whether financial creditors might pursue personal or corporate guarantees provided by the promoters after resolution.
  5. Modification of the 330 –Day Timeline : the court had read down the word “ mandatorily” to maintain constitutional validity even though it had upheld the 330 day deadline for CIRP completion under the IBC Amendment Act. This suggests that the deadline might be surpassed in extraordinary circumstances. The IBC was enacted to prevent inconsistent application and judicial delays, which could result from the absence of clear standards for what qualifies as “exceptional”.

INFERENCE 

The Supreme Court’s Decision in the Essar Steel case was  turning point in Indian bankruptcy law as it upheld the Insolvency and Bankruptcy Code,2016 and the supremacy of Committee of Creditors (CoC). The Court had avoided a potentially disastrous precedent that may have ruined the settlement process by confirming that equality under the IBC had referred to equitable, not identical recovery by maintaining differing treatement between financial & operational creditors. 

Court had promoted the time bound resolution mandate by upholding the constitutionality of the IBC and extinguishing the unresolved and previous claims after they were resolved. However the decision had left behind some important questions to be answered, most significantly the uncertainty regarding the enforceability of promoters personal promises following resolution. Despite their financial interest operational creditors were not given any voice in the process nor were the conflict of interest inside the CoC addressed. 

Therefore even though the ruling had solidified a process that is led by creditors and pushed by business, it had also made clear the necessity of further changes and judicial clarification. The Supreme Court had further established the foundation for a more resilient, effective and investor friendly insolvency framework in India by setting important cases and enforcing procedural discipline. 

REFERENCES

  1. Insolvency and Bankruptcy Code, No. 31 of 2016, § 29A (India).
  2. Insolvency and Bankruptcy Code (Amendment) Act, No. 26 of 2019 (India).
  3. India Const. art. 142. 

GAYATRI SAHA 

 (UPES DEHRADUN) BA LLBHONS. 4TH YEAR