- Abstract
DIP-based model to restructuring an insolvent entity has gain prominence under the current set up of the Indian debt restructuring model. In order to keep the company under duress and the corporate debtors’ ability to function alive, this model gains further traction as it provides a cogent remedy to keep the creditors and the outgoing management of the company in yielding maximum result. The traditional alternatives that involve restructuring under the strict purview of the provisions laid down under IBC still has some areas which do not harness the maximum efficiency of the ‘going concern’. This paper analyses the capability of the DIP-model in the Indian regime and check its viability in comparison to same model adopted by other prominent countries. DIP-model does not provide a straight-jacket formula to the problems associated with debt restructuring, which the author discusses in light of dilemmas accompanied with the said model and possibility of furthering this model in the mainstream, outside the strict adherence to plain reading of the provisions of Insolvency and Bankruptcy Code, 2016. The author also analyses other options besides DIP-model to gauge the efficiency of such model in India’s restructuring of assets bid.
- Key Words
IBC – Insolvency and Bankruptcy Code
DIP – Debtor in-Possession
CIP – Creditor in-Possession
CIRP – Corporate Insolvency Resolution Procedure
IF – Interim Financer
IBBI – Insolvency and Bankruptcy Borad of India
- Research Methodology
The author in this paper relies solely on secondary sources of data, mainly through published journals and articles related to the aforementioned topic. Due to location disadvantage, primary data source could not be fed in the writing of this paper.
- Method
The method applied in writing this paper is doctrinal in nature where the author uses non-empirical data through analysis of journal, articles, case laws, and other secondary sources available from other countries as well. Through the analysis of present data and texts, the author has derived at suggestions and conclusion in ratiocinated way, subject to the limit of the author’s rationale and reasoning. The study adopted in writing this paper is qualitative.
- Introduction
One of the main goals of the Insolvency and Bankruptcy Code (IBC), 2016 is to safeguard and maintain the corporate debtor’s existence “as a going concern” by aiming for restructuring as a last option to end the debtor’s insolvency. The major role of resue financers is to inject capital into the failing business business in order to impede the relentless pitfall of the going concern while appropriating the risks concerned. They avoid the need for the entity to go bankrupt by providing the requisite capital and some breathing while in distress, and the lenders with some other viable options to uplift their economic status poured into the said company and regroup their restructuring strategy. Getting a hold of the risk-reward matrix would yield the rescue financer to inject the funds required at exorbitant interest rate, if the going concern satiates the condition for which the funds are to be directed and become a profitable endeavor to the rescue financer.
The definition of “interim finance” is given in Section 5(15) of the IBC and is defined as “any financial debt raised by the resolution professional during the insolvency resolution process period or by the corporate debtor during the pre-packaged insolvency resolution process period, as the case may be, and such other debt as may be notified. According to the definition, the corporate debtor under Chapter III-A, the interim resolution professional under Section 20(2)(c) of the Code, and the resolution professional under Section 25(2)(c) are all authorized by IBC to pursue rescue financing in order to keep the corporate debtor operating as a going concern. The Insolvency and Bankruptcy Board of India (Liquidation Process) (Amendment) Regulations, 2018, which provide interest payments to the interim financiers for the duration of the CIRP, have further strengthened the recourse of interim financing and provided the necessary incentive for fund infusion in distressed entities. Without a doubt, rescue funding proves to be a wonderful strategy for rescuing the failing businesses and, consequently, for protecting the Indian economy.
Due to concerns about distress, investors and lenders have begun to infuse rescue funds into certain firms even before they reach the bankruptcy stage. under agreeing to “pre-bankruptcy settlements,” lenders and borrowers might bypass the drawn-out and arduous corporate insolvency resolution procedure (CIRP) required under IBC.
Beyond the Code’s purview, rescue funding also entails the infusion of cash through private equity firms’ acquisition transaction arrangements or subscriptions to dependent convertible instruments. Pre-packaged arrangements and fund-raising via private equity companies are particularly advantageous for managements that refuse to relinquish control over their corporate debtor. Private equity companies who are ready to provide financing on a super-priority basis have begun entering the Indian rescue finance market in large numbers recently. These firms include Bain Capital, KKR & Co., Blackstone, Eight Capital, Lone Star, and a few more. It is evident that India is seeing a sharp increase in the use of rescue finance in a variety of forms to keep bankrupt companies operating as going concerns. The legal system hasn’t changed enough, though, to completely handle the myriad issues that surround the concept of this kind of funding.
- Challenges and Role of “Debtor in possession” (DIP) Model
At any stage of CIRP, rescue funding may be necessary to pay for a variety of operating obligations, such as staff compensation, lease payments, machinery maintenance costs, and raw material procurement fees. The resolution professional, who must get the CoC’s approval in this respect, is ultimately responsible for determining the necessary quantities of rescue funds and the payments to whom they should be distributed.
There is a lack of guidance about the substantive meaning of interim financing, which presents a dilemma for the resolution specialists in this case over the extent of their discretion. The consequences of such a void include the careless raising of interim funds and needless lawsuits by creditors who assert that the money they have loaned are interim funds in order to get super-priority status over these funds. The primary goal of corporate debtors’ asset value maximization, as envisioned by the Code’s Preamble, is hampered by such consequences. The National Company Law Appellate Tribunal (NCLAT) ordered, ignoring the appellant’s claims, that the advance money received by the corporate debtor in exchange for the promise to supply goods to the creditor does not constitute interim finance under Section 5(15) of the Code and that the appellant is merely a “unsecured financial creditor” with no super-priority right over other creditors. This recent ruling in the Tuf Metallurgical (P) Ltd. v. Impex Metal & Ferro Alloys Ltd. case makes this point clear. Therefore, the provision is vulnerable to widespread misuse and manipulation in the lack of clear standards about the scope of temporary funding under the Code.
This calls upon the scheme which DIP proposes dampen this insipid structure which IBC has not categorically underlined in its provisions. The US Bankruptcy Code’s (11 USC 9) DIP financing has drawn a lot of attention in the literature since it is a well-liked kind of short-term funding that has been expanding rapidly during the 1990s. The popularity of the DIP model is evident, with over half of bankrupt corporations in the US having availed of DIP financing.
A specific kind of funding known as DIP finance is available to businesses who file for reorganization under Chapter 11 of the US Bankruptcy Code. DIP financing is governed by Section 364(a) of the US Bankruptcy Code, which also allows insolvent corporate debtors to acquire unsecured credit in the regular course of business while filing for bankruptcy. The bankruptcy court must first approve any exceptions (11 USC, s. 364[b]). The DIP finance has therefore been characterized by some academics as court-approved funding for Chapter 11 petitions. DIP offers “troubled company a new start albeit under strict conditions” and makes debt financing easier during bankruptcy. When filing for bankruptcy, a DIP agreement is typically already in place.
The challenge impending upon the IBC in this context, sans the DIP, is that ‘third-party rescue financing’ is extremely beneficial for the corporate debtor as well as the overall economy, it is utterly despised by the business debtor’s current creditors. This is due to their reluctance to grant rescue financiers the designation of “super-priority”, which would force them to violate the Code. Notably, the Committee of Creditors’ (CoC) voting members must approve the interim financing plan with a 75% majority vote. Due to the existing creditors’ adamant opposition to third-party rescue proposals, which is understandable given that the corporate debtor’s survival, restructuring, and revival inevitably require financial resources, the only option left to them is to liquidate the corporate debtor. This is demonstrated by the fact that resolution plans are rarely even created or submitted to the National Company Law Tribunal (NCLT) in the majority of bankruptcy cases. Additionally, the risk that the corporate debtor may not survive even with the infusion of super-priority rescue money causes them to vote against super-priority financing since they believe that this would further reduce the realisable repayments for the current creditors. It is obvious that there is a conflict of interest between the rescue financiers and the current lenders, which leads to the needless liquidation of corporate debtors in flagrant contravention of the Code’s goal.
The extremely limited number of financial institutions willing to pursue the endeavor of interim funding is another obstacle preventing the Code’s goals from being fulfilled. For resolution specialists, luring in new or current creditors to finance enterprises that have become insolvent due to nonpayment of debts is an extremely difficult undertaking. Furthermore, the Reserve Bank of India (RBI) has long refused to allow financial service providers (FSPs) to assist failing corporate debtors due to the risk exposure of FSPs and the growth in their non-performing assets (NPAs). This is made worse by the current state of the Indian economy, which is characterized by a cash flow crisis. As a result, these providers and other rescue financiers are discouraged from lending money to corporate debtors.
- Foreign Legal Framework (USA)
Given the foregoing, the significance of rescue funding, and the insufficiency of the current Indian legal system to handle the resulting obstacles, it is appropriate to review and take cues from the legal system pertaining to the same that is in place in American jurisdiction.
The United States Bankruptcy Code’s Chapter 11, which outlines funding options for insolvent companies based on the “debtor-in-possession (DIP)” insolvency model, makes reference to the rescue finance provision. These options make it easier to raise the money needed to cover the costs of restructuring in order to fully revive these organizations as well as the basic working capital requirements for their continued existence. The DIP-funding model provides creditors with favorable interest rates, which is a crucial motivation for them to undertake rescue funding. In essence, this secures not just the freshly provided rescue cash but also the previous loans extended by these current creditors. The aforementioned two tactics do not seek to provide the bankrupt firms with a fresh start, even though they conveniently ensure the return of their creditors’ prior debts. Additionally, they disadvantage other creditors and the insolvent firms by providing these few DIP-Financing creditors with asymmetrical benefits.
The Code notably represents a change from the DIP model to the “creditor-in-possession” insolvency model in the Indian legal system. As a result, the creditors of the corporate debtors hold the authority to make decisions regarding them, so depriving the former management of any voting rights. It is implied that some elements of the DIP-Financing model would be reincorporated into Indian insolvency legislation with the official introduction of pre-packaged insolvency resolution for MSMEs. This has furthermore made it possible to incorporate additional advantageous DIP procedures to enhance the Code’s current insolvency resolution process. The two DIP-financing schemes mentioned above have a number of fundamental problems, but they can be gradually included into the Code with the appropriate disclaimers to bring them into line with the objective of reviving the bankrupt firms.
Lenders to DIP financing often consist of the pre-petition lenders themselves, but new investors like hedge funds and private equity may also be involved (Li & Wang, 2016). Nonetheless, Section 364 of the US Bankruptcy Code provides lenders with “superior seniority and enhanced security” as an incentive to provide financing to bankrupt firms, since many lenders would be hesitant to do so. According to the US Bankruptcy Code, if the corporate debtor is unable to raise unsecured financing, the court may approve the raising of DIP financing with the following provisions: (a) priority over all administrative expenses (11 USC s. 364[c][1]); this is a feature that DIP lenders in the US regularly offer; (b) first lien on unencumbered assets (11 USC, s. 364 [c][2]); (c) junior lien on encumbered assets (11 USC, s. 364[c][3]); or (d) priming lien, which implies “a senior or equal lien on the property of the estate that is subject to lien” (11 USC, s. 364[d]). The US has a strong DIP finance framework with super-priority given to interim funding providers thanks to these enabling regulations.
Types Of Firms That Receive DIP
A few academics have conducted an empirical analysis of the companies that have greater success obtaining DIP financing. Larger companies, better operating performance (and hence higher chances of emerging from bankruptcy), more unencumbered assets, temporary liquidity problems, low cash holdings, high working capital needs, and non-declining industries are among the characteristics that make a company more likely to receive DIP financing.
However, DIP funding is also available to small businesses with comparatively poor operational results; this is mostly dependent on the sort of DIP lender. According to Li and Wang (2016), there are two different categories of DIP financiers: “loan to own (LTO) lenders”, which are defined as “activist investors comprising hedge funds or PE funds”, and “loan to loan” (LTL) lenders”, which are pre-petition secured bank lenders”. Each’s reasons for offering DIP funding are unique. Li and Wang discovered that LTL lenders seek for undercollateralized borrowers that have a history of loan from them, perform comparably well operationally, and are undercollateralized. LTO lenders, on the other hand, focus on small businesses that are not bank-dependent, overcollateralized, and may not even have strong operational success.
Owing to this restructuring process, it can be said that LTO is alluded to not only loan but control finance as well. The ultimate purpose of it being to periodically shift control to DIP lender.
- Suggestion and Conclusion
Apart from drawing inspiration from foreign jurisdictions in the way described in the previous section, it is imperative that the difficulties surrounding rescue finance in India be addressed swiftly. It is important to remember that the rescue finance law does not automatically become operative just because it exists in paper. Research has indicated that a very small proportion of bankrupt corporations actually make use of the explicit procedures that control rescue finance, even in cases where they exist. Consequently, creating incentives for corporate debtors and their creditors alike is essential to the Indian rescue financing market’s successful growth.
The awarding of super-priority status alone is insufficient motivation. To give the rescue financiers, whether they are current creditors or outside funders, better security of repayment, a legal clause ensuring a minimum return even in the event of the corporate debtor’s declaration of liquidation must be incorporated into the Code.
The legislature and the Insolvency and Bankruptcy Board of India (IBBI) should work together to balance the interests of the corporate debtors’ current creditors and third-party financiers in order to encourage the former to provide rescue funds and the latter to vote in favor of raising such funds. This will help to promote DIP-based rescue financing in India. Similarly, the legislature and the IBBI should work to strike a balance between the interests of these creditors and the other stakeholders of the corporate debtors in topics pertaining to rescue funding by current creditors. In actuality, no rigid legislative provision can be established to promote all rescue finance situations, as each of these problems has unique and particular conditions that must be taken into consideration in order to advance the interests of many stakeholders in corporate debtors. Therefore, in order to successfully integrate the culture of rescue finance in India, the Italian Model of judicial approval—in which the Court performs the function of balancing the interests of the stakeholders of troubled entities—is essential.
Furthermore, prompt clarification is required about the Code’s substantive definition of interim financing, feasible sources for funding it, and the minimum and maximum interest rates that corporate debtors must pay to those who supply it. Legal guidelines pertaining to these issues would restrict the use of rescue finance to legitimate and practicable cases alone, so averting needless lawsuits as to the one that occurred recently in Tuf Metallurgical. Furthermore, the rules that add to the aforementioned significant measures must to clearly specify the criteria that courts would use to consider and approve petitions for obtaining rescue funds. These considerations ought to be consistent with the standards established in Attilan Group Ltd. case, which stipulate that the applicants must adequately demonstrate the applicants’ bona fide need for money and the extent of the corporate debtor’s potential recovery before the court. The RBI may be encouraged to loosen the funding limits it places on Financial Service Providers (FSPs), which are a major barrier to the expansion of the rescue financing market in India, if a too rigorous regulatory framework governing rescue financing concerns is in place.
In addition, the recently implemented pre-packaged insolvency resolution for the MSME sector—a component of the DIP-Financing insolvency model—should progressively be expanded to include all corporate persons covered by the Code. Furthermore, to safeguard the interests of unsecured creditors, who frequently oppose pre-packaged resolutions, the proposers of such resolutions should be required by law to certify that the resolution will not negatively impact the interests of any other stakeholder of the corporate debtor. After all, the Code signifies a shift in the Indian legal framework towards the creditor-in-possession model, which prioritizes the interests of creditors—and any return to the DIP model should first ensure the repayment of the debts for these creditors.
Abhigya Mohan,
Institute of Law, Nirma University (5th Year).