When a company becomes insolvent, there are several parties involved in the resolution process, not only the corporate debtor and its creditors. Understanding equitable treatment under insolvency law is essential, as it ensures a fair distribution of assets and protects the interests of all stakeholders. The Insolvency and Bankruptcy Code, 2016 (IBC) provides the framework for the treatment of stakeholders, clearly outlining the rights and responsibilities of various parties in the resolution process. This framework guarantees equitable treatment under insolvency law, making sure that all parties, including creditors, employees, and shareholders, are treated fairly and transparently.
Understanding the Principle of Equitable Treatment
Defining Equitable Treatment:
“Equitable treatment” means that all creditors with similar claims against the corporate debtor should be treated fairly and proportionally when distributing the debtor’s assets. It ensures that all creditors are treated fairly, considering their rights and claims and the core tenet of insolvency frameworks
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Key Elements of Equitable Treatment in Insolvency:
Equitable treatment in the insolvency framework includes transparency and accessibility such as public disclosure of insolvency proceedings and clear communication regarding the insolvency process to all creditors. It will also include creditor equality, meaning there should be a fair distribution of proceedings among creditors, no differential treatment based on the class of creditors, and protection of dissenting creditors’ interests. Therefore, key elements of equitable treatment include fair and transparent procedures for all creditors, proportionate distribution of assets based on the priority of claims, equal access to information about the debtor’s financial situation, protection against preferential treatment of certain creditors, and a mechanism for addressing potential conflicts of interest among stakeholders.
Legal Framework for Equitable Treatment in India
In India, the legal framework for equitable treatment relies on the fair and equitable treatment principle. This is governed by the Insolvency and Bankruptcy Code, 2016 (IBC):
Statutory Basis Under IBC:
Section 30(4) mandates the approval of resolution plans with fair treatment for all creditors by the Committee of Creditors (CoC). The manner of distribution proposed must take into account the order of priority amongst creditors as per section 53(1). This section defines the waterfall mechanism for the distribution of proceeds.Â
Role of the Committee of Creditors:
The CoC is the decision-making body that is responsible for upholding fairness and balancing the interests of creditors in the IBC. Their decisions are guided by the principle of maximising the value of the debtor’s assets and ensuring a fair distribution of proceeds among creditors.Â
Judicial Interpretations:
The Hon’ble Supreme Court in Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta highlighted the importance that the same class of creditors should be given equal treatment. The National Company Law Appellate Tribunal in NCC Ltd. Golden Jubilee Hotels Pvt. Ltd. and Ors. held that different treatment among creditors if it serves the larger purpose of reviving the company, is justified.Â
Examining Cramdowns and Dissenting Creditors
The IBC also has provisions for cramdowns and dissenting creditors, two important concepts to understand when reading about the principle of equitable treatment.
What is a Cramdown?
“Dissenting creditors” refers to a creditor who disagrees with a proposed resolution plan during the insolvency process and under equitable principles, they are entitled to receive a payout equivalent to the liquidation value of their security interest, even if they voted against the plan. The IBC allows a court to impose a restructuring plan on dissenting creditors if the court determines the plan is fair and equitable. The court will consider factors like the advantages of the plan, the treatment of each creditor class, and the interests of creditors. This is known as “cramdowns” and is used to address deadlocks in the insolvency process, such as differential treatment.
Judicial Interpretation of Cramdowns in India:
The IBC has provisions for not only intra-class cramdown but also interclass or cross-class cramdown, In the DBS Bank Case, the Supreme Court held that when a plan is approved, an unwilling secured creditor has to forgo its security but is entitled to the value of the security as payable in case of liquidation. Therefore, under Indian law, there is a requirement of fairness even when dissenting creditors are overruled.Â
Balancing Dissent and Consensus:
The principle of equitable treatment ensures that dissenting creditors are compensated adequately. For instance, under section 53 of the IBC, priority has been given to secured creditors, but as per this principle and judicial precedents, it is also crucial to safeguard operational creditors.Â
Challenges in Ensuring Equitable Treatment
Despite providing explanations on the importance of equitable treatment under insolvency law law, there are several challenges in ensuring equitable treatment:
Balancing Conflicting Interests:
To balance the interests of stakeholders, there must be a fair and justifiable obligation on the part of both the stakeholders and the entity. In practice, there is an inherent conflict in claim prioritisation, and operational creditors are often perceived as less protected.
Judicial Discretion and its Limitations:
There are several judicial interpretations of fairness and equality. However, many of the decisions portray subjectivity in classifying creditors and claims.
Cross-border insolvency:
Determining which country’s laws and courts have jurisdiction over equitable treatment under insolvency law proceedings can be challenging. Therefore, it becomes difficult to establish the treatment of all creditors in cross-border insolvency matters.Â
Implications for Stakeholders
Stakeholders significantly influence the success of the equitable treatment under insolvency law process. To implement the principle of equitable treatment during this process, there are also hindrances faced by insolvency professionals, creditors, policymakers, and the judiciary.Â
Insolvency Professionals:
Insolvency professionals must ensure fairness in resolution plans and the decisions of the CoC. They also handle numerous stakeholders at once and have issues balancing the interests of different creditor classes.Â
Creditors:
Most creditors, regardless if they are operational creditors, financial creditors, secured creditors, or unsecured creditors, have a lack of understanding of their rights and obligations under equitable treatment provisions. Therefore they may not be able to leverage legal mechanisms to safeguard interests.
Policymakers:
Policymakers have a role in refining the IBC to address ambiguities and inequitable treatment. However, there are many hindrances in introducing reforms to establish a detailed principle of treatment.Â
Judiciary:
As stated above, judgments are both for and against the treatment of classes of creditors. The Adjudicating Authority faces the main challenge of establishing consistent precedents to minimize interpretative challenges.
Conclusion
The principle of equitable treatment in insolvency law means that creditors with similar legal rights should be treated fairly and receive a distribution based on their relative ranking and interests. Therefore, equitable treatment under insolvency law law is a balancing act, ensuring fairness while maintaining the efficiency of resolution processes. Effectively applying this principle in practice has many challenges due to several conflicts of interest between creditors, issues in cross-border insolvency, and divergent judicial interpretations.Â
FAQs
1. What is the principle of equitable treatment in insolvency?
The principle of equitable treatment in insolvency states that all creditors with similar claims against the debtor should be treated fairly and proportionally when distributing the available assets.
2. How does the IBC ensure equitable treatment?
The IBC ensures equitable treatment by providing a transparent and time-bound process for resolving equitable treatment under insolvency law, where creditors have the opportunity to participate in the decision-making process through the CoC. It thereby, aims to distribute the debtor’s assets fairly among all stakeholders involved, regardless of their hierarchy in the debt structure.
3. Can dissenting creditors challenge resolution plans under IBC?
No, dissenting creditors cannot challenge resolution plans under the IBC. However, if the court may allow for such objections if they believe it is fair and equitable. Dissenting creditors are entitled to payment of debt, which shall not be less than the amount to be paid to such creditor in terms of 53 of the IBC.
4. What are cramdowns, and how do they relate to equitable treatment?
“Cramdown” refers to the legal power of a court to impose a debt restructuring plan on a company undergoing insolvency proceedings, even if certain classes of creditors object to the plan, as long as the court deems it “fair and equitable” to all parties involved.