When a company undergoes insolvency proceedings, and a resolution plan has been approved by the adjudicating authority, does it essentially hit a reset button on past claims against it? If so, then - Who pays off these claims? What happens to the claimants involved? And what about past claims that surface belatedly and reported after the CIRP proceedings have begun?
These questions unravel the intricacies of insolvency and bankruptcy proceedings. This article aims to shed light on the Clean Slate Theory under the Insolvency and Bankruptcy Code, 2016. This doctrine plays a crucial role in reshaping the financial landscape for distressed companies, offering insights from precedents.
Introduction
The Insolvency and Bankruptcy law in India was developed to foster economic activity among existing businesses and provide a framework for rehabilitating financially distressed companies.
As per s.31 (1) of the Insolvency and Bankruptcy Code, 2016 (‘IBC’), when a resolution plan (‘Plan’) is greenlit by the committee of creditors (‘CoC’), it becomes binding on all stakeholders. This provision ensures that the resolution applicant (‘RA’) takes over the business without being weighed down by past liabilities. At the heart of this provision is the clean slate theory.
Clean Slate Theory (‘CST’)
CST posits that an applicant assuming control of an entity in insolvency proceedings should not face unforeseen claims. RA is thus safeguarded from being overwhelmed by past claims against the entity before the corporate insolvency resolution process. (‘CIRP’).
In simple terms, once a Plan is approved, all claims included in the plan become fixed, while any claims not included are extinguished. As a result, no legal proceedings pertaining to the period before the CIRP can continue or be initiated against the corporate debtor (‘CD’) for claims excluded from the approved Plan. This provision ensures a fresh start for the successful RA, shielding them from being burdened by new claims against the former entity.
This approach enables a seamless transition, allowing the new RA to start business operations anew and contributing to a more robust and efficient CIRP.
CST aims to strike a fair balance between the interests of creditors and the CD. It is based on the belief that a successful Plan should not only maximize the recovery of dues for creditors but also ensure the CD's return to operational viability.
However, it is essential to understand that the CST applies solely to CDs and does not exonerate the former directors from their personal liabilities. For example, wilful defaulter proceedings can persist even after the Plan is approved, as these proceedings aim to prevent further financial misconduct and protect public money.
Evolution of CST under IBC
The idea of a ‘clean slate’ is central to contemporary bankruptcy systems. It embodies the principle that a CD should have the opportunity to overcome financial difficulties and resume participation in the economy, as opposed to a more punitive approach that focuses on penalizing past failures. This principle, encapsulated in the CST, has been recognised both domestically and internationally. In India, its footing has emerged prominently in the 2019 Supreme Court case -Essar Steel India Limited v. Satish Kumar Gupta[i].
In the case, the Supreme Court laid down CST in the context of insolvency law. The court noted that ‘a successful resolution applicant cannot suddenly be faced with ‘undecided’ claims after the resolution plan submitted by him has been accepted as this would amount to a hydra head popping up which would throw into uncertainty amounts payable by a prospective resolution applicant who successfully take over the business of the corporate debtor. All claims must be submitted to and decided by the resolution professional so that a prospective resolution applicant knows exactly what has to be paid in order that it may then take over and run the business of the corporate debtor. This is what the successful resolution applicant does on a fresh slate[ii]'.
The Supreme Court underscored that the corporate insolvency process was the exclusive avenue for addressing claims against the CD. Hence, RA should avoid unforeseen claims post-acceptance of their Plan, as such uncertainties would complicate the financial obligations and hinder the takeover of the CD's operations.
The CST is reflected in s. 31 of the IBC, which states that an approved Plan is binding on all stakeholders involved. Initially, the wording of s. 31(1) of the IBC was ambiguous, leading the Central and State governments to continue with legal proceedings even after the approval of the Plan. This was a misinterpretation of the section and contrary to the legislative intent. To address this, the Insolvency and Bankruptcy Code (Amendment) Act, 2019 amended this provision to include ‘Central Government, any State Government, or any Local authority’ among those bound by the successful Plan. This amendment was clarificatory in nature and thus applied retrospectively. As a result, any claims, even if they relate to a period before the amendment's effective date, will not be considered once the Plan is approved.
Further reinforcing the above, the Rajasthan High Court, in the Ultra Tech Nathdwara Cement Ltd. v. UOI[iii], had a consistent view as to the CST and affirmed that a successful RA must be allowed a fresh start, free from the unpaid debts of operational creditors (OCs), including government entities like the Central Goods and Service Tax Department who are not part of the Plan. The clear takeaway from this judgement is that after a Plan is approved, government agencies and statutory authorities must adhere to the plan. They must present valid claims per the timeline mentioned in the CIRP process. Therefore, creditors, including government entities, cannot bypass the process set forth by the IBC.
Subsequently, the Parliament codified the CST into law through s. 32A of the IBC, brought about by the Insolvency and Bankruptcy Code (Amendment) Act, 2020.
Once the Plan is approved by the adjudicating authority (‘AA’), this section takes effect by providing security and immunity to the CD, its new management and officials, and its properties from any offences committed by the CD before the commencement of the CIRP.
This provision stipulated that upon the approval of a Plan resulting in a change of control of the CD to an entity not previously involved as a promoter, controller, or manager during the insolvency period nor implicated in any wrongdoing, the CD would be absolved from prosecution for prior offences. Additionally, the provision safeguarded the CD's property from legal actions such as attachment, seizure, or confiscation.
The constitutional validity of s.32A of the IBC was subsequently challenged in the Manish Kumar v. Union of India[iv] case. The Supreme Court stated that ‘The extinguishment of the criminal liability of the corporate debtor is apparently important to the new management to make a clean break with the past and start on a clean slate’[v]. In its wisdom, the Supreme Court affirmed that without such protective measures, potential RAs would be deterred from bidding on the CD, thereby obstructing the CIRP. The Court clarified that the immunity provided under s.32A extended solely to the CD and not to other individuals culpable of any misconduct.
Emphasizing the economic rationale behind s.32A, the Supreme Court upheld its constitutionality, recognizing the necessity of such provisions in facilitating effective and efficient resolution of corporate insolvencies. This judicial endorsement ensured the implementation of the CST, reinforcing the legislative intent and preserving the integrity of the insolvency resolution framework in India.
Reg. 36 of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations[vi] mandates the inclusion of specific details in the information memorandum ('IM'). These details provide prospective RAs with a complete overview of the CD’s liabilities, enabling them to devise a Plan that can effectively extinguish these liabilities and ensure the CD’s successful recovery.
Additionally, s.15 of the IBC provides creditors with an opportunity to submit their claims against the CD when a public announcement is made to initiate the CIRP. However, questions arise about handling liabilities disclosed after the initial public announcement or after the acceptance of the Plan.
This issue was addressed in Ghanashyam Mishra and Sons v. Edelweiss Asset Reconstruction Company[vii] (‘Ghanshyam Mishra’). The Court observed ‘That once a resolution plan is duly approved by the Adjudicating Authority Under Sub-section (1) of Section 31, the claims as provided in the resolution plan shall stand frozen and will be binding on the Corporate Debtor and its employees, members, creditors, including the Central Government, any State Government or any local authority, guarantors and other stakeholders. On the date of approval of the resolution plan by the Adjudicating Authority, all such claims which are not a part of the resolution plan shall stand extinguished, and no person will be entitled to initiate or continue any proceedings in respect to a claim, which is not part of the resolution plan [viii]'.
Additionally, the court determined that no proceedings can be initiated in other competent courts. ‘Insofar as, the claims of Labour and Workmen are concerned, RP has specifically stated before NCLAT, that whatever claims were received from the workmen were duly considered in the resolution plan. Despite that, observing that a liberty is available to the workmen to raise their claims before a Civil Court or Labour Court, in our view, is totally in conflict with the provisions of I&B Code’[ix].
Navigating Belated Claims Through the Lens of the CST
a. How are claims managed?
Examining the management of claims under the CIRP process is essential to comprehending why belated claims pose a problem.
A moratorium is put in place with the admission of an insolvency petition, referred to as the insolvency commencement date. This moratorium stops the initiation of new legal actions and the continuation of pending legal proceedings against the CD, including the enforcement of any court, tribunal, arbitration, or other authority's judgment, decree, or order. As a result, creditors' claims submitted to the Resolution Professional (‘RP’) are effectively frozen from this date.[x]
Following the imposition of the moratorium, the CIRP starts with the RP issuing a public notice to announce the commencement of the CIRP and soliciting claims from creditors[xi]. The RP aggregates these claims into an IM[xii], which is used by potential RAs to propose their plans. The CoC is notified about the claims against the CD in terms of their number and value. The RP then verifies and updates the list of claims.[xiii] Starting from the insolvency commencement date, creditors have 90 days to file their claims with the RP to be included in the IM[xiv].
This verification and consolidation process decides which creditors will be involved in the decision-making process during the CIRP based on the nature and amount of their claims. It also influences the RA's finalization of a Plan and the distribution of proceeds to creditors from an approved Plan, hence managing the financials.
Timely disclosure of claims is an essential component of this process, as it ensures that all claims are accurately assessed and addressed from the outset and leads to a stable and predictable framework for the revival of the CD. It ensures that all financial obligations are transparently addressed during the CIRP, which helps formulate a comprehensive Plan. This, in turn, minimizes uncertainties and fosters confidence among stakeholders, facilitating a smoother and more efficient revival of the CD.
b. Judicial Perspectives on Belated Claims
In light of this, the recent judicial trend indicates that the courts have routinely denied fresh claims, which are either filed after the CoC has sanctioned the Plan or regardless of whether the plan is still awaiting the AA’s approval.
In the recent judgment of Rajan Shivkumar Mangave v. Arun Kapoor[xv], the NCLT’s Mumbai bench stated that claims ‘cannot be entertained at such a belated stage where the resolution plan has been unanimously approved by the Committee of Creditors and the same is pending for the approval of the Adjudicating Authority. At this stage, we cannot allow to unleash the hydra-headed monster of undecided claim(s) on the successful resolution applicant.’
Similarly, the above stance was in line with the perspective taken by Ghanashyam Mishra ‘After CoC approves the plan, the Adjudicating Authority is required to arrive at a subjective satisfaction, that the plan conforms to the requirements as are provided in Sub-section (2) of Section 30 of the I&B Code. Only thereafter, the Adjudicating Authority can grant its approval to the plan. It is at this stage, that the plan becomes binding on Corporate Debtor, its employees, members, creditors, guarantors and other stakeholders involved in the resolution Plan. The legislative intent behind this is, to freeze all the claims so that the resolution applicant starts on a clean slate and is not flung with any surprise claims. If that is permitted, the very calculations on the basis of which the resolution applicant submits its plans, would go haywire and the plan would be unworkable[xvi]'.
Reinforcing this view, in Ruchi Soya Industries & Ors. vs. Union of India & Ors.[xvii], the Supreme Court reaffirmed that on the date of approval of the Plan by the AA, all claims are frozen, and those not included in the Plan are extinguished.
Furthermore, in RPS Infrastructure Ltd. v. Mukul Kumar[xviii], the Supreme Court observed that ‘The mere fact that the Adjudicating Authority has yet not approved the plan does not imply that the plan can go back and forth, thereby making the CIRP an endless process. This would result in the reopening of the whole issue, particularly as there may be other similar persons who may jump onto the bandwagon. As described above, in Essar Steel, the Court cautioned against allowing claims after the resolution plan has been accepted by the CoC.’
These judicial precedents make it clear that the primary objective of IBC is to rehabilitate the CD economically. The established timelines are designed to protect the CD's assets from further depletion. Therefore, it is crucial to prevent creditors from submitting late claims against the RA, which is endeavouring to revive the CD.
The above discussion also underscores that the successful implementation of the CST within the framework of insolvency resolution fundamentally depends on the cooperative efforts of all parties involved. For the clean slate approach to effectively offer a fresh start for the CD, it is crucial that debtors, claimants, and resolution professionals adhere to the prescribed procedures and timelines set forth by the IBC. RPs must manage the insolvency process with diligence and transparency, ensuring that claims are verified and addressed in a timely manner. Meanwhile, claimants must comply with deadlines for submitting their claims and respect the boundaries established by the Plan. This collective adherence helps to avoid the risks of belated claims. It contributes to a successful resolution that not only offers the CD a genuine fresh start but also fosters a fair and efficient insolvency process.
c. Alternative Judicial Perspectives
In a different vein, Go Airlines (India) Ltd. v. Sovika Aviation Services Pvt. Ltd. & Ors.[xix] reveals another aspect of insolvency proceedings. The NCLAT held that legal proceedings between the Creditor and the CD could continue following the withdrawal of the CIRP under s.12A of the IBC. This case serves to illustrate that when the claims process has not yet reached the stage of Plan approval, legal actions against the CD can still proceed.
This perspective is further supported in the judgement of State Tax Officer v. Rainbow Papers Ltd.[xx], where the Court observed that ‘delay in filing a claim cannot be the sole ground for rejecting the claim.’ Relying on ‘Vishal Saxena & Anr. v. Swami Deen Gupta Resolution Professional’[xxi], the NCLT took the view that the time stipulation in reg. 12(2) for submission of a claim is a directory and not mandatory; hence, set aside the Plan.
Although the Supreme Court has traditionally held that any unresolved claims are extinguished upon the approval of the Plan, the ruling in Fourth Dimension Solutions Ltd. V. Ricoh India[xxii] (‘Fourth Dimension Solutions Ltd.’) represents a significant deviation by permitting the introduction of new claims after this stage. The Supreme Court stated that the appeal should be disposed of while granting the parties the liberty to pursue any contentions in the pending arbitration proceedings. The Court observed that although the Plan had been approved, there were ongoing arbitration proceedings between the parties. As such, the Court permitted the continuation of these proceedings, instructing that all claims and defences be examined on their own merits and according to legal standards.
According to this decision, creditors are allowed to continue contesting legal proceedings, raising claims against a CD, and initiating execution actions even after the Plan has been approved and the RA has assumed control. His stance appears to be at odds with the SC's interpretation of s.31 of the IBC in Ghanshyam Mishra, which held that the purpose of the Plan is to provide the CD with a ‘fresh start’ after it is sanctioned.
Despite the subsequent ruling in the Fourth Dimension Solutions Ltd. various NCLT benches have continued to invoke the principles from Ghanshyam Mishra. It is still uncertain whether the Fourth Dimension Solutions Ltd. decision will be regarded as a definitive framework for similar situations or if the continuation of proceedings will be evaluated on a case-by-case basis. The evolving judicial landscape indicates a potential for future conflicts between maintaining the integrity of the CST and accommodating exceptional claims beyond the formal CIRP.
Issues with CST
The first issue that arises is the conflict between s. 31(1) and s. 60 of the IBC. This issue is well illustrated through the example of a company undergoing the CIRP under the IBC. During the CIRP, a legal moratorium is imposed on the company. According to the CST enshrined in s.31(1) of the IBC, once the court approves a Plan, all previous debts and claims against the company are extinguished, thereby granting the company a fresh start. However, s. 60(6) introduces a significant complication by stipulating that the period of the moratorium is excluded from the calculation of the limitation period for any legal claims.
In other words, while the moratorium is in effect, the deadline for creditors to pursue legal claims is paused. Consequently, this provision means that even after the moratorium ends, creditors may still have the opportunity to seek legal recourse.
This creates an issue between CST and s. 31(1), which aims to eliminate all pre-existing claims upon the approval of the Plan. The extended claim period permitted by s.60(6) allows creditors to continue their claims post-moratorium.
S. 14's proviso, in conjunction with s. 60(6) of the IBC provides that claims may continue to be adjudicated before the appropriate forums in accordance with legal provisions following the conclusion of the moratorium.
This conflict raises complex legal questions regarding the effective management of ongoing claims in light of the Plan’s finality.
Another significant issue with the CST arises when a Plan is approved before the crystallization of certain liabilities. In such cases, creditors are precluded from both initiating future claims against the rehabilitated CD and pursuing ongoing proceedings before other competent courts. This problem becomes particularly pronounced when the exact amount of a claim or debt is not immediately ascertainable at the time of its submission.
A possible solution to this issue is to adopt the provisional admission of claims at a notional value.
The UNCITRAL Legislative Guide on Insolvency Law (1997), Part II, Chapter V[xxiii], suggests provisional admission of claims at a notional value. This approach allows provisional admission to account for uncertainties, ensuring that claims are acknowledged and considered within the insolvency process even when the precise figures are not immediately available.
Conclusion
CST under the IBC is crucial for revitalizing financially distressed companies in India. Once a Plan is approved, CST ensures that a successful RA inherits a company free from past liabilities and unforeseen claims. This principle, affirmed by landmark judgments such as Essar Steel India Limited v. Satish Kumar Gupta[xxiv] and Ghanashyam Mishra and Sons v. Edelweiss Asset Reconstruction Company[xxv], provides RAs with the certainty needed to revive distressed companies effectively.
However, implementing CST faces challenges, including the tension between s. 31(1) and s. 60 of the IBC and the handling of uncrystallized liabilities.
Overall, CST is a cornerstone of the IBC's framework, enabling RAs to revitalize distressed assets with confidence. Effective claim management and adherence to procedural timelines are essential for the CST's success, ensuring a robust and efficient insolvency resolution regime in India.
End Notes
[i] (2020) 8 SCC 531.
[ii] Ibid.
[iii] 2020 SCC OnLine Raj 1097.
[iv] MANU/SC/0029/2021.
[v] Ibid.
[vi] 17079b9123b1e517e074bef04e7c3400.pdf (ibbi.gov.in)
[vii] 2021 SCC OnLine SC 313.
[viii] Ibid.
[ix] Supra at vii.
[x] S. 14 of the Insolvency and Bankruptcy Code, 2016.
[xi] S. 13, S. 15 of the Insolvency and Bankruptcy Code, 2016.
[xii] S. 29 of the Insolvency and Bankruptcy Code, 2016.
[xiii] S.29 of the Insolvency and Bankruptcy Code, 2016.
[xiv] S. 12 of the Insolvency and Bankruptcy Code, 2016.
[xv] 2024 SCC OnLine NCLT 790.
[xvi] Supra at vii.
[xvii] 2022 SCC OnLine SC 455.
[xviii] 2023 SCC OnLine SC 1147.
[xix] 2022 SCC OnLine NCLAT 2236.
[xx] MANU/SC/1109/2022.
[xxi] 2 (2020) SCC Online NCLT 2734.
[xxii] MANU/NL/0284/2021.
[xxiii] Https://uncitral.un.org/sites/uncitral.un.org/files/media-documents/uncitral/en/05-80722_ebook.pdf
[xxiv] Supra at i.
[xxv] Supra at vii.
Authored by Shreya Manchanda, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.