The draftsmen and legislators of the Insolvency and Bankruptcy Code could never have dreamed of a worse start to the statutory regime they helped create than the one given by the first case to be resolved under the Code – that of Synergies Dooray. The case reeked of fraud. A resolution plan submitted by a related party of the debt-ridden company got the approval of the National Company Law Tribunal, and lenders had to take a 94% hit on their outstanding loans. The resolution plan itself was approved by Dooray’s Committee of Creditors (the body of financial creditors that must approve a resolution plan before it is submitted to the NCLT for its approval) because of the affirmative vote of Millennium Finance Limited, an ostensibly unrelated party that had a super-majority 76.33% vote share on the Committee of Creditors.

How did this come to pass?

From the facts set out in the Order sanctioning the resolution plan, it appears that just before the repeal of the Sick Industrial Companies Act, Synergies Casting Limited, a related party of Dooray, assigned more than 90% of the debts it held in Dooray to Millennium Finance. This assignment enabled Millennium Finance to vote on Dooray’s Committee of Creditors.

Now, Section 21 of the Code prohibits related parties of the debtor company from representation on the Committee of Creditors, and for good reason. A fundamental precept of the Code is that when a company defaults on its loan, control of the company passes from its equity owners to its creditors. As the Bankruptcy Law Reforms Committee, which designed the Code, put it in its report, “The limited liability company is a contract between equity and debt. As long as debt obligations are met, equity owners have complete control, and creditors have no say in how the business is run. When default takes place, control is supposed to transfer to the creditors; equity owners have no say.”

The insolvency resolution process under the code is fully controlled by creditors and allowing equity holders to dictate proceedings would frustrate the scheme of the Code.

Coming back to Dooray’s case, Synergies Casting applied to submit a resolution plan (this would not be possible now due to the new Section 29A, which prohibits related parties from submitting resolution plans), and was allowed to do so. The plan submitted by it was approved by Millennium Finance, which as we have seen, controlled over 75% votes on the Committee, enough to approve a plan as per the Code. Edelweiss, an owner of about Rs. 87 crores worth of debt in the company, objected, saying that Millennium Finance ought to have had no place on the Committee due to the sequence of events that led to its acquiring debt in the company. The resolution professional and NCLT brushed aside these objections, and the scheme was approved.

Everyone can smell a rat here, but what if it is really impossible to prove any relation between Millennium Finance and Synergies Dooray? Is there a loophole in the Code? A lawyer quoted in Bloomberg Quint said a solution to this problem could be that if a lender buys debt at a discount, its voting weightage would be proportionate to the buying price. So a Rs. 50 debt bought at Rs. 20 would only count for Rs. 20. This is an unsatisfactory solution, as it still doesn’t prevent equity shareholders from being able to vote on the Committee of Creditors and influence its decisions.

I think the antidote is simpler and doesn’t need any amendments to the Code. This isn’t the first case in the history of law where someone has tried to bypass a statutory prohibition by entering into a convenient assignment. But courts have consistently held in such cases that the assignee does not get any better right then the assignor. So, if Synergies Casting had no right to vote on the Committee of Creditors, neither did Millennium Finance, to whom it assigned the debt. The earliest case I could find on this point was a 1940 Nagpur High Court judgment that featured the legendary Justice Vivian Bose as one of the judges on the Division Bench that passed judgment. It is titled Panmal Keshrichand v. Dhanalal Laxmichand.

In that case, a lady called Dhanabai had a right to the profits of a partnership firm to which she was also indebted, as she had taken loans from the firm. So, she couldn’t get to the profits, because the other partners would insist that they be appropriated towards the amounts she owed the firm. Presumably to get around this, Dhanabai’s son-in-law seems to have filed a collusive suit against her, and obtained a consent decree. He then sought to partition the property of the firm in the guise of executing his decree. Repelling this attempt, the High Court held that the son-in-law’s rights were the same as his mother-in-law, and the assignment from one party to the other wouldn’t put him in a better position.

By the same logic, Millennium Finance’s had the same right to sit on Dooray’s Committee of Creditors as Synergies Casting – zero.

The NCLT ought to have rejected the resolution plan. Edelweiss, the distraught minority lender, appears to have filed an appeal to the NCLAT. Let’s hope they succeed.