Asset Separation in Insolvency: Insights from the BRS Ventures vs. SREI Infrastructure Judgment

The Article has been authored by Suman Kumar Jha (Founder & Managing Partner), Afnaan Siddiqui (Co-Founder & Partner) & Visakha Raghuram (Associate) and Bharat 

Introduction

In the recent judgment of ‘BRS Ventures Investments Ltd. vs. SREI Infrastructure Finance Limited’ (Civil Appeal 4565 of 2021), the Supreme Court addressed a critical issue regarding the maintainability of a second application under Section 7 of the Insolvency and Bankruptcy Code (IBC) against a corporate debtor, following the Corporate Insolvency Resolution Process (CIRP) of its corporate guarantor. This judgment highlights the distinct legal identities and asset separations between holding companies and their subsidiaries, emphasizing that a subsidiary’s assets cannot be included in the liquidation estate of a corporate debtor. This principle is reinforced by the Supreme Court’s stance in ‘Vodafone International Holdings vs. UOI,‘ which underscores the separate legal existence of companies, irrespective of ownership. The decision delineates the limitations of control and ownership in insolvency proceedings, ensuring that the liquidation processes adhere strictly to the assets owned by the corporate debtor

Facts:

1. The corporate debtor approached SREI Infrastructure Finance Limited (financial creditor) for a Rs. 100 crore loan for a SEZ project. The corporate debtor is a subsidiary of Assam Company India Limited (ACIL). The loan was secured by a mortgage of the corporate debtor’s leasehold land and a pledge of shares of the corporate debtor and ACIL.
2. The loan was secured by a corporate guarantee from ACIL. On March 24, 2015, a “debt repayment and settlement agreement” was executed among the financial creditor, the corporate debtor, and ACIL. Due to default, the financial creditor invoked ACIL’s corporate guarantee and filed an application under Section 7 of the Insolvency and Bankruptcy Code, 2016 (IBC) against ACIL, which was admitted on October 26, 2017.
3. The appellant, the successful Resolution Applicant of ACIL, submitted a resolution plan, approved on August 13, 2018, by the Committee of Creditors (COC) and by the adjudicating authority on September 20, 2018. This order was confirmed on appeal by the National Company Law Appellate Tribunal (NCLAT).
4. On February 10, 2020, the financial creditor filed another application under Section 7 of the IBC against the corporate debtor for Rs. 1428 crores, claimed as the balance amount payable under the Rs. 100 crore loan facility. The adjudicating authority admitted the application on November 18, 2020. The appellant’s appeal to NCLAT was dismissed.

Issue:

Whether the second application under Section 7 of IBC is maintainable against the corporate debtor for the same debt and default, considering the Corporate Insolvency Resolution Process (CIRP) has already taken place against the corporate guarantor, and the financial creditor has accepted the amount in full and final settlement of all its dues?

Arguments from Appellant:

1. The appellant’s resolution plan was approved, and Rs. 38.87 crores were paid to the financial creditor in full and final settlement. According to Section 140 of the Indian Contract Act, 1872, the financial creditor’s rights should be subrogated in favor of the appellant.
2. The appellant has the right of subrogation over the financial creditor’s right against the corporate debtor and its secured mortgage.
3. Partial payment in full and final settlement triggers subrogation. The debt has been discharged upon receipt of Rs. 38.87 crores from the guarantor, and the financial creditor cannot enforce the remaining debt from the corporate debtor.
4. The business of the corporate debtor was included in the insolvency plan, and admitting the Section 7 application against the corporate debtor deprives ACIL of a valuable asset.

Arguments from Respondent:

1. The resolution plan for the corporate debtor was approved on September 19, 2023. No payment was made against ACIL’s claim as an unsecured financial creditor due to the low liquidation value of the corporate debtor.
2. Under Section 36(4) of the IBC, a subsidiary’s assets cannot be included in the liquidation estate of the corporate debtor. Section 18 of the IBC clarifies that a subsidiary’s assets are not part of the resolution process for the corporate debtor.
3. Clauses 13.1 and 13.3 of the resolution plan state that ACIL’s assets and corporate guarantee are extinguished, with no subrogation rights for the existing guarantors.
4. The financial creditor can proceed against the corporate debtor for the remaining amount after partially recovering from the guarantor.

Rationale:

1. According to the Indian Contract Act, a creditor recovering part of the amount from the surety can still proceed against the principal borrower for the remaining debt.
2. If a corporate guarantor’s CIRP ends with a resolution plan, the creditor’s rights against the guarantor may end, but the principal borrower’s liability remains for the unpaid debt.
3. The liability of the principal borrower and the surety is co-extensive, allowing separate or simultaneous Section 7 IBC proceedings against both.
4. The corporate debtor’s liability to repay the loan remains unaffected by the CIRP process of ACIL.
5. Subrogation applies only to the amount recovered from the surety; the financial creditor retains the right to recover the balance from the corporate debtor.
6. The financial creditor can file separate Section 7 applications against both the corporate debtor and the corporate guarantor.

Analysis:

The Supreme Court clarified that under Section 36(4) of the IBC, a subsidiary’s assets cannot be included in the liquidation estate of the corporate debtor. The resolution plan for ACIL did not extinguish the corporate debtor’s liability, emphasizing that the corporate debtor’s assets are separate from the insolvency proceedings of the holding company, ACIL

The base principle arising out of the judgement is the relationship between a holding company and its subsidiary. Holding company do not own the assets of the subsidiary companies. Hence, they cannot be included in the resolution plan for winding up of a holding company

Vide another judgement, ‘Vodafone international holdings vs UOI’ the supreme court held that a company is a separate legal persona and the fact that all its shares are owned by one person or by the parent company has nothing to do with its separate legal existence. If the owned company is wound up, the liquidator, and not its parent company, would get hold of the assets of the subsidiary. In none of the authorities have the assets of the subsidiary been held to be those of the parent unless it is acting as an agent. Thus, even though a subsidiary may normally comply with the request of a parent company it is not just a puppet of the parent company.

Section 36 of the IBC requires the liquidator to identify the assets of the corporate debtor and form a liquidation estate of the corporate debtor for the facilitating sale and distribution of proceeds to stakeholders. Furthermore, section 36 (4) provides a list of assets that cannot be included in the liquidation estate and must not be used for recovery in the liquidation and sub clause (e) empowers the IBBI to specifically exclude certain assets from the liquidation estate. Under these powers the assets of a subsidiary cannot be included in the process of liquidation.

The case of Small Industries Development Bank of Indian v. Creation Investments Equitas Holdings LLC, backs up all these cases as well. The case highlighted the fact that a holding company and the subsidiaries are distinct entities and that the holding company does not own the subsidiary’s assets. However, in this case, both the holding company and the subsidiary were dissolved to avoid legal ramifications. Not only were the entities one and the same, they were, also operated by the same person. The sole purpose of the person who created such companies was to defeat the rights of the parties outside the countries. Therefore, the Court held that principles laid down in the Vodafone judgment could not be applied to defeat the rights and encourage fraudulent activities.

This highlights the most obvious and glaring exception to section 36 (4), the amount of control held by the holding company over the subsidiary company. The quantum of “how much control” and the “nature” of the holding and subsidiary company’s relation also has a significant impact on it’s functioning.

The Vodaphone judgement emphasises this point specifically too by stating that the parent company’s control or power over the subsidiary depends on the specific circumstances of each case. Citing an example in this case, the court stated that if a man is the shareholder of 99% if the shares of a one-man company and his wife holds 1 per cent, his control over the company is so complete that it is his alter ego. However, in case of multinationals, it is important to highlight that their subsidiaries operate with significant autonomy in the country concerned except when created or used as a legal façade.

Conclusion:

From the above, it is clear that in an insolvency resolution process initiated against the corporate debtor, the IRP can only take control over the assets over which the corporate debtor has ownership rights and cannot take charge of the assets of the subsidiary of the corporate debtor unless an order from the competent court/forum is obtained by the IRP.

However, it is pertinent to note that under Section 18 read with Section 36 of IBC, the IRP and the liquidator, respectively can exercise control over the shares of the subsidiary being the assets of the corporate debtor and thereby exercise control over the assets of the subsidiary.

The Supreme Court’s ruling in ‘BRS Ventures Investments Ltd. vs. SREI Infrastructure Finance Limited’ reaffirms the separate legal identities of holding companies and their subsidiaries in insolvency proceedings. It establishes that a subsidiary’s assets cannot be included in the liquidation estate of the corporate debtor unless specifically ordered by a competent court. This decision protects the integrity of corporate structures and ensures that liquidation and insolvency processes are conducted fairly, based solely on the assets legally owned by the entity under resolution.