CREDITORS CAN’T LAY HANDS ON THE ASSETS OF A WHOLLY OWNED SUBSIDIARY. BUT….. – An Article by Vijay K Sondhi

CREDITORS CAN’T LAY HANDS ON THE ASSETS OF A WHOLLY OWNED SUBSIDIARY. BUT…..

Author: Mr. Vijay K. Sondhi[1], Senior Partner

Research Contribution by: Mr. Abhishek Kisku, Managing Associate

 

Due to the lack of a singular law in India dealing with insolvency and bankruptcy, the Insolvency and Bankruptcy Code, 2016 (“Code”) was introduced to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner. The said Code received the Presidential assent on 28th May, 2016.

 

The Code applies Companies (under the Companies Act, 2013 or governed by any special law), Limited Liability Partnerships, Partnership Firms, Individuals and such other bodies incorporated under any law for time being in force, as the Central Government may notify. Part II of the Code (Ss. 4 to 77) deals with the Insolvency Resolution and Liquidation for Corporate Persons. Under Part II of the Code, Insolvency Proceedings can be initiated by a Financial Creditor under Section 7 of the Code, by an Operational Creditor under Section 9 and by Corporate Debtor itself under Section 10 of the Code.

 

After the filing of an application under Section 7 (by a Financial Creditor), or under Section 9 (by an Operational Creditor) or under Section 10 (by the Corporate Debtor), the Adjudicating Authority has to admit or reject the application within 14 days of the receipt of the Application. Once the application is admitted, an Interim Resolution Professional (“IRP”) is appointed and moratorium kicks in under Section 14 of the Code. It may be noted that the purpose of the code is not to wind up defaulting debtors – but an attempt is made by the resolution professional to restructure the debts of the companies so that all the creditors are paid off without the need to wind up the company. A resolution plan is prepared and submitted by the Resolution Professional, in consultation with the creditors, for the approval of the Adjudicating Authority. However, if the Adjudicating Authority rejects the Resolution Plan, it shall pass an Order requiring the corporate debtor to be liquidated.

 

Now, in a situation where insolvency proceedings have been initiated against a Holding Company and an Insolvency Resolution Professional has been appointed, a question arises whether the assets of the Wholly Owned Subsidiary (“WOS”) of the Holding Company (the corporate debtor) be brought under the purview of the Resolution Plan. Further, in the event the said Resolution Plan is not accepted by the Adjudicating Authority, can the liquidator appointed under the Code bring the assets of the corporate debtor company under its fold?

 

When a holding company[i] owns all of the voting stock of another company, the (latter) company is said to be a WOS[ii] of the parent company. The Companies Act in India and all over the world have statutorily recognized subsidiary company as a separate legal entity. In this regard, the Hon’ble Supreme Court in Vodafone International Holdings BV v. Union of India, (2012) 6 SCC 613 has held that[iii] “The legal relationship between a holding company and WOS is that they are two distinct legal persons and the holding company does not own the assets of the subsidiary and, in law, the management of the business of the subsidiary also vests in its Board of Directors.” The Hon’ble Apex Court, in the Vodafone case went on to opine that the “Shares of stock in the subsidiary company are held as assets on the books of the parent company and can be issued as collateral for additional debt financing. Holding company and subsidiary company are, however, considered as separate legal entities, and subsidiary is allowed decentralised management.”

 

The position of a shareholder with respect to Company’s assets has been considered by the Hon’ble Supreme Court in a plethora of judgments[iv] and it is a settled law that the a company is a juristic person and is distinct from the shareholders. It is the company which owns the property and not the shareholders. The shareholders are not the owners of the property of the company.

 

In light of the above, it can be seen that a holding company and its subsidiary are considered as separate entities under law. Further, though, the shares of the WOS held by the holding company are its assets, however, the holding company, per se, cannot claim any right over the assets of its WOS.

 

Section 18 of the Code[v] provides for the duties of the IRP. As per the said Section, the IRP shall, inter alia, takes control and custody of any assets over which the corporate debtor[vi] has ownership rights as recorded in the balance sheet of the corporate debtor, or with the information utility or the depository of security or any other registry that records the ownership of assets. However, as per the explanation to the said Section, the assets would not include, inter alia, the assets of any Indian or foreign subsidiary of the corporate debtor. Further, on a failure of the insolvency proceedings and subsequent initiation of liquidation mechanism under the Code, once a Liquidation Estate is formed by the liquidator under Section 36 of the Code[vii], the same would also not include the assets of subsidiary of the corporate debtor.

 

In addition to the above, the National Company Law Tribunal (“NCLT”), in its order dated 10.07.2017 passed in Alpha & Omega Diagnostics (India) Ltd. v Asset Reconstruction Company of India Ltd. & Ors.[viii], while interpreting Section 14 of the Code has held that the term “its” used in the said Section denotes the property owned by the corporate debtor. The properties not owned by the corporate debtor do not fall within the ambit of the moratorium. It is further worthy to note that the aforementioned ruling of the NCLT has been upheld by the National Company Law Appellate Tribunal (“NCLAT”) in Company Appeal (AT) (Insol.) No. 116 of 2017 vide its order dated 31.07.2017. The aforementioned NCLAT ruling has been subsequently followed by the NCLAT in Schweitzer Systemtek India Pvt. Ltd. Vs. Phoenix ARC Pvt. Ltd. & Ors.[ix] where also the NCLAT has approved that the properties not owned by the corporate debtor do not fall within the ambit of the moratorium under Section 14 of the Code.

 

From the aforesaid ruling, it can be derived that once the insolvency resolution process has been admitted and initiated, only such properties which are reflected in the balance sheet of the corporate debtor are subject to the insolvency resolution process.

 

Therefore, in light of the above, the insolvency resolution profession and/or the liquidator under the Code do not have direct access to the assets of the WOS of the corporate debtor. However, it may be noted that both the IRP, as well as the liquidator, have a control over the securities, including shares held in any WOS of the corporate debtor / holding company. Therefore, in the event if the creditors initiate proceedings against the corporate debtor / holding company under the IBC and the same is admitted, the IRP would gain control over the shares of the WOS being held by the corporate debtor / holding company. Similarly, in the event the liquidation process commences under the IBC, the liquidator will gain control over the shares of the WOS, being held by the corporate debtor / holding company and the same will be included in the Liquidation Estate. Conclusively, though, the assets of the WOS may not be subject to liquidation/realization, it goes without saying that once the shareholdings of the WOS held by the corporate debtor is liquidated, the WOS’s assets would ultimately go out of the control of the corporate debtor.


[1] The author of this article, Vijay K. Sondhi is a Senior Partner at Luthra and Luthra Law Offices, New Delhi, India. (Views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of the firm)

[i] As per Section 2(46) of the Companies Act, 2013, “holding company”, in relation to one or more other companies, means a company of which such companies are subsidiary companies.

[ii] Section 2(87) of the Companies Act,2013 – “subsidiary company” or “subsidiary”, in relation to any other company (that is to say the holding company), means a company in which the holding company-

(i) controls the composition of the Board of Directors; or

(ii) exercises or controls more than one-half of the total share capital either at its own or together with one or more of its subsidiary companies:

Provided that such class or classes of holding companies as may be prescribed shall not have layers of subsidiaries beyond such numbers as may be prescribed.

Explanation.-For the purposes of this clause,-

(a) a company shall be deemed to be a subsidiary company of the holding company even if the control referred to in sub-clause (i) or sub-clause (ii) is of another subsidiary company of the holding company;

(b) the composition of a company‘s Board of Directors shall be deemed to be controlled by another company if that other company by exercise of some power exercisable by it at its discretion can appoint or remove all or a majority of the directors;

(c) the expression “company” includes any body corporate;

(d)“layer” in relation to a holding company means its subsidiary or subsidiaries;

[iii] Paras 257, 258

[iv] See Bacha F. Guzdar v. CIT, AIR 1955 SC 74, at para 7; Chiranjit Lal Chowdhuri v. Union of India, AIR 1951 SC 41, at paras 54, 55; U.P. State Industrial Development Corpn. Ltd. v. Monsanto Manufacturers (P) Ltd., (2015) 12 SCC 501, para 31.3; Hindustan Lever Employees’ Union v. Hindustan Lever Ltd., 1995 Supp (1) SCC 499, para 49.

[v] Section 18 of the Insolvency and Bankruptcy Code, 2016-

Duties of interim resolution professional-(1) The interim resolution professional shall perform the following duties, namely:—

(a) collect all information relating to the assets, finances and operations of the corporate debtor for determining the financial position of the corporate debtor, including information relating to—

(i) business operations for the previous two years;

(ii) financial and operational payments for the previous two years;

(iii) list of assets and liabilities as on the initiation date; and

(iv) such other matters as may be specified;

(b) receive and collate all the claims submitted by creditors to him, pursuant to the public announcement made under sections 13 and 15;

(c) constitute a committee of creditors;

(d) monitor the assets of the corporate debtor and manage its operations until a resolution professional is appointed by the committee of creditors;

(e) file information collected with the information utility, if necessary; and

(f) take control and custody of any asset over which the corporate debtor has ownership rights as recorded in the balance sheet of the corporate debtor, or with information utility or the depository of securities or any other registry that records the ownership of assets including—

(i) assets over which the corporate debtor has ownership rights which may be located in a foreign country;

(ii) assets that may or may not be in possession of the corporate debtor;

(iii) tangible assets, whether movable or immovable;

(iv) intangible assets including intellectual property;

(v) securities including shares held in any subsidiary of the corporate debtor, financial instruments, insurance policies;

(vi) assets subject to the determination of ownership by a court or authority; (g) to perform such other duties as may be specified by the Board.

Explanation.—For the purposes of this sub-section, the term “assets” shall not include the following, namely:—

(a) assets owned by a third party in possession of the corporate debtor held under trust or under contractual arrangements including bailment;

(b) assets of any Indian or foreign subsidiary of the corporate debtor; and

(c) such other assets as may be notified by the Central Government in consultation with any financial sector regulator.

[vi] Section 3(8) of the Insolvency and Bankruptcy Code, 2016- “corporate debtor” means a corporate person who owes a debt to any person;

[vii] Section 36 of the Insolvency and Bankruptcy Code, 2016-

Liquidation Estate- (1) For the purposes of liquidation, the liquidator shall form an estate of the assets mentioned in sub-section (3), which will be called the liquidation estate in relation to the corporate debtor.

(2) The liquidator shall hold the liquidation estate as a fiduciary for the benefit of all the creditors.

(3) Subject to sub-section (4), the liquidation estate shall comprise all liquidation estate assets which shall include the following:-

(a) any assets over which the corporate debtor has ownership rights, including all rights and interests therein as evidenced in the balance sheet of the corporate debtor or an information utility or records in the registry or any depository recording securities of the corporate debtor or by any other means as may be specified by the Board, including shares held in any subsidiary of the corporate debtor;

(b) assets that may or may not be in possession of the corporate debtor including but not limited to encumbered assets;

(c) tangible assets, whether movable or immovable;

(d) intangible assets including but not limited to intellectual property, securities (including shares held in a subsidiary of the corporate debtor) and financial instruments, insurance policies, contractual rights;

(e) assets subject to the determination of ownership by the court or authority;

(f) any assets or their value recovered through proceedings for avoidance of transactions in accordance with this Chapter;

(g) any asset of the corporate debtor in respect of which a secured creditor has relinquished security interest;

(h) any other property belonging to or vested in the corporate debtor at the insolvency commencement date; and

(i) all proceeds of liquidation as and when they are realised.

(4) The following shall not be included in the liquidation estate assets and shall not be used for recovery in the liquidation:—

(a) assets owned by a third party which are in possession of the corporate debtor, including—

(i) assets held in trust for any third party;

(ii) bailment contracts;

(iii) all sums due to any workman or employee from the provident fund, the pension fund and the gratuity fund;

(iv) other contractual arrangements which do not stipulate transfer of title but only use of the assets; and

(v) such other assets as may be notified by the Central Government in consultation with any financial sector regulator;

(b) assets in security collateral held by financial services providers and are subject to netting and set-off in multi-lateral trading or clearing transactions;

(c) personal assets of any shareholder or partner of a corporate debtor as the case may be provided such assets are not held on account of avoidance transactions that may be avoided under this Chapter;

(d) assets of any Indian or foreign subsidiary of the corporate debtor; or

(e) any other assets as may be specified by the Board, including assets which could be subject to set-off on account of mutual dealings between the corporate debtor and any creditor.

[viii] [T.C.P. No. 1117/I&BP/NCLT/MB/MAH/2017]

[ix] [Company Appeal (AT) (Insolvency) No. 129 of 2017]

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