No Smooth Sailing For Insolvency Law

Insolvency Law

INTRODUCTION

The Insolvency and Bankruptcy Code, 2016 (“the Code”) was inter alia enacted to consolidate and amend the laws relating to the reorganisation and insolvency of corporate persons. It marked a sea change (nautical references will be a recurring theme in this piece) in the manner in which corporate insolvencies were treated. Replacing multiple legislation and mechanisms in this field, the legislature saw the need for a complete “Code”, rather than an “Act”, to “bring the insolvency law in India under a single umbrella with the object of speeding up of the insolvency process”.1

Although the Code did address many problems relating to restructuring and insolvency law, one issue that has cropped up is its general application to all corporate entities, whereas certain types of corporate entities would require differential treatment. For instance, real estate companies were a class of corporate entities where the extant provisions in the Code were found to be problematic. Accordingly, by an amendment2, the Code now specifies a minimum number of allottees in a real estate project who must join an action to trigger a corporate insolvency resolution process (“CIRP”). Similarly, financial service providers, despite being corporate entities, are treated differently inasmuch as they are not “corporate persons”3 and an application against them for initiation of a CIRP would not lie as it would for other corporate entities. Pursuant to Section 227 of the Code and to an extensive report which proceeds on the basis that “financial firms are different from other firms”4, the Central Government notified separate rules5 for them.

Therefore, there appears to be a recognition that the Code cannot apply to all corporate entities uniformly. While, perhaps understandably, shipping companies did not loom large on the lawmakers’ horizon, they too are an entirely distinct subset of corporate entities and present unique challenges for the purpose of the Code.

The primary assets of shipping companies tend to be the vessels themselves. The difficulty arises on account of the fact that a vessel is to be treated as an independent juristic person. This has followed the long and storied development of admiralty law internationally, leading to the excellent judgment of Thommen, J. in MV Elisabeth v. Harwan Investment and Trading (P) Ltd.6 reading those internationally-accepted positions into Indian law. A person having a maritime claim (which includes the higher subset of maritime lien) could proceed against the vessel independent of the owner. Unless the owner entered appearance and deposited security, the vessel could be sold and the proceeds appropriated as per a predetermined waterfall amongst different categories of claimants. India codified admiralty law for the first time through the Admiralty (Jurisdiction and Settlement of Maritime Claims) Act, 2017 (“the Admiralty Act”),7 largely following extant international conventions and the position in common law. Pertinently for us, it continued treating vessels as independent juristic persons; allowed those vessels to be proceeded against independently; and prescribed a waterfall for treatment of claimants vis-à-vis the sale proceeds.

It was thus inevitable that the provisions of the Code and the subsequent Admiralty Act would have to be reconciled in the case of a shipping company undergoing a CIRP. In an admirable attempt to resolve this impasse, the Bombay High Court pronounced an exhaustive judgment in Barge Madhwa8.

DECISION IN BARGE MADHWA8

The Court first examined whether or not there was a conflict between the two statutes. It observed that in the event of a conflict between two special statutes—one with a non obstante clause and the other without—the one with a non obstante clause would prevail.9 This presumably proceeds on the basis that both the Code and the Admiralty Act were deemed to be special statutes. However, the Court did not find itself to be in a position where this principle of statutory interpretation would have to be applied because it concluded that there was no conflict and it was possible to harmoniously interpret the two statutes.10

The Court found that since admiralty proceedings were in rem against the vessel, a distinct juridical entity, they were capable of being initiated both during moratorium11 and in liquidation12. However, if the owner of the vessel entered appearance and furnished security, the admiralty suit would no longer be in rem, but would be in personam against the owner of the vessel. Consequently, the moratorium prescribed under the Code13 would apply and the suit would not proceed.8 Where no security was furnished by the owner, the admiralty suit would continue to be a proceeding in rem and thus not barred by the moratorium. However, while the vessel could be arrested/remain under arrest, the suit would not to proceed during the CIRP since that would undermine the objectives of the Code.14 No such limitation would exist once liquidation commenced and the vessel could be sold and the proceeds distributed in accordance with the Admiralty Act. In fact, the Court correctly observed that a sale under the Admiralty Act would likely fetch a better price since it would be free of all encumbrances (including liens).15

Further, it held that an arresting plaintiff would be considered as a secured creditor (qua the vessel) for the purposes of a Resolution Plan under the Code, and would be entitled to satisfaction of its claim as if sale proceeds had been distributed on the basis of the priorities enlisted in Section 10 of the Admiralty Act.16 If, on an application of this formula, the entirety of its claim were not satisfied, it would rank as an operational creditor for the remainder of its claim.17

BATTENING DOWN THE HATCHES

Despite the attempt by the Bombay High Court to harmonise the Code and the Admiralty Act, there are a few issues that require consideration, inasmuch as these form the basis of the harmonisation exercise in Barge Madhwa8 and necessitate a particularly delicate balancing act. For the purpose of this article, the following four broad categories have been dealt with:

(a) Vessels as independent juristic persons.

(b) The treatment of a plaintiff as a secured creditor for the purpose of a resolution plan under the Code.

(c) Distribution of proceeds/determination of priorities in liquidation.

(d) The Code — a general law or special law?

Vessels as Independent Juristic Persons

To aid the process of reorganisation, the Code mandates a moratorium13 during which the institution or continuation of suits or proceedings against the company is prohibited. But what of vessels that are independent juristic persons? If suits against them are allowed to proceed, a shipping company is likely to be left with no assets to offer a prospective resolution applicant. Imagine the steel producing factories of Essar Steel being treated as independent juristic persons against whom the moratorium would not operate — would there be any chance of a successful resolution process?

The Bombay High Court, relying upon the decision in MV Elisabeth6, has reiterated that a vessel is a “separate juridical personality” and, more importantly for this study, that a person having a maritime claim against the vessel: (Barge Madhwa case8, SCC OnLine Bom para 40)

40. … has a right in rem conferred by the Admiralty Act, to arrest the vessel to perfect his claim … a very valuable right which cannot be taken away or destroyed by implication or inference unless there is an express provision in any law to this effect.8

Given that there was no express bar against proceeding against vessels in rem under the Code, it was held that “there is little conflict … the two Acts can be read and construed harmoniously so as to give effect to both”.18 This harmonious construction leads to the mechanism which Barge Madhwa8 prescribes—the existence of a moratorium would not preclude the initiation or continuation of admiralty proceedings, however, they would not proceed beyond the arrest of the vessel since that “would defeat the very purpose of insolvency resolution under the IBC”19.

This tightrope walk i.e. finding that a vessel is a distinct juridical entity and thus a moratorium would not protect it, but then restricting any such action to the arrest of the vessel alone and prohibiting further steps, being the sale of the vessel and distribution of the proceeds, is the price one must pay in terms of conceptual purity at the altar of practicality and harmonious construction. If the vessel was distinct from the corporate entity, which indeed it is, there is no reason in theory that would justify prohibiting a sale and the distribution of proceeds. This would, however, render the insolvency resolution attempt of any shipping company entirely untenable. Any harmonious construction of the two statutes would have to be anchored by the accord struck in Barge Madhwa8 which prohibits these further steps from taking place. However, as will be seen below, this tightrope walk leads to problems of its own.

Treatment of Admiralty Act plaintiffs in an Insolvency Resolution

One of the other pillars of the harmonious construction exercise is the treatment of a plaintiff who has secured an arrest order from an admiralty court. Barge Madhwa8, following the decision of the Court of Appeal in ARO Company Ltd., In re20 holds that once a person has obtained an arrest, the vessel stands charged with his claim and he thus becomes a secured creditor. Accordingly, any resolution plan must treat that plaintiff as a secured creditor for the value of his charge on the vessel.

This proposition is difficult to reconcile with the definition of a secured creditor under the Code. Under the Code21, a secured creditor is defined as one in whose favour a security interest has been created, which in turn is defined22 as any right, title, interest or claim to property created to secure the payment or performance of an obligation. It is submitted that, it is difficult to see how the mere factum of an arrest or the deposit of money into court to secure the release of an arrested vessel, creates a security interest as defined under the Code. This is particularly so because there would be no adjudication of the plaintiff’s claim given that further proceedings are stayed. Even if there is a deposit, it would be in favour of the plaintiff only once the suit is decreed. Such a mechanism would also tantamount to an artificial distinction between similarly placed creditors, say bunker suppliers, in their treatment in the resolution process—some of who may be “secured” by obtaining the arrest and others who have not.

There is a further difficulty. Barge Madhwa8 says that, “In such a situation plaintiff should ordinarily be entitled to realise his claim to the full extent of the security provided.”23 In practice, this would mean that various claimants who qualify as operational creditors under the Code will have to be paid out in full prior to any financial creditors, who effectively control the CIRP. Whether this is something that would appeal to the “commercial wisdom” of the committee of creditors is anyone’s guess; it is entirely likely that such treatment would lead to the exact situation which the Court wished to avoid in the first place, i.e. undermining the resolution process under the Code.

Determination of priorities in liquidation under the Code and the Admiralty Act

Difficulties though, are not confined only to the designation of an arresting plaintiff as a secured creditor in the CIRP. In the event that the CIRP fails, the shipping company would immediately proceed to liquidation. This gives rise to a difference in treatments under the Code and the Admiralty Act which is impossible to overcome without one prevailing over the other.

Under the Code, Section 53, which begins with a non obstante clause, sets out the distribution waterfall with respect to sale proceeds of the liquidation assets. In the Admiralty Act, Sections 9 and 10 deal with the determination of priorities. For several categories of claims these provisions are at odds with one another. For instance, the wages of seamen working on the vessel would constitute the highest category of maritime lien under Section 9 of the Admiralty Act, which consequently is the highest category of maritime claim during the determination of priorities. In other words, seamen wages would be paid out in full and have the first right over the sale proceeds of the vessel. Under the Code, seamen would be considerably worse off. Firstly, a secured creditor of the vessel could choose to remain outside liquidation altogether, in which case the seamen would have no specific right with respect to the sale proceeds of that vessel. Even otherwise, assuming that there is either no mortgagee of the vessel or the mortgagee has relinquished his rights in favour of the liquidation estate, seamen’s claims would rank pari passu with such secured creditors, and that too only for wages which precede the date of liquidation by 24 months. A similar situation would also arise with respect to port dues and statutory dues, which albeit ranking lower than crewmen’s wages, still constitute maritime liens and hence, rank above a secured creditor under the Admiralty Act while falling further down the waterfall under the Code.

In Barge Madhwa8, the Bombay High Court has addressed this conundrum by finding that, on liquidation, the: (SCC OnLine Bom para 102)

102. … determination of priorities will also be done in accordance with Section 10 of the Admiralty Act and inter se priorities of maritime liens will be decided in accordance with Section 9 of the said Act. Section 53 of IBC which refers to distribution of assets will not apply.24

Although the pronouncement of law is categorical, there are a few issues that merit consideration. Firstly, is it fair that wages for seamen are accorded such a high priority in the case of a liquidation under the Code when wages of workmen in other industries fall far lower in the pecking order? Was this the legislative intent i.e. distinguishing between workers on a ship and, for instance, workers in a coal mine, both of whom are subject to considerable personal peril? Secondly, elsewhere in the decision, the Court arrived at a finding that: (Barge Madhwa case8, SCC OnLine Bom para 72)

72. … where there are two special enactments, one of which contains a non obstante provision and bars the jurisdiction of the civil court and the other which does not contain a non obstante provision, the clear legal position is that in the event of conflict, the former Act will prevail. The principle of interpretation that the later Act overrides the earlier Act is not applicable in such a situation.9

Therefore, in the event of a conflict, this would suggest that the Code would prevail over the Admiralty Act. It is then difficult to see the legal justification for why the determination of priorities would proceed in accordance with the Admiralty Act rather than the Code.

This leads straight to the next part of this article where it is considered whether the Code is in fact a general law and the Admiralty Act, being a special law, ought to prevail.

The Code: A General Law or Special Law?

The decision in Barge Madhwa8 tries to harmonise the Code and Admiralty Act—as any judgment must attempt to—and finds that there is no conflict. The difficulties with such an approach have been considered above and the apparent conflicts that arise. While it may be possible to harmonise the statutes in the context of proceedings in rem against a vessel, which Barge Madhwa8 has done excellently, it is submitted that in the treatment of the plaintiffs as secured creditors and the determination of priorities in liquidation, the two statutes are completely divergent, and harmonisation may not have been the appropriate answer.

It is submitted that it would have been apposite for the Court to consider whether one statute would prevail over the other in these circumstances. Although having found that the two statutes are capable of harmonisation, the Court has observed that, in the case of two special statutes, one of which contains a non obstante clause, that statute would prevail in the case of a conflict. This would suggest that the Code would prevail. However, there is another way to consider this situation.

A statute may be general in one context, but special in another; what has to be seen to determine whether or not a statute is general is (i) its principal subject-matter, and (ii) the perspective in consideration.25 As we have seen above, the Code was enacted to consolidate and amend insolvency laws.26 In doing so, it does not distinguish amongst different types of corporations and applies uniformly to all of them. The Admiralty Act, on the other hand, applies only in the context of shipping corporations.

Moreover, claims such as “rewards for salvage services”, and in respect of “loss of life and personal injury” do not even find a mention under the Code. These are claims which are unique to the Admiralty Act and would, at best, fall under the residual category of “any remaining debts and dues” under Section 53 of the Code. They would thus rank sixth in the order of priorities under the Code, but rank highest under the Admiralty Act. Mortgage debts, on the other hand, would be satisfied on a priority basis under the Code whereas, under the Admiralty Act, they would be satisfied only after all maritime liens have been discharged.

Therefore, it is apparent that, while the Code deals generically with classes of creditors that would ordinarily be found in any corporation, the Admiralty Act recognises certain stakeholders that are unique to maritime operations and provides for a distinct manner in which their interests are to be satisfied. This again suggests that the Admiralty Act is a special law vis-à-vis the Code.

Maritime liens are another marker for why the Admiralty Act should be treated as a special law qua the general Code. As Nigel Meeson puts it poignantly, a maritime lien, although a sui generis concept,27 is essentially a charge which adheres to the vessel from the time the fact giving rise to the lien occurs and which continues to bind the ship until it is discharged.28 The fact that a vessel may change hands, whether in terms of possession or ownership, is immaterial.29 A maritime lien continues to attach itself to the vessel.

Under Section 31(1) of the Code, a resolution plan, once approved by the adjudicating authority, is binding on the corporate debtor and its creditors. However, insofar as maritime lien holders are concerned, they are not just creditors of the corporate debtor, but their claim also attaches to the vessel regardless of ownership, until it is discharged. Therefore, conceptually, this charge would continue to attach itself to the vessel even if the ownership of the corporate debtor changed hands under a resolution plan. The Code neither contemplates, nor deals with such a scenario. On the contrary, Section 8 of the Admiralty Act does. It says that, on the sale of a vessel by an admiralty court, it would vest free of all liens, attachments, charges, encumbrances and registered mortgages.

In light of these reasons, we believe that considering the subject-matters of the two statutes as well as from the perspective of the stakeholders involved, the Admiralty Act is a special statute vis-à-vis the Code. Although Barge Madhwa8 has made a creditable attempt to harmonise the two statutes, given the difficulties that are likely to arise, it is submitted that the Court ought to have held that the Admiralty Act prevails over the Code. This would no doubt lead to a CIRP for shipping companies being rendered difficult—given that their assets would be the subject-matter of admiralty proceedings—but we see that as something that is likely to arise even under the harmonisation method. It would, however, lead to a quicker resolution through sale of the vessel in case the shipowner is defunct, and the distribution of proceeds as per the maritime industry’s time-honoured priorities (now encapsulated in the Admiralty Act), without undergoing a CIRP and dealing with competing creditors. It would also serve the overarching principle of the Code i.e. maximisation of value given that a prompt admiralty sale is likely to achieve a far higher price, in light of Section 8 and without the delays of the CIRP.


Advocates, Bombay High Court.

*The article has been published with kind permission of SCC Online cited as (2021) 5 SCC J-31

1 Innoventive Industries v. ICICI Bank, (2018) 1 SCC 407, para 13 (Nariman, J.).

4 Report of the Sub-Committee of the Insolvency Law Committee for Notification of Financial Service Providers under Section 227 of the Insolvency & Bankruptcy Code, 2016, 1 (dated 4-10-2019).

7 The Act came into effect on 1-4-2018.

8 Raj Shipping Agencies v. Barge Madhwa, 2020 SCC OnLine Bom 651

9 Id, para 72.

10 Id, paras 78 to 131.

11 Id, para 112.

12 Id, para 123.

14 Raj Shipping Agencies v. Barge Madhwa, 2020 SCC OnLine Bom 651, para 100.

15 Id, para 125.

16 Id, para 104.

17 Id, para 106.

8 Raj Shipping Agencies v. Barge Madhwa, 2020 SCC OnLine Bom 651.

6 MV Elisabeth v. Harwan Investment and Trading (P) Ltd., 1993 Supp (2) SCC 433

8 Raj Shipping Agencies v. Barge Madhwa, 2020 SCC OnLine Bom 651, para 40.

18 Id, para 90.

19 Id, para 92.

8 Raj Shipping Agencies v. Barge Madhwa, 2020 SCC OnLine Bom 651.

23 Id, para 98.

8 Raj Shipping Agencies v. Barge Madhwa, 2020 SCC OnLine Bom 651.

24 Id, para 102.

9 Id, para 72.

8 Raj Shipping Agencies v. Barge Madhwa, 2020 SCC OnLine Bom 651.

25 See: LIC v. D.J. Bahadur, (1981) 1 SCC 315; Yakub Abdul Razak Memon v. State of Maharashtra, (2013) 13 SCC 1.

27 Nigel Meeson & John Kimpbell, Admiralty Jurisdiction and Practice (4th Edn., Lloyd’s Shipping Law, 2011) p. 260.

28 Id, p. 266.

29 Id, pp. 260-61.

8 Raj Shipping Agencies v. Barge Madhwa, 2020 SCC OnLine Bom 651.

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