CoC APPROVAL FOR CHANGING THE CAPITAL STRUCTURE OF THE CD AS PER S.28(1)(c) of the IBC, 2016

The Insolvency and the Bankruptcy Code, 2016 mandates the resolution professional to seek the approval of the committee of creditors for undertaking certain activities during the corporate insolvency resolution process of the corporate debtor. One of such actions is mentioned in sub-clause (c) of section 28(1), which pertains to changing the capital structure of the corporate debtor. The capital structure may be changed in any of the following ways: (i) issuance of additional securities; (ii) creating a new class of securities or (iii) buying back or redemption of issued securities, if the corporate debtor is a company.

But what could be the justification for this? Why is the approval of the CoC material for affecting the capital structure of the corporate debtor? Here is why:

The capital structure of a business comprises of debt and equity. In the event of performance of any of the activities listed in section 28(1)(c), the existing capital structure of the corporate debtor in question would invariably be altered, and this could consequentially affect the creditors of the CD adversely.

• Action: Issuance of additional securities or creating a new class of securities

  Effect on CoC: In the event of issuing additional securities or creating a new class of securities, there is likelihood for the dilution of the respective voting shares of the existing creditors. With the entry of new financial creditors into the CoC (supposing debt-instruments are issued), the total financial debt owed by the corporate debtor would correspondingly increase and this would proportionately reduce the voting share of the existing financial creditors. Needless to say, their decision-making power is affected for future course of actions. Moreover, this problem is augmented when a new class of securities is issued. This would result in adversely affecting the existing unsecured creditors as they would become subordinate to the new secured creditors, since their position in the waterfall distribution is inferior to the class of secured creditors under section 53, should the matter lead to liquidation.

• Action: Buying back or redemption of issued securities

  Effect on CoC: Buying back/redemption of securities has the effect of reducing the liquidity of the corporate debtor. Since the corporate debtor already has limited cash reserves during its CIRP, buying-back and redemption would dry these reserves up further. Resultantly, it would increase the dependence on interim finance which forms a part of the CIRP costs and they need to be paid in utmost priority to all the stakeholders of the corporate debtor. To avoid this dependence, the creditors would instead prefer the reserves of the CD be used for debt repayment. Secondly, buying back and redemption of securities might result in disturbing the waterfall distribution by preferring shareholders over creditors (since they would be paid in priority to creditors), where the former are positioned at the extreme bottom in the order of priority. Another possible reason for seeking approval could be that the resolution professional engaged may have a vested interest and is a shareholder himself/herself of the corporate debtor. This could give him/her the impetus to buy back his/her own shares owing to the insolvent status of the entity. This would put him/her in an unfair advantageous position as they are able to redeem their shares in priority to others as well as are entitled to receive the fees for conducting the CIRP which again ranks first in the order of priority.

  Therefore, it can be seen why the approval of the CoC is required, as their rights and priority could be substantially affected by any of the actions mentioned above. It has to be kept in mind that performing any of the actions in section 28(1)(c) requires an approval of minimum of sixty six percent of voting shares of the CoC members, non-compliance of which could entitle the CoC to report the actions of the resolution professional to IBBI for taking necessary actions against him/her.