Viability of Corporate Insolvency Resolution for Section 8 Companies

Insolvency in a company arises when it cannot settle its debts to creditors. There are two key assessments for corporate insolvency:

1. Cash-flow Test: This evaluates whether the company can meet its debt obligations presently or in the future.
2. Balance Sheet Test: This assesses whether the company’s assets’ value is less than its liabilities, accounting for future obligations.

The Corporate Insolvency Resolution Process (CIRP) serves as a means of recovery for creditors when a corporate entity faces insolvency. In the event of insolvency, initiation of CIRP can be triggered by a financial creditor, an operational creditor, or the corporate entity itself.

Upon the submission of an application, the CIRP is set in motion. This process involves an assessment by Insolvency Resolution Professionals (IRPs) to determine the defaulting party’s ability to repay. By evaluating assets and liabilities, the IRPs ascertain whether the debtor can meet the repayment obligations. If repayment is deemed unfeasible, the company undergoes either restructuring or liquidation.

In the case of Educomp Infrastructure & School Management Limited v. Millennium Education Foundation on July 4, 2023, the National Company Law Appellate Tribunal (NCLAT) ruled that a petition filed under Section 9 of the Insolvency and Bankruptcy Code, 2016 (IBC) is permissible for a non-profit company functioning under Section 8 of the Companies Act, 2013. This significant decision authorises the initiation of the Corporate Insolvency Resolution Process (CIRP) against a Section 8 company. This post aims to analyse the validity and implications of adopting such an approach.

Background of the Case:

1. The central issue in the case revolves around the applicability of the Corporate Insolvency Resolution Process (CIRP) to non-profit companies, particularly those falling under section 8 of the Companies Act.
2. The corporate debtor’s argument opposes the extension of the Insolvency and Bankruptcy Code (IBC) to section 8 companies, citing their charitable nature, which could deter resolution applicants and lead to liquidation.

Interpretation of IBC:

1. The National Company Law Appellate Tribunal (NCLAT) referenced section 3(7) of the IBC, emphasising that the definition of a “corporate person” encompasses all companies per section 2(20) of the Companies Act. The objective of the company is not considered a distinguishing factor.
2. NCLAT’s position rests on a straightforward interpretation, asserting that section 8 companies unequivocally fall within the IBC’s scope, allowing for the initiation of CIRP.

Critical Analysis:

Despite the NCLAT’s stance, it is acknowledged that the tribunal’s position lacks a thorough examination of the complexities associated with section 8 companies and the potential implications of subjecting them to the IBC framework.

Intricacies Surrounding Section 8 Companies

1. Distinct Regulatory Framework:

Section 8 of the Companies Act delineates a specialized code governing companies dedicated to non-profit objectives such as promoting commerce, art, science, and social welfare. This framework operates within the broader context of the Companies Act.

2. Special Privileges:

Section 8 companies enjoy unique privileges, including the ability to include partnership firms as members, enhancing their capacity to pursue charitable activities effectively. Notably, while having a corporate structure, these companies are explicitly barred from distributing dividends to members to align with their non-profit goals.

3. Legal Standing Equivalence:

While Section 8 companies are intended to have a legal standing equivalent to other companies under the Companies Act, this equivalence is established explicitly beyond the specific provisions outlined in Section 8. The case of ShaHindumullDalichand v. Madras Kirana Merchants Association affirms this principle.

4. Legislative Intent and Altruistic Endeavors:

Recognising the legislative intent behind Section 8 is crucial, as it uniquely fosters altruistic endeavours. The section establishes specialised laws aimed at protecting and promoting the distinctive nature of these companies.

5. Consideration for CIRP Proceedings:

When contemplating Corporate Insolvency Resolution Process (CIRP) proceedings against Section 8 companies, it is essential to account for the specific treatment of assets and funds outlined in Section 8. Rather than broadly applying the Insolvency and Bankruptcy Code (IBC), a nuanced approach considering these differences is warranted.

Contrast Between Section 8 and IBC:

Section 8 of the Companies Act outlines a specific procedure for managing assets and income during winding up and amalgamation. Notably, amalgamation under Sections 8(8) and 8(10) is limited to companies registered under this section with similar objectives. Winding up under Section 8(9) involves transferring remaining assets to a similar Section 8 company or selling them, with proceeds credited to the Insolvency and Bankruptcy Fund under Section 224 of the IBC. These provisions aim to safeguard the non-profit nature of company assets.

This deviates significantly from the standard IBC treatment of a company’s assets. In the Corporate Insolvency Resolution Process (CIRP), assets are typically transferred to the resolution applicant or liquidated, with proceeds distributed among creditors and members according to the resolution plan or the established waterfall mechanism in Section 53 of the IBC. This contradicts Section 8 requirements and breaches the principle in Rule 22(4) of the Companies (Incorporation) Rules, 2014. The rule mandates a declaration from the board of directors ensuring no direct or indirect distribution of income or property to members, thereby restricting various forms of profit distribution.

The broad language of “or otherwise” in Rule 22(4) limits indirect profit distribution, including bonus shares, premium redemption of debentures, and selling property below market value. The implementation of IBC’s Section 53(g) and (h) in distributing liquidation proceeds among preference and equity shareholders would, therefore, run afoul of Rule 22(4) of the Incorporation Rules.

Divergence in Legislative Intent

Moreover, the contention that section 238 of the IBC, housing a non-obstante provision elevating the IBC above the Companies Act and Incorporation Rules, cannot be sustained. Notably, despite amendments aligning the winding-up process under the Companies Act with the IBC in sections 270 and 271, provisions for winding up under section 8 were retained. This underscores the legislative intent for the continued relevance of the Section 8 procedure, even in the IBC era.

This is particularly significant considering the amendment to section 8(9) by Schedule XI of the IBC, which replaced the “Rehabilitation and Insolvency Fund” with the “Insolvency and Bankruptcy Fund.” This sole amendment reflects the necessary alignment of the Companies Act with the IBC. Consequently, the process under section 8 of the Companies Act should take precedence over the IBC for non-profit companies despite the IBC being a subsequent enactment.

Considering the unique characteristics of section 8 companies and its codified nature, section 8 should prevail as it explicitly addresses processes tailored to the unique nature of these companies. This is notwithstanding the IBC being a specialised legislation for insolvency, as it provides a general insolvency process not tailored to the specific needs of a Section 8 company. The principle of lexspecialisderogatlegigenerali, as elucidated in National Highway Authority of India v. Sayedabad Tea Company and Co., reinforces the need to safeguard the specialised objective of section 8.

Additionally, the overarching structure of the IBC revolves around the “going concern” concept, aiming to preserve the corporate entity’s viability. This objective, highlighted in K. Sashidhar v. Indian Overseas Bank, prioritises the commercial wisdom of the committee of creditors in the Corporate Insolvency Resolution Process (CIRP). However, this objective does not align seamlessly with the non-commercial, non-profit nature of a Section 8 company. Recognising these disparities, the overarching framework might encounter challenges in effectively accommodating the objectives of Section 8 companies, leading to potential implementation hurdles.

Revival Possibilities for Section 8 Companies under the IBC:

The inquiry revolves around whether Section 8 companies can undergo revival through Section 10 of the IBC or be subject to default applications under Section 7 or Section 9. The IBC, without any explicit prohibition or exception for Section 8 companies, allows for corporate insolvency resolution, liquidation, or voluntary liquidation. The primary focus of the IBC is company revival, primarily through resolution plans. However, challenges arise in charitable organisations where profit motives are minimal. If the Corporate Insolvency Resolution Process (CIRP) fails, liquidation becomes an option, but this may not align with the IBC’s revival objectives. An alternative avenue involves another Section 8 company submitting a resolution plan, ensuring both the revival and the preservation of the company’s original objectives.

Conclusion

The examination of relevant provisions and the court judgment indicates that Section 8 companies fall under the purview of the IBC, making them liable for defaults in loans and advances. However, the intricate structure of Section 8 companies, marked by a potential absence of share capital, reserves, or assets, introduces complexities that can impede their efficient resolution and revival. This complexity poses a risk of undermining the primary objective of the IBC.

In light of these challenges, there is a compelling need for the government to consider introducing specific provisions, exemptions, or relaxations under the IBC. Amendments tailored to the unique characteristics of Section 8 companies could streamline the resolution process, ensuring a more effective and expeditious revival of these charitable entities and aligning with the overarching goals of the insolvency framework.

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