Raghav Pandey* & Reyyi Sameera**
A moratorium, or statutory stay, represents a vital component within insolvency proceedings, whether they pertain to resolution or liquidation, constituting a cornerstone of the Insolvency and Bankruptcy Code (IBC) framework. Nonetheless, as per the IBC regime, certain transactions, agreements, and arrangements may be excluded from the purview of the moratorium by the government if it is deemed desirable. Recently, the Central Government, through a notification dated June 14, 2023, exercised this authority by exempting contracts, exploration licenses, and related agreements crucial to the operations of oil companies from the ambit of the moratorium. This article undertakes a critical examination of this policy decision, exploring its underlying aims, objectives, and potential ramifications. It contends that such an exemption may fail to achieve desired policy outcomes.
Introduction:
The Central Government on 14th June 2023 had notified that Section 14(1) of Insolvency and Bankruptcy Code, 2016 (IBC) will not apply to any company (referred to as Corporate Debtor when facing an insolvency proceeding) which has entered into any transaction, arrangement or agreements of Production Sharing Contracts, Revenue Sharing Contracts, Exploration licenses and Mining Leases including Joint Operating Agreements made under Oilfields (Regulation and Development) Act, 1948.
Section 14 of the IBC provides for a statutory stay on insolvency proceedings under the IBC (hereinafter referred to as a moratorium) that shall compulsorily come into effect.During this period, it is provided, inter alia, no suits shall be initiated or continued against the Corporate Debtor (CD). The objective is to protect the assets (movable, immoveable and intangible) of the CD from being alienated, while the IBC process, known as the Corporate Insolvency Resolution Process (CIRP), is underway. A moratorium makes sure that the possibilities of resolution of the insolvency situation are high, as a prospective buyer can offer more value for a greater number of assets. Even if the resolution process fails, the assets can be liquidated and the realizations from them can be redistributed equitably, respecting the priority amongst the creditors. Thus, having a statutory moratorium is critical in any insolvency process. Accordingly, IBC provides for the same, but with an exemption under, Section 14(3)(a) which provides that the moratorium shall not apply to:
“Such transactions, agreements or other arrangements as may be notified by the Central Government in consultation with any financial sector regulator or any other authority”.
The Central Government has been vested here with the power to exempt such measures from the moratorium after consultation with the concerned authorities as it deems fit. Using these powers, the government exempted transactions related to oilfields. It is argued in this piece that such exemption may not be the best recourse considering the policy objectives of the IBC as well as the purpose for which this exemption has been granted.
In terms of the IBC regime, this mandate has shrunk the feasibility of the revival of oil sector companies under the resolution process and has incidentally given ascendancy to government dues, over other creditors. This notification is also in the same line as the law laid down in the two prominent cases where the order of distribution during the insolvency process has been disturbed by the court. First, in Union of India Vs. Vijaykumar V. Iyer, it was held that only on the payment of government dues can the spectrum license be sold during the CIRP. Second, in the case of State Tax Officer Vs. Rainbow Papers Ltd. it was held that a debt can be classified as secured debt by operation of law and an actual security or collateral is not required in such cases.
In this regard, the Bankruptcy Law Reforms Committee (BLRC) report had recommended a priority order(known as the waterfall mechanism) wherein the rights of Central and State Governments to recover their dues were kept below the secured and even unsecured financial creditors for promoting the availability of credit and other policy considerations. It is argued in this piece that this oil-sector notification does not align with either the goals as contemplated by the BLRC or the preamble of the IBC. The primary goals of the moratorium are also outlined in this report, which are useful to examine before exploring the rationale for the notification
Examining the BLRC Report: What does a Moratorium Do?
The BLRC report has argued that:
“The motivation behind moratorium is that it is value maximizing for the entity to continue operations even as viability is being assessed during the Insolvency Resolution Process.”
It has delineated the fundamental intent of the calm period as a mechanism to sustain the viability of the Corporate Debtor during CIRP. The Delhi High Court has held in Power Grid Corporation of India Limited Vs. Jyoti Structures Limited, that the object of the IBC is to ensure that the CD receives relief during the “standstill” period, protecting its assets from being diminished and alternatively using this period to strengthen its financial position. It has been further argued by the Supreme Court in Swiss Ribbons v Union of India that,
“The Code is thus beneficial legislation which puts the corporate debtor back on its feet, not being a mere recovery legislation for creditors.”
The moratorium also prevents all sorts of debt recovery actions and initiation or continuation of any new legal proceedings against the Corporate Debtor. The Supreme Court in Alchemist Asset Reconstruction Company Limited Vs. Hotel Gaudavan Private Limited has affirmed that once a moratorium is imposed under the IBC, any proceeding initiated against the CD is non-est (does not exist) in law. The moratorium fosters peaceful negotiations among creditors and debtors for assessing the viability of an entity. This is in line with the creditor-in-control model and global best practices.
With this very objective, an explanation was inserted in S.14 (1) of the code where a license, permit, registration, quota, concession, clearance or similar grants given by the central government, state government, local authority or any other sectoral regulator are not suspended on the grounds of insolvency post the judgment in M/S Embassy Property Development Pvt. Ltd. Vs. Stake of Karnataka. The purpose of this explanation was to make sure that in some instances where one of the most valuable assets of the corporate debtor is a lease or license, the same is not terminated during the CIRP. This is true for an oil mining company where the oil mining license is perhaps the most important asset for such a company. If the same is terminated, it will be close to impossible to prevent the liquidation of such a company. In this light, we shall now explore the rationale behind the notification, and how it squares with the rationale of the moratorium.
Analysis: Macro-Economic and Policy Rationale for the Exemption from Moratorium
India’s Energy market is expanding rapidly, catalyzed by the increased consumption of natural gas, crude oil and petroleum. Russia, being one of the bigwigs in the natural gas sector, has faced several sanctions in the wake of its war with Ukraine. Out of the total, 85% of the crude oil requirement of India is met through imports. Capitalizing on this opportunity, India imported 1.96 million b/d of crude oil from Russia in May 2023 at discounted prices, as India did not impose any sanctions on Russia. India is planning to increase its crude oil refining capacity by 77% to 438.65 million tons over the next 12 years after meeting its rising demand for crude oil. Once this is achieved, India has the advantage of being a net exporter of petroleum products with its surplus refining capacity. To accomplish this goal and to draw global investment, the Government of India has taken various initiatives and measures, one of them being the inapplicability of moratorium on
“Production Sharing Contracts, Revenue Sharing Contracts, Exploration Licenses and Mining Leases, Joint Operating Agreements or any transactions or arrangements made under the Oilfields (Regulation and Development) act, 1948 notified in June 2023”.
It can be reasonably anticipated that the government made such a decision to allow itself to terminate these contracts during the moratorium period and assign them to some other entity as soon as possible. It is indeed arguable on behalf of the government that it is the trustee of natural resources, and it has to make sure that they are utilized as efficiently as possible. Moreover, the Corporate Debtor is really not the owner of the resources and has just been licensed by the state to mine oil in the interest of the public at large and the national economy. Thus, the moratorium seems to address the issue of suboptimal value realization from the oil fields, if the lessee corporation is facing an insolvency situation. Thus, it needs to be examined whether such exemption helps achieve a more efficient exploitation of these natural resource.
Is the Problem of Suboptimal Value Realization from Oil Fields Resolved by this Measure?
It can be the argument of the government that the IBC process is adversarial to its interests. As per the data released by the Insolvency and Bankruptcy Board of India (IBBI), the average time taken for resolution under CIRP has increased to 635 days for operational creditors and 643 days for financial creditors, both exceeding the 270-day limit set by the law. Thus, the cancellation of arrangements and agreements of the government (such as mining leases) with the debt-ridden oil companies during the moratorium can save the long haul for the government to realize its dues.
Additionally, the non-payment of the agreed consideration for granting licenses, and leases and breach of other contracts between the government and oil sector companies fall within the ambit of Operational Debt (Government dues). Government dues fall very low under the waterfall mechanism, in the event of liquidation leading to minimal realizations of their dues. This problem is, in turn, aggravated by the applicability of the moratorium, as the leases and licenses cannot be granted to someone else. Prima facie, this results in substantial loss during the moratorium period to the government.
It is, therefore, a case for the government to transfer the leases given to the corporate debtor to some other person as quickly as possible. to benefit the state exchequer. However, we will list out that how this may not a be good policy decision in the long run, and can in fact adversely impact the state exchequer.
A moratorium plays a crucial role in the success of the code. It has now been firmly established that the IBC regime is the best shot for revival for any company that is undergoing financial distress. According to the IIM Ahmedabad’s “Report of Study on Effectiveness of the Resolution Process: Firm Outcomes in the post- IBC period” published in August 2023 shows that the average sales of companies have surged by 76% in the three years since their respective resolutions and employee expenses have increased by 50% that indicates higher employment intensity. The liquidity of the resolved companies rose by 80%, and the total market valuation of all such firms increased from 2 lakh crores to 6 lakh crores post-resolution. Thus, it is clear that a company that has the potential for revival can be resolved through the CIRP, and the sickness can be cured.
On the other hand, companies that are engaged in oil mining have their primary business focused on excavating minerals from the granted leases. To conduct their business they have to first negotiate an oil/gas exploration license with the country’s government. Canceling these leases during the resolution process will substantially reduce the chances of their revival if not completely erase them. Consequently, the creditors who have extended their financial facilities will be left with little to no realization from the concerned corporate debtor. The employees of the corporate debtor may be rendered out of employment, which will impact their spending capacity, which can have cyclical effects on the economy.
Ultimately, the confidence of the market players in the oil field sector(which are not many as it is) will be diminished due to this measure. Further, the government’s withdrawal of its licenses from a distressed company during its CIRP and granting it to another company can raise concerns in the latter company and all other persons operating in the sector, that they can meet the same fate as the former if an insolvency situation arises.
Protecting the legitimate interests of one insolvent corporation as per the global best practices is bound to inspire confidence in other corporations as well. If not done, in the long run, lesser and lesser companies may be willing to apply for a mining license in India, because the license can be taken away at the whims and wishes of the government in the event of a financial or business downturn. This will certainly give rise to serious apprehension in industry, impacting the business environment and ease of doing business, especially in this sector. If there are lesser number of persons available to mine oil, then healthy competition will naturally be curtailed and can result into inefficient outcomes. This will necessarily result in a substantial loss to the exchequer.
Conclusion and Suggestions
There are ways in which both the interests of the Government as well as the debtor companies can be balanced, like in the case of Halliburton Offshore Services Inc. Vs Mercator Petroleum Ltd. Herein, Indian Oil Corporation (IOC), a government undertaking, had submitted a resolution plan for Mercator Petroleum (Corporate Debtor), where financial creditors were able to realize 46% of their dues. The resolution applicant’s business interests encompassed the entire hydrocarbon value chain from exploration and production of oil, gas, refining, pipeline transportation, and marketing to natural gas and petrochemicals. Such takeovers by a public sector undertaking by submitting a resolution plan during the CIRP, by not disturbing any arrangements or agreements during the moratorium, not only promote the resolution of CD but also fulfill the object with which the notification has been served, i.e., efficient utilization of natural resources.
Another way can be where, at the minimum, the moratorium be made applicable during CIRP so that the viability of the company can be assessed and the chances of it being revived can be envisioned.
The BLRC has recommended keeping the rights of Central and State Governments in the distribution waterfall even below the unsecured financial creditors to promote the availability of credit and develop a market for unsecured financing. This notification not only dehors the development of the corporate bond markets by raising the cost of capital but also diminishes the prospects of revival of oil companies. Balancing the conflicting interests is essential, with the public good tied to natural resources like oil on one side and the interests of companies undergoing resolution on the other. Achieving a fair equilibrium between both these concerns is paramount.
*Raghav Pandey is an Assistant Professor of Law at the National Law University, Delhi
**Reyyi Sameera is a student of the Post Graduate Insolvency Program at the Indian Institute of Corporate Affairs.
