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Writer's pictureRFMLR RGNUL

QUANDARIES IN RECOGNITION OF FOREIGN PROCEEDINGS UNDER DRAFT PART Z OF THE IBC

This post, the entry winning the Third Position of the RFMLR-IBBI Blog Series Competition, 2021, is authored by Trisha Singh Naulakha and Ishu Gupta, both fifth-year students of B.A. LL.B. (Hons.) at the Symbiosis Law School, Noida.


1. INTRODUCTION


In June 2018, the Ministry of Corporate Affairs ("MCA") released a draft framework for cross-border insolvency (Draft Part Z) for its incorporation in the Insolvency and Bankruptcy Code, 2016 ("IBC") and invited comments from experts and stakeholders. Based on the comments and feedback received from the stakeholders, the Insolvency Law Committee ("ILC") released its second report on the legislative framework for cross-border insolvency. Draft Part Z incorporates the principles of access, cooperation, coordination, recognition, and relief in cross-border insolvency proceedings as envisaged under the UNCITRAL Model Law on Cross Border Insolvency 1997 ("MLCBI"). In this article, the quandaries concerning the recognition of foreign proceedings ("FP") under Draft Part Z are demystified by analyzing the provisions of the MLCBI, recommendations of the ILC, and Cross Border Insolvency Rules/Regulations Committee ("CBIRC"), and the approach of courts in various jurisdictions.


2. RECOGNITION OF FOREIGN PROCEEDINGS


The definition of FP provided under the MLCBI has been incorporated stricto sensu under Clause 2(g) of the Draft Part Z. Draft Part Z in consonance with the MLCBI, provides access to a foreign insolvency professional (foreign representative under clause 2(h)) to a domestic court by making an application for the recognition of FP before the Adjudicating Authority (AA). On being satisfied with the existence of an FP, the AA shall recognize the FP as a (i) foreign main proceeding ("FMP"); or (ii) foreign non-main proceeding ("FNMP"). An FMP is the proceeding that takes place in a country where the centre of main interest ("COMI") of the debtor is located and an FNMP is the proceeding taking place in a country where the debtor has an establishment. While the effect of the recognition of an FP as an FMP is that the AA mandatorily declares a moratorium identical to Section 14 of the IBC, stipulating a stay on legal proceedings and enforcements against the debtor, the recognition of an FP as FNMP does not result in the declaration of a mandatory moratorium by the AA. The relief of moratorium in case of an FNMP may, however, be granted on a discretionary basis by the AA at the request of a foreign representative.


2.1 COMI analysis for determining FMP


The process for the recognition of an FP as an FMP requires the AA to determine the centre of main interest (COMI) of the debtor. The COMI of the debtor has been understood to mean the seat of the business operations of the debtor which is ascertainable by third parties. The MLCBI and the Draft Part Z stipulate that the country in which the COMI of the debtor lies shall be considered as an FMP. Further, as discussed above, unlike in the case of FNMP, the AA is mandatorily required to give the relief of moratorium after recognizing an FP as an FMP. While both Draft Part Z and the MLCBI are silent on the definition of COMI, Clause 14(1) of Draft Part Z and Article 16(3) create a rebuttable presumption in favor of recognizing the registered office of the debtor as its COMI. Nevertheless, various jurisdictions have determined the COMI of debtors under the MLCBI by applying different tests such as the nerve centre test and principal place of business test, entailing an inquiry into the command and control of the debtors. The tests applied and the factors considered while deciding the COMI of the debtor are nonetheless required to be objective and ascertainable by third parties.


The factors considered by courts while deciding the COMI of a debtor can be divided into sub-categories, i.e., debtor-based and creditor-based factors. The debtor-based factors include factors such as the location of the debtor’s books, records, assets, site of controlling law, laws under which the debtor was incorporated, the location from which tax returns indicate income from trade and business, etc. Conversely, the creditor-based factors include factors like the location of the majority of the creditors or the location of the affected creditors. The CBIRC in its Report on the Rules and Regulations for Cross-border Insolvency Regulations 2020 seems to suggest the incorporation of various debtor-centric factors in determining the COMI of the debtor which shall be included in the rules framed by the MCA, however, it does not include any creditor-based factor for determining COMI of the debtor. Such an approach is, nevertheless, erroneous as there is established jurisprudence, for instance, In re SphinX Ltd., which advocates for the inclusion of creditor-based factors in determining the COMI of the debtor. Accordingly, it is suggested that the rules and regulations framed with regards to the cross-border insolvency regime in India shall take a holistic view and include both debtor-centric as well as creditor-centric factors for determining the COMI of the debtor.


2.2 Interpretation of ‘establishment’ for FNMP


Draft Part Z substantially incorporates the definitions of FNMP and establishment under clauses 2(f) and 2(c), respectively. Article 2(b) of the MLCBI defines an FNMP as one that occurs where the debtor has an “establishment”. To determine the existence of “establishment”, the MLCBI has set out four crucial factors under Article 2(f): “[i] any place of operations where the debtor carries out [ii]a non-transitory [iii] economic activity [iv] with human means and goods or services.” However, there are no definitions in the MLCBI and Draft Part Z that explicitly outlines what qualifies as terms, such as "operations," "non-transitory," and "economic activity." It is critical to define these terms because the kind of relief that a foreign entity may seek under Part Z is dependent on whether an FP is recognised as an FMP or as an FNMP. Due to the lack of clarity surrounding these terms, which are required to constitute an "establishment," the entire procedure of providing relief based on recognition of an FNMP would be rendered redundant.


Considering there is no definition for "non-transitory" under the MLCBI, it is unclear if the phrase relates to the duration of a relevant economic activity or the geographical area where the activity is carried out. To specify the time duration required for qualifying non-transitory economic activity, Draft Part Z espouses three months before the commencement of insolvency proceedings in the State where the COMI lies. Nevertheless, Draft Part Z fails to define the scope of other factors in the definition of establishment. Different courts have adopted different approaches in defining the terms mentioned in the definition of establishment. For instance, in Trustees of the Olympic Airlines SA Pension & Life Assurance Scheme v Olympic Airlines, while interpreting the scope of non-transitory economic activity with human means and assets or services, the court observed that a minimum level of organization or stability is required to qualify as an establishment under the MLCBI. On the other hand, the MLCBI in its Guide advocates the applicability of the objective test of third-party perception for determining the existence of an establishment in line with In re Stanford Int’l Bank Ltd. which used the third-party perception test to determine the COMI of the debtor. The emerging inconsistency and difference of opinions in the interpretation of non-transitory economic activity in the definition of establishment under the MLCBI can be mischievous for an accurate and consistent interpretation of establishment under the Draft Part Z of the IBC. The correct approach is to define terms like non-transitory, economic activity, and place of operations under Draft Part Z or the proposed rules made by the central government thereunder. The endeavor shall be to create a balance between the creditor-centric factors, such as third-party perception and legitimate expectation, and corresponding debtor-centric factors including stability and meaningful operations in defining establishment.


3. THE PUBLIC POLICY EXCEPTION AND NON-RECOGNITION OF AN FP:


The Draft Part Z under Clause 4 empowers the AA to refuse to recognize an FP if such action would “manifestly [contravene] the public policy of India”. This incorporation is a verbatim adoption of public policy exception enshrined under Article 6 of MLCBI. However, neither the MLCVI nor the Draft Part Z elucidates on what constitutes “public policy”. The ramifications of the lack of a categorical definition of "public policy" under the MLCBI have led the exegesis of the public policy exception to be contingent upon state practices, which vary per jurisdiction. In this vein, jurisdictions have espoused Article 6 of the MLCBI into their domestic legal framework in one of the two ways: (i) enacting the exact verbatim supplied in Article 6; or (ii) adopting a provision that either precludes the expression "manifestly" from their public policy exception or inculcates a distinct provision with its roots in Article 6 of the MLCBI. It is particularly in the former situation that public policy is interpreted more restrictively than the enactment of public policy exception in the second scenario.


The US courts have narrowly interpreted the public policy exception encapsulated under Section 1506, which is an exact acceptance of the public policy exception under the MLCBI. While underlining the narrowness of public policy exception, the courts in the cases of In re Qimonda AG Bankruptcy Litigation and In re Gold & Honey, Ltd have set forth the following factors which would trigger the public policy exception: (i) instances where an FP is procedurally unfair, or (ii) where recognition of FP would adversely infringe a U.S. constitutional or statutory right and would thwart the ability of US Court to undertake insolvency proceedings.


In the Indian context, the second report of ILC recommended that the AA must take into account the international jurisprudence as well as domestic interpretations for assessing the ambit of public policy under Clause 4 of Draft Part Z. The ILC has also laid down the situations in which the exception of public policy would apply. The illustrative account of such situations includes: (i) abuse of the domestic court's order of automatic stay by an FP; (ii) violation of privacy and criminal laws within the domestic jurisdiction; (iii) harmful impact on technological innovation within the domestic court's jurisdiction. Although the ILC did not prescribe a restrictive interpretation of "public policy," it did stress upon confining the purview of public policy. Furthermore, the scope of public policy has been interpreted by the Supreme Court of India under Sections 34 and 48 of the Arbitration and Conciliation Act, 1996. A narrow construction of the notions of public policy has been delved in detail in Ssangyong Engineering and Construction Co. Ltd. vs. National Highways Authority of India (NHAI) wherein the Supreme Court constricted the scope of public policy to only include: (i) “fundamental policy of Indian law”, and (ii) “most basic notions of morality or justice” which are so fundamental that a breach of such principles of justice would “shock the conscience of the Court”.


In light of the evolving jurisprudence of interpreting the public policy exception in a restrictive manner, the public policy exception in Draft Part Z must also be interpreted restrictively to prevent any unnecessary impediments from granting any aid in support of an FP. Additionally, the term "manifestly" under clause 4 of Draft Part Z should be construed as a qualifier for "public policy", as it will limit the scope of public policy while also allowing the public policy exception to be invoked in exceptional circumstances encompassing matters of fundamental importance to the State. This way the principles of comity and universalism, which are the cornerstones of MLCBI, will be put into action under this interpretation.


4. CONCLUSION:


As discussed in this article, the incorporation of the MLCBI in the Indian insolvency regime by inserting Draft Part Z in the IBC is a welcome step as it gives access to foreign representatives to domestic courts and enables them to institute insolvency proceedings in India; permits the recognition of foreign insolvency proceedings in India; promotes cooperation between relevant stakeholders in cross-border insolvency; advances coordination in conducting simultaneous insolvency proceedings in different jurisdictions. The recognition of an FP as an FMP or FNMP is one of the most crucial stages in providing access to domestic courts to a foreign representative in cross-border insolvency. To achieve the true objectives of the Draft Part Z and the MLCBI, India needs to ensure that simpler and perspicuous norms are laid down in the tests applied and factors considered by the AA while recognizing FMPs and FNMPs. This can be achieved by incorporating both creditor-based and debtor-based factors under the rules and regulations framed under Draft Part Z that can act as guidance for the AA in determining the COMI and the existence of the establishment of the debtor. Further, it shall also be ensured that the public policy exception under Draft Part Z is construed in a restrictive manner and unnecessary restraint is not created by refusing to provide access and relief from domestic courts to foreign representatives in aid of a cross-border insolvency proceeding.

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