The author is Shalin Ghosh, a first year student at Maharashtra National Law University (MNLU), Mumbai.
The Supreme Court (“SC”), in M.K. Rajagopalan v Dr. Periasamy Palani Gounder & Anr. (“M.K. Rajagopalan”), recently held that any violation of a director’s fiduciary duties as mentioned under Section 166(4) of the Companies Act, 2013 (“Act”) would impair a resolution applicant’s right to submit a resolution plan under the Insolvency and Bankruptcy Code, 2016 (“IBC”).
This article seeks to critically analyse the SC judgment by pointing out that it rests on a misplaced interpretation of Section 166(4) of the Act. To this end, the article would scrutinize the contours of Section 166(4) and propose a contextually suitable approach, considering global practices and commercial soundness. It also argues that the SC’s decision of setting aside the resolution plan due to an alleged violation of Section 166(4) is legally unsound due to an erroneous reading of the provisions of IBC.
The present case concerns the Corporate Insolvency Resolution Process initiated against the corporate debtor, Appu Hotels Limited. The National Company Law Tribunal (“NCLT”) admitted the corporate debtor into CIRP, and the resolution plan submitted by the successful resolution applicant was approved by the Committee of Creditors (“CoC”) and subsequently by the NCLT. The order was challenged before the National Company Law Appellate Tribunal (“NCLAT”), which eventually rejected the resolution plan earlier approved by the NCLT and the CoC. The resolution applicant filed an appeal before the SC against the NCLAT’s decision.
Ruling and Analysis
Misguided application of ‘conflict of interest’ under Section 166(4) of the Act.
In the appeal, one of the many grounds for rejecting the resolution plan submitted by the respondent-Resolution Applicant (“RA”) was that the concerned RA was the Managing Director of another company and that an approval of the proposed resolution plan would have resulted in the corporate debtor being engaged in a business similar to that of the RA’s company. The SC ruled that this aspect of the resolution plan would attract the rigours of Section 166(4) of the Act which precludes a director of any company from involving himself in a situation which directly or indirectly raises, or might raise, any interest which conflicts with the interest of the company where he is engaged as a director.
The SC’s observation that the RA investing in an enterprise engaged in a similar and competing business with the company he is a director in, thereby giving rise to a conflict of interest under Section 166(4) reflects an incorrect interpretation of the provision. Section 175 of the UK Companies Act, 2006 (“UK Act”), the corresponding provision dealing with conflicts of interest in English law, spells out a no-conflict doctrine similar to the one enumerated under Section 166(4) of the Act. Section 175 of the UK Act provides that a purported violation of the no-conflict principle will not fall under its ambit if it has been approved by the company’s board of directors.
The centrality of consent in this context has been well-established by precedents like Regal Hastings Ltd v. Gulliver and Shepherds Investment Ltd. v. Walters which have firmly traced the application of the no conflict principle to an absence of consent and have recognized that a company loses its right to proceed against an alleged breach of the no-conflict if the concerned act has obtained its ratification. Therefore, when the law prohibits a director from entering any situation which poses a conflict of interest, it implies that the concerned director is forbidden from appropriating any profit or advantage without obtaining the consent or approval of the company’s board. While the SC’s rigid application of the no-conflict rule found favour with early English precedents like Keech v. Sandford, UK courts have, over the years, adopted a more liberal application of the principle.
The modern approach taken by UK courts, evident in Balston v. Headline Filters Ltd, entails a greater emphasis on a fact specific analysis, with the courts considering a slew of factors like the intention of the directors, the bona fides of his actions, the source which informed him of the conflicting opportunity, among others. Similarly, Section 5.05 of the American Law Institute Project on Corporate Governance prescribes a diluted application of the no-conflict rule by allowing directors to avail potentially conflicting opportunities and making profits, provided that the directors adequately disclosure the concerned business opportunity and obtain the necessary consent and ratification from the company in this regard.
A major problem with a strict application of the no-conflict principle is that it could potentially stifle commercial creativity and directorial entrepreneurialism. This is particularly relevant and concerning in the context of corporate insolvency resolution because this judgment could set a precedent where otherwise commercially sound and viable resolution plans are rejected merely due the successful resolution applicant attracting the unmitigated rigours of Section 166(4). Such unfortunate outcomes are unlikely to bring about a timely and effective revival of a distressed entity, thereby frustrating the foundational objectives of the IBC.
Therefore, the rigid and textual application of the no-conflict rule under Section 166(4) by the SC is not only commercially unsound but is also not in accordance with the established global understanding of the no-conflict rule. It is argued that ‘conflict of interest’ for the purposes of Section 166(4) of the Act must only be applied in cases involving a real and apparent breach by a director of his fiduciary duties such as a failure to provide disclosures and obtain necessary approvals from the company regarding a potentially conflicting business opportunity instead of solely directing it, as in the present case, to the presence of a mere interest in an enterprise operating in a competing business. Applying this approach and taking the multiple conditions listed in the precedents into account while deciding similar cases in the future is important because Section 166(4) of the Act, as it currently stands, does not have any exceptions recognized in other jurisdictions and is, therefore, harsher, and more rigorous than the analogous English and American provisions.
Erroneous interpretation of Section 30(2) of the IBC
The SC’s observation that the violation of Section 166(4) of the Act triggered the prohibitions under Section 30(2) of the IBC, thereby rendering the concerned resolution plan untenable, is also problematic as it rests on an incorrect reading of the provision. Section 30(2), linked to the submission of the resolution plan, states that the resolution professional must ensure that any plan submitted by the prospective RA is not in contravention of any law. This implies that any analysis, for the purposes of Section 30(2), must be confined strictly to the contents of the resolution plan to determine whether the concerned plan violates or overlooks any legal principle or obligation. A breach of a director’s fiduciary duties under Section 166(4) under the Act might constitute a violation of law on the part of the resolution applicant. However, this cannot be extended to imply that such a contravention would attract the force of Section 30(2) of the IBC, consequently rendering an otherwise sound resolution plan untenable. A violation of Section 166(4) of the Act could conceivably be relevant while determining the eligibility of a resolution applicant under Section 29A and not, as is the case with the present judgment, while ascertaining the legality of a resolution plan under Section 30(2) of the IBC.
The SC’s adoption of a strict approach while applying the no-conflict rule has also largely been the result of a lack of adequate jurisprudence that sufficiently explains the content and scope of Section 166(4) of the Act. A sound interpretation and application of Section 166(4) would entail striking a balance between adherence to fiduciary duties and promoting directorial entrepreneurialism and commercial creativity. A revisitation of the SC’s observations in M.K. Rajagopalan in this regard is necessary not only to align the Indian understanding of the no-conflict rule with the established global position but also to encourage speedy and effective debt resolutions to further the objectives of the IBC.