Analysing the Fresh Start Doctrine: A South Asian Perspective through the Lens of India
-Sagar Manju, Hitoishi Sarkar & Naman Katyal†
In a recent ruling in Re: Purdue Pharma, the Southern District Court of New York has held that the U.S. Bankruptcy Code does not confer on any court the power to approve the release of non-derivative third-party claims. The ruling serves as a periodic reminder about the implications of the ever-expanding fresh start approach across the world. The fresh start approach untangles the debtor's future income from the chains of previous debts. At the same time, equally relevant is the concern that while bankruptcy law should be able to sufficiently discharge/provide immunity to the erstwhile management, the same should not be used as a mechanism to extinguish non-derivative claims by negligent promoters (such as the Sackler family in the present ruling).
Apart from the western jurisdictions, the fresh start doctrine has found statutory sanction in several South Asian jurisdictions. It is pertinent to note that South Asia is an exciting region to analyze both on account of the paucity of legal scholarship and since it has a mix of the Debtor-in-Possession model ("DIP model") and the Creditor-in-Possession model ("CIP model") unlike developed jurisdictions which have a focus on the DIP model. Under the DIP model, the erstwhile management is permitted to remain in the management of the debtor's affairs, while in the CIP model, control shifts to the creditors. Additionally, certain South Asian jurisdictions like India have been perceived to be very harsh on the erstwhile management of the debtors and have enacted penalizing provisions such as Section 29A of the Insolvency and Bankruptcy Code, 2016 (“IBC”).
This post seeks to analyze the ramifications of the ruling in Re: Purdue Pharma from the standpoint of the fresh start doctrine. To achieve the same, the authors trace the evolution of the fresh start doctrine in western jurisdictions and their treatment of the erstwhile management. After that, the post analyses the treatment of non-derivative claims against the erstwhile management in South Asian jurisdictions and critiques the harsh treatment of promoters in certain jurisdictions like India.
The triggering event for the debtor's (Purdue) bankruptcy was an "explosion of opioid addiction” in the United States. The opioid addiction was primarily attributable to the over-prescription of highly addictive medications including, Purdue's proprietary OxyContin. Purdue admitted that it had falsely marketed OxyContin as non-addictive and had submitted false claims to the federal government for reimbursement of medically unnecessary opioid prescription.
A flurry of lawsuits was brought against the debtor by persons who had become addicted to OxyContin and by the estates of addicts who had overdosed. Consequently, Purdue filed for chapter 11 bankruptcy in September 2019. A reorganization plan (“the Plan”) was drafted and approved by a supermajority of votes by each class of creditors. However, some of the creditors voted against the adoption of the Plan and preferred an appeal against the same.
The Appellants attacked the legality of the Plan's non-consensual release of third-party claims against non-debtors. In this matter, the Sackler family, which was at the helm of the debtor, withdrew money, thereby reducing the debtor's solvency cushion and reinvesting the same in offshore companies and assets that could not be reached in bankruptcy. The Sackler's offered to contribute toward a settlement only if every family member could "achieve global peace" from all civil litigation.
The Court opined that the Bankruptcy Code does not confer on any court the power to approve the release of non-derivative third-party claims against non-debtors. The Court carved out a difference between liability arising from derivative claims and direct claims. While the Sackler family was provided with the release from derivative claims, i.e., claims that would render the Sackler's liable because of Purdue's actions. However, the family was not provided with release from direct claims that are not derivative of Purdue's liability but are based on Sackler's own individual liability.
Evolution of the Fresh Start Doctrine
The treatment of debtors in early bankruptcy laws was severe, and bankruptcy was a creditor-driven process. However, with the advent of the change in the U.S. attitude towards business bankruptcy in the second half of the 19th century, in principle due to the failure of a high number of U.S. railway companies and a need to safeguard the strategically important railway industry, evolved the "fresh start" approach. Central to a "fresh start" is the discharge in bankruptcy, which frees a debtor's future income from existing creditor claims. The "fresh start" approach, which is now firmly ingrained in the bankruptcy mentality of the U.S., was first discussed by the U.S. Supreme Court in Local Loan Co. v. Hunt, where the Court underlined the bankruptcy's rehabilitative purpose.
Other developed jurisdictions such as the United Kingdom ("U.K.") and Australia have not remained untouched by the fresh start approach either. The U.K., for reference, incorporated the fresh start concept in its 2002 Enterprise Act following its 2001 report titled “Insolvency-A Second Chance." The report emphasized that companies in financial difficulties should not be allowed to close down unnecessarily, and honest individuals should be granted a "fresh start," given that "in a dynamic market economy, some risk-taking will inevitably end in failure". In Australia, the idea of a fresh start directed towards corporate rescue has found recognition by the Australian courts. Furthermore, i n recent times, there has been a global push towards the fresh start approach, and as a consequence, more nations will likely implement this change.
At this juncture, a question regarding the possibility of the erstwhile management of the debtor (such as the Sackler family) to return at the helm of the debtor arises. For instance, in certain jurisdictions like India, the erstwhile management of the debtor is obligated to transfer the management to a committee of creditors, and if their corporation has grown out of its Micro, Small & Medium Enterprises status, the management is also often barred from submitting a resolution plan due to Section 29A of the IBC. This approach is at loggerheads with the approach adopted by the more developed jurisdictions we previously discussed. In the U.S., the erstwhile management of the debtor not only remains at the helm of the debtor's affairs during bankruptcy proceedings but also gets an exclusive right to propose a plan for the restructuring. In the case of the U.K., although a limit underlines the ability of a debtor's erstwhile management to operate the debtor during the insolvency proceeding, the law does not prevent them from participating in the company's rescue and eventually regaining control of their companies. Likewise, in Australia, the erstwhile incumbent management had to cede control to an external administrator; however, a recent change in law has put in place the DIP model for debtors with liabilities of less than A$1 million. Furthermore, there exists no bar on the erstwhile management, and the restructuring process usually concludes with the vote to wind up the company, return the debtor to the erstwhile management or enter into a Deed of Company Arrangement.
Treatment of non-derivative claims in South Asian jurisdictions
As mentioned earlier, Purdue Pharma's ruling is significant for carving out a niche difference between derivative and non-derivative claims and refusing to discharge liability/debt arising out of non-derivative claims. It is essential to analyze the legal position concerning non-derivative claims in South Asian jurisdictions for two primary reasons. Firstly, most South Asian jurisdictions enacted insolvency statutes almost decades after the U.S. Bankruptcy Code. Therefore, it is imperative to look at whether they have drafted their statutes in a manner that reduces ambiguity regarding the discharge of non-derivative claims. Secondly, the region represents a mix of DIP and CIP jurisdictions.
The DIP jurisdictions in South Asia represent a perfect balance of statutory unambiguity and commercial sense. Singapore’s Insolvency, Restructuring and Dissolution Act 2018, which was enforced very recently, provides commendable clarity in this regard. Section 397(5) to 397(8) of the statute clearly outlines circumstances in which non-derivative claims are not discharged under the statute. The Malaysian position of law is quite similar to that of Singapore. Section 35(2) of the Insolvency Act, 1967 expressly provided that an order of discharge shall not absolve the bankrupt from any liability incurred on account of an offence.
The Indian position of law is quite different from that of Singapore and Malaysia, primarily because it is based on a CIP model. Section 32A of the IBC discharges the debtor of the liabilities only if management changes. This provision has been at the centre of many judicial rulings, with the Indian Supreme Court invoking its version of the "fresh start" approach coined as the "clean slate" theory. Thus, the erstwhile management (such as the Sackler Family) cannot seek any immunity under Section 32A of the IBC . This is significant because the Indian position has generally been bitter towards that of the erstwhile management, as is also exemplified by Section 29A of the IBC, 2016, which prohibits the erstwhile management of the debtor to bid for the enterprise under a resolution plan. This makes the Indian legal position stand out in stark contrast to other South Asian jurisdictions. For instance, neither the Malaysian statute (Section 36) nor the Singaporean statute (Section 400-401) prescribes such a blanket disqualification for the erstwhile management. Even the Enterprise Insolvency Law of the People’s Republic of China is devoid of a similar prohibition for erstwhile management (Chapter 11).
Unlike most western jurisdictions, the South Asian statutory position has been relatively unambiguous about the discharge of non-derivative claims. While the jurisdictions with a DIP model such as Singapore and Malaysia have outlined clear circumstances in which non-derivative claims are unable to be discharged, jurisdictions such as India with a CIP model, have further restricted the benefits of the fresh start doctrine to instances only where there is a change in management of the debtor.
The ruling in Purdue Pharma is refreshing for attempting to limit the scope of the fresh start doctrine. While such rulings must be appreciated for their endeavour to prevent abuse of the fresh start doctrine, a statutory position such as that of India towards erstwhile management is also undesirable. This is because while Section 29A of the IBC was enacted with an express aim "to disqualify only those who had contributed to the downfall of the debtor," it provides for a blanket disqualification for the erstwhile management.
This approach is particularly undesirable in the cases where the erstwhile management’s bid supersedes the offer made by other bidders in the resolution process, nonetheless still they might be not eligible under Section 29A. The insolvency of Essar Steel Ltd. is the prime example of such a situation wherein the erstwhile management was barred from offering a competing bid even when the bid offered was approximately 25% higher than the amount being offered by the highest bidder. The situation worsens and liquidation remains the only option (as in the recent instance of Siva Industries' insolvency) if the debtor is small, with few or no prospective buyers other than the erstwhile management. Interestingly, the Supreme Court itself in its ruling in Committee of Creditors of Essar Steel India Ltd v. Satish Kumar Gupta had reiterated the primacy of the commercial wisdom of the Committee of Creditors (“CoC”). Thus, there exists a dichotomy in the Indian scenario whereby the courts acknowledge the supremacy of the CoC’s commercial wisdom but the statutory structure seems to believe otherwise. While the authors acknowledge that disqualifications such as those provided under Section 29A may be well intentioned but we argue that the provision could be tweaked further to increase resolutions.
A suggestion in this regard could be to carve out an exemption under Section 29A to provide relief to the erstwhile management whose businesses have turned insolvent due to abrupt changes in the economy with no negligence or fault on their part. A probable mechanism to establish negligence in such circumstances would be to subject the transactions of the corporate debtor to an audit to determine the same. This would provide the CoC with a choice on whether to retain the erstwhile management or to accept their resolution plans. Simultaneously, it would address the concerns of policy makers that the IBC would be used as a backdoor by negligent erstwhile management to regain control over the corporate debtor. Furthermore, because the erstwhile management has traditionally been in charge, any diligence and fact-finding requirements can be bypassed, and the Corporate Insolvency Resolution Procedure process can progress quickly.
Similar sentiments had been echoed in the 2001 U.K. Report, which acknowledged that bankruptcy law should be able to provide some respite to the erstwhile management as in a market economy, some businesses would inevitably end in failure without any fault on the part of the erstwhile management.
†Sagar Manju is a Partner at Saraf and Partners. Hitoishi Sarkar and Naman Katyal are penultimate year students of lw at Gujarat National Law University, Gandhinagar.