In recent years, company groups have become increasingly common worldwide due to the financial and operational advantages they offer. As these groups grow, many are also facing insolvency, leading regions like the EU and Canada to develop specialized frameworks for resolving such cases more efficiently. India, too, has seen the emergence of large company groups. However, the Insolvency and Bankruptcy Code (IBC) of 2016 lacks clear guidelines on handling group insolvencies. To address this gap, Indian courts have begun applying the principle of substantive consolidation to manage complex insolvency cases within these groups. This evolving landscape highlights the need for more defined regulations to keep up with the challenges of group insolvency in India.
Substantive consolidation is an extraordinary legal tool used in bankruptcy cases to treat multiple companies within a group as a single entity. This allows their assets and liabilities to be merged, making it easier to handle insolvency.1 This method helps when companies in a group are so closely linked that separating them would lead to a loss in value and create confusion for creditors. In simple terms, it is a way of addressing the reality that companies in a group often act like one unit, even if they are legally separate.
The Rise of Corporate Groups in India
India has witnessed a significant rise in complex corporate groups, where companies form multiple layers of subsidiaries. According to a report by the OECD, some large Indian companies listed on the NIFTY-50 index have an average of 50 subsidiaries. In fact, 15 companies have over 100 subsidiaries, and a few even have more than 200. These complex structures are designed to gain operational benefits like cost savings, shared assets, and reduced dependence on outside funding.
However, these corporate groups can also create challenges, especially during insolvency. Many of these companies share assets, pledge each other’s properties as security, or have common directors and shareholders. These interconnections make it difficult to separate individual companies’ finances during insolvency proceedings. As a result, Indian courts are frequently confronted with complicated cases involving group insolvencies, where current laws are insufficient to provide quick and effective resolutions.
What is Substantive Consolidation?
Substantive consolidation is a legal concept that allows a court to treat multiple companies in a corporate group as one for bankruptcy purposes. It is similar to the idea of piercing the corporate veil, but instead of holding individual owners responsible for company debts, it focuses on merging the assets and liabilities of different group companies. This approach is only used in special cases where separating the companies would cause more harm than good. It is important to not be confused between the corporate law principle of ‘piercing the corporate veil’ and the bankruptcy law principle of substantive consolidation.’ Piercing the veil is used to hold shareholders or directors personally liable for the company’s debts in cases of fraud or misconduct. Substantive consolidation does not extend liability to shareholders; it simply merges the companies within the group to simplify the insolvency process. This makes it a more suitable tool for handling the complexities of corporate group insolvencies
How Creditors View Corporate Groups
Creditors often view group companies as one entity when deciding whether to extend credit. They rely on the financial strength of the entire group, not just individual companies, when making lending decisions. During insolvency proceedings, forcing a strict separation between group members can disrupt this understanding and reduce the chances of recovering money. By allowing substantive consolidation, courts can streamline the process and make it easier for creditors to recover their assets.
Substantive consolidation also helps during the Corporate Insolvency Resolution Process (CIRP). It enables struggling subsidiaries to draw on the resources of their parent company, improving the chances of their survival. Without consolidation, these subsidiaries may not be able to attract buyers or investors, leading to liquidation and a loss of value.
Indian Courts and Substantive Consolidation: The Videocon Case
Even though the IBC does not have explicit provisions for substantive consolidation, Indian courts have borrowed this principle from U.S. bankruptcy law. An important case in Indian law is State Bank of India v. Videocon Industries Ltd., where the National Company Law Tribunal (NCLT) developed a test for applying substantive consolidation. The court looked at two main factors: first, whether the companies in the group were so interconnected that they operated as a single unit, and second, whether keeping them separate would make it impossible to revive the companies.
In this case, the NCLT found that the companies were heavily intertwined through shared financial obligations, cross-guarantees, and overlapping management. Trying to separate them during insolvency would have caused a loss of value, so the court ruled in favour of substantive consolidation. This decision set an important precedent for how Indian courts might handle similar cases in the future.
It is important to note that substantive consolidation is different from procedural consolidation. In procedural consolidation, courts manage the insolvency processes of separate companies in a coordinated way, but the companies remain distinct entities with separate assets and liabilities. Substantive consolidation, on the other hand, merges everything together, treating the group as a single debtor.
The Giriraj Case: Substantive Consolidation as a Legal Principle
In the case of Giriraj Enterprises, the tribunal considered whether to consolidate the insolvency processes of Regen Infrastructure and its parent company Regen Powertech. The opposition argued that substantive consolidation was an equitable remedy and could not be applied under the IBC. However, the NCLAT disagreed, stating that consolidation was a legal principle aimed at maximizing the value of assets and improving the chances of revival. The court emphasized that substantive consolidation was not just about fairness but was essential to achieving the IBC’s goals of value maximization and respecting the decisions of the Committee of Creditors. This case reinforced the idea that substantive consolidation is a valid legal principle in India, even without explicit provisions in the IBC.
The Need for Clear Rules on Substantive Consolidation
While substantive consolidation offers an effective way to handle group insolvencies, it needs to be applied carefully. Creditors often rely on the separate legal status of companies when extending credit, and merging these entities can disrupt their expectations. Indian courts have been cautious in using this doctrine because the IBC lacks clear rules on when and how it should be applied. To address this, an amendment to the IBC is needed to define the conditions under which substantive consolidation can be used. This would help avoid inconsistent decisions and ensure a more predictable process for resolving group insolvencies. Additionally, involving the Committee of Creditors in decisions about consolidation could further safeguard the interests of all stakeholders.
Disclaimer: This article is for informational purposes only and does not constitute legal advice. The content may not reflect the most current legal developments and is not guaranteed to be accurate, complete, or up-to-date. Readers should consult a qualified legal professional before taking any action based on the information provided. The authors and publishers disclaim any liability for any loss or damage incurred as a result of reliance on this article. This article does not create an attorney-client relationship.