Environmental Claims in Insolvency in India

The Indian Insolvency and Bankruptcy Code, 2016 (IBC) primarily aims to provide failing firms one last chance at survival. The IBC focuses on restructuring and rescuing the stressed firm, which leads to value maximization for all creditors. While restructuring occurs within a protected framework, the IBC honours the pre-insolvency contractual rights through a waterfall mechanism whereby secured creditors are prioritized over unsecured creditors. Such a prioritization is reflected in the treatment of tortious rights holders, who would be classified in the residuary basket of ‘any remaining debts and dues’ and fall behind secured creditors in priority.

Now assume an accident in a chemical plant causes massive environmental pollution, which incurs a considerable clean-up cost, affects many individuals’ health, and damages private property. Due to the accident, the chemical plant's licence to operate is revoked, impacting the cash flow of the company, which causes it to default on a debt obligation. Meanwhile, the company faces several claims arising from the environmental pollution caused by the accident. Overwhelmed by all the claims, fines, and finding itself in a cash flow crisis, the company initiates a corporate insolvency resolution process (CIRP) under the IBC.

Once insolvency is initiated, the company is protected by way of a moratorium against all the fines levied by various government agencies and environmental claims before various courts. These fines and claims would be processed under the CIRP. This post, which is based on my co-authored paper ‘Environmental Claims under Indian Insolvency Law: Concepts and Challenges’, explores how environmental claims are treated in a CIRP and seeks to understand how contractual liability is prioritized over environmental liability.

The Treatment of Environmental Claims Under CIRP

Any resolution of the company and settlement of claims would have to abide by the waterfall mechanism prescribed under the IBC, which differentiates between secured and unsecured creditors. In Swiss Ribbons v Union of India, the Supreme Court of India held that unsecured creditors would only be legally obliged to obtain the amount they would have received if the company were liquidated. For instance, if the company was valued at 100 units and the secured creditors had outstanding dues amounting to 120 units, the unsecured creditors would not be legally obliged to receive any funds.

To date, there have been no environmental claims received in a CIRP. In general, environmental claims can be classified under two heads: contingent environmental claimants, where the case was ongoing and has been halted due to the moratorium; and environmental decree holders, where the case was decided in favour of the environmental claimant. Environmental decree holders would be classified as low-priority unsecured creditors under the header ‘other debts and dues’ as the Tripura High Court classified decree holders as ‘other creditors’. Similarly, environmental contingent claimants would be classified under ‘any remaining debts and dues’. There are a few instances of a successful resolution applicant setting out funds for contingent claimants.

Environmental claims can also be extinguished if environmental claimants are not legally obliged to obtain compensation under the waterfall mechanism. There have been cases where contingent claims have been extinguished via a resolution plan. If environmental claims are extinguished in the CIRP, it results in insolvency and economic policy superseding environmental policy by design. Such overriding of environmental policy has a direct and visible human rights impact wherein individuals whose rights were breached are not adequately compensated.

While the IBC seems to be agnostic to social issues, it needs to be construed harmoniously with other social frameworks to try and resolve those social issues. The IBC is not to be understood as ‘overriding’ other laws. Instead, the IBC is to be understood as attempting to fulfil its limited objective of rescuing a failing company. Insolvency is a consequence and not a cause. The IBC seeks to address the consequence of insolvency and not the cause of insolvency. The cause and other parallel issues, social or otherwise, cannot be addressed by insolvency–they need to be addressed by a holistic policy formulation, of which insolvency is one tool among many.

There is no perfect solution concerning the interaction between insolvency policy and environmental laws. A workable solution may lie in insurance law, specifically India’s Public Liability Insurance (PLI) Act, which may act harmoniously with the IBC.

Public Liability Insurance as a Solution

The PLI Act mandates companies handling hazardous chemicals to get insurance protection against accidents involving hazardous chemicals. Determining a claim under the PLI Act is relatively straightforward, with the Collector determining the compensation based on the principle of no-fault liability. A Collector, who is also the District Magistrate (and in some instances, an Executive Magistrate), is present in each district, overseeing various government and administrative tasks. The Collector is also tasked with performing some quasi-judicial functions, such as the determination of compensation under the PLI Act.   

However, how a company’s fresh start would impact such a public liability insurance scheme is unclear. The principle of fresh start in insolvency law dictates that if a company is successfully rescued, it gets a fresh financial start, which means all its previous liabilities (save for what was decided in the resolution plan) are extinguished. In such an instance, the company would not be liable for any previous liability after receiving a fresh start. If the company is not liable for its previous liability, the insurer would, in turn, claim to be rid of its liability which directly arises from the company's liability. While this is an untested scenario, a simple amendment allowing claimants to directly sue the insurance companies directly may solve such issues. However, there remain other limitations with insurance as a solution.

The Limits of Insurance as a Solution

The PLI Act was drafted in 1991. Its compensation figures have not been updated since and are severely outdated. For instance, for a medical injury, compensation is capped at Rs 12,500 (roughly $154) and Rs. 25,000 (roughly $308) in case of death. In this regard, some efforts have been initiated to update the figures and amend the Act. Another limitation is that the PLI Act restricts its scope to accidents. This means that if the pollution caused was intentional or knowingly caused, the PLI Act does not apply.

The insurance policies impose certain caveats, further limiting what is covered. Government fines in response to the accident are not covered under the policies, meaning government clean-up costs would not be covered under the policy. The policy wording may also provide an escape route to the insurers after the insured company gets a fresh start–as the policy only indemnifies any loss from the liability arising from the insured actions. As discussed, a fresh start rids the insured company of liability, possibly allowing the insurer off the hook.

Conclusion

Regardless of the cause, insolvency is complex, where what is sought for is greater than what can be repaid. The IBC, which is agnostic to social issues by design, overrides environmental policy. In such a scenario, public liability insurance can provide a harmonious solution. For instance, schemes under the PLI Act, while not perfect, are better suited to tackle such a situation–which better balance both environmental policies by resolving environmental claims while respecting insolvency policies.

Sriram Prasad is a Researcher at the Indian Institute of Management Ahmedabad.