INTRODUCTION: THE TWILIGHT PERIOD AS A CORPORATE GOVERNANCE ISSUE

The twilight period can best be interpreted as a corporate governance crisis but not as just an insolvency phase. Modern corporate governance has been organised in the way that it is based on the doctrine of shareholder primacy, in which directors are supposed to maximise the value of the firm to shareholders as the key residual claimants. This orientation is supported by economic studies of corporate law which conceptualise the firm as a place of contract between different stakeholders in which governance rules bring the managerial incentives and shareholder wealth maximisation interests into consonance.

Yet this model is unstable in a situation when a business is nearing financial distress. The limited liability also protects the shareholders against losses that are more than what the shareholder invested, which leads to taking of risks during economic crunch even when such decisions might end up depleting the value that can be offered to the credit providers. In the process, the creditors assume more economic risk since the remaining assets of the firm are basically used to fulfil the claims of the debts. The study of insolvency, thus appreciates the fact that when a firm is likely to collapse financially, creditors will become the main economic stakeholder of the firm.

This tension is indirectly expressed through Indian law. Although a fiduciary model remains shareholder-centric as captured in 166 of the Companies Act, 2013, Section 66 of the Insolvency and Bankruptcy Code, 2016, imposes liability where directors proceed with the company despite the imminent insolvency. The twilight period, in this case, demonstrates the structural governance conflict where the directors must negotiate the opposing shareholder and creditor interests.

DOCTRINAL DEVELOPMENT OF CREDITOR DUTIES IN COMMON LAW JURISDICTIONS

The common law courts realised that structurally the fiduciary governance by shareholders is structurally unsustainable as insolvency sets in due course since creditors, not shareholders, were now the main bearers of economic risk. Judicial doctrine thus changed to rebalance fiduciary liability of directors in case of financial distress. The basis of this change in the United Kingdom was established in West Mercia Safetywear Ltd v Dodd, whereby the Court of Appeal ruled that, once the insolvency threat has arisen, directors should not, so far as they can, distribute corporate assets to the prejudice of creditors, but they should instead act in the best interest of the company creditors, which was more in line with creditors’ interests. This principle is subjected to the larger statutory context of Section 172 of the Companies Act 2006, according to which directors are expected to give effect to the success of the company but implicitly permits the nature of the content of that duty to develop where the interests of the creditors prevail.

In BTI 2014 LLC v Sequana SA, the UK Supreme Court has made it clear that the doctrinal trigger occurs when directors are aware, or should be aware, that an insolvent liquidation is likely to occur, which, contrary to that approach, alters but does not supersede the shareholder-focused fiduciary duties. Statutory reinforcement is found in Section 214 of the Insolvency Act 1986 which creates liability for directors who keep trading even though they know they will go into insolvency.

Australian jurisprudence, by contrast, focuses on the maintenance of assets for the creditors in insolvency, whereas U.S. courts came to the notion of the “zone of insolvency” in Credit Lyonnais v Pathe Communications, where creditors can claim assets, but since then the rights of creditors have been limited to derivative proceedings in Gheewalla. These teachings show that various jurisdictions are aware of the twilight governance issue but solve it with different fiduciary models.

INDIAN CORPORATE LAW – A FRAGMENTED ARCHITECTURE

Indian corporate law depicts a structural division between corporate governance and insolvency regulation, and the twilight period is largely unregulated. The main statutory statement of the duties of directors is in Section 166 of the Companies Act, 2013 stating that directors of the company must exercise their degree of good faith in the best interests of the company and its members. Even though the provision has codified fiduciary obligations of care, diligence, and loyalty, it is based on a shareholder-centric governance paradigm, and it is yet to be determined whether the interests of the company are also applicable to creditors in cases of financial distress. Extended debates of corporate governance in India mostly focus on board supervision and responsibility but remain largely in a shareholder-only context.

The measures that the institutions have to control the failures of the governance systems, including independent directors, should help reduce such failures, but as the research in the emerging markets demonstrates, the concentrated ownership structure and the lack of effective enforcement will often prove to be factors that restrict the ability of such institutions to punish management. Therefore, the law of corporate governance does not offer any form of guidance to the directors to make decisions during times of financial distress, as it lacks any doctrine.

Part of the ramification of opportunistic behaviour in the Insolvency and Bankruptcy Code is the existence of Section 66, which places a liability on directors who go on with trading despite having known that the company is insolvent, and of Section 70, which proclaims it a crime to act improperly when going about insolvency resolution. Judicial rationale also puts a lot of emphasis on creditor protection; in the case of Puneet Kaur v K.V. Developers, the NCLAT stated that the insolvency systems should provide fair treatment of creditor claims. However, these clauses only come into play once insolvency has started, showing that Indian law implicitly acknowledges twilight-period misconduct but does not give a consistent fiduciary standard of conduct of directors prior to the insolvency process commencing.

THE REGULATORY BLIND SPOT – MISSING PRE-INSOLVENCY GOVERNANCE

The Indian corporate regulation sets up a structural distinction between the corporate governance law and the insolvency law, and the twilight period is almost unregulated. The solvent companies are largely regulated under the Companies Act, 2013, which defines the legal framework of board authority, fiduciary responsibility, and shareholder oversight. When a company is officially declared as in default, however, the new regulatory framework transpires from the Insolvency and Bankruptcy Code, 2016, which provides the resolution mechanism driven by creditors based on the Corporate Insolvency Resolution Process and the power of the Committee of Creditors. The institutional system that has been set by the Insolvency and Bankruptcy Board of India further assures that the regulation system is mainly meant to help the insolvency after it has become formal.

Economic scholarship gives a reason why this discontinuity is a problem. Regimes to deal with insolvency are aimed at the coordination of the claims of creditors and salvaging the value of firms once they are insolvent, but the significant destruction of values before the process of insolvency starts when directors postpone it or pursue too risky courses of action. Since the Indian law governs the conduct of directors when a firm is solvent and governs the conduct of directors when a firm is insolvent, but not the conduct of directors operating in financial distress, directors acting in this phase are at a loss as to whose interests they must follow.

THE TWILIGHT DUTY: A DESIGN OF AN INDIAN CORPORATE LAW

The solution to the governance vacuum between corporate law and insolvency law is to provide a framework of twilight-period governance to balance the responsibility of directors in financial distress. A potential reform is that a statutory duty of creditor-consideration be introduced, following Section 172 of the UK Companies Act, which obliges directors to ensure that the company prospers without disregarding the interests of a wider group of stakeholders. An equivalent Indian law provision might help explain that directors need to consider creditor interests in deciding which interests of the company are best when faced with an insolvency, and this is consistent with the shift in the allocation of economic risk.

Such a reform is not without statutory basis as the Ministry of Corporate Affairs’ has previously stated its remarks on broadening the Directors’ responsibilities towards stakeholders, suggesting that a creditor-consideration approach is in line with the current trend of the Indian corporate law reform.

The second reform consists of early-distress governance mechanisms. The International governance standards highlight that boards are supposed to keep an eye on the financial sustainability and uphold a check on the risk management systems. Using this principle, Indian boards may be mandated to oversee indicators of solvency and liquidity levels so that before formal insolvency practices are enforced, financial distress is tracked and resolved.

An existing domestic framework is already in place. The Prompt Corrective Action framework of the Reserve Bank of India (RBI) has introduced clear regulatory guidelines for institutions which show adverse financial trends, before the institution is forced into formal resolution. Doctrinally and institutionally a comparable early-warning requirement would fit for non-banking corporates.

Lastly, the reform should include a safe harbour mechanism to restructure, as in the case of Australian safe harbour reforms. These clauses allow directors to be free of liability for insolvent trading when they are seeking to implement some restructuring measures that have high chances of a superior result over liquidation.

Importantly, it is not something new and novel in Indian law. The pre-packaged insolvency resolution process introduced in the IBC in 2021 already presents a legislative lens that favours dynamic approach to debtor-by-initiator debtor resolution process over adversarial process of liquidation – this would simply be extended to pre-insolvency phase by the proposed regime.

A combination of these reforms would create a calibrated twilight-period responsibility where creditors are safeguarded and executives of the company can still use lawful corporate salvage tactics.

CONCLUSION – RE-CONCEPTUALISING FIDUCIARY DUTIES IN CORPORATE DISTRESS

The twilight period reveals a basic tension of governance in the sphere of corporate law. With the increasing financial distress, the conventional model of shareholders is more unstable since creditors are the main economic risk-takers instead of shareholders. The answer to this dilemma by comparative common law jurisdictions has been to identify doctrines which mandate that directors take cognisance of creditor interests in the event of insolvency. Such doctrines recognise that fiduciary duties need to be varied in cases where the residual risk-bearers of a firm are varied.

However, Indian corporate law is still incomplete. Although directors of solvent companies are regulated by the Companies Act, 2013, and formal insolvency cases are controlled by the Insolvency and Bankruptcy Code, 2016, the two systems do not explicitly highlight the behaviour of directors when a firm is in financial distress before it enters an insolvency process. As a result, Indian corporate law does not have a consistent doctrinal system on the fiduciary duty of the directors in the twilight period.

As much as it is vital to understand what is not a twilight duty. It’s not a call for the complete primacy of creditors, nor it is a proposal that creditors are liable for every business decision made by the directors in crisis. The duty as described here is calibrated in that it is expected that directors will put the interests of their creditors on the table but will not take the place of the entrepreneurial judgment that is demanded by any real restructuring. It is not necessarily questioning the issue of taking risk; it’s questioning the issue of the opportunistic conducting that is deprived value from creditors in the meanwhile no insolvency has been technically acknowledged.

This article offers a map of comparative doctrines, outlines this regulatory void and recommends the introduction of a calibrated twilight duty for corporate law, so that the next IL&FS does not make Indian law fill the gap as creditors would assume the risk of not being compensated for every day within the twilight zone that corporate law is silent.