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Insolvency and Bankruptcy Code, 2016 – Jurisprudence Bolsters and Aids Implementation

India’s Insolvency and Bankruptcy Code has both improved its business rankings and, arguably, its credit culture as well. Divyanshu Pandey & Soumitra Majumdar discuss its evolution.

India has managed to significantly improve its ranking in World Bank’s ease of doing business report – from 130 in 2016 to 77. A major contributor to this is the enactment and implementation of a comprehensive insolvency resolution eco-system through the Insolvency and Bankruptcy Code, 2016 (IBC). Breaking the cumbersome, inefficient, subjective, debtor-in-possession model, the IBC ushered in a simple and modern framework which provides certainty of outcome, ensures value maximization for all stakeholders through a time bound process. IBC arguably has improved the credit culture in India.

The credit ecosystem survives on the prospects of timely and maximum recovery. Pursuant to implementation of IBC, we are witnessing green shoots of a robust credit ecosystem developing. This will, hopefully, lead to deepening of our financial markets where credit is affordable and less reliant on collateral.

Our judiciary has aided immensely in the successful journey of IBC so far. The adjudicating fora right from National Company Law Tribunal (NCLT) to the Supreme Court (SC), through their various judgements, have helped in ironing out the creases in implementation of IBC and laid down substantial jurisprudence on a relatively new legislation. In this article, we discuss the evolution of IBC complemented by some of the important judgments of the SC and how these judgments, in a time span of only two years, have paved the way for achieving IBC’s stated objectives.

The SC has been particularly cautious in moulding the jurisprudence in a balanced manner – the thrust on economic revival and resolution has never overshadowed the principles of equity, natural justice and the imperatives of ensuring procedural and ethical propriety of a creditor – in – control process.

IBC: a paradigm shift in law – overrides other laws

‘IBC is a paradigm shift in law’ – observed the SC in one of the earliest applications moved before it under the IBC1 This was the first case where the overriding effect of IBC was upheld by the SC. The SC had to decide on the issue of repugnancy between Maharashtra Relief Undertaking Act (MRU, a state legislation) and IBC (a central legislation) and which statute should prevail. The issue was that corporate debtor’s liabilities and all related remedies of enforcement being suspended under the MRU, there was no debt due in law. Accordingly, an action under IBC against such a protected corporate debtor could not be tenable. The SC observed that if the discretionary moratorium under MRU is to be held binding, then it will completely frustrate the insolvency resolution process outlined in the IBC and its objectives. Relying on the overriding effect of Section 238 of the IBC (i.e. non-obstante clause under the IBC) the SC recognized the wide terms in which Section 238 was couched. This was to ensure that any right of a corporate debtor under any other law should not defeat IBC’s objectives.

This judgment established the primacy of the insolvency framework under the IBC, being an exhaustive code on insolvency. Being one of the first applications which reached the highest court under IBC framework, any different view would have put the efficacy of the insolvency framework in question.

Existence of a dispute: Test of bona fide claims

A large number of applications filed under the IBC are by operational creditors and IBC is allegedly being used by them as a recovery tool. The judgment in Mobilox Innovations Pvt Ltd vs Kirusa Software Limited2 helped in distilling the instances when an application filed by an operational creditor can be entertained. This judgment clarified the ambiguity on the amorphous definition of ‘dispute’ under IBC. The definition of ‘dispute’ under IBC is an inclusive one and provides that ‘dispute’ includes a suit or arbitration proceedings relating to (i) existence of amount of debt; (ii) quality of goods or services; or (iii) breach of a representation or warranty. While examining this issue, the SC set out the difference in requirements, both substantive and procedural, with respect to applications filed by financial and operational creditors respectively. The SC outlined that applications filed by operational creditors under Section 9 of the IBC needs to be examined by NCLT to determine: (i) whether debt is an operational debt which is due and payable; and (ii) whether there is existence of a dispute between the parties or a record of the pendency of a suit or arbitration proceeding filed before the receipt of the demand notice of the unpaid operational debt in relation to such dispute? If any of the above conditions are lacking, then the application will have to be rejected.

In relation to existence of dispute, the court read the word ‘and’ as ‘or’ in Section 8(2)(a) of IBC. The SC arrived at this view as reading it in any other manner would create a situation where without institution of suit or arbitration proceedings existence of a dispute cannot be established. Further, given the laws of limitation, a corporate debtor may not initiate any proceedings as long as limitation period is applicable and would become subject to insolvency proceedings even though a bona fide dispute exists. Relying upon interpretation of ‘existence of dispute’ in English and Australian cases, the SC held that while determining ‘existence of dispute’ the NCLT without going into the merit of the dispute needs to examine whether there is a ‘plausible contention which requires further investigation’ and that the “dispute” is not a patently feeble legal argument or an assertion of fact unsupported by evidence.

This decision has helped as a basis for rejection of many applications at the admission stage where operational creditors have tried to use the IBC for extraneous reasons i.e. as a tool for recovery.

Timelines are directory and not mandatory

One of the pivotal conditions of the IBC framework is the timelines specified for each part of its processes. Each part is regulated to ensure that the whole process is completed within the overall timeframe of 180 or 270 days, as applicable. This is essential to mitigate value destruction due to delays. While the SC endorses this time- bound scheme, however, it balances this with the overarching imperative of achieving just outcomes.

When the IBC was implemented, the questions which arose were, ‘what are the consequences of not adhering to the prescribed timelines’, ‘what remedy one has if timelines is not adhered to for procedural issues, or ‘are these timelines realistic’? In this context, NCLAT in Surendra Trading Company vs Juggilal Kamplamat Jute Mills Company3 examined the question “whether the time limit prescribed in IBC for admitting or rejecting a petition or initiation of insolvency resolution process is mandatory?”. The NCLAT held that the period of fourteen days prescribed for the NCLT to pass such an order is directory in nature, whereas the period of seven days given to the operational creditor for rectifying the defects in its application is mandatory. On appeal, the SC noted that to serve the ends of justice, the period prior to admission of an application is not to be treated as mandatory – judicial decision making cannot be made subservient to technical rigors of timelines. The ends of justice will not be met if an application is rejected, not on merits, but on technical issue of defects. The SC though cited a word of caution and said that if defects cannot be removed within 7 days then application can be admitted only if NCLT is satisfied that there was a sufficient cause for the delay.

Foreign Creditor vs Domestic Creditor: procedural formality is not mandatory

There is no distinction between a foreign creditor and a domestic creditor under IBC and they have similar rights. This is a marked departure from creditor protection laws4 which were enacted for speedy recovery of debts of banks and certain financial institutions in India. The benefit of such laws is not available to foreign creditors. The remedy available to the foreign creditors was to file for winding up or a money suit- which were plagued with delays. This asymmetry only compounded the problems and resulted in worse outcomes for all stakeholders.

To ensure that IBC provides a level playing field to all creditors and procedural formalities do not obstruct availing remedy by a creditor under IBC, in Macquarie Bank Limited vs Shilpi Cable Technologies Ltd5 the SC disregarded the procedural formality of having a certificate issued from an Indian financial institution6 as a mandatory supporting document for insolvency resolution application of an operational creditor. The SC held that rights accorded to creditors under IBC, who are within its ambit, are similar without distinguishing their nationality. The only mandatory condition for triggering the process under IBC is occurrence of a default in payment of a debt which can be proven by other documentary evidence. Therefore, this condition cannot be mandatory condition precedent for filing of an application as it will create an artificial divide between foreign operational creditors who bank with an Indian financial institution and those who do not or cannot.

By recognizing that rights of foreign creditors cannot be diluted on account of procedural formalities, this judgment lent credence to the efficacy of the insolvency resolution regime under IBC. This judgment by preventing dilution of foreign creditors remedy helps in increasing availability of credit from foreign creditors to the Indian corporates.

Law of Limitation applies to IBC

An important issue arose whether law of limitation applies to IBC. The NCLAT in its various pronouncements had held that the limitation law does not apply to IBC and even if it applies, limitation will start after commencement of IBC i.e. after December 1, 2016. This question was also examined by the Insolvency Law Committee7 and based on its recommendation the Indian Parliament in the second amendment to IBC8 introduced Section 238A which provides that laws of limitation will be applicable to proceedings before NCLT and NCLAT. The question also arose before the SC, prior to the second amendment, and in a judgment delivered in B.K. Educational Services Pvt Ltd vs Parag Gupta and Associates9 the SC clarified that laws of limitation applies and that too retrospectively. The court observed that IBC cannot be mechanism to resurrect a time barred debt as the consequences of filing under IBC can be dire leading to liquidation of a corporate debtor. The SC held that the trigger for filing under IBC is when there is default in payment of debt which is ‘due and payable’ that is a debt which should be due under law and not barred by law of limitation.

Eligibility of Resolution Applicants: Section 29A

One of the most critical and controversial sections of IBC is Section 29A. In order to ensure that the persons who, on account of their misconduct, contributed to defaults of companies or are otherwise undesirable, do not regain control of such companies by participating in the resolution process, the Government through the first amendment to IBC10 inserted section 29A which sets out the disqualification criteria for resolution applicants.

The original section was cast in very wide terms and attracted substantial criticism from various quarters. Keeping in mind the practical difficulties thrown up by section 29A which limited the pool of eligible resolution applicants, this section was further amended by second amendment to IBC11. The scope of Section 29A (as amended) was first examined by the SC in one of the most bitterly fought court battle for insolvency resolution of Essar Steel.

In its judgment in ArcelorMittal Indian Pvt Ltd vs Satish Kumar Gupta and Ors12 the SC laid down certain core principles in relation to applicability of Section 29A and who is required to examine such eligibility. The SC held that: (i) to arrive at persons who are actually in control whether jointly, or in concert with other persons, Section 29A is to be interpreted as a see through provision13; (ii) “Control” under Section 29A(c) denotes only positive control, thus, mere power to block special resolutions of a company cannot amount to control.; (iii) ‘acting in concert’ with an acquirer means that there should be commonality of objective and interest14; (iv) the ineligibility under Section 29A would apply from the date when the Resolution Plan is submitted and not before that; (v) the ineligibility under Section 29A(c) can be removed only if the overdue corporate debt is paid before submission of a resolution plan; (vi) relevant time to determine ineligibility under Section 29A(c) is date of submission of Resolution Plan, antecedent facts, reasonably proximate to this point of time can always be seen to determine the correct factual position. The competent authority must examine that by merely paying off debts the persons do not wriggle out of consequences of other ineligibility conditions.

The SC also took cognizance of the applications filed by resolution applicant(s) challenging the eligibility of other resolution applicant (s) on the grounds prescribed under Section 29A. With a view to reduce time spent in litigations adjudicating eligibility of a resolution applicant during insolvency resolution process, the SC ruled that a resolution applicant has no vested rights to challenge a resolution plan while the CoC is examining a Resolution Plan. Further, NCLT does not have the jurisdiction to interfere at behest of a resolution applicant under Section 60(5), before quasi-judicial determination under Section 31 of the IBC. The only reasonable construction of IBC is the balance to be maintained between timely completion of the corporate insolvency resolution process and the corporate debtor being put into liquidation.

It was also observed by SC that duty of a resolution professional (RP) is to examine the submitted resolution plans to ensure that they are complete in all respect and present it before CoC. A RP is not to decide upon eligibility of a resolution applicant. It is the CoC which will approve or disapprove a resolution plan under Section 30(4). Even the determination by CoC that plan violates provision of law including section 29A is not final and NCLT as quasi-judicial authority can determine whether a plan is violative of any law including 29A by allowing a resolution applicant and CoC to put forth their respective arguments.

By laying down the above core principles to be applied while interpreting ineligibility under 29A, the much-needed clarity on scope of application of Section 29A was provided by the SC. This judgment not only maintained the sanctity of IBC but also has helped in curtailing frivolous litigation under the garb of Section 29A, leading to inordinate delays and thereby defeating IBC’s objectives.

IBC is not unconstitutional

The constitutional validity of IBC being challenged was a likelihood quite a few anticipated. More so because the prospect of losing one’s business on account of non-payment of a loan was unimaginable in India. The constitutional validity of IBC was challenged in Swiss Ribbons Pvt Ltd & Anr vs Union of India & Ors15. The grounds of challenge were manifold: (i) no intelligible differentia between operational and financial creditors; (ii) unfavourable treatment of operational creditors; (iii) unbridled adjudicatory powers vested in the CoC which is a non-judicial authority; and (iv) retrospective application of 29A imposing a blanket ban on promoters who are unable to pay debt due to extraneous reasons.

The SC upholding the constitutional validity of IBC reiterated the principle that scope of judicial review of economic legislation is limited and unless such legislation is arbitrary a court does not sit in judgment over such legislation. On the basis of differences in terms on which financial and operational creditors advance credit to businesses, amounts lent by financial creditors being more, operational creditors outnumber the financial creditors, and the involvement of financial creditors in determining the viability of corporate debtor in distress, the SC upheld that there is intelligible differentia between the financial creditors and operational creditors. This differential treatment is not violative of Article 14 of the Indian Constitution.

On basis of its judgment in Arcelor Mittal, the SC reiterated that there is no vested right in the resolution applicant and hence rejected the challenge on retrospective application of Section 29A. The challenge that there is no distinction between a ‘good erstwhile manager’ and a ‘bad erstwhile manager’ was also dismissed on the ground that malfeasance is not the only ground for disqualification under Section 29A. Ineligibility can also be on grounds of disqualifications due to operation of law16.

The SC also had an opportunity in this case to read down the scope of application of section 29A (as amended by the second amendment to IBC) by clarifying the term ‘relative’ in context of 29A (j) should be interpreted narrowly to mean only those persons who are connected with the business activity of the resolution applicant. This interpretation again exemplifies the SC’s balancing act of ensuring fair play, but in a market dominated by family-run enterprises and conglomerates. A high-strung ethical stand, divorced from the reality, would have been an over-kill.

Limited judicial scrutiny of CoC Decisions

The design of the IBC is that insolvency resolution is a commercial decision and this decision- making power should vest with the financial creditors instead of being adjudicated upon. A resolution professional is mandated to act as facilitator of the entire process. The tribunal was designed only as a supervisory body to ensure procedural propriety and legality. This division appeared threatened in some cases – particularly, the amendment to Section 30 (4) of the IBC in June 2018, which introduced the requirement for the CoC to consider the feasibility and viability of a resolution plan before approval, as it had the potential to re-open every approved resolution plan and be challenged on account of commercial non-viability. This potentially dangerous trend was appropriately curbed by the SC in the case of K. Sashidhar V. Indian Overseas Bank17. The SC held that the IBC has not endowed the NCLT with any jurisdiction to analyse or evaluate the commercial decision of the CoC. There is an intrinsic assumption that financial creditors are fully informed about the viability of the corporate debtor and feasibility of the proposed resolution plan. The limited points of judicial scrutiny of CoC decisions primarily appear to be limited only to those pertaining to determinations made by the CoC under Section 30(2) or 29A of the IBC and mandatory requirements of IBC.

While this judgment does protect the commercial decision-making power of CoC in a CIRP, however, it does not absolve the CoC from the high degree of care and responsibility imposed on, and expected of, it.

Conclusion

A country like India always suffers from an infrastructure lag – the mounting work load of the various NCLTs, unless countered by proportionate increase in NCLT benches – may rob the CIRP of its potential. Certainty and clarity of jurisprudence evolved by the highest court of our country can naturally minimize the time spent in each of the cases. Needless to say, this has been invaluable in retaining the sanctity of the IBC. Further, an insolvency regime with certain outcomes can only incentivize stakeholders to resolve credit defaults through private negotiations in a timely manner, and not enter the adjudicatory arena – unlike the earlier regimes which almost incentivized defaults by protecting debtors at the cost of the creditors. IBC, as is being implemented and interpreted by the SC, does bear the promises of the above. The IBC has already facilitated the recovery of almost INR 60,000 crores, resulting in an increase of flow of credit to the economy. Other collateral benefits like improved credit discipline are already perceptible. All this would not have been possible had the legislation been struck down or the judicial authorities not appreciating the importance of not interfering in the scope of this legislation.

The SC has demonstrated its will to uphold the IBC, in letter and spirit. The above judgments clearly manifest that the highest court of this country understands and appreciates the importance of an economic legislation like IBC and its role in the growth of our country. Any other approach would have only had a debilitating effect.

The authors are partners of J. Sagar Associates, Advocates & Solicitors. The views expressed are personal.

Footnotes

  1. Innoventive Industries v. ICICI Bank (2018) 1 SCC 407
  2. (2018) 1 SCC 353
  3. (2017) 16 SCC 143
  4. The Recovery Of Debts Due To Banks And Financial Institutions Act, 1993 and The Securitisation And Reconstruction Of Financial Assets And Enforcement Of Security Interest Act, 2002. Even the SICA (now repealed) was abused by defaulting borrowers.
  5. (2018) 2 SCC 674
  6. An operational creditor is required to file certain documents along with its application for initiation of insolvency resolution process. One such document is the copy of a certificate from a financial institution who maintains account of an operational creditor, certifying that no payment has been made towards unpaid operational debt. The definition of ‘financial institution’ under IBC does not include foreign banks or foreign financial institutions. This requirement created serious hardship for operational creditors who were non-residents and did not have an account with a financial institution in India to evidence non -payment of defaulted operational debt
  7. A committee constituted by the Government on working of IBC and to suggest necessary changes.
  8. Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 came into from 06.06.2018
  9. 2018 SCC OnLine SC 1921
  10. Insolvency and Bankruptcy Code (Amendment) Act, 2017 came into effect from 23.11.2017
  11. Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 came into effect from 06.06.2018
  12. (2019) 2 SCC 1
  13. The SC in this case for both Arcelor Mittal and Numetal lifted corporate veil to ascertain the actual beneficiaries behind the smokescreen created by complex maze of companies and trusts.
  14. The SC relied on SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 1994 to determine what is ‘acting in concert’.
  15. (2019) 4 SCC 17
  16. Illustratively, under Section 29A (a) (an undischarged insolvent) and 29 A(e) (disqualification as a director)
  17. 2019 SCC OnLine SC 257

Contact:

Divyanshu Pandey

E:

Soumitra Majumdar

E:

www.jsalaw.com

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