Insolvency Law Update – India

The Supreme Court of India on 25 January 2019 has passed a landmark judgement upholding the constitutional validity of the Insolvency and Bankruptcy Code, 2018.

1. Introduction

The judgment tests the Insolvency and Bankruptcy Code, 2018 on the bases of the approach of the courts remaining hands of economic legislation and the principle of judicial restraint in economic matters is reiterated:

“The court must defer to legislative judgment in matters relating to social and economic policies and must not interfere unless the exercise of legislative judgment appears to be palpably arbitrary.” (Para 7 and 8)

The judgement upholds the constitutional validity of the IBC in totality and the two effective changes that arise out of the judgement (i) setting up of circuit benches of the NCLAT within 6 months (ii) ‘related party” and ‘relative’ in section 29 A has to be read so as to include only those persons connected with the business activity of the resolution applicant.

1. Appointment of Members of NCLT and NCLAT

The challenge to the appointment of the present judicial and technical members of the NCLT and NCLAT fails as the appointments have been duly made in compliance of the directions of the Hon’ble Supreme Court and advertisement dated 10 August 2015. [Para 14 @ Page 41]

1. Circuit Benches for NCLAT

The Union of India has been directed to set up Circuit Benches of the NCLAT within a period of 6 months. [Para 16 @ Page 43] and it has further been directed that the Union of India should follow the direction in Madras Bar Association v. Union of India, (2010) 11 SCC 1 to provide administrative support for NCLT and NCLAT through the  Ministry of Law and Justice. 1 [Para 19 @ Page 45]

1. Classification between operation and Financial Creditor upheld

No discrimination results if the Court can be shown that there is an intelligible differentia which separates the two kinds of creditors so long as there is some rational relation between the creditors so differentiated with the object sought to be achieved by the Code [Para 20 @ Page 45]. The intelligible differentia is evident from the following:

• Financial Creditors (‘FC’) are secured whereas most Operational Creditors (‘OC) are unsecured.
• The nature of loan agreements with FC is different from contracts with OC for the supply of goods and services.
• Financial Contracts generally involve large sums of money, while Operational Contracts have dues whose quantum is less.
• In the running of a business, OC is many as compared to FC who lend finance for setting up or working of the business.
• FC have specified repayment schedules and default entitles them to recall a loan in totality as opposed to contracts with OC which do not have any such stipulations,
• Operational debts tend to be recurring and the possibility of a genuine dispute is much higher as compared to Financial Debts, which, on the other hand being debts made to banks and financial institutions, are well documented and thus defaults are easily verifiable
• FC are involved in assessing the viability of the CD which the OC do not have the commercial insight to do.

In this context at Para 23, the Court has observed on the interpretation of financial debt that “A perusal of the definition of “financial creditor” and “financial debt” makes it clear that a financial debt is a debt together with interest, if any, which is disbursed against the consideration for time value of money. It may further be money that is borrowed or raised in any of the manners prescribed in Section 5(8) or otherwise, as Section 5(8) is an inclusive definition.”

[Para 27 @ Pages 64,65,66]

1. Operational creditors not having a vote in CoC has been upheld

The OC’s by being denied participation in the CoC has not been discriminated against under the Code and thus there is no violation of Article 14 for the following reasons:

• After examining the working of the Code, the Joint Parliamentary Committee Report of April 2016, the BLRC Report and the Insolvency Law Committee Report of March 2018( ‘ILC Report, 2018’) thought it fit not to amend the Code so as to give OC the right to vote in the Committee of Creditors (‘CoC’) because, under the Code, the CoC is entrusted with the primary responsibility of financial restructuring. They are required to assess the viability of a corporate debtor by taking account of all available information, alternative investment opportunities available and to evaluate the resolution plan as the FC are best equipped to assess the feasibility and viability of the business of the Corporate Debtor unlike OC, who provide goods and services are involved only in recovery of the amounts unpaid on the goods and services and are typically unable to assess the viability and feasibility of a business. [Para 42, 43, 44 @ Pages 91- 94]

• Further, it has been seen that the resolution plan cannot pass the muster under Section 30(2) (b) read with Section 31 of the Code unless minimum payment is made to Operational creditors, is not less than the liquidation value. [Para 46 @ Page 95]

• Post-amendment, the Regulation 38 which provides for mandatory contents of a Resolution Plan, further strengthens the rights of the OC by statutorily incorporating the principle of fair and equitable dealing of OC’s rights together with priority in payment over financial creditors. [Para 47 and 48 @ Page 97]

1. SECTION 12 A IS NOT VIOLATIVE OF ARTICLE 14

• Once the Code gets triggered by admission of a creditor’s application under Section 7 or 9, the proceedings before the Adjudicating Authority, being collective proceeding, becomes a proceeding in rem. Being a proceeding in rem, it is necessary that the body which is to oversee the resolution process must be consulted before any individual corporate Debtor is allowed to settle its claim. [Para 52 @ Page 100]

• In case of withdrawal at any stage before the CoC is constituted, a party can approach the NCLT directly, which will then exercise its inherent powers under Rule 11 of the NCLT Rules, 2016 to allow or disallow an application for withdrawal or settlement. [Para 52 @ Page 101]

• The high threshold of 90% of the CoC to allow withdrawal under Section 12 A has been explained in the ILC Report as all FC have to put their heads together to allow such withdrawal as, ordinarily, an omnibus settlement involving all creditors ought, ideally, to be entered into. [Para 53 @ Page 101]

• If CoC arbitrarily rejects a just settlement/withdrawal, the NCLT/ NCLAT can set aside such decision under Section 60 of the Code.

1. Resolution professional does not have any quasi-judicial powers

• The Resolution Professional (‘RP’) is a facilitator of the resolution process whose administrative functions are overseen by the CoC and the Adjudicating Authority. The functions performed by the RP are administrative in nature as opposed to being quasi-judicial [Para 59 -61 @ Pages 107-110]

1. Constitutional Validity of Section 29-A

• Retrospective application of Section 29 A: A Statute is not retrospective merely because it affects existing rights nor is it retrospective because a part of the requisites for its action is drawn from a time antecedent to its passing. Further, following the decision in ArcelorMittal’s case a resolution applicant has no vested right for consideration or approval of its resolution plan. [Para 64 @ Pages 120, 121]

• Section 29 A is not restricted to malfeasance. The categories of persons who are ineligible under Section 29 A includes both, persons who are malfeasant and those who have fallen foul of the law in some way.[Para 69 @ Page 124]

• Related Party: Persons who act jointly or in concert with others are connected with the business activity of the resolution applicant. In the absence of showing that a person is connected with the business activity of the resolution applicant, such person cannot be disqualified under Section 29 A. The expression “related party” and therefore, “relative” contained in the definition sections must be read noscitur a sociis with the categories of persons mentioned in Explanation I and so read, would mean only those persons having a connection with the business activity of the resolution applicant. [Para 73-76 @ Pages 130-140]

Thus, the experiment contained in the Code, judged by the generality of its provisions and not by the so-called crudities and inequities that have been pointed out in these petitions, passes the constitutional muster.

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Contributing Advisors