In this article, Surbhi Jaju discusses the Constitutional Validity of Insolvency and Bankruptcy Code.

The Insolvency and Bankruptcy Code 2016 (the ‘Code’) provides the creditors with a comprehensive solution for recovery of dues from willful defaulters. While this legislation has been facing teething issues and inconsistencies from its inception, the proactive approach of the government in amending this liquidation law from time to time has led to its significant implementation.

Like any fresh legislation, issues pertaining to the constitutional validity of the Code have been raised by various stakeholders time and again. It has been alleged that the Code violates Article 14 of the Constitution of India and is discriminatory in nature. In a plethora of applications made to various National Company Law Tribunals (‘NCLT(s)’) and High Courts, the operational creditors have claimed that the classification of creditors as operational creditors and financial creditors is manifestly arbitrary and there is no intelligible differentia applied by the legislators in making such a demarcation.

Furthermore, in the aftermath of the 2017 Amendment of the Code which was subsequently amended by 2018 Amendment of the Code, another provision that led to massive hue and cry was the bar put on promoters from bidding for their own company under Section 29A. The Code forced the sale of the Company to new bidders and was argued to be against the fundamental right of the promoters. Additionally, another claim pertaining to the inequitable nature of Section 29A was raised and it was argued that the exclusion of the relative of an ineligible person, who is otherwise qualified to be the resolution applicant is extremely capricious.

Responding to a series of petitions that had challenged the constitutional validity of various provisions of the Code, the Supreme Court (‘Court’) in the case of Swiss Ribbons Private Limited and Anr v. Union of India and Ors (Bench of Hon’ble Mr. Justice Rohinton F Nariman and Hon’ble Mr. Justice Navin Sinha) upheld the validity of the Code in its entirety laying rest to several issues which arose due to the departure of the Code from previous insolvency laws. The Court, taking inspiration from the verdict in Bhavesh D. Parry v. Union of India was of the view that – ‘matters of policy are best left to the wisdom of the legislature, and in policy matters, the accepted principle is that the courts should not interfere’.

The judgement dealt with significant issues pertaining to the admission process, lack of participation of operational creditors in the Committee of Creditors (‘CoC’) and the bar put on the defaulting promoters and their relatives from participating in the resolution plan, all of which significantly changed the way the insolvency law operated in our country.

The Court made several observations in response to the arguments put forth by the petitioners. Analysis drawn by the Court pertinent to their ruling is as follows –

Classification of creditors

The petitioners had contended that financial creditors and operational creditors provided money to the debtor either in terms of financial assistance or goods respectively. The classification between them makes no real difference in terms of the object to be achieved by the Code that is, either an insolvency resolution plan or liquidation as an end result. The petitioners had argued that even if the Court believes that their exists a logical distinction between the two types of creditors, the operational creditors are discriminated and are treated with hostility.

The Court observed that there is an existing intelligible differentia between the two creditors which directly relates to the object sought to be attained under the Code. The key observations made by the Court are –

(i) financial creditors are secured creditors and operational creditors are unsecured creditors as payment for goods to the operational creditors is not secured by mortgage documents;

(ii) the quantum of money due to the operational creditors is substantially less than the money owed to the financial creditors;

(iii) repayment of debt to a financial creditor is organized under various schedules and default in payment attracts penalty and a similar scenario does not exist for operational creditors; and

(iv) the financial creditor is required to prove existence of default by the debtor whereas the operational creditor simply claims his right of payment.

The Court also analyzed the role played by the two set of creditors in furtherance of the Code. Basis its observation, the Court said that the absence of operational creditors in the CoC has a valid basis and is not violative of their rights. The viability and feasibility of the business of the corporate debtor is extensively assessed by the financial creditors while providing the debt and they are in a better position to evaluate the resolution plan as compared to the operational creditors explaining their presence in the CoC.

Therefore, preservation of the corporate debtor as a going concern while ensuring maximum recovery for all creditors being the underlying intention of the Code, there exists substantial difference between financial creditors and operational creditors and the operational creditors are not discriminated against under the Code.

Validity of Section 29A

Furthermore, a four-fold contention against the validity of Section 29A was heard by the Court. In its findings, the court noted the following.

(i) Vested rights of promoters to participate in the recovery process of a corporate debtor have been impaired by retrospective application of Section 29A;

(ii) Further, an erstwhile promoter who may outbid all other applicants and may be able to formulate the most comprehensive resolution plan is kept out of the process;

(iii) Also, a persons account may be classified as a non performing asset (NPA) despite him not being a willful defaulter;

(iv) Lastly, the relatives of the promoters who are within the eligibility criteria are barred from participating in the resolution process.

The Court observed that it is settled law that a statute is not retrospective merely since it has an impact on existing rights or because a part of the requisites for its action is drawn from a time antecedent. There exist no vested rights of participation in any resolution applicant and the same can be connoted to the widespread rejection of such resolution applications due to lack of feasibility. With respect to the participation of the relative of an ineligible person, the Court pointed that if it is not shown that such ‘related person’ is connected with the business of the activity of the resolution applicant, he cannot be excluded under Section 29A(j). Therefore, Section 29A is constitutionally valid and is applicable in its entirety.

Section 12-A upheld

The relevant contention against Section 12A was that approval of ninety percent of the CoC is required to allow withdrawal of a petition made under Section 7 or 9 of the Code. The Court observed that this threshold has been substantiated in the Insolvency Law Committee Report as withdrawal is a major decision and requires significant deliberation. Also, the Code assigns the NCLT with the role to finalize such withdrawal. This indicates that the CoC does not have the last say and therefore, this provision passes the constitutionality test.

Conclusion

Conclusively, Justice Nariman while penning the verdict stated that, ‘the experiment contained in the Code passes the constitutional muster’. The judgment reiterates the contribution of the Code in increasing the flow of financial resource to the commercial sector in India as a result of repayment of financial debts. It also promotes ethical practices and is considered as a landmark step towards a better economy enhancing the rate of recovery of debts in the country.