This article has been written by Saurab Verma, a student of RMLNLU, Lucknow.
Insolvency And Bankruptcy Code was introduced in 2016 to consolidate the existing legal framework by creating a single law for insolvency and bankruptcy. It aimed to resolve the insolvencies which were previously a long process that did not offer an economically viable arrangement. The code was regulated by Insolvency and Bankruptcy Board of India (IBBI),2016 and two separate tribunals were formed namely National Company Law Tribunal (NCLT ) which was established under Companies Act, 2013 on the recommendation of Justice Eradi Committee for companies and Limited Liability Partnership firms and the other Debt Recovery Tribunal for individuals and partnerships and an appellate tribunal was formed NCLAT( National Company Law Appellate Tribunal). As we know that everything has its boon and bane, similarly, IBC came with several difficulties and which were obvious because they can be shown only at the time of implementation and according to that since 2016 several vital developments have been seen which have reduced some loopholes to a certain extent. In this article, I will talk about the recent developments in Chapter II of the code which serves as the basis of IBC.
Differential treatment between the financial creditors and operational creditors is justified
The difference between the financial creditor and operational creditor has been made on the basis of the financial debts and operational debts defined under sections 5(8) and 5(21) of the Insolvency And Bankruptcy Code, 2016. There were the contentions of the counsels that the provisions of the code are discriminatory in behalf of the operational creditors in the case of Swiss Ribbons Pvt. Ltd. vs. Union of India. It was argued by the counsels that there was no intelligible differentia between operational and financial creditor and despite that the code treated them differently. Firstly, while the financial debtor is neither entitled to notice nor to the dispute to the claims of financial creditor, the operational debtor is given a notice of default. Also, to initiate the CIRP proceedings by an operational creditor, a demand notice is required but when it is initiated by the financial creditor or corporate debtor it is not required. Secondly, in the committee of creditors, operational creditors have no place if they amount to less than 10% and also they are not entitled to vote in the committee of creditors. The Supreme Court has upheld this distinction and said that Since the financial creditors are usually banks and financial institutions, they are best equipped to assess the viability and feasibility of the business of the corporate debtor. Most of them carry out techno-economic valuations and financial projections at the time of granting the loans.
On the other hand, operational creditors, are primarily interested in recovery and are neither concerned with nor equipped to assess the viability and feasibility of a business. Nevertheless, the check and balances are already in place as a resolution plan cannot pass muster under Section 30(2)(b) read with Section 31 unless a minimum payment is made to operational creditors, being not less than the liquidation value.
The constitutional validity of some important provisions of IBC
Since two years, there have been several cases which have discussed the various sections and the constitutional validity of some sections have been challenged as are arbitrary or discriminatory. Here, in this part, I will discuss some of the controversial provisions of this code.
Section 10 of IBC provides the initiation of CIRP ( Company Insolvency Resolution Proceedings) by the corporate debtor itself. This affords an opportunity for the company to resolve its debt and revive the company through the resolution process. But its validity was challenged because the procedure under this section violates the principle of natural justice as the rule of “Audi altrem partem ” is not followed in this section as the opportunity of being heard is not provided on behalf of the creditors. Also, in the case of Maneka Gandhi vs Union of India, it was held that principle of natural justice is an integral part of the equality clause under Article 14 of the Indian Consitution and thus this section infringes the fundamental right of the creditors. Also, in this section, the power of the Adjudicating Authority was challenged in the case of Leo Duct Engineers and Consultants ltd. vs Canara Bank where it was held that NCLT has the power to look beyond the records and scope of section 10 of IBC and has the discretion to reject the application even if it was completed under this section and if the debtor is ineligible under section 11 of the code but this decision was overruled in the case of Unigreen Global Pvt. Ltd. vs Punjab National Bank where it was held by NCLAT that the Adjudicating Authority does not have the power to go beyond the scope of section 10 and if the application filed by corporate debtor is complete and does not fall under the criteria of section, the NCLT has to admit the application and NCLT gives the notice to the creditors to raise the objections regarding the application filed by the corporate debtor.
The moratorium is given to Corporate Debtor
Section 14 of the code states about the declaration of moratorium period prohibiting the institution of any suits or execution of any judgement, order or decree. This section was made to ensure that no judicial proceedings for recovery to be initiated or any transfer of assets or termination of any essential contracts can be instituted or continued against the corporate debtor. But there have been several cases in which the corporate debtor or the personal guarantors have initiated the CIRP under section 10 with malafide intention and have abused the moratorium given to them. Some of the notable judgements were Alpha and Omega Diagnostics (India) Ltd. v. Asset Reconstruction Company of India and Schweitzer Systemtek India Private Limited v. Phoenix ARC Private Limited. This basically created the problem for the adjudicating authority and thus was a kind of loophole in the provisions of IBC but later the Delhi High Court in the case of Power Grid Corporation Of India vs Jyoti Structures ltd held that “until and unless the pending proceeding has the effect of endangering, diminishing, dissipating or adversely impacting the assets of the corporate debtor, it would not be prohibited under Sec. 14(1)(a) of the Code” . Also, SC in the case of State Bank Of India vs Ramakrishanan held that moratorium for the limited time period mentioned in the code, on the admission of an insolvency petition would not apply to the personal guarantor of a corporate debtor.
Section 30 and 31 of IBC
Section 30(2)(b) which states that the amount that would have been paid to such creditors, if the amount to be distributed under the resolution plan had been distributed in accordance with the order of priority in sub-section (1) of Section 53, act as the waterfall provision in chapter II of the code . This section earlier has been seen as discriminatory on behalf of the operational creditor because where the Financial Debt of a Corporate Debtor exceeds its Liquidation Value by a considerable margin and the Resolution Plan offers a sum that is insufficient to repay the entire Financial Debt. In such case, by virtue of the waterfall provision, nothing remains to be paid to Operational Creditors as the resolution amount gets exhausted in repaying the debts/sums ranking higher than the dues of Operational Creditors under Section 53. Only when the resolution amount exceeds the dues of Financial Creditors does the question of repaying the Operational Creditors arise. In the case of Binani Industries ltd vs Bank of Baroda and Anr. the court held that if the ‘Operational Creditors’ are ignored and provided with ‘liquidation value’ on the basis of misplaced notion and misreading of Section 30(2)(b) of the ‘I&B Code’, then in such case no creditor will supply the goods or render services on credit to any ‘Corporate Debtor’. All those who will supply goods and provide services will ask for advance payment that will totally result in the imbalance of the sector. Also, the liquidation value which is guaranteed to the operational creditors may be negligible as they fall under the residual category of creditors under section 53 of the Code. Also , section 31 which states about the approval of resolution plan was also challenged as it lacked subjectivity as it did not provide adjudicating authority with enough powers to revisit the decision of CoC to determine the viability and feasibility of resolution plan and was discriminatory for operational creditors as they do not have the voting right in the committee of creditors for the approval of the plan and their opinion is only persuasive. However, they could not be prohibited in attending the meetings as held in Innovative Industries Ltd vs ICICI
Bank. Later, the later the SC had upheld the validity of section 30 in the case of Swiss Ribbons vs Union Of India and highlighted that “financial creditors are from the very beginning involved with assessing the viability of corporate debtor and are therefore engaged in restructuring of the loan as well as recognization of the corporate debtor’s business when there is financial stress, which is operational creditors do not and cannot do”. This was relied on along with the legislative case law developments that guarantee fair and equitable treatment to operational creditors, to hold that the provisions giving only financial creditors the right to vote as part of the committee creditors are valid. Also, in case of Arcelor Mittal India Private Ltd. vs Satish Kumar Gupta the Apex court upheld the validity of section 31 and deliberated on the extent to which the Adjudicating Authority can exercise the power under its provision and have the discretion to admit the plan if satisfied or can reject it and acting quasi-judicially, can determine whether the resolution plan violates the provisions of any law, including section 29A of the code, after hearing arguments from the resolution applicant as well as the committee of creditors.
Timelines under the code
At the time of admission of an application for initiating insolvency proceedings, the Code provides 14 days time to the NCLT to make a decision regarding admission or rejection. Before rejecting an application, the NCLT is required to provide 7 days time to the applicant to rectify defects, if any, in the application. There was a lack of clarity on whether this was mandatory or directory. In JK Jute Mills Company Ltd. v. M/s Surendra Trading Company, the NCLAT held that time is of the essence under the Code, which requires the NCLT and all stakeholders to perform within the time limits prescribed except in exceptional circumstances. However, the NCLAT held that the 14 days timeline is a directive, and the NCLT has inherent powers to extend the 14-day period on a case-to-case basis in the interest of fairness and justice. It was further observed that the time period of 7 days to rectify the defects in the application is mandatorily compiled and no concession could be granted in this regard. Also, the time period for the entire resolution process as prescribed by section 12 of the code is the maximum time provided for completion. However, there are some instances where a resolution process is completed before the maximum time period. In Prowess International Pvt. Ltd. v. Parker Hannifin India Pvt. Ltd, the NCLAT observed that where all creditors have been satisfied and there is no default with any other creditor, the formality of submission of the resolution plan under section 30 or its approval under section 31 is required to be expedited on the basis of the plan if prepared. In such case, the Adjudicating Authority without waiting for 180 days of the resolution process, may approve resolution plan under section 31, after recording its satisfaction that all creditors have been paid/ satisfied and any other creditor do not claim any amount in absence of default and required to close the Insolvency Resolution Process. Where the whole period of 180 days passes and the Adjudicating Authority is satisfied that the process cannot be completed during the given time period, it may extend the period by up to 90 days. While the Code states that no further extension may be given after this period, there was a concern that this maximum timeline may also be extended by courts. However, the Supreme Court in ArcelorMittal India Pvt. Ltd. v. Satish Kumar Gupta unequivocally held that the entire time period within which the corporate insolvency resolution process ought to be completed is strictly mandatory in nature, and cannot be extended. It relied on the primary objective of the Code, which is to ensure a timely resolution process for a corporate debtor, and principles of statutory interpretation to hold that the literal language of section 12 mandates strict adherence to the time frame it lays down. To enable this adherence to the outer time limit provided in the Code, the court also held that the model timeline provided in Regulation 40A of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 should be followed “as closely as possible”.
The Insolvency and Bankruptcy Code, 2016 is a very good initiative by the government and its consequences will be very beneficial for the Indian Economy. However, there are some loopholes which have been seen through recent cases and they are reduced to some extent by the decisions of NCLT, NCLAT and SC. There is a need to review and classify the entire resolution process whether it is initiated by a financial creditor, an operational creditor or corporate debtor. The whole process should be done in accordance with the provisions prescribed under chapter II of the code and its provisions should not be in contradiction to the Constitution of India.
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