THE CURIOUS CASES OF INSOLVENCY AND BANKRUPTCY CODE, 2016 

Author: Vijay K. Sondhi[1]

Research contribution by: Anshul Sehgal[2]

The Supreme Court of India within a span of two weeks recently, between two separate benches was caught in a tussle of interpretation of the nascent Insolvency and Bankruptcy Code of 2016 (“Code”). On 31.08.2017, a division bench comprising of Justice R.F. Nariman and Justice S.K. Kaul, passed an over 100 page judgment, which set the jurisprudence on the new born Code in motion. Whereas on the other hand, on 04.09.2017 and 11.09.2017, a three judge bench comprising of Chief Justice, Justice Khanwilkar and Justice Chandrachud passed interim orders under the Code that impinged upon the letter and spirit of the Code and the only jurisprudence on the Code passed by the division bench earlier.

In the case of M/s. Innoventive Industries Ltd. v. ICICI Bank & Anr.[3] (“Innoventive”), Justice Nariman speaking for the bench dealt with the aspect of whether a parliamentary law would prevail over the State law. ICICI Bank, being the financial creditor had filed an application for insolvency under Section 7 of the Code against the Corporate Debtor. The National Company Law Tribunal, Mumbai (“NCLT”) while dealing with the same objection held that the Code would prevail over the state act and furthermore what was required to be established under the Code was whether a corporate debtor had defaulted in making payments to the creditors or not. Interestingly, NCLT had also held that under the Code there was no provision that provided for an audience to a corporate debtor in proceedings filed by a financial debtor.

Aggrieved by the same, the corporate debtor approached the Bombay High Court to decide as to whether a corporate debtor has the right to be heard and sought for provisions under the Code to be struck down for being unconstitutional. During the same period, the corporate debtor filed an appeal before the National Company Law Appellate Tribunal (“NCLAT”). The Bombay High Court on having learnt that an appeal was pending before the NCLAT refused to decide the issue and held the same to be an academic exercise, since NCLAT was seized of the matter. The said order came across as a one to be forgotten too soon as the High Court failed to appreciate that the NCLAT is not empowered to deal with challenges to the vires of the Code.

However, at the very same time the High Court at Calcutta, while dealing with the same issue[4] held that the NCLT and NCLAT is bound by the procedures as prescribed under Section 424 of the Companies Act, 2013 that requires the tribunals to follow the principles of natural justice and held that though the Code is silent on whether to hear a corporate debtor, however, no party shall be left unheard before the tribunal under the principles of natural justice. This brings a huge question as to how one High Court deems the issue to be an academic one whereas on the other hand, another High Court passes a judgment that puts to rest a burning issue on a newly introduced law. Surprisingly despite having noted the order passed by the NCLT, Mumbai dealing with the issue of whether a corporate debtor ought to be heard, the Supreme Court while interpreting the entire Code made a pass on this issue.

Coming to the issue on hand, the Apex court in the Innoventive case held that once moratorium is declared for a corporate debtor company, the directors of the company are no longer in management and any application or appeal filed by the company through the directors were held to be non-maintainable. Further, interpreting the objective of the Code, the Apex court held that the intent of the legislature is to bring all the laws concerning insolvency under one umbrella. Most importantly, a moratorium which has been portrayed as doomsday by many legal pundits was given clarity to be held as a period where the management of a distressed company could work on a permanent resolution to settle its indebtedness.

The trigger process under the Code has been interpreted by the Apex court when there is a default[5] of Rs. 1 Lakh or more[6]. A default under the Code refers the non-payment of a debt[7] that is due and payable. Further, a debt refers to the liability or an obligation that can be crystallized into a claim[8] i.e. a right to payment, even if disputed.

Once the above essentials are fructified, Corporate Insolvency Resolution Process (“CIRP”) can be initiated by three sets of categories viz. the corporate debtor itself, a financial creditor or an operational creditor. The Code provides a clear distinction between operational and financial creditors. A financial creditor[9] is defined under the Code to be a person to whom a financial debt[10] is owed i.e. a debt disbursed against consideration for the time value of money. On the other hand, an operational creditor means a person to whom an operational debt[11] is owed i.e. a claim with regards to goods and services. Importantly, dealing with a financial debt, the NCLT is only required to ascertain the default from records provided, evidence provided or the information utility.

CIRP is set in motion by a financial creditor when an application is filed in the prescribed form[12] and manner under the Code. The only requirement for the applicant is to provide a copy of the filed application upon the corporate debtor. On receipt of the application, the NCLT is put on a ticking timer. The NCLT is mandated under the Code to ascertain the existence of a default on the debt within 14 days.

However, the CIRP process for an operational creditor is starkly distinct from that of a financial creditor. Once a default occurs on an operational debt, the operational creditor is obliged to serve a demand notice[13] on the debtor. However, the Code is quite balanced in its approach towards the debtor in an operational debt scenario than financial debt. The operational debtor upon receiving the demand notice can within 10 days[14] thereto bring to the notice of the creditor the existence of a dispute, pending of suit / arbitration, however, the catch being that it should be prior to the notice. Once the same is shown on record, the Code ceases to operate upon the operational debtor.

Once the application, in either of the scenarios above, is admitted; CIRP is set in motion. Immediately a moratorium[15] is imposed and the reigns of the debtor company is put in the hands of the Interim Resolution Professional (“IRP”) and the management of the company is removed. The IRP then manages[16] the operations of the corporate debtor as a going concern, subject to the directions[17] of the committee of creditors (“CoC”). Importantly, all decisions taken by the CoC have to meet the threshold of 75% of the voting share. The entire process for reaching a resolution has to be completed within a period of 180 days, extendable for another 90 days subject to 75% vote by the CoC[18].

One of the most important processes under the Code[19] deals with the concept, of where any person who is keen to put the debtor company back in operation may submit a resolution plan to the Resolution Professional (“RP”), which has to be in sync with the information memorandum prepared  by the RP. Such a plan should have three essential ingredients, before the same is put to vote before the CoC, payment for the CIRP cost, management and affairs of the debtor after the approval of the plan and a streamlined process on the implementation and supervision of the plan.

The resolution plan is then supposed to be put to vote before the CoC, and unless approved by 75% vote, the plan cannot be put before the concerned adjudicating authority. Once approved by the adjudicating authority, on being satisfied of the provisions under the Code, the resolution plan gets enforced and becomes binding upon the corporate debtor and its employees, members, creditors, gurantors and stakeholders. However, one of the most important aspect of this provision under the Code is that upon approval of the resolution plan by the adjudicating authority, the moratorium imposed ceases to be in effect.

The Apex court summarizing the entire Code held as below:

“… The scheme of the Code, therefore, is to make an attempt, by divesting the erstwhile management of its powers and vesting it in a professional agency, to continue the business of the corporate body as a going concern until a resolution plan is drawn up, in which event the management is handed over under the plan so that the corporate body is able to pay back its debts and get back on its feet. All this is to be done within a period of 6 months within a period of 6 months with a maximum extension of another 90 days or else the chopper comes down and the liquidation process begins.”

Coming to factual scenario that was before the Apex court in the Innoventive  judgment dealt with the issue that whether a moratorium imposed by a state legislation would prevail over the provisions of the Code. Further, the Apex court went on the interpret the provision[20] under the Code dealing with overriding other provisions of the law.

The NCLT, Mumbai in the impugned judgment that applying Section 238 of the Code held that the state act cannot stall CIRP under the Code. However, NCLAT in the impugned judgment held that there was no repugnancy between the Code and the state act, for both being operational in separate fields. The issue of law that came before the Apex court, from the ruling of the NCLAT was whether there was any repugnancy between the state act and the Code.

Referring to Article 254[21] of the Constitution of India, the Apex court traced the history of judicial precedents on the issue of repugnancy of state laws and a central law starting from 1955 in the case of Zaverbhai Amaidas v. State of Bombay[22] to the recent precedent passed in the case of Rajiv Sarin v. State of Uttarakhand[23] and on an analysis, propositions that evolved from the entire blanket of precedents, the Supreme Court laid down the principles governing Article 254 of the Constitution of India.

Thus, applying the above, Supreme Court held the state act to be repugnant to the Code to the extent where the state government could take over the management of a relief undertaking and also impose a moratorium which was in conflict with Section 13 and Section 14 of the Code. As a consequence, on an application of Section 238 of the Code, it was held that the state act was repugnant to the Code and the state act could not in any way stall proceedings under the Code.

The Apex court, through Justice Nariman speaking for the bench held that the Code was a complete legislation in itself that dealt with the statement and objectives as provided under the Code and under no circumstance, could the same be held to be in conflict with other laws once the essentials as provided to initiate CIRP were satisfied.

On hand where the Supreme Court set the ball rolling on interpretation of the Code, on the other hand an aggrieved group of buyers came knocking on the doors of Supreme Court to protect their investments made in the real estate company that was put under CIRP.

The case of Chitra Sharma & Ors v. Union of India & Ors.[24] which was a Public Interest Litigation was entertained by the three judge bench of the Supreme Court which sought protection in view of the CIRP that was initiated upon a major real estate agent. In this case, upon an application filed by a financial creditor, the NCLT, Allahabad in a detailed judgment found all ingredients to initiate CIRP of the debt ridden real estate company.

As provided under the Code and as held by the Apex court in the Innoventive judgment, the moment CIRP is initiated, the management of the corporate debtor ceases and a moratorium becomes operational. The said order made the buyers go in a tizzy, as the Code did not provide any categorization for buyers being a creditor and as to whether the said buyer would be in a position to get their investment of flats returned.

In view of the un-thought of situation, the government introduced another category for the buyers to file their claims before the IRP under the Code, which all the more worsened the situation as the buyers were left puzzled whether to claim money for the investments or claim possession for the properties invested in.

Left with no other alternative, the bunch of buyers approached the Apex court by way of PIL and the Apex court, vide an interim order dated 04.09.2017 passed interim stay on the order allowing the CIRP passed by the NCLT, Allahabad.

The said order brings to light an important aspect that whether under Article 142[25] of the Constitution of India, which provides the powers to the Supreme Court to do complete justice, was such an interim order passed applying the principles of Article 142 of the Constitution of India?

The Supreme Court not very long, interpreted Article 142 of the Constitution and in essence it was held[26] that the powers under Article 142 cannot be exercised mechanically and the same cannot be restricted by any statute. However, the Apex court also clarified and explained that no such orders could be passed ignoring the express statutory provisions and such power cannot be exercised to supplant the applicable law. Further, it was held that no relief should be granted while exercising Article 142  that is inconsistent with the case on hand and the same should be used sparingly and not in a mechanical manner.

Applying the said ruling, when once the adjudicating authority found all the statutory requirements to initiate the CIRP, further when the Government introduced a special category for the missing element under the Code, coupled with fact that Apex court a few days before this order had passed the only judgment under the Code wherein it was held that if the ingredients under the Code were made out nothing could stop the CIRP, such an interim order passed by the Apex court invoking Article 142 appears to be beyond the scope of Article 142 of the Constitution of India.

It is important to note that no where the Apex court went onto hold that the order of the NCLT, Allahabad or the introduction of a special category by the government was bad in law that denied justice to the buyers. Furthermore, it appears that the provision under the Code dealing with Appeals[27] that explicitly provides for ‘any person’ being aggrieved of an order by the NCLT may appeal to NCLAT, was not brought to the notice of the Apex court. The term ‘any person’ would have definitely included the ‘aggrieved buyers’ as well. Since the Code provides for all mechanism for an aggrieved person from any orders passed under the Code, was the interim stay on the order of NCLT Allahabad contrary to precedents and the law laid down on Article 142?

However, vide order dated 11.09.2017, the three judge bench modified its earlier order with certain directions and most importantly it was held that the modification of the order has been made under the provisions of the Code and the interest of buyers.

Since, on one hand in the detailed judgment passed in Innoventive case where it was held that nothing in the Code or any other law could stall the CIRP and on the other hand, , a three-judge bench stalls, though for an interim period modified later, CIRP process of major-debt ridden company by invoking Article 142.

However, it is true that the interim stay passed by the order and the orders passed subsequent thereto appears to have been passed by the Apex court on compassionate grounds, keeping in mind the investments made by middle class economic groups and to avoid multiplicity of proceedings that would have ensued by the 36,000 odd home buyers.

A case of abridged use of power by the Apex court? Or as it is said “Fiat justitia, ruat caelum. — Let justice be done, though the heavens may fall.” The curiousness on the interpretation and implementation of the Code, still lies in a conundrum.

[1] The author of this article, Vijay K. Sondhi is a Senior Partner at Luthra & Luthra Law Offices, New Delhi, India. The views of the authors expressed in this article are personal.

[2] Senior Associate, Luthra & Luthra, Law Offices

[3] Civil Appeal Nos. 8337-8338/2017.

[4] Sree Metaliks Lts. & Anr. v. Union of India & Ors. W.P. 7144 (W) of 2017, decided on 07.04.2017.

[5] Section 3(12) of the Code.

[6] Section 4 of the Code.

[7] Section 3(11) of the Code.

[8] Section 3(6) of the Code.

[9] Section 5(7) of the Code.

[10] Section 5(8) of the Code.

[11] Section 5(21) of the Code.

[12] Form 1 under Rule 4 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016.

[13] Section 8(1) of the Code.

[14] Section 8(2) of the Code.

[15] Section 14 of the Code.

[16] Section 17 of the Code.

[17] Section 21 of the Code.

[18] Section 12 of the Code.

[19] Section 30 of the Code.

[20] Section 238 of the Code.

[21] Article 254. Inconsistency between laws made by Parliament and laws made by the Legislatures of States

(1) If any provision of a law made by the Legislature of a State is repugnant to any provision of a law made by Parliament which Parliament is competent to enact, or to any provision of an existing law with respect to one of the matters enumerated in the Concurrent List, then, subject to the provisions of clause ( 2 ), the law made by Parliament, whether passed before or after the law made by the Legislature of such State, or, as the case may be, the existing law, shall prevail and the law made by the Legislature of the State shall, to the extent of the repugnancy, be void

(2) Where a law made by the Legislature of a State with respect to one of the matters enumerated in the concurrent List contains any provision repugnant to the provisions of an earlier law made by Parliament or an existing law with respect to that matter, then, the law so made by the Legislature of such State shall, if it has been reserved for the consideration of the President and has received his assent, prevail in that State: Provided that nothing in this clause shall prevent Parliament from enacting at any time any law with respect to the same matter including a law adding to, amending, varying or repealing the law so made by the Legislature of the State

[22] (1955) 1 SCC 799

[23] (2011) 8 SCC 708

[24] Writ Petition (Civil) No. 744/2017.

[25] Article 142. Enforcement of decrees and orders of Supreme Court and unless as to discovery, etc

(1) The Supreme Court in the exercise of its jurisdiction may pass such decree or make such order as is necessary for doing complete justice in any cause or matter pending before it, and any decree so passed or orders so made shall be enforceable throughout the territory of India in such manner as may be prescribed by or under any law made by Parliament and, until provision in that behalf is so made, in such manner as the President may by order prescribe

(2) Subject to the provisions of any law made in this behalf by Parliament, the Supreme Court shall, as respects the whole of the territory of India, have all and every power to make any order for the purpose of securing the attendance of any person, the discovery or production of any documents, or the investigation or punishment of any contempt of itself.

[26] Laxmidas Morarji v. Behrose Darab Madan (2009) 10 SCC 425

[27] Section 61 of the Code.