Under the Insolvency and Bankruptcy Code, 2016 (Code), a financial creditor may initiate corporate insolvency resolution process (CIRP) if there is a default of INR 10 million, by filing an application before the National Company Law Tribunal (NCLT). The settled principle is that an application made by a financial creditor under the Code must be admitted and CIRP initiates against the corporate debtor, if the NCLT is satisfied that a default has occurred in payment of debt. However, the Supreme Court of India (Supreme Court) in Vidarbha Industries Power Limited v. Axis Bank Limited (Judgement) has held that the NCLT has discretion to reject a financial creditor’s application even if it is satisfied that default has occurred.
Supreme Court’s observations in the Judgment
In the Judgment, Vidarbha Industries was awarded a contract for implementation of a power project. Due to increase in fuel costs and running of the power plant, Vidarbha Industries filed an application before the Maharashtra Electricity Regulatory Commission (MERC) for determination of tariff rate which was disallowed. An appeal was filed before the Appellate Tribunal for Electricity (APTEL) which awarded a sum of INR 17.3 billion to Vidarbha Industries (APTEL Award). This APTEL Award was appealed before the Supreme Court (MERC Appeal) due to which Vidarbha Industries was unable to realize the sum awarded in the APTEL Award.
Meanwhile, a financial creditor filed an application for initiation of CIRP against the corporate debtor i.e., Vidarbha Industries (CIRP Application). Vidarbha Industries contented that the CIRP Application must not be admitted if the MERC appeal is pending. The NCLT admitted the CIRP Application since the conditions for admission were satisfied (NCLT Order). On appeal, the NCLAT concurred with the NCLT Order. Subsequently, Vidarbha Industries filed an appeal before the Supreme Court.
The question before the Supreme Court was whether the NCLT must mandatorily admit an application filed by a financial creditor if it is satisfied that debt and default exist. The Supreme Court made the following observations on the issue:
(i) Use of expression ‘may’ in Section 7(5)(a) of the Code
Section 7(5)(a) of the Code provides the conditions for admission of an application by a financial creditor to initiate CIRP. The provision states that the NCLT ‘may’ admit an application if it is satisfied of the following conditions: (a) a default has occurred; (b) the application is complete; and (c) no disciplinary proceedings are pending against the proposed resolution professional.
Ordinarily, the word ‘may’ is directory in nature and use of the word ‘shall’ postulates a mandatory requirement. The words ‘may’ and ‘shall’ should be given their ordinary and literal meaning unless there is ambiguity in a provision. The Supreme Court held that there is no ambiguity in section 7(5) of the Code and hence, the word ‘may’ should be interpreted literally.
(ii) Difference between procedure for financial creditor and operational creditor to apply for CIRP
The Supreme Court noted that there is a noticeable difference between an operational creditor and a financial creditor. An operational creditor is usually in the business of supply of goods and services. The debts owed to an operational creditor are largely unsecured. On the other hand, a financial creditor is in the business of investment where credit given by it is generally secured. Hence, the impact of non-payment of debt is far more serious on an operational creditor.
Thus, the Code mandates the admission of an application made by an operational creditor if it follows the Code. As opposed to this, the word ‘may’ is used for admitting the application of a financial creditor which confers discretion on the NCLT.
(iii) Decide the application on basis of other factors
The Supreme Court held that NCLT should apply its mind and consider other factors including the financial health and viability of a corporate debtor. If it finds that circumstances require it to exercise its discretion even if the conditions are fulfilled, the NCLT may not admit the application. Especially in the case of solvent companies which temporarily default in repayment of its financial debt, the NCLT has the power to use its discretion of ‘may’ while deciding on the application.
Accordingly, the Supreme Court held that the NCLT must consider the grounds made by a corporate debtor against the admission of an application by a financial creditor on merits, if the circumstances are compelling.
Analysis of the Judgment
The insolvency courts have previously dealt with (a) scope of inquiry by the NCLT to admit or reject an application of a financial creditor; and (b) literal interpretation of ‘may’ in section 7(5)(a). Some of them are analysed below:
(i) The scope of inquiry by NCLT
The interim report of the Bankruptcy Law Reform Committee dated February 2015 (Report) has made observations regarding the power of NCLT to hear an application for initiation of CIRP. The Report stresses that the NCLT should not be allowed to hear the applications by creditors on merits in the pre-admission stage as it causes inordinate delays in the process before it even gets started.
In Innoventive Industries Ltd. v. ICICI Bank, (Innoventive Industries Case), the Supreme Court noted that upon being satisfied of a default on debt owed to a financial creditor, the NCLT must admit the financial creditor’s application unless it is not complete in accordance with the formalities laid under the Code. It also stated that the NCLT can only reject an application if there has been no default on the debt.
The Innoventive Industries Case was later affirmed by the Supreme Court in E.S Krishnamurthy and Ors. v. Bharat Hi-Tech Builders Private Limited. The Supreme Court considered whether the NCLT can reject an application of a financial creditor by applying its mind to its merits. The Supreme Court stated that the extent and scope of an inquiry for rejection of an application by the NCLT is limited to the existence of debt and a default.
In Swiss Ribbons (P) Ltd. v. Union of India, the Supreme Court noted that the legislative policy marks a clear shift from the earlier position where the solvency of the company was a relevant consideration for triggering insolvency proceedings against it. Now, under the Code, the NCLT has to only make a factual determination of existence of default in order to admit or reject the application.
Thus, the position taken by the Supreme Court in the Judgment varies from its precedents.
(ii) Literal interpretation of ‘may’ under section 7(5)(a)
The Supreme Court in Bachahan Devi and Ors. v. Nagar Nigam, Gorakhpur and Ors., observed that use of the term ‘may’ in a provision does not make it directory in nature. It noted that in order to interpret the legal substance of the provision, (a) the object and scheme of the legislation, (b) the background and context in which the words have been used, and (c) the purpose sought to be achieved by the use of the words must be considered. If the intention of the legislature is to convey a sense of compulsion, mere use of ‘may’ will not prevent the courts from giving it the effect of compulsion.
Considering that the legislature did not intend to give discretion to the NCLT during the admission or rejection of an application for initiation of CIRP, the word ‘may’ used in section 7(5)(a) of the Code must be read as mandatory.
The above principles of insolvency law signify the legal position prior to the Judgment where a financial creditor’s application for initiation of CIRP may be rejected by the NCLT only if the debt was non-existent or there was no default on the payment. The NCLT did not look into the merits of an application for initiation of CIRP.
Our thoughts:
The Judgment has conferred additional powers on the NCLT allowing it to examine other factors including the solvency and financial health of a corporate debtor while initiating CIRP. This is contrary to the precedents discussed above which limits the power of NCLT merely to determination of debt and default.
It is relevant to highlight that under the Sick Industrial Companies (Special Provisions) Act, 1985 (SICA), the prevalent judicial practice was to initiate insolvency proceedings based on the merits of the case. This caused unnecessary delays in resolution of the debt which made it difficult to revive the corporate debtor from financial stress. This was one of the primary reasons to repeal SICA and enact a new insolvency regime, i.e., the Code.
The interpretation of the Code provided by the Judgment may be detrimental to the rights of financial creditors. Even after the occurrence of a default, the insolvency courts may not admit a corporate debtor to restructure its debt / business under the control of an independent resolution professional acting within the remit of the Code and the supervision of the creditors. In such a situation it may happen that the very concept of “creditor in possession”, post default by a corporate debtor may be defeated. Therefore, it is submitted that the Parliament may be required to step in and clarify that upon satisfaction of the existence of debt and default by a corporate debtor, the insolvency court “shall” be required to admit the corporate debtor into the resolution process. This will ensure that no additional responsibility of deciding the financial position of the corporate debtor is imposed on the insolvency courts and that the creditors have the primary say in the conduct of affairs of a defaulting corporate debtor!
Authors: Souvik Ganguly, Niyati Bhogayta, Shrishti Mishra and Paridhi Rastogi
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