Increase of threshold — Insolvency and Bankruptcy Code, 2016  | An Act done in Haste? 

The Finance Minister while addressing the media on several financial decisions and schemes undertaken by the Government for the benefit of the common masses due to the sudden outbreak of novel COVID-19, which has brought the entire country to a grinding halt, announced that the threshold limit for triggering a Corporate Insolvency Resolution Process under the Insolvency Bankruptcy Code, 2016 (hereinafter referred to as “the Code”) shall stand increased to INR 1 crore.

The Gazette Notification dated 24-03-2020 [MCA Notification S.O. 1205(E)] categorically states that, by virtue of the power conferred by Parliament on the Central Government, vide the proviso to Section 4 of the Insolvency and Bankruptcy Code, 2016, may, by notification, increase the amount of default to a maximum amount of INR 1 crore. However, the said notification does not have any clarification as to the cut-off date with respect to the effective date, or, in the alternative if the notification comes into force immediately then what happens to the pending matters where notices have been issued but the National Company Law Tribunal (“the Adjudicating Authority”) is yet to admit the same. There is lack of clarity with respect to the aforesaid scenario, which will be creating confusion and will result in an ouster of cases which could not have been taken up due to this pandemic. A noble cause will get buried in this act of haste which will result in loss of forum, class-based differential treatment and confusion in the minds of the mass which are all attributes to the test of arbitrariness under Article 14 of the Constitution of India. In this article, we have tried to test the viability of the Notification dated 24-03-2020 as it is and whether the lack of clarification will create more confusion than already existing, which will result in multifarious litigation.

While answering a policy decision, the first question that needs to be addressed is whether there is a power or is a colourable exercise of power or, a case of excessive delegation of powers?

The answer in this case is that, the power of the executive Government to increase the amount of default is beyond question, however, it should be examined on the bedrock and touchstone of reasonability and also whether it satisfies the test of objectivity for the purpose the  executive seeks to achieve through this notification.

For better understanding, Section 4 of the Code is reproduced:

“PART II

Insolvency Resolution and Liquidation for Corporate Persons

CHAPTER I

Preliminary & Definitions

4. Application of this Part.— (1) This Part shall apply to matters relating to the insolvency and liquidation of corporate debtors where the minimum amount of the default is one lakh rupees:

Provided that the Central Government may, by notification, specify the minimum amount of default of higher value which shall not be more than one crore rupees.

The proviso to the aforesaid section empowers the executive to increase the threshold limit up to INR 1 crore and the minimum amount for triggering is mentioned as INR 1 lakh.

While testing a policy decision on the anvil of Article 14 of the Constitution needs more scrutiny than otherwise as the scope for judicial review is very limited. We need to apply the settled parameters as laid down by the Supreme Court from time to time starting from Budhan Choudhry v. State of Bihar.[1]

The principles are the following:

  1. The policy decision should not be class based which is strictly forbidden.
  2. It should not be manifestly arbitrary causing confusion and prejudice so as to negate statutory rights as well fundamental rights.
  3. It should satisfy the object and the rationale test.

To understand the purpose of the executive in enacting the aforesaid Notification dated 24.03.2020, one needs to scrutinise the object with the purpose the notification seeks to achieve.

The Government, as an aid to provide boost to the micro, small & medium enterprises industrial sector (hereinafter referred to as the “MSME”) during this period of worldwide lock-down raised the threshold and ordered immediate implementation of the same. However, the intent although shown in the press conference does not find place in the notification, as the notification has raised the threshold limit en bloc irrespective of sectors and category. However, the possible justification which could be inferred from the press conference is that, unless the threshold is increased, the MSME sector might default in payments and the creditors may send the industries into Corporate Insolvency Resolution Process and subsequently into liquidation.

As an illustration, if an MSME industry causes default in payments, then the financial creditor or the operational creditor might drag the company to the National Company Law Tribunal under Section 7 or Section 9 of the Code.

The aforesaid object and reasoning seems plausible, if we look at it with the object to save medium and small-scale industries as they also feature as the backbone of the Indian industrial economy.

On the other hand, while backing the aforesaid object with the rationale; the intention of executive militates against the very object behind framing of the Code which are:

  • The small-scale industries and medium scale, workmen, employees, distributors who basically come within the framework of operational creditors do not have to run from pillar to post to recover their money.
  • Clear demarcation of financial creditors and operational creditors and their stakes along with disbursement procedure.
  • Faster resolution process and time bound court process.
  • Cost-effective.
  • Easy accessibility.

The recent notification, in the absence of any clarification with respect to the date of commencement or the “effective date” and also, with respect to the cases where demand notices have been sent under Section 8 of the Code by an operational creditor, the cases which have been filed but could not be taken up because of this pandemic coupled with the cases which are yet to be admitted.

The notification in the absence of any clarification will be creating problem for the Courts with respect to the application of the same, as going by prior experience, the matters are likely to be shown the door due to lack of pecuniary jurisdiction. It will create a void as well as havoc as to the transition or transfer of those matters.

For example, if a default had arisen in January 2019, it cannot be simply  shown the door under the Code of 2016 by giving the justification of a pandemic in March 2020 by virtue of this notification, as the limitation to trigger insolvency under this Code stays live for a period of 3 years from the date of default[2]. Normally, by applying the canons of statutory interpretation and by invoking Section 6(e) of the General Clauses Act, 1897, all amendments or notifications are prospective unless specified to be retrospective; for which the power must be delegated to the executive by the legislature in the statute itself. However, none of the provisions in the Code, delegate that power to the executive.

When we think about the application of the upgraded threshold limit on the fresh cases which have been filed but could not be taken up due to limited functioning of the Courts and also the cases where defaults range from 2018-till date and the demand notices have been issued, the doors of the National Company Law Tribunal are likely to be shut on their faces because without there being any clarificatory note, the notification has come into application and might impact such pending cases also. Hence, by necessary implication this notification could become retrospective which is not only illegal but also perverse because the Supreme Court in the judgment of S.L. Srinivasa Jute Twine Mills (P) Ltd. v. Union of India[3] while considering a retrospective notification under the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952 had laid down the following: (SCC p. 746)

“18. It is a cardinal principle of construction that every statute is prima facie prospective unless it is expressly or by necessary implication made to have retrospective operation.(See Keshavan Madhava Memon v. State of Bombay[4]). But the rule in general is applicable where the object of the statute is to affect vested rights or to impose new burdens or to impair existing obligations. Unless there are words in the statute sufficient to show the intention of the legislature to affect existing rights, it is deemed to be prospective only ‘nova constitutio futuris formam imponere debet, non praeteritis’. In the words of Lord Blanesburgh,

“provisions which touch a right in existence at the passing of the statute are not to be applied retrospectively in the absence of express enactment or necessary intendment.”

It is an accepted position that this notification is an executive act and not an amendment. Hence, this can be safely termed as a delegated piece of legislation. It is trite in law that a delegated piece of legislation cannot be made to be retrospective by the executive unless and until the statute gives the executive such power[5]. It is an accepted norm since the age of Rai Sahib Ram Jawaya Kapur v. State of Punjab[6] that, the executive can do such acts under a statute as far as permitted and as far as the power of the legislature extends.

Whenever the Government had decided on issues relating to raising the  pecuniary limit or enacting a separate law, which would cause loss of jurisdiction, the executive and the legislature in its wisdom on earlier occasions had taken care of such transition by issuing a clarification or by enacting a provision.

For example, when the Administrative Tribunals Act, 1985 was enacted, cases were transferred to the Central Administrative Tribunals (CAT) vide Section 29 of the Act of 1985. Similar situation and enactment had taken place when the Company Law Board was abolished and the jurisdiction got transferred to the National Company Law Tribunal vide Section 466 of the Companies Act, 2013.

However, there is no such provision in the Insolvency and Bankruptcy Code, 2016. The amendment of March 2020[7] is also silent on this aspect. The notification is also silent on the aspect of pending cases or where demand notices have been issued within the period of limitation prescribed under Section 238-A of the Code, 2016, which is three years.

As a recent example, we would like to cite the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2019  dated 28-12-2019 whereby vide Section 3 of the said Ordinance, the criteria for home-buyers for approaching the NCLT under Section 7 of the Code was amended and the criteria was modified to 10% or 100 home-buyers from the same real estate project. The proviso to such an amendment laid down that for pending applications which were yet to be admitted, they must be amended within 30 days.

The said proviso was taking away the right of the people which had already accrued and was made to operative retrospectively by giving a time period of 30 days to amend the petition. Such an exercise of power in the absence of a provision expressly granting such retrospective enactments was prima facie arbitrary and called for a scrutiny by the  Court.

The said provision was challenged by way of a writ petition before the Supreme Court of India, wherein the Supreme Court vide order dated 13-01-2020 was pleased to order status quo with respect to the petitions already filed[8]. The matter is sub judice before the Supreme Court and we shall await the decision of the Supreme Court on this aspect which will be critical to the analysis of delegated powers to the executive under the Code, 2016.

However, despite the pendency of the said writ petition and the Ordinance being subject-matter of challenge, the Government went ahead and passed the aforesaid Ordinance as an Amendment Act on 13.03.2020. The passage of the ordinance as an Amendment Act on 13.03.2020 by retaining the same provision which was stayed by the Supreme Court, nullifies the writ petition pending adjudication and the order of the Supreme Court. However, that is a separate matter to be examined by the Court.

The Notification dated 24.03.2020 does not have such a proviso also as that of the Amendment Act of 2020, which makes things worse, as in both the litigants and the Courts will be clueless with respect to its applicability and the effect it would have on the pending petitions which are yet to be admitted. Hence, on this aspect also, the notification fails to satisfy the test of objectivity.

Thereafter, coming to the question of class-based legislation, the Notification dated 24.03.2020, completely ignores many aspects, namely, as far as the workmen are concerned, they must now rely on the trade unions to initiate or trigger insolvency, but again small trade unions with limited number of members will not be able to match the threshold. The Government by this way has pushed them to the already pre-existing alternative remedy under the Industrial Disputes Act, 1947. On the other hand, if there is no trade union then the option under the Insolvency and Bankruptcy Code, 2016 fizzles out, even though both workmen and employees are covered under the definition of “operational creditors.” However, such remedy does not seem plausible for employees, as they cannot be a part of a trade union under the Trade Unions Act, 1926. Hence, the employees who were in the process to approach the National Company Law Tribunal, now must take the alternate routes, as available under law even though they are time consuming and expensive.

Hence, here also it results in class-based distinction. For example, trade unions having a membership of over 200 will be able to achieve the threshold limit and other unions having a membership of 25 or 50 workmen cannot fulfil the threshold limit. The Trade Unions Act, 1926, however, prescribes the number of workmen required to register a trade union as seven. Hence, by default, there will be a sub-classification within a class; if a trade union is taken to be a class by itself.

Secondly, the small-scale distributors who supply goods, raw materials etc, but suffer from defaults in the hands of debtors, will have to fall back to the civil courts and file recovery suit or summary suit or a suit for specific performance, as the case may be.

The object of the Code to save the Indian economy from the backlash of bad debts and bringing the perpetrators to justice by tightening the noose of insolvency ends with this notification, as it will suit a particular class, which therefore turns out to be manifestly arbitrary.

For example, a small distributor of cotton yarn whose yearly billing with one manufacturer who takes supply of cotton yarn is around INR 20 lakhs, has to wait for 5 years from the date of default to reach the INR 1 crore mark but again will fail under the Limitation Act, 1963 read with Section 238-A of the Code, 2016 which says that the aggrieved must approach the court within 3 years of default, else it becomes time barred.

The Government prior to raising the threshold under the Code, had already issued an Office Memorandum dated 19.02.2020 with a clarificatory Office Memorandum dated 20.03.2020 covering the current situation of the country wide lockdown due to the pandemic under the “force majeure” clause (act of God) of the subsisting contracts.[9] Hence, the default on payments during this time could not have been considered as intentional defaults. The office memorandum could still be clarified further, saying, that the aforesaid force majeure clause shall apply to any transaction with effect from 19.2.2020 for a period of one year.

Neither the notification of increase of threshold under the Code, 2016 nor the office memorandums referred above have a retrospective effect whereby, the rights of the operational as well as the financial creditors which have accrued for the past one year or two years cannot suddenly be shut out by this action, which will result in manifest arbitrariness.

The ungazetted Notification dated 29.03.2020 published by the Insolvency and Bankruptcy Board of India (IBBI) with respect to the third amendment sought to be effected in the Insolvency and Bankruptcy  Board  of  India  (Insolvency  Resolution  Process  for Corporate Persons) Regulations, 2016 vide Clause 40-C, is that, the period of lock-down as notified by the Government will not counted for the purposes of limitation or for the purposes of cause of action/defaults in payment. Therefore, the proposed Clause 40-C should have been enough to tackle the present situation rather than arbitrary action of the Executive by raising the threshold limit for triggering insolvency process, as it clearly says that the present period of lockdown shall not be counted for any purpose including defaults.

On the other hand, Reserve Bank of India, vide press statement dated 27.03.2020 granted a three-month moratorium to all term loans, outstanding as on 01.03.2020 from payment of equated monthly instalments (EMIs), which would cover the working capital loans, cash credit/overdraft loans, housing loans, etc. It has further been clarified that this moratorium will not affect the classification of the assets which are under hypothecation or mortgage.

On the legal aspect, we should examine the aforesaid Notification dated 24.03.2020 on the touchstone of Article 14 and see whether the notification passes the muster for the test of manifest arbitrariness as laid down by the  Supreme Court recently in the judgment of Hindustan Construction Company Ltd. v. Union of India[10]. The test of “manifest arbitrariness” involves a determination as to whether something is done capriciously, irrationally and/or without adequate determining principle by the legislature. Particularly, while applying this doctrine to a piece of legislation, the Court must examine whether that legislation is unfair, unreasonable, discriminatory, non-transparent, capricious, biased with favoritism or nepotism, and not in pursuit of promotion of healthy competition and equitable treatment.

Now, the aforesaid notification of increase of threshold is unreasonable and discriminatory qua financial creditors and operational creditors as financial creditors as a class gets to stay within framework and there is a sub-classification with the class of operational creditors wherein small and medium scale players lose out while on the contrary, the habitual defaulters who are within the definition of small scale industries to medium scale industries stand to benefit. Next, on the issue of equitable treatment, the notification as explained above creates a sub-class within the class of financial as well as operational creditors which the legislature in its wisdom chose not to do.

It is trite in law that there cannot be a sub-class within a class. Operational creditors taken as a class cannot be further segregated on the pre-emption that the defaults below INR 1 crore are suddenly not worth adjudicating under the IBC regime.

While the action of the executive may look fantastic at first brush, the same is definitely not backed up by reasons while the settled law is that class specific legislation is not supported by jurisprudence and we have settled precedents under Article 14 of the Constitution of India.

Further, the Government has issued a press statement specifying that they are contemplating suspension of the operation of Sections 7 to 10 of the Code, 2016 which provide for the mechanism for petitions by the Financial Creditors (Section 7) and by the operational creditors (under Sections 8 and 9 of IBC, 2016). The aforesaid notification of increase of threshold amount has already made the operation of Sections 7 to 9 of IBC, 2016, redundant as it will suit only a handful of big businessman/corporate houses, which fall within the ambit of operational creditors and big financial institutions who fall within the ambit of financial creditors. It will also suit home-buyers who have invested in big projects of worth more than a crore, while the small scale home buyers whose flats are worth INR 40-50 lakhs stand to lose out.

While Section 4 of IBC, 2016 gives the Government a prerogative to issue policy directions, but those policy directions must not be manifestly arbitrary and cannot result in sub-classification which ultimately runs contrary to the object and purpose of the legislature and of the statute itself.[11]

However, the notification for the reasons mentioned above if at all is put to test, in our opinion will have slim chances of getting approved, as it fails to stand on legs and pass the muster of manifest arbitrariness.

Going by the logic of the executive that is to safeguard the small scale and medium scale industries from getting doomed under the present scenario, militates against itself considering the invocation of force majeure clause which includes the present scenario and the moratorium announced by Reserve Bank of India for a period of three months. Therefore, the defaulter of less than INR 1 crore shall stand to benefit from all the three notifications while the small scale/medium scale companies stands to huge pecuniary loss who cannot resort to any remedy for realisation of its debts/losses. The statement issued by RBI  and the force majeure clause would have saved the defaulters for 3-6 months, whereas by this notification, the perpetual defaulters are saved from the rigours of the Insolvency and Bankruptcy Code, 2016 for eternity.

CONCLUSION

As it is said, an act of haste is not always advisable and good. The proper act of the Government should be to come out with a proper clarification of the notification as to its applicability with a proper provision dealing with pending matters.

In the alternative, the Government can altogether withdraw the notification and issue a notification as indicated by suspending Sections 7 to 10 of IBC, 2016 for a period of 6 months, as it will support the cause as intended by the Government through its Notification dated 19.2.2020 (force majeure) and the press statement issued by Reserve Bank of India on 27.03.2020.

If the aforesaid is not done, in all probability the noble cause might face difficulty if challenged before a court of law.


*This article has been co-authored by Mr Wasim Beg, Partner; L&L Partners Litigation, New Delhi and;

**Mr Swarnendu Chatterjee, Advocate-On-Record, Supreme Court of India and Senior Associate, L&L Partners, Litigation, New Delhi.

[1] (1955) 1 SCR 1045

[2] Section 238-A, Insolvency and Bankruptcy Code, 2016 and the Limitation Act, 1963.

[3] (2006) 2 SCC 740

[4] 1951 SCR 228

[5] Director General of Foreign Trade v. Kanak Exports, (2016) 2 SCC 226

[6] (1955) 2 SCR 225 .

[7] Insolvency and Bankruptcy Code (Amendment) Act, 2020

[8] Manish Kumar v. Union of India, WP (Civil) No. 26 of 2020, order dated 13.01.2020

[9] OM No. 283/18/2020 and OM No. F/18/4/2020-PPD, Ministry of Finance, Department of Expenditure.

[10] 2019 SCC OnLine SC 1520.

[11] Rashbihari Panda v. Union of India, (1969) 1 SCC 414


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