Decoding Section 7 of IB Code for admitting an application for Corporate Insolvency Resolution Process

The Insolvency and Bankruptcy Code, 2016 (Code) was enacted to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time-bound manner. The Code has been constantly evolving since inception. For instance, Section 29-A was added in 2018 which, amongst others, rendered promoters of the corporate debtor (CD) ineligible to submit a resolution plan. Section 12-A was also added to provide for withdrawal of an admitted application with the approval of 90% of CoC members. In 2020, real estate allottees were granted the status of financial creditors under Section 7.

Section 7 of the Code provides for initiation of corporate insolvency resolution process (CIRP) against a Corporate Debtor (‘CD’) by a financial creditor (FC). Section 7(5) of the Code states that, where adjudicating authority [National Company Law Tribunal (NCLT)] is satisfied that a default has occurred and that the application is complete, it may, by order, admit such application.

Since its enactment in December 2016, a total of 6571 applications have been filed. Out of which, 2912 were filed by FCs. Amongst which, 1803 have been closed. Amongst the closed cases, 264 were closed by appeal/review/settlement, 232 were withdrawn after admission, 380 were closed due to approval of resolution plan and 927 went into liquidation.¹ Till 31-3-2023, realisation by FCs under resolution plans in comparison to their claims was merely 34.20% which meant a haircut of almost 65.80%.²

The ambit and scope of Section 7(5) of the Code came up for consideration before the Supreme Court in several landmark cases, such as, Innoventive Industries Ltd. v. ICICI Bank³, Swiss Ribbons (P) Ltd. v. Union of India⁴ and E.S. Krishnamurthy v. Bharath Hi-Tecch Builders (P) Ltd.⁵ The Supreme Court interpreted Section 7(5) of the Code and held that the NCLT has to only satisfy itself that a default has occurred for admitting an application under Section 7 of the Code. The Supreme Court also held that the debt could even be disputed but, as long as it is “due” and a “default” has occurred, the NCLT must admit an application under Section 7 of the Code.

Thereafter, in Vidarbha Industries Power Ltd. v. Axis Bank Ltd.⁶ (Vidarbha), the Supreme Court interpreted Section 7(5) of the Code and held that, since the provision used the term “may”, it was apparent that the legislature intended the admission of an application under Section 7 to be discretionary. It was held that the NCLT may in its discretion, reject an application after examining the expedience of initiation of CIRP, taking into account all the relevant facts and circumstances, including the overall financial health and viability of the CD. In a review petition⁷, the Supreme Court clarified that Vidarbha⁸ was not to be read as provisions of a statute and that it was passed in its peculiar facts. This was again clarified by the Supreme Court in M. Suresh Kumar Reddy v. Canara Bank⁹, where it was held that Vidarbha¹⁰ cannot be understood as taking a view contrary to Innoventive Industries¹¹ and E.S. Krishnamurthy¹².

In light of the above judgments, the present position is that once the debt and default is established under Section 7 of the Code, then the NCLT must admit the application if it is otherwise complete. However, in exceptional cases, if the CD is able to make out a case that it is a viable entity, then there is a possibility that the application may be kept in abeyance or even rejected. Some examples where the NCLT has examined the viability of the CD and either kept the application in abeyance or rejected it are discussed below.

For instance, in Central Bank of India v. Simplex Infrastructures Ltd.¹³, the Kolkata Bench of the NCLT rejected an application under Section 7 of the Code even though the debt and default of about Rs 105 crores was established. In this case, the CD had contended that it had secured several arbitral awards totaling about Rs 554.17 crores in its favour. Interestingly, awards totaling only about Rs 3.38 crores had been upheld and the rest were under challenge at various stages. Nonetheless, the NCLT rejected the application.

Similarly, in HDFC Bank Ltd. v. John Energy Ltd.¹⁴, the Ahmedabad Bench of the NCLT rejected an application under Section 7 of the Code, wherein the debt and default of Rs 86 crores was established. The application was rejected on the ground that the CD was one of India’s leading oil and gas service providers having a significant contribution to the market with multiple high value contracts. The NCLT held that the CD was a solvent company which could restructure its loan accounts. Further, the liquidation value of the CD was almost half its fair value and the initiation of CIRP would hamper the CD’s subsisting contracts and its valuation.

In Kotak Mahindra Bank Ltd. v. Kunal Structure (India) (P) Ltd.¹⁵, the Ahmedabad Bench of the NCLT relied on Vidarbha¹⁶ and kept an application under Section 7 of the Code in abeyance for a period of six months on the ground that as against the established default of Rs 18.11 crores, the CD had secured arbitral awards totaling Rs 41.23 crores which were under execution. The NCLT also noted that the CD had a positive net worth of Rs 284.87 crores and was currently working on 15 projects.

Similarly, in SREI Equipment Finance Ltd. v. Madhucon Projects Ltd.¹⁷, the Hyderabad Bench of the NCLT relied on Vidarbha¹⁸ and rejected an application under Section 7 of the Code on the ground that there was a decree and an arbitral award in the CD’s favour. The CIRP was kept in abeyance for a period of three months with a liberty to the FC to approach the NCLT if the dues remained unpaid.

In SBI v. Krishidhan Seeds (P) Ltd.¹⁹, the Indore Bench of the NCLT kept an application under Section 7 of the Code in abeyance for a period of six months on the ground that the management of the CD was trying hard to revive the CD.

In Bank of Maharashtra v. Newtech Promotors & Developers (P) Ltd.²⁰, the New Delhi Bench of the NCLT relied on Vidarbha²¹ and rejected an application under Section 7 of the Code on the ground that initiation of CIRP would adversely affect the rights of homebuyers.

It is quite possible that many of these judgments may be set aside in appeal by applying the ratio in Innoventive Industries²² and E.S. Krishnamurthy²³. However, the CDs in these cases have certainly been given a chance to live to fight another day. In genuine cases, this breather may give the CD enough time to bail itself out.

Strictly speaking, an application under Section 7 of the Code is to be admitted as long as the debt is “due” and a “default” has occurred. But such a binary approach may not always be in the best interest of all stakeholders. No doubt, a defaulting CD should not be given too much leeway at the cost of other stakeholders. However, in our view, if the NCLT is satisfied that the CD is a viable entity and decided to keep the admission of the application in abeyance for a short period of time, then such a course would be in consonance with the letter and spirit of the Code. But an outright dismissal of an application on the ground that the CD is a viable entity would conflict with the letter and spirit of the Code and would lead to further litigation.