Discretion Available to NCLT to Admit or Reject a Section 7 Application: NCLAT Almost Settles the Dust

The Insolvency and Bankruptcy Code, 2016¹ (the Code) has established itself as one of the most significant legislations in India in the last decade and has given a new lease of life to the identity of companies as separate legal entities. As per Section 7 of the Code², a financial creditor may file an application for the initiation of the corporate insolvency resolution process (CIRP) against a corporate debtor. Section 7(5)(a) further stipulates that upon the adjudicating authority being satisfied that default on a debt had occurred, that the threshold for filing such an application had been met, that the application under Section 7(2) was complete, and that there were no disciplinary proceedings against the proposed interim resolution professional (IRP/RP), then it may admit the corporate debtor into CIRP.

The narrow compass, within which the present controversy lies, is largely concerned with this power of the adjudicating authority to admit a corporate debtor into CIRP being discretionary, or simply mechanical on fulfilment of the ingredients of Section 7(5) mentioned above. India’s insolvency regime, unlike several of its foreign counterparts, requires the RP to be appointed by the NCLT (National Company Law Tribunal) after admission into CIRP. Hence, such a discretion of the adjudicating authority is of great relevance as insolvency cases, often, necessitate timely attention where the corporate debtor needs to be kept running as a going concern in order to maintain its viable resolution if admitted into CIRP.

Ordinarily, as per Section 7(4) of the Code, such an application by a financial creditor needs to be decided within 14 days of its receipt after ascertaining the existence of default. However, in the time that the Code has been active, this timeline has seldom been adhered to due to inordinate delays in hearing and deciding these applications. As per the Thirty-Second Report on Implementation of Insolvency and Bankruptcy Code — Pitfalls and Solutions³ prepared by the Standing Committee on Finance, the major reasons attributed to the slow insolvency resolution process were the inordinate delays in admission of cases and the approval of resolution plans by the National Company Law Tribunals.

In the early days of the Code, it was well settled by a two-Judge Bench of the Supreme Court of India in Innoventive Industries Ltd. v. ICICI Bank⁴ that the spirit of the Code entailed that upon the NCLT being satisfied that a debt was due, and that consequently default had occurred, it was bound to commit the corporate debtor into insolvency. Further, in Swiss Ribbons (P) Ltd. v. Union of India⁵, a two-Judge Bench of the Supreme Court cemented the principle that if debt and default were adequately demonstrated to the NCLT, then it was incumbent on it to initiate the CIRP of the corporate debtor, and that it enjoyed no discretion once the same was proved. The Court in Swiss Ribbons case⁶, while observing that the days of corporate finance being a defaulters’ paradise were lost, strengthened a paradigm changing shift in law that focused on the determination of default, from the usual inability of corporate borrowers to pay their debts.

However, on 12-7-2022, a two-Judge Bench of the Supreme Court in Vidarbha Industries Power Ltd. v. Axis Bank Ltd.⁷ held that the adjudicating authority (NCLT) had to consider the grounds made out by a corporate debtor against admission, on its own merits; the NCLT would have the discretion under Section 7(5)(a) of the Code to keep the admission of the application by the financial creditor in abeyance unless there was a good reason to not do so. In other words, the then mandatory admission into CIRP by the NCLT upon establishment of debt and default was then made discretionary. The Court in Vidarbha case⁸, interpreted may in Section 7(5)(a) in such a manner that rendered this exercise of power discretionary and not mandatory marking a departure from the dicta of Innoventive Industries case⁹. In Vidarbha case¹⁰, the corporate debtor was due a sum of Rs 17,30,00,00,000 by virtue of an order of the Appellate Tribunal for Electricity, due to which an order directing the NCLT to apply its mind to such factors affecting the health of the corporate debtor was issued.

The proponents of Vidarbha case¹¹ believe that such a departure was of the utmost importance in bolstering the flailing defences of corporate debtors before the NCLT. It was argued that the Code had often been used by financial creditors as an arm-twisting mechanism to admit an otherwise healthy corporate debtor into insolvency on account of isolated defaults. The critics of Vidarbha case¹² countered such arguments by contending that such a pronouncement elongated the summary nature of such proceedings and that this was a step backwards toward the pre-Code regime.

In the aftermath of Vidarbha case¹³, there seem to have been several instances where NCLTs and National Company Law Appellate Tribunal (NCLAT) have relied on it to render such Section 7 proceedings abeyant due to circumstances surrounding the purported good financial health of the corporate debtor. However, another twist in the tale was added on 11-5-2023, when a two-Judge Bench of the Supreme Court in M. Suresh Kumar Reddy v. Canara Bank¹⁴ distinguished Vidarbha case¹⁵ on facts and noted that when the existence of debt and default had been proved, the NCLT was bound to admit the petition under Section 7 of the Code. The M. Suresh Kumar Reddy case¹⁶ was of the view that in light of the dismissal of the review petition against Vidarbha case¹⁷, it was clear that the same had only been passed in the factual conspectus of the matter before the Court. Hence, Vidarbha case¹⁸ could not be understood as taking a contrary position in law as opposed to Innoventive Industries case¹⁹ (and also E.S. Krishnamurthy v. Bharath Hi-Tech Builders (P) Ltd.²⁰).

It could be said that M. Suresh Kumar Reddy case²¹, to a reasonable extent, has attempted to settle the tempest caused earlier by a Coordinate Bench of the Supreme Court in Vidarbha case²². Subsequently, the NCLAT, in Sunder Nagar Coop. Housing Societies Union Ltd. v. SBI²³ passed on 31-5-2023, distinguished Vidarbha case²⁴ on facts as in the matter before it, there was a clear admission of debt by the corporate debtor unlike Vidarbha case²⁵; the NCLAT relied on M. Suresh Kumar Reddy case²⁶ and dismissed the appeals against Section 7 admission order by the NCLT.

The NCLAT, in its recent judgment on 21-7-2023, in Ashok Kumar Tyagi v. UCO Bank²⁷ has delivered what could potentially be seen as a unique harmonisation of Vidarbha case²⁸ and M. Suresh Kumar Reddy case²⁹. The NCLAT noted that in the given case, there was an admission of debt and default by the corporate debtor. However, after the pronouncement of the Section 7 admission order by the NCLT, the corporate debtor issued a one-time settlement (OTS) proposal to the financial creditor, which was then sought to be increased by the latter through a counterproposal; the order records that the corporate debtor had accepted the financial creditor’s counterproposal, but no further response was received from the financial creditor. In a unique circumstance where both Vidarbha case³⁰ and M. Suresh Kumar Reddy case³¹ were cited before the NCLAT, it stayed the Section 7 admission order by 60 days in order to give the financial creditor an opportunity to take a final decision on the corporate debtor’s acceptance of the counterproposal. In any event, if there was no settlement reached between the parties, the CIRP of the corporate debtor would commence and the stay granted by the NCLAT would become inoperative. In an interesting trend of judicial pronouncements, ultimately, the NCLAT seems to have struck a fine balance between the rights of financial creditors and corporate debtors as seen in Ashok Kumar Tyagi case³². However, the subjective nature of such a judgment, whilst paving the way for a more streamlined approach in the admission of Section 7 petitions, cannot still settle the law as conclusively as the Supreme Court, and hence a decision of a larger Bench is awaited.

Section 7 of the Code has arguably played the most vital role in facilitating the resolution of corporate insolvency cases in India. In line with the promise of the Code, it grants financial creditors the right to initiate the CIRP against defaulting corporate debtors, ensuring a structured process to address their claims and recover outstanding debts. This provision’s efficacy will lie not only in its ability to strike a balance between financial creditors’ rights but also in debtor protection, ultimately fostering a more efficient and stable business environment in the country. It is essential that Section 7, and the Code at large, have a certain stability in judicial interpretation to ensure that the bustling commercial sector in India benefits from this modern legislation, rather than falter from such an unexpected quarter. Although the dust on this contested question of law seems to have almost been settled, it remains to be seen whether the matter is finally put to rest either by the Supreme Court, or Parliament.