Resolution versus Penalisation: Is IBC Deviating from its Purpose?

Introduction

The object of the legislature in enacting the Insolvency and Bankruptcy Code, 2016¹, was to modernise the economic ecosystem of the industry. The aim of the Code was to restructure and resolve the deficiency of a company’s old management and conclude the resolution process within 330 days.

But, in the recent past, courts and tribunals have inclined towards an interpretation which diverts from this premise. This interpretation allows for multiple proceedings to run, with the aim of chasing and penalising the alleged wrongdoers and also recovering the lost money. But the aim was not recovery of dues, instead was to set up a new management capable of bringing scalability and growth to the business. These multiple and parallel proceedings undermine the purpose of having consolidated proceedings aimed at seamless debt recovery.

On that note, the following paper analyses these provisions and their possible overlap. The paper attempts to answer how parallel proceedings play a role in creating a sharp difference between money recovery and penalising a person for misappropriation.

Undermining the ease of doing business

In the second decade of 2000s, the Indian Parliament recognised the credit situation and decided to bring a Code to recover the bad loans. The present legislations at that time, the Sick Industrial Companies (Special Provisions) Act, 1985 (SICA)² and Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (Sarfaesi)³, were not adequate and effective because of their inability to help the financial creditor recover the debt. Four major legislations were dealing with corporate insolvency, namely, the Companies Act, 1956⁴, SICA, 1985, Sarfaesi Act, 2002 and Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (Rddbfi)⁵, and so there were four different authorities preceding over the adjudication, namely, the Board for Industrial and Financial Reconstruction (BIFR), the Company Law Board, Debt Recovery Tribunals (DRTs), and the High Courts. This was causing several issues of overlapping jurisdictions and procedural delays and thus an urgent need for integration was felt. With this premise, the Insolvency and Bankruptcy Code was introduced, to cut down on parallel proceedings and have an integrated legislation.

The Statement of Objects and Reasons of the Insolvency and Bankruptcy Code says, “It would also improve ease of doing business and facilitate more investments leading to higher economic growth and development.” Thus, the purpose of the Code is to solve the problems of parallel proceedings, not allow for it. While we understand the objective of the Act, it is rather ironical how the provisions in the Code itself are allowing for a mechanism of parallel proceedings. Further, it can also be seen that the courts, while interpreting the Code, have allowed for the overlapping of laws which is causing parallel proceedings to run. In ultimatum, this is essentially against the true objective of the Code.

Running the Prevention of Money-Laundering Act, 2002⁶, Preferential, Undervalued, Fraudulent and Extortionate (PUFE), Sarfaesi or even Recovery of Debts and Bankruptcy (RDB) proceedings together, simultaneously in different forums would decelerate the debt recovery process. Instead of strengthening the legal infrastructure, it would weaken the country’s credit ecosystem, and because of this premise, allowing for parallel proceedings stands in direct contra of ease of doing business in the country.

Overriding effect of Section 238

Section 238 of the Insolvency and Bankruptcy Code (IBC)⁷, holds in situations wherein the Code is in conflict with any other prevailing law, the Code will prevail and override other laws. Thus, in effect the Code subsumes all the other legislations. In Rakesh Kumar Gupta v. Mahesh Bansal⁸, the National Company Law Appellate Tribunal (Nclat) read Section 238 to hold that even if there is pendency of proceedings pending under the Sarfaesi Act or the Rddbfi Act, this would not obstruct the courts from allowing for an application under Section 7 of the IBC, 2016.⁹. Thus, this provision has an applicability even when the proceedings against the corporate debtor are lis pendens, which speaks about the overarching nature of Section 238. The Supreme Court has upheld this reasoning in Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat (P) Ltd.¹⁰, be holding that “Section 238 of the IBC overrides the provisions of the Electricity Act, 2003¹¹, despite the latter containing two specific provisions which open with non obstante clauses (i.e. Sections 173¹² and 174¹³).”

Thus, this provision has been interpreted to give IBC, 2016 the preference and priority over other laws. So, the moment Section 238 is applicable, other proceedings are meant to halt. But, then in application, there is no such halting of other proceedings. Despite this legislative mandate, the courts and tribunals have seemed to be diverge. These mechanisms (one being PUFE) are not only confusing everyone — courts, debtors, creditors but also leading to delay for the successful resolution applicant (SRA) to enforce the resolution plan. If the money recovery process becomes so complicated by overlapping proceedings and requires knocking of so many doors, then the entire idea of ease of doing business is being undermined.

The Madras High Court in Anandram Developers (P) Ltd. v. National Company Law Tribunal¹⁴, interpreted Section 238 differently by holding that when the proceedings under the DRT are pending, approaching the National Company Law Tribunal (NCLT) amounts to forum shopping, even though it is permitted by the law in light of Section 238. While it is logical as to why the proceedings under IBC have to prevail, it is causing problems if the creditors are also going under other legislations to different authorities, knocking their doors and then also letting IBC proceedings to run. This is opposed to the true spirit of Section 238, that is, to subsume all other proceedings, regardless of when they are filed (before or after the insolvency proceedings under IBC). Nclat – ­New Delhi also enforced this principle in Encore Asset Reconstruction Co. (P) Ltd. v. Charu Sandeep Desai¹⁵, held that “Sarfaesi Act, 2002 being an existing law, Section 238 of the ‘IBC’ will prevail over any of the provisions of the ‘Sarfaesi Act, 2002’ if it is inconsistent with any of the provisions of the ‘IBC’.”

So, when moratorium is invoked under Section 14¹⁶, then why are the courts allowing for an interference with the assets of the corporate debtor thereby delaying the entire corporate insolvency resolution process (CIRP) and the implementation of the resolution plan?

Parallel proceedings and doctrine of double jeopardy violation

From a constitutional law perspective, being under trial for the same offence and being vexed twice is against the law. Article 20(2) of the Indian Constitution¹⁷, protects its citizens from being tried again for the same transaction or the same cause of action.

Moratorium and Negotiable Instruments Act

In 2021, P. Mohanraj v. Shah Bros. Ispat (P) Ltd.¹⁸, raised a critical question of whether Section 14, that enforces the moratorium, also include the proceedings under the Negotiable Instruments, 1881 (hereinafter “NI Act”)¹⁹, and ensure halting them as well? Can a creditor also knock the doors of the courts under the NI Act demanding a penal action against those responsible for cheque bouncing? While emphasising on separate legal entity of the company (the corporate debtor) and how it is a different legal entity than its directors and officers, the Supreme Court held that the relief of a moratorium protects the assets of the company and not of the officers running it. Further, because the proceedings under the NI Act are quasi-criminal and not civil, thus, they lay outside the ambit of Section 14. Thus, the proceedings under the NI Act can be initiated (and if already initiated, will not be halted) in case a moratorium is imposed against the directors, officers in charge, and other managers who were running the affairs of the corporate debtor. This was reiterated by the Supreme Court in Ajay Kumar Radheyshyam Goenka v. Tourism Finance Corpn. of India Ltd.²⁰, in 2023 that the insolvency processes cannot be a reason to excuse the accused from any criminal liability in cheque dishonour cases. In 2024, the same reasoning has been endorsed by the Supreme Court in Ansal Crown Heights Flat Buyers Assn. v. Ansal Crown Infrabuild (P) Ltd.²¹, as the Court held that the imposition of moratorium will be no excuse, and so the execution of decree can be allowed against the directors or officers even during moratorium under Section 14.

This interpretation has thus narrowed the ambit of Section 14 and stands in contradiction of what the purpose of moratorium under Section 14 of the IBC was. This provision was intended to be a blanket relaxation so that there could be a concrete attempt at reviving the corporate debtor. It ideally included all other mechanisms such as cheque bouncing under Section 138 of the NI Act²². Section 14 uses the phrases “any court” and “any case” to give the provision the widest amplitude. Further, the intent of the legislators was to give Section 14 overarching powers regardless of nature of the proceedings, criminal or civil. But, as opposed to this, the Court allowed for continuation of the parallel proceedings and the institution of fresh proceedings against the directors and officers. This means that in cases of genuine insolvency as well, its stakeholders will be dragged to courts and tribunals and persecuted twice for the same transactions. And in some cases, so will the corporate debtor be a part of proceedings despite moratorium as how can a cheque bouncing proceeding be possibly instituted without the corporate debtor? And how can a trial be initiated without a corporate debtor thereby causing prejudice? Once the resolution plan allocates funds to be paid to the creditor, how can the creditor approach the Court demanding the same payment from the directors and officers?

Such reasoning diverges from the purpose of the Code which aimed at revival of the company as opposed to punishing the debtor. These interpretations are allowing for a double vexation of the stakeholders by punishing them twice as the proceedings would be dual, one of civil nature under IBC and the other of criminal nature under the NI Act. And thus, one could argue that this is violative of the protection that the Constitution promises under Article 20(2).

Guarantors and double jeopardy

In Lalit Kumar Jain v. Union of India²³, the Supreme Court in 2021, held that discharge of a principal borrower from the debt owed by it to its creditor will not mean absolving the surety/guarantor of liability.

Thus, the financial creditor can file different claims for same debt, such as, one against the corporate debtor and the other against the personal guarantor. This interpretation of the court is leading to a situation wherein the guarantors can be sued twice, once indirectly in the proceedings against the principal debtor (for which they have given a guarantee) and secondly, directly against them.

PUFE and moratorium

During the corporate insolvency resolution process (hereinafter “CIRP”), it is the duty of the resolution professionals to look for certain transactions such as PUFE. Based on this forensic audit, if any transaction is found to be covered under PUFE, in that event the resolution professionals or the liquidator (as the case may be), has to report to the adjudicating authority (NCLT). Once the moratorium is declared, there is no protection for the old management including the suspended Board of Directors or the personal guarantors, and so different provisions of IBC can be invoked against the same persons to hold them accountable.

Insolvency Law Committee in its 5th Report of May 2022²⁴ opined that, “clarificatory amendment may be made to Section 26²⁵, so that the completion of the CIRP proceedings do not affect the continuation of proceedings for avoidable transactions or improper trading”. The report endorsed on “independence of proceedings for avoidance of transactions and improper trading”. If the recommendations of the Insolvency Law Committee are to be considered, then the legislation that had intended to consolidate proceedings will be signing off on multiplicity of proceedings. It would essentially mean that even after the successful conclusion of the CIRP, PUFE transactions may run parallelly as an independent proceeding. Therefore, vexing twice the erstwhile management of the corporate debtor.

Conclusion

One could justify this divergent approach of the courts that creating an environment of positive fear for the entrepreneurs so that they manage they set the house in order. Even if one agrees to this justification, it still stands against the law.

There is a stark distinction between money recovery and penalising the persons responsible for putting a company in a state of insolvency. The case of Rita Malhotra v. Orris Infrastructure (P) Ltd.²⁶, held that IBC is a beneficial legislation intended to be invoked to ensure the continuity of business companies by saving sick companies through resolution. It is not a recovery legislation and is not aimed to satisfy the selfish interest of claimant. The Code cannot be used as a tool for recovery when it is supposed to revive the company and bring it out of the state of insolvency and ultimately save it from going bankrupt.

Thus, the paper submits that the recent interpretations of the Supreme Court are allowing for double vexing of the stakeholders, directors, and promoters. These interpretations are against the basic legal tenet of IBC that that post the successful conclusion of the CIRP, all litigation with effect to that CIRP, must also conclude. Thus, is IBC deviating from its purpose?