Insolvency

Akaant MittalExperts Corner

Introduction

A liquidation proceeding stands initiated once the corporate insolvency resolution process fails. Section 33 of the Insolvency and Bankruptcy Code, 2016 (IB Code) sets out the conditions laying down three scenarios wherein liquidation proceedings can be initiated against the corporate debtor.

 

First, when the adjudicating authority does not receive the resolution plan upon expiry of the insolvency process or it rejects the resolution plan.[1]

 

Second, when the resolution professional intimates the adjudicating authority that the committee of creditors has decided to liquidate the corporate debtor.[2]

 

Third, when any person, whose interests are prejudicially affected when the approved resolution plan is contravened by the corporate debtor, makes an application to the adjudicating authority to initiate liquidation proceedings.[3]

 

Once the liquidation process is initiated, the same concludes with the distribution of the assets of the corporate debtor in accordance with the waterfall (distribution) mechanism provided under Section 53 of the IB Code.

 

This column seeks to discuss about one peculiar aspect of liquidation wherein it is sought to be ensured that workers of a corporate debtor suffer the least on account of the expiration of the corporate debtor.

 

“Gratuity” and its Interplay with IB Code

While the Payment of Gratuity Act has not explicitly defined the term “gratuity”, it can be understood to be a sum payable by the employer to his workers upon completing service for the prescribed period of time.[4] Now once the company is brought to an end by the liquidation, then clearly such payment is to be paid to the workers.

 

Simultaneously, the IB Code provides for the formation of a “liquidation estate”[5] containing all the assets of the debtor. It is these proceeds that will be distributed to the respective stakeholders (creditors) in terms of waterfall mechanism under Section 53 of the IB Code.

 

Issue arises because if the gratuity falls under the “liquidation estate” and is to be distributed in terms of Section 53, then the workers may not get their dues in total. For instance, assuming that the only asset of the company is the gratuity sum to the tune of Rs 1 crore. Now if this sum forms part of the liquidation estate, then this sum of Rs 1 crore will be distributed firstly towards the insolvency resolution process costs and liquidation costs. If these costs run over Rs 1 crore, then the entire gratuity amount will be consumed under these expenses only. Otherwise, if these costs are, let us say, Rs 50 lakhs, then the remaining Rs 50 lakhs will be distributed towards the workers’ dues for the period of 24 months preceding the liquidation commencement date and dues towards secured creditors. The list goes so on and so forth.

 

However, Section 36 of the IB Code stipulates certain payments that are not to form part of the “liquidation estate”. Section 36(4)(a)(iii) of the IB Code stipulates that:

(4) The following shall not be included in the liquidation estate assets and shall not be used for recovery in the liquidation:

(a) assets owned by a third party which are in possession of the corporate debtor, including–

(i)-(ii)                             ***

(iii) all sums due to any workman or employee from the provident fund, the pension fund and the gratuity fund;

 

In other words, any amount due to the workers from the pension fund, provident fund, and the gratuity fund will not form a part of the liquidation estate of the corporate debtor and will not be used for recovery in liquidation.

 

Since in many instances, liquidation results in the complete closure of the business of the ailing debtor, which results in the termination of the employment of the workers. In legal parlance, this discharge of workers amounts to their retrenchment i.e. the termination of service of workers by the employer for any reason other than punishment inflicted by way of disciplinary action.[6] Naturally to protect the workers, funds such as pension fund, provident fund, and the gratuity fund are kept out of the liquidation distribution and to be used solely for the benefit of the workers.

 

This question was even dealt with by the National Company Law Appellate Tribunal (NCLAT) in Somesh Bagchi v. Nicco Corpn. Ltd.[7] (Somesh Bagchi) as well SBI v. Moser Baer Karamchari Union[8] (Moser Baer – NCLAT) wherein the Appellate Tribunal had held that gratuity does not form a part of the liquidation estate.

 

Unsettled Legal Issues Arising with Gratuity

Now further issue arises on whether a liquidator can be directed to make provision for the payment of gratuity to the workers in case the erstwhile management of the corporate debtor did not create such fund for the workers.

 

The recent ruling by the National Company Law Tribunal (NCLT) Allahabad in Standard Chartered Bank v. JVL Agro Industries Ltd.[9] (Agro Industries) brings out the trouble in how to counter balance the workers benefit wherein the employer had faulted in not providing for gratuity; all the while respecting the statutory limitations of the authority of a liquidator.

 

In Agro Industries[10], a resolution proceeding was initiated and consequently a moratorium was declared and a resolution professional was appointed. Since, no resolution plan was approved by the committee of creditors, the liquidation proceeding was initiated. The corporate debtor had nearly 500 employees some of whom had filed an application for payment of their dues after the public announcement of liquidation was made. The corporate debtor had taken gratuity policy for 92 of its employees from Life Insurance Corporation (LIC), and the other 403 were not covered by it. It was further represented before the NCLT that the corporate debtor has requisite funds to cover the gratuity payments of the rest of its employees as well as pay the renewals for the already existing policyholders.

 

The NCLT referring to the ruling in Alchemist Asset Reconstruction Co. Ltd. v. Moser Baer India Ltd.[11] (Moser Baer – NCLT) which had been upheld by the NCLAT allowed the same and directed the liquidator to pay for the existing holders whose premiums are due as well as procure a new gratuity policy for the other 403 employees.

 

The precedent of Moser Baer – NCLT[12] referred to by the NCLT in Agro Industries[13] was primarily on the issue of whether gratuity funds could be used to make up the “liquidation estate” and consequently available for distribution amongst other creditors in terms of Section 53 of the IB Code. Allowing the prayer of the workers, the NCLT held that amount due towards the workers cannot be used for the purposes of distribution in terms of Section 53 of the IB Code.

 

In Moser Baer – NCLT[14], the Court further directed the liquidator that in cases there is any deficiency to the provident, pension or the gratuity funds; the liquidator shall ensure that the fund is available in these accounts, “even if their employer has not diverted the requisite amount”.

 

This order was impugned by the State Bank of India – a secured creditor of Moser Baer in SBI v. Moser Baer Karamchari Union,[15] where the limited question that came before the NCLAT was whether the gratuity dues formed a part of the liquidation estate. Holding the answer in negative, the NCLAT decided not to interfere with the order of the NCLT.

 

However, complications arise from the facts that confronted the NCLAT in its ruling in Savan Godiwala v. Apalla Siva Kumar[16] (Siva Kumar) wherein the NCLAT had held that if there has been no fund set aside for the payment of gratuity, provident and pension dues then the liquidator cannot be directed to do so.

 

The ex employees of the corporate debtor herein had contended that since corporate debtor had failed to maintain a gratuity fund or obtain insurance for the fulfilment of its liability towards payment of the gratuity to its employees, the gratuity dues payable to the employees shall be treated as an asset of the employee lying in possession of corporate debtor and as such, cannot be treated as a claim at par with other creditors.

 

In the counter the liquidator submitted that if there is no separate fund for gratuity payments, the same cannot be done from the running accounts of the corporate debtor, presumably because under the statutory scheme[17] of the IB Code the gratuity funds are excluded from the ambit of “liquidation estate”.

 

The NCLAT, firstly, discussed judicial precedent in Moser Baer – NCLAT[18] and Section 36(4)(a)(iii) as to how funds such as gratuity and provident funds do not form part of liquidation estate, therefore, are outside the purview of any discussion on “liquidation estate”. Secondly, it referred to Section 36(2)[19] of the IB Code to reason that the liquidator holds the funds in the “liquidation estate” in a fiduciary capacity for the purposes of distribution amongst creditors in terms of Section 53 of the IB Code, therefore such funds cannot be used for any other purpose except the distribution mechanism under Section 53 of the IB Code. Thirdly and finally, the NCLAT referred to the facts and circumstances, where there was no separate fund provided by the erstwhile management for the purposes of gratuity funds.

 

Resultantly, the NCLAT concluded:

  1. … [i]n a case, where no fund is created by a company, in violation of the statutory provision of Section 4 of the Payment of Gratuity Act, 1972, then in that situation also, the liquidator cannot be directed to make the payment of gratuity to the employees because the liquidator has no domain to deal with the properties of the corporate debtor, which are not part of the liquidation estate.[20]

 

The Agro Industries[21] case refers to a situation where funds for payment of gratuity have been set aside by the corporate debtor but are not enough to cover the dues. Siva Kumar[22] talks about a situation where the corporate debtor has failed to comply with its statutory obligation of creation of gratuity funds under the Payment of Gratuity Act – in such a situation no funds can be set aside by the liquidator since she/he lacks the domain to do so. Therefore, the ratio of Siva Kumar[23] seems to hold that unless there are funds specifically set aside for the payments of premium for gratuity; funds from the “liquidation estate” cannot be used for the payments of such payments. On the other hand, the Moser Baer – NCLT[24] as a matter of principle rules that provident, pension and gratuity funds should be kept duly furnished by the liqudiator even if the employer did not divert the requisite amount.

 

Conclusion

It is now a settled position of law that gratuity funds due towards the workers fall outside the scope of the liquidation estate, and cannot be used for payments of dues of other creditors.

 

That still leaves a difficult position (at least in equity) if the statutory duty to cover the workers with gratuity and provident is avoided purely on account of the illegality of the erstwhile management who originally did not create any funds for the payments of premiums towards these funds. The only consequence is that the workers stand to lose the rightful coverage.

 

† Akaant Kumar Mittal is an advocate at the Constitutional Courts, and National Company Law Tribunal, Delhi and Chandigarh. He is also a visiting faculty at the NUJS, Kolkata and the author of the commentary Insolvency and Bankruptcy Code – Law and Practice. 

†† 4th year law student at the National University of Juridical Sciences, Kolkata. She can be contacted at lavanya218024@nujs.edu

[1] S. 33(1), Insolvency and Bankruptcy Code, 2016.

[2] S. 33(2), Insolvency and Bankruptcy Code, 2016.

[3] S. 33(3), Insolvency and Bankruptcy Code, 2016.

[4]Payment of Gratuity Act, 1972.

[5]IB Code, S. 36.

[6]S. 2(oo), Industrial Disputes Act, 1947.

[7]2018 SCC OnLine NCLAT 833 .

[8]2019 SCC OnLine NCLAT 447.

[9] CA No 294/2019 in CP No (IB) 223/ALD/2018, order dated 10-12-2020 (NCLT).

[10] Ibid.

[11]2019 SCC OnLine NCLT 118.

[12]Ibid.

[13] CA No 294/2019 in CP No (IB) 223/ALD/2018, order dated 10-12-2020 (NCLT).

[14] 2019 SCC OnLine NCLT 118.

[15]2019 SCC OnLine NCLAT 447.

[16]2020 SCC OnLine NCLAT 191.

[17]See IB Code, S. 36(4)(a)(iii).

[18] 2019 SCC OnLine NCLAT 447.

[19]IB Code, S. 36(2) stipulates:

“(2) The liquidator shall hold the liquidation estate as a fiduciary for the benefit of all the creditors.”

[20]2020 SCC OnLine NCLAT 191.

[21] CA No 294/2019 in CP No (IB) 223/ALD/2018, order dated 10-12-2020 (NCLT).

[22] 2020 SCC OnLine NCLAT 191.

[23] Ibid.

[24] 2019 SCC OnLine NCLT 118.

Op EdsOP. ED.

Introduction

Financial distress and insolvency in the context of non-profit organisations (NPOs) have been widely discussed in other jurisdictions, however, Indian NPOs are yet to meet a similar fate, despite India containing in itself a huge NPO sector.[1] In India, NPOs majorly comprise of companies with charitable objects (Section 8 companies), societies, trade unions, trusts, cooperative societies, etc. This article talks of insolvency resolution only in the context of Section 8 companies.

Section 8 of the Companies Act, 2013[2] (CA’13) provides a framework for companies having charitable objectives like, promotion of commerce, art, science, sports, education, research, social welfare, religion, charity, protection of the environment, etc. Such companies cannot distribute dividends in members and are required to use the profits to promote their objectives. They are required to use terms like Foundation, Confederation, Association, etc. in their names instead of “‘Private”, “Private Limited”, etc.

The Insolvency and Bankruptcy Code, 2016 (IBC)[3] defines a “corporate person” under Section 3(7)[4], which, inter alia, includes a “company” under Section 2(20) of CA’13. Hence, a literal interpretation of the provisions does not bar IBC’s application to Section 8 companies. Further, Section 8 companies are not covered under the exclusionary clause of Section 3(7) of the IBC. Further, Section 2(a) makes the IBC applicable to “any company incorporated under the Companies Act” and does not create a differentia based on the objectives of different companies. Thus, clearly, Section 8 companies are covered under the IBC as a corporate person.

The pertinent question that arises is whether the application of IBC to such companies is appropriate? In other words, should the charitable motive of Section 8 companies affect the applicability of the IBC?

Application of the Insolvency and Bankruptcy Code, 2016 to Section 8 companies

The IBC envisages two potential outcomes – revival or liquidation. It intends to revive distressed businesses, even at the cost of some haircuts to creditors’ claims. During Corporate Insolvency Resolution Procedure (CIRP), the Committee of Creditors considers and votes on resolution plans (plans) submitted by various resolution applicants willing to take over the company by fully or partially paying off its debts. The primary goal of the process is to maximise the value of the company so that good plans are attracted to rejuvenate it. For revival of the company through the CIRP, there must exist the potential for profitability as a going concern for such company to attract good plans and avoid liquidation. One of the reasons for high liquidation to resolution ratio under IBC is that the companies under CIRP lack profitable viability.

By virtue of the nature of Section 8 companies, there is minimal scope of monetary returns for the members, neither is there a distribution of dividend in the long run. Hence, if a Section 8 company undergoes CIRP, most of them are unlikely to attract good plans. Alternatively, a restructuring of the company under which it is converted into a for-profit company is possible under a plan. However, this would dilute the public interest that the charitable company served.

Thus, absent a resolution plan, the company would get liquidated. Liquidation is undesirable for it destroys the company’s organisational capital, in addition to diminishing its assets’ values. For charitable companies, liquidation also jeopardises the larger public interest by destroying their intangible assets. For example, charitable companies dedicated to promoting arts are often sole custodians of certain intangible assets that enrich the society by providing cultural, civic, and social benefits for people at large, however they have no liquidation value.[5]

Proposed solution: A middle ground?

The above discussion does not intend to suggest that charitable companies should be completely exempted from the IBC. After all, these companies, like any other companies, require sources of funding, employees and strategic plans for their operations. For example, the extent of donations or credit a company obtains depends upon the credibility/influence it has in society, which in turn depends on the nature of projects undertaken and their success. Meaning that, while the core purpose of these companies is charitable with non-profit motive, their operations are similar to a for-profit company in terms of daily management. So, their creditors should not be devoid of the rights/benefits otherwise available under the IBC. Further, IBC is an economic legislation aimed at augmenting the economic viability of distressed companies and preserving their organisational capital (BLRC Report)[6]. So, if a Section 8 company is under distress, IBC should aid in its rescue.

Given that, one needs to reach some middle ground. Owing to the different nature and object of these companies, the CA’13 provides slightly different amalgamation and winding-up provisions for these companies than their for-profit counterparts. As per Section 8(10)[7], a Section 8 company can only be amalgamated with another Section 8 company having similar objects. Further, on winding up, the residual assets of the company are to be transferred to another Section 8 company having similar objects, or the proceeds go to the insolvency and bankruptcy fund formed under Section 224 of IBC[8]. The idea is to preserve the company’s objectives as far as practicable. The authors argue that similar concessional arrangement for them under the IBC is feasible and desirable.

A charitable company focuses on social welfare rather than economic benefits to its members. On the other hand, the IBC aims to maximise the value of the company under distress. Thus, there is an apparent mismatch between the objectives of Section 8 companies and the IBC. Similar consideration made an National Company Law Tribunal (NCLT) Judge, in Harsh Pinge v. Hindustan Antibiotics Limited[9] say that certain public sector undertakings, like the Hindustan Antibiotics Limited, are corporate entities but as their larger objective is social welfare and not making huge money, hence this should absolve them from the clutches of the IBC in event of default.

Insights from the United States and the United Kingdom

The US Bankruptcy Code exempts charitable companies from involuntary bankruptcy proceedings, initiated by the creditors. However, some scholars criticise this provision as it insulates the fraudulent charitable fiduciaries in companies from creditor-demanded bankruptcy.[10] However, for those companies that face insolvency due to genuine business failures, the UK model offers some insights. The UK Insolvency Act, 1986, that is a creditor-in-control model provides for an American style debtor in possession provision as well viz. the Company Voluntary Arrangement (CVA). Under CVA, the directors of a company may propose to its creditors an arrangement for satisfaction of its debts under which there would be debt haircut, delay in payment provision, or both. The directors then nominate an insolvency practitioner who then, in 28 days submits his report to the court opining if the arrangement has reasonable prospects of approval and implementation. For small-scale companies, the directors can also obtain a moratorium when CVA is proposed, to avoid individual recovery proceedings. On the court’s order, the CVA is discussed and voted by the creditors and if approved, goes for final court approval. After approval, the insolvency practitioner supervises the implementation after which the control goes back to the directors. This provision is in addition to the administration/winding-up provisions.[11]

In the Indian context, the apprehensions over the complete exemption under the US model hold merits. A blanket exemption from the IBC may open floodgates for unfair dealings or fraudulent conduct. In that case, the creditors should always have an option to approach the NCLT and follow the regular CIRP. An arrangement on lines of the UK CVA model should also be provided for Section 8 companies. This model is well suited for these companies that can avoid the rigours of the CIRP and also satisfy their debts and preserve their enterprises. On failure, the creditors can resort to the CIRP. Nevertheless, a rational creditor would prefer CVA over CIRP, for the former would be speedier and more certain. Adopting a procedure like CVA for such companies would allow early resolution and will be in the larger public interest. Implicit in such model is minimum governmental intervention in the process. It is important because these companies already face the problem of excessive governmental regulations in incorporation, functioning, receiving foreign contributions [regulated through the Foreign Contribution (Regulation) Act, 2010[12]], etc.[13], extending the same to restructuring (as is the current process of amalgamation)[14] would not be in the best interests of the company and the public. Making it a court-monitored, creditor-debtor-insolvency professional driven process would do far better, in terms of both its economic and social outcomes.

Conclusion

While Section 8 companies are not exempted and should not be exempted from the clutches of IBC, the inherent nature and objectives of these companies demands reconsideration on the role of IBC to rescue them from distress. The authors propose an option of the UK-style CVA model to be provided for these companies for rescue. Nevertheless, in determining whether to extend the benefit of CVA to a particular company or to directly subject it to the CIRP, the actual functioning of that company, possibility of misconduct, mala fide practices, etc. should be duly considered. But absence these cases, where a Section 8 company faces distress due to genuine business failure, a CVA-style arrangement should be preferred, and CIRP may act as the final resort.

*3rd year student (6th Semester), BA LLB (Hons.), National Law University, Delhi. Author can be reached at kumari.saloni18@nludelhi.ac.in

[1]As per MCA data, total number of charitable companies incorporated under Section 25 of the Companies Act, 1956 stood close to 5000 right before the implementation of the Companies Act, 2013. Further, a 2014 Report concludes that India has one NGO on 600 people of its population.

[2] Companies Act, 2013, Section 8. .

[3] Insolvency and Bankruptcy Code, 2016.

[4] Ibid, Section 3(7)

[5]Reid K. Weisbord, Charitable Insolvency and Corporate Governance in Bankruptcy Reorganisation, (2013) 10 Berkeley Bus LJ 305, 315.

[6]Report of the Bankruptcy Law Reforms Committee, Vol. I: Rationale and Design (November 2015). 

[7]Companies Act, 2013, Section 8(10).

[8]IBC, Section 224.

[9] C.P. No. (IB) 2482/2018, order dated 16-7-2019 (NCLT Mumbai Bench).

[10] Supra Note 5, 347.

[11]UK Insolvency Act, 1986 c. 45, Part I Company Voluntary Arrangements.

[12]Foreign Contribution (Regulation) Act, 2010.

[13]Pushpa Sundar, Why India’s Non-Profit Sector Needs Comprehensive Legal Reform (The Wire, 10-5-2017).

[14]As is provided under the Companies Act wherein amalgamation can happen if the Central Government is of that opinion [Section 8(10)].

Case BriefsSupreme Court

Supreme Court: The 3-judge bench of RF Nariman, BR Gavai* and Hrishikesh Roy, JJ has held that any creditor including the Central Government, State Government or any local authority is bound by the Resolution Plan once it is approved by an adjudicating authority under sub­-section (1) of Section 31 of the Insolvency and Bankruptcy Code, 2016.

Resolution Plan – When becomes binding?

After taking note of Section 31 of IBC, the Court observed that once the resolution plan is approved by the Adjudicating Authority, after it is satisfied, that the resolution plan as approved by CoC meets the requirements as referred to in sub-section (2) of Section 30, it shall be binding on the Corporate Debtor and its employees, members, creditors, guarantors and other stakeholders.

“Such a provision is necessitated since one of the dominant purposes of the I&B Code is, revival of the Corporate Debtor and to make it a running concern.”

The Court explained one of the principal objects of IBC is, providing for revival of the Corporate Debtor and to make it a going concern. Here’s the scheme of the Code:

  • Upon admission of petition under Section 7, there are various important duties and functions entrusted to RP and CoC. RP is required to issue a publication inviting claims from all the stakeholders. He is required to collate the said information and submit necessary details in the information memorandum.
  • The resolution applicants submit their plans on the basis of the details provided in the information memorandum.
  • The resolution plans undergo deep scrutiny by RP as well as CoC. In the negotiations that may be held between CoC and the resolution applicant, various modifications may be made so as to ensure, that while paying part of the dues of financial creditors as well as operational creditors and other stakeholders, the Corporate Debtor is revived and is made an on-going concern.
  • After CoC approves the plan, the Adjudicating Authority is required to arrive at a subjective satisfaction, that the plan conforms to the requirements as are provided in sub-section (2) of Section 30 of the IBC. Only thereafter, the Adjudicating Authority can grant its approval to the plan.
  • It is at this stage, that the plan becomes binding on Corporate Debtor, its employees, members, creditors, guarantors and other stakeholders involved in the resolution Plan.

“The legislative intent behind this is, to freeze all the claims so that the resolution applicant starts on a clean slate and is not flung with any surprise claims. If that is permitted, the very calculations on the basis of which the resolution applicant submits its plans, would go haywire and the plan would be unworkable.”

2019 Amendment – Nature and effect of  

After the 2019 amendment, any debt in respect of the payment of dues arising under any law for the time being in force including the ones owed to the Central Government, any State Government or any local authority, which does not form a part of the approved resolution plan, shall stand extinguished.

The mischief, which was noticed prior to amendment of Section 31 of IBC was, that though the legislative intent was to extinguish all such debts owed to the Central Government, any State Government or any local authority, including the tax authorities once an approval was granted to the resolution plan by NCLT; on account of there being some ambiguity the State/Central Government authorities continued with the proceedings in respect of the debts owed to them.

In order to remedy the said mischief, the legislature thought it appropriate to clarify the position, that once such a resolution plan was approved by the Adjudicating Authority, all such claims/dues owed to the State/Central Government or any local authority including tax authorities, which were not part of the resolution plan shall stand extinguished.

Further, the word “other stakeholders” would squarely cover the Central Government, any State Government or any local authorities. The legislature, noticing that on account of obvious omission, certain tax authorities were not abiding by the mandate of IBC and continuing with the proceedings, has brought out the 2019 amendment so as to cure the said mischief.

Therefore, the 2019 amendment is declaratory and clarificatory in nature and   therefore retrospective in operation.

“Creditor” and “Other Stakeholders” – If includes Central Government, State Governments or local authorities

“Creditor” – If covers Government

“Creditor” has been defined to mean ‘any person to whom a debt is owed and includes a financial creditor, an operational creditor, a secured creditor, an unsecured creditor and a decree-holder’.

“Operational creditor” has been defined to mean a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.

“Operational debt” has been defined to mean a claim in respect of the provision of goods or   services including employment or a debt in respect of the payment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority

Harmonious construction of subsection (10) of Section 3 of the IBC read with subsections (20) and (21) of Section 5 thereof would reveal, that even a claim in respect of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority would come within the ambit of ‘operational debt’.

The Central Government, any State Government or any local authority to whom an operational debt is owed would come within the ambit of ‘operational creditor’ as defined under sub¬section (20) of Section 5 of the IBC.  Consequently, a person to whom a debt is owed would be covered by the definition of ‘creditor’ as defined under sub-section (10) of Section 3 of the IBC.

“As such, even without the 2019 amendment, the Central Government, any State Government or any local authority to whom a debt is owed, including the statutory dues, would be covered by the term ‘creditor’ and in any case, by the term ‘other stakeholders’ as provided in subsection (1) of Section 31 of the IBC.”

Key findings

(i) Once a resolution plan is duly approved by the Adjudicating Authority under subsection (1) of   Section 31 of Insolvency and Bankruptcy Code, 2016, the claims as provided in the resolution plan shall stand frozen and will be binding on the Corporate Debtor and its employees, members, creditors, including the Central Government, any State Government or any local authority, guarantors and other stakeholders.

Further, on the date of approval of resolution plan by the Adjudicating Authority, all such claims, which are not a part of resolution plan, shall stand extinguished and no person will be entitled to initiate or continue any proceedings in respect to a claim, which is not part of the resolution plan;

(ii) 2019 amendment to Section 31 of the IBC is clarificatory and declaratory in nature and therefore will be effective from the date on which IBC has come into effect;

(iii) Consequently all the dues including the statutory dues owed to the Central Government, any State Government or any local authority, if not part of the resolution plan, shall stand extinguished and no proceedings in respect of such dues for the period prior to the date on which the Adjudicating Authority grants its approval under Section 31 could be continued.

[Ghanshyam Mishra and Sons Pvt. Ltd. v. Edelweiss Asset Reconstruction Company Limited, 2021 SCC OnLine SC 313, decided on 13.04.2021]

*Judgment by Justice BR Gavai

Know Thy Judge| Justice B.R. Gavai

For Appellants: Senior Advocates Dr. A.M. Singhvi, Neeraj Kishan Kaul

For respondents: Senior Advocate Gurukrishna Kumar, Advocate Prashant Bhushan

For State Authorities: Advocate V. Shekhar

 

 

Case BriefsSupreme Court

Supreme Court: The Division Bench of Rohinton Fali Nariman* and B.R. Gavai, JJ., addressed the instant appeal involving the question that whether an insolvency proceedings could be initiated after the winding up application had been admitted under the Companies Act. The Bench stated,

“…every effort should be made to resuscitate the corporate debtor in the larger public interest, which includes not only the workmen of the corporate debtor, but also its creditors and the goods it produces in the larger interest of the economy of the country.”

The Appellant was an operational creditor of Respondent 2, Shree Ram Urban Infrastructure Limited (SRUIL). A winding up petition was filed by the respondent 3 herein, Action Barter Pvt. Ltd. against SRUIL, stood admitted on 05.10.2016, due to failure of SRUIL and subsequently, the physical possession of the assets of the company was taken over by the provisional liquidator.

Meanwhile, Indiabulls, a secured creditor of the company, filed an application to realise its security outside such winding up proceeding, which had been allowed by the Company judge and the Provisional Liquidator was directed to handover possession of the Mortgaged Property of the company to Indiabulls. Though, it had been directed that Indiabulls should conduct the sale of the property in consultation with the Official Liquidator. The property was sold and the said sale was challenged by the provisional liquidator in the Bombay High Court, alleging that the conditions of the order were flouted, and that what was sold was much more than what was mortgaged to the secured creditor, and that too at a gross undervalue.  The said representation by the provisional liquidator is still pending in the Court.

Additionally, the respondent 1, SREI Equipment Finance Ltd. (SREI) filed a petition under Section 7 of the IBC before the NCLT, which petition was admitted by the NCLT. In the instant case the appellant was contesting that the petition under Section 7 of the IBC would have to be held to be non-maintainable that no suit or other legal proceeding can be initiated once there is admission of a winding up petition. The appellant argued that post admission of a winding up petition; no petition under Section 7 of the IBC could be filed. It was also contended that the fact that the company was under winding up had been suppressed in the petition filed under Section 7 of the IBC.

In Swiss Ribbons (P) Ltd. v. Union of India, (2019) 4 SCC 17, it was held that, “the IBC is a special statute dealing with revival of companies that are in the red, winding up only being resorted to in case all attempts of revival fail. Vis-à-vis the Companies Act, which is a general statute dealing with companies, including companies that are in the red, the IBC is not only a special statute which must prevail in the event of conflict, but has a non-obstante clause contained in Section 238, which makes it even clearer that in case of conflict, the provisions of the IBC will prevail.”

Relying on the decision in Forech (India) Ltd. v. Edelweiss Assets Reconstruction Co. Ltd., (2019) 18 SCC 549, the Bench stated, in a situation in which notice had been issued in a winding up petition the said petition could be transferred to the NCLT, wherein it would be treated as a proceeding under the IBC. The Bench stated, a conspectus of the aforesaid authorities would show that a petition either under Section 7 or Section 9 of the IBC is an independent proceeding which is unaffected by winding up proceedings that may be filed qua the same company.

Given the object sought to be achieved by the IBC, it is clear that only where a company in winding up is near corporate death that no transfer of the winding up proceeding would then take place to the NCLT to be tried as a proceeding under the IBC.

The Bench stated, it is settled law that a secured creditor stands outside the winding up and can realise its security dehors winding up proceedings. Relying on S. 230(1) of the Companies Act, 2013, the Bench expressed that a compromise or arrangement is admissible in law in an IBC proceeding if liquidation is ordered.

In Food Controller v. Cork, (1923) A.C. 647, it had been explained that;

“The phrase ‘outside the winding up’ is an intelligible phrase if used, as it often is, with reference to a secured creditor, say a mortgagee. The mortgagee of a company in liquidation is in a position to say “the mortgaged property is to the extent of the mortgage my property. It is immaterial to me whether my mortgage is in winding up or not. I remain outside the winding up” and shall enforce my rights as mortgagee. This is to be contrasted with the case in which such a creditor prefers to assert his right, not as a mortgagee, but as a creditor. He may say ‘I will prove in respect of my debt’. If so, he comes into the winding up”.

The Bench expressed, that corporate death is inevitable, every effort should be made to resuscitate the corporate debtor in the larger public interest, which includes not only the workmen of the corporate debtor, but also its creditors and the goods it produces in the larger interest of the economy of the country.

Once a winding up petition is admitted, the winding up petition should not trump any subsequent attempt at revival of the company through a Section 7 or Section 9 petition filed under the IBC.

Consequently, though no application for transfer of the winding up proceeding pending in the Bombay High Court has been filed, the High Court had itself, directed the provisional liquidator to hand over the records and assets of SRUIL to the resolution professional (IRP) in the Section 7 proceeding that is pending before the NCLT.

In the light of above, the Bench held that any “suppression” of the winding up proceeding would, therefore, not be of any effect in deciding a Section 7 petition on the basis of the provisions contained in the IBC. Hence, the appeal was dismissed.

[A. Navinchandra Steels (P) Ltd. v. SREI Equipment Finance Ltd., 2021 SCC OnLine SC 149, decided on 01-03-2021]

Kamini Sharma, Editorial Assistant has put this story together 

*Judgment by: Justice Rohinton Fali Nariman

Know Thy Judge| Justice Rohinton F. Nariman

Appearance before the Court:

For the appellant: Sr. Adv. Abhishek Manu Singhvi and Sr. Adv. Ranjit Kumar,

For SREI: Adv. Abhijeet Sinha,

Case BriefsSupreme Court

Supreme Court: The bench of Dr. DY Chandrachud* and MR Shah, JJ has held that under Insolvency and Bankruptcy Code, 2016 (IBC), NCLT has jurisdiction to adjudicate disputes which arise solely from or which relate to the insolvency of the Corporate Debtor. The Court, however, issued a note of caution to the NCLT and NCLAT to ensure that “they do not usurp the legitimate jurisdiction of other courts, tribunals and fora when the dispute is one which does not arise solely from or relate to the insolvency of the Corporate Debtor. The nexus with the insolvency of the Corporate Debtor must exist.”

Jurisdiction of the NCLT/NCLAT over contractual disputes

“NCLT owes its existence to statute. The powers and functions which it exercises are those which are conferred upon it by law, in this case, the IBC.”

The NCLT has been constituted under Section 408 of the Companies Act, 2013 ―to exercise and discharge such powers and functions as are, or may be, conferred on it by or under this Act or any other law for the time being in force.

Sub-section (1) of Section 60 provides the NCLT with territorial jurisdiction over the place where the registered office of the corporate person is located. NCLT shall be the adjudicating authority ―in relation to insolvency resolution and liquidation for corporate persons including corporate debtors and personal guarantors.

The institutional framework under the IBC contemplated the establishment of a single forum to deal with matters of insolvency, which were distributed earlier across multiple fora. In the absence of a court exercising exclusive jurisdiction over matters relating to insolvency, the corporate debtor would have to file and/or defend multiple proceedings in different fora. These proceedings may cause undue delay in the insolvency resolution process due to multiple proceedings in trial courts and courts of appeal.

“A delay in completion of the insolvency proceedings would diminish the value of the debtor‘s assets and hamper the prospects of a successful reorganization or liquidation. For the success of an insolvency regime, it is necessary that insolvency proceedings are dealt with in a timely, effective and efficient manner.”

Residuary jurisdiction of the NCLT under section 60(5)(c)

The residuary jurisdiction conferred by statute may extend to matters which are not specifically enumerated under a legislation. While a residuary jurisdiction of a court confers it wide powers, its jurisdiction cannot be in contravention of the provisions of the concerned statute.

The residuary jurisdiction of the NCLT under Section 60(5)(c) of the IBC provides it a wide discretion to adjudicate questions of law or fact arising from or in relation to the insolvency resolution proceedings.

“If the jurisdiction of the NCLT were to be confined to actions prohibited by Section 14 of the IBC, there would have been no requirement for the legislature to enact Section 60(5)(c) of the IBC. Section 60(5)(c) would be rendered otiose if Section 14 is held to be the exhaustive of the grounds of judicial intervention contemplated under the IBC in matters of preserving the value of the corporate debtor and its status as a ‘going concern’. “

Ruling on facts 

In the present case, NCLT stayed the termination by the Gujarat Urja Vikas Nigam Limited of its Power Purchase Agreement (PPA) with Astonfield Solar (Gujarat) Private Limited on the ground of insolvency. The order of the NCLT was passed in applications moved by the Resolution Professional of the Corporate Debtor and Exim Bank under Section 60(5) of the Insolvency and Bankruptcy Code, 2016. On 15 October 2019, the NCLAT dismissed the appeal by Gujarat Urja Vikas Nigam Limited under Section 61 of the IBC.

The PPA was terminated solely on the ground of insolvency, since the event of default contemplated under Article 9.2.1(e) was the commencement of insolvency proceedings against the Corporate Debtor. Hence, the NCLT was empowered to restrain the appellant from terminating the PPA. In the absence of the insolvency of the Corporate Debtor, there would be no ground to terminate the PPA. The termination is not on a ground independent of the insolvency. The present dispute solely arises out of and relates to the insolvency of the Corporate Debtor.

“The PPA has been terminated solely on the ground of insolvency, which gives the NCLT jurisdiction under Section 60(5)(c) to adjudicate this matter and invalidate the termination of the PPA as it is the forum vested with the responsibility of ensuring the continuation of the insolvency resolution process, which requires preservation of the Corporate Debtor as a going concern. In view of the centrality of the PPA to the CIRP in the unique factual matrix of this case, this Court must adopt an interpretation of the NCLT‘s residuary jurisdiction which comports with the broader goals of the IBC.”

The Court further explained that the adjudication of disputes that arise dehors the insolvency of the Corporate Debtor, the RP must approach the relevant competent authority. For instance, if the dispute in the present matter related to the non-supply of electricity, the RP would not have been entitled to invoke the jurisdiction of the NCLT under the IBC. However, since the dispute in the present case has arisen solely on the ground of the insolvency of the Corporate Debtor, NCLT is empowered to adjudicate this dispute under Section 60(5)(c) of the IBC.

The Court took further care to clarify that,

“Judicial intervention should not create a fertile ground for the revival of the regime under section 22 of SICA which provided for suspension of wide-ranging contracts. Section 22 of the SICA cannot be brought in through the back door. The basis of our intervention in this case arises from the fact that if we allow the termination of the PPA which is the sole contract of the Corporate Debtor, governing the supply of electricity which it generates, it will pull the rug out from under the CIRP, making the corporate death of the Corporate Debtor a foregone conclusion.”

Conclusion

“NCLT‘s jurisdiction shall always be circumscribed by the supervisory role envisaged for it under the IBC, which sought to make the process driven by trained resolution professionals.”

The jurisdiction of the NCLT under Section 60(5)(c) of the IBC cannot be invoked in matters where a termination may take place on grounds unrelated to the insolvency of the corporate debtor. Even more crucially, it cannot even be invoked in the event of a legitimate termination of a contract based on an ipso facto clause, if such termination will not have the effect of making certain the death of the corporate debtor. As such, in all future cases, NCLT would have to be wary of setting aside valid contractual terminations which would merely dilute the value of the corporate debtor, and not push it to its corporate death by virtue of it being the corporate debtor‘s sole contract.

Section 60(5)(c) of the IBC vests the NCLT with wide powers since it can entertain and dispose of any question of fact or law arising out or in relation to the insolvency resolution process. However,

“NCLT‘s residuary jurisdiction, though wide, is nonetheless defined by the text of the IBC. Specifically, the NCLT cannot do what the IBC consciously did not provide it the power to do.”

The Court, however, made it clear that it’s finding on the validity of the exercise of residuary power by the NCLT is premised on the facts of the case at hand and that it was not laying down a general principle on the contours of the exercise of residuary power by the NCLT. However, it is pertinent to mention that the NCLT cannot exercise its jurisdiction over matters dehors the insolvency proceedings since such matters would fall outside the realm of IBC.

[Gujarat Urja Vikas Nigam Limited v. Amit Gupta,  2021 SCC OnLine SC 194, decided on 08.03.2021]

*Judgment by: Justice Dr. DY Chandrachud

Know Thy Judge| Justice Dr. DY Chandrachud

Appearances before the Court by”

For appellant: Senior Advocate Shyam Diwan and Advocate Ranjitha Ramachandran

For Respondent: Senior Advocate C U Singh and Nakul Dewan

Case BriefsTribunals/Commissions/Regulatory Bodies

National Company Law Appellate Tribunal (NCLAT): The Division Bench of Justice Bansi Lal Bhat (Acting Chairperson) and Dr Ashok Kumar Mishra (Technical Member) observed that:

“I&B Code would not permit the Adjudicating Authority to make a roving enquiry into the aspect of solvency or insolvency of the Corporate Debtor except to the extent of the Financial Creditors or the Operational Creditors, who sought triggering of Corporate Insolvency Resolution Process.”

Present appeal has been heard in ex-parte.

Bench notes that the application of appellant filed under Section 9 of the Insolvency and Bankruptcy Code, 2016 has not been admitted or rejected by the Adjudicating Authority (NCLT, Bengaluru Bench).

Adjudicating Authority disposed of the application directing the respondent to make endeavours for resolution in respect of outstanding debt, failing which the appellant would be at liberty to invoke the arbitration clause contained in the Agreement.

The above finding of the Adjudicating Authority was found to be unique and not in conformity with the provisions embodied in Section 9 (5) of the I&B Code, hence cannot be supported.

Section 9(5) of the I&B Code, 2016:

“9(5) The Adjudicating Authority shall, within fourteen days of the receipt of the application under sub-section (2), by an order—

(i) admit the application and communicate such decision to the operational creditor and the corporate debtor if,—

(a) the application made under sub-section (2) is complete;

(b) there is no repayment of the unpaid operational debt;

(c) the invoice or notice for payment to the corporate debtor has been delivered by the operational creditor;

(d) no notice of dispute has been received by the operational creditor or there is no record of dispute in the information utility; and

(e) there is no disciplinary proceeding pending against any resolution professional proposed under sub-section (4), if any.

  1. ii) reject the application and communicate such decision to the operational creditor and the corporate debtor, if—

(a) the application made under sub-section (2) is incomplete;

(b) there has been repayment of the unpaid operational debt;

(c) the creditor has not delivered the invoice or notice for payment to the corporate debtor;

(d) notice of dispute has been received by the operational creditor or there is a record of dispute in the information utility; or

(e) any disciplinary proceeding is pending against any proposed resolution professional:

Provided that Adjudicating Authority, shall before rejecting an application under sub-clause (a) of clause (ii) give a notice to the applicant to rectify the defect in his application within seven days of the date of receipt of such notice from the adjudicating Authority.”

The above provision abundantly makes it clear that the Adjudicating Authority has only two options, either to admit Application or to reject the same. No third option or course is postulated by law.

Appellant’s counsel invited Tribunal’s attention to the fact that the Adjudicating Authority took note of the fact that the respondent did not respond to the Demand Notice, demanding the outstanding amount in respect of the four invoices noticed in the impugned order.

Further another point was brought in from the impugned order wherein it was observed that mere acceptance of the debt in question by the Respondent would not automatically entitle the Appellant to invoke the provisions of the Code, unless the debt and default is undisputed and proved to the satisfaction of the Adjudicating Authority.

Bench in view of the above expressed that the Adjudicating Authority should have, in absence of any dispute contemplated under Section 8(2) having been raised by the Respondent as a pre-existing dispute or that the claim of Appellant had been satisfied, proceeded to admit the Application, as no dispute had been raised before it, justifying its disinclination to admit the Application.

We cannot understand as to how the availability of alternate remedy would render the debt and default disputed.

Tribunal further added to its reasoning that

In absence of pre-existing dispute having been raised by the Corporate Debtor or it being demonstrated that a suit or arbitration was pending in respect of the operational debt, in respect whereof Corporate Debtor was alleged to have committed default, the Adjudicating Authority would not be justified in drawing a conclusion in respect of there being dispute as regards debt and default merely on the strength of an Agreement relied upon by the Appellant.

Adjudicating Authority clearly landed in error by observing that the course adopted by it was warranted on the principle of ease of doing business, ignoring the fact that such course was not available to it, ease of doing business only being an objective of the legislation.

Hence, while allowing the appeal and setting aside the impugned order, Tribunal directed the Adjudicating Authority to pass an order of admission. [Sodexo India Service (P) Ltd. v. Chemizol Additives (P) Ltd., 2021 SCC OnLine NCLAT 18, decided on 22-02-2021]

Case BriefsSupreme Court

Supreme Court: The bench of Dr. DY Chandrachud* and MR Shah, JJ has held that there is nothing wrong with the bar imposed under Section 10A of Insolvency and Bankruptcy Code, 2016 on the filing of applications for the commencement of the CIRP in respect of a corporate debtor for a default occurring on or after 25 March 2020 retrospectively to application filed before June 5, 2020.

ISSUE

Whether the provisions of Section 10A stand attracted to an application under Section 9 which was filed before 5 June 2020 (the date on which the provision came into force) in respect of a default which has occurred after 25 March 2020?

ARGUMENTS

By appellant

(i) Section 10A creates a bar to the ‘filing of applications’ under Sections 7, 9 and 10 in relation to defaults committed on or after 25 March 2020 for a period of six months, which can be extended up to one year;

(ii) The Ordinance and the Act which replaced it do not provide for the retrospective application of Section 10A either expressly or by necessary implication to applications which had already been filed and were pending on 5 June 2020;

(iii) Section 10A prohibits the filing of a fresh application in relation to defaults occurring on or after 25 March 2020, once Section 10A has been notified (i.e., after 5 June 2020);

(iv) Section 10A uses the expressions “shall be filed” and “shall ever filed” which are indicative of the prospective nature of the statutory provision in its application to proceedings which were initiated after 5 June 2020; and

(v) The IBC makes a clear distinction between the “initiation date” under Section 5(11) and the “insolvency commencement date” under Section 5(12).

(vi) In each case it is necessary for the Court and the tribunals to deduce as to whether the cause of financial distress is or is not attributable to the Covid-19 pandemic.

By Respondent

(i) The legislative intent in the insertion of Section 10A was to deal with an extraordinary event, the outbreak of Covid-19 pandemic, which led to financial distress faced by corporate entities;

(ii) Section 10A is prefaced with a non-obstante clause which overrides Sections 7, 9 and 10; and 9

(iii) Section 10A provides a cut-off date of 25 March 2020 and it is evident from the substantive part of the provision, as well as from the proviso and the explanation, that no application can be filed for the initiation of the CIRP for a default occurring on and after 25 March 2020, for a period of six months or as extended upon a notification.

PROVISION IN QUESTION

Section 10A is prefaced with a non-obstante provision which has the effect of overriding Sections 7, 9 and 10. Section 10A provides that:

(i) no application for the initiation of the CIRP by a corporate debtor shall be filed;

(ii) for any default arising on or after 25 March 2020; and

(iii) for a period of six months or such further period not exceeding one year from such date as may be notified in this behalf.

The proviso to Section 10A stipulates that “no application shall ever be filed” for the initiation of the CIRP of a corporate debtor “for the said default occurring during the said period”. The explanation which has been inserted for the removal of doubts clarifies that Section 10A shall not apply to any default which has been committed under Sections 7, 9 and 10 before 25 March 2020.

WHAT THE SUPREME COURT SAID

“The correct interpretation of Section 10A cannot be merely based on the language of the provision; rather it must take into account the object of the Ordinance and the extraordinary circumstances in which it was promulgated.”

Going into the legislative intent, the Court noticed that the date of 25 March 2020 has consciously been provided by the legislature in the recitals to the Ordinance and Section 10A, since it coincides with the date on which the national lockdown was declared in India due to the onset of the Covid-19 pandemic.

The Ordinance and the Amending Act enacted by Parliament, adopt 25 March 2020 as the cut-off date.

  • The proviso to Section 10A stipulates that “no application shall ever be filed” for the initiation of the CIRP “for the said default occurring during the said period”.
  • The expression “shall ever be filed” is a clear indicator that the intent of the legislature is to bar the institution of any application for the commencement of the CIRP in respect of a default which has occurred on or after 25 March 2020 for a period of six months, extendable up to one year as notified.
  • The explanation which has been introduced to remove doubts places the matter beyond doubt by clarifying that the statutory provision shall not apply to any default before 25 March 2020. The substantive part of Section 10A is to be construed harmoniously with the first proviso and the explanation.

Reading the provisions together, the Court noticed that the Parliament intended to impose a bar on the filing of applications for the commencement of the CIRP in respect of a corporate debtor for a default occurring on or after 25 March 2020; the embargo remaining in force for a period of six months, extendable to one year. Therefore,

“Acceptance of the submission of the appellant would defeat the very purpose and object underlying the insertion of Section 10A. For, it would leave a whole class of corporate debtors where the default has occurred on or after 25 March 2020 outside the pale of protection because the application was filed before 5 June 2020.”

The Court, however, noticed that the retrospective bar on the filing of applications for the commencement of CIRP during the stipulated period does not extinguish the debt owed by the corporate debtor or the right of creditors to recover it.

Section 10A does not contain any requirement that the Adjudicating Authority must launch into an enquiry into whether, and if so to what extent, the financial health of the corporate debtor was affected by the onset of the Covid-19 pandemic.

“Parliament has stepped in legislatively because of the widespread distress caused by an unheralded public health crisis. It was cognizant of the fact that resolution applicants may not come forth to take up the process of the resolution of insolvencies (…), which would lead to instances of the corporate debtors going under liquidation and no longer remaining a going concern.”

Hence, the embargo contained in Section 10A must receive a purposive construction which will advance the object which was sought to be achieved by enacting the provision.

The Court further explained that the date of the initiation of the CIRP is the date on which a financial creditor, operational creditor or corporate applicant makes an application to the adjudicating authority for initiating the process. On the other hand, the insolvency commencement date is the date of the admission of the application.

To explain this further, the Court referred to the NCLAT’s order which stated that while ‘initiation date’ is referable to filing of application by the eligible applicant, ‘commencement date’ refers to passing of order of admission of application by the Adjudicating Authority.

“The ‘initiation date’ ascribes a role to the eligible applicant whereas the ‘commencement date rests upon exercise of power vested in the Adjudicating Authority. Adopting this interpretation would leave no scope for initiation of CIRP of a Corporate Debtor at the instance of eligible applicant in respect of Default arising on or after 25th March, 2020 as the provision engrafted in Section 10A clearly bars filing of such application by the eligible applicant for initiation of CIRP of Corporate Debtor in respect of such default.”

NCLAT had also noted that the bar created is retrospective as the cut-off date has been fixed as 25th March, 2020 while the newly inserted Section 10A introduced through the Ordinance has come into effect on 5th June, 2020.

“The object of the legislation has been to suspend operation of Sections 7, 9 & 10 in respect of defaults arising on or after 25th March, 2020 i.e. the date on which Nationwide lockdown was enforced disrupting normal business operations and impacting the economy globally. Indeed, the explanation removes the doubt 19 by clarifying that such bar shall not operate in respect of any default committed prior to 25th March, 2020.”

[Ramesh Kymal v. Siemens Gamesa Renewable Power Pvt Ltd, 2021 SCC OnLine SC 72, decided on 09.02.2021]

*Judgment by: Justice Dr. DY Chandrachud

Appearances before the Court by

For appellant: Senior Advocate Neeraj Kishan Kaul

For respondent: Senior Advocate Gopal Jain

Op EdsOP. ED.

Bilateral Netting of Qualified Financial Contracts Act was introduced in the Parliament and received the parliamentary assent on 28-09-2020 and was made effective from 1-10-2020; it is also known as the Netting Act. This Act was created by the Parliament in order to reduce the credit risk exposure and systematic risk prevailing in the financial markets. The purpose of this Act is to “ensure stability and promote competitiveness in Indian financial markets by providing enforceability of bilateral netting of qualified financial contracts and for matters connected therewith or incidental thereto.”[1] The key purpose of the Act is to consolidate, regulate and establish a legal foundation for the bilateral netting of qualified financial contracts, which have been the major instruments of the OTC (over-the-counter) derivatives market in India.

This Act is based on the Model Netting Act created by the ISDA (International Swaps and Derivatives Association) with specific changes and adaptations in compliance with the legal and regulatory system prevailing in India. India has adopted the ISDA’s advisory to take a more flexible and principle-based approach.

Applicability of the Act

If we look at Section 3 of the Act2, it says that this Act will apply to the qualified financial contracts between two qualified financial market participants where one party must be regulated by the specific regulatory authorities mentioned under Schedule I of the Act3.

Key concepts

  • Netting

The term netting is defined under Section 2(1)(j) of the Act as—

“netting” means determination of net claim or obligations after setting off or adjusting all the claims or obligations based or arising from mutual dealings between the parties to qualified financial contracts and includes close-out netting;4

In simple terms, netting allows two parties in a bilateral financial arrangement to balance their charges/claims against each other in order to assess a single net payment due from one party to another in the case of default.

In the absence of a regulatory mechanism for bilateral netting, the banks are required to calculate the credit exposure of the counterparty for the over-the-counter (OTC) derivative contracts on a gross basis rather than on a net basis.

(i) Qualified financial contracts

It is a simple term which means a financial contract which is notified by the appropriate authority.5 The appropriate authority or regulators under the Act6 are:

 “Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), Insurance Regulatory and Development Authority of India (IRDAI), Pension Fund Regulatory and Development Authority (PFRDA), International Financial Services Centres Authority (IFSCA) and through notification, the Central Government can exempt contracts with certain parties or with certain terms from being designated as QFCs.”

(ii) Close-out netting

It is defined under Section 2(1)(e) of the Act as—

“close-out netting” means a process involving termination of obligations under a qualified financial contract with a party in default and subsequent combining of positive and negative replacement values into a single net payable or receivable as set out in Section 6;7

Basically, it gives the party the right to cancel its obligations under the contract and to blend positive and negative substitution amounts in order to determine the net sum payable of receivable. Section 6 of the Act8 talks about the invocation of close-out netting. Under Section 6, the process can be triggered by a party to the QFC in the event of9 (i) default (failure to comply with the obligations of the QFC) by the other party; or (ii) termination, as defined in the netting agreement, which grants either or more parties the right to cancel transactions under the agreement.

(iii) Qualified financial market participant

The authorities to be regarded as qualified financial market participant are defined under Section 2(1)(o) of the Act which is as follows:10

“qualified financial market participant” includes: —

(i) a banking institution, or a non-banking financial company, or such other financial institution which is subject to regulation or prudential supervision by the Reserve Bank of India;

(ii) an individual, partnership firm, company, or any other person or body corporate whether incorporated under any law for the time being in force in India or under the laws of any other country and includes any international or regional development bank or other international or regional organisation;

(iii) an insurance or reinsurance company which is subject to regulation or prudential supervision by the Insurance Regulatory and Development Authority of India established under the Insurance Regulatory and Development Authority Act, 199911;

(iv) a pension fund regulated by the Pension Fund Regulatory and Development Authority established under the Pension Fund Regulatory and Development Authority Act, 201312;

(v) a financial institution regulated by the International Financial Services Centres Authority established under the International Financial Services Centres Authority Act, 201913; and

(vi) any other entity notified by the relevant authority under clause (b) of Section 4;14

As per this sub-section the authorities mentioned under Schedule I of the Act are to be considered as the qualified financial contract participants and any other agency as notified by the appropriate Government under the given Act.

Importance of this law

Previously, when RBI used to set norms for the derivative markets or the qualified financial contracts, it has been regularly observed by the Central Bank that there is certain irregularity or ambiguity in the enforceability of the bilateral netting from the legal perspective.

The existing law would offer a major incentive for productive marginalisation, legislative reforms to RBI and allow financial firms to measure their market worth not on a gross basis but on a net basis.

The interaction of the Act with the Insolvency and Bankruptcy Code, 201615

One of the main benefits of this Act is that it has been granted the authority to circumvent other legislations, especially the Insolvency Code, which creates greater safety netting for the parties. This is made in accordance with the International Swaps and Derivatives Association’s suggestion that the key aim of the netting regulation should be to guarantee the enforceability of a netting arrangement against a party that is subject to insolvency proceedings. Similar guidance is set out in the rules regulating the financial markets dealing with the functioning of the central clearing counterparties. The Model Netting Act created under the shadow of the ISDA also makes a special reference to the cases of the insolvency resolution of the financial institutions and highlights the need to reconcile the goals of netting law with the need to assure that the resolution mechanisms are reliable. However, no specific mention is made under this Act.

If we look previously, the market participants have expressed questions over the unequal netting treatment under various legislations relating to the insolvency of the statutory entities and banking institutions, as opposed to the corporations established under the company law. Other than this, the Act also expressly overrides the rules of such enumerated laws and any legislation by which the market participants i.e. the RBI, SEBI, IRDAI, PFRDA, IFSCA has been incorporated, constituted or governed.

Critical analysis

This law, no doubt is a big government financial initiative, particularly in this pandemic period, when we can only hear stories relating to how our banking system is collapsing in these difficult times. This law will help the financial institutions of the country to participate more freely in the derivative markets or the corporate bonds market. It will not only strengthen the corporate bond market in India but it will help the country to achieve financial stability as it is a tested method which is used by almost all the countries in the world. This Act will offer more funding to the businesses through the purchasing of bonds as they obtain a sense of security through a credit swap contract or a netting agreement.

As said earlier, this Act will give life to the dull Indian corporate bond market. Previously, RBI noted that one of the major reasons for lack of interest in the credit defaults was the restriction on the netting position of the mark on the market for capital adequacy and exposure standards. The modification brought by the Act will make a positive impact on the bond market. However, in my view, the Act will not be in a capacity to transform the dynamics of the corporate bond industry by itself and may need more reforms and changes, including the simplification of the corporate bond operating rules, optimisation of pricing and expanded long-term investor engagement.

The issue which can be attracted in this Act is that this Act says that the contracts which are entered on a multilateral basis with the Securities Contracts (Regulation) Act, 195616 and the Payment and Settlement Systems Act, 200717 are excluded from the preview of the Act.18 As such, these rules deal with netting and settlement in particular cases (i.e. the operation of the stock markets and centralised counterparties, and the payment processes, respectively) and are better served by the exemption of the statute.19

† 4th year student BBA LLB (Hons.) School of Law, UPES.

[1]Preamble, Bilateral Netting of Qualified Financial Contracts Act, 2020

2 http://www.scconline.com/DocumentLink/ozOzrYs7

3 http://www.scconline.com/DocumentLink/JDn3ql97

4 S. 2(1)(j) of Bilateral Netting of Qualified Financial Contracts Act, 2020

5 Id., at S. 2(1)(n).

6 Id., at Sch. 1.

7 Id., at S. 2(1)(e).

8 <http://www.scconline.com/DocumentLink/YO47Q1ui>.

9 Supra note 4 at S. 6.

10 Id., at S. 2(1)(o).

11 <http://www.scconline.com/DocumentLink/Q43JYv8R>.

12 <http://www.scconline.com/DocumentLink/hg37x3r0>.

13 <http://www.scconline.com/DocumentLink/2CW1VS4K>.

14 Supra note 10.

15 <http://www.scconline.com/DocumentLink/86F742km>.

16 <http://www.scconline.com/DocumentLink/8Xj668B0>.

17 <http://www.scconline.com/DocumentLink/Q9aQ21VT>.

18 Supra note 4 at S. 4(a).

19 Supra note 17.

Case BriefsSupreme Court

Supreme Court: The 3-Judge Bench of Rohinton Fali Nariman, Navin Sinha and K.M. Joseph, JJ., in a 465-pages long judgment, upheld the validity of several provisions of the Insolvency and Bankruptcy Code (Amendment) Act, 2020, albeit with directions given in exercise of powers under Article 142 of the Constitution of India. While so upholding the impugned amendments, the Bench expressed an observation that:

“There is nothing like a perfect law and as with all human institutions, there are bound to be imperfections. What is significant is however for the court ruling on constitutionality, the law must present a clear departure from constitutional limits.”

The Challenge

In the instant matter, the petitioners approached the Court calling in question the following Sections of the Insolvency and Bankruptcy Code (Amendment) Act, 2020: Sections 3, 4 and 10.

Section 3 of the impugned amendment, amends Section 7(1) of the Insolvency and Bankruptcy Code, 2016 (“IBC”). It incorporates 3 provisos to Section 7(1).

Section 4 of the impugned amendment, incorporates an additional Explanation in Section 11 (Explanation II) IBC.

Section 10 of the impugned amendment inserts Section 32-A in IBC.

The Petitioners

Majority of the petitioners were the allottees under the real estate projects and they have trained the constitutional gun at the impugned provisos.

Under the second proviso, a new threshold was declared for an allottee to move an application under Section 7 for triggering the insolvency resolution process under IBC. The threshold is the requirement that there should be at least 100 allottees to support the application or 10% of the total allottees whichever is less. Moreover, they should belong to the same project.

Some other petitioners were money lenders, who stepped in to provide finance for the real estate projects. They were also visited with the requirement which is imposed upon them under the first impugned proviso which is on similar lines as those comprised in the second proviso.

Point-wise Discussion & Observations

A. Challenging a Plenary Law

The Court noted the following two contentions urged by some of the petitioners:

A.1. The law was created by way of pandering to the real estate lobby and succumbing to their pressure or by way of placating their vested interests.

In regard with this contention, Court stated that such an argument is nothing but a thinly disguised attempt at questioning the law of the Legislature based on malice. It was observed:

“While malice may furnish a ground in an appropriate case to veto administrative action it is trite that malice does not furnish a ground to attack a plenary law.”

 Reliance was placed on the earlier Supreme Court decisions in K. Nagaraj v. State of A.P., (1985) 1 SCC 523 and State of H.P. v. Narain Singh, (2009) 13 SCC 165.

A.2. Another contention was that, due to its stand before the Court in Pioneer Urban Land and Infrastructure Ltd. v. Union of India, (2019) 8 SCC 416, the supreme legislature was estopped by the principle of promissory estoppel from enacting the impugned enactment.

To this, the Court answered that: “A supreme legislature cannot be cribbed, cabined or confined by the doctrine of promissory estoppel or estoppel. It acts as a sovereign body.“

The theory of promissory estoppel, on the one hand, has witnessed an incredible trajectory of growth but it is incontestable that it serves as an effective deterrent to prevent injustice from a Government or its agencies which seek to resile from a representation made by them, without just cause. Reliance was placed on Union of India v. Godfrey Philips( India) Ltd, (1985) 4 SCC 369.

B. Challenge to newly inserted Provisos in S. 7(1)

Under the impugned provisos inserted in Section 7(1) of the Code, an application by an allottee, can be made only if there are hundred allottees or a number representing one-tenth of the total number of allottees, whichever is less, with a further rider that the allottees must be part of the same real estate project.

B.1. Allottee and Real Estate Project

The Court was of the opinion that the definition of the word “allottee” appears to be split up into three categories broadly, they are- plot, apartment and buildings. In the context of the impugned proviso, in calculating the total number of allottees, the question must be decided with reference to real nature of the real estate project in which the applicant is an allottee. If it is in the case of an apartment, then necessarily all persons to whom allotment had been made would be treated as allottees for calculating the figure mentioned in the impugned proviso. As to what would constitute the “real estate project”, it must depend on the terms and conditions and scope of a particular real estate project in which allottees are a part of. These are factual matters to be considered in the facts of each case.

B.2. Workability of Default

 Since, default can be qua any of the applicants, and even a person, who is not an applicant, and the action is, one which is understood to be in rem, in that, the procedures, under IBC, would bind the entire set of stakeholders, including the whole of the allottees, the Court saw no merit in the contention of the petitioner based on the theory of default, rendering the provisions unworkable and arbitrary.

It was explained that if a law contemplates that the default in a sum of R 1 crore can be towards any financial creditor, even if he is not an applicant, the fact that the debt is barred as against some of the financial creditors, who are applicants, whereas, the application by some others, or even one who have moved jointly, fulfill the requirement of default, both in terms of the sum and it not being barred, the application would still lie.

B.3. Allottees to be from same real estate project: Constitutionality 

The rationale behind confining allottees to the same real estate project is to promote the object of IBC. Once the threshold requirement can pass muster when tested in the anvil of a challenge based on Articles 14, 19 and 21, then, there is both logic and reason behind the legislative value judgment that the allottees who must join the application under the impugned provisos must be related to the same real estate project. If it is to embrace the total number of allottees of all projects, which a Promoter of a real estate project, may be having, it will make the task of the applicant himself more cumbersome.

B.4. Point of time to comply with the Threshold Requirements

There can be no doubt that the requirement of a threshold under the impugned proviso in Section 7(1) must be fulfilled as on the date of the filing of the application. In the matter of presentation of an application under Section 7, if the threshold requirement under the impugned provisos stands fulfilled, the requirement of the law must be treated as fulfilled.

B.5. Holding by family members and joint holdings: Whether Single Allottee

 In the case of a joint allotment of an apartment, plot or a building to more than one person, the allotment can only be treated as a single allotment. This for the reason that the object of the Statute, admittedly, is to ensure that there is a critical mass of persons (allottees), who agree that the time is ripe to invoke IBC and to submit to the inexorable processes under IBC, with all its attendant perils.

B.6. No power of waiver to Central Government unlike in Companies Act

 Section 399(4) of the Companies Act, 1956, empowers the Central Government to waive certain requirements allowing applicants to approach the Tribunal, if found just and equitable.

However, the scheme of IBC is unique and its objects are vividly different from that of the Companies Act. Consequently, if the Legislature felt that threshold requirement representing a critical mass of allottees alone would satisfy the requirement of a valid institution of an application under Section 7, it cannot be dubbed as either discriminatory or arbitrary.

B.7. Or. 1 R. 8 CPC and S. 12, Consumer Protection Act

Under Order 1 Rule 8 CPC, where there are numerous persons having the same interest in one suit, one or more such persons can, with the permission of the court, sue or be sued or may defend such suit on behalf of or for the benefit of all persons so interested, at the instance of a single person with whom numerous persons share the same interest. Similar is the provision of Section 12 of the Consumer Protection Act, 1986.

However, it is important to not be oblivious to the scheme of IBC and to distinguish it from a civil suit laid invoking Order 1 Rule 8 or the consumer complaint presented by one consumer, sharing the same interest with numerous others. As to whether the procedure contemplated in Order I Rule 8 is suitable, more appropriate and even more fair, is a matter, entirely in the realm of legislative choice and policy.

“Invalidating a law made by a competent Legislature, on the basis of what the Court may be induced to conclude, as a better arrangement or a more wise and even fairer system, is constitutionally impermissible. If, the impugned provisions are otherwise not infirm, they must pass muster.”

 B.8. The Pioneer judgment: Are amendments violative of it

In Pioneer Urban Land and Infrastructure Ltd. v. Union of India, (2019) 8 SCC 416, certain amendments to IBC were challenged. The challenged provisions included the Explanation added to Section 5(8)(f).

After culling out the findings of the Court in the Pioneer judgment, the Court opined that the impugned provisos do not set at naught the ruling in Pioneer judgment. In a challenge by real estate developers upholding the provisions in the manner done including the Explanation in Section 5(8)(f) and allaying the apprehension about abuse by individual allottees cannot detract from the law giver amending the very law on its understanding of the working of IBC at the instance of certain groups of applicants and impact it produces on the economy and the frustration of the sublime goals of the law.

B.9. Information Asymmetry

 It was contended that the information relating to allottees in respect of real estate projects and the debenture holders and security holders in regard to the first proviso is not available, which makes it arbitrary and unworkable.

On this, the Court noted that as far as allottees are concerned in regard to apartments and plots, Section 11(1)(b) of the RERA makes it mandatory for the promoter to make available information regarding the bookings. The Court conflated bookings with allotments. Further, the Association of allottees has to be formed under the mandate of the law it is expected to play an important role. It was stated:

“The law giver has therefore created a mechanism, namely, the association of allottees through which the allottees are expected to gather information about the status of the allotments including the names and addresses of the allottees.”

Similarly, contention regarding non-availability of information regarding debenture holders and security holders was turned down in view of statutory mechanism comprised in the provisions of the Companies Act 2013, namely Section 88.

B.10. The first and second provisos classification

The petitioners emphasised the principle that the object itself cannot be discriminate. It was pointed out that the object in the case of impugned provisos between different sections of financial creditors is such discrimination. Further, the corporate debtors are discriminated again in that builders are accorded special treatment qua other corporate debtors.

Following a plethora of judicial precedents, the Court concluded that:

“It is clear that the law does not interdict the creation of a class within a class absolutely. Should there be a rational basis for creating a sub-class within a class, then, it is not impermissible.”

It was noted that allottees are indeed financial creditors. They do possess certain characteristics, however, which appear to have appealed to the Legislature as setting them apart from the generality of financial creditors. These features are: (i) Numerosity; (ii) Heterogeneity; (iii) Individuality in decision making.

“In the case of the allottees of a real estate project, it is the approach of the Legislature that in a real estate project there would be large number of allottees. There can be hundreds or even thousands of allottees in a project. If a single allottee, as a financial creditor, is allowed to move an application under Section 7, the interests of all the other allottees may be put in peril. This is for the reason that as stakeholders in the real estate project, having invested money and time and looking forward to obtaining possession of the flat or apartment and faced with the same state of affairs as the allottee, who moves the application under Section 7 IBC, the other allottees may have a different take of the whole scenario.”

It was added that some of them may approach the Authority under the RERA. Others may, instead, resort to the fora under the Consumer Protection Act, though, the remedy of a civil suit is, no doubt, not ruled out. In such circumstances, if the Legislature, taking into consideration, the sheer numbers of a group of creditors, viz., the allottees of real estate projects, finds this to be an intelligible differentia, which distinguishes the allottees from the other financial creditors, who are not found to possess the characteristics of numerosity, then, it is not for the Court to sit in judgment over the wisdom of such a measure.

“This is not a case where there is no intelligible differentia. The law under scrutiny is an economic measure. As laid down by this Court, in dealing with the challenge on the anvil of Article 14, the Court will not adopt a doctrinaire approach.”

 B.11. Allottees v. Operational Creditors

One of the contentions raised by petitioners was as regards the hostile discrimination between petitioner (allottees) and operational creditors. The advantages which financial creditor have over operational creditors was referred to.

The Court was of the view that as far as the argument relating to violation of Article 14 qua operational creditor was concerned, there is no merit in the same. Quite apart from the fact that under IBC they are dealt with under different provisions and a different procedure is entailed thereunder, even the earlier decisions have treated the financial creditor differently from the operational creditor. Reliance was placed on Innoventive Industries Ltd. v. ICICI Bank, (2018) 1 SCC 407; Swiss Ribbons (P) Ltd. v. Union of India, (2019) 4 SCC 17 and Pioneer Urban Land and Infrastructure Ltd. v. Union of India, (2019) 8 SCC 416. It was observed:

“While it may be true that the allottee is not a secured creditor and he is not in the position of a bank or the financial institution, the contentions of the petitioners that there is hostile discrimination forbidden (under) Article 14 is untenable. There cannot be any doubt that intrinsically a financial creditor and an operational creditor are distinct.”

It was noted that it is not a case where the right of the allottee is completely taken away. All that has happened is a half-way house is built between extreme positions, viz., denying the right altogether to the allottee to move the application under Section 7 IBC and giving an unbridled license to a single person to hold the real estate project and all the stakeholders thereunder hostage to a proceeding under IBC which must certainly pass inexorably within a stipulated period of time should circumstances exists under Section 33 into corporate death with the unavoidable consequence of all allottees and not merely the applicant under Section 7 being visited with payment out of the liquidation value, the amounts which are only due to the unsecured creditor.

C. Challenge to newly inserted Explanation II to S. 11

It was contended that an Explanation cannot modify the main provision to which it is an Explanation. Section 11(a) and Section 11(b) unequivocally bar a Corporate Debtor from filing a Corporate Insolvency Resolution Process application qua another Corporate Debtor under Section 7 and Section 9 IBC. It was complained that the label of an Explanation has been used to substantially amend, which is an arbitrary and irrational exercise of power.

It was pointed out that the word “includes” in Explanation I to Section 11 would indicate that an Application for CIRP is barred not only against itself but also against any other Corporate Debtor when the applicant-Corporate Debtor is found placed in circumstances expressed in Section 11. If the purport of  Explanation II, which was impugned, is that the intention of the law was to only bar an Application for CIRP by a Corporate Debtor against itself, then, it will be unworkable and practically impossible. Explanation II, it was contended, is manifestly arbitrary. It was further contended that the amendment cannot be used retrospectively and take away the vested right.

Dealing with this challenge, the Court analysed the limbs of Section 11 and  Explanation I. Then finally coming to Explanation II, it was opined that The intention of the Legislature was always to target the corporate debtor only insofar as it purported to prohibit application by the corporate debtor against itself, to prevent abuse of the provisions of IBC. It could never had been the intention of the Legislature to create an obstacle in the path of the corporate debtor, in any of the circumstances contained in Section 11, from maximizing its assets by trying to recover the liabilities due to it from others. It was further held:

“The provisions of the impugned Explanation II, thus, clearly amount to a clarificatory amendment. A clarificatory amendment, it is not even in dispute, is retrospective in nature.”

D. Challenge to newly inserted S. 32-A

It was contended that the immunity granted to the corporate debtors and its assets acquired from the proceeds of crimes and any criminal liability arising from the offences of the erstwhile management for the offences committed prior to initiation of CIRP and approval of the resolution plan by the adjudicating authority further jeopardizes the interest of the allottees/creditors. It will cause huge losses which is sought to be prevented under the provisions of the Prevention of Money Laundering Act, 2002. Section 32-A, it was argued, is therefore arbitrary, ultra vires and violative of Article 300-A and Articles 14, 19 and 21.

Answering this, the Court was of the clear view that no case whatsoever is made out to seek invalidation of Section 32-A. The boundaries of the Court’s jurisdiction are clear. The wisdom of the legislation is not open to judicial review. It was observed:

“The provision is carefully thought out. It is not as if the wrongdoers are allowed to get away. They remain liable. The extinguishment of the criminal liability of the corporate debtor is apparently important to the new management to make a clean break with the past and start on a clean slate.”

Further, it was stated that it must be remembered that the immunity is premised on various conditions being fulfilled. In Court’s opinion, there was no basis at all to impugn the Section on the ground that it violates Articles 19, 21 or 300A.

E. Restrospectivity in third proviso to S. 7 and effect on vested rights

The third proviso is a one-time affair. It is intended only to deal with those applications, under Section 7, which were filed prior to 28.12.2019. In other words, the legislative intention was to ensure that no application under Section 7 could be filed after 28.12.2019, except upon complying with the requirements in the first and second provisos. The Legislature did not stop there. It has clearly intended that the threshold requirement it imposed, will apply to all those applications, which were filed, prior to 28.12.2019 as well, subject to the exception that the applications, so filed, had not been admitted, under Section 7(5).

The Court considered, whether the right under the unamended Section 7 was a vested right of the financial creditors or allottees covered by the provisos 1 and 2, respectively.

It was the Court’s view that there is a right which is vested in the cases where, the petitioners have filed application, fulfilling the requirements under unamended Section 7 of IBC. The very act of filing the application, even satisfies the apparent test propounded by the Additional Solicitor General, that the right under Section 7 is only one to take advantage of the statute and unless advantage is actually availed it does not create an accrued right. When applications were filed under the unamended provisions of Section 7, at any rate it would transform into a vested right. The vested right is to proceed with the action till its logical and legal conclusion.

It was noted, every sovereign Legislature is clothed with competence to make retrospective laws. It is open to the Legislature, while making retrospective law, to take away vested rights. If a vested right can be taken away by a retrospective law, there can be no reason why the Legislature cannot modify the vested rights.

During the course of discussion, it was also noted that imposing the threshold requirement under the third proviso, is not a mere matter of procedure. It impairs vested rights. It has conditioned the right instead, in the manner provided in the first and the second proviso. The Court already upheld the first and second proviso, which, in fact, operates only in the future. In that sense, the Legislature has purported to equate persons who had not filed applications with persons like the petitioners who had filed the applications under the unamended law.

Lastly, the Court discussed certain factors including clarity regarding “withdrawal” under the third proviso, as also the question of court fees. Analysing such points, the Court finally passed certain directions.

Conclusion & Relief

The Court upheld the impugned amendments, albeit subject to certain directions issued under Article 32 of the Constitution:

(i) If any of the petitioners move applications in respect of the same default, as alleged in their applications, within a period of two months from today, also compliant with either the first or the second proviso under Section 7(1), as the case may be, then, they will be exempted from the requirement of payment of court fees, in the manner, which we have detailed in the paragraph just herein before.

(ii) If applications are moved under Section 7 by the petitioners, within a period of two months from today, in compliance with either of the provisos, as the case may be, and the application would be barred under Article 137 of the Limitation Act, on the default alleged in the applications, which were already filed, if the petitioner file applications under Section 5 of the Limitation Act, the period of time spent before the Adjudicating Authority, the Adjudicating Authority shall allow the applications and the period of delay shall be condoned in regard to the period, during which, the earlier applications filed by them, which is the subject matter of the third proviso, was pending before the Adjudicating Authority.

(iii) The time limit of two months is fixed only for conferring the benefits of exemption from court fees and for condonation of the delay caused by the applications pending before the Adjudicating Authority. In other words, it is always open to the petitioners to file applications, even after the period of two months and seek the benefit of condonation of delay under Section 5 of the Limitation Act, in regard to the period, during which, the applications were pending before the Adjudicating Authority, which were filed under the unamended Section 7, as also thereafter. [Manish Kumar v. Union of India, 2021 SCC OnLine SC 30, dated 19-01-2021]

Op EdsOP. ED.

Vide an Ordinance dated 05.06.2020[1], the Government of India suspended the operation of Sections 7, 9 and 10 of the Insolvency and Bankruptcy Code, 2016 (‘IBC, 2016’) with a view to shield corporates from fresh insolvency actions, citing economic slowdown on account of the COVID-19 pandemic (‘the Ordinance’). The move ensured that corporates in India could not be dragged to insolvency courts for any default in re-payment of debt which occurred after 25.03.2020. The suspension of fresh insolvency actions for defaults which occurred after 25.03.2020 was initially for a period of six months (with effect from 25.03.2020), and has been extended for another three months with effect from 25.09.2020 vide  Notification dated 24.09.2020.

Introduced as a tool to help small businesses survive during the COVID-19 pandemic, the Ordinance dated 05.06.2020 attributed reasons such as:

(i) uncertainty and stress for business for reasons beyond their control;

(ii)difficulty to find adequate number of resolution applicants to rescue the corporate person who may default in discharge of their debt obligations;

(iii)expediency to exclude the defaults arising on account of unprecedented situation for the purposes of insolvency proceeding under this Code etc. for its immediate promulgation.

What is conspicuous by its absence, though, is a similar suspension of relevant provisions of Part III of IBC, 2016 dealing with individual/personal insolvency, including personal guarantors to corporates. It is fair to assume that the economic slowdown as a result of COVID-19 would affect the corporates as well as individual guarantors equally, at least insofar as their ability to repay the debts is concerned. This has led to a peculiar situation wherein the creditors now have the option of proceeding against the personal guarantors even during COVID-19 pandemic, but are statutorily barred from proceeding against the corporates/principal debtors for the same debt.

The same goes against the very objective of IBC, 2016 – which was enacted to restructure and resolve bad debts by way of a Corporate Insolvency Resolution Process. The limited suspension of provisions of IBC, 2016 on account of COVID-19 has the effect of converting the said legislation into a mere money recovery tool. While there is no quarrel with the position of law that liability of a guarantor and a principal is co-extensive, and the creditor has the option of proceeding against either of them for recovery of its debt. However, allowing a creditor to proceed against the personal guarantor of a corporate debtor, without any attempts at restructuring/resolution of debt militates against the core objectives of IBC, 2016.

It will also be seen that the provisions of Part III of IBC, 2016 have only recently been notified by the Government of India vide a Notification dated 15.11.2019. A prima facie examination of the legislative scheme envisaged under Part III of IBC, 2016 reveals that the same are unfairly prejudicial to the interests of personal guarantors.

Firstly, under the current regime of IBC, 2016, a creditor has the option of simultaneously proceeding against the Corporate Debtor and a personal guarantor of a corporate debtor for the same debt. This may lead to a situation where the creditor despite having filed and recovered part of its debt before a Resolution Professional in the Insolvency Resolution Process of the corporate, proceeds to file its claims for the complete debt in the Insolvency Resolution Process of the personal guarantor. The Insolvency Law Committee Report, 2020 (published by the Ministry of Corporate Affairs, India) recognises this anomaly and suggests that upon recovery of any portion of claim by a creditor in one proceeding, there should be a corresponding revision in the claim filed in another proceeding. This is to prevent the creditors from unjustly enriching itself and realising more amounts than what is actually due to it.

Secondly, Section 96 of the IBC, 2016 imposes an ‘interim moratorium’ in relation to ‘all the debts’ of the guarantor as soon as an application under Sections 94/95 of IBC, 2016 seeking to initiate Insolvency Resolution of the personal guarantor is ‘filed’. During the subsistence of such interim moratorium, all legal proceedings initiated against the personal guarantor in respect of any debt shall be deemed to be stayed. The same is in the teeth of established principles which require the adjudicating authorities under the IBC, 2016 (the Tribunals) to observe principles of natural justice, inasmuch as the ‘interim moratorium’ will be imposed on the date of filing of an application under Part III without any adjudication by any judicial forum and without an opportunity of hearing being afforded to the personal guarantors.

Thirdly, there appears to be no express provision under Part III of IBC, 2016 allowing a personal guarantor to appeal against the order passed by the adjudicating authority. The only provision which entitles an aggrieved party to file an appeal before the appellate authority is Section 61. However, Section 61 only allows an aggrieved a party to prefer an appeal against the orders passed by the Adjudicating Authority under Part II of IBC. Since an order of interim moratorium under Section 96 or a moratorium under Section 101 by the adjudicating authority is an order passed under Part III of IBC, 2016, the remedy to an aggrieved guarantor may not lie under Section 61.

Fourthly, there appears to be no intelligible differentia in enforcing the provisions under Part III of IBC, 2016 only qua ‘Personal Guarantors to Corporate Debtors’ vide the Notification dated 15.11.2019, and not qua other individuals and partnership firms as referred to in Part III. While the statute itself makes no sub-classification/categories of guarantors, individuals and partnership firms, the Notification dated 15.11.2019 appears to enforce the provisions of Part III only qua personal guarantors to corporate debtors.

Fifthly, as stated above, there appears to be no justification or rationale as to why suspension of initiation of insolvency resolution process of guarantors during the COVID-19 pandemic ought not to include suspension of initiation of insolvency process against personal guarantors.

The time is ripe for the legislature to take immediate steps in order to secure the interests of personal guarantors, especially during the COVID-19 pandemic.

*The author is a practising Advocate in New Delhi, and can be contacted at vipul.rmlnlu@gmail.com.

[1] Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020

New releasesNews

A panel discussion on  “4 Years of IBC – The Revolution Witnessed and the Promise for Future” was held on 12th December, 2020.  The event also marked the release of Mr Akaant Kumar Mittal’s book on Insolvency and Bankruptcy: Law and Practice. It had several prominent personalities in attendance such as Justice AB Singh, Judicial Member, NCLAT, Dr MS Sahoo, President of Insolvency and Bankruptcy Board of India, Ms Mamta Binani, ex- Chairman, ICSI and others. This discussion was moderated by Ms Haripriya Padmanabhan, Advocate, Supreme Court of India.

 

After a brief introduction, Ms Padmanabhan proceeded to ask Justice Singh whether in his extensive experience as a judge of the High Court where he would have had an occasion to decide winding up cases, compared to his present office as Member of the NCLAT, does he think, that the IBC has made the process of insolvency more efficient? Listen to his answer below

To Dr Sahoo, Ms Padmanabhan asked whether that as new cases are time bound as they come under the new code, shouldn’t we consider transferring the existing winding up cases from HC to NCLT and NCLAT? She also asked his opinion on the fact that  the Code was brought in to save businesses, however it has been found that more than half the cases which are closed under the Code ended up in Liquidation and only 14.93% of the cases ended up with a Resolution Plan. Why does he think this is the case? Dr Sahoo’s reply to the question can be seen below. Kindly pardon Dr Sahoo’s video quality because of connectivity issues.

Next Ms Padmanabhan asked Dr Binani that by the time companies reach NCLT they are very sick, the amount of time available for resolution should increase or decrease depending on what is at stake? Also, What does she think are some of the biggest challenges that a Resolution Professional  faces under the Code? To see Dr Binani’s reply, watch the video below.

Ms Padmanabhan next addressed the author, Mr Mittal and asked him his opinion on the recent Supreme Court’s judgment with respect to the limitation act being applied to IBC. His answer can be seen below.

In the second round, Ms Padmanabhan proceeded to ask each panelist what measures can be introduced to make IBC more effective. See the video below for Justice Singh’s reply.

Listen to Dr Sahoo answer Justice AB Singh’s question on prepackaged insolvency and Ms Padmanabhan’s question on group insolvency and how to make IBC better. Kindly pardon the bad audio because of connectivity issues.

Ms Padmanabhan asked Dr Binani whether foreign portfolio investors are permitted to rescue companies under current IBC, the need to create a fund to facilitate the process and how to make the IBC better.

Ms Padmanabhan commented that Mr Mittal’s book contains many reports on the basis of which IBC was evolved. She asked him whether he thinks there are any lacunas in the law which can be addressed. See the video below for Mr Mittal’s reply.

Dr Padmanabhan finally ended the panel discussion by stating that the new law on insolvency has been a resounding success both in terms of reduction of time and recovery of dues and that she is very optimistic about the future of IBC. The webinar concluded with a vote of thanks to all panelists and all the people who contributed to the book in any small or big way.

The book can be bought here.

Nilufer Bhateja, Associate Editor has put this story together 

Legislation UpdatesRules & Regulations

Insolvency and Bankruptcy Board of India releases the Insolvency and Bankruptcy Board of India (Use of Caveats, Limitations, and Disclaimers in Valuation Reports) Guidelines, 2020.

These Guidelines provide guidance to the Registered Valuers in the use of Caveats, Limitations, and Disclaimers in the interest of credibility of the valuation reports. These also provide an illustrative list of the Caveats, Limitations, and Disclaimers which shall not be used in a valuation report.

These Guidelines shall come into force in respect of valuation reports in respect of valuations completed by Registered Valuers (RVs) on or after 1st October, 2020.

These Guidelines are divided into three sections. The first section elaborates on the need for Caveats, Limitations, and Disclaimers in a valuation report.  The second section provides a guidance note on the use of Caveats, Limitations, and Disclaimers, while the third section provides an illustrative list of Caveats, Limitations, and Disclaimers for each asset class provided in the Rules.

Read the detailed Notification here: NOTIFICATION

Insolvency and Bankruptcy Board of India

[Notification dt. 01-09-2020]

Case BriefsTribunals/Commissions/Regulatory Bodies

National Company Law Appellate Tribunal (NCLAT): A Bench comprising of Justice S.J. Mukhopadhaya (Chairperson) and Justice B.L. Bhat (Judicial member) rejected an appeal challenging an NCLT judgement where it allowed a liquidator to sell the assets of a company which had been attached by the Directorate of Enforcement (ED) during the period of ‘Moratorium’.

The Resolution Professional had filed an application before the NCLT for releasing the attachment of certain assets of Varrsana Ispat Limited (Corporate Debtor) by the ED. The NCLT held that ordering the release of the attached assets would not be maintainable since the attachment order was issued before the order of declaration of ‘Moratorium’ in the present case. The aforesaid NCLT order had been challenged in this appeal.

The Tribunal rejected the appellant’s contentions that Section 14 of the Insolvency and Bankruptcy Code, 2016 would have an overriding effect over the Prevention of Money Laundering Act, 2002 and that creditors and investigative agencies could not disrupt the ‘Corporate Insolvency Resolution Process’ during the period of ‘Moratorium’. The bench observed that since the provisions of the Prevention of Money Laundering Act, 2002 pertained to ‘proceeds of crime,’ Section 14 of the I&B Code would not be applicable to such a proceeding.

The Order stated that the offence of money-laundering has nothing to do with the ‘Corporate Debtor’ but will be applicable to individuals such as ex-Directors and shareholders of the ‘Corporate Debtor,’ who cannot be given protection from the Prevention of Money Laundering Act, 2002 by taking advantage of Section 14 of the I&B Code. Rather, it held that both the Acts would be invoked simultaneously. Since the attachments were made by the ED long before the initiation of the Corporate Insolvency Resolution Process, this would disallow the ‘Resolution Professional’ from taking advantage of Section 14 of the I&B Code. [Varrsana Ispat Limited v. Deputy Director, Directorate of Enforcement, Company Appeal (AT) (Insolvency) No. 493 of 2018, decided on 27-07-2020]

Op EdsOP. ED.

Abstract

The utility of international commercial arbitration is to provide redressal and resolution in disputes arising out of international trade and commerce. Entities may not care much about development of arbitral jurisprudence but the outcome which has quantified damages. A conflicting obstacle, rather a dead end, surfaces when a party to an arbitration agreement is hit by the trappings of insolvency. Such circumstances potentially defeat the entire purpose of an arbitration agreement leaving the creditor effectively remediless. This paper examines the need to address potential insolvency and why it is important to take pre-emptive measures at the time of contract negotiation.

1. INTRODUCTION

International arbitration is a manifestation of party autonomy, free will to engage in transnational trade, and a sought after dispute resolution mechanism that safeguards and promotes international trade and commerce. The New York Convention[1] is the global voice and assent which backs and supports the idea of arbitration, and for an arbitration to be successful; the Convention lays down the law for recognition and enforcement of foreign arbitration awards – the test of a successful arbitration. Since international arbitration still hits a deadlock when insolvency is triggered, it would be ideal to pre-empt such a scenario and address it beforehand, while negotiating contracts, because what emanates after insolvency is triggered, leaves less or no room for the parties to breathe in. The New York Convention may have been the most successful private international law in the world, but even that fails[2] to address such a conflict, and rather adds to it.

2. THE INTERSECTION

While international arbitration and domestic insolvency are conceptually different – the latter focusing on centralisation of all proceedings against the debtor to one location and the former advocating a decentralised approach vested in party autonomy in the world of economic trade – there comes a point of intersection when one of the parties to an international arbitration is subject to insolvency proceedings in its home State. This may happen before or during arbitration, or even at the stage of enforcement of an award.

The interaction of insolvency and arbitration not only creates conflict of laws issues, but issues of primacy in adjudication[3]. Insolvency law may result in the preliminary suspension of all litigation including arbitration, yet arbitration law may not take insolvency into account and not recognise such a stay. When the insolvency is of a multinational business, the problems increase. Such cases are increasing with globalisation and the increased use of arbitration[4].

Therefore the interaction is an important matter to consider.  Failing to recognise insolvency could jeopardise the enforceability of the arbitral award, whether in domestic or international arbitration. Insolvency is often considered State public policy[5]. Hence, on an international plane ignoring the insolvency recognised in the seat risks setting aside under adoptions of Article 34(2)(b)(ii) of the UNCITRAL Model Law on International Commercial Arbitration[6] or similar provisions in national laws[7]. A tribunal dealing with an insolvent party or a party facing insolvency proceedings, must decide the relevant law to apply to determine the impact of the possible/insolvency on the disputed matter. A common approach is for the tribunal to apply the lex fori or the law of the seat of arbitration. Therefore the essential issue is the international public policy of the seat in the sense of Article V(2)(b) of the New York Convention[8].

Deciding upon the conflict of laws rules to apply becomes difficult[9] without a clear lex fori. The tribunal has a conflict of laws problem[10]. Three main approaches to the issue are:

  1. the seat’s insolvency specific conflict of laws system;[11]
  2. the seat’s international private law conflict of laws system; and
  3. any mandatory rules from the lex fori concursus.[12]

The tribunal is not even bound by the conflict of laws systems of the seat jurisdiction, but that system has an important impact in the interaction between the award and the wider world. Choosing the insolvency specific conflict of laws rules is a logical route, but in the significant case of Vivendi v. Deutsche Telekom, the Swiss Supreme Court preferred the second option and translated all issues to a private law conflict of laws system, applying the Swiss Private International Law.[13]

Applying the mandatory rules approach ties in the arbitration way of thinking. Mandatory rules need to be adhered to so awards may be enforced. Mandatory rules include the lex fori concursus[14] and the mandatory rules of the seat. However, the tribunal can be left with an incomplete conflict of laws framework as not all rules are mandatory. Some mandatory rules in lex fori concursus and from seat may conflict. The tribunal would have to choose the mandatory rules with the associated risk of unenforceability of the award. As a precaution it is probable that a tribunal would choose to apply the mandatory rules of the seat to prevent setting aside action.  In this difficult area, the tribunals often directly apply particular insolvency laws without in depth discussion[15].

It is crucial to classify the particular insolvency issue that the tribunal is dealing with[16]. A different qualification can lead to a different applicable law depending on the conflict of laws system. Many courts see the impact of insolvency on arbitration as a question of party capacity so they apply the conflict of laws rules dealing with capacity. Other tribunals see the issue as the validity of the arbitration agreement[17], leading to applying different conflict of laws rules[18].

The question can also be addressed from the lex causae. This leads to a presumption of validity; one needs to apply the chosen law and its characterisation to determine if that law was chosen validly. If there is no chosen law, this is problematic as there is no starting point. Furthermore, the law chosen to govern the merits of a case often is not the law governing the insolvency. The characterisation can be decided via the lex fori concursus, the law of the insolvency forum, but this would also start with a presumption of applicability.[19]

Finally, there are a range of comparative and functional approaches to the issue. Comparative approaches take into account several legal systems. Functional approaches do the same but keep the focus on the lex fori. These methods balance the lex fori approach and the lex causae approach[20]. Together they can be viewed as opposing options based in the territorial and contractual approaches. Therefore, one could consider this the hybrid option.

The applicable law is critical in international arbitration and cross-border insolvency. Different laws may govern different parts of the arbitration: the law applicable to the merits, the law applicable to the procedure and the law applicable to the arbitration agreement. To determine the effects that any insolvency has on the arbitration, the tribunal will have to make another conflict of laws determination.

Approaches in literature range from the pragmatic to the highly theoretical regarding managing the applicable law. Tribunals like pragmatic, direct approaches, avoiding complex choice of law discussions. The complex arbitration to seat relationship means, with the associated legal theory, that there is not a right or wrong way to determine the law applicable to the impact of the insolvency on an arbitration; it is more a case specific determination. This creates uncertainty and unpredictability but gives freedom of manoeuvring to the tribunal[21]. The parameters of this freedom are the mandatory rules and the international public policy of the seat. The tribunal acts within these parameters to reduce the risk of setting aside later.  One key consideration for the tribunal is to ensure its award is reasoned to avoid it being set aside for lack of reasoning.

A hybrid theory or applying the conflict of laws rules of the lex fori for the applicable law to insolvency provides more legal certainty. It takes into account any relevant mandatory rule or rule of public policy of the lex fori.  However, it does not provide certainty regarding which the rules will be applied.

3. THE HURDLE

Many national insolvency laws or court procedural laws have clauses that suspend any ongoing legal proceedings of the insolvent entity once insolvency commences[22]. These clauses usually prevent further proceedings from being initiated[23]. Several jurisdictions have concluded that the suspension and prevention extends to arbitration proceedings.[24]

According to the rule of suspension, which reflects the principle of jurisdictional attraction, the commencement of bankruptcy proceedings as a form of court proceeding should abate or interrupt all other actions in order to preserve the bankruptcy estate, and all creditors of the debtor, except for the privileged creditors, are put in the same position.

This rule exists as protection to the creditors since in most developed systems of insolvency, law presumes that the creditors of an insolvent debtor must be treated equally and transparently; regardless of any individual agreements they may have concluded with the debtor, and therefore contemplate collective proceedings to bind all. Insolvency proceedings have emerged to be the only way to protect the interests of all the creditors equally. If the arbitration agreement supersedes such a proceeding then most creditors, would be suffering huge losses if they were not part of an arbitration agreement and their cause of action will go in vain. However, to tackle such issues, EC and EU Insolvency Regulation have an underlying principle known as the principle of universality wherein there is a system in which all aspects of the debtor’s insolvency are encompassed by a single central proceeding under one insolvency law.

In contrast, the United States Supreme Court while discussing the refusal to enforce international arbitration agreements held that “would surely damage the fabric of international commerce and trade, and imperil the willingness and ability of businessmen to enter into international agreements…To refuse to enforce an arbitration clause in the context of an international transaction ‘would reflect a parochial concept that all disputes must be resolved under our laws and in our courts…We cannot have trade and commerce in world markets … exclusively on our terms, governed by our laws, and resolved in our courts.”[25] In another case, a US Court held that Congress did not intend for the Bankruptcy Code to modify the Federal Arbitration Act and that no irreconcilable conflict existed between the purposes of the Bankruptcy Code and the arbitration of non-core matters, where the bankruptcy courts do not have exclusive jurisdiction over such matters[26]. Another US Court[27] held that the key in determining whether arbitration may continue or whether arbitral judgement can be affirmed or enforced, is whether arbitration “would contravene a strong public policy of the forum”.

4. INSOLVENT ENTITIES MAY ARBITRATE

In summary, some countries used to, or still, have rules that interfere with the arbitration agreement and arbitration proceedings in case of insolvency, making them null and void or inoperable. Party capacity cannot be forgotten in an insolvency setting. The party’s original representative may need to be replaced by the insolvency administrator causing delays in the proceedings to ensure procedural fairness. An award against an insolvent entity is vulnerable to unenforceability on several grounds and is highly dependent on the approach to insolvency and arbitration in the jurisdiction of enforcement, however, a tribunal can minimalise such risks by careful consideration of due process.

Therefore, arguments for not providing a stay of proceedings may find little force in the current scenario. It may seem prudent to a tribunal to stay proceedings so that the parties and the tribunal may carefully consider the appropriate steps and consequences of the insolvency. The loss of time in the arbitration proceedings is to be measured against the integrity of the arbitration and the award.  Tribunals may look favourably upon a request from the insolvent entity to provide at least an informal stay or delay. In any event the tribunals should consider a stay or delay ex officio, as it may take some time for the insolvency administrator to be duly appointed and get up to speed with the arbitration.

On becoming aware of insolvency, the tribunals may take the necessary common sense steps, such as accepting the administrator into the proceedings and staying proceedings to consider the insolvency implications. In most jurisdictions their awards may be set aside or become non-enforceable if they deal with core insolvency issues. The tribunals would likely look at the insolvency law of the fori concursus, specifically its public policy and mandatory rules, particularly if that is the expected enforcement jurisdiction. 

While the arbitrators should not consider insolvency as automatically ending an arbitration because insolvency procedures can be misused as an inappropriate substitute for debt enforcement procedures by parties[28], arbitrators should note the measures in the insolvency laws that try to prevent such misuse[29].  In English common law, a debt must be “bona fide” to attract the winding up jurisdiction of the English courts.  A disputed debt, which still might have appeals processes to exhaust, would entitle the winding up of a company to be delayed[30]. Likewise in Singapore, if a debtor has a valid counterclaim equivalent to or exceeding the claimed debt, then the insolvency process cannot be applied to the party.[31]

5. INSOLVENCY, SECURITY FOR COSTS ORDERS AND THE UNCITRAL MODEL LAW TEST FOR SECURITY FOR COSTS

It is sometimes argued that when a party in arbitration goes insolvent or is insolvent, that constitutes a ground for security for costs. Security for costs requests are interim measure applications governed mainly by the lex arbitri which is commonly the law of the seat of arbitration.  This is not as straightforward as it might seem.  The UNCITRAL Model Law Article 17-A mentions three basic and common requirements for interim measures, which is widely understood to include security for costs[32]:

  1. the danger of substantial harm;
  2. this harm outweighing the potential harm caused by the interim measure; and
  3. a chance to win the on the merits of the case.

An insolvency event may meet the first requirement as it increases the chance that the other party would not be able to enforce a costs award in practice[33]. It does not influence the third requirement, but it may have an indirect influence on the second requirement. The weight of case law points to insolvency not being a valid or sufficient reason to order security for costs.  The cases indicate that insolvency alone does not necessarily mean a lack of funds – an insolvent company may have enough money to pay for a potential costs award[34]. It follows that insolvency itself is not enough to justify a security for costs award[35]. The Chartered Institute of Arbitrators’ guidelines for requesting security for costs confirm this.  It states that if the insolvent party had a questionable financial situation at the inception of the contract, security for costs are further barred because the risk of insolvency was accepted[36].

Further, if non-compliance occurs after ordering security for costs some legislation allows for the claims may be dismissed, for example under Section 41(6) of the English Arbitration Act[37]. This would complicate the consideration for providing for security for costs in case of insolvency; the insolvency now interacts with an access to justice issue.

Therefore insolvency does not automatically justify a security for costs award, even though a quick analysis might have suggested otherwise. Instead it complicates the decision on security for costs and related issues which the tribunal makes.

6. INSOLVENCY AS A TOOL FOR ABUSE

In bankruptcy or insolvency law, irrespective of the jurisdiction, there may be the potential for abuse of the codified provision by actors seeking advantages in litigation. One of the most common forms of abuse is forum shopping. When a debtor or creditor has the ability to choose among forums that may have jurisdiction, naturally the party will want to go to the forum that will offer the best options as a matter of both procedural and substantive law. Of course, in an efficient legal system this would not necessarily be possible because there should be only one jurisdiction to open proceedings and deal with the matter at hand. In the European Union, however, with a common internal market, freedom of establishment, and the free movement of capital and goods, debtors and creditors deal with each other across national lines, national law is the substantive law regarding insolvency proceedings under the EU Insolvency Regulation, with judgments being given effect in the other member States. Insolvency, doubtlessly, is a great arm-twisting tool used to cough out money. It is often criticised as such, as it is not used with the degree of responsibility that is legislatively desired. Insolvency may also be abused by a party, by either voluntarily opting for insolvency, or fraudulently inducing a creditor to initiate insolvency. Under the new Insolvency & Bankruptcy Code of 2016 in India, promoters of Medium and Small Enterprise are eligible to re-acquire the insolvency estate of their corporate entity. It is not to be forgotten that the result of insolvency is either liquidation or re-organisation, all litigations being extinguished in both cases. Insolvency, therefore, is a tool that can be strategically abused to evade liability.

7. ENFORCEMENT OF AWARDS

We dive into a deeper, darker and uncertain abyss when it comes to enforcement of awards[38] against an insolvent debtor. Most international arbitration award holders would not even proceed to enforce awards once the debtor is subject to insolvency. Not only do the domestic courts refuse such enforcement proceedings, but the award-holders are discouraged from even making the effort to enforce these awards knowing that the estate of the debtor is in the hands of the creditors and the insolvency mechanism. But why should this be the case? It takes years of efforts and resources to conclude an arbitration – a result of parties’ consent – there is application of mind.

The two most probable hurdles to enforcement of an award would, in light of the  New York Convention, be

  1. Capacity, and
  2. Public Policy.

While delving into the two aspects should, in the authors’ view, remain a separate topic to be discussed while testing the legalities involved in the conflict between an international award its conflict with a domestic insolvency, it is safe to assume and conclude that no international arbitral awards are enforced against an insolvent entity as that would be conflicting with the public policy of the State where such enforcement is sought. But what is the fault of the creditor concerned, who believed in the now insolvent business entity to be able to engage in business. Such confidence has much to do with the comity of nations and the contracting party’s host State’s commitment of treaties and conventions.

How do we look at enforcement. Domestic laws may provide for a mechanism to punish bad faith cases, but those are not the concern of businesses. More than the evolution of jurisprudence, businesses are concerned about the colour of money. That’s the reason behind business. Either party may, in an unfortunate or unforeseen scenario, fall into the trappings of insolvency/bankruptcy. The other party may, either during or after or before such circumstances arise, have an arbitration award in their hands or may initiate arbitral proceedings.

8. THOUGHTFULNESS AT THE TIME OF CONTRACT NEGOTIATION

It may take time for laws in this regard to get harmonised, but what parties can do to circumvent such juxtapose or mitigate chances of hitting this apparent dead-end is to ensure that the aforementioned issues are well thought of and dealt with at the time of entering into contracts.

Take for example, the United Nations Convention on Contracts for the International Sale of Goods, 1980 (“CISG”), Preamble of which considers the development of international trade on the basis of equality and mutual benefit, and the adopting States being of the opinion that “adoption of uniform rules which govern contracts for the international sale of goods and take into account the different social, economic and legal systems would contribute to the removal of legal barriers in international trade and promote the development of international trade”. Article 8 of the CISG speaks of interpreting statements of the parties in terms of their intent and while considering the circumstances of the negotiations. A holistic reading of the CISG, including Article 19, would provide a great platform for recording negotiations pertaining to prospective /potential insolvency of the parties in the travaux préparatoires so as to be in a position to address these in accordance with State laws in case any party is hit by insolvency.

It would not be out of context to propose it as a model practice for the vendors to ensure that the purchasers conditionally pledge shares at the time of entering into cross-border transactions, or to create some form of security that would make the trade more responsible. More importantly, this would ensure that in the event of an insolvency, the vendor shall have a seat at the table in the reorganisation of the purchaser and shall also have a claim at par with other secured creditors. This would also be in respect and honour of the NY Convention which seemingly did not address insolvency and perhaps cannot unless it is amended or revamped.

CONCLUSION

The New York Convention, respect be paid to it in sync with the number of signatories it has, is pro-arbitration and it may not be out of place to assert that international commercial arbitration should trump domestic insolvency hurdles. But until such provisions are harmonised at an international level with domestic support, the parties must resort to pre-emptive and mitigating measures to safeguard their interests. The issues discussed hereinabove are what may hinder or even defeat an entire transaction and therefore, it becomes incumbent upon the parties to carefully consider issues of jurisdiction, insolvency and security to avoid getting into transactions that may lead to cascading losses should insolvency loom over a party.

*Candidate, White & Case International Arbitration LLM, 2019, University of Miami School of Law

**Assistant Professor, Jindal Global Law School

[1] The Convention on the Recognition and Enforcement of Foreign Arbitral Awards, 1958

[2] Dependence on factors mentioned under Article V(ii)

[3] ‘Insolvency in International Arbitration: where two fields meet’,  Fabian A van der Ven, LLM Thesis, University of St Gallen

[4] Sara Nadeau-Séguin, ‘When Bankruptcy and Arbitration Meet: A Look at Recent ICC Practice’ (2011) 5 Disp Resol Int’l 79 79 just 17 ICC awards on the subject in 1968-2002 and 16 between the years of 2002-2006.

[5] Domitille Baizeau, ‘Arbitration and insolvency: issues of applicable law’ in Christoph Müller and Antonio Rigozzi (eds), New Developments in International Commercial Arbitration (Schulthess 2009) 100

[6] UNCITRAL Model Law on International Commercial Arbitration

[7] Domitille Baizeau, ‘Arbitration and insolvency: issues of applicable law’ in Christoph Müller and Antonio Rigozzi (eds), New Developments in International Commercial Arbitration (Schulthess 2009) 100. France, for example considers at least parts of its insolvency law as public policy see (2009) No. 08-10.281 (French Supreme Court)

[8] Sara Nadeau-Séguin, ‘When Bankruptcy and Arbitration Meet: A Look at Recent ICC Practice’ (2011) 5 Disp Resol Int’l 79 at 86

[9] Also in the absence of specific agreement between the parties to this effect.

[10] Filip de Ly, ‘Arbitation and Insolvency – Selected Conflict of Law Problems’ in F. Ferrari and S. Kröll (eds), Conflict of Laws in International Arbitration (Sellier European Law Publishers 2011) 3

[11] Elektrim v. Vivendi Universal [2009] EWCA Civ. 677, [2010] IILR 39 (Court of Appeal London)

[12] Simon Vorburger, International Arbitration and Cross-border Insolvency: Comparative Perspectives (International Arbitration Law Library vol 31, Kluwer Law International 2014) 6 at 86-89

[13] Vivendi S.A et al. v. Deutsche Telekom AG et al. [2009] 4A_428/2008, [2010] 28 ASA Bull 104 et seq. (Swiss Federal Supreme Court) 2-3

[14] Simon Vorburger, International Arbitration and Cross-border Insolvency: Comparative Perspectives (International Arbitration Law Library Vol. 31, Kluwer Law International 2014) 88-89

[15] Swiss entity v.  Dutch entity [2001] HKZ Case No. 415, [2002] 20 ASA Bull 467 III; (2011) CAM Case No. 2412 A contribution by the ITA Board of Reporters, Kluwer Law International

[16] Marta Tsvengrosh, Arbitration and insolvency – conflict of laws issues: Conflict of laws in international arbitration: cross-border insolvency cases (LAP LAMBERT Academic Pub 2011) 7

[17] However, such conflicts in the opinion of the authors do not qualify the arbitration agreement as a nullity.

[18] Samantha J Lord, ‘When Two Polar Extremes Collide: An Exploration into the Effects of Insolvency on International Arbitration’ (2012) 15 Int’l Trade & Bus L Rev 316 at 323

[19] Simon Vorburger, International Arbitration and Cross-border Insolvency: Comparative Perspectives (International Arbitration Law Library, Vol. 31, Kluwer Law International 2014) 92-93

[20] Simon Vorburger, International Arbitration and Cross-border Insolvency: Comparative Perspectives (International Arbitration Law Library, Vol. 31, Kluwer Law International 2014) 93-94

[21] Simon Vorburger, International arbitration and cross-border insolvency: Comparative Perspectives (International Arbitration Law Library Vol. 31, Kluwer Law International 2014) 84

[22] Fernando Mantilla-Serrano, ‘International Arbitration and Insolvency Proceedings’ (1995) 11(1) Arbitration International 51, 57; Alexander J Be?lohlávek, ‘The impact of insolvency of a party on pending arbitration proceedings in Czech Republic, England and Switzerland and other countries’ in Marianne Roth and Michael Geistlinger (eds), Yearbook on international arbitration. Vol. 1 (DJØF Publishing 2010) 146 151; Ge Yang, ‘Insolvency Proceedings and Their Effect on International Commercial Arbitration’ (LLM Thesis, University of Ghent 2012) 30

[23] Simon Vorburger, International arbitration and cross-border insolvency: Comparative perspectives (International Arbitration Law Library, Vol. 31, Kluwer Law International 2014) 179

[24] Franco Ferrari and Stefan Kröll, Conflict of laws in international arbitration (Sellier 2011) 362; Ge Yang, ‘Insolvency Proceedings and Their Effect on International Commercial Arbitration’ (LLM Thesis, University of Ghent 2012) 32

[25] Scherk v. Alberto-Culver Company, 1974 SCC OnLine US SC 128 : 417 US 506, at 519 (1974)

[26] Hays and Co. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 885 F.2d 1149 (3d Cir. 1989)

[27] Fotochrome, Inc. v. Copal Co., Ltd., 517 F.2d 512 (2d Cir. 1975)

[28] Mobilox Innovations Private Limited v. Kirusa Software Private Limited, (2018) 1 SCC 353 at para 13 referring to the Legislative Guide on Insolvency Law of the United Nations Commission on International Trade Law

[29] The draft of Section 8 of the Indian Insolvency and Bankruptcy Code, 2016 included “bona fide dispute”.  “Bona fide” is absent in the enacted Code

[30] See Re A Company – Victory House General Partner Ltd. v. RGB P&C Ltd., 2018 EWHC 1143 (Ch)

[31] Lim PohYeoh (alias Lim Aster) and TS Ong Construction Pte Lt., 2016 SGHC 179 at paras 43 and 45

[32] Weixia Gu, ‘Security for Costs in International Commercial Arbitration’ (2005) 22(3) Journal of International Arbitration 167 167

[33] James Hargrove and Vanessa Liborio, ‘Arbitration and Insolvency: English and Swiss Perspectives’ (2009) 75 Arbitration 47 50–51

[34] Smith v. UIC Insurance Co Ltd (2001) BCC 11 (Comm (QBD)); James Hargrove and Vanessa Liborio, ‘Arbitration and Insolvency: English and Swiss Perspectives’ (2009) 75 Arbitration 47, 51 referring to

[35] [2007] ICC Case No. 14993, [2014] 24 ICC Bulletin 24; Hargrove and Vanessa Liborio, ‘Arbitration and Insolvency: English and Swiss Perspectives’ (2009) 75 Arbitration 47, 51

[36] [1994] ICC Case No. 7047, [1995] ASA Bull 301 et seq. n. 18 as referred to by; Chartered Institute of Arbitrators, ‘International Arbitration Practice Guideline: Applications for Security for Costs’ (London 2015) Commentary to Article 3 (b) <http://www.ciarb.org/docs/default-source/ciarbdocuments/guidance-and-ethics/practice-guidelines-protocols-and-rules/international-arbitration-guidelines-2015/2015securityforcosts.pdf?sfvrsn=28>

[37] Hargrove and Vanessa Liborio, ‘Arbitration and Insolvency: English and Swiss Perspectives’ (2009) 75 Arbitration 47, 51

[38] Given the arbitration proceedings see the light of the day in terms of an award being rendered

COVID 19Op EdsOP. ED.

On 24-3-2020, the threshold for initiation of Corporate Insolvency Resolution Process (‘CIRP’) under the Insolvency and Bankruptcy Code (‘IBC’) against the erring companies was increased from Rupees 1 lakh to Rupees 1 crore, vide MCA Notification No. S.O.1205(E). The decision was made in view of the lockdown announced by the Prime Minister to prevent the widespread of COVID-19. The announcement made in a press conference was convened by the Union Finance Minister subsequent to which the notification was published in the Official Gazette.

The MCA Notification No. S.O. 1205(E) dated 24.03.2020, reads as follows:

“S.O. 1205(E).— In exercise of the powers conferred by the proviso to Section 4 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), the Central Government hereby specifies one crore rupees as the minimum amount of default for the purposes of the said section.”

The increase in the trigger amount will supposedly benefit small companies and particularly the MSMEs (medium, small and micro enterprises) which are struggling during this lockdown period. This action will save a lot of businesses which are already facing a threat of default and thus avoid large scale insolvencies. In addition to this announcement, the Finance Ministry has also issued a statement that it might consider suspending  Sections 7, 9 and 10 of IBC, if the lockdown continues beyond 30-4-2020.

The notification was published in exercise of the powers conferred to the Central Government under the proviso to Section 4 of IBC. Section 4 of the IBC provides as under:

“4. Application of this Part.: 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 Section 4 of the IBC empowers the Central Government to issue notification to specify the minimum amount of default of higher value which shall not be more than Rupees one crore. This is the first time the Central Government has exercised this power. These measures adopted by the Government, in the guise of the financial stress caused due to COVIV-19 mayhem, may not be a temporary amendment. If this increase of minimum amount of default, which is a prerequisite for both operational creditors and financial creditors for initiation of insolvency against a corporate debtor, is a permanent increase, then this measure is supposed to benefit the MSMEs even after the lockdown period, as there are various instances where a small private limited company’s default is more than its nominal share capital and paid-up share capital itself. In such cases insolvency also does not lead to a meaningful end.

However, this amendment is at the cost and detriment of the operational and financial creditors, who most often than not, are also MSMEs, and the amount of loan or default would also be less in comparison to the debt in case of an MNC or a bank. Therefore, raising the minimum amount of default to Rupees one crore will hamper the rights of these Operational and Financial creditors, especially during the times when the country is going through a financial crisis. There are a lot of companies which were in a distress even before the lockdown. These measures are against the purpose and objective of the Insolvency and Bankruptcy Code itself, the Preamble of the IBC reads as follows:

“An Act to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximisation of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders…”

                       (emphasis supplied)

The object of the IBC cannot be read unilaterally to protect the defaulters and to restrict the growth and survival odds of small entrepreneurs. The Supreme Court in Swiss Ribbons (P) Ltd. v. Union of India [1], while discussing the purpose and objective of the IBC, has held that the provisions and the Preamble of the IBC ensures maximum recovery for all creditors, while preserving the corporate debtor as a going concern during the insolvency process. The rights of a creditor will supersede any interest of a defaulter.

Relying upon the Bankruptcy Law Reforms Committee Report of November, 2015[2] and in particular Para 3 of ‘Box 5.2 – Trigger for IRP’ which discuss the threshold and triggers for initiation of insolvency against a corporate debtor by a creditor. This Committee Report, which subsequently led to the enactment of the IBC, is an important guide in understanding the provisions and the objective of the IBC. It is pertinent to note that the threshold limit to trigger the Code was purposely kept low — at only Rupees one lakh , making it clear that small individuals/companies may also be able to trigger IBC as operational and financial creditors, along with banks and big financial institutions to whom crores of money may be due. Thus, preserving the rights of a small creditor, and eventually creating a system of checks and balances for the big companies while taking loans or availing services from these small entrepreneurs.

Further, the Central Government failed to establish whether these amendments are prospective or retrospective in nature. Currently, the applications before the Adjudicating Authority (NCLT) can be divided into 3 heads:

  1. where applications are yet to be filed by the operational and financial creditors for initiation of corporate insolvency proceedings of corporate debtors (specifically in the case of an operational debt, where a demand notice under Section 8 of the IBC has already been sent),
  2. where applications already filed, but not admitted by the Adjudicating Authority against the corporate debtor,
  3. where applications admitted for initiation of corporate insolvency proceedings against the corporate debtor.

A bare perusal of the Notification dated 24-03-2020 and the statements issued by the Ministry, does not clarify if the increase in the threshold, will affect all the three heads (retrospective applicability) as mentioned above, or only the first (prospective applicability).

The notification does not explicitly or implicitly state whether the applicability of the increase in threshold amount will be prospective or retrospective. The Supreme Court of India in S.L. Srinivasa Jute Twine Mills v. Union of India [3], has held that: (SCC para 18)

“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…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.…”

Therefore, even though the notification will be deemed to be prospective, there still remains scope for interpretation of the notification, and thus a subsequent scope for judicial interference. Further, the notification was a subordinate or delegated legislation, and not a legislative amendment of the IBC itself, thereby increasing scope for judicial interference especially in regard to its applicability.

More changes to the IBC i.e. suspension of Sections 7, 9 and 10 for six months, as indicated by the Finance Minister, may be in the pipeline, if the lockdown continues beyond April 2020. If Section 7 is suspended, it will tremendously affect the home-buyers and the erring real estate developers will get further time to alienate their assets. Further, suspension of Section 10 might not be the most pragmatic move either. If a company itself wants to file for insolvency, and if the provisions of Section 10 are suspended, it will inevitably lead to consequences which will harm the interests of the various stakeholders of that incorrigible entity.

During the current financial stress, these amendments will not resolve any immediate purpose towards solving the financial condition of the MSMEs and of the entire country. Moreover, due to the lockdown, the Courts and Tribunals have also restricted its functioning, and the Supreme Court on 23-3-2020 passed a general order extending the limitation, whether condonable or not, for filing in all Courts and Tribunals, until further orders.

Therefore, in the midst of a public health and economic crisis, a lopsided approach to amend the IBC is not the most ideal and pragmatic way forward, which in turn will severely affect various stakeholders throughout the country. The system of checks and balances has to be utilised in a balanced manner with the primary objective of accelerating economic growth rather than suspending its growth by doubting the constitutional efficacy of the Insolvency and Bankruptcy Code at the threshold itself.

*Udian Sharma is a practicing advocate in Supreme Court of India, Delhi High Court and various Tribunals including NCLT and NCLAT, having an expertise in Dispute Resolution practice, with a focus on insolvency laws and restructuring. The author can be reached at udian.s@gmail.com.

[1] Swiss Ribbons (P) Ltd. v. Union of India, 2019 SCC OnLine SC 73

[2] The Report of the Bankruptcy Law Reforms Committee, Vol. I (04.11.2015)

[3] S.L. Srinivasa Jute Twine Mills v. Union of India, (2006) 2 SCC 740

Image Credits: Business Line

Case BriefsSupreme Court

Supreme Court: The bench of AM Khanwilkar and Dinesh Maheshwari, JJ has restored the NCLT order wherein it was held that the lenders of Jaiprakash Associates Limited (JAL) were not the financial creditors of the corporate debtor Jaypee Infratech Limited (JIL) and that the transactions in question were to defraud the lenders of the corporate debtor JIL. The Court held,

“such lenders of JAL, on the strength of the mortgages in question, may fall in the category of secured creditors, but such mortgages being neither towards any loan, facility or advance to the corporate debtor nor towards protecting any facility or security of the corporate debtor, it cannot be said that the corporate debtor owes them any ‘financial debt’ within the meaning of Section 5(8) of the Code; and hence, such lenders of JAL do not fall in the category of the ‘financial creditors’ of the corporate debtor JIL.”

The Court was hearing the case relating to JAL, a public listed company with more than 5 lakh individual shareholders, which was facing insolvency proceedings under the Insolvency and Bankruptcy Code, 2016. In the year 2003, JAL was awarded the rights for construction of an expressway from Noida to Agra. A concession agreement was entered into with the Yamuna Expressway Industrial Development Authority. Coming on the heels of this project, JIL was set up as a special purpose vehicle. Finance was obtained from a consortium of banks against the partial mortgage of land acquired and a pledge of 51% of the shareholding held by JAL. The banks in question instituted a petition under Section 7 of the Insolvency and Bankruptcy Code, 2016 before the NCLT, seeking initiation of Corporate Insolvency Resolution Process (CIRP) against JIL, while alleging that JIL had committed a default in repayment of its dues to the tune of Rs. 526.11 crore.

NCLT in it’s order held,

“the transactions in question were to defraud the lenders of the corporate debtor JIL, as 858 acres of unencumbered land owned by the corporate debtor to secure the debt of the related party JAL was mortgaged in the midst of the corporate debtor’s immense financial crunch, while continuing with default towards the home buyers and financial creditors and after it had been declared as Non Performing Asset, in utter disregard to fiduciary duties and duty of care to the creditors; and further that the mortgage of land was created without any counter guarantee from the related party and with no other consideration being paid to the corporate debtor.”

While interpreting Section 43 of the Code, the Supreme Court noticed that the transfers in question could be considered outside the purview of sub-section (2) of Section 43 of the Code only if it could be shown that same were made in the ‘ordinary course of business or financial affairs’ of the corporate debtor JIL and the transferees. It, however, further explained that even when furnishing a security may be one of normal business practices, it would become a part of ‘ordinary course of business’ of a particular corporate entity only if it falls in place as part of ‘the undistinguished common flow of business done’; and is not arising out of ‘any special or particular situation’.

“It is difficult to even surmise that the business of JIL, of ensuring execution of the works assigned to its holding company and for execution of housing/building projects, in its ordinary course, had inflated itself to the extent of routinely mortgaging its assets and/or inventories to secure the debts of its holding company. It had also not been the ordinary course of financial affairs of JIL that it would create encumbrances over its properties to secure the debts of its holding company.”

Holding that the NCLAT had not been right in interfering with the well-considered and justified order passed by NCLT, the Supreme Court said,

“the transactions in question are hit by Section 43 of the Code and the Adjudicating Authority, having rightly held so, had been justified in issuing necessary directions in terms of Section 44 of the Code.”

The Court, hence, concluded:

“1) The impugned order dated 01.08.2019 as passed by NCLAT in the batch of appeals is reversed and is set aside.

2) The appeals preferred before NCLAT against the order dated 16.05.2018, as passed by NCLT on the application filed by IRP, are dismissed; and consequently, the order dated 16.05.2018 so passed by NCLT is upheld in regard to the findings that the transactions in question are preferential within 171 the meaning of Section 43 of the Code. The directions by NCLT for avoidance of such transactions are also upheld accordingly.

3) The appeals preferred before NCLAT against the orders passed by NCLT dated 09.05.2018 and 15.05.2018 on the applications filed by the lender banks are also dismissed and the respective orders passed by NCLT are restored with the findings that the applicants are not the financial creditors of the corporate debtor Jaypee Infratech Limited.”

[Anuj Jain v. Axis Bank Ltd., 2020 SCC OnLine SC 237, decided on 26.02.2020]

Case BriefsSupreme Court

Supreme Court: The 3-judge bench of RF Nariman, Surya Kant and V. Ramasubramanian, JJ has set aside the NCLAT order dated 04.07.2019 in the Essar Steel India insolvency case and has held,

“The NCLAT judgment which substitutes its wisdom for the commercial wisdom of the Committee of Creditors and which also directs the admission of a number of claims which was done by the resolution applicant, without prejudice to its right to appeal against the aforesaid judgment, must therefore be set aside.”

NCLAT had, in the impugned order, held that in a resolution plan there can be no difference between a financial creditor and an operational creditor in the matter of payment of dues, and that therefore, financial creditors and operational creditors deserve equal treatment under a resolution plan. Accordingly, the NCLAT has re-distributed the proceeds payable under the approved resolution plan as per the method of calculation adopted by it so that all financial creditors and operational creditors be paid 60.7% of their admitted claims.

The present appeals and writ petitions were an aftermath of this Court’s judgment dated 04.10.2018 in ArcelorMittal India Private Limited v. Satish Kumar Gupta, (2019) 2 SCC 1.

The Court also answered some important questions which have been elaborated as follows:

Role of Resolution Professional

Resolution professional is a person who is not only to manage the affairs of the corporate debtor as a going concern from the stage of admission of an application under Sections 7, 9 or 10 of the Code till a resolution plan is approved by the Adjudicating Authority, but is also a key person who is to appoint and convene meetings of the Committee of Creditors, so that they may decide upon resolution plans that are submitted in accordance with the detailed information given to resolution applicants by the resolution professional.

“Another very important function of the resolution professional is to collect, collate and finally admit claims of all creditors, which must then be examined for payment, in full or in part or not at all, by the resolution applicant and be finally negotiated and decided by the Committee of Creditors.”

Role of the prospective resolution applicant

The prospective resolution applicant has a right to receive complete information as to the corporate debtor, debts owed by it, and its activities as a going concern, prior to the admission of an application under section 7, 9 or 10 of the Code. For this purpose, it has a right to receive information contained in the information memorandum as well as the evaluation matrix mentioned in Regulation 36-B.

Role of Committee of Creditors

Since it is the commercial wisdom of the Committee of Creditors that is to decide on whether or not to rehabilitate the corporate debtor by means of acceptance of a particular resolution plan, the provisions of the Code and the Regulations outline in detail the importance of setting up of such Committee, and leaving decisions to be made by the requisite majority of the members of the aforesaid Committee in its discretion.

“The Committee of Creditors does not act in any fiduciary capacity to any group of creditors. On the contrary, it is to take a business decision based upon ground realities by a majority, which then binds all stakeholders, including dissentient creditors.”

The decisions relating to management of the corporate debtor cannot be taken without the prior approval of at least 66% of the votes of the Committee of Creditors.

Constitution of a sub-committee by the Committee of Creditors

Sub-committees cannot be constituted for:

  • Exercising of the Committee of Creditors’ powers on questions which have a vital bearing on the running of the business of the corporate debtor.
  • approving a resolution plan.

However, sub-committees can be appointed for the purpose of negotiating with resolution applicants, or for the purpose of performing other ministerial or administrative acts, provided such acts are in the ultimate analysis approved and ratified by the Committee of Creditors.

Jurisdiction of the Adjudicating Authority and the Appellate Tribunal

The Adjudicating Authority generally cannot interfere on merits with the commercial decision taken by the Committee of Creditors. However, the limited judicial review available is to see that the Committee of Creditors has taken into account the fact that the corporate debtor needs to keep going as a going concern during the insolvency resolution process; that it needs to maximise the value of its assets; and that the interests of all stakeholders including operational creditors has been taken care of.

If the Adjudicating Authority finds, on a given set of facts, that the aforesaid parameters have not been kept in view, it may send a resolution plan back to the Committee of Creditors to re-submit such plan after satisfying the aforesaid parameters. The reasons given by the Committee of Creditors while approving a resolution plan may thus be looked at by the Adjudicating Authority only from this point of view, and once it is satisfied that the Committee of Creditors has paid attention to these key features, it must then pass the resolution plan, other things being equal.

Secured and unsecured creditors; the equality principle

Financial creditors are in the business of lending money who are capital providers for companies, who in turn are able to purchase assets and provide a working capital to enable such companies to run their business operation. Whereas operational creditors are beneficiaries of amounts lent by financial creditors which are then used as working capital, and often get paid for goods and services provided by them to the corporate debtor, out of such working capital. Hence,

“If an “equality for all” approach recognising the rights of different classes of creditors as part of an insolvency resolution process is adopted, secured financial creditors will, in many cases, be incentivised to vote for liquidation rather than resolution, as they would have better rights if the corporate debtor was to be liquidated rather than a resolution plan being approved.”

This would defeat the entire objective of the Code which is to first ensure that resolution of distressed assets takes place and only if the same is not possible should liquidation follow.

Constitutional validity of Sections 4 and 6 of the Insolvency and Bankruptcy Code (Amendment) Act, 2019

Section 4

So far as Section 4 is concerned, it is clear that the original timelines under Section 12 of the Code in which a CIRP must be completed have now been extended to 330 days, which is 60 days more than 180 plus 90 days. The proviso to Section 12 reads:

“the corporate insolvency resolution process shall mandatorily be completed within a period of three hundred and thirty days from the insolvency commencement date, including any extension of the period of corporate insolvency resolution process granted under this section and the time taken in legal proceedings in relation to such resolution process of the corporate debtor.”

The Court, hence, while leaving the provision otherwise intact, struck down the word “mandatorily” as being manifestly arbitrary under Article 14 of the Constitution of India and as being an excessive and unreasonable restriction on the litigant’s right to carry on business under Article 19(1)(g) of the Constitution. The effect of this declaration is that ordinarily the time taken in relation to the corporate resolution process of the corporate debtor must be completed within the outer limit of 330 days from the insolvency commencement date, including extensions and the time taken in legal proceedings.

It was, however, explained that on the facts of a given case, if it can be shown to the Adjudicating Authority and/or Appellate Tribunal under the Code that only a short period is left for completion of the insolvency resolution process beyond 330 days, and that it would be in the interest of all stakeholders that the corporate debtor be put back on its feet instead of being sent into liquidation and that the time taken in legal proceedings is largely due to factors owing to which the fault cannot be ascribed to the litigants before the Adjudicating Authority and/or Appellate Tribunal, the delay or a large part thereof being attributable to the tardy process of the Adjudicating Authority and/or the Appellate Tribunal itself, it may be open in such cases for the Adjudicating Authority and/or Appellate Tribunal to extend time beyond 330 days.

Section 6

Section 30(2)(b) of the Code as substituted by Section 6 of the Amending Act is in fact a beneficial provision in favour of operational creditors and dissentient financial creditors as they are now to be paid a certain minimum amount, the minimum in the case of operational creditors being the higher of the two figures calculated under sub-clauses (i) and (ii) of clause (b), and the minimum in the case of dissentient financial creditor being a minimum amount that was not earlier payable. As a matter of fact, pre-amendment, secured financial creditors may cramdown unsecured financial creditors who are dissentient, the majority vote of 66% voting to give them nothing or next to nothing for their dues. In the earlier regime it may have been possible to have done this but after the amendment such financial creditors are now to be paid the minimum amount mentioned in sub-section (2).

It was also noticed that the discretion given to the Committee of Creditors by the word “may” again makes it clear that this is only a guideline which is set out by this sub-section which may be applied by the Committee of Creditors in arriving at a business decision as to acceptance or rejection of a resolution plan.

[Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta, 2019 SCC OnLine SC 1478, decided on 15.11.2019]

Law School NewsOthers

An Essay Competition is being organised by Gujarat National Law University and Insolvency & Bankruptcy Board of India (IBBI) on the theme of “Potential of Strategic Default in the Insolvency and Bankruptcy Code, 2016 “
About the Competition:
The Insolvency and Bankruptcy Board of India (IBBI). The Insolvency and Bankruptcy (Code) is a major economics reform of this decade and on completion of its two years of implementation, it will be a great resources for the research and academics to understand in details the change that is in the offing. In this context the IBBI is promoting essay competition through Institute of Learning to create awareness about the insolvency and bankruptcy regime amongst the students of Higher Education, Students of graduation and post-graduation courses of any disciplines, Deemed University and Professional Institute ( Institute of Charted Accountants of India, Institute of Cost Accountants of India and Institute of Company Secretaries of India) can participate in this competition.
The IBBI announces the Essay Competition on Insolvency and Bankruptcy legislation through institutes of learning. Under the said scheme the Gujarat National Law University (GNLU) is organising an essay competition for the students of GNLU.
Theme of Essay :
  • Potential of Strategic Default in the Insolvency and Bankruptcy Code, 2016
Prize:
Best essay will receive INR 10000/-
Second best essay will receive INR 5000/-
Who can Participate:
Students of Under Graduate i.e. LLB and Postgraduate Programmes i.e. both LLM and MBA in Financial and Management Laws
Submission Guidelines:
  • Minimum words-4000, maximum words-8000
  • Font Type: Times New Roman; Font Size: Heading-14, Text-12; Line Spacing: 1.5
  • Citation Method: OSCOLA, 4th Edition
  • Co-authorship is not allowed
Entry for the Submission will be open :
  • 10th February to 10th April 2019 (23:59 Hours)
For further details, refer Essay Cpmt Banner
AchievementsLaw School News

A team comprising of Samidha Mathur, Brijraj Deora, Ravin Abhyankar and Anadi Singh Rathore represented GNLU at the 2nd edition of the NLU Delhi Insolvency and Bankruptcy Moot Court Competition held from 15-17 November 2018. The team adjudged as the winners of the moot.  The Moot was based on a relatively new concept of Insolvency and Bankruptcy Code.
Law School NewsMoot Court Achievements & Reports

The National Law University, Delhi, supported by the Insolvency and Bankruptcy Board of India (IBBI), and the UNCITRAL RCAP, in collaboration with INSOL India and Society of Insolvency Practitioners of India (SIPI) have initiated a moot competition on insolvency and bankruptcy. The Moot was organized by the Centre for Transnational Commercial Law (CTCL). The second edition of the competition was held on November 15-17, 2018 at the National Law University, Delhi, India.

The theme of 2018 edition was Process Memorandum and Resolution Plan. The participating teams had to prepare and submit a Resolution Plan as Resolution Applicant based on information memorandum and other relevant information supplied to them. Teams were shortlisted based upon the quality of submission. The shortlisted teams participated in the oral rounds. In the oral rounds, teams presented the Resolution Plan and made arguments on its merits to industry experts acting as judges.

In the finals, University of Petroleum and Energy Studies (UPES) faced Gujarat National Law University (GNLU), in which the latter defeated the former.