Last week, a Supreme Court (SC) bench comprising justices Indira Banerjee and JK Maheshwari held that the National Company Law Tribunal (NCLT) has the discretion to admit or reject a valid initiation of the insolvency process by a financial creditor (FC) under Section 7 of the Insolvency and Bankruptcy Code (IBC). Changing the rules of the game, the judgement now says that loan defaults will have to be assessed to check if it was due to genuine business reasons or contingencies such as pending litigation. The order has the potential to throw a serious spanner in the process-driven bankruptcy process.
The SC ruling was made in Vidarbha Industries Power Ltd vs Axis Bank Ltd (Civil Appeal No. 4633 of 2021), where Axis Bank, as a lender, had initiated the corporate insolvency resolution process (CIRP) against Vidarbha Industries Power, the corporate debtor (CD).
Vidarbha Industries, a power generation company, had set up a 600MW (megawatt) coal-fired thermal power plant comprising two units of 300MW each in the Butibori industrial area of Nagpur district in Maharashtra.
It resisted admission to the bankruptcy process on the ground that it had a valid claim against the distribution company for additional pass-through charges under its power purchase agreement (PPA). Hence, it argued, that it had defaulted on its loans because it had not received payments from the power distribution company on account of litigation pending before the SC.
Citing the past precedents of the SC, Vidarbha Industries’ contention had been rejected by the NCLT as well as the appellate authority (AA). They had held the AA can, at best, verify if a valid debt existed and there was a default in loan repayment and the application filed by the creditor, under the insolvency process was complete. Both authorities had agreed that there was no room for assessment of whether the loan default was due to genuine business reasons or contingencies like a pending litigation, as in the Vidarbha case.
A plethora of SC precedents have held that CIRP is entirely driven by the committee of creditors (COC), which are entities with the maximum financial stake and it is assumed that they would opt for a recovery process that would extract the best possible value through the recovery process.
Until this order, the courts have repeatedly held the view that the AA can only check for compliance and adherence to the legal framework and not interfere in the commercial aspect of negotiation or resolution. This tenet was reinforced every time the appellate authorities’ attempt, to interfere with ‘the commercial wisdom of the creditors’ in the resolution process, was rejected.
This time, however, the apex court chose to look at the wording of sub-section 5 of Section 7 of the IBC with a different lens and concluded that the AA has discretionary power at the admission stage even when the financial creditor establishes a loan default. The said sub-section 5 is extracted below
(5) Where the Adjudicating Authority is satisfied that-
(a) a default has occurred and the application under sub-section (2) is complete, and there is no disciplinary proceedings pending against the proposed resolution professional, it may, by order, admit such application; or
(b) default has not occurred or the application under sub-section (2) is incomplete or any disciplinary proceeding is pending against the proposed resolution professional, it may, by order, reject such application:
The Court was persuaded by the use of the word ‘may’ in clause (a) to conclude that it was not obligatory for the AA to admit a case even if the default in payment of the outstanding debt is established and the application was complete.
To buttress its conclusion, the Court relied on Section 9 of the IBC where the word shall has been employed with regard to the admission of an application by an operational creditor (OC) whose dues stand unpaid.
In para 79 of the judgement, the apex court further demonstrated its application of the mind to this dichotomy and holds forth at length to conclude that an OC stands on a better footing than a FC under the code!
There could not have been a greater violence done to the texture of the IBC which is, rightly or wrongly, skewed in favour of the FC, as has been repeatedly affirmed by various judicial pronouncements.
Having said this, it is relevant to highlight that clause 5 (b) of Section 7 also employs the term ‘may’ in a situation where the AA concludes, with regard to an insolvency application, that no default has occurred or the application is incomplete.
If one were to stretch the conclusion of the Vidarbha decision it its extreme, it would mean that an AA can, if it deems fit, admit an incomplete application on one where a no default has occurred because the law did not mandate the rejection by using shall!
Nothing would be more absurd!
The use of the word ‘may’ or ‘shall’ cannot be the test to decide between discretion and obligation. Such a test may be valid if the context lends a basis or that a sensible outcome is achieved in that way.
The judgement has put the operational creditor on a firmer footing that a financial creditor. In effect, an application by an operational creditor, that is complete in all respects and demonstrates a default, has to be willy-nilly accepted by the NCLT for initiating insolvency proceedings. However, in the case of a financial creditor, the NCLT has the choice or option to reject an application, even if complete in all respects and the creditor has established a default, only because the language of the law has used the word ‘may’ instead of ‘shall’. The judgement appears to have undone repeatedly affirmed jurisprudence that the financial creditor has the whip in the CIRP.
This interpretation, which completely sets at nought the very raison d’etre of the law, is most unfortunate and a reflects a pedantic exercise at the highest judicial forum as the legislative intent.
What appears to be an anomaly is taken as legal intent. Unfortunately, the damage that is done can only be undone by the legislature making a curative amendment which makes its position amply clear.
(Ranganathan V is a CA and CS. He has over 43 years of experience in the corporate sector and in consultancy. For 17 years he worked as Director and Partner in Ernst & Young LLP and three years as senior advisor post-retirement handling the task of building the Chennai and Hyderabad practice of E&Y in tax and regulatory space. Currently, he serves as an independent director on the board of four companies.)