NCLT’s power to direct pre-admission enquiry: NCLAT settles the law

NCLAT

Overview

While an insolvency application filed by an operational creditor can be resisted on the ground that there is an “existing dispute”, the Insolvency and Bankruptcy Code, 2016 (Code) does not provide for such a defense for resisting an insolvency application filed in respect of a financial debt.

In case of an application filed by a financial creditor, the Adjudicating Authority is only required to: (a) satisfy itself of the occurrence of default; (b) ensure that the application is otherwise complete; and (c) ascertain whether any disciplinary proceeding is pending against the proposed resolution professional.

In such a case, the debtor can resist an application only by highlighting that there is no debt, or the debt is not due i.e. it is not payable in law or in fact. In other words, the Code is to be triggered as long as a default of an amount exceeding INR 1 lakh (now, INR 1 Crore) is made out by a financial creditor and in such a case, the Adjudicating Authority is not required to consider any other fact or even determine the exact amount of default.

The NCLAT reiterated this principle very recently in the decision of Allahabad Bank v. Poonam Resort Ltd. and Allahabad Bank v. Link House Industries Limited (Company Appeal (AT) (Insolvency) Nos. 1303 and 1304 of 2019) wherein the corporate debtor tried to defer and resist the admission of an insolvency application even though it had admitted to a default of financial debt exceeding INR 1 lakh on the ground that application contained certain false statements and that the application was filed with a fraudulent / malicious intent.

NCLT directs pre-admission forensic audit

On October 16, 2019, the Adjudicating Authority (Mumbai Bench) passed an order appointing a forensic auditor at the pre-admission stage to examine the correct position of the loan account and to test the corporate debtor’s allegation that the financial creditor had furnished false information in its insolvency application. Such allegations were raised by the corporate debtor by filing an application under Section 75 of the Code which penalizes a financial creditor for knowingly providing materially false information in its application under Section 7 and contemplates a fine of at least INR 1 Lakh extending up to INR 1 Crore.

Interestingly, on the one hand, the Adjudicating Authority records that “Up to the said date, as per the statement a sum of Rs. 25 Crores was found to be physical disbursed […]”, however, on the other hand, it directed a forensic investigation “considering an application under Section 75 of the Insolvency Code moved from the side of Corporate Debtor in which certain allegations are made, this Bench is of the considered view that during the entire loan process, due diligence was not carried out, So as to examine the correct position of Loan account for same be examined by the professional of this field.”

Since it appears that there was a “debt” and “default”, the Adjudicating Authority ought to have admitted the application in terms of the various decisions of the Supreme Court and the NCLAT. However, it entered disputed questions of fact and directed a forensic investigation to unravel the true position of the loan account, which could have otherwise been easily decided by the resolution professional.

NCLAT sets aside NCLT’s decision

Not surprisingly, therefore, the Adjudicating Authority’s order was assailed by the corporate debtor before the Appellate Tribunal primarily on the ground that the Adjudicating Authority ordered a forensic investigation even though the application was otherwise complete and deserved to be admitted in terms of Section 7 of the Code. Further, it was also contended that the applications have been pending consideration since September 2019.

On May 22, 2020, the NCLAT set aside the order of the Adjudicating Authority. The NCLAT reasoned that the Adjudicating Authority ignored the 14-day timeframe provided under the Code for admitting and rejecting insolvency application filed by the creditors. Amongst others, it relied on the following passage from the Supreme Court’s decision in the case of Innoventive Industries Limited v. ICICI Bank and Anr. ((2018) 1 SCC 407):

“30. On the other hand, as we have seen, in the case of a corporate debtor who commits a default of a financial debt, the adjudicating authority has merely to see the records of the information utility or other evidence produced by the financial creditor to satisfy itself that a default has occurred. It is of no matter that the debt is disputed so long as the debt is “due” i.e. payable unless interdicted by some law or has not yet become due in the sense that it is payable at some future date. It is only when this is proved to the satisfaction of the adjudicating authority that the adjudicating authority may reject an application and not otherwise.”

In view of the law laid down by the Supreme Court, it opined that “the satisfaction in regard to occurrence of default has to be drawn by the Adjudicating Authority either from the records of the information utility or other evidence provided by the ‘Financial Creditor’”. In doing so, the NCLAT held, that the Adjudicating Authority cannot direct a forensic audit and engage in a long-drawn pre-admission exercise which will have the effect of defeating the object of the Code. It observed that the if the financial creditor failed to prove the occurrence of a default by presenting appropriate evidence, the Adjudicating Authority may reject the application. Alternatively, the Adjudicating Authority may return the application if it is found to be incomplete.

While emphasising on the importance of speedy adjudication and strict adherence to the timelines provided under the Code, the NCLAT held that the Code does not envisage a pre-admission enquiry into the proof of default by an independent forensic audit as that may defeat the object of the Code. It held that the corporate debtor cannot be allowed to thwart the insolvency application by resorting to section 75 of the Code “unless in a given case forgery or falsification of documents is patent and prima facie established.”

While the NCLAT did not discuss in detail the level of proof or the situations in which a corporate debtor could take shelter or resort to section 75 of the Code, given the penal consequences provided thereunder, it observed that it “postulates an enquiry and recording of finding in respect of culpability of the Applicant regarding commission of an offence.” That said, the Adjudicating Authority is unlikely to conduct such an enquiry itself given that the proceedings conducted by it are of summary nature and it does not have the technical expertise to take up such an exercise. Further, the Adjudicating Authority does not possess the powers to punish for a section 75 violation insofar as such offences are required to be finally tried by the Special Courts established under the Companies Act, 2013 in the manner provided under section 236 of the Code.

Lastly, considering that in the facts of the case, the corporate debtor had, in fact, admitted liability and default for an amount exceeding INR 1 lakh, the NCLAT refused to entertain the objections of the corporate debtor under section 65 of the Code. In conclusion, the Appellate Tribunal set aside the Adjudicating Authority’s order appointing a forensic auditor with a direction to deal with the issues related to the admission of the insolvency application

Concluding remarks

Understandably, provisions such as section 75 have been inserted in the Code to deter the creditors from wrongly invoking the Code and protecting the corporate debtor from being dragged into insolvency process for extraneous purposes. A creditor who approaches the Adjudicating Authority with unclean hands and for no bona fide reasons should not be allowed to trigger the Code which is intended for a holistic collective healing process. However, at the same time, the debtors apprehending an imminent corporate insolvency process cannot be allowed to invoke such provisions in a routine manner. It would be important for the debtor to prima facie satisfy the Adjudicating Authority that the creditor filed an application dishonestly which contains material misstatements before the insolvency proceedings can be stalled.

The insolvency proceedings are summary in nature and expected to be decided within 14 days from the date when the application is presented before the Adjudicating Authority and therefore, the Adjudicating Authority cannot, in such a summary proceeding, be allowed to be get into disputed questions of fact and deal with every faint allegation raised by a corporate debtor. The NCLAT very rightly holds that the Adjudicating Authority cannot be permitted to delve into long drawn enquiry into every allegation raised under sections 65 and 75 of the Code to find out a potential violation at a pre-admission stage unless the corporate debtor meets the initial threshold and satisfies the Adjudicating Authority of a material wrongdoing and that the creditor failed to disclose the true state of affairs.

This decision joins the already existing long line of judgments which emphasize on adhering to the time periods prescribed under the Code. Although the Supreme Court has held the 14-day period provided under section 7(4) is directory, it is critical for the proper functioning of the Code that the Adjudicating Authorities conform to the prescribed timelines.