Insolvency and Bankruptcy Code: Highlights of the Supreme Court Judgment

In a judgment that has surprised the legal fraternity and many industry experts, the Supreme Court today upheld the validity of the Insolvency and Bankruptcy Code in its entirety.

. The case was heard at length by a Bench of Justices Rohinton Nariman and Navin Sinha before it pronounced its verdict today.

. Below are some of the key highlights of the judgment.

. On appointments to NCLT and NCLAT

. Challenging the appointments to National Company Law Tribunal (NCLT) and NCLAT, the petitioners had argued that Section 412(2) continued on the statute book even after the Supreme Court had struck it down in its judgment in Madras Bar Association.

. The Court noted that Section 412 of the Companies Act has been amended to bring it in tune with judgment. Further, an affidavit was also submitted by the Central government which stated that acting in compliance with the directions of the Supreme Court, a Selection Committee was constituted to make appointments of members of the NCLT in the year 2015 itself.

. Thus, by an order dated July 27, 2015, (i) Justice Ranjan Gogoi (as he then was), (ii) Justice NV Ramana, (iii) Secretary, Department of Legal Affairs, Ministry of Law and Justice, and (iv) Secretary, Corporate Affairs, constituted the Selection Committee. This Selection Committee was reconstituted in 2017 to make further appointments.

. In compliance with the directions of the Court, advertisements were issued on August 10, 2015, inviting applications for Judicial and Technical Members as a result of which, all the present Members of the NCLT and NCLAT have been appointed.

. The Court, therefore, held that it need not detain itself further with regard to this submission.

. Set up Circuit Benches within 6 months

. In this regard, the Court noted the submission of Attorney General KK Venugopal , who assured the Court that the directions in Madras Bar Association will be followed, and that circuit Benches of NCLAT will be established.

. The Court recorded this submission and directed the Central government to establish Circuit Benches of the NCLAT within 6 months.

. “The learned Attorney General has assured us that this judgment will be followed and Circuit Benches will be established as soon as it is practicable. In this view of the matter, we record this submission and direct the Union of India to set up Circuit Benches of the NCLAT within a period of 6 months from today.”

. Tribunals functioning under wrong Ministry

. It was the argument of the petitioner that administrative support for all tribunals should be from the Ministry of Law and Justice, and not from the Ministry of Corporate Affairs, under which the NCLT and NCLAT are currently functioning.

. Reliance was placed by the petitioners on the judgment in Madras Bar Association in this regard. The Court agreed to this, and urged the Central government to follow the Madras Bar Association judgment in letter and spirit.

. “As far as we are concerned, we are bound by the Constitution Bench judgment in Madras Bar Association (I) (supra). This statement of the law has been made eight years ago. It is high time that the Union of India follow, both in letter and spirit, the judgment of this Court.”

. Classification of Financial Creditors and Operational Creditors not discriminatory

. The Court first set out the distinction between a financial creditor and operational creditor as follows:

. “A perusal of the definition of financial creditor and financial debt makes it clear that a financial debt is a debt together with interest, if any, which is disbursed against the consideration for time value of money. It may further be money that is borrowed or raised in any of the manners prescribed in Section 5(8) or otherwise, as Section 5(8) is an inclusive definition. On the other hand, an ―operational debt would include a claim in respect of the provision of goods or services, including employment, or a debt in respect of payment of dues arising under any law and payable to the Government or any local authority.”

. The Court held that most financial creditors – particularly banks and financial institutions – are secured creditors, whereas most operational creditors are unsecured.

. The distinction between secured and unsecured creditors is a distinction which has obtained importance since the earliest of the Companies Acts, both in the United Kingdom and in India, the Court stated.

. Apart from the above, the nature of loan agreements with financial creditors is different from contracts with operational creditors for supplying goods and services. Financial creditors generally lend finance on a term loan or for working capital that enables the corporate debtor to either set up and/or operate its business. On the other hand, contracts with operational creditors are relatable to supply of goods and services in the operation of business. Financial contracts generally involve large sums of money. By way of contrast, operational contracts have dues whose quantum is generally less.

. Most importantly, financial creditors are, from the very beginning, involved with assessing the viability of the corporate debtor. They can, and therefore do, engage in restructuring of the loan as well as reorganisation of the corporate debtor‘s business when there is financial stress, which are things operational creditors do not and cannot do, the Court held.

. Thus, preserving the corporate debtor as a going concern, while ensuring maximum recovery for all creditors being the objective of the Code, financial creditors are clearly different from operational creditors.

. Therefore, there is an intelligible differentia between the two that has a direct relation to the object sought to be achieved by the Code. Hence, the Court concluded that there is no violation of Article 14.

. Operational Creditors have no vote in Committee of Creditors

. Regarding operational creditors not having a vote in the Committee of Creditors, the Court held that financial creditors like banks and financial institutions, being in the business of money lending, are best equipped to assess viability and feasibility of the business of the corporate debtor. Even at the time of granting loans, these banks and financial institutions undertake a detailed market study which includes a techno-economic valuation report, evaluation of business, financial projection, etc.

. Since this detailed study has already been undertaken before sanctioning a loan, and since financial creditors have trained employees to assess viability and feasibility, they are in a good position to evaluate the contents of a resolution plan.

. On the other hand, operational creditors, who provide goods and services, are involved only in recovering amounts that are paid for such goods and services, and are typically unable to assess viability and feasibility of businesses.

. Further, the Court also noted that the NCLAT, while looking into viability and feasibility of resolution plans that are approved by the Committee of Creditors, always goes into whether operational creditors are given roughly the same treatment as financial creditors, and if they are not, such plans are either rejected or modified so that the operational creditors’ rights are safeguarded.

. Hence, the contention that operational creditors are discriminated against or that Article 14 has been violated either on the ground of equals being treated unequally, or on the ground of manifest arbitrariness, was rejected.

. Notice, hearing, and set-off or Counterclaim qua Financial Debts

. The Court found that at the stage of the NCLT‘s satisfaction under Section 7(5) of the Code, the corporate debtor is served with a copy of the application filed with the NCLT and has the opportunity to file a reply before the said authority and be heard by the said authority before an order is made admitting the said application. Insofar as set-off and counterclaim is concerned, the Court observed that,” a set-off of amounts due from financial creditors is a rarity. Usually, financial debts point only in one way – amounts lent have to be repaid. ” However, legitimate set-off may be considered by the Resolution Professional during the filing of proof of claims, the Court ruled.

. The Supreme Court further observed that a Financial Creditor has to prove default as opposed to an Operational Creditor who merely claims a right to payment of liability or obligation in respect of a debt which may be due. The Court noted that “ a claim gives rise to a debt only when it becomes due, a default occurs only when a debt becomes ―due and payable and is not paid by the debtor. ” When this aspect is borne in mind, the differentiation in triggering insolvency resolution process by a Financial Creditor under Section 7 and by Operational Creditors under Section 8 and 9 of the Code becomes clear.

. Section 12A valid

. Section 12A was inserted by the Insolvency and Bankruptcy (Second Amendment) Act, 2018 with retrospective effect from June 6, 2018. It reads as follows:

. “Withdrawal of application admitted under Section 7, 9 or 10.—The Adjudicating Authority may allow the withdrawal of application admitted under Section 7 or Section 9 or Section 10, on an application made by the applicant with the approval of ninety per cent voting share of the committee of creditors, in such manner as may be specified.”

. The Court held that once the Code gets triggered by admission of a creditor‘s petition under Sections 7 to 9, the proceeding that is before the Adjudicating Authority, being a collective proceeding, is a proceeding in rem .

. Hence, it is necessary that the body which is to oversee the resolution process must be consulted before any individual corporate debtor is allowed to settle its claim.

. The main thrust against the provision of Section 12A was the fact that ninety per cent of the Committee of Creditors has to allow withdrawal. The Court, however, noted that this high threshold has been explained in the ILC Report as all financial creditors have to put their heads together to allow such withdrawal as, ordinarily, an omnibus settlement involving all creditors ideally ought to be entered into.

. This explains why ninety per cent – which is substantially all the financial creditors – have to grant their approval to an individual withdrawal or settlement. In any case, the figure of ninety per cent, in the absence of anything further to show that it is arbitrary, must pertain to the domain of legislative policy, the Court ruled.

. Regarding what is to happen before a Committee of Creditors is constituted, the Court held that a party can approach the NCLT directly, and the Tribunal may, in exercise of its inherent powers under Rule 11 of the NCLT Rules, 2016, allow or disallow an application for withdrawal or settlement.

. For the above reasons, the Court held that Section 12A passes Constitutional muster.

. Information provided by Private Information Utilities

. Private information utilities were attacked by the petitioners on the ground that they are not governed by proper norms. It was also stated that the evidence by way of loan default contained in the records of such utility cannot be conclusive evidence of what is stated therein

. The Court, however, proceeded to place reliance on Information Utilities Regulations and stated that apart from the stringent requirements as to registration of such utility, the moment information of default is received, such information has to be communicated to all parties and sureties to the debt. Apart from this, the utility is to expeditiously undertake the process of authentication and verification of information, which will include authentication and verification from the debtor who has defaulted.

. This being the case, coupled with the fact that such evidence is only prima facie evidence of default, which is rebuttable by the corporate debtor, the challenge based on this ground also failed.

. IRP has no adjudicatory powers

. The Court made it clear that the Interim Resolution Professional (IRP) is given administrative powers, as opposed to quasi-judicial powers. In fact, even when the resolution professional is to make a determination under Regulation 35A, he is only to apply to the Adjudicating Authority for appropriate relief, the Court held.

. Unlike the liquidator, the resolution professional cannot act in a number of matters without the approval of the Committee of Creditors under Section 28 of the Code, which can, by a two-thirds majority, replace one resolution professional with another, in case they are unhappy with his performance. Thus, the Court made it clear that the resolution professional is really a facilitator of the resolution process, whose administrative functions are overseen by the Committee of Creditors and by the Adjudicating Authority.

. Constitutional Validity of Section 29A

. Section 29A lays down the persons who are not eligible to be resolution applicants. This Section was first introduced by the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2017, which amended the Insolvency and Bankruptcy Code.

. Various aspects of this provision were considered by the Court.

. Retrospectivity

. It was the argument of the petitioners that the vested rights of erstwhile promoters to participate in the recovery process of a corporate debtor have been impaired by retrospective application of Section 29A.

. The Court, however, placed reliance on the judgment in the ArcelorMittal case , wherein it had been observed that a resolution applicant has no vested right for consideration or approval of its resolution plan.

. Since a resolution applicant who applies under Section 29A(c) has no vested right to apply for being considered as a resolution applicant, it cannot be claimed as an argument against retrospectivity.

. Section 29A(c) not restricted to malfeasance

. The petitioners had mounted a challenge to Section 29(c) on the ground that it treats unequals as equals. A good erstwhile manager cannot be lumped with a bad erstwhile manager. Where an erstwhile manager is not guilty of malfeasance or of acting contrary to the interests of the corporate debtor, there is no reason why he should not be permitted to take part in the resolution process.

. However, the Court applied the same rationale as was applied to answer the contention with regard to retrospectivity – that there is no vested right.

. “The same rationale that has been provided earlier in this judgment will apply to this proviso as well – there is no vested right in an erstwhile promoter of a corporate debtor to bid for the immovable and movable property of the corporate debtor in liquidation.”

. Further, the Court also noted the categories of persons who are ineligible under Section 29A, which includes persons who are malfeasant, or persons who have fallen foul of the law in some way, and persons who are unable to pay their debts in the grace period allowed, are further, by this proviso, interdicted from purchasing assets of the corporate debtor whose debts they have either wilfully not paid or have been unable to pay.

. The legislative purpose which permeates Section 29A continues to permeate the Section when it applies not merely to resolution applicants, but to liquidation also, the Court held and dismissed this contention.

. One year period in Section 29A(c) and NPA

. The Supreme Court has held that the legislative policy, is that a person who is unable to service its own debt beyond the grace period referred, is unfit to be eligible to become a resolution applicant. This policy cannot be found fault with. Neither can the period of one year be found fault with, as this is a policy matter decided by the RBI and which emerges from its Master Circular, as during this period, an NPA is classified as a substandard asset. The ineligibility attaches only after this one year period is over as the NPA now gets classified as a doubtful asset.

. Related Party under 29A(j)

. A Constitutional challenge was raised against Section 29A(j) read with the definition of related party. What was argued by the petitioners is that the mere fact that somebody happens to be a relative of an ineligible person cannot be good enough to oust such person from becoming a resolution applicant, if he is otherwise qualified.

. The Court held that it was of the view that persons who act jointly or in concert with others are connected with the business activity of the resolution applicant. Similarly, all the categories of persons mentioned in Section 5(24A) show that such persons must be connected with the resolution applicant within the meaning of Section 29A(j). This being the case, the said categories of persons who are collectively mentioned under the caption relative obviously need to have a connection with the business activity of the resolution applicant.

. In the absence of showing that such person is connected with the business of the activity of the resolution applicant, such person cannot possibly be disqualified under Section 29A(j), the Court ruled.

. The expression “related party” contained in the definition Sections must be read noscitur a sociis with the categories of persons mentioned in Explanation I, and would include only persons who are connected with the business activity of the resolution applicant.

. Read the full judgment:

Insolvency and Bankruptcy Code: Highlights of the Supreme Court Judgment

Murali Krishnan

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