A Twist in the Tale – Has the Supreme Court diluted the Insolvency and Bankruptcy Code?

Premise

Since the advent of the Insolvency & Bankruptcy Code, 2016 (“IBC”), the insolvency law regime in India has been consolidated and uniformized. Courts have repeatedly held that the IBC is a code in itself and that one need not look elsewhere in deciding matters under it.

A key element that makes the IBC effective (and at times, almost mechanical) is the manner in which it provides for deciding insolvency petitions, particularly those filed by financial creditors. As understood historically on a reading of the IBC and the jurisprudence that has developed over the years, it was a settled position of law that in an insolvency petition filed by a financial creditor, the Adjudicating Authority, being the National Company Law Tribunal (“NCLT”), is required only to ascertain the existence of debt and the factum of default. The presence of both elements was, until now, understood to mean an almost assured result, being the commencement of corporate insolvency resolution process (“CIRP”) of the corporate debtor.

The above principle has been enunciated in one of the formative judgments in IBC jurisprudence of the Supreme Court of India in Innoventive Industries Limited v. ICICI Bank & Another(1) (“Innoventive Industries”) wherein the Court held that the NCLT, upon ascertaining the existence of a debt and default, must initiate CIRP of the corporate debtor.

However, a recent judgment of the Supreme Court in the case of Vidarbha Industries Power Limited v. Axis Bank Limited(2) (“Vidarbha Industries”), has created paradigm shift in this settled position, wherein the Supreme Court being seized of what seemed to be an ordinary, straightforward case of financial debt and default, has applied an altogether different and novel test for deciding the case.

Facts

The facts of the case were fairly straightforward. The debtor, Vidarbha Industries Power Limited (“Debtor”) was a power generation company, one of whose financial creditors, Axis Bank Limited (“Bank”), had filed a petition before the NCLT as a financial creditor basis a default of Rs. 553 Crores.

While the Petition was pending, the Debtor filed an application for stay on the ground that it had in its favour an order of the Appellate Tribunal for Electricity (“APTEL Order”), whereunder it was liable to recover an amount of Rs. 1,731 Crores. However, since the APTEL Order was challenged before the Supreme Court (which was still pending), the Debtor had yet not received the amounts due under the APTEL Order.

The NCLT, Mumbai Bench found that the Debtor had defaulted in repayment of a financial debt and basis this, rejected the Debtor’s stay application, which decision was upheld in appeal by the National Company Law Appellate Tribunal. Aggrieved, the Debtor appealed to the Supreme Court.

Supreme Court’s findings

The judgment of the Supreme Court is centred around the interpretation of Section 7 of the IBC and whether existence of a debt and default ought to mandatorily result in admission of an insolvency petition. The Court observed that in cases of financial debt, when the NCLT is satisfied of the existence of a debt and a default, there exists a further discretion with it to reject the petition for other reasons. The rationale given by the Court for this is that Section 7 of the IBC uses the word ‘may’ and not ‘shall’. This, in the Court’s view, is because the object of the IBC is not to ‘penalize solvent companies temporarily defaulting in repayment of their debts’.

Delving into the facts of the case, the Court noted that while the default amount claimed in the Petition was Rs. 553 Crores, the Debtor stood to recover a far greater amount under the APTEL Order. In the Court’s view, this fact ought to have weighed with the NCLT while deciding the Debtor’s stay application.

It was argued on behalf of the Bank that the Supreme Court’s earlier decision in Swiss Ribbons Private Limited v. Union of India & Others(3) (“Swiss Ribbons”), which authoritatively quotes Innoventive Industries, mandates the NCLT to admit a petition on ascertaining the existence of a debt and default and hence, there was no discretion with the NCLT to reject a petition of a financial creditor in the face of a debt and default. The Court, however, opined that the Swiss Ribbons judgment was passed in a challenge to the constitutional validity of the IBC and hence, it could not be applied in interpreting Section 7 of the IBC.

Based on the above reasoning, the Court directed the NCLT to re-consider the Debtor’s stay application
on merits.

In addition to the discussion on a financial creditor’s petitions, the Court also made certain observations on insolvency petitions by operational creditors and noted that it is, in fact, in those cases that the NCLT has no discretion. The Court’s reasoning for taking this position was that Section 9 of the IBC (which concerns operational creditors) uses the word ‘shall’ instead of ‘may’. The Court also observed that the financial strength and bargaining power of a typical operational creditor is usually far lesser than that of a financial creditor. Consequently, the impact of non-payment of dues would be much greater on an operational creditor as compared to a financial creditor. This, in the Court’s view, is why the legislature intended to make petitions by operational creditors inflexible but chose to give some leeway to the NCLT while deciding petitions filed by financial creditors.

Analysis

Judicial record is testament to the fact since inception, the IBC has been embroiled in a myriad of litigation with the Supreme Court intervening on various occasions to interpret the legislation in its true spirit. All the significant judgments that emerged, including the earliest one in the case of Innoventive Industries, parrot the same intent and mandate over and over, being that financial debt and default ought to necessarily result in admission of an insolvency petition. On the other hand, early judgments of the Supreme Court, starting from the case of Mobilox Innovations Private Limited v. Kirusa Software Private Limited(4) (“Mobilox”), have reiterated that in cases of insolvency petitions filed by operational creditors, the NCLT must examine the pre-existence of disputes between the parties and only upon being satisfied that there is no pre-existing dispute, operational creditor petitions should be admitted.

Compared to the jurisprudence that has developed in a pointed direction and which has formed the bedrock of insolvency, the view taken by the Supreme Court in Vidarbha Industries appears to have been based on a rather startling approach on certain fundamental aspects of the IBC. We analyse some key concerns.

1. A debtor’s defences to a financial creditor’s petition, that the NCLT now needs to consider, have become seemingly limitless. All extraneous factors can be pleaded and will have to be dealt with by the NCLT on a case-by-case basis. This is a complete overhaul from the existing regime as contemplated in Innoventive Industries.
2. The apprehension of financial creditors triggering the IBC was a consistent motivation for promoters and management to keep bank defaults in check. However, the Supreme Court has now provided promoters and management of defaulting companies with a handle to plead extraneous reasons for defaults, which is bound to result in slower adjudication of petitions by NCLT. This risks taking the edge out of the IBC and is contrary to the intent of the legislation.
3. While placing reliance on the APTEL Order to keep on hold the Bank’s petition, the Supreme Court did not consider that the APTEL Order was under challenge and could well be reversed in the future. The Supreme Court also did not consider that while the APTEL Order may be sufficient to cover the debt of the Bank, the default committed by the Debtor in repayment of the other lenders in the consortium was much larger. This judgment, thus, sets a precedent in that a money decree in a defaulting debtor’s favour is to be treated as grounds for rejection of insolvency petitions, regardless of the fact that the decree may be set aside or reversed in appeal. In fact, it could be argued that any contingent / future asset would qualify as a defence to an insolvency action by a financial creditor. The judgment seems to miss the point that a financial creditor’s right to be paid is not contingent upon receipt of moneys due to the corporate debtor. It appears to go against the settled concept of contract law that parties must be held to their bargain.
4. A shift in the position of law has also been caused on account of the Supreme Court handing significance to concepts such as “solvency” or “bankruptcy” of a company. Such a view effectively marks a shift to the pre-IBC regime when the winding-up of companies was governed by the Companies Act, 2013 / 1956 where “inability to pay debts” was considered a sin qua non for initiation of winding-up. That apart, this also contradicts the Supreme Court’s judgment in the case of Swiss Ribbons where it was observed that with the enforcement of the IBC, the legislative policy has moved away from “inability to pay debts” to “determination of default”.
5. As in the case of financial creditors, this judgment also marks a slight shift in the jurisprudence in respect of operational creditors. Given that judgments on operational creditor issues have reiterated that pre-existence of dispute could be determined by the NCLTs, operational creditor petitions were as such decided on a case-by-case basis.
6. Another interesting aspect of the judgment is the Court’s observations on the comparison between the position of financial creditors and operational creditors in the insolvency regime. The finding of the Court that there is more flexibility with the NCLTs in deciding financial creditor applications rather than operational creditor applications, is yet another deviation from the settled understanding.
7. An altogether different question that arises is on the legality of this judgment itself. This judgment contradicts two earlier decisions of the Supreme Court, viz. Innoventive Industries and Swiss Ribbons, both passed by coordinate benches of the Supreme Court.

The judgment is transformative on many fronts and has the potential to reshape the IBC regime, essentially to the detriment of banks and financial institutions. The intent behind certain provisions of the Reserve Bank of India’s prudential framework for stressed assets may also stand diluted.

Whether the judgment stands as good law in future, is something only time will tell. For now, it seems fitting to say that in the life of the IBC, there is never a dull moment. The hope remains that this twist in the tale does not take the sting out of the legislation that intended with rigour to resolve stressed assets in a timely manner. We fear that unscrupulous defaulters may use this judgement to default in payment of financial debt resulting in the agency problem sought to be resolved by IBC being reinstated. This is a space to watch.

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(1) Innoventive Industries Limited v. ICICI Bank & Another, Civil Appeal Nos. 8337-8338 of 2017, decided on August 31, 2017.

(2) Vidarbha Industries Power Limited v. Axis Bank Limited, Civil Appeal No. 4633 of 2021, decided on July 12, 2022.

(3) Swiss Ribbons Private Limited & Another v. Union of India & Others, Writ Petition (Civil) No. 99 of 2018, decided on January 25, 2019

(4) Mobilox Innovations Private Limited v. Kirusa Software Private Limited, Civil Appeal No. 9405 of 2017, decided on September 21, 2017.

AUTHORS: Sakate Khaitan (Senior Partner) | Dhiraj Mhetre (Partner) | Smiti Tewari (Partner) | Shreyas Lele (Associate)