The authors are 3rd year students of NLU, Jodhpur.
“The defaulter’s paradise is lost. In its place, the economy’s rightful position has been regained.”
The Insolvency and Bankruptcy Cody, 2016 [“the Code”] received the official sanction[i]recognizing its constitutional tryst in entirety in quite a significant verdict. We still remember the packed courtroom to hear the amusing and intelligent arguments of the virtuoso lawyers. IBC, a landmark aspired by high-ranked officials for improving the financial structure of the country (seeI do as I doby Raghuram G. Rajan and Of Counselby Arvind Subramanian) has sustained the constitutional scrutiny. It is worth mentioning that the judgment is beautifully written and structured. Though at certain places one might feel less satisfied with the restricted reasoning of the Court, however, such concession can be granted for the Court’s recognition of limited judicial review in economic matters at the outset of the judgment. Here, we endeavour to present a brief overview of the judgment spiced with our critique.
The Court has tried to establish the premise behind its reasoning and exercising judicial restraint by considering the fall of Lochnerdoctrine (practice of the US Supreme Court to declare the socio-economic legislations as unconstitutional using the ‘due process’ clause) in the US, which initiated with the dissents of Justice Holmes and Justice Brandeis of the U.S. Supreme Court. As per Justice Holmes’ dissenting opinion in Lochner v. New York[198 U.S. 45 (1905)]:
“The courts do not need to substitute their social and economic beliefs for the judgment of legislative bodies, who are elected to pass laws.”
Further, the Court relied on its own judgment in R.K. Garg v. Union of India[ii]to hold that the laws relating to economic activities should be viewed with greater latitude as compared to laws relating to civil rights. As there is no straitjacket formula to solve an economic problem, the legislature will employ trial and error method to find solution of such problems. The Court, therefore, should exercise judicial restraint in interfering with legislations like the Code, and question the constitutionality only when such legislations are ‘palpably arbitrary, manifestly unjust and glaringly unconstitutional’.
The Court, after establishing the premise behind presuming the constitutionality of the court, delved into the objects underlined the Code – to bring the insolvency law in India under a single unified umbrella, to speed up the insolvency process and to ensure revival and continuation of the corporate debtor. Prior to the Code, the insolvency matters were dealt by multiple fora under various laws such as Sick Industrial Companies (Special Provisions) Act, 1985; the Recovery of Debts Due to Banks and Financial Institutions Act, 1993; the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; and the Companies Act, 2013.
The petitioner had successfully argued that the constitution of the NCLAT, with its lone bench in Delhi, goes against the judgment of the Court in Madras Bar Association v. Union of India[iii](2014) where it was held that permanent benches of NCLAT have to be constituted wherever there is a seat of the High Court, or circuit benches be constituted. The Court has ordered the Union of establish circuit benches of NCLAT within 6 months.
Next, the petitioner argued that in Madras Bar Association v Union of India[iv](2015), it was held that the administrative support to all the tribunals should be from the Ministry of Law and Justice; therefore, the NCLAT should not function under the Ministry of Corporate Affairs. Though the Government cited Article 77(3) of the Constitution and Delhi International Airport Limited v. International Lease Finance Corporation and Ors.[v]to argue that the allocation of rules of business among various Ministries is mandatory, the Court accepted petitioner’s claim. However, we see the existing regime, the Ministry of Corporate Affairs deals exclusively with all the matters pertaining to the administration of companies – the Code;[vi]the Insolvency and Bankruptcy Board of India; the Competition Commission of India; the Companies Act, et al. Therefore, we argue that for better corporate governance, NCLT and NCLAT should continue to function under the Ministry of Corporate Affairs only. This goes in line with the existing setup wherein Ministries provide administrative support to their corresponding tribunals. For instance, Department of Telecommunication administers Telecom Disputes Settlement and Appellate Tribunal; Ministry of Environment, Forest and Climate Change administers National Green Tribunal and Department of Revenue administers the GST Appellate Tribunal.
Next, the Court was confronted with multiple challenges related to arbitrariness, the first being the issue of reasonable classification between financial creditors and operational creditor. At the outset, the Court laid down a common rule of Article 14 for all such challenges – A constitutional infirmity is found in Article 14 only when the legislation is manifestly arbitrary.The petitioners had challenged the requirement of a demand notice to the operational debtor by the operational creditor before initiating the process under the Code, which is absent in case of a financial debt. The Court did not uphold this argument and distinguished the two debts as follows:
|Financial Debt||Operational Debt|
|Financial debt is given for establishment of business and keeping the business as a going concern in an efficient manner.||Operational debt is generated as part of a business activity owing to exchange of goods and services, including employment.|
|Evidence of debt is readily available with the financial creditor and in the records of information utilities. The information utilities are under the duty to send notice to the debtor before recording any debt for verification purposes.||All operational creditors might not have accurate account of all liabilities in verifiable form due to its recurring nature. It increases the possibility of disputed debts.|
|It is generally given in large sum and by a small number of persons.||It is given in small sum by a large number of persons.|
|It is a secured debt.||Sometimes, it is not secured against collaterals.|
|Here, the contracts provide a specified repayment schedule, wherein defaults entitle financial creditors to recall a loan in totality.||The nature of contract is different. Instead, defaults generally lead to initiation of dispute resolution process.|
|Financial creditors are involved with assessing the viability of the debtor from the very beginning.||Due to the lack of information, the operational creditors are not in the capacity to keep a regular check on the viability of the business.|
Additionally, the Court cited Rule 4 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016; Section 420 of the Companies Act, 2013 and Rules 11, 34 and 37 of the NCLT Rules, 2016 to establish that principles of natural justice have been upheld by obligating the creditor and the adjudicating authority to send a notice to the debtor on acceptance of the application.
It was followed by an elegant use of interpretative mechanism to further distinguish the two. The Court identified the meaning of the terms ‘claim’, ‘debt’ and ‘dispute’ to establish that a claim gives rise to a debt, and a dispute occurs only when such debt becomes due and payable but is not paid by the debtor. As the Code requires the financial creditor to prove a ‘default’, whilst the operational debtor is merely required to prove a ‘claim’, the distinction becomes reasonable. This policy was identified as a move away from the concept of ‘inability to pay debts’ to ‘determination of defaults’ to enable the financial creditor to timely effectuate reconstruction based on the documentary evidences.
The next challenge of arbitrariness was regarding non-availability of voting rights to the operational creditors in the Committee of Creditors under Section 21 of the Code. The Court upheld the provision recognizing that as power the committee is to keep the entity as a going concern, only those persons should be part of it who have the capability to assess the viability and willing to modify the existing terms of liabilities, which is generally restricted to financial creditors. Alongside, the Court considered four-fold institutional mechanism to establish that no prejudice is maintained against the operational creditors:
- The power of the significant operational creditors, whose aggregate dues is not less than 10% of the debt, to observe the meeting;
- To be effective, the resolution plan of the Committee has to be first approved by the adjudicating authority;
- The Code disallows implementation of any resolution plan unless it provisions for a minimum payment to the operational creditors, being not less than the liquidation value;
- The Code mandates the payment to the operational creditors in priority to the financial creditors.
The Court considered data of 80 cases that have been resolved since the Code has been implemented to indicate the priority given to the operational creditor.
Next up was a challenge of arbitrariness against Section 12-A of the Code which allows the withdrawal of application from the adjudicating authority by the approval of 90% voting share of the Committee of Creditors. The court upheld the threshold of 90% recognizing that once a proceeding is initiated, it is a collective proceeding in rem. Therefore, any withdrawal of such proceedings has to be effectuated only with all the financial creditors have put their heads together. Though it could be argued that ‘90%’ is a random choice and is arbitrary, however, this does not fulfil the threshold of Article 14 – manifest arbitrariness. The Court went on to refer to Section 60 of the Code to establish that the mechanism is free from possibilities of unfair withdrawal as the NCLT is the final approving authority, whose decision can be further challenged in the NCLAT.
The next challenge of the petitioners was on the information utilities itself. It was argued that they have been established for mere profit purposes and are not properly regulated, thus, their account cannot be treated as conclusive proof of default. The Court considered the regime of credit information companies, followed by the information utilities to appreciate the purpose of reducing information asymmetry, improving credit risk assessment and pace up the resolution process. The Court then considered the Information Utilities Regulations, 2017 to appreciate the expedite mechanism for verification and authentication of information. However, the Government conceded in favour of the petitioners, and the Court ruled that the information is only a prima facie evidence of default, which can be rebutted.
The petitioners then challenged the adjudicatory powers of the resolution professional, a claim refuted by the Court by the plain reading of the Code. It was held that the powers of the interim resolution professional under Section 18 of the Code and CIRP Regulations, 2016 are merely administrative in nature and restricted to the determination and verification of the amount of claim. It is the adjudicating authority who can determine and effectuate the appropriate relief based on the IRP’s report. To clarify the difference between administrative and quasi-judicial powers, the Court referred to the powers of the liquidator under the Code. The determination of the value of claim by the liquidator is in the nature of a ‘decision’, thus an appeal lies against such determination. However, the IRP is only empowered to submit its report for the final determination by the adjudicating authority.
It was followed by a challenge against Section 29A of the Code, which enlists certain person who are ineligible to be a resolution applicant. The provision was inserted in the Code by the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2017 to disqualify corporate debtors, their relatives, undischarged insolvent, one prohibited under the SEBI Act et al.from acting as resolution applicant to facilitate effective corporate governance. The Court referred to its judgment in ArcelorMittal India Private Limited v. Satish Kumar Gupta and Ors.[vii]to hold that the principles of Salomon v. A. Salomon and Co. Ltd.regarding separate corporate entity cannot be applied, and all those persons who acted jointly or in concert to drag the company to a stage of resolution, shall be disqualified from being the resolution applicant.
The Court was then asked to analyse whether the retrospective application of some provisions of the Code renders it unconstitutional. A statute can be construed as retrospective if its provisions operates on an antecedent set of facts but affects a vested right. As a resolution applicant does not have any vested right to be so appointed, the court concluded that there is no need to discuss the question of retrospectivity.
Next, the ineligibility of a corporate debtor to act as resolution applicant whose assets have been declared as NPAs in accordance with the guidelines of the Reserve Bank of India, and remained such for the period of one year, was challenged. The relevant guidelines declare an account as an NPA only if defaults made by a corporate debtor are not resolved within 3 months. The Court held that if a person is unable to service his own debt within the period of 15 months, then he cannot be allowed to allowed to become a resolution applicant. The said grace period is a question of legislative policy, which is not worth interfering.
The next challenge was pertaining to the restriction of related party to act as resolution professional. The Court, applying the ‘doctrine of nexus’, held that the reason behind not allowing related parties to be a resolution professional is the connection of such parties to the business activities or the resolution applicant. Such connections deem them disqualified to enable the Committee of Creditors to function independently.
Lastly, the court further held that the exemption of Micro, Small and Medium Enterprises from Section 29(A) is based on the rationale that the only interested parties in such enterprises are their promoters, therefore, not many resolution applicants might turn up and it would lead to the liquidation of the company. Liquidation is not in consonance with the objective of the Code.
The judgment is a bright light in the regime of corporate governance. By upholding the constitutional validity of the Code, the Court has validated its purpose and given more pace to the ease of doing business-
“The objective of the Insolvency and Bankruptcy Code, 2015 is to consolidateand amend the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time-bound mannerfor maximization of value of assetsof such person, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders. … It would also improve Ease of Doing Business, and facilitate more investments leading to higher economic growth and development. ”
Before parting, we appreciate the approach of the Court in drafting the judgment. The Court has resorted to the reports of the Bankruptcy Law Reforms Committee (2016), Joint Parliamentary Committee (2016), Insolvency Law Committee (2018) and the Statement of Objects and Reasons on multiple occasions. The introductory speech of the Finance Minister while moving the IBC (Amendment) Ordinance, 2017 and recommendations of the Siddiqui Working Group, 1999 on Credit Information Companies were also resorted to once. This shows that the Court is moving from the strict interpretation mechanism to the purposive interpretation mechanism, trying best to uphold the intentions of the legislature and increasing synergy between the two organs of the Government. We hope that such approach continues to prevail.