A Stitch in Time saves nine: Notice to creditors mandatory?

[By Saumya Mittal & Keerthana Rakesh]

The authors are students of Gujarat National Law University.

 

Introduction

In a dramatic chain of events, Go First, one of the most profitable and most sought-after airlines in India, had to take a flight on the wings of Section 10 of the Insolvency and Bankruptcy Code, 2016. With its faulty engines, the aviation company found itself in hot water due to mounting losses and unpaid credit. But the news didn’t bode well for the operational creditors of the company who were well aware that a Corporate Insolvency Resolution Process (CIRP) takes an average of 588 days in India and by the time a resolution plan develops, most of the value of the assets would have eroded. To counter the same, they presented the National Company Law Tribunal (NCLT) with multiple arguments, one of them being that no notice of initiation of CIRP under section 10 was served to the operational creditor by the corporate debtor, thus depriving them of the opportunity to object to the said application.

Section 10 of the Insolvency and Bankruptcy Code, 2016 (“IBC”) allows the Corporate Debtor to initiate CIRP against itself by filing an application before the Adjudicating Authority. Having heard both the sides, the NCLT vide order no. (IB)-264(PB)/2023 admitted the application and favored the Corporate Debtor by stating that a Corporate Debtor is not obliged to serve notice to its creditors as Section 10 or 11 of the IBC does not prescribe the said requirement. The position on serving of notice being clear, this article attempts to inspect the decision of the NCLT with respect to the serving of notice under section 10 and whether the same should be made mandatory.

Issue and Contentions of the Parties

The issue arose when Go Airlines (India) Limited filed an insolvency application under Section 10 of the IBC before the NCLT, Delhi, to initiate the CIRP proceedings against itself. The Corporate Debtor submitted that it is in financial distress due to continuous default in payments to vendors and aircraft lessors. Since it has a subsisting debt of more than Rs. 1 Crore, it is entitled to file an application under the said section of the IBC.

The creditors of the Applicant, on the other hand, were against the insolvency application as they contended that the Corporate Debtor did not give them due notice before filing the application before the NCLT. They pleaded that they were entitled to prior notice and that principles of natural justice should be duly adhered to. Further, the creditors contended that they should be provided with an opportunity to file an application under Section 65 of the IBC, which provides for action to be taken against any person who initiates CIRP with malicious intent.

Notice under Sections 7 and 9 similar to that under Section 10?

One important observation made by the tribunal in the Go First proceedings was that serving of notice to a corporate debtor by the financial and the operational creditor under sections 7 and 9 respectively, was a matter of right as application under the two sections was in personam and in the nature of a litigation thus making the corporate debtor a respondent. Also, the tribunal noted that a corporate debtor is an ‘aggrieved party’ and thus it should be served notice. But the same was not the case for notice under section 10. Since creditors didn’t constitute an ‘aggrieved party’ and are in the nature of a third party, serving notice to them is not legally compulsory and it merely depends upon the facts of each case. Thus, the notice under sections 7 and 9 is significantly different from that under section 10. The matter of whether notice under this section is obligatory has been largely resolved by the tribunal. However, a new consideration arises: Should this requirement be mandated? Before addressing this, it is prudent to examine Section 65, which grants distressed creditors the authority to initiate fraud proceedings against any deceitful CIRP.

Rationale behind notice requirement in light of Section 65

Mention of section 65 whilst dealing with section 10 is a no-brainer. Section 65 of the 2016 code deals with the fraudulent initiation of Insolvency resolution proceedings by a person in order to defraud any stakeholder. It is settled law that section 65 proceedings can be initiated even after the imposition of a moratorium under section 14 of the code, and the same has been reiterated in the Go First NCLT Order. In this order, one sound question was raised- why should notice be served under section 10 if the provision of section 65 is there? If a party has the grievance that application for CIRP is fraudulent and has been filed just to defraud the creditors of their loans, the latter can very well file an application under section 65, and the proceedings would go along with the CIRP proceedings. Why does one, then, need an intimation via notice of filing for CIRP by the corporate debtor just to make sure that no fraudulent proceedings are initiated? The answer lies in the limited scope of section 65, which deals with only those cases where ‘fraudulent intention’ exists. However, consideration must also be given to instances where the corporate debtor’s actions were not driven by malicious intent. Nonetheless, these actions still had a substantial adverse effect on the creditors. In such cases, a prompt notification of the impending CIRP filing was essential to allow creditors to strategize appropriately. For these scenarios, regardless of intent, the necessity for a notice persists, and this requirement cannot be solely addressed by the provisions of section 65.

Need for serving of notice under section 10

Serving notice to creditors during the initiation of the CIRP is a prudent approach that aligns with the spirit of IBC 2016 while fostering transparency, efficiency, and the best interests of all stakeholders involved. One of the primary reasons to serve mandatory notice to creditors is to enable them to be adequately prepared for any economic setbacks they may encounter during the CIRP. By being informed at the outset, creditors can evaluate the potential impact on their financial position and take necessary measures to mitigate any adverse effects.

Moreover, creditors can explore alternative avenues and strategies to safeguard their interests and participate effectively in the resolution process. Creditors often possess intricate knowledge of the debtor’s operations, financial health, and industry dynamics. Involving creditors from the initial stages of the CIRP allows debtors to tap into this valuable technical know-how. Creditors can assist debtors in devising a suitable and realistic path forward for the revival of the business. The collective expertise of creditors can significantly contribute to the development of a comprehensive resolution plan tailored to address the root causes of financial distress and ensure the long-term viability of the debtor’s business. Mandatory creditor notice promotes a collaborative approach, enabling the debtor to benefit from all stakeholders’ collective wisdom and experience. While the tribunal is responsible for overseeing the CIRP, creditors are better placed to assess the financial viability and feasibility of different resolution options. Creditors can provide valuable insights into whether the debtor should pursue resolution, opt for liquidation, or explore the formulation of new credit terms. This informed decision-making process enhances the efficiency and effectiveness of the CIRP, guiding it toward the most appropriate resolution path while protecting the rights and interests of all stakeholders.

Also, Section 424 of the Companies Act 2013 states that the tribunal is to be guided by the principles of natural justice. Although the creditors would have the opportunity of being heard in the later stage of the proceedings by way of filing a petition under section 65 or during the constitution of the committee of creditors, timely hearing of the creditors is necessary to safeguard their interest. All in all, it must be borne in mind that serving timely notice to them simply means involving them from the first instance so that they can prepare themselves for the likely economic blow that they might face due to the CIRP and at the same time assist the tribunal in formulating the most reasonable way forward for every stakeholder.

Way forward

In the Go Air NCLT order, the tribunal stated that serving notice to each creditor is not reasonable since it would lead to innumerable filing of objections by the latter, which would, in turn, waste the crucial time of the CIRP process, thus leading to depreciation of assets’ value. This genuine concern can be resolved by issuing a notification whereby creditors can be allowed to raise objections via a single representative, which would be appointed by creditors surpassing a monetary threshold. Alternatively, the committee of creditors can be constituted initially through which a representative can be elected. Also, by serving a notice to the creditors, the corporate debtor and creditor must try to negotiate and arrive at a decision that serves the best interest of all. Last but not the least, the tribunal had stated in its order that creditors do not fall under ‘aggrieved party’ and only the corporate debtor does. This view should be changed since after the shareholders, creditors form the largest source of capital for the debtor. Thus, discarding them as not an aggrieved party is unjust in its entirety. The tribunal should broaden the purview of the term ‘aggrieved party’ under the golden rule of interpretation and must include creditors in it so that complete justice can be achieved and the interest of all parties can be taken into account.

While it is true that the objective of the IBC is to minimise the distress of the Corporate Debtor and maximise the value of assets held, it is equally vital to safeguard the interest of the creditors. Therefore, a more balanced approach by the NCLT by way of mandating the serving of notice under section 10 would be appreciated.

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