Analysing the limit of ‘Discretion’ in a situation of ‘Default’ under the IBC.

[By Yash Sameer Joshi]

The author is a student at the National Law University, Jodhpur.

I. Introduction

 The Insolvency and Bankruptcy Code, 2016 [“IBC”] has oft been described as a consolidating and amending Act enacted to ensure the viability of company assets in the case of corporate insolvency. The IBC provides for the initiation of the Corporate Insolvency Resolution Process [“CIRP”] in case of such insolvency, and the initiation of this process has traditionally been ‘default based’ (meaning of the term default can be found in Section 3(12) of the IBC) in the context of the IBC. What this means is that only when there is an actual non-payment of a pending debt by the corporate debtor can the CIRP process be initiated. This view has been upheld by both the National Company Law Appellate Tribunal [“NCLAT”] in the decision of Innoventive Industries v. ICICI Bank and is supported by the definition of ‘insolvent’ as is given in Section 2(8) of the Indian Sale of Goods Act, 1930. Due to this ‘default’ threshold, whose amount was increased to Rupees 1 crore through the recent amendments, the position that has always been interpreted was that the mere existence of said ‘default’ would compel the adjudicating authority to accept the application filed for the initiation of the CIRP.

The High Court of Kerala in the Cyriac Case has gone as far as saying that “The litmus test on the anvil of which, the adjudicating authority will scrutinise the matter, is only the existence of the default, as defined in Section 4 of the Code”. The reasoning of the Court was in consonance with the Swiss Ribbons Judgement, in which it was held that “no other extraneous” matters should be considered while contemplating a decision under Section 7 (financial creditors) or Section 9 (operational creditors) of the IBC.

 Recently, however, the Supreme Court in Vidarbha Industries Power v. Axis Bank [“Vidarbha”] brought in the element of discretion while deciding an application for the CIRP with respect to Section 7(5)(a), even in the case of a default. The word ‘may’ in the Section was given a literal interpretation, and the revival of the company was put on a higher pedestal than liquidation. The aspect of the presence of this discretion has already been explored and established, and in light of this, the main purpose of today’s article will be to analyse the extent to which this discretion can/should be used. Further, this article will also dwell on the conundrum of whether a discretion-based model vitiates the need for there being a ‘default’ as a condition for filing an application for the initiation of the CIRP.

II. The extent of discretion: Construed Broadly or Narrowly

 The fact that Vidarbha has brought in a degree of discretion is undisputed, but to what limit should the adjudicating authority exercise this? The Court in Vidarbha gave a very broad outline saying that discretion could not be used “arbitrarily or capriciously”. The Supreme Court tried to bring about some clarity by giving an example:

 “For example, when admission is opposed on the ground of the existence of an award or a decree in favour of the Corporate Debtor, and the Awarded/decretal amount exceeds the amount of the debt, the Adjudicating Authority would have to exercise its discretion under Section 7(5)(a) of the IBC to keep the admission of the application of the Financial Creditor in abeyance, unless there is a good reason not to do so.”

 However, this did little to the fog, considering that the example was almost parallel to the facts present in the instantaneous case. The doubt that is bound to arise is that apart from the existence of an award that is in favour of the corporate debtor that exceeds the debt amount, when can discretion be used. According to the author, this can be interpreted in two ways:

A) Broad Construction

What this approach would entail is that the adjudicating authority or NCLT would use its jurisdiction widely by looking at the overall financial health of the company in question. This would entail roughly following what is known as the ‘balance sheet’ test of determining insolvency, which takes into account external aspects like examining the balance of total assets and liabilities or any outside phenomenon that prevented the payment of debts that was not the fault of the debtor. As was rightly analysed by a working paper published by the Indian Institute of Management Ahmedabad, while the dominant position in India has been the ‘default’ based approach post-IBC, there have been instances where the Court has brought in the balance sheet test to an extent. This test has been successfully implemented to varying degrees in Jurisdictions such as the United States and the United Kingdom.

At a preliminary glance, it seems as if Vidarbha is aiming to bring in the balance sheet test, with the adjudicating authority expected to look at the situation as a whole and apply what it seems right in a manner that is not ‘capricious’. However, we cannot overlook the fact that the Court in this case relied more on ‘rules of interpretation’ by referring to cases such as Hiralal and Premchand. The main purpose for which the IBC was brought in was to solve the insolvency of a company, and the main purpose of the CIRP is to keep the company as a ‘going concern’, as was also elucidated in the Tata Consultancy Services Case. Therefore, its timely imitation may many a time be a boon rather than a bane in consonance with this ‘purpose’.

B) Narrow Construction

The second approach that can be taken is to look at the reasoning of the Court in Vidarbha in a more pragmatic manner. As we have already seen, both the facts in the said case and the example given by the Supreme Court indicated a pending decree, which on resolution in the favour of the debtor would allow it to repay its debts. In pursuance of this, what the author is propounding is that this method of interpretation would allow the adjudicating authority to apply its discretion only in situations where there is a ‘direct phenomenon’ (this term is just a suggestion and may be refined by the legislature for clarity’s sake) on whose resolution the debtor would be able to repay its debts. This line of reasoning, while more inclined towards the ‘default’ based model, allows for a reasonable ambit of discretion in cases where it is evident that it is not the debtor that has failed to pay the debt by itself, but a directly related event that is stopping the same. If we take the above example of a pending award, the instant that (hypothetically) the award would have been passed against the debtor, the adjudicating authority would be mandated to accept the application for the initiation of the CIRP. Another example could be where the debtor is only temporarily cash flow insolvent, and there is good reason to show that the required resources to pay back the debt will soon be acquired in the normal course of business (perhaps because of deferred payment from a party that owes a sum to the debtor).

This approach would not only solve the ‘something above a mere default’ issue that has been associated with the default-based model but would also help in maintaining the ‘efficient and timely’ based insolvency model for which the IBC was enacted in the first place.

III. The need for ‘default’ as a condition to file a CIRP application in the case of ‘Broad Construction’

Section 3(12) of the IBC provides for the meaning of default as “non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not repaid by the debtor or the corporate debtor, as the case may be”. As we have already seen, the current regime requires default, failing which it is illegal to initiate the CIRP process. Now the question that is bound to arise is if the position is interpreted such that the court has discretion in the ‘broad’ sense, why should default act as a threshold for the filing of an application? This can be looked at both from the side of the debtor and creditor. (i) This may lead to an excess of claims by overzealous and overcautious creditors, encumbering both debtors and the adjudicating authority. (ii) Without the default threshold, the adjudicating authority may be too quick or casual in rejecting claims. Thus even if the broad construction is taken (as opposed to the narrow approach suggested by the author), the default threshold should still be maintained.

Conclusion

Thus, the narrow construction of the court’s reasoning in Vidarbha, rather than a mix of the balance sheet and default tests, can more aptly be called “a default-based model with objective discretion” or “a discretion-based model limited to the happening of a contingent event”. The term ‘objective’ has been added as the adjudicating authority would only have the discretion to look into aspects, which if they occur or do not occur, would allow the corporate debtor to repay his debts. As has already been discussed in depth in the article, a touch of mild discretion in the current system may go a long way in fulfilling legislative intent and tackling the shortcomings in the current application initiation model.

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