Did the NCLAT Through IL&FS Case Rejig the Waterfall Mechanism?

[By Nishita Agrawal and Arth Singhal]


The authors are students at the National Law University Odisha.

The Companies Act, 2013 [“the Act”] lays down special provisions with respect to prevention of oppression and mismanagement in order to safeguard the interests of the investors, the minority shareholders, and especially the interests of the public under Sections 241 and 242. In September 2018, the Central Government had filed an application under Section 241(2) of the Act against the Infrastructure Leasing & Financial Services Limited [“IL&FS”] a systemically important core investment Non-Banking Financial Company [“NBFC”]  & its  169 group entities. The provision allows Central Government to make an application to the Tribunal for relief if it is of the opinion that the affairs of the company have been or are being conducted in a manner prejudicial to the public interest. In case of the service provider and its entities, the Central Government was of the opinion that its managerial persons were negligent and incompetent and its affairs were being conducted in a manner detrimental to the public interest.[i]

In order to resolve such matters under Section 241, the tribunal is empowered under section 242(1) to make ‘any order’ as it may think fit to end the matters complained of. Sub-clause (2) further provides for an illustrative list of reliefs along with a residuary clause which confers wide powers on the tribunal to pass orders with regard to any matter which, in its opinion is just and equitable.[ii]   This power of the tribunal has been affirmed in the case of Sanjeev Agrawal v. Shri Omkaleshwar Coloniseers Pvt. Ltd.[iii] where the National Company Law Appellate Tribunal [“NCLT”] reiterated the Supreme Court’s [“SC”] decision on the scope of Section 241(2).[iv]   The court stated thatthe jurisdiction of the Court to grant appropriate relief … indisputably is of wide amplitude” and that “[r]eliefs must be granted having regard to the exigencies of the situation”.

When the affairs of the company are conducted in a manner prejudicial to the public interest, the appropriate tribunals can pass orders relating to change of management or debt restructuring so that there is an inflow of money to restore the trust of the public stakeholders.[v] Pursuant to this power, the NCLAT in Union of India v. Infrastructure Leasing & Financial Services Limited[vi]  on March 12, 2020, allowed for restructuring of IL&FS and its entities by approving the resolution framework proposed by the Central Government.

However, NCLAT in the aforementioned resolution framework refused to follow the waterfall mechanism for distribution of proceeds, as laid down under Section 53 of the Insolvency and Bankruptcy Code 2016 [“the code”]. Section 53 of the Code provides for a detailed hierarchical order of distribution of liquidated assets of the Corporate Debtors [“CD”] between the Operational Creditors [“OC”] and the Financial Creditors [“FC”], in case of liquidation. Further, Section 30(2)(b) of the code required that the payment of debts of the OC were to be made in a manner that the board may specify which shall not be less than the amount to be paid to the OC in the event of a liquidation of the CD under Section 53. In India, the code is still in its nascent stages and faces several issues with respect to its applicability and interpretation.

There has been a wide array of disagreement as to whether the NCLAT was within its powers to not follow the waterfall mechanism, or not. With this background, however, it is the authors’ opinion that the NCLAT was right in not following the waterfall mechanism due to reasons discussed hereafter:

  • The code remains inapplicable in the present case due to lack of adequate provisions for resolution of such companies;
  • The principles of code are also not binding on the tribunal under Section 424 of the Act or any other provision; and
  • Even if code or its principles were applicable, it would have been impossible to make the ends of justice meet, as public interest is not an exception to the code.

Finally, the IL&FS case has no bearing on the settled principles of code, it is not contrary to the Essar Steel judgment[vii] and the commercial wisdom of the Committee of Creditors [“CoC”] still has supremacy.

  • Non-Applicability of the code

When IL&FS defaulted on its debts and was exploring its options, the Code did not pose as a viable solution primarily because, it is a Financial Service Provider [“FSP”]  as defined under Section 3(17) of the code, which, until recently,[viii] was excluded from the purview of the code. A financial service provider is a person engaged in the business of providing financial services in terms of authorisation issued or registration granted by a financial sector regulator[ix]; Although, as per Section 227 of the code, the Central Government had the power to notify FSPs which may be conducted under the Code, but failure to do the same, made a remedy under the code impossible. Furthermore, the code lacks a proper framework for the resolution of Group Companies, which discouraged the resolution of IL&FS under the provisions of the code.

In this background where India lacked any specific framework for resolution of corporations to the likes of IL&FS, the Financial Resolution and Dispute Insurance Bill first introduced in 2017 could have posed a viable solution to the issues arising in the present case had it not been withdrawn in 2018. Therefore, the code remained inapplicable in the present case, and the tribunal issued the order of resolution under Section 242 of the Act.

  • Non-bindingness of the Principles of code under Section 424 of Companies Act, 2013

Section 424 of the Act lays down the procedure to be followed by the appellate tribunal while deciding any proceedings under the Act. In broad terms, the section lays down the procedure to be followed by the tribunal/appellate tribunal before passing any order.[x]  It also confers the tribunal with the power to regulate its own procedure in accordance with principles of natural justice and provisions of the Act or rules framed thereunder.[xi] Thus, the limited object of the provision is to determine the procedure for adjudication and it does not confer any additional powers to the tribunal.

When the code was introduced in 2016, the same tribunals were given the additional power to adjudicate Insolvency proceedings initiated under the code. Thereafter, a corresponding amendment was made in Section 424 of the Act with the intent of bringing the Companies Act, 2013 in conformity with the code. The limited effect of the amendment was that, while adjudicating the Insolvency proceedings, the tribunal shall be allowed to regulate its own procedure, subject to the provisions of the Code only. However, it did not intend to change the scope of the tribunal’s powers while adjudicating proceedings under the Companies Act.[xii]

Therefore, when the present application is filed under Section 241 of the Act and not under the code, the tribunal shall only be bound by the principles laid down under the Companies Act 2013. The tribunal was not bound by the principles of the code and was within its power to deviate from following the creditor’s hierarchy under Section 53 of the Code.

  • Public interest is not an exception to the code

The tribunal due to its wide powers to issue any order as it deems fit in case of oppression and mismanagement was within its power when it refused to follow the waterfall mechanism under the code, but it faltered in its reasoning to do so when it cited public interest as an exception to follow the procedures under the code.

The term ‘public interest’ is of wide amplitude and derives its meaning from the context in which it is used.[xiii] It is to serve the general interest of the community at large and not just that of the individuals or anyone’s private interest.[xiv] The Black’s Law dictionary defined public interest as “Something in which the public, the community at large, has some pecuniary interest, or some interest by which their legal rights or liabilities are affected. It does not mean anything so narrow as a mere curiosity, or as the interests of the particular localities, which may be affected by the matters in question. Interest shared by citizens generally in affairs of local, state or national government.”[xv]

Therefore, when the term ‘public interest’ is connoted with respect to the resolution process as envisaged under the code, it is interpreted to mean protection of existing rights of stakeholders by following the due process of law and in accordance with the intent of the legislature. The resolution process of a stressed entity is never confined to a creditor or a debtor but it always has the interest of the society involved.[xvi] The Supreme Court has also acknowledged that the object of the code is not merely the recovery of debts in resolving corporate insolvencies but is also to protect the ‘wider public interest’.[xvii] 

Thus, in this background where neither the statute nor the tribunal in any matter under the code has recognized it as an exception, the authors are of the opinion that the tribunal cannot carve out ‘public interest’ as an exception to the code when the present case itself falls outside the purview of the Code.

Besides, the code provides for equitable treatment of different classes of creditors and not their equal treatment by paying them the same amounts under the resolution plan. This distinction between the operational and financial creditors, secured and unsecured creditors has been recognised in various judgments which note no such exception as public interest whatsoever. Therefore, the tribunal cannot make an exception of ‘public interest’ in favour of any of the stakeholders that never existed in the Code.

IL&FS case has no bearing on the settled principles

The conundrum with respect to the hierarchy of creditors under the Code was put to rest in the case of Essar Steel India Ltd. v. Satish Kumar Gupta.[xviii] The NCLAT’s order in the IL&FS case, however, has no bearing on their hierarchy because the Code remains inapplicable to the IL&FS case. Any conclusions drawn by the tribunal with reference to the code are limited to IL&FS and its group entities and cannot be used to draw an interpretation of the Code or of any principles enlisted thereunder.

In the Essar Steel case, the SC had upheld the ‘commercial wisdom’ of the CoC consisting of financial creditors as sacrosanct and supreme. The Court reiterated that the CoC shall assess the feasibility and viability of the resolution plan which includes the manner of distribution of funds amongst different classes of creditors.[xix] It also noted that the authority of CoC cannot be subjected to judicial review once the CoC approves a resolution plan keeping in mind the interest of all the stakeholders and the intent of code i.e. maximisation of the value of the assets.[xx]


The tribunal in the IL&FS case took notable measures to address the novel issues arising before it, related to mismanagement of affairs and acts which are detrimental to the interests of the public within the group companies. Since neither the Code nor any principles thereunder were applicable to the special case of IL &FS, a remedy was sought under the provisions of the Companies Act, 2013, in pursuance of which the tribunal exercised its wide and discretionary powers under Section 242 of the Act,  and decided not to follow the waterfall mechanism for the distribution of assets.

We conclude that NCLAT has rightly approved the resolution plan and this in no way alters the legal principles of the creditor hierarchy laid down under the Code and the judgment of Essar Steel.  However, it faltered in its reasoning by citing ‘public interest’ as an exception which does not exist anywhere in the Code. Lastly, the complexities of the case also reiterate the need to introduce a proper resolution framework for Group Companies in India. Therefore, the IL&FS case, though important, does not become an exception to the general principles of the Insolvency Resolution Framework in India.

[i] GK Kapoor & Sanjay Dhamija, Company Law And Practice Book 430 (24th ed., Taxmann 2019).

[ii] Amritsar Swadeshi Woollen Mills Private Limited v. Vinod Krishan Khanna, 2019 SCC OnLine NCLAT 166.

[iii] Sanjeev Agrawal v. Shri Omkaleshwar Coloniseers Pvt. Ltd., (2017) 139 CLA 434.

[iv] Sangramsinha P. Gaekwad v. Shantadevi P. Gaekwad, (2005) 11 SCC 314.

[v] The Companies Act, 2013, § 242.

[vi] Union of India v. Infrastructure Leasing & Financial Services Limited, Company Appeal (AT) No. 346 of 2018.

[vii] Essar Steel (India) Ltd. v. Satish Kumar Gupta, (2020) 8 SCC 531.

[viii] Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019.

[ix] The Insolvency and Bankruptcy Code, 2016, section 3(17).

[x] Embassy Property Developments Pvt. Ltd. v. State of Karnataka, (2020) 13 SCC 308.

[xi] Univalue Projects Pvt. Ltd. v. Union of India, (2020) SCC OnLine Cal 1452.

[xii] The Insolvency and Bankruptcy Code, 2016, Eleventh Schedule.

[xiii] 63 Moon Technology Ltd. v. Union of India, (2019) 18 SCC 401.

[xiv] State of Bihar v. Maharajadhiraja Sir Kameshwar Singh of Darbhanga, (1952) 3 SCR 889, ¶¶1073-1075; Manimegalai v. Special Tehsildar Adi Dravidar Welfare, (2018) 13 SCC 491, ¶14.

[xv] Public Interest, Black’s Law Dictionary (6th ed.1990).

[xvi] U.K., Cork Committee, Cmnd. No. 8558, Insolvency Law and Practice 1734 (London: Her Majesty’s Stationary Office, 1982).

[xvii] Krish Steel and Trading Pvt. Ltd. v. Venkatesan Sankaranarayan, 2020 SCC Online SC 889.

[xviii] Id. at 9.

[xix] Id. ¶ 40.

[xx] Id. ¶ 46; The Insolvency and Bankruptcy Code, 2016, section 30(2).


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