IBC vis-a-vis the Hands-off Doctrine in the Moser Baer Case

[By Ansruta Debnath and Shubham Singh]

The authors are students of National Law University Odisha.

 

INTRODUCTION

In the recent case of Moser Baer Karamchari Union Thr. President Mahesh Chand Sharma and Ors. v. Union of India, the court has used the doctrine of hands-off to refuse to interfere with the waterfall mechanism in the Insolvency and Bankruptcy Code, 2016 (“IBC”) which it categorised as an economic legislation. This doctrine is a manifestation of the principle of separation of powers and has originated in the United States, essentially laying down that courts should not interfere in the executive’s work.

BACKGROUND

In the Moser Baer case, the constitutional validity of Section 327(7) of the Companies Act, 2013 was challenged because it was an overriding provision that cancelled the effects of Section 326 and 327 when kicked in. Section 326 and 327 would not apply at the time of liquidation, Section 53 of IBC would and that proposes a waterfall mechanism which proposes a different order of priority for distribution of proceeds. According to Sections 326 and 327, payments of worker’s dues, revenues, taxes and cesses due to the Union would have had priority but under Section 53, the order of priority is secured financial creditors, insecure financial creditors, government dues and finally, operational dues. In this case, workers’ dues come under operational creditors. This apparent dichotomy was challenged in this case because it was violative of Article 21 of the Indian Constitution.

HANDS-OFF BY INDIAN COURTS IN LIGHT OF IBC

Economic legislations are laws and regulations on various aspects of economic activity. These legislations aim to promote economic growth, protect consumer rights, ensure fair competition, regulate financial systems and maintain stability in the economy. While the Indian Judiciary is well known for its activist role when it comes to the rights of Indian citizens, a trend of non-interference has been seen in the case of so-called “economic legislations”. IBC is an economic legislation.

The Moser Baer petition involved the validity of certain provisions of the Insolvency and Bankruptcy Code, 2016. The Supreme Court recognized that IBC is primarily economic legislation and that the judiciary should not unilaterally give judgements that would affect its intricacies without legislative consensus. The Court acknowledged IBC’s impact on secured creditors and financial institutions, stressing the importance of their economic stability for the general public and the national economy. It was stated that employment opportunities, economic growth, and investments depend on IBC’s provisions. Since the IBC was the result of an organic evolution of law and extensive consultation, the prescribed waterfall mechanism should not be interfered with.

A key case which highlights the implementation of the hands-off doctrine vis-a-vis IBC is  Swiss Ribbons Private Limited and Anr. v. Union of India and Ors. This case yet again involved a challenge to IBC by operational creditors, alleging discrimination. The Court acknowledged that legislators consider practical and administrative factors and engage in experimentation when formulating such laws. Therefore, a rigid doctrinaire approach should be avoided.

This principle, apart from IBC, has been used for economic policies as well. The Supreme Court of India, relying on multiple prior judgements have categorically stated that “it is neither the domain of courts nor the scope of judicial review to embark on whether a particular public policy is wise”. Courts have time and again advised caution when it comes to economic and fiscal regulatory matters since they are not experts in those matters. The only way the same can be struck is if they are manifestly arbitrary and contrary to any law.

A FAIR PLAY BY THE JUDICIARY OR A MISSTEP?

Adjudicating on legality instead of soundness or wise ness of a law or policy seems to be the appropriate job for the judiciary. However, this is quite a difficult line to tread upon. The judicial hands-off doctrine is a manifestation of the principle of judicial restraint, which needs to be exercised while treading that line. By limiting judicial intervention, the doctrine upholds the integrity of this separation and fosters a healthy balance of power. It is also observed whenever fundamental rights and principles are affected; the court has always intervened in the legislature. India, however, does not follow a strict separation of powers as in the United States. Instead, there is a “broad separation of powers”.

The term “broad” implies that the organs are to not interfere in the core functions of each other but a general overlap among each other is permissible. The judiciary’s involvement in the structuration of laws primarily occurs to safeguard the Constitution, most importantly fundamental rights contained therein. It is, however, interesting to note that in all the above-mentioned cases there was one common argument i.e., a violation of a fundamental right. Yet, the judiciary chose to take a hands-off approach and not interfere.

Concerning fundamental rights, the court has consistently opined that a legislation cannot be deemed manifestly arbitrary if it explicitly addresses certain provisions, even if it looks like a violation of some rights of an individual. This standpoint was evident in the case of Moser Baer, wherein the court held that the Preferential Payments provision in the Companies Act would no longer be applicable once the liquidation process of a company has been initiated, as the Insolvency and Bankruptcy Code of 2016 now governs the procedures related to liquidation.

THE ULTIMATE CONUNDRUM

Judiciary intervening in the functioning of legislations are aplenty. With respect to economic legislations like IBC specifically, the count is comparatively low as there have been incidents when the courts have given judgements that have led to negative consequences. A prominent case in this regard is State Tax Officer v. Rainbow Papers Limited, in which the courts categorised government dues as secured creditors if they have security thus, going against  the provisions of IBC and creating quite a quandary.

Why a hands-off approach is warranted when it comes to statutes like IBC can be attributed to India being a growing economic market. The dynamic nature of economic activities makes the intent of every economic legislation by the legislature dynamic. Understanding and respecting legislative intent is crucial before judicial intervention. The court must minutely analyse the risk of intervening in an economic legislation as it may have a cascading effect on the economy as a whole.

Courts often find themselves facing this exact conundrum when deciding whether they should intervene in the functioning of an economic legislation. However, failure to adopt a hands-off approach in these cases by the court can result in procedural delays, consequently impacting our economic system. This is primarily because a divergent interpretation, devoid of a comprehensive understanding of the dynamic nature and underlying intent of economic legislation, can lead to adverse effects on the economy.

CONCLUSION

The prudent application of the hands-off doctrine in the Moser Baer case demonstrated wisdom. Had section 327 (7) of the Companies Act, 2017 been struck down, it could have potentially resulted in a situation akin to the anomaly witnessed in the Rainbow Papers case. Such an outcome would have created a void in the waterfall mechanism, potentially leading to an overlap between Section 53 of IBC, and Section 327 of the Companies Act, 2013. Consequently, the overarching purpose behind the enactment of the Insolvency and Bankruptcy Code, 2016, would have been rendered ineffective.

At this point in time, what is evident is that considering IBC, unless there is some gross violation of fundamental rights or arbitrariness, Courts will not entertain any argument with respect to its provisions violating fundamental rights. Given the state of pendency of cases and the misuse of judicial instruments, the implementation of the hands-off doctrine by the courts in the interpretation of economic legislation is a wise approach.

The judgments referred to above shows that the Indian judiciary is on the right path when it comes to the interpretation of economic legislation. Care must be taken to ensure steps are taken when warranted. However, certain anomalies do exist, creating more problems rather than solutions. Further, till now only IBC has been properly categorised as an economic legislation for the purposes of adjudication. A directive with respect to which laws will come under the ambit of being economic in nature is also warranted. For the same, careful consideration is required to ensure that judgments do not create unintended consequences or disrupt the overall economic framework.

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