Nature of Section 7 (5) of the IBC – Discretionary or Mandatory

[By Ritik Jhanwar & Kiran Nilawar]

The authors are students at Gujarat National Law Univeristy.

 

Introduction

In this article the author would highlight the interpretation of word ‘may’ in Section 7 of Insolvency and Bankruptcy Code, 2016 (“IBC”) and the difference between ‘may’ and ‘shall’ of Section 7 and 9 of the IBC respectively which are two mirror provisions in their application. The author would also explore the discretion exercised by adjudicating authority while deciding to admit any application filed under Section 7 of IBC in light of the recent judgement of the Supreme Court in M. Suresh Kumar Reddy v. Canara Bank & Ors.[1]

The legal issue that this article clarifies comes into its existence because of the provisions Section 7 and Section 9 of the Insolvency and Bankruptcy Code (“IBC”) which are almost mirror provisions apart from the fact that while the former mentions application for Corporate Insolvency Resolution Process (“CIRP”) by Financial Creditors and the latter talks about the application by Operational Creditors. The issue stems from the fact that Section 7 (5) uses the word ‘may’ while section 9 uses the word ‘shall’ thus leading to conundrum as to whether Section 7 (5) confers discretion on the part of Adjudicating Authority while deciding an application for CIRP filed by Financial Creditors.

In the Innoventive Industries Ltd. v. ICICI Bank and Ors.[2] (hereinafter “Innoventive Industries”), the Supreme Court stated that Section 7(5) of the Code confers the Adjudicating Authority to either accept or reject an application based on their assessment of whether a default has taken place or not. In Pratap Technocrats (P) Ltd. and Ors. v. Monitoring Committee of Reliance Infratel Limited and Ors.[3] (hereinafter “Pratap Technocrats”) it was further emphasized that a default refers to the failure to make a timely payment of a debt, and the jurisdiction of the Adjudicating Authority  is limited to identifying such defaults by the corporate debtor. Once the Adjudicating Authority is satisfied that a default has taken place, the application should be admitted, as long as it is properly filled out and there are no ongoing disciplinary actions against the proposed Resolution Professional.

A similar stance was taken in E.S Krishnamurthy and Ors. v. Bharat Hi-Tech Builders Private Limited[4](hereinafter “E.S. Krishnamurthy”) wherein the Apex Court held that the Adjudicating Authority has only two options under Section 7(5) of the Code: either to accept or reject the application based on the verification of whether a default has taken place or not.

But a contrary stance is taken in the case of Vidarbha Industries Power Limited v Axis Bank Limited[5] (hereinafter “Vidarbha Industries”), wherein some of the major issues that were discussed were:

  1. Whether there is a distinction between Section 7(5) and Section 9(5) of the IBC, 2016?
  2. Whether Section 7(5) of the IBC is a mandatory provision?

The apex court while deciding these issues observed that Section 9 of the Code deals with initiation of CIRP by operational creditor, wherein a mandatory demand notice to be served on the Corporate Debtor by the Operational Creditor and after the expiry of 10 days of the notice and Operation Creditor without receiving the payment due or a notice of dispute by the Corporate Debtor, the Operational Creditor becomes qualified to file application to initiate CIRP before the Adjudicating Authority. Section 9(5)(i) also entails some conditions to be fulfilled for admitting the application by the Adjudicating Authority. On the contrary, Section 7(5) of the IBC deals with initiation of CIRP by the financial creditors.

The court also observed that there was some legislature wisdom that led to using of word “may” in Section 7(5) and “shall” in Section 9(5) of the Code. Thus, an application under Section 9(5) is intended to be a mandatory provision but an application under Section 7(5) to be interpreted as a discretionary provision. The justification for this interpretation is rooted in the distinction between the business activities of financial creditors, who concentrate in investing and financing activities, whereas operational creditors, who often involves in supplying goods and services. Financial credits are typically characterized by larger amounts, secured assets, and longer repayment periods, while operational credit tends to involve smaller amounts, lack of collateral, and shorter repayment terms. As a result, it is inappropriate to compare the financial strength and business nature of a Financial Creditor with that of an Operational Creditor involved in the supply of goods and services. The non-payment of acknowledged dues can have a much more severe impact on an operational creditor compared to a financial creditor.

Thus, court held that while deciding application filed by financial creditors under Section 7(5) of the IBC, the adjudicating authority has been conferred discretion. Adjudicating Authority may exercise this discretion while taking into account the overall financial health and viability of the corporate debtor and the relevant facts.

From the above-mentioned judgements, a key conclusion that can be drawn is that while Innoventive Industries, Pratap Technocrats and E.S Krishnamurthy reiterate the delimited power of the Adjudicating Authority in the admittance of an application under Section 7 of the Code thus supporting the interpretation of mandatory nature of Section 7(5) of the Code, the decision in Vidarbha Industries supports the interpretation that discretionary nature of Section 7(5) of the Code.

The position of law regarding nature of Section 7 of the Code was that of Vidarbha Industries only i.e., discretionary nature. Therefore, the Adjudicating Authority has discretion while deciding an application for CIRP filed by financial creditors under Section 7 (5) of the IBC by virtue of the word used in the provision “may” in the section. But this position was recently questioned in the case of M. Suresh Kumar Reddy v. Canara Bank & Ors.[6]

Suresh Kumar Reddy v. Canara Bank & Ors. (hereinafter “M. Suresh Kumar Reddy”)

Brief facts:

Respondent bank had sanctioned a Secured Overdraft Facility of Rs. 12 Crores and a Guarantee Limit of Rs. 110 Crores to the Corporate Debtor on 28 February, 2017. However due to irregularities committed by the Corporate Debtor, its accounts were classified as Non-Performing Asset (NPA) since 6 August 2018. The Financial Creditor issued demand notice on 29 August 2018 to the Corporate Debtor demanding outstanding payment of Rs. 23,96,08502/-, which the Corporate Debtor failed to honour. As on November 11, 2019, the amount due on the secured overdraft facility was Rs. 74,52,87,564/- and Bank Guarantee outstanding was Rs. 19,16,20,100/-, thus the Financial Creditor filed an application for CIRP under Section 7 of the Code before the National Company Law Tribunal (“NCLT”), Hyderabad, Telangana which by an order dated 27 June 2022 admitted the application and declared a moratorium under Section 14 of the IBC. The Corporate Debtor appealed the said order before the National Company Law Appellate Tribunal (“NCLAT”), but the appeal was dismissed by NCLAT via order dated 5 August 2022. Hence the Corporate Debtor appealed before the Supreme Court.

Submissions by appellants (Corporate Debtor):
  1. The Corporate Debtor made repeated efforts to have one time settlement of dues payable to the Financial Creditor, but the same were denied.
  2. The Corporate Debtor referred to the case of Vidarbha Industries and contended that even if it is assumed that the existence of financial debt and default by the Corporate Debtor was proven, the NCLT was not required to accept the Section 7 application. The NCLT had the discretion to reject the application if there were good reasons to do so. NCLT could have stated that despite the State of Telangana’s request, Syndicate Bank did not provide the necessary bank guarantees, which compelled the Corporate Debtor to default.
Submissions by the respondents:
  1. Financial Creditor submitted that the request of the Corporate Debtor regarding One Time Settlement and extension of the Bank Guarantees were specifically rejected by the Financial Creditor.
  2. Financial Creditor argued that the decision in case of Vidarbha Industries is in peculiar facts of the case.
  3. Financial Creditor relied on S. Krishnamurthy arguing that once the NCLT determines that a financial debt exists and a default has taken place, it is obligated to accept and proceed with an application filed under Section 7.
Judgement and rationale of the Supreme Court:

The Supreme Court uphold the view of Innoventive Industries and E.S. Krishnamurthy and held that the moment the adjudicating authority is satisfied that a default has occurred, the application must be admitted unless it is incomplete, in which case it may give notice to the applicant to rectify the defect within 7 days of receipt of a notice from the adjudicating authority. In case of a default of financial debt, Adjudicating Authority is merely to see the records of Information Utility and evidence produced by the Financial Creditor to satisfy itself that the default has occurred i.e., whether the “debt” (which may still be disputed) was due and remained unpaid. If the adjudicating authority is of the opinion that a “default” has occurred, it has to admit the application unless it is incomplete.

The apex court also relied on the Review Petition[7] filed by the Axis Bank seeking review of Vidarbha Industries and observed that Vidarbha Industries was in the setting of the facts before the Court. Thus, the decision in Vidarbha Industries cannot be read and understood as taking a view contrary to the view taken in Innoventive Industries and E.S. Krishnamurthy. Hence the view taken in E.S. Krishnamurthy still holds good. In the present case, the debt was due and the Corporate Debtor defaulted, hence the Adjudicating was right in admitting the application for CIRP under Section 7 of the IBC, thus affirmed the order of the NCLT, Hyderabad dated 27 June 2022.

Conclusion

Through this case of M. Suresh Kumar Reddy v. Canara Bank & Ors., it can be said that there has been a change in the jurisprudence of interpretation of Section 7 of the IBC. Whereas earlier it was discretionary on the part of Adjudicating Authority to admit the application in light of Vidarbha Industries, the Court through this case had made clear that the once the default is established, the Adjudicating Authority cannot exercise the discretion and it becomes mandatory on their part to admit the application.

This interpretation of mandatory nature of Section 7(5) of the IBC is in align with the recent changes proposed by Ministry of Corporate Affairs wherein Ministry has invited public comments on changes being considered by notice dated 18 January 2023. The proposed amendment in Section 7(5) of the IBC aims to make it clear that while reviewing a CIRP application filed by Financial Creditor, Adjudicating Authority only needs to confirm the occurrences of default and fulfilment of necessary procedural conditions, without any additional requirements.  Thus, where a default is established, it would be mandatory for the Adjudicating Authority to admit the application and initiate the CIRP, which is in line with the decisions in Innoventive Industries, E.S. Krishnamurthy and M. Suresh Kumar Reddy.

 

[1] M. Suresh Kumar Reddy v. Canara Bank, 2022 SCC OnLine SC 1972.

[2] Innoventive Industries Ltd. v. ICICI Bank and Ors., AIR 2017 SC 4084.

[3] Pratap Technocrats (P) Ltd. and Ors. v. Monitoring Committee of Reliance Infratel Limited and Ors., AIR 2021 SC 4118.

[4] E.S Krishnamurthy and Ors. v. Bharat Hi-Tech Builders Private Limited, (2022) 3 SCC 161.

[5] Vidarbha Industries Power Limited v. Axis Bank Limited, (2022) 8 SCC 352.

[6] M. Suresh Kumar Reddy v. Canara Bank, 2022 SCC OnLine SC 1972.

[7] Axis Bank Limited v. Vidarbha Industries Power Limited, Review Petition (C) No.1043 of 2022.

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