‘Vidarbha Industries’- A Problematic Interpretation

[By Shalin Ghosh]

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

Introduction

The Insolvency and Bankruptcy Code, 2016 (“IBC”) contemplates the initiation of insolvency proceedings only by financial and operational creditors under Section 7 and Section 9 respectively. Section 7 (5) (a), in particular, triggers the insolvency process for financial creditors, once the Adjudicating Authority (“AA”) decides the existence of debt and default. The Supreme Court’s (“SC”) recent judgement, in Vidarbha Industries Power Ltd. v. Axis Bank Ltd (“Vidarbha Industries”), rendered the aforementioned provision discretionary. The ruling disturbs settled law and could significantly impact India’s insolvency and credit recovery mechanism.

Facts

The appellant, a power generating company, was contracted for implementing a Group Power Project (“GPP”) by the Maharashtra Industrial Development Corporation (“MIDC”). In 2016, the appellant filed an application before the Maharashtra Electricity Regulatory Commission (“MERC”) demanding the actual fuel costs for the Financial Years 2014-2015 and 2015-2016. MERC rejected the appellant’s request, disallowing a major proportion of the demanded fuel costs while also capping the tariffs for the Financial Years 2016-2017 to 2019-2020.

This was challenged before the Appellate Tribunal for Electricity (“APTEL”). Allowing the appeal, APTEL directed MERC to allow the actual costs incurred by the appellant to purchase coal for the plant’s first unit. It also temporarily imposed a limit on the fuel costs for the second unit. According the appellant, Rs. 1,730 crores were due to it as a result of the APTEL’s order. Subsequently, the appellant filed an application before the MERC for implementing the APTEL’s order.

However, MERC filed a civil appeal before the SC which remained pending. The appellant claimed that it was unable to implement the directions in the APTEL’s order due to MERC’s pending appeal before the SC and that it faced a fund shortage. An implementation of the said order, the appellant argued, would help it discharge its outstanding obligations.

In 2020, Axis Bank, the financial creditor, initiated CIRP against the appellant under Section 7 of the IBC before the National Company Law Tribunal (“NCLT”), Mumbai. Upon being challenged, NCLT, Mumbai declined the appellant’s plea demanding a stay on the CIRP, ignoring the pending amount realizable by the APTEL’s order, adding that disputes between the appellant and MERC were irrelevant to the concerned issue. The National Company Law Appellate Tribunal (“NCLAT”) affirmed NCLT’s observations, also adding that if the latter is satisfied about the existence of both debt and default, that itself would be sufficient to trigger CIRP. The appellants, aggrieved by the order, approached the SC for relief.

Decision

Section- 7(5)(a)- Discretionary or Mandatory?

While deciding the nature of the provision, the Court acknowledged that although no extraneous factor should impede a speedy insolvency resolution under the IBC, it importantly held that aspects particular to the case, such as a pending appeal and the appellant’s financial condition cannot be termed ‘extraneous. The SC categorically stated that the NCLAT incorrectly observed that it merely has to ascertain the presence of a debt and default as sufficient conditions to trigger CIRP. The Court opined that the NCLT must apply its mind and consider relevant factors and examine the corporate debtor’s arguments against admission on its own merits, before admitting a CIRP application.

Notably, it pondered on the connotations of ‘may’ in Section 7 (5) (a) observing that had the legislative intent been to construe the aforementioned provision as ‘mandatory’, then it would have used ‘shall’ instead of ‘may’. The Court reasoned that the object of the IBC is not to penalise solvent companies who temporarily defaulted on their dues. Therefore, CIRP, in the Court’s opinion, does not arise unless the concerned entity is insolvent or bankrupt.

These observations led the Court to hold that Section 7 (5) (a) is a discretionary provision and that the NCLT is not compelled to admit a financial creditor’s CIRP application even when the corporate debtor has defaulted on its dues. The SC noted that the admission in the cases of financial creditors may be suspended indefinitely, till the extraneous matter is sorted. However, spelling out different standards for operational creditors, the Court observed that if such a creditor files a CIRP application, then it is obligatory for the AA to admit it, provided it is satisfied about the existence of a debtor’s default.

Analysis

Troubling consequences for the insolvency regime

This is a concerning judgment that can potentially hamper the IBC’s effective application and dilute the robustness and efficacy of the prevailing insolvency culture. Firstly, the legislative scheme prescribed by the IBC provides for a judicial ‘hands-off’ approach by strictly limiting the scope of judicial intervention. The Court clarified this legal position in the landmark Essar Steel judgment wherein it was held that the AA is merely required to ascertain whether the legal requirements under the IBC have been satisfied and that it cannot sit in judgment over the ‘commercial wisdom’ of the CoC. Other than several orders of the NCLTs and the NCLAT, this position was reiterated by the Court itself in a number of well-known precedents like  K. Sashidhar v. Indian Overseas Bank and Vallal RCK v. Siva Industries and Holdings Limited. By requiring NCLT to scrutinize the corporate debtor’s financial health and viability, generally considered to be the domains of the CoC, the judgment in Vidarbha Industries completely goes against this established and settled legal principle, distorting the clearly defined boundaries stipulated both in the IBC and in a litany of judgments. It deprives the CoC of having an authoritative say in matters crucial to their interests while paving the way for greater judicial overreach.

Secondly, the Court’s opinion, that the AA is required to examine additional grounds raised by the corporate debtor on merits before admitting a CIRP application, could adversely impact both the IBC’s application and its objectives. Till now, the NCLT only had to consider the existence of a debt and the evidence proving that the corporate debtor has defaulted on honouring the said debt. Once these two elements were ascertained, a CIRP application could be admitted. As per the Bankruptcy Law Reforms Committee (“BLRC”) Report, the default was chosen as the point to set the CIRP into motion as it would curb inordinate delays and facilitate swifter insolvency resolution by preventing multiplicity of suits during admission. The current judgment upends this objective as the AA is given the discretion to probe into grounds not envisioned under the IBC while deciding the admissibility of a CIRP application. The Court’s dictum that NCLT must consider the corporate debtor’s arguments on merits before admitting a CIRP application implies that it might refuse to admit a financial creditor’s CIRP application despite a prima-facie proof of both debt and default. This might cause excessive litigation delaying a CIRP application’s admission, consequently leading to an erosion in the entity’s value- a fundamental problem which the IBC seeks to correct.

Thirdly, the verdict also weakens the ‘creditor-in-control’ model which the IBC is premised upon. This model, sharply contrasting with the ‘debtor-in-control’ model of the earlier regime, aims at strengthening the creditors by changing the locus of power from the debtors to creditors. The move was intended to deal with defaulting borrowers with a firm hand by vesting their entity’s management and control in the hands of the creditor, by initiating CIRP, if they failed to discharge their debts. However, the wide latitude given to the NCLT by the Court while deciding the admission of a CIRP application is quite likely to be to be used by erring corporate debtors to stall the passage of an otherwise admissible CIRP application, obstructing creditors from legally taking the defaulters to task and preventing them from taking control over the corporate debtor’s business.

A divergent view

The SC in Innoventive Industries v. ICICI Bank, one of the first judgments on the IBC’s operation, ruled that the AA is bound to admit a financial creditor’s application the moment it is satisfied about the presence of two key ingredients necessary to invoke Section 7- debt and default. An application could only be rejected if it is incomplete. This prescription was reaffirmed in ES Krishnamurthy with the Court adding that the AA cannot apply its mind while rejecting an application, being bound by the debt-and-default test. Coming too late in the day, the position taken by the Court in Vidarbha Industries contradicts established precedents and alters a settled legal interpretation. This could potentially have far-reaching impacts on the IBC’s operative mandate of ensuring time-bound resolution of distressed entities.

Conclusion

The delays, likely due to this judgment, could take the IBC on the road of the Sick Industrial Companies Act, 1985 (“SICA”), whose inefficiency, incidentally, lead to the IBC’s enactment. The SICA and its adjudicating body, the Board for Industrial and Financial Reconstruction (“BIFR”) delayed resolutions, eroded an entity’s assets and shielded defaulters from legal action. The judgment further muddies the waters by diverging from settled precedents. Ensuring that the IBC does not meet SICA’s fate will either require the NCLTs to tread a fine line and cautiously exercise their discretion or a corrective amendment by the legislature.

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