Windmills in an Indian wind farm. (Photographer: Dhiraj Singh/Bloomberg)

Challenge To Insolvency Law: Defaulters’ Paradise Is Lost, Says Supreme Court

The Supreme Court today upheld the constitutional validity of the Insolvency and Bankruptcy Code, 2016 in its entirety.

The apex court, in the case of Swiss Ribbons and others, pointed out that the total flow of resources to the commercial sector in India, both bank and non-bank, and domestic and foreign has gone up from a total of Rs 14,530 crore in 2016-2017, to Rs 18,469 crore in 2017-2018, and to Rs 18,798 crore in the first six months of 2018-2019.

These figures show that the experiment conducted in enacting the (Insolvency and Bankruptcy) Code is proving to be largely successful. The defaulters’ paradise is lost.
Supreme Court, Swiss Ribbons Case

The apex court has given a significant message that it will not encourage a litigious approach unsettling the code which is principally premised on speed, Sudipta Routh, partner at Indus Law, said. The Supreme court has made it clear that it will not encroach upon the domain of legislature, especially with respect to socioeconomic legislation on mere whiff of suspected arbitrariness or crudity in dealing with a distinction, he said.

Here are the highlights of the apex court’s ruling:

Operational Creditors ≠ Financial Creditors

The petitioners had argued that there is no intelligible differentia between the two types of creditors i.e. operational and financial creditors. And since IBC distinguishes between the too, it’s violative of Article 14 of the Constitution. Even if it is assumed that valid distinction exists between the two, there is hostile discrimination against operational creditors since they have no voice on the creditors’ committee, they said.

Also read: IBC: What The Supreme Court Ruling Means For The Essar Steel Case

Under Article 14, right to equality is a fundamental right and as per the settled legal position, equality can only be among equals. If an intelligeble differntia can be established between two classes, then a legislation is not violative of Article 14.

The apex court has reiterated this principle and dismissed the Article 14 argument. In this particular case, the Supreme Court has noted that the difference between the two is in the relative importance of the two types of debts when it comes to the object sought to be achieved by the Insolvency Code.

We have already seen that repayment of financial debts infuses capital into the economy inasmuch as banks and financial institutions are able, with the money that has been paid back, to further lend such money to other entrepreneurs for their businesses. This rationale creates an intelligible differentia between financial debts and operational debts, which are unsecured, which is directly related to the object sought to be achieved by the Code. 
Supreme Court, Swiss Ribbons Case

Also read: IBBI Announces New Norms To Stop Successful Bidders From Backing Out

Section 12A: Constitutionally Valid

Section 12A of the IBC allows for withdrawal of an insolvency petition filed against a corporate debtor only if 90 percent of the Committee of Creditors (CoC) by vote share approve such a withdrawal. It was argued that this section gives unbridled and uncanalised power to the committee of creditors to reject legitimate settlements between creditors and corporate debtors.

The Supreme Court has taken note of the Insolvency Law Committee’s report that reasoned the threshold of 90 percent.

...All financial creditors have to put their heads together to allow such withdrawal as, ordinarily, an omnibus settlement involving all creditors ought, ideally, to be entered into. This explains why 90 percent, which is substantially all the financial creditors, have to grant their approval to an individual withdrawal or settlement.
Supreme Court, Swiss Ribbons Case

In any case, the figure of 90 percent, in the absence of anything further to show that it is arbitrary, must pertain to the domain of legislative policy, the apex court has stated. It further pointed out that there’s additional safeguard by way of section 60 of IBC. ‘ If the committee of creditors arbitrarily rejects a just settlement and/or withdrawal claim, the NCLT, and thereafter, the NCLAT can always set aside such decision under section 60 of the Code,”

Section 29A: Relief To ‘Related Party’

The petitioners made five arguments against section 29A which bars promoters of defaulting companies (classified as NPAs) and connected persons from participating as resolution applicants. They are:

  • Vested rights of erstwhile promoters to participate in the recovery process of a corporate debtor have been impaired by retrospective application of Section 29A.
  • The section is contrary to IBC’s objective of speedy disposal of the resolution process as it will inevitably lead to challenges.
  • A blanket ban on participation of all promoters, without distinguishing between unscrupulous ones versus those who couldn’t pay their debt for other reasons, is arbitrary and treats unequals as equals.
  • The section impairs the object of maximisation of value of assets as an erstwhile promoter, who may outbid all other applicants and may have the best resolution plan, is kept out at the threshold.
  • Relatives of the erstwhile promoters are also barred from submitting a plan, despite the fact that they may have no business connection with the erstwhile promoters.

The Supreme Court has dismissed the first four arguments and upheld the fifth one.

It has pointed to the settled law that a statute is not retrospective merely because it affects existing rights. That being the case, it said, resolution applicants have no vested right to be considered in the resolution process.

The legislative policy is that a person who is unable to service its own debt beyond the grace period referred to above, is unfit to be eligible to become a resolution applicant. This policy cannot be found fault with. 
Supreme Court, Swiss Ribbons Case

The SC has held that section 29A, which contains the disqualifiers for errant promoters and prevents them from gaming the system, is not violative of Article 14, Routh said. At the same time, he added, the Supreme Court has nimbly reconciled the seemingly opposing principle by upholding the constitutional validity of Section 12A, meaning the same errant promoters can use this route to take back the company provided it has the blessings of 90 percent of financial creditors.

As far as those related to ineligible persons are concerned, the Supreme Court has clarified that the definition of relative/related person will mean persons who are connected with the business activity of a resolution applicant. In the absence of showing that such a person is connected with the business activity of the ineligible resolution applicant, such a person cannot possibly be disqualified, the apex court has said.

On other points of contention, for instance, the NCLAT bench being only in Delhi, the apex court has directed the government to set up circuit benches of the NCLAT within six months. As for the argument that the NCLTs continue to work under the wrong ministry eight years after the Madras High Court judgement said administration of tribunals must be under the Law Ministry, the Supreme Court said that “this needs to be rectified at its earliest.’’