Insolvency Code: Supreme Court’s Order Has A Stern Message For Company Managements
The Supreme Court has given the Iron Throne to the Insolvency Code
In its first detailed order on the Insolvency and Bankruptcy Code, the Supreme Court has, via a series of observations, made it clear to managements of insolvent firms that their rule is over.
The judgement was pronounced in the case of Innoventive Industries that had challenged an unfavorable order by the National Company Law Appellate Tribunal. Last year in December, in what was the first case under the new IBC regime, ICICI Bank Ltd. had initiated insolvency proceedings against Innoventive Industries as it had defaulted on its dues to the bank.
The company challenged the move on grounds that all remedies for enforcement against it were temporarily suspended thanks to a reprieve it had won under the Maharashtra Relief Undertaking (Special Provisions Act), 1958 (MRU Act). The provisions in the MRU Act allow the state government to take over the management of a company.
This argument was rejected by the NCLAT which held that the insolvency code shall prevail over the provisions of the MRU Act.
The Supreme Court has now affirmed this view, concluding that the MRU Act cannot stand in the way of the insolvency code. It ruled so on the basis of Section 238 of the insolvency law that gives the IBC an overriding effect over conflicting laws.
The Supreme Court has laid down that state laws will be subservient to the central Act, Bhavin Gada, a partner practising insolvency law at ELP, told BloombergQuint.
Under the Sick Industrial Companies Act (SICA) too, there were certain companies that obtained relief under such state laws. Even under the old regime, the judicial pronouncements laid down that SICA would prevail over state laws.Bhavin Gada, Partner, ELP
Gada pointed out that the apex court is adopting a similar approach even in the context of central laws like the Negotiable Instruments Act. Section 138 of this Act makes cheque bouncing a criminal offence.
In a recent judgment, the Supreme Court held that if a company is not made a party to cheque-bouncing proceedings, no action can be taken under the Negotiable Instruments Act, he said.
If a creditor facing a bounced cheque were to seek action against only the director of the company, so as to not be constrained by the insolvency process, such action will not be permitted as eventually the company would have to pay the money, explained Gada.
Take a situation where insolvency proceedings against a company have been initiated. If an operational or financial creditor had a bounced cheque issued by one of the directors of such a company, to get paid under the criminal proceeding, the creditor would’ve initiated Section 138 (Negotiable Instruments Act) proceedings without making the company party to the case. He would do so because as soon as you make such a company a party, Section 14 of the insolvency code will kick-in and all actions against the company will come to a standstill.Bhavin Gada, Partner, ELP
“The judiciary is looking at the insolvency code favorably to ensure that various other remedies available to creditors are aligned with it,” Gada explained.
Fereshte Sethna, a partner practising insolvency law at DMD Advocates, has a word of caution for situations like Innoventive where ICICI Bank had refused to infuse fresh funds as per the terms of a restructuring agreement. It is this refusal that had led Innoventive to dispute its defaulter status against the bank.
Sethna said while the insolvency code must be accorded its rightful statutory overriding priority, she worries that creditors will now be trigger-happy, prefering to head to insolvency proceedings rather than honour restructuring plans.
Indeed, dangerous waters lie ahead, if lenders are entitled to walk away from a signed Master Restructuring Agreement. Myriad complex issues that are emerging warrant balancing out divergent interests. Amidst this difficult conundrum, is the lack of certainty, emanating from over broad positioning. Unless both direct and indirect consequences are fully evaluated and calibrated, we are at risk of a slew of rights being eviscerated and being rendered virtually remediless, which in turn may cause economic decline.Fereshte Sethna, Partner, DMD Advocates
Impact On Managements’ Might
ICICI Bank had also argued against the maintainability of Innoventive’s appeal on grounds that former directors cannot bring an action on behalf of the company once an order appointing an Insolvency Resolution Professional (IRP) has been passed. Interestingly, this argument was raised by the bank only before the apex court and not the NCLAT.
Even so, the apex court accepted this argument.
As per the provisions of the insolvency code, once an IRP is appointed, he becomes the alter ego of the current management, Diwakar Maheshwari, partner at law firm Khaitan & Co., told BloombergQuint.
The judgement has given a correct direction to the insolvency code. Once an insolvency application is admitted, a moratorium is imposed. And once an order appointing an IRP is passed, the current management will become remediless. Now once this happens, who will file an appeal? Most certainly, the IRP will not.Diwakar Maheshwari, Partner, Khaitan & Co.
Maheshwari said all the pending cases before the NCLAT where IRP appointment orders have been passed and managements have appealed them, will be directly hit by this observation.
Creditors will use this judgment to argue against maintainability of such appeals, he added.
Besides disarming managements thus, the court has also sent a direct message to managements of indebted firms. The order laid down that “entrenched managements are no longer allowed to continue... if they cannot pay their debts”.
This and the order, experts say, will have a significant impact on pending and potential actions by managements of distressed companies.
