The Supreme Court’s judgment in the case of Vidarbha Industries Power v Axis Bank opened a Pandora’s box earlier this year when it unsettled a long established practice of the adjudicating authority admitting insolvency applications.
Prior to the decision, the adjudicating authority – the National Company Law Tribunal (NCLT) – could admit applications from financial creditors on the basis of the existence of a debt and a default in its repayment. This meant it did not have to get into the nitty-gritty of why the company had defaulted.
However, the July 2022 judgment has effectively overturned the jurisprudence set by Supreme Court Judge RF Nariman for the NCLT to decide on applications filed by financial creditors under the Insolvency and Bankruptcy Code, 2016 (IBC). Now the judgment gives corporate debtors an enticing defence against the initiation of the corporate insolvency resolution process (CIRP) under the IBC.
“The whole purpose of the IBC is to resolve the insolvency of a corporate debtor in a time-bound manner because any delay could impact the company’s ability to revive, and could result in possible liquidation,” PSL Advocates & Solicitors’ managing partner, Sandeep Bajaj in New Delhi, tells India Business Law Journal.
Rishi Thakur, a Mumbai-based principal associate at ZBA Advocates & Solicitors, says that the intention of the legislature was to empower banks/financial investors to resolve stressed assets, with minimum judicial intervention.
“It was left to the wisdom of financial creditors or banks, which are better suited to understand the economy,” says Thakur.
But the Supreme Court bench of Judge Indira Banerjee and Judge JK Maheshwari seems to have felt otherwise. Their judgment read: “It is certainly not the object of the IBC to penalise solvent companies, temporarily defaulting in repayment of their financial debts, by the initiation of the CIRP.”
The Vidarbha ruling could prove to be a death knell for the banking and insolvency system by giving the NCLT discretion before admitting an application under section 7 of IBC. Discretion could include evaluating criteria such as the viability of the company and the circumstances of the company becoming a non-performing asset.
Bajaj says that the Vidarbha verdict has started causing delays in other IBC proceedings, citing the Ahmedabad bench of the NCLT exploring the possibility of settlement.
Similarly, the Indore bench of the NCLT decided to keep in abeyance for six months a section 7 petition filed by the State Bank of India against Krishidhan Seeds, although the application filed by the financial creditor ticked all the necessary boxes.
In its order dated 25 August, the Indore NCLT bench said that while facts proved that the corporate debtor had to be admitted in the CIRP, “we have to examine other facts to decide whether this case falls in exception as indicated by the Supreme Court”.
The NCLT bench said that it would not be “proper for us to admit the corporate debtor in the CIRP at once”; not when the management of Krishidhan Seeds was trying to get out of the debt trap. The bench has adjourned the case for six months.
Sakate Khaitan, a founder and senior partner at Khaitan Legal Associates, says: “The Supreme Court ruling seems to imply that while litigation is ongoing in respect of a claim made by the corporate debtor, the corporate debtor could be considered solvent even though it had defaulted in payment of debt when due.
“This may create adverse incentives as the fear of IBC proceedings will no longer remain,” fears Khaitan, who divides his time between London and Mumbai.
Niloufer Lam, a Mumbai-based partner at ZBA, says: “With the Supreme Court having overly relied on the literal interpretation of the word ‘may’ in section 7 of the IBC, it has lost sight of the economic rationale of the IBC.”
Thakur agrees, adding that the judgment failed to discuss or explain why it overturned the settled jurisprudence.
Corporate debtors could refuse to pay financial creditors without the fear of an insolvency petition being admitted, says Khaitan, adding that it could increase the cost of capital.
“The intent behind certain provisions of the Reserve Bank of India’s prudential guidelines for non-performing assets will also likely get diluted if there is no pressure on solvent defaulting corporate debtors,” he says.
As of 31 March 2022, 66% of the ongoing CIRPs had crossed the 270-day timeframe, according to data shared by ZBA. From April 2021 to March 2022, 121 of the CIRPs took an average of 711 days for completion, which is more than twice the stipulated 333 days, notes Lam.
She says the delays in the insolvency process are mostly attributed to protracted litigation by promoters or debtors, the heavy backlog on NCLTs and the lack of commercial acumen of NCLT members. “The Vidarbha judgment will further add to the existing uncertainty in a process that is already struggling on multiple fronts.”
When the Supreme Court had initially agreed to Axis Bank petitioning for a review of the Vidarbha ruling, Khaitan did not expect a change in the decision, but had hoped for clarity that the observations made were specific to the case and should not set a precedent.
However, the Supreme Court bench on 22 September dismissed Axis Bank’s review petition – a day before Judge Banerjee retired – and upheld its July ruling that afforded discretion to the NCLT to admit or reject petitions initiating the insolvency process by financial creditors.
Khaitan says that the dismissal of the review petition means that the “Vidarbha judgment is now the law of the country”.
Thakur is still optimistic, anticipating that the matter will be “reviewed by a larger bench”, although not necessarily in the near future. “The question remains whether the government needs to step in and set some guidelines on when the adjudicating authority should exercise its discretion under section 7 of the IBC.”
A NEW CAN OF WORMS
Meanwhile, the Supreme Court ruling in the case of State Tax Officer v Rainbow Papers Limited has opened another can of worms. Bajaj says this warrants an amendment to the IBC because the court has equated governmental authorities as secured creditors. “Along with secured financial creditors, statutory bodies have been given the first charge over the company’s assets,” he says.
Since they cannot be discriminated against, and have to be given the minimum against their dues in equal proportion to the secured financial creditors, banks may not be able to recover their dues and thereby push the company into liquidation instead of a resolution, he adds.
Khaitan agrees, saying that more litigation may follow if there is no clarity on the priority of charges under the IBC. “Even today, cases that deal with similar questions, including priority of charges, are pending before the Supreme Court,” he says.
Bajaj sums up: “An amendment to the law may be required stating that statutory bodies are not secured creditors.”
The Briefing is written by Freny Patel.