Supreme Court says financial creditors not so supreme

By Sudeshna Guha Roy and Elisha Vaswani, Bharucha & Partners

In the recent case of Vidarbha Industries Power Limited v Axis Bank Limited, the Supreme Court held that the National Company Law Tribunal (NCLT), as the adjudicating authority, has discretion to admit or reject the claims of financial creditors under section 7(5)(a) of the Insolvency and Bankruptcy Code, 2016 (IBC) despite the existence of a debt and default. This is a clear departure from the previously held position.

Vidarbha, the corporate debtor, appealed against the refusal of the National Company Law Appellate Tribunal (NCLAT) to stay proceedings initiated by Axis Bank under section 7. Vidarbha argued that the Maharashtra Electricity Regulatory Commission owed it INR17.3 billion (USD217 million) under an order of the Appellate Tribunal for Electricity. As that order was itself being appealed before the Supreme Court, the corporate debtor had not recovered the funds and was, therefore, unable to repay its debts. The funds were sufficient to pay the debts.

Sudeshna Guha Roy, Bharucha & Partners
Sudeshna Guha Roy
Bharucha & Partners

The NCLT and the NCLAT held that an application must be admitted under section 7(5)(a) of the IBC if a debt existed and the corporate debtor had defaulted. The section was construed as mandatory. This finding followed the Supreme Court’s analysis of the respective admission processes of claims by financial and operational creditors in Innoventive Industries Ltd v ICICI Bank Ltd and Mobilox Innovations Pvt Ltd v Kirusa Software Pvt Ltd, in which the court considered whether there existed a financial debt meeting the threshold in section 4 of the IBC and whether the corporate debtor had defaulted on such debt.

Since then, courts have consistently held that applications by financial creditors, unless incomplete, must be admitted when the NCLT is satisfied that a default has occurred. However, in Vidarbha the Supreme Court distinguished sections 7 and 9 of the IBC, holding that the use of may in section 7(5)(a), the initiation of the corporate insolvency resolution process (CIRP) by a financial creditor, and shall in the nearly identical section 9(5)(a), the initiation of the CIRP by an operational creditor implied that section 7(5)(a) was intended to be discretionary. The court held that the existence of a debt and default gave a financial creditor the right to apply for a CIRP but the NCLT was still required to analyse all material factors when deciding whether to admit the application.

The Supreme Court held that, in exercising its discretion, the NCLT may examine all relevant facts and circumstances, including the overall financial health and viability of the corporate debtor. The court therefore set aside the orders of the NCLT and the NCLAT and returned the matter to the NCLT, directing it to reconsider the application for a stay of further proceedings on the merits.

The verdict in Vidarbha will provide corporate debtors with a plethora of defences to avoid insolvency proceedings. It may also be inequitable that claims by operational creditors will now be given preference over claims by financial creditors. There is a risk that discretion will also be used in resolving situations under section 7(5)(b) of the IBC which provides that the NCLT may reject applications where the resolution professional is the subject of disciplinary proceedings or the application is incomplete.

The departure from the previously accepted test of debt and default could allow the NCLT to apply less reliable tests such as the balance sheet test and the commercial insolvency test. These are subject to the quality of accounting standards and practice and were viewed unfavourably by the Bankruptcy Law Reform Committee.

The trigger point is important for any CIRP. The law must clearly provide when an insolvency application against a corporate debtor should be admitted. According to the Insolvency and Bankruptcy Board of India’s April 2022 consultation paper, the average duration of CIRPs was 468 days, with some taking over two years, despite there being a prescribed 330-day limit. The exercise by the tribunal of its discretion in the admission process could lead to further delay.

The decision in Vidarbha appears to favour corporate debtors in applications under section 7 and to make the initiation of CIRPs more difficult for financial creditors. It remains to be seen how far the decision will impact the very effectiveness of CIRPs themselves.

Sudeshna Guha Roy is a partner and Elisha Vaswani is an associate at Bharucha & Partners.

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