Supreme Court puts aims of bankruptcy code to rest

By Shardul S Shroff and Misha, Shardul Amarchand Mangaldas & Co

The Supreme Court of India on 25 January 2019 dismissed a challenge to the constitutional validity of the Insolvency and Bankruptcy Code, 2016, and has observed that the economic experiment conducted by means of the enactment of the code is proving to be largely successful going by the large numbers of cases resolved by following the prescribed insolvency resolution process. Below are some key observations by the Supreme Court.

Shardul S Shroff
Executive chairman
Shardul Amarchand Mangaldas

Objective of the code. The Supreme Court has put to rest the deliberation on the true objective of the code and has observed that its primary focus is the revival and continuation of operations of the corporate debtor, and not merely recovery for the creditors.

Differentiation between the financial and operational creditors. Under the code, financial creditors are mainly banks and financial institutions that disburse credit against the consideration for the time value of money. Operational debts, on the other hand, are debts in respect of the provision of goods and services to the corporate debtor. While financial creditors have a place on the committee of creditors (CoC) of a corporate debtor – which is in charge of taking significant decisions in relation to the conduct of the insolvency resolution process of the corporate debtor – operational creditors do not.

The Supreme Court has, recognizing the difference in the basic nature of contracts entered into by the corporate debtor with the financial and operational creditors, observed that financial creditors, being mainly banks and financial institutions that are in the business of money lending, are best equipped to assess the feasibility and viability of the business of the corporate debtor, and evaluate the contents of resolution plans proposed by resolution applicants for restructuring the operations of the corporate debtor and ensuring insolvency resolution.

Shardul Amarchand Mangaldas

Therefore, there exists an intelligible difference in classification of financial and operational creditors that has a direct nexus with the object sought to be achieved with the code and does not suffer from arbitrariness, making it constitutionally valid under article 14 of the Indian Constitution. In any case, the code requires that payment to operational creditors is made in priority to financial creditors, and the National Company Law Appellate Tribunal (NCLAT) has always considered whether operational creditors are given roughly the same treatment as financial creditors.

Withdrawal/settlement of insolvency proceedings with consent of CoC. Section 12A of the code allows withdrawal of insolvency proceedings if approved by the CoC with a majority of 90%. The Supreme Court has upheld this provision on the rationale that once an application for initiation of insolvency proceedings has been admitted in respect of a corporate debtor, it becomes a collective proceeding in rem and any settlement by the corporate debtor will require the consent of the body overseeing the resolution process. However, it has been clarified that where the CoC has not been constituted, the National Company Law Tribunal (NCLT) may exercise its inherent powers to allow or disallow an application for withdrawal or settlement of an insolvency proceeding.

Ambit of section 29A. The petitioners had challenged the wide ambit of section 29A of the code, which prescribes a set of stringent disqualifications for persons desiring to submit resolution plans for a corporate debtor, persons acting jointly or in concert with such persons and connected persons.

The term “connected person” includes within its ambit a relative of the prospective resolution applicant. The Supreme Court observed that a resolution applicant has no vested right for consideration or approval of its resolution plan, and that the legislative policy behind section 29A, which is that a person who is unable to service its own debt beyond the grace periods statutorily allowed, is unfit to be eligible to become a resolution applicant, cannot be faulted. However, a “relative” of a person should be read to include only persons who are connected with the business activity of the resolution applicant.

Validity of liquidation waterfall. The petitioners had challenged the liquidation waterfall on the grounds that the placement of debts of operational creditors below the debts of secured and unsecured financial creditors is manifestly arbitrary and contrary to article 14 of the Indian Constitution. The Supreme Court, rejecting this argument, held that such discrimination is not arbitrary inasmuch as repayment of financial debt infuses capital into the economy, which can be further lent to entrepreneurs for their businesses, which is directly related to the objective sought to be achieved by the code.

Hence, the Supreme Court has affirmed the constitutional validity of the code on all counts.

Shardul S Shroff is executive chairman and head of insolvency and bankruptcy practice, and Misha is a partner in that practice at Shardul Amarchand Mangaldas


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