The Insolvency and Bankruptcy Code, 2016 (“IBC”) is one of the most monumental legal reforms for Indian economy as it enabled prompt initiation of insolvency proceedings to achieve best possible economic outcome as per the market forces to prevent erosion of value of assets. IBC marked a change in legislative policy which incentivised early detection of stress in a business by making “default” by debtor as threshold for initiation of reconstruction process whereas the erstwhile regime had “inability to pay debts” as a yardstick to initiate winding up of a debtor. The legislative intent as exhibited in reports of Bankruptcy Law Reform Committee Report, 2015 (“BLRC Report”) and legislative debates, clearly shows that legislature intended admission of a debtor to the corporate insolvency resolution process under IBC (“CIR Process”) before it turns sick and unviable. Judiciary also took cognisance of the legislative intent and held that debt and evidence of default are the objective triggers to the CIR Process in landmark judgments of
BRIEF FACTS AND THE SUPREME COURT JUDGMENT
The Corporate Debtor filed an interim application seeking stay of further proceedings in light of various proceedings pending before
Relying on the threshold requirements for initiation of CIR Process provided by statute, i.e., existence of debt and evidence of default (commonly known as twin test), upheld by the
An appeal before the NCLAT was also dismissed on ground that if debt and default are not disputed, external factors like financial difficulties and liquidity problems faced by the Corporate Debtor do not have any bearing on the commencement of the CIR Process. The Corporate Debtor assailed this order of the NCLAT before the SC.
The
The
The
The
Our Comments
- The
Supreme Court has overlooked the objectives and legislative intent of IBC
The
A closer examination of Section 7(5)(a) makes it crystal clear that at threshold, Adjudicating Authority merely needs to satisfy itself on occurrence of default, completeness of an application and credentials of the proposed resolution professional. Occurrence of default in debt repayment is the objective test and the substantive criteria for triggering CIR Process. As per
- The
Supreme Court has rewritten the law in violation of legislative policy and clear statutory guidelines
As per legislative discussion on IBC, speed of the process has been highlighted as one of the key features of IBC. Taking cognisance of the legislative intent and scheme of the IBC, it has been held by the
In its earlier orders, the
- The
Supreme Court has erred in holding that impact of non-payment of admitted dues on an OC is greater than on an FC
Financial creditors like banks and financial institutions form the bedrock of an economy and low recovery rates due to non-payment of dues by debtors not only impacts the individual financial creditor but also has a cascading effect on the economy at large. Non-payment of dues of an operational creditor (“OC”) may lead to stress to a particular entity, however, non-payment of dues of an FC escalate the cost of credit for the economy at large. Determination by the
Practical Implications
- This judgment of the
Supreme Court inVidarbha Industries gives discretionary powers to the NCLT to entertain the merits of underlying reasons of default by a corporate debtor. As per data released by IBBI[4], average time taken for admission of an insolvency application by an operational creditor was 650 days in 2021-2022. Similarly for financial creditors it takes substantial time (between 12-24 months) at pre-admission stage. Such delays result in significant erosion of the value of assets. IfAdjudicating Authority is going to assess and make determination on merits on factors in addition to the twin test, it will substantially increase the time taken at pre-admission stage for the financial creditor and will further exacerbate the issue of delays. Vidarbha Industries prioritises going concern status of the corporate debtor over other objectives of IBC, i.e., time bound resolution of insolvency, maximisation of value of assets, promotion of entrepreneurship, availability of credit and balance the interests of all the stakeholders. If existing management will get a shot at keeping the control of a corporate debtor citing business difficulties, the behavioural change and financial discipline sought to be brought by IBC will never be achieved.-
As per IBBI Quarterly Newsletter for Q4 - FY 22, till
March 2022 , IBC has rescued 480 corporate debtors by CIR Process since the inception of IBC. For the said 480 Corporate Debtors, the value of assets was INR 1.31 lakh crores for debt liabilities of INR 7.61 lakh crores at insolvency commencement date. This shows that in real world situation, by the time stress is detected and CIR Process is initiated, value of assets may erode by approximately 83%. Hence, prioritisation of going concern status of corporate debtor over maximisation of value of assets in a time bound manner is hugely problematic and will have impact on ease of doing business inIndia as the exit window for economic resources from a bad asset will become narrower and longer due to discretion applied by Adjudicating Authority at pre-admission stage. - The objective of IBC is also to increase availability of credit by reallocating credit from sick units to successful units to ensure the best possible outcome for FCs and economy at large. Cost of credit increases if credit is stuck with sick units. IBC improves the credit delivery to the efficient part of the economy by reallocating the financial assets and control of such assets to resolution applicants. If money will be stuck in bad assets due to discretionary criteria applied by NCLT at pre-admission stage, cost of capital will go up.
Vidarbha Industries discounts the fact that for financial creditors, credit risk i.e., the possibility payment default by borrower, constitutes a significant risk which need to be covered by maintaining adequate capital and risk provisions. Due to money stuck in bad assets, due to capital adequacy and provisioning requirements availability of credit to economy at large will be hampered by this judgment of theSupreme Court .Vidarbha Industries creates a new category of default, i.e., temporary default. All corporate debtors will now seek refuge under newfound discretionary power of NCLT to not admit them into CIR Process citing their default as temporary and not a long-lasting one. The ruling on indefinite (read infinite) time-line at pre-admission stage will frustrate the object of IBC to have a time bound mechanism to detect and resolve stress in financial assets.-
The principles set out in
Innoventive Industries and Swiss Ribbons have been followed by theSupreme Court in catena of judgments includingEssar Steel and have been relied upon in hundreds of orders passed by NCLT and NCLAT. A contradicting judgment ofSupreme Court inVidarbha Industries will lead to conflicting orders by NCLT and NCLAT to further delay the adjudication process.
Footnotes
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3 Civil Appeal No. 372 of 2017
4 IBBI Consultation paper on issues related to reducing delays in the corporate insolvency resolution process, dated
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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