Comprehending Underpinnings of Insolvency and Bankruptcy Code, 2016

Swiss Ribbons Pvt. Ltd. & Anr. v. Union Of India & Ors. (Supreme Court)

“The defaulter’s paradise is lost. In its place, the economy’s rightful position has been regained”, this is how the Supreme Court summed up the judgment upholding the constitutional validity of various provisions of the Insolvency and Bankruptcy Code, 2016 (herein referred to as “Code”). The Code paves way for a consolidated and un-bifurcated exhaustive law for insolvencies and bankruptcies applicable to corporate persons, firms and individuals. The amalgamated provisions of the current legislative framework  forms a common forum for debtors and creditors of all classes to resolve insolvency. The paradigm shift from the“inability to pay debts”to “determining default”has led to a transitional reformation with respect to assessing the viability of the business or to render it as a“bad asset”.

The experiment contained in the Code, judged by the generality of its provisions and not by so called crudities and inequities that have been pointed out by the petitioners, passes constitutional muster. The Apex Court, on 25^th January, 2019 in the case of Swiss Ribbons Pvt. Ltd. & Anr. v. Union of India & Ors. has upheld the constitutional validity of ‘The Insolvency and Bankruptcy Code 2016’ in its “entirety” eliminating all the ambivalence. The bench comprising of Justices R F Nariman and Navin Sinha had reserved orders on January 15, 2019 on the various petitions including that of High Courts of Calcutta and Gujrat, thereby by way of transfer, challenging the validity of the Code. The bunch of petitions were moved primarily contending that the three year old law was being discriminatory, unfair, and arbitrary to operational creditors as compared to financial creditors.

Synopsis Of The Judgement:

The major issues and observations in the present case are enumerated below:

1. Differential treatment of class of creditors justified: Intelligible Differentia Between Financial Creditor And Operational Creditor.

The court held that financial creditors are clearly differentiated from operational creditors and therefore, there is an intelligible differentia between the two which has a direct relation to the objects sought to be achieved by the Code.

The bench explained and examined the contrast between financial creditor and operational creditor. It said: “A perusal of the definition of financial creditor and financial debt makes it clear that a financial debt is a debt together with interest, if any, which is disbursed against the consideration for time value of money. It may further be money that is borrowed or raised in any of the manners prescribed in Section 5(8) or otherwise, as Section 5(8) is an inclusive definition. On the other hand, and ‘operational debt’ would include a claim in respect of the provision of goods or services, including employment, or a debt in respect of payment of dues arising under any law and payable to the Government or any local authority.”

The following observations which were made by the bench, introspecting the positions of both the classes of creditors:

• Most financial creditors, particularly banks and financial institutions, are secured creditors whereas most operational creditors are unsecured, payments for goods and services as well as payments to workers not being secured by mortgaged documents and the like.
• The nature of loan agreements with financial creditors is different from contracts with operational creditors for supplying goods and services. Financial creditors generally lend finance on a term loan or for working capital that enables the corporate debtor to either set up and/or operate its business. On the other hand, contracts with operational creditors are relatable to supply of goods and services in the operation of business.
• Financial contracts generally involve large sums of money. By way of contrast, operational contracts have dues whose quantum is generally less. In the running of a business, operational creditors can be many as opposed to financial creditors, who lend finance for the set up or working of business.
• Financial creditors have specified repayment schedules, and defaults entitle financial creditors to recall a loan in totality. Contracts with operational creditors do not have any such stipulations.
• Financial creditors are involved with assessing the viability of the corporate debtor. They are engaged in restructuring of the loan as well as reorganization of the corporate debtor’s business when there is financial stress, which are things operational creditors do not and cannot do.
• Whereas a ‘claim’ gives rise to a ‘debt’ only when it becomes ‘due’, a ‘default’ occurs only when a ‘debt’ becomes ‘due’ and ‘payable’ and is not paid by the debtor. It is for this reason that a financial creditor has to prove ‘default’ as opposed to an operational creditor who merely ‘claims’ a right to payment of a liability or obligation in respect of a debt which may be due. When this aspect is borne in mind, the differentiation in the triggering of insolvency resolution process by financial creditors under Section 7 and by operational creditors under Sections 8 and 9 of the Code becomes evident.

2. Withdrawal of application filed under Section-7, 9 or 10: Section 12A of the Code Upheld

The primary issue against the provision of Section 12A is the fact that ninety per cent of the committee of creditors has to allow withdrawal. This high threshold has been explained in the Insolvency Law Committee Reports as all financial creditors have to put their heads together to allow such withdrawal as, ordinarily, an omnibus settlement involving all creditors ought, ideally, to be entered into. This explains why ninety per cent, which is substantially all the financial creditors, have to grant their approval to an individual withdrawal or settlement.

It is also a clear proposition that under Section 60 of the Code, the committee of creditors do not have the last say on the same. If the committee of creditors arbitrarily rejects a just settlement and/or withdrawal claim, the NCLT, and thereafter, the NCLAT can always set aside such decision under Section 60 of the Code. Hence, this provision also passes the constitutional muster.

3. Insolvency Resolution Professional has only administrative and no adjudicatory powers.

The bench observed that, under the Code, the resolution professional is given administrative as opposed to quasi-judicial or adjudicatory powers. It added that, even when the resolution professional is to make a ‘determination’ under Regulation 35A [IBBI (Insolvency Resolution Process for Corporate Persons) (Third Amendment) Regulations, 2018] he is only to apply to the Adjudicating Authority for appropriate relief based on the determination. It said: “Unlike the liquidator, the resolution professional cannot act in a number of matters without the approval of the committee of creditors under Section 28 of the Code, which can, by a two-thirds majority, replace one resolution professional with another, in case they are unhappy with his performance. Thus, the resolution professional is really a facilitator of the resolution process, whose administrative functions are overseen by the committee of creditors and by the Adjudicating Authority.”

 4. Section 29A of the Code has been held constitutionally Valid: ‘Related Person’ not connected with the business activity of the resolution applicant cannot be disqualified.

The challenge against Section 29A of the Code, which deals with eligibility of persons to be a resolution applicant, has been dealt with elaborately in this judgment. The bench referred to cases, in which it had held that resolution applicants have no vested right to be considered as such in the resolution process. The contention raised by the petitioners was that the Section 29A(c) treats un-equals as equals and that a good erstwhile manager cannot be lumped with a bad erstwhile manager. According to them, keeping out good erstwhile managers from the resolution process would go contrary to this objective.

Rejecting this argument, the bench said that this ineligibility is not restricted to malfeasance. It said: “Even the categories of persons who are ineligible under Section 29A, which includes persons who are malfeasant, or persons who have fallen foul of the law in some way, and persons who are unable to pay their debts in the grace period allowed, are further, by this proviso, interdicted from purchasing assets of the corporate debtor whose debts they have either wilfully not paid or have been unable to pay. The legislative purpose which permeates Section 29A continues to permeate the Section when it applies not merely to resolution applicants, but to liquidation also. Consequently, this plea is also rejected.”

5. Related Party Unconnected With The Business Of The Activity Of The Resolution Applicant

The judgment only makes some intervention in the interpretation of Section 29A(j) which defines ‘related party’. The court dealt with the contention that, mere fact that somebody happens to be a relative of an ineligible person cannot be good enough to oust such person from becoming a resolution applicant, if he is otherwise qualified. The court held that, in the absence of showing that such a ‘related person’ is connected with the business of the activity of the resolution applicant, such person cannot possibly be disqualified under Section 29A(j).

“We are of the view that persons who act jointly or in concert with others are connected with the business activity of the resolution applicant. Similarly, all the categories of persons mentioned in Section 5(24A) show that such persons must be ‘connected’ with the resolution applicant within the meaning of Section 29A(j). This being the case, the said categories of persons who are collectively mentioned under the caption ‘relative’ obviously need to have a connection with the business activity of the resolution applicant. In the absence of showing that such person is ‘connected’ with the business of the activity of the resolution applicant, such person cannot possibly be disqualified under Section 29A(j). All the categories in Section 29A(j) deal with persons, natural as well as artificial, who are connected with the business activity of the resolution applicant. The expression ‘related party’, therefore, and ‘relative’ contained in the definition Sections must be read noscitur a sociis with the categories of persons mentioned in Explanation I, and so read, would include only persons who are connected with the business activity of the resolution applicant.“, the bench said.

6. Section 53 is not violative of Article 14 of the Constitution of India.

While challenging Section 53, in the event of liquidation, operational creditors are at the lowest stage of receiving anything as they rank below all other creditors, including other unsecured creditors who happen to be financial creditors The court said: “It will be seen that the reason for differentiating between financial debts, which are secured, and operational debts, which are unsecured, is in the relative importance of the two types of debts when it comes to the object sought to be achieved by the Insolvency Code. We have already seen that repayment of financial debts infuses capital into the economy inasmuch as banks and financial institutions are able, with the money that has been paid back, to further lend such money to other entrepreneurs for their businesses. This rationale creates an intelligible differentia between financial debts and operational debts, which are unsecured, which is directly related to the object sought to be achieved by the Code. In any case, workmen’s dues, which are also unsecured debts, have traditionally been placed above most other debts. Thus, it can be seen that unsecured debts are of various kinds, and so long as there is some legitimate interest sought to be protected, having relation to the object sought to be achieved by the statute in question, Article 14 does not get infracted.”

Conclusion:

The Court must defer to legislative judgement in matters relating to social and economic policies and must not interfere, unless the exercise of legislative judgment appears to be palpably arbitrary. The system of checks and balances has to be utilized in a balanced manner with the primary objective of accelerating economic growth rather than suspending its growth by doubting its constitutional efficacy at the threshold itself.

The Supreme Court has strongly validated the Code right from its inception. By upholding the constitutionality of the statute, the judgment in Swiss Ribbons has laid the corner-stone for the successful implementation of the Code. It focuses on the intention of the legislature behind promulgation of the Code to resolve and revive a corporate debtor and thereby significantly reinforces the efforts of the creditors and other stakeholders to achieve such end. The impact of the judgement will be measured by the number of settlements and resolutions that will commence pre-insolvency as well as a swift resolution of the corporate debt in insolvency. This masterpiece will facilitate to boost the confidence and morale of investors and bidders overall through the Code, as well as generally improve ease of doing business in India.

(Article is authored by ‘Puneet Agrawal and Tejaswini Tripathy’ who are associated with ‘ALA Legal, Advocates & Solicitors’)