Introduction
The Indian corporate insolvency environment was a maze before 2016. Several intersecting laws, the Companies Act, Sick industrial companies (Special provisions) Act (SICA), the SARFAESI Act and proceedings by Debt Recovery Tribunals were all tugging in different directions creating endless delays and bleeding asset values. This was followed by the Insolvency and Bankruptcy Code, 2016 (IBC)[1], which was a watershed reform, bringing all the facets of insolvency under one roof and offering something never seen; time-limited resolution of corporate distress. The results were striking. Recovery rates improved. The same strength of the IBC quickly turned to be its weakness: creditors were using insolvency as not a serious instrument of solving financial distress, but as a crude instrument of coercion to settle a commercial dispute. This blog discusses how this abuse came to be, how the courts have reacted with judicial inventiveness of a spectacular order, and why the historic decision in the case of Vidarbha Industries Power Limited v. Axis Bank Limited marks a turning point and a controversial one in the Indian insolvency law.
The Strategic Use Problem: When Insolvency Becomes a Weapon
The IBC vests in the financial creditors (banks, financial institutions) and operational creditors (suppliers, contractors, service providers) the right to commence the Corporate Insolvency Resolution Process (CIRP) by a default. The requirement of an operation creditor is just 1 crore that is easy to access, yet, it is also easy to abuse. The impact of an NCLT accepting a CIRP petition is immediate and drastic on the corporate debtor, with the management kicked out and a moratorium imposed on litigation, the business reputation publicly wounded, and the banks declaring old loans NPAs. The consequences are so dangerous such that, the very fact that a petition has been filed, not even admitted, sends corporate debtors shivers to pay up. It is the loophole in the structure that is learnt to be exploited by strategic litigants. Academic commentary on IBC abuse has noted that insolvency proceedings are occasionally used as a pressure tactic to force corporate debtors to pay disputed dues instead of being a good faith effort to address insolvency. What was a last resort to a really failing company has in the hands of some become a first-call lever in a typical commercial negotiation. The IBC has been aptly termed as a double-edged sword by the Economic Times; a sword whose effectiveness is its own perverse incentive. A creditor with a bad invoice is aware that by proceeding to the civil court he or she will wait years. Filing under IBC? The debtor suffers existential implications in weeks. The enticement of using the Code as a weapon is, thus, economically sound, and legally disastrous.
How Courts Fought Back: Building a Jurisprudence of Restraint
1. Mobilox Innovations v. Kirusa Software (2018): The Pre-Existing Dispute Doctrine
The decision made by the Supreme Court in Mobilox Innovations Private Ltd v. Kirusa Software Private Ltd (2018) 1 SCC 353[2] was the initial significant firebreak over opportunistic IBC litigation. Mobilox was indebted to Kirusa Software which had filed an insolvency petition against it. Mobilox claimed that there was a contractual dispute between the two parties and the Supreme Court concurred. The Court decided that petition by an operational creditor cannot proceed in the case of a pre-existing dispute, that is not a question of tactics, but an actual, bona fide conflict that existed prior to the insolvency notice. Imperatively, courts should not be used as debt collection courts; the work of the NCLT is to weed out cases where insolvency is being used as a cover to make collections. It has since been used as a pillar of the IBC practice, with legal analysis on the pre-existing dispute defence highlighting the importance of the doctrine. It shields businesses against being dragged to CIRP on truly disputed bills and invoices.
2. K Kishan v. Vijay Nirman Company (2018): No Insolvency When Arbitration Is Pending
In K Kishan v. Vijay Nirman Company Pvt Ltd (2018) 17 SCC 662 [3], the Supreme Court took a step further in Mobilox case. In a case where an arbitration award had already been appealed, the claim in existence and undergoing a proper trial, the admission of an insolvency petition would amount to an abuse of process. The Court ruled that an operational creditor who is in active arbitral proceeding may not avoid the current arbitral proceeding by registering under the IBC. It was also very clear that the IBC is not an alternative to the dispute resolution process. It is not a way out of the implications of having a truly disputed claim. Courts would not allow the insolvency law to devour the rich arsenal of contract and arbitration jurisprudence which are used to settle commercial disputes.
3. Swiss Ribbons v. Union of India (2019): Reasserting the Code’s True Purpose
In Swiss Ribbons Pvt Ltd v. Union of India (2019) 4 SCC 17[4], the constitutional bench of the Supreme Court affirmed the validity of the IBC but also made it clear that it is an essential character. The reason the Code exists, the Court held, is to solve corporate distress and maximise asset value not to recover debt. The IBC is intended to save businesses and conserve economic value and not to act as an instrument of credit enforcement by predatory lenders. This philosophical explanation is huge. It implies that any application of the IBC that favours recovery by the creditors above bona fide economic recovery is at its core inconsistent with the constitutional purpose of the Code. Swiss Ribbons provided the future courts with the doctrinal anchor to act against abuse without subverting the statute itself.
The Vidarbha Industries Case: Judicial Discretion in the Age of Mandatory Admission
Of all the judicial interventions shaping IBC jurisprudence, none has been more radical, or more debated, than the Supreme Court’s 2022 ruling in Vidarbha Industries Power Limited v. Axis Bank Limited [(2022) 8 SCC 352][5]. To understand why this case matters, one must first understand the legal orthodoxy it overturned.
Background
Section 7[6] of the IBC, which governs petitions by financial creditors, uses the word “shall”, as in, the NCLT shall admit a petition if the applicant establishes a financial debt and a default. Tribunals and courts have been interpreting this as mandatory duty and not a discretionary obligation over the years. Prove the debt. Prove the default. Admission ensues automatically. This mechanical reading was regarded as the strength of the IBC, guarantee to the creditors, discipline to the debtors. Vidarbha Industries Power Limited (VIPL) was a power generating company in Maharashtra, with its root in regulated tariff wrangles with the Maharashtra Electricity Regulatory Commission (MERC). VIPL had outstanding regulatory claims in the value of thousands of crores, claims, had it been awarded, would have exceeded the value of the dues due Axis Bank. This notwithstanding, Axis Bank presented a petition under Section 7. The NCLT admitted it. The NCLAT upheld admission. The case was taken to the Supreme Court.
The Supreme Court’s Ruling
In VIPL’s specific situation, the Court found that the company had substantial regulatory dues pending from the state government, dues that could satisfy its creditors if realised. Triggering CIRP in this scenario would destroy a functional power company for no genuine insolvency-related reason. As the Supreme Court’s judgment itself makes clear, the power to admit is not a ministerial function; it requires judgment. In a decision that was determined by Justice Indira Banerjee, the Supreme Court reasoned that the word “shall” in Section 7(5)[7] does not deprive the NCLT of any discretion. Instead, the Adjudicating Authority is empowered, in fact required, to consider the broader circumstances of the case during a petition admission including whether it is in the interest of all parties and the continued solvency of the corporate debtor. The Court in the case of VIPL was of the opinion that the company owed a high amount of regulatory dues to the state government, which could be used to pay off its creditors in the event of realisation. Enacting CIRP in this case would bring down a power company without any real insolvency-related cause.
Why Vidarbha Is Bigger Than One Case
The Vidarbha decision was controversial in itself. As pointed out by the insolvency law scholars that it brought uncertainty to what had been a free, creditor-friendly regime. When the NCLT can deny admission of a petition despite having proved the default, then the creditors lose the certainty that they had come to rely on. The risk of litigation, of corporate debtors opposing admission on the ground of working up elaborate fairness cases, greatly increased. However, this objection lacks the deeper meaning of the decision. The Court of Vidarbha was not repealing the rights of creditors, but demanding that the insolvency law is not all about creditors. It is impossible to mechanically liquidate power companies, hospitals, infrastructure companies, and entities that are embedded in the public welfare just due to a Section 7 petition by a creditor. The aspect of corporate insolvency, which relates to the public interest, is actual and the courts must be able to take it into account. The strategic misuse problem is also addressed in the ruling. When admission is automatic, then any creditor who has a provable default, irrespective of whether the debtor is actually insolvent, can threaten CIRP. The discretion doctrine of Vidarbha provides at least some breathing room: the courts may enquire whether the CIRP should be initiated in the circumstances, but not whether the technical qualifications are satisfied. It is notable that later cases in NCLAT have struggled with the nature of the scope of the discretion doctrine of Vidarbha, and subsequent cases in the Supreme Court, have made it clear that the discretion is limited, and is not a licence to reopen debt claims. The argument is still going on, though the rule that insolvency admission is not a rubber stamp has now gained a solid foundation in Indian jurisprudence.
Conclusion: Balancing the Scales
One of the most significant changes in the law in India was the Insolvency and Bankruptcy Code, 2016. It has changed the face of corporate debt recovery, revived the confidence of the creditors and introduced some forms of fiscal discipline to the corporate sector in India. The law has not only shown us a darker possibility, however, namely that, in the hands of the wrong persons, the strong legal instruments themselves may become the instruments of coercion. The judicial reaction, of the pre-existing doctrine of Mobilox to the protection of arbitral procedures, to the protection of such arbitral procedures by K Kishan, to their defence by Swiss Ribbons, and above all to the insistence of Vidarbha upon the contextual discretion of the judicial process, is a sign of the wisdom in understanding that law must not be left to defend itself. In the future, the legitimacy of the IBC is hinged on balancing this. Creditor rights should be strong and there should be substantial protection against strategic abuse. The courts should be the last resort defence as the Insolvency and Bankruptcy Board of India (IBBI) is still perfecting the structure: making sure that a law that is meant to salvage the troubled companies does not become the instrument of corporate torment. It is a long way to go through the broken insolvency system to a system that has reached maturity and is resistant to abuse, but each judgment in this series is a step in the right direction by India.
Notes:
[1] Insolvency and Bankruptcy Code, 2016
[1] Insolvency and Bankruptcy Code 2016, Act No 31 of 2016 (India)
[2] Vidarbha Industries Power Limited v. Axis Bank Limited [(2022) 8 SCC 352]
[3] Mobilox Innovations Private Ltd v. Kirusa Software Private Ltd (2018) 1 SCC 353
[4] K Kishan v. Vijay Nirman Company Pvt Ltd (2018) 17 SCC 662
[5] Swiss Ribbons Pvt Ltd v. Union of India (2019) 4 SCC 17
[6] Vidarbha Industries Power Limited v. Axis Bank Limited [(2022) 8 SCC 352]
[7] Insolvency and Bankruptcy Code 2016, s 7 (India)
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